Islamic banking for a better world
Islamic
banking is now a well-known term and has emerged as one of the most important
industries worldwide. Islamic banking is known for its interest free concept and
operates in many countries including Bahrain, Pakistan, Jordan, Iran,
Sudan,United Kingdom, Singapore and Malaysia. Islamic banking and finance has
undergone
rapid transformation and growth from an industry striving to satisfy the
Muslim
community needs, to a multibillion dollar industry upholding Islamic
principles.
Over recent decades the Islamic banking industry has emerged as one of
the
fastest growing industries and has spread to all corners of the globe,
receiving
wide acceptance from Muslims and non-Muslims. Muslims as well as non Muslims are increasingly
coming to invest in Islamic banks and financial institutions.
Islamic banking
refers to a system of banking or banking activity that is consistent with
islamic law (sharia) principles and guided by islamic economics, the aim of which is the introduction of value system
and ethics of Islam into the economic sphere. In order to establish justice and
welfare in the society, a financial system, which does not allow Riba (interest),
should be in operation. Islamic banks use Islamic finance products like Mudaraba,
Bai-Murabaha, Bai-Muajjal, Bai-Salam, Istisna, Ijara, etc., instead of conventional
financing mechanisms like loan and advance, cash credit (CC), over draft (OD) etc.
Islamic banks earn “profit” (not “interest”) from the Shariah compliant
economically viable projects and credit worthy customers.
The
veteran justice VR Krishna Iyer said
while he was delivering an inaugural
speech in an international seminar on Islamic finance in Kochi last year,
that Islamic banking is promoting the
human values. The country like India with 50 percent of population living below
poverty line needed the financial system which is considering human values.
In this occasion a banking system which considering the mercy, justice and
values are necessary. So Islamic banking is fit for our country. Islamic
banking is not only for Muslims but for all communities. It is free from
exploitative mode of interest. It is practicing the method of sharing of earned
income in between the participants in economic activities. So the people who
believe in God should support the Islamic banking system.
HISTORY OF
ISLAMIC BANKING
Sharia scholars
started writing on the ills of interest based system of economics and the need
and possibilities of reverting the trend in favour of the Islamic system, where
riba/interest will have no place, from the late thirties of the
twentieth century. For example, series of articles written by Syed Abul Ala
Maududi from 1936 to 1960 were published in book forms under the titles Islamic
Economics and Riba .Muslim economists took clue from shariah scholars
and they came out with the blue prints of how to form any bank without
interest. For example, Dr. Mohammad Najatullah Siddiqi’s book “Interest Free
Banking” was published in the year 1968. The practical shape of these writings
in form of Islamic Finance and Islamic Banking were experimented in Malaysia
and Egypt. Malaysia became independent in 1956 and within couple of years
thereafter Tabbung Hajji started functioning. Individual recurring
savings by Muslims for the purpose of performing hajj pilgrimage were
mobilised and invested in accordance with sharia. This made the
pilgrimage easier because profit earned on such savings lessened the total
savings required for the purpose. Further, this concept popularised the concept
of sharia-compliant investment. This successful venture in Malaysia
remained outside the view of the world. It was noticed in 1981 at the time when
proposal for formation of the Islamic Bank of Malaysia was under the
consideration of the Islamic Development Bank, Jeddah. One visionary cum
activist Ahmad Najjar established a saving cum investment venture in a small
town of Egypt named Mit Ghamr in 1963. Later he opened several such ventures in
many small towns of Egypt. This experiment could not last long. It failed owing
to various reasons including the lack of home works done before their commencements.
However, the Mit Ghamr experience, despite failure, served as a beginning of
the Islamic banking movement. An experience based on the concept of a
cooperative bank was done in Karachi in 1965. The government of Egypt started
the Nasser Social Bank on the principles of Islamic banking in the year 1971. A
number of Islamically oriented financial institutions came up in different
parts of the world after mid 1970s. A landmark in the history of Islamic
finance was the establishment of Dubai Islamic Bank in 1975. At this stage the
new development was noticed by the Federal Reserve Bank, USA, Bank of England,
World Bank, Harvard University and London School of Economics. Thereafter there
has been no looking back in the development of Islamic banking in the one hand,
analysis and research of the outcomes of the movement by the academia of the
world, on the other hand. Hundreds of books have been written on the subject
and scores of research materials, articles, dissertations submitted in the
western universities, have been published.
Analysis of the Islamic finance products in
use would be useful to identify the potential of Islamic finance. Moreover, it would be worthy
to examine the impact of those potentials on financial resource mobilization. Raghuram
Rajan (chief financial advisor of prime minister) suggests starting interest
free financial institutions in India as a remedy of financial exclusion; which
is the main reason for extreme poverty in the country. He also argues that
interest free finance especially in microcredit is an effective way to
strengthen the vulnerable class. The finance sector in the country is eagerly
waiting for the favorable decision from the part of the government of India.
Working of an
Interest free Institution
Interest free establishments are
those institutions which are financing without interest. These institutions are
financing to the needy people in different ways. Receiving deposits from the
public as shares and returning it after maturity with a part of profit earned
from investments. These institutions are providing capital to the unemployed
and needy entrepreneurs and strictly monitoring the working of these
institutions. Through this on the one side they create employment and the other
and more important side encouraging the productivity of the nation.
Providing consumer loans is
another important function of interest free establishments.
Instruments used
in interest free institutions
Microfinance-Interest free (Islamic Microfinance)
Most of MFIs are providing micro lending on more than 20 percent
interest even reaching 30 percent which is higher than commercial banking.
Reason for these higher rates is of high institutional cost, giving loan on
door steps, small loan amount and higher number of customer therefore increased
expense to maintain all operations and risk factors. This high interest ratio
put pressure on loan borrower which can affect the overall success of business.
Interest Free finance is
primarily conceived as an alternative to Interest based finance. Interest based
finance or for that matter economy is exploitative, oppressive, inflationary
and draining wealth from poor to rich. The Interest Free economy aims at equity
and justice in economy. “Justice is largely perceived in terms of equivalence
(in exchange transaction) and reciprocity (in social relationships). But equity
(ihsan) is urged on top of justice and is defined as giving more than is due
according to the standards of equivalence and reciprocity to ensure survival
with dignity for all. This emanates from a certain world view, vision and
strategy. It insists on certain values and moral guidelines. Interest Free
economy should be inclusive both in terms of participation of all humanity as
well as it should encompass all good experiences of humanity. It should also
try to accommodate the alternative experiments and moral basis in the society.
New and emerging approach is introducing interest free microfinance
(Islamic Microfinance). As in Islam, charging interest (Riba) on liquid
cash is prohibited because by Islamic teachings, money is not an asset for
earning profit..Islam emphasizes on social, ethical, moral factors for
distribution of wealth and guide towards social and economic justice. Islam
rather than interest, encourage profit because earning profit evolve productive
activity and involve in profit and risk sharing between lender and borrower. Basic
motive behind this approach is more than profitability, repository of wealth
but collective wisdom of development of business, sharing profit and loss and
collective struggle for business development. So the final gain from this is
social benefit rather than profit gain and maximization which is helpful to
microfinance and micro entrepreneurship. Let’s discuss main instruments of
financing that are in use in Interest free banks and microfinance institutions.
Mudaraba (Participation financing): Mudaraba mean transaction between financial
institution and borrower and for this option, both capital provider and
entrepreneur have no pre decided amount as an interest but will work on basis
of profit sharing and both will share this. According to Zaher,Kaber ,
”Mudaraba is a trust based financing agreement whereby an investor (Islamic
bank) entrusts capital to an agent (Mudarib) for a project. Profits are based
on a pre-arranged and agreed on a ratio. This agreement is akin to the Western
style limited partnership, with one party contributing capital while the other
runs the business and profit is distributed based on a negotiated percentage of
ownership. In case of a loss, the bank earns no return or negative return on
its investment and the agent receives no compensation for his (her) effort”.
Musharaka: This
is same like as joint venture between two or more persons or institutions.
According to Segrado (2005), “Two parties provide capital for a project
which both may manage. Profits are shared in pre-agreed ratios but losses are
borne in proportion to equity participation”. So it will not be based on profit
sharing business but it depends on decision making and management capacity and
role in business.
Murabahah: In
this model, MFIs first buy items and then resell it to borrowers with adding
some reasonable profit/markup. After this, agreement will be establish to
return amount to lender. Installment will then make over, and duration of pay
will be decided. Owner ship of good will remain in name of MFI until all credit
will be cleared. It is important to quote here that markup or profit add on
actual amount by MFIs is consider administrative cost, and it is demand of
Islamic practices that profit margin should be as much as minimized. Dhumale,
Sapcanin (p.10) resemble Murabahah as “The Murabahah contract is similar to
trade finance in the context of working capital
loans and to leasing in the context of
fixed capital loans.” Murabahah consider the suitable method in IMFIs due to
its clear and easy to understand methodology.
Qard-e-Hassan:The
Prophet Muhammad (PBUH) says “the inmates of Paradise are of three types: one
who wields authority and is just and fair; one who is truthful and has been
endowed with power to do good deeds and the person who is merciful and
kindhearted towards his relatives and to every pious Muslim, and who does not
stretch out of his hand in spite of having a large family to support. [Sahih
Muslim]”. Teaching of Islam encourage to rich poor to help poor so that poor
can also benefit with social services and uplift their standards of life. Qard
Hassan’s principal is that lender give loan to borrowers with out any
profit/extra amount or interest and debtor is supposed to return back as soon
or pre decided date but lender will not press to return back as soon . Qard
Hassan’s working is same as conventional MFIs but there are some differences
like no interest will be charged and there will be no strict fine or charges on
default or delay of amount. But the following rules should be obeyed.
1. There should be proper contract between
lender and borrowers in which all terms and conditions will be written
2. Date of payment must be
specified
3. Loan contract should written
4. Getting two witnesses
5. Charging membership or
administrative fee.
Some possible reasons of the popularity and
acceptability of the Islamic Banking are as under:
1
Evils of interest based system have become so
obvious that men are in search of an alternative and Islamic economics, banking
and finance have been accepted to be the much needed panacea.
2
The performance of Islamic Banking as practiced in
many countries has become so much attractive that the world is now craving for
it.
3
Islamic Banking will add to the reach of banking
activity, making a significant chunk of population bankable.
4
It will attract petrodollar.
The conventional banks render
many basic and essential services without which no modern economy can survive
but their most important function is the financial intermediation between the
lenders and the borrowers on the basis of interest. However, Islamic economists
have suggested an alternative banking system without ‘interest’. Let’s dream a
world where without farmers’ suicides because of heavy burden of interest
rates……
