Issues in Islamic Banking[1]
Preface
The idea that Islam is a unique
way oflife distinct from all other isms and ideologies naturally extends to the
economic life of the Umma. A determination to reshape the economy on
distinctive Islamic lines has been an important dimension of the Islamic resurgence
visible allover the world oflslam. The areas of money, banking and investment
are regarded as crucial to the process of Islamisation of the economy. Modem
banking, based on interest and biased in favour of the capitalists and the rich
and well-to-do, is rejected as un-Islamic because of the unequivocal
prohibition of ribti by the Qur' an, which the consensus of Muslim jurists has interpreted
as covering all kinds of interest, usurious or otherwise, irrespective of the
nature and function of the loan. The Islamic emphasis on cooperation as the key
concept in economic life has led to reliance on profit-sharing and
participation as the alternative bases for banking and investment in the Islamic
framework.
Muslim society never legitimised
interest: throughout the thirteen centuries of its history prior to domination
by imperialist powers, it managed its economy and carried on domestic and international
trade without the institution of interest Profitsharing and various kinds of
participation arrangements served as adequate bases for savings and investment
and considerable
Capital was mobilisedformining,ship-building,textilesandother
industries, as well as for maritime trade. Introduction of interest based banking
by colonial regimes in the Muslim countries during the nineteenth century
failed to involve the bulk of the community until the legal framework made it
almost impossible for any business to thrive without such involvement Efforts
of some pseudo-jurists to distinguish between ribti and bank interest and to legitimise
the latter met with almost universal rejection and contempt Despite the fact
that circumstances force many people to deal with interest-based fmancial
institutions, the notion of its essential illegitimacy has always remained. A
sizeable section of the community still refuses to have any dealings with these
institutions despite the inconveniences involved
Rejection of interest is seen as
a necessary part of the rejection of the exploitative capitalist system which
is to be replaced by the just and equitable Islamic system. The recent
literature on interest-free Islamic banking in fact grew as a part of the
literature on the economic system of Islam in contradistinction to the capitalist
and the socialist systems of various hues. Now wehave a number of books and
articles in Arabic, English, Urdu, Turkish,
Persian and Bengal~ etc. Early
writers mostly attempted a critique of modern banking, exposing the role of
interest in the exploitation of individuals and nations. Then they proceeded to
suggest that partnership and profit-sharing could form a viable basis for bankinJ.
Some economists with adequate training in the Shafi'a sciences worked out a
detailed model of interest-free banking on these bases. My earlier work Banking
Without Interest (1973, first published in Urdu in 1969) belongs to this
category. Since
then the subject of Islamic
banking has undergone considerable development Discussion is now conducted in
the broader context of economic analysis inspired by Islamic values and ends.
'The Governors appreciated the
desire to apply Islamic Shan-
What lends added credibility to
the whole exercise is the perilous condition of the monetary and financial
system the world over. With two-figure inflation raging alongside high levels
of unemployment, with interest rates soaring at times beyond twenty percent,
and the system of international payments under heavy strain due to piling up of
debts, the situation is becoming increasingly untenable. The system has lost
credibility, leading to a universal recognition of the need for basic changes.
The basic change advocated by
Islamic economists is a changeover from interest to profit-sharing. This simple
change, some implications of which are elaborated and examined in this volume,
has far-reaching consequences for the entire system. It amounts to a change
from a lending-based system to one based on real investment and participation.
It affects the supply of money, linking it directly with the transactions needs
ofthe community, as well as the allocation of financial resources in direct
response to production possibilities. Both affects strike at the very roots of inflation.
In international relations the change would force nations with a surplus to
invest to enter into participatory arrangements with developing nations,
expecting a return only to the extent real development takes place. While it
cannot be claimed that these and other implications of the change have been
fully worked out,
discussion has largely centred
around these issues in recent years. The present writer had the opportunity of
participating in this discussion through a number of papers and notes some of
which are presented here. Their availability in oQevolume will be useful for
those who do not have access to the journals or seminar proceedings where most
of these papers were first published or read The volume also contains some
hitherto unpublished material.
The first essay on the Islamic
Approaches to Money, Banking and Monetary Policy is in the nature of a review
of the literature up to 1977. It sets the perspective in which later
contributions can be meaningfully studied It covers what Islamic economists
have written about the nature of money and its functions, and the demand for
money in an Islamic economy. The nature of bank money or credit, its
desirability or otherwise, and the possible ways of its management also come up
for discussion. The idea of hundred percent reserves is also examined in this
context as are the suggestions to confine creation of credit to the Central
Bank. The essay surveys the major contributions to the subject of interest-free
banking, reporting the various viewpoints on such issues as supply of
short.,.terminterest-free loans, bills of exchange, financing the consumer and
fmancing the government The paper reviews the various writings on Central
banking and monetary policy in an Islamic framework, examining the various
policy instruments discussed by our writers. This includes the suggestion to use
profit-sharing ratios as an instrument of policy, besides the reserve ratio,
selective credit control and open market operation through sale and purchase of
shares, etc. Originally written for a seminar held in 1978, a postscript has
been added to cover the contributions up to 1981, covering issues not discussed
earlier such as indexation and seigniorage.
The next paper, Banking in an
Islamic Framework, gives an exposition of the model of interest-free banking
based on twcrtier muqaraba that now forms the operational basis of Islamic banking.
It examines .such.evil consequences of interest-based banking as distribution
of income and wealth and inflation and demonstrates the advantages ofIslamic
banking which is free from these evils, examining the creation of credit at
some length. Some of the other issues briefly dealt with in the first essay
also come up . for detailed consideration.
The third article, Rationale of
Islamic Banking, answers the question why Islamic economists advocate a change
from inter~st to profit-sharing. It is argued that the interest-based system is
inefficient as well as unjust It has an inherent tendency towards inflation and
it fails to provide a just and viable basis for international monetary
relations. The change to a system based on profit-sharing will contribute to
allocative efficiency, justice and stability. It can also serve as a viable
basis for internatienal flow of funds..
The fourth paper, Economics of
Profit-Sharing, covers entirely new ground by discussing how the ratios of
profit-sharing between the depositors and banks, and between the banks and
businessmen willbe determined It studies the effects of changes in the expected
rate of profits on these ratios and the alternative possibilities as regards
the responsiveness of supply of and demand for deposits to changes in the
expected rates of profits. It examines and refutes the contention that a system
based on profit-sharing must' be unstable and subject to wide fluctuations. The
paper demonstrates that the system gains in efficiency by assigning the
allocative.role to the rate of profit without the disturbing interference from
rate of nterest
The brief paper on Monetary
Theory of Islamic Economics that follows restates the main points made in the
three preceding papers in a summary form with a view to providing a synoptic
view of the subject It also takes notice of some fresh doubts on the viability
of interest-free banking, being the report of a discussion in which non-Muslim
professional economists were also participating.
The sixth paper, on Issues in
Islamisation of Banking, is a comment on the Report of the Council of Islamic
Ideology on elimination of interest from the ~conomy, submitted to the Government
of Pakistan in 1980. I have tried to make this note meaningful to readers, to
whom the Report itself may not be available, by addingexplanatory footnotes.
The comment discusses such practices as Muraba!J.aand investment-auctioning
proposed in the context of interest-free banking.
These six papers along with this
introduction wil~ I hope, inform the reader of the current state of debate on
Islamic banking. This will facilitate understanding of much that is being
reported in some journals and a section of the Press. To students of Islamic economics
in general, and of Islamic banking in particular, it provides a comprehensive
up-dated report on the subject and identifies possible subjects for further
research. It is hoped that the publication of this volume will provoke further
deliberations on this vital subject
King Abdulaziz University,Jeddah
Muhammad Nejatullah Siddiqi
[1]
The Islamic Foundation 1983/1403 H. Reprinted 1994/1415 H. Published by The
Islamic Foundation Markfield Dawah Centre Ratby Lane, Markfield Leicester LE67
9RN, UK (P. 9 - 14)
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