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ISLAMIC BANKING AND THE ISSUES OF INTEREST RATES.
Lateef Muse.
Introduction.
I congratulate the Chairman and other members of your group for their initiative in organizing this lecture and also choosing this very sensitive topic. I regard the topic as sensitive from the standpoint of the secular status of the Nigerian society and the close relationship that exist between Muslims and non-Muslims especially in this part of the country. To those who may wonder about the resurgence of Islamic activities to the point of discussing this seemingly overbearing concept of Islamic economics, let the issue of interest-free banking be seen from several standpoints.
(i) From an academic standpoint, is it not time that we consider other options to support our financial system?
(ii) Can it be said that outside the influence of capitalism and the failing concept of socialism, our options have some to an end?
(iii) In the context of social welfare and economic development, can it be said that our freedom of choice need not be controlled ethically in the overall interest of sanity and orderly growth of society?
To most of our Christian brothers and sisters, a discussion such as this provokes the ‘us and them’ syndrome – (this people again!) considering the reactions to the vexed OIC issue. It is not the attempt here to rake up any subject to disturb
Alhaji Latif Muse was the former Managing Director of Access Bank of Nig. Ltd.
the hitherto cordial relationships. What is being amplified is a system of relationship between banks and their willing customers that exists in some societies / countries and already provided for in the Nigerian banking statute books.
I plead with them that we discuss the content and substance of the presentation for our common good. “Islam was the last of the world religions to appear, and it may be safely described as the most advanced of them all. It is a total and unified way of life, both religious and secular; it is a set of beliefs and a way of worship; it is a vast and integrated system of law; it is a culture and civilization; it is an economic system and a way of doing business; it is a polity and a method of governance; it is a special sort of society and a way of running a family; it prescribes for inheritance and divorce, dress and etiquette, food and personal hygiene. It is a spiritual and human totality.” Islam is scriptural, egalitarian and very strictly monotheist. It is also very simple. It stresses the consistence of the individual before God; observation of the Five pillars (acknowledgement of Allah, daily prayers, fasting at Ramadhan, alms-giving and pilgrimage) makes one a full member of the faith. There are no mysteries needing to be interpreted by a formal ecclesiastical organization.
In this paper, we are interested in efforts to set up general outlines of the concept of Islamic banking explaining from whence it came, “not least in order that we may bare what it is about us that truly is different and novel.” No pretension is being made by the writer to be an authority on the emerging phenomenon of Islamic banking. On the contrary, an attempt is being made to engender further discourse of this all important development in the interest of the society at large.
The Beginning.
For centuries, many Muslims have had to comply with this Allah’s decree by lending money to fellow human beings and shunning interest takings. With the introduction of modern day banking into Muslim societies, largely through colonization
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Islamic Banking and the Issues of Interest Rates
a small number of people became influenced by western culture and tradition. In spite of the advent of modern day banking, or what can be referred to as conventional banking practice with its influences. A significant number of people in the Muslim world still have reservations about the operations of interest based modern banking practices. Thus people kept away from banks for fear of violating Quranic injunction against interest takings.
About three decades ago, some Muslim scholars came together to fashion out an arrangement for both banks and depositors alike taking into cognizance the commandment of Allah on the issue of interest. Having worked on this, some financial institutions have now resorted to fashioning some of their banking products in line with the new dispensation. Thus, depositors could now exercise a choice of taking profits on their investable funds as opposed to earning interest to give fillip to the practice of Islamic banking in its pure form.
The first attempt at Islamic banking was with Mit Ghamr Bank which commenced operation in 1963 in a place called Mit Ghamr, a rural setting in Egypt. The operators of the bank combined the idea of German rural banking system with the principles of rural banking within the general framework of Islamic ethics.
After Mit Ghamr failed, the Nasser Social Bank was established again in Cairo in 1972 by the Egyptian Government to provide social services such as granting interest free loans for small projects on a profit sharing basis among others. The Dubai Islamic Bank in the United Arab Emirates also commenced business in 1975, making it the third Islamic bank in history. Also, Saudi Arabia, in conjunction with 21 other countries founded Islamic Development Bank in Jeddah in October 1975. Other nations that have established Islamic banks are Iran, Malaysia, Pakistan, Sudan, Kuwait, Qatar, Bahrain and Oman. Also, a number of Islamic banks operate in non-Muslim countries such as Islamic Bank International in Denmark, the Islamic Finance House Universal Holding in Luxembourg, the Phillipine Amanah Bank, Albaraka Bank Limited in South Africa, Massraf Faysal Al-Islami Limited, Jersey, United Kingdom, just to mention a few.
It is important to mention that in most of these countries, there are wholly Islamic banks operating side by side with conventional banks. In some of them, some Western styled banks have Islamic Banking Department. However, a country like Pakistan has shifted her banking system to Islamic mode of financing in 1st July, 1984. This means that the financial system of the country has been wholly Islamized. Here interest has been replaced by non-interest based techniques like Profit and Loss Sharing (PLS), mark up etc. which is the hallmark of Islamic banking system.
Theoretical Framework for Validity of Islamic Banking.
In most societies of the world, the pattern of economic system is largely formulated in line with the ethical norms of the society. It has been found out that the economic performance of a society is related to its moral philosophy and this is why the “implicit logic of the socio-economic behaviour of a people can be traced to their metaphysical or religious conceptions.” For instance, “the economic behaviour of a Muslim is deeply influenced by his firm belief in the Day of Judgement and the life after death.” In like manner, the economic behaviour of the West is enshrined in capitalism. Max Weber wrote that “the rise of capitalism in the West presupposed a universal acceptance in the West of Protestant ethics which legitimized unlimited accumulation of wealth and extolled thriftiness and worldly asceticism, even if it meant causing considerable social suffering.”
Capitalism has been found to have failed to realize the unity of life by overemphasizing materialism at the cost of spiritual and ethical dimension to human existence. It also destroys nature’s Equilibrium by allowing wealth to be concentrated in a few hands. Another failing of capitalism is its unqualified support for the institution of private property as it has little to control human freedom and imposing little or no social responsibility on the wealth at the expense of the poor.
Islamic ethical philosophy on the contrary, does not permit exploitation of the poor by the rich, does not condone indefinite savings and investments without regard to the social consequence of such actions. Islam explains that all property belongs to God and that man holds it in trust for him. Hence, property should be shared by all, particularly by the rich and poor.
In all the continents of the world, there is a well-developed monetary system recognizing interest and dividend as rewards of capital. These are characteristics of capitalism and in spite of their limitation, have resulted in some economic growth and welfare in varying proportions. However, the problem of commerce and finance remain thorny and is a major divide between the various strata of society accounting for poverty, pent up vexation, and social unrest the world over.
From the Islamic point of view, a society with a fair income distribution is better than a society with an unequal distribution of income. This disproportionate income distribution and wealth are prevalent in both capitalist and socialist economies.
In capitalist economies, a fixed interest charge is one of the causes of income disparities. Here, competitors not only own the bulk of the national wealth, but also, control the whole market and run it at their whims and caprices.
In socialist economies, there is no such thing as private property and wealth is distributed in wages. Under this system, there prevails the worst form of concentration of wealth as the system deprives human labour of its natural right to individual choice and control. What we have is tyranny as the huge resources of national wealth is left in the hand of a big capitalist i.e. the state which can deal with this wealth arbitrarily.
As Almighty Allah has warned mankind against the taking of Riba, the contemporary Islamic societies have tried to enforce this injunction by finding an alternative means of pricing capital appropriately, satisfying the requirements of Islamic ethics.
It is very important for us to know that the Islamic injunction against Riba is not aimed at establishing a value free economics as Islam believes that “the maximization of social welfare requires the superimposition of a social welfare function to reflect the best rank ordering of social preferences.” Once Riba is out of the way, the range of choice of feasible economic policies in an economy become restricted to those policies which do not exacerbate social injustice particularly those arising out of the inequalities of income and wealth distribution.
Secondly, any proposition which suggests that interest free banking in an economy – capitalist or socialist is sufficient for the establishment of an Islamic economic system cannot be true. This is because, the ultimate objective of Riba free society carries with it social elements in basic production and consumption relationships, the saving –investment nexus and the process of money creation.
Thirdly, the abolition of Riba implies, in a deeper sense, a rejection of the entire capitalist system. The reason is that capitalism is run on the basis of limited liability to risk and at its worst uncaring about transaction details. The concept of “guaranteed profit” and its attendant evil effect in the form of excessive love of money, exploitation and oppression of the needy by the wealthy crooked and corrupt way of life: this is capitalism.
Lastly, we should understand clearly that Islamic reform is not so much on abolishing interest as on replacing it with a much better islamically legitimate return / reward system which will engender a wide ranging appreciation of the contributions of various strata of society in the economic system. It does not also negate the Fisherian explanation for a positive rate of interest, which is explained as the net productivity of the ‘roundabout’ methods of production, and a positive preference for the present consumption over future consumption. What Islam is against is the justification of this reason for perpetuating the institution of interest, which allows the wealthy to hive off interest income.
In their resolve to find an alternative, scholars and Ulamah came together to fashion out a financial re-arrangement and restructuring of the entire economic system. Thus, two forms of investing capital was approved and incorporated into the Shariah. This came in the form of “Partnership” (Mudarabah) and “Co-operation” (Musharakah). Thus, when a capitalist is entitled to his share of profit, he should also be prepared to share the burden of loss, in case the business suffers loss.
Operation of Islamic Bank
Like conventional banks, Islamic banks act as financial intermediaries by attracting funds from surplus lenders such as individuals and institutions and then channel them to firms which needs to finance their productive activities. However, the basic difference between the conventional banks and Islamic banks lies in how these intermediary roles are performed. This means, how funds are mobilized and utilized. Since we are all familiar with the way conventional banks operate, let us examine the ways Islamic banks source and utilize funds.
- Sources of Funds.
Islamic banks accept deposits on different maturities, but do not pay interest on those deposits. This is in conflict with conventional banks that pay interests on deposits. The types of deposits that Islamic banks operate are described below:
(a) Current Account: All Islamic banks operate current accounts otherwise known as demand deposits for their customers, with the undertaking that a full return is guaranteed without prior notice being given to the bank. The bank may utilize the funds for its day to day operations, but at its own risk. Because of the high risk which is being borne by the bank, the depositor are not entitled to any share in the profits earned by the bank.
(b) Savings Account: Islamic banks operate four types of savings account. They are:
(i) Principles of “al-wadi’a” (trust): This mode of operation allows a depositor to give his banker the permission to use the deposit at its own risk, but guaranteeing full return of the deposits and sharing any profits voluntarily.
(ii) Accepting deposits on the principle that a bank can invest the deposits at its own risk but share the profit with the depositor at an agreed manner, subject to maintenance of a minimum balance.
(iii) Principles of Qard Hasan: This is treating savings account taken from a depositor as a benevolent loan and granting such depositor, pecuniary or non-pecuniary benefits.
(iv) Accepting savings deposits into an investment pool and treating such deposits as investment deposits. This will be explained later.