|
Evolution
| Rationale
| Anatomy
| Literature:
Theory
Literature:
Practice | Conclusion
| Glossary
Appendix: Islamic Financial Institutions | References
Literature:
Theory
It is not
possible to cover in this survey all the
publications which have appeared on Islamic banking.
There are numerous publications in Arabic and Urdu
which have made significant contributions to the
theoretical discussion. A brief description of these
in English can be found in the appendix to Siddiqi's
book on Banking without Interest (Siddiqi
1983a).
The early
contributions on the subject of Islamic banking were
somewhat casual in the sense that only passing
references were made to it in the discussion of
wider issues relating to the Islamic economic system
as a whole. In other words, the early writers had
been simply thinking aloud rather than presenting
well-thought-out ideas. Thus, for example, the book
by Qureshi on Islam and the Theory of Interest
(Qureshi 1946) looked upon banking as a social
service that should be sponsored by the government
like public health and education. Qureshi took this
point of view since the bank could neither pay any
interest to account holders nor charge any interest
on loans advanced. Qureshi also spoke of
partnerships between banks and businessmen as a
possible alternative, sharing losses if any. No
mention was made of profit-sharing.
Ahmad, in
Chapter VII of his book Economics of Islam
(Ahmad 1952), envisaged the establishment of Islamic
banks on the basis of a joint stock company with
limited liability. In his scheme, in addition to
current accounts, on which no dividend or interest
should be paid, there was an account in which people
could deposit their capital on the basis of
partnership, with shareholders receiving higher
dividends than the account holders from the profits
made. Like Qureshi, above, Ahmad also spoke of
possible partnership arrangements with the
businessmen who seek capital from the banks.
However, the partnership principle was left
undefined, nor was it clear who would bear the loss
if any. It was suggested that banks should cash
bills of trade without charging interest, using the
current account funds.
The principle
of mudaraba based on Shariah was
invoked systematically by Uzair (1955). His
principal contribution lay in suggesting mudaraba
as the main premise for 'interestless banking'.
However, his argument that the bank should not make
any capital investment with its own deposits
rendered his analysis somewhat impractical.
Al-Arabi
(1966) envisaged a banking system with mudaraba
as the main pivot. He was actually advancing the
idea of a two-tier mudaraba which would
enable the bank to mobilize savings on a mudaraba
basis, allocating the funds so mobilized also on a mudaraba
basis. In other words the bank would act as a mudarib
in so far as the depositors were concerned, while
the 'borrowers' would act as mudaribs in so
far as the bank was concerned. In his scheme, the
bank could advance not only the capital procured
through deposits but also the capital of its own
shareholders. It is also of interest to note that
his position with regard to the distribution of
profits and the responsibility for losses was
strictly in accordance with the Shariah (6).
Irshad (1964)
also spoke of mudaraba as the basis of
Islamic banking, but his concept of mudaraba
was quite different from the traditional one in that
he thought of capital and labour (including
entrepreneurship) as having equal shares in output,
thus sharing the losses and profits equally. This
actually means that the owner of capital and the
entrepreneur have a fifty-fifty share in the profit
or loss as the case may be, which runs counter to
the Shariah position. Irshad envisaged two
kinds of deposit accounts. The first sounded like
current deposits in the sense that it would be
payable on demand, but the money kept in this
deposit would be used for social welfare projects,
as the depositors would get zero return. The second
one amounted to term deposits which would entitle
the depositors to a share in the profits at the end
of the year proportionately to the size and duration
of the deposits. He recommended the setting up of a
Reserve Fund which would absorb all losses so that
no depositor would have to bear any loss. According
to Irshad, all losses would be either recovered from
the Reserve Fund or borne by the shareholders of the
bank.
A pioneering
attempt at providing a fairly detailed outline of
Islamic banking was made in Urdu by Siddiqi in 1968.
(The English version was not published until 1983.)
His Islamic banking model was based on mudaraba
and shirka (partnership or musharaka
as it is now usually called). His model was
essentially one based on a two-tier mudaraba
financier-entrepreneur relationship, but he took
pains to describe the mechanics of such transactions
in considerable detail with numerous hypothetical
and arithmetic examples. He classified the
operations of an Islamic
bank into three categories: services based on fees,
commissions or other fixed charges; financing on the
basis of mudaraba and partnership; and
services provided free of charge. His thesis was
that such interest-free banks could be a viable
alternative to interest-based conventional banks.
The issue of
loans for consumption clearly presents a problem, as
there is no profit to be shared. Siddiqi addressed
this problem, but he managed only to scratch the
surface. While recognizing the need for such
interest-free loans (qard hasan), especially
for meeting basic needs, he seemed to think it was
the duty of the community and the State (through its
baitul mal or treasury) to cater to those
needs; the Islamic bank's primary objective, like
that of any other business unit, is to earn profit.
He therefore tended to downplay the role of Islamic
banks in providing consumption loans, but he
suggested limited overdraft facilities without
interest. He even considered a portion of the fund
being set aside for consumption loans, repayment
being guaranteed by the State. He also suggested
that consumers buying durables on credit would issue
'certificates of sale' which could be encashed by
the seller at the bank for a fee. It was then the
seller not the buyer who would be liable as far as
the bank was concerned. However, the principles of murabaha
and bai' muajjal were not invoked.
Strangely,
Siddiqi favoured keeping the number of shareholders
to the minimum, without advancing any strong
reasons. This is contrary to the general consensus
which now seems to have emerged with reference to
Islamic banks operating on a joint stock company
basis, a consensus which incidentally is also in
line with the Islamic value attached to a broad
equity base as against heavy concentration of equity
and wealth. Ironically, Siddiqi thought that
interest-free banking could operate successfully
'only in a country where interest is legally
prohibited and any transaction based upon interest
is declared a punishable offence' (1983b:l3). He
also thought it important to have Islamic laws
enforced before interest-free banking could operate
well. This view has not gained acceptance, as
demonstrated by the many Islamic banks which operate
profitably in 'hostile' environments, as noted
earlier.
Chapra's
model of Islamic banking (Chapra 1982), like
Siddiqi's, was based on the mudaraba
principle. His main concern, however, centred on the
role of artificial purchasing power through credit
creation. He even suggested that 'seigniorage'
resulting from it should be transferred to the
public exchequer, for the sake of equity and
justice. Al-Jarhi (1983) went so far as to favour
the imposition of a l00 per cent reserve requirement
on commercial banks. Chapra was also much concerned
about the concentration of economic power private
banks might enjoy in a system based on equity
financing. He therefore preferred mediumsized banks
which are neither so large as to wield excessive
power nor so small as to be uneconomical. Chapra's
scheme also contained proposals for
loss-compensating reserves and loss-absorbing
insurance facilities. He also spoke of non-bank
financial institutions, which specialize in bringing
financiers and entrepreneurs together and act as
investment trusts.
Mohsin (1982)
has presented a detailed and elaborate framework of
Islamic banking in a modern setting. His model
incorporates the characteristics of commercial,
merchant, and development banks, blending them in
novel fashion. It adds various non-banking services
such as trust business, factoring, real estate, and
consultancy, as though interest-free banks could not
survive by banking business alone. Many of the
activities listed certainly go beyond the realm of
commercial banking and are of so sophisticated and
specialized a nature that they may be thought
irrelevant to most Muslim countries at their present
stage of development. Mohsin's model clearly was
designed to fit into a capitalist environment;
indeed he explicitly stated that riba-free
banks could coexist with interest-based banks.
The point
that there is more to Islamic banking than mere
abolition of interest was driven home strongly by
Chapra (1985). He envisaged Islamic banks whose
nature, outlook and operations could be distinctly
different from those of conventional banks. Besides
the outlawing of riba, he considered it
essential that Islamic banks should, since they
handle public funds, serve the public interest
rather than individual or group interests. In other
words, they should play a social-welfare-oriented
rather than a profit-maximizing role. He conceived
of Islamic banks as a crossbreed of commercial and
merchant banks, investment trusts and
investment-management institutions that would offer
a wide spectrum of services to their customers.
Unlike conventional banks which depend heavily on
the 'crutches of collateral and of non-participation
in risk' (p. l55), Islamic banks would have to rely
heavily on project evaluation, especially for
equity-oriented financing. Thanks to the
profit-and-loss sharing nature of the operations,
bank-customer relations would be much closer and
more cordial than is possible under conventional
banking. Finally, the problems of liquidity shortage
or surplus would have to be handled differently in
Islamic banking, since the ban on interest rules out
resort to the money market and the central bank.
Chapra suggested alternatives such as reciprocal
accommodation among banks without interest payments
and creation of a common fund at the central bank
into which surpluses would flow and from which
shortages could be met without any interest charges.
The
literature also discusses the question of central
banking in an Islamic framework. The general opinion
seems to be that the basic functions of a modern
central bank are relevant also for an Islamic
monetary system, although the mechanisms may have to
be different. Thus, for example, the bank rate
instrument cannot be used as it entails interest.
Uzair (1982) has suggested adjustments in
profit-sharing ratios as a substitute for bank rate
manipulations by the central bank. Thus, credit can
be tightened by reducing the share accruing to the
businessmen and eased by increasing it. Siddiqi
(1982) has suggested that variations in the
so-called 'refinance ratio' (which refers to the
central bank refinancing of a part of the
interest-free loans provided by the commercial
banks) would influence the quantum of short-term
credit extended. Siddiqi has also proposed a
prescribed 'lending ratio' (i.e., the proportion of
demand deposits that commercial banks are obliged to
lend out as interest-free loans) that can be
adjusted by the central bank according to changing
circumstances. In this context, reference may also
be made to a proposal by Uzair (1982) that the
central bank should acquire an equity stake in
commercial banking by holding, say, 25 per cent of
the capital stock of the commercial banks. The
rationale behind this proposal was that it would
give the central bank access to a permanent source
of income so that it could effectively act as lender
of last resort.
The
discussion of central banking in an Islamic context
is somewhat scanty, presumably because Islamic
central banking is viewed as too farfetched an idea,
except in Iran and Pakistan.
It emerges
from all this that Islamic banking has three
distinguishing features: (a) it is interest-free,
(b) it is multi-purpose and not purely commercial,
and (c) it is strongly equity-oriented. The
literature contains hardly any serious criticism of
the interest-free character of the operation, since
this is taken for granted, although concerns have
been expressed about the lack of adequate
interest-free instruments. There is a near-consensus
that Islamic banks can function well without
interest. A recent International Monetary Fund study
by Iqbal and Mirakhor (1987) has found Islamic
banking to be a viable proposition that can result
in efficient resource allocation. The study suggests
that banks in an Islamic system face fewer solvency
and liquidity risks than their conventional
counterparts.
The
multi-purpose and extra-commercial nature of the
Islamic banking operation does not seem to pose
intractable problems. The abolition of interest
makes it imperative for Islamic banks to look for
other instruments, which renders operations outside
the periphery of commercial banking unavoidable.
Such operations may yield economies of scope. But it
is undeniable that the multipurpose character of
Islamic banking poses serious practical problems,
especially in relation to the skills needed to
handle such diverse and complex transactions (Iqbal
and Mirakhor 1987).
The stress on
equity-oriented transactions in Islamic banking,
especially the mudaraba mode, has been
criticized. It has been argued that the replacement
of predetermined interest by uncertain profits is
not enough to render a transaction Islamic, since
profit can be just as exploitative as interest is,
if it is 'excessive' (Naqvi 198l). Naqvi has also
pointed out that there is nothing sacrosanct about
the institution of mudaraba in Islam. Naqvi
maintains that mudaraba is not based on the
Qur'an or the Hadith but was a custom of the
preIslamic Arabs. Historically, mudaraba, he
contends, enabled the aged, women, and children with
capital to engage in trade through merchants for a
share in the profit, all losses being borne by the
owners of capital, and therefore it cannot claim any
sanctity. The fact remains that the Prophet raised
no objection to mudaraba, so that it was at
least not considered un-Islamic.
The
distribution of profit in mudaraba
transactions presents practical difficulties,
especially where there are multiple providers of
capital, but these difficulties are not regarded as
insurmountable. The Report of Pakistan's Council of
Islamic Ideology (CII 1983) has suggested that the
respective capital contributions of parties can be
converted to a common denominator by multiplying the
amounts provided with the number of days during
which each component, such as the firm's own equity
capital, its current cash surplus and suppliers'
credit was actually deployed in the business, i.e.,
on a daily product basis. As for deposits, profits
(net of administrative expenses, taxes, and
appropriation for reserves) would be divided between
the shareholders of the bank and the holders of
deposits, again on a daily product basis.
Courtesy
of Mohamed Ariff, University of Malaya
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