Interest Free Banking

Reply to # 22 tahmad32

I do not agree with you when you say that the portion of the rent paid is equal to interest. Rent and interest are two different things.

Interest is cost of money

Rent is cost of using an item

How can these two be equal


Lets use another example (A bit simpler one)

Suppose you are renting a house. You come in agreement with the owner of the house that you will buy the house and pay the price in 4 equal payments within a year while still paying the rent for that year.

Is this OK with you? Show me where interest comes up in this transaction?

Asfand Siddiqui
Sacramento CA

sul #34 Welcome to chowk. You are right in saying that during inflationary times fixed interest deposits earn a real interest rate that is lower than the nominal amount (or even negative). However, it does not also hold true that under profit-sharing one will obtain a high return, since returns here are determined by the quality of the investment and the manner in which returns are affected by inflation. Indeed, inflationary conditions tend to play havoc with the economy, and investment under inflationary conditions is done more by speculators rather than by solid investors (the US and Europe have learnt this lesson the hard way and switched from the inflation-prone keynesian approach to the more anti-inflationary monetarist approach and thus prices have been stable in these countries in recent years).
I am not against islamic banking per se. What I oppose is the suppression through government fiat of free competition from standard banking and other financial intermediation services - as the mullahs in pakistan would like to see. And I oppose the delusion of the ordinary investor into believing that they are fulfilling their religious duties by using the services of islamic bankers, rather than being honest and advising them to read the Quran for themselves and reach their own conclusion on what is right and wrong (as each muslim is expected to do). I am sorry if I seem cynical for the way islam is preached and widely accepted in pakistan, but i believe i have good reason to be not just cynical but totally opposed. This malpractice of islam is ruining individual lives and ruining us as a nation.

Re: #33 by Urstruly [``...A paradigm shift is possible when such institutions are viewed as to how they can be used to benefit society at large and how the interest of individual and the society can be streamlined. If we keep this in mind a new kind of bank is possible, which can be a non-profit cooperative institution...``]

Being a utopian idealist deep down myself, I cannot help but fully agree with (and wish for) such a world view. Personally, I hate the whole greedy, stealing, thieving, lying, cheating banking industry, second only to the insurance industry. But those are just my personal gut emotions and I keep them to myself since in this cold, callous and unjust world there is scant opportunity to create utopias.

Faced with the existing realities of the world we just have to make do the best we can under the existing circumstances.

My sympathies may be with Sparticus, but I know better than to abandon the camp of Marcus Crassus.

...SR

Though not wishing to cause the author undue offence, I do feel that his effort was both supercilious and superficial, lacking both penetration and the subtle understanding of Islamic Finance.

The reason I start of on a somewhat cautious note is twofold.

1. This is my first foray on this website.
2. I’m averse to being too critical because surely the point of such a community of Chowk, is to make productive comments to improve our collective lot than to become embroiled in negativity.

But I digress. As relate to the viability of Islamic Finance, the author states he believes it would be unworkable. He envisages that Musharakas are impractical because “banks would need to hire dozens of people to work in each business that it finances just to monitor the operations and the profit and loss”.

At a superficial level this argument seems sound. Banks would surely be reluctant to employ trained professionals with experience of particular industries to able to rely on its ability to competently manage a business, as this would vastly increase their overheads. A more subtle analysis however would reveal that this exists in every major ‘Conventional’ and ‘Islamic’ Bank under the auspices of Venture Capital (if you’re from the US) or Private Equity (if like myself you’re from the UK – oh dear, I hope I haven’t left myself open to being randomly attacked by acronyms!!)

Musharakas are both popular and workable and moreover they enjoy one key advantage over conventional private equity. The latter only failed dramatically in the recent dotcom era because it was based on high risk, short term, and greed driven lending divorced from sound financial ideas.

Musharakas in contradistinction are much far more reliable for two main reasons:

1. Since the Banks are the lenders and their only source is profit is from the success of the joint venture, only those ideas for business which are premised on sound economics and business workability.

2. Perhaps more importantly still, the Banks would wish for the success of the venture and would therefore not unduly harass the business for payment of debts, but would be either more accommodating, or act in a similar capacity to administrators in insolvency. Essentially what I’m getting at is the businesses that do start up would be more likely to prosper because it would be in everybody’s interests for their success.

As regards the author’s point on consumers, most of these financial products are not individual consumer oriented but meant for businesses. In fact the concepts of Zakat, Sadaqat and Kard-e-Hassana are more appropriate Islamic remedies to personal impecuniosity, and I believe that Rafay touched upon this in his response.

Murabaha

Whilst I acknowledge that much criticism abounds re: the disingeniousness / insincerity of Murabaha as a ‘hiyal’ or method by which to circumnavigate certain Islamic imperatives, permit me introduce at this juncture, the ethical hierarchy of actions in Islam. I apologise for any loss of brevity, but I hope its relevance makes up for it.

Idiosyncratic to Islamic law is the gradation of morality that is applied to everyday acts, in the form of a quintuple classification. At the pinnacle of this classification are obligatory actions (fard/wajib) a category that is composed of positive obligations. On the opposite end of the spectrum, the last and only non-halal degree of actions are those which are forbidden (haram) forbidden and considered illegal. In the context of our discussion on Riba, it is evident that that would fall within the haram category.

Out of the five categories of actions, four levels are classed as permissible and it is those varying degrees of permissibility that are of import to this discussion. Actions that do not quite fall within the domain of positive obligations are referred to as mandub/ mustahib (recommended). This is a non-compulsory, ethically desirable class of actions that are encouraged to be followed. It is noteworthy to remember that such acts, by the nature of the ethico-legal injunctions of the Quran, are rewarded by God and thus no other practical benefit can be accrued by such compliance.

The next grade of actions is known as mubah, a term to denote the indifference to and legal neutrality of a particular act. Subsequent in the hierarchy of actions are acts described as makruh, used to connote their reprehensible nature. Poignantly, despite being heavily disapproved of, makruh acts are still considered legally permissible. This presents individuals with an opportunity to decide for themselves the degree to which they intend to pursue the Quranic instructions of ethically desirable conduct.

Therefore a Murabaha may fall within one of the latter two categories, but its practical benefit is that we need not have the perfect system to begin with. Indeed the present capital markets system traces its origins back to 1680s Amsterdam (some may even argue as far back as 1400s Genoa) which illustrates that systems develop and improve over time. In fact it’s only in the past 40 years or so that capital markets have become so complex. Thus, given that Islamic banking is in its infancy, being only a 20-year-old system, it needs to be given the opportunity to develop more refined financial mechanisms that become true alternatives to conventional banking constructs. And significantly, by using this ethical hierarchy, it is possible to begin with Murabahas and abandon them as better alternatives make themselves apparent. It is unhelpful and counterproductive to dismiss this form of financing entirely.

Re the example at the end of the article by the author: it is dealt with far more aptly with a Musharakah that with a Mudarabah.

#14 tahmed32

Your point re: small time savers and moral travesty is well founded. I would approach your criticism from a different perspective, in that I do not believe it is correct to define Riba as ‘Interest’ and thus prohibit interest entirely.

Flexibility is required when considering the real value of money. Most Muslim states suffer from high rates of inflation and regular depreciation of their currencies. In such an economic environment, the “interest” accrued on a deposit may yield an increase, but the real purchasing power of the original deposit often decreases by a far greater proportion than the “increase”. For example, a deposit of Rs. 5000 in a bank account offering 5% interest would result in the amount increasing to Rs. 5250. However, if the Dollar-Rupee rate at the start was Rs. 50 to US$1 and at the end of the year was Rs. 60 to US$1, then the actual international purchasing power of the Rs. 5000 would have decreased by 20%, a net loss of Rs. 1000. In addition, if the domestic rate of inflation were at 20%, the amount of interest a deposit attracts would have to be commensurate with inflation to maintain the same purchasing power. In such circumstances, is it really just and fair for a depositor to be prevented from merely preserving the value of their savings?

I would argue that it is not, and most economists I have spoken to on the subject concur. So whilst the point raised by tahmed 32 was valid indeed, it was unfortunate that it was almost obscured by the surrounding cynicism. Whilst I do not have the luxury of time to wade through each individual response, it does appear that many respondents are confusing the ideology of Islamic finance with its imperfect implementation.

Its time indeed that Islamic finance is becomes the specialism of those whose knowledge of Islamic, Finance and Sharia is equal as opposed to Mullahs attempting to understand finance or Financiers attempting to evade the injunctions of Sharia.

Rafay

I thought your piece hit the proverbial nail on the head. I’d love to talk to you on the subject sometime - I may be in town in February, so maybe see you then?

And finally, the author says ``Looking at the three modes of interest-free financing described above; I find it hard to believe that any one of these would be successful``; perhaps thats because he lacks imagination and an appreciation of the subject matter. There is enough material out there and work being done to suggest that Islamic Finance can and shall insha Allah succeed. Its just up tous to make it work!!


Sulaiman.

SR

Thank you for your response, but I dont think the analogy fits the scenario. Anyway I get the point that calling something with another name does not change the inherent character of the thing. I have heard the argument, before, that the institution of marraige is in fact an institution of legalized prostitution. Sure logically the argument makes sense if you`re wearing those blinders which they put on horses` eyes while yoked in front of a tonga. But the bigger picture is that the marraige benefits society whereas prostitution disintegrates it. Why? because prostitution is enjoyment without responsibility and marraige is resposibility with fulfillment and enjoyment. So it all boils down to the paradigm through which you look at things.

Same is the case with the interest free banking. If you look at banks as money earning institutions; making money to multiply the wealth of shareholders then the people who have stakes in it will view it as such and only so. So their paradigm of thinking is making money no matter what. A paradigm shift is possible when such institutions are viewed as to how they can be used to benefit society at large and how the interest of individual and the society can be streamlined. If we keep this in mind a new kind of bank is possible, which can be a non-profit cooperative institution. In this case first of all the compounding of interest goes away because that is greed pure and simple. We then are left with two issues to deal with:

1. Compensation for the rate of inflation. But in this case borrower must be benefitted in case of deflation; meaning that there is a variable charge to cover inflation.

2. Mark-up; call it profit sharing; cost of staying in business; or simple interest. In my uneducated opinion that can be pre-determined or fixed in advance. The idea here is not to earn profit but to stay in business. I think in this case society at large can benefit along with the individual.

Rafay-Alam

Good points. Would you like to share your views with us on non-profit cooperative banking.

re SR #30:

``my intuition says that interest free banking is at best no more practical than a sex-free marriage.``

How long have you been married? :)

As usual the mullahs got there before you did. The Islamic term for what your proposed House of Virtue and Matrimony is called `Mut`aa`. Ask anNy for details.

Islamic banking or for that matter any system of capital allocation is fine. My question is what are you trying to achieve by adopting it? If the question boils down to simply assuaging your guilty conscience, its a mighty stupid way of doing it. If the objective is to usher in a more efficient/equitable/rational way of doing things, I am all for it. Unfortunately all it is, is the earlier and not the latter. So keep digging.

later
-sac

P.S:GhalibZaman alias farangi_kush: How`s the prostate treating you these days my man?

rafay-alam

Seems like you are doing well in your law school. Maybe you have graduated and are already a promising lawyer.

Nevertheless, CONGRATULATIONS!

Re: #12 by Urstruly

Though personally I do not believe in paying interest (not averse to earning it) and am no a banking expert, my intuition says that interest free banking is at best no more practical than a sex-free marriage. I’m sure its possible, but it takes extra ordinary effort.

Banks have capital and are in the business to make money by use of that capital. The bank customer want to have access to capital and is willing to pay extra for the opportunity of using that capital. You can call it mark-up but that changes nothing.

Let us suppose that I decide to move to Bangkok and open a House of Virtue and Matrimony. My purpose in so doing is to provide a respectable and moral alternative (for our virtuous young Muslim brothers who travel through there) to the sinful lewdness and fornication that goes on shamelessly. With this noble intention I invite young unmarried ladies to come and reside in the House of Virtue and Matrimony under my fatherly guardianship. Then I arrange for a nikah between each of the young ladies and respectable visiting businessmen from Karachi and Bombay. A haq mehr is negotiated and paid up prior to the ceremony and then the young couple is left alone to make the beast with two backs. After a period of time, prior to his departure, the young husband says talaaq, talaaq, talaaq and walks. I will, of course, console the divorced young lady and try to find her a new husband.

Now, I could turn blue in the face trying to explain to you that my House of Virtue and Matrimony is an ethical and moral alternative to keep our lusty young men from committing sin. But I suspect, that you will call me a lying pimp and insist that I was running just another whorehouse.

…SR

Mr. Kazi has taken a cursory view of a vast subject, and cursorily dismissed the same. There are other pertinent areas of concern which have not been touched upon, least of which is the theoretical framework within which such a system is to operate.

There are several theoretical aspects to Islamic finance which, I think, are crucial to understanding such a form a business. And it would be unfair to dismiss any sort of theory without at least a theoretical understanding of it.

The first concept is that of Riba. Riba, unfortunately, is not defined in the Quran, but investigations into the Hadith and the financial transactions of the early Muslim Ummah tend reveal that is the rough equivalent to usury. Riba – or usury, which is the working definition of Riba – has been condemned in Islam, and not without good reason. Riba connotes income derived from the use of funds. In other words, it is money made from letting others use your funds. It is this aspect of financing which is frowned upon in Islam, as it allows a lender to increase his or her wealth without partaking in any of the risk involved in a business venture.

The reason why Islamic Banking bases itself on mark-up – which Mr. Kazi has correctly pointed out is almost the same as interest – is that mark-up eliminates uncertainty. During the early days of Islam (and indeed, according to most tales told of usurers), the interest on funds lent would often increase to dwarf the initial capital lent. Further, as the interest would always be increasing, it was impossible for a lender to determine what the exact amount It was this unfairness and uncertainty which the laws relating to Islamic finance seek to eliminate.

Mark-up is a pre-determined rate which a borrower will return to the lender along with the amount lent. Since it is fixed, and cannot increase, it eliminates the uncertainty of the repayment amount. Also, Islamic law forbids a lender to charge mark-up after the period agreed upon, so a borrower will never have to repay more than what is mentioned in the mark-up agreement.

In this day and age, and assuming all borrowers are honest and will return their money when it is due, it is easy to determine what the total amount to repay is, even if the amount lent has been lent on an interest-bearing basis. But it is not a perfect world, and interest-bearing loans will always be accruing sums to the original amount lent. This accrual can, and often does, bypass and far exceed the amounts originally lent. Such a scenario is not permitted in Islam, which is why interest-bearing loans are not allowed in Pakistan.

However, having said that, and in reference to Mr. Kazi assertion that mark-up and interest are practically the same, the situation is Pakistan when it comes to mark-up financing show no dissimilarity from the interest banking it seeks to avoid. For example, the mark-up amount often rivals the capital amount of the loan. For example, if the financing is for $1 million, the mark-up will be $0.75 million. Further, Banks often (if not always), attempt to charge mark-up after the period contracted for. This means that the amount to be repaid will always be increasing and will not be a fixed and determined sum.

But I digress, one of most interesting aspects of Islamic financing is that Islamic law does not recognize funds as having their own intrinsic value. This is why interest – which is more or less rent for an amount loaned – is so alien a concept to it. If the Islamic financing system wants to revolutionize itself in order to bring to par with other financing methods, then Islamic though needs to interpret and understand that cash, in this day and age, has a value of its own. Once this hurdle is crossed, there will be need to scream up and down about the evils of Riba. Islamic financing could then concentrate of doing what is was supposed to: Make the playing field for lenders and borrowers even and fair.

My own view of Islamic banking is shared with my view of, say, socialism: A great idea, but it needs to be implemented globally before it works. Islamic banking will always be rivaling interest finance, which is a form of lending which is far larger in scope than Islamic finance. I mean, how can Feisal Bank compete with Deutsche Bank or Citibank, both of which have incredible resources to bak them up.

One last thing: The reason why mark-up rates are so high is because business is a risky prospect in place like Pakistan. If there was to be interest banking in Pakistan, interest rate would be close to 20%. Japan, on the other hand, where business is not so risky, has an interest rate bordering 4% (this may have changed in the recent past). According to this view, it is less usurious to lend in Japan, even if you charge interest, than in Pakistan, where the mark-up rate is often 60%. What I’m trying to say is that it not just the banking system which determines the fairness of banker/lender relations, but the performance of the whole economy.

FJ
Abu Jehal was not ignorant. In fact he was the most learned one among his tribesmen. He was given this title, by which name he is now notorious, is because he refused & denied (meaning uttered kufr; kufr literally means denial) the new reality.

The unfortunate ones among us have become so thoroughly educated (indoctrinated?) that they mistake culture for learning. As if exhibitionism and accent would suddenly elevate them to mensa status. Such kind have earned nothing but the worst of both worlds.

Flowers they couldn`t reach, so they befriended thistles
To reincarnate as someone else, they took their own life.

Asfand Siddiqui

Would you kindly name those institutions, you mentioned in your post.

Islamic-finance.net is one of the best places on the net for questions on Islamic banking. There are certification programs offered by Netversity.org for those interested in pursing this growing field.

Readers may also wish to refer to the following:

www.islamicbankingnetwork.com
www.hifip.harvard.edu www.siddiqi.com/mns/
www.halalco.com/economics.html
www.islampub.com/books/econom.html

Not only are muslim-owned entities key players in this arena, but also conventional fogerign banks such as HSBC, Barclays, Citibank, Chase Manhattan, UBS United Bank of Switzerland - nearly all of which have established subsidiaries that offer Islamic products. For such global operations to want to explore such a niche market definitely means there is something viable and sustainable there.

As an aside: the fact that a relevant topic like Islamic Banking has received fewer replies than an article on homosexualty is indicative of Chowk`s current downward trend.

freethinker

Please do not use your graibaan as a hijab. Queen Elizabeth agreed to visit Saudi Arabia as an honourary male. The chinese & Japanese were declared, pre-mandela, as honourary whites. Gandhi circumvented the strike and protest ban by calling it a `day of prayer & fasting`. The entire western legal system is based on `technicalities`. The successive progression of someone from dictator to strongman to leader to statesman , the indicment of a freedom-fighter as a rebel and then a terrorist seems quite normal, doesn`t it?
This is called pragmatism, cleverness, loopholes, technicality and ``hypocricy is the tribute vice pays to virtue``. Now please lift your head and walk a little tall---as a muslim.

It is good to be a freethinker as long as free does not mean `of no cost, price or value` .

Khirad kaa naam junooN rakh diyaa, junooN kaa khirad
Jo cvhaahay aap kaa husn e karishmaa saaz karay.

Happy to know that as a muslim you are earnestly looking for ways to become a practising muslim.

First the news from al-Azhar. According to The Nation of November 18, 2002, “Sunni Islam’s highest authority, al-Azhar institute in Cairo, has given a green light to fixed-interest banking in Egypt, an issue that has been a focus of debate among the world’s Muslims. Al-Azhar’s Islamic theological research committee reached the verdict on October 31, the head of the committee’s secretariat told AFP on Sunday”. Hopefully, it will settle the riba issue in the Islamic world.

Just for academic interest, I would appreciate if some body could suggest a book to me which explains the concepts of Mushiraka, Morabha, and Modhraba. I have learnt that modharaba is used for sleeping partnership. This is okay, but how does it work? Are there rules and laws, which are uniformly accepted concerning these concepts? Is there any theory behind these concepts? Effectively, is there any Islamic banking theory? Or are these just stratagems to circumvent the sharia legislation regarding riba.

Stratagems which are called hiyal in Islamic legal lexicon are designed to circumvent riba. By using these devices, one can stick to the letter of the law violating its essence. And strangely, this was considered permissible.

According to Joseph Schacht (An Introduction to Islamic Law, p. 78), a very learned legal authority on Islamic Law, “The customary commercial law was brought into agreement with the theory of the sharia by the hiyal (sing. hila) or ‘legal devices’, which were often legal fictions. The hiyal, which are not confined to commercial law but cover other matters as well, can be described, in short, as the use of legal means for extra-legal ends, ends that could not, whether they themselves were legal or illegal, be achieved directly with the means provided by the sharia”. For example, Schacht illustrates the application of hila to circumvent the injunction on interest when he describes, “..the Koran prohibits interest, and this religious prohibition was strong enough to make popular opinion unwilling to transgress it openly and directly, while at the same time there was an imperative demand for the giving and taking of interest in commercial life. In order to satisfy this need, and at the same time to observe the letter of the religious prohibition, a number of devices were developed... Another, very popular, device consisted of a double sale (bay’atan fi bay’a), of which there are many variants. For instance, the (prospective) debtor sells to the (prospective) creditor a slave for cash, and immediately buys the slave back from him for a greater amount payable at a future date; this amounts to a loan with the slave as security, and the difference between the two prices represents the interest…Euphemistically, it is also called mu’amala…”. There were hundreds of these devices with different kinds of transactions. Schacht also described a practice called tahlil (making lawful) which was used to “removing the impediment to remarriage between the former husband and wife after a triple repudiation by arranging for the marriage of the woman to another husband with the understanding that this marriage would be immediately dissolved after (real or pretended) consummation”. There are many other situations described by Schacht. Hiyal have also been discussed in some detail by Wael B. Hallaq in “A History of Islamic Legal Theories”.

Who would like to live with this hypocrisy? Natiqa sar be gareban keh issay kiya kahiyyay?

islamic banking falls in the same category as maswak, watwani and halal pakistani chinese food ........

asfand #21 This does not seem any different (other than in name) from regular mortgage lending. The lenders equity here, as you indicate, is ``80 percent of the market rent`` for the house. In other words, the buyer is paying an (implied) interest rate that is equal to the rent on the house (and so the whole scheme is merely a change in terminology to what is ``religiously correct``).
Furthermore, the buyer is not reducing his risks or increasing his well being in any particular way. Indeed the waiting lines of ardent borrowers would indicate that this is a banker`s market and not a buyers market (like standard mortgage banking). I assume therefore that the waiting lines are of those individuals who think they are being good muslims by following this piece of religious dogma.
To repeat therefore what I said earlier, Islamic Banking is a travesty of Islam (although admittedly not as much as travesty as Shariah Courts, but that is another story).