1. INTRODUCTION
Some pundits of Islamic Economics who obviously seem to have been influenced by the tremendous growth of modern banking are of the opinion that Islamic Banks can function with a low rate of interest. After differentiating between 'usury' and 'interest', they claim that a low rate of interest is just in line with the spirit of al-Qur'an. 1 And there are some Islamic jurists and economists who are of the view that it is the "compound interest" and not the "simple interest" which is forbidden in Islam. That Islam has prohibited interest regardless of the form or the rate has been made unambigiously clear in al-Qur'an and al-Hadith. It is also clear that the distinction between "usury" and "interest" found in the English language is completely alien to the Islamic ideology.
However, doubts have been raised about the viability and ability of Islamic banks to function free of interest. Can the newly established Islamic banks co-exist, compete and survive with the modern banks based on interest? or will the Islamic Banks ultimately concede to world financial pressure? What should be the modus operandi of Islamic banks for inter-bank dealings as well as in performing other banking functions?
These questions are not new but are posed in a novel setting. The purpose of this paper is to answer these questions; and to define and state the scope of Riba-free banking in the context of modern banking and financial practices. It will also be shown that a socially, economically and financially viable model of Riba-free banking based on sound banking principles can be carved out.2
A model of Riba-free banks must, however, meet two basic requirements. First, it should be based on the Islamic shari'ah, and second, it must meet all the requirements of sound banking.
2. SHARl'AH FRAMEWORK OF RIBA-FREE BANKS
In terms of the Shari'ah Riba-free banking will be based on the principles of Mudarabah, or "mutual funds" where the share-holders, depositors, investors, borrowers and employees of the bank will be sharing the fruits of the system. The guiding principles of operation shall be based on the Qur'anic injunction: "Allah permitteth trading and forbiddeth usury". 3
"Trade" covers all types of spot transcations in finance, commerce, agriculture and industry including manufacturing and distribution. While Islam has encouraged such trade, it has prohibited gambling, extravagance and usury.
The present analysis is based upon the interpretation that Islam forbids all types of interest compound or simple, and that the RFB will neither accept nor pay even the lowest rate of interest whatsoever. But this should not be taken to imply that Islam forbids business on credit. Indeed, Islam prescribes a code of conduct for such credit
transactions. For example, the following verse lays down a moral constraint on the part of the lender:
"And if the debtor is in straitened circumstances, then (let there be) postponement to the time of ease; and that ye remit the debt as alms giving would be better for you if ye did but know"4
At the same time al-Qur'an directs to ensure safety and security in credit transaction as is evident from the following:
"O ye who believe! When ye contract a debt for a fixed term, record it in writing. Let a scribe record it in writing between you in (terms of) equity. No scribe should refuse to write as Allah hath taught him. So let him write, and let him who incurreth the debt dictate, and let him observe his duty to Allah his Lord, and diminish naught thereof".5
It is clear, therefore, that interest-free credit transactions with adequate safety are permitted in Islam.
It is, however, claimed that interest is such a key factor in all money transactions that people will not "save" and in any case will not part with their liquidity in the absence of interest payments. To what extent saving function is independent of the rate of interest cannot be discussed here. Suffice it to mention that in view of the present usage of interest rates in the financial system, it is observed that modern banks strive to earn profit mainly by making loans and by investing in such securities as government or private bonds. In the process, each bank acquires a portfolio of earning assets including bonds, promisory notes and other instruments, which yield an interest income. The banker's choice between "loan" and investment security is a function of "rate of return" and "risk" differentials.
How, then, will it be possible: for the RFB to assume "risk" and at the same time deny to itself any expectation of "rewards" or to expect a rate of return without the assumption of risk? In what manner will it cover its costs and earn compensation for the use of funds of others? What should be its modus operandi without rate of interest?
In finding solutions to these problems, it should be made clear that Islam fully appreciates the existence of all forms of natural and economic risks in 'trade' and in all types of business activities. But it insists that the 'risk' and 'return' must be equitably shared by all the participants in the productive process.
Modern financial institutions, for safeguarding the interest of various ranks of depositors, have encouraged the use of different types of 'privilege securities' where a class of capitalist is protected against the vicissitudes of business. Islam's denial of interest means that both capitalists and entrepreneurs, whose services are productive and essential, must assume risk and share rewards equally. It does not deny the existence of 'risk' but it encourages its widest diffusion throughout the entire society. This difference in approach, as will be shown in Section 5 of this study, has important bearing on the generation and distribution of economic surplus in a country.
The other part of the problem is related to the feasibility of a banking operation without the use of rate of interest. Is it possible to select assets without rate of interest, especially where the entire world economy is polluted with several structure of rate of interest? To reject the rate of interest is one thing: but to deny rate of interest to others who do not subscribe to the ideology is quite another.
There is certainly a way out. In the first instance, in a 'trading' operation which is quite different from a 'loan' operation, the RFB can be an active or sleeping partner in business without any prior claim on the surplus of the venture. In other words, it is possible for the RFB to enter into various forms of profit-sharing joint ventures.
In the case of loan transaction, the RFB will be allocating the 'risk' and 'reward' among all the member of the group. Thus, the depositors, the borrowers, the shareholders, employees and the RFB itself will be sharing the 'risk' and 'rewards' in proportion to the contribution made by each member of the mutual fund. From this fund it will grant interest-free consumption and business loans. But the borrowers in the group will not be penalised for the use of funds. In fact, the entire group shall bear the cost and shall be benefitted by the improved productivity of the users of capital. As will be shown in Section 4, this can be made possible by several 'Deposits' and 'Loans' Schemes.
It is important to note that Islam has not illegalised all those transactions from where fixed income may accrue without labour. It has made lawful those incomes which accrue from the rent of property including agricultural land. The RFB will, therefore, be free to buy, sell or rent land and buildings and undertake the construction of residential and commercial property. But it will not enter into 'speculation' or 'forward dealings' of any sort. In all avenues of business activities, the RFB will emphasize 'spot' transactions.
Further, as part of its business activity, the RFB will be charging commission and fees for the banking and non-banking services such as use of safe vault, trusteeship, remittances, collection, foreign exchange transmission, etc. These charges will be basd on actual cost of service without any element of 'interest'. Nonbanking activities have become an integral part of modern banks. The RFB will fully exploit the net-avenues in non-banking business which have no element of interest rates.
In these several ways, with a given characteristic distribution of its liabilities. The RFB will attempt to structure its portfolio of assets in such a manner as to yield the greatest return, subject to its accepted 'constraints'. Its assets will be divided into two broad classes-earning and non-earning assets. Its earning assets will consist of loan and investment. Its non-earning assets will consist of the total resources which will be partitioned into required reserves (secondary) and excess reserves (primary).
Modern banks make a selection of assets from the available menu of investment material according to their ability to assume risk. The RFB will choose investment avenues according to its own liability characteristics within the framework of the Shari'ah.
Having considered the broad Shari'ah framework within which the RFB can operate, we shall now turn to the details of the Riba-free banking principles which are discussed in the next section.
3. PRINCIPLES OF RIBA-FREE BANKING
A prudent bank will attempt to minimise risks. But the rate of return is directly related to the 'degree of risk'. Commercial banks are quite sensitive to investment risks because their capital cushion is very thin.6 Consequently, their investment policy has the following chief characteristics: (a) no item of less than first rate quality; (b) maturity staggered with the average length of deposits; (c) the bulk of funds to be invested in treasury issues, with ample diversification; (d) both the total and average maturity of the fund kept down to a point consistent with the size of the buffer provided by the bank's capital funds in general and its investment reserves in particular. This policy is adopted to insulate the funds against any possible investment risk, irrespective of the composition of deposits.7
A similar strategy shall be followed by the RFB, as its operation will not be free from 'risk'. The RFB will look upon its assets as providing first for the safety and availability at all times of the deposits entrusted to it and second, for the best earnings on its capital funds, consistent with such safety and availability. With a view to minimise the investment risks, the RFB will diversify its investment in terms of different types of securities, different firms, different industries and different geographical areas.
The allocation of the resources of the RFB among various categories of assets will be related to the characteristics of its deposits liabilities, i.e., their relative permanence, composition, concentration, pattern of seasonal and other fluctuations, etc.
In the choice of securities modern banks arc aided by legal regulations. The purpose of statutory regulations is to safeguard the interest of depositors and shareholders and also to prevent the banks from entering into 'undesirable' social activities. But an important feature of the banking legislation is that there is no uniformity. In the US itself, legislation differs from state to state. These variations aie made according to the social, economic and financial circumstances of the countries. But in all countries, within imposed molecular structure and a pedestrian operating technology, banks have found ways and means of participating in money markets without significant statutory constrictions.
The molecular structure of the RFB will be based on the Sluiri'uli. The RF:B shall follow a 'matching policy', just like the modern commercial banks, in the procurement of assets to match the nature of liabilities.
The Islamic Sharia'ah insists upon the institution of a socially optimal banking strucutre. This will be based on the following four criterion: (a) productive efficiency; (b) allocative efficiency; (c) absence of exploitation of depositors, borrowers and other clients; and (d) its adaptability to change with the demand tor banking.
Productive efficiency means that the RFB will be operating on commercial principles, maximising its profits. It also means that the social cost of its banking service should be equal or less than the social cost of producing the same service in modern banks.
Allocative efficiency requires that its loan structure does not give rise to inflationary conditions by encouraging extravagance. The loans granted must be safe and secure, especially since the RFB will be using the savings entrusted to it by the depositors without generating funds itself. Allocative efficiency also implies that the overall allocation of resources in the economy should not have any adverse effects on account of the loans being interest-free.
These macro considerations apart, allocative neutrality is needed to ensure a judicious distribution of earnings in the micro sense among depositors, shareholders, borrowers and employees. The RFB will make a fair allocation of profit between all the participants in the flow of funds - depositors, borrowers, shareholders - and will retain a portion of it for its own expansion- and growth. In addition, under the profit-sharing scheme linked with salary, a part of the profit will be allocated to the employees.
The third desideratum can be considered a derivative of the second. It will preclude exploitation of the borrowers, depositors, consumers of banking services and the employees of the bank - exploitation usually associated with discriminatory interest rates charged by modern banks. All borrowers will be assessed on their ability to repay the principal. In other words, all the 'admitted' borrowers of the RFB will be treated at 'par'. Thus, the RFB could never behave like a discriminating monopolist. This is a safeguard associated with name and intrinsic nature of business that emerges from the accepted framework of its organisation.
Finally, the RFB must be able to meet the changing technological and economic needs. With the effective mobilisation of savings, greater responsibilities will be imposed on the RFB which requires that resources flow into areas of relative scarcity so as to accelerate economic development. The investment policy of the RFB must be sensitive to changing needs so that it does not in any way impede stable economic growth. This requires that RFB should take shortest possible time to adjust its operation in response to changes in public demand.
4. A MODEL OF RIBA-FREE BANKING
Within the stated dimensions, the model suggested here specifies the following-range of activities, capital structure, distribution of profit and constitution of the Board of Directors of the RFB.
4 A. Range of Activities
The main activities of the RFB can be broadly categorized into (i) mobilisation of savings and (ii) investment of funds.
The RFB must, in the first instance, direct its efforts to mobilising savings, not only to accumulate resources, but also to change the 'passive forms of savings' in a less developed economy 8 by educating and motivating the masses because:
"Saving is also a habit, which can to some extent be created by propaganda...people can be persuaded to save in their own individual or family interest."9
Thus with a view to catering for people of different ages and income groups and of varying tastes and habits the RFB will be offering a variety of savings schemes. A few are mentioned below:
(i) Demand Deposits: Demand or Sight Deposits are the commonest type of deposits offered by banks in all countries. No interest is paid on these deposits. Charges are levied to meet the cost of the service. Some large banks insist on the maintenance of a minimum balance. The RFB will also levy charges and impose other conditions which are practised by other local banks.
(ii) Profit-Earning Deposits: These will be of two types: i.e., deposit received under the Joint Venture Plan, and deposit received under 'Unit Investment Plan'. Under the Joint Venture Plan, the deposit will be received for a term of 'trading period' which may be defined as one ranging from a week.to a year or several years. Those depositing under this plan will share the profit and losses of the RFB only for that trading period. The 'trading period' can be extended at the request of the depositor. The 'Joint Venture Account' holder shall be entitled to a pro-rata share of profit on the basis of effective average balance maintained by him during a specific 'trading period'.
Under the Unit Investment Plan, the depositors will be required cither to deposit a lump sum or to make a regular contribution. The deposit made under the Unit Investment Plan will be treated as part of capital of the bank, but it will be refundable at the option of the depositor after the expiry of a stipulated time. The pro-rata profit will be paid to the depositors either in cash or credited to the 'Unit-Investment Plan'.
(iii) Saving-cum-Housing Plan Deposits: A person with specific income can become a member of the Saving-cum-Housing Plan Deposit Scheme. Under this scheme, in exchange for a monthly subscription, the RFB will give loans to construct or purchase a house The RFB may also construct houses as per specifications of the clients. The member will be refunding the principal amount in monthly instalment without any rate of interest. But he will be required throughout his membership of the scheme to pay a monthly sum into the 'Unit Investment Plan' explained above. He thus becomes eligible to share in the profits of the RFB and enjoy the advantage of holding double assets at the same time - a house plus Investment Units.
Having considered mobilisation of savings, we shall now turn to the investment of funds so mobilised. The distribution of assets into primary, secondary and earnings reserves is a function of the volume and types of deposits attracted by a bank. The composition of assets of the RFB will therefore be conditioned by the liability characteristics of deposits mobilised, the Shan'ah and the availability of investment opportunities. The investment outlets for the RFB include loans, direct investment, and non-financial business.
(i) Loans: The lending of money is regarded as one of the essential functions of n modern bank. But every bank has its own lending policy and procedure. In the case of the RFB, a number of possibilities exists: (a) lendings to those business concerns in which it has profit-sharing interests; (b) lendings to firms and families under Credit Plan linked with the Unit Investment Plan' and (c) lendings to consumers and business concerns under 'Check-Credit Plan', credit card scheme, etc.
The RFB may provide loans to business concerns on a profit-sharing basis. Alternatively, interest-free loans may be linked to the Unit-Investment Plan discussed earlier. The 'Unit Investment Plan' in this case would act as a 'Revolving oFund' were all members contribute their respective share to a joint fund from which they are allowed to borrow. The RFB may extend a line of credit under the 'Check-Credit Plan', were credit is posted to the Customer's Check-Credit Account. The RFB may also provide a line of credit in the form of a credit card whjch will enable the holder to buy goods and services from approved merchants. The RFB will not be charging any interest but it will be asking the borrower to become the member of the 'Unit Investment Plan'. A service charge will be imposed on the borrower on the "amount of credit utilised (withdrawn) by him.
(ii) Direct investments: The direct invcsmcnts of the RFB will take the form of equity participation in companies with limited liability and dealings in real estate.
The RFB will be seeking profit-sharing opportunities preferably in companies incorporated with limited liability. In case the profit-sharing opportunities are not available at home, the RFB can serve as a feeder bank to the bigger institutions such as the multi-lateral, bilateral and regional Islamic Banks.
In view of the limited investment opportunities in developing economies, it may be necessary for the RFB to invest in real estate. The RFB can acquire land and construct housing colonies and commercial property.10 It will be retaining full control over these investments. A part of the real estate can be maintained for rental income and the rest can be sold under 'saving-cum-housing' scheme described above.
(iii) Non-Financial business of the RFB: Income from non-financial husiness transactions accounts for an increasingly significant proportion of the total earning-of modern hanks. This is an area where the RFB can he more venturesome, as there is an enormous scope for it within the Shar'ah Framework. Its non-financial business will include consignment, joint venture, factoring, management consultancy counselling in trade, trust business, safe deposit, and other hanking and agenq services.
The RFB can enter into consignment business under an agreement with the exporters. Consignment agreements are short-term arrangements where goods an despatched to an agent (say the RFB) for sale, but the ownership of such good; remains vested in the name of the sender (consignor).
When the RFB, as agent, effects a sale, the property and the ownership of goods are transferred to the buyer. Thus the goods will not at any time be the property ol the RFB which will however, receive payment for the goods from the buyer. After deducting any expenses incurred together with its own commission, the RFB will remit the balance (the net proceeds) to the consigner. In order to reduce risks involved in the transactions, the RFB can simply take factoring or enter into joint ventures, as explained below.
In factoring, the lender (the bank) underwrites the extension of credit bv purchasing the accounts or notes receivable of his clients, typically without recourse to them for any credit losses. Consequently, the factor must take the responsibility for approving credit on sales made by manufacturers and merchants. The customers of these companies are notified that their accounts have been purchased and are payable to the factor on due dates, usually within 60 days. In modern banking, the factor's compensation consists of a commission (usually 1 percent to 1 1/2 percent based in the face value of the purchase receivables and interest.11 In the Riba-free system the terms, conditions and commission rates can be modified after eliminating the interest element. In addition to assuming the role of collecting money, the RFB may also enter into a joint venture with the exporter or the supplier of goods. A joint venture is regarded as partnership for a specific transaction, and/or for a specific term, where the resultant profit or loss is shared in the porportion agreed upon.
The venture may take the form of development and exploitation of a patent, where the RFB will be contributing capital for expenses and experiments. More often than not, the RFB venture will consist of trading transaction e.g., buying a consignment of importd goods.
'Trading' cither by consignment, factoring or joint venture involves more risk than the simple 'loaning' which is carried on by the modern banks. The liability structure is accordingly designed to permit assumption of risk, vis-a-vis deposit pattern. But to ensure safety RFB will take following protective measures:
In the first instance, under no circumstances should the RFB indulge in hoarding, speculation and forward transactions, which are prohibited in Islam. Secondlly, its trading should be restricted to products which have stable demand and form the necessities of life, thus avoiding those commodities which are prone to violent price fluctuations. Finally, it would be wise on the part of the RFB to diversify its trading activities. For divcrsificaion of funds among several consignments and ventures helps spread the risks, although it does not eliminate them.
The RFB will have to develop its own technical, managerial and financial expertise which will provide an important input into decision-making on non-financial business matters. This pool of expertise can also he tapped to provide consultancy services to the business clients of the RFB at a fee.
Similarly, for real estate management, a full cadre of architects, engineers, legal experts and real estate managers will he required. The services of the same staff can be utilised in the running of the hanks trust business, i.e. the management of the property of others.
Rental from safe deposit vault constitutes an important source of income for the modern hanks. The RFB can easily offer this service, as it will amount to fully utilizing the capacity of the watch and ward establishment which it will have to maintain in any case. The RFB can also offer a number of other usual banking services such as remittances, transmission of money by wire and cable, collection exchange of foreign currency, etc. These services will carry fees without any interest element.
The RFB can extend its operations internationally by linking itself with the already existing multi-lateral and bilateral Islamic Development Banks (IDBs) 12 which provide interest-free loans and outright grants to finance specific development projects. In some less developing countries IDBs have been successful in establishing enterprises on a profit-sharing basis. There will be room for partnership for RFB in such joint ventures. In addition, a 'consortium' of IDBs can he set up to finance various projects thereby proportionately reducing the financial risk of each participating member.
4B. Optimal Capital Structure of the RFB
Given the range of activities described above, it is possible to determine the capital structure of the RFB. The question of capital adequacy is important because the RFB has been conceived in this study as an aggressive, growth-oriented institution. The RFB requires adequate capital to meet the growing demand of the clientele and to earn profits for its share-holders.
The operating efficiency of a bank is governed not only by the volume of capital but also by its composition. A bank's capital fund normally consists of capital stock, surplus, undivided profits and reserves. In addition, the capital of the RFB will also include the trading balances of 'Unit Investment Plan' and 'Joint Venture Account'. The capital structure should conform to the ratio of capital to 'risk assets' and the degree of risk.
The proportion of assets held in the form of required reserve is determined by the existing legal reserve requirements against commercial bank's demand and time deposits. Given the de jure and de facto status of the majority of its liabilities, and given that the bank cannot predict with certainty the future deposit flows, loan demands and actions of the monetary authority, the RFB will have in its portfolio of assets a stock of liquidity to act as a buffer against changes in these factors. The RFB may hold this stock of liquidity in the form of excess reserves which will act as an immediate source of liquidity, enabling the RFB to minimise the adjustment problems associated with the re-structuring of its portfolio.
However, experience shows that the commercial banks' exposure to the liquidity demand of small and medium-sized depositors is, under most circumstances modest in proportion, predictable in time and, therefore, manageable. Specially in respect of demand deposits, the commercial banks have observed that ordinary money claims (withdrawals) against demand deposit simply roll around the community from one account to another. This indicates that if the RFB could attract a balanced panel of depositors from various economic strata of society and geographical sectors, in its area of operation, it could safely re-lend the funds to industry, agriculture and the government on a long-term basis.
4C. The Distribution of Profits
It was indicated earlier that the RFB will be operating as a mutual fund and that its profit will be distributed among all the participants. Joint Venture Account depositors. Unit Investment Plan depositors, shareholders, and employees will have claim on the profits of the RFB. The shareholders will have a right to expect a reasonable distribution of the bank profit, after all others have been paid their respective share of profits in proportion to their contribution to the system. It is to be expected that the dividend rate as well as the share of each participant in the system will vary from time to time.
Modern business firms contribute to the employees' provident funds. These funds grow with interest payments credited every year. The RFB employees and other executives will not be deprived of any such benefit simply because the bank cannot enter into any such transactions based on interest. The RFB may offer the following schemes to its employees: (a) Pension Plan linked with Unit Investment Plan: and (b) Profit-sharing Plan with benefit paid in cash or deferred until retirement.
Under the Pension Plan the employees will receive a number of actuarially computed Units which will be a source of income to him in the future. Such funds are contributory, where the employees will pay their share in cash.
In the Profit-sharing Plan the employee will be sharing in the profit of the RFB. He can withdraw the annual profit in cash or he can purchase the 'Units' from the 'Unit Investment Plan' or he may resort to a combination of both. The Profit sharing Plan should offer the employees a continuing incentive to improve the efficiency of the organisation and to increase the profits.
4D. The Inter-Rank Relation:
Although banks actively compete with each other, they are mutually dependent upon each other. Banks must have an agreed plan for inter-bank services, especially the following: (a) collection of checks, drafts, notes, trade acceptance, commercial papers, bonds, and other items; (b) investment information and advice, buying and selling of securities; (c) international transfers; by wire or cable and information and aid on foreign transactions; (d) credit information and assistance on loans, including participation in loans; and (e) supply of currency and loans. In addition to these commonly used sen/ices, banks frequently give specialised help and assistance to correspondent banks on such matters as appraisals, tax information and advances operating equipment and procedures, training of officers and employees, trust service and other activities.
Inter-bank services and relations are based upon mutual understanding and regard. They are tailor-made and work by crediting and debiting items on each other. Hardly any cash passes on between the banks, the RFB can establish such bank relations without any deviation from its principles.
4E. The Constitution of Board
The RFB in this study has been conceived as an institution which will ensure allocative efficiency. This cannot be attained fully without proper balance of control. This calls for a 'balanced' Board representing the various interests such as depositors, borrowers, other consumers of bank services, shareholder. Government, the central monetary authority, etc.
A balanced board, as outlined above, will ensure wide representation from each category of shareholders, each category of depositors and each category of employee.
4F. Summarised Model of the Riba-Free Bank
The RFB model can be condensed in the form of an Income Statement- and Balance Sheet item.
MODEL OF INCOME AND EXPENDITURE STATEMENT OF THE RFB OPERATING EXPENSES:
Salaries and Wages and Other Employees Expenses Expenses on Account:
Consignment
Factoring
Joint Venture
Trust Business
Real Estate Department
Trade and Management Consultancy
Safe Vault
Other Banking Business Expenses
Total Operating Expenses
OPERATING INCOME.
Income from:
Consignment
Factoring
Joint Venture
Trust Business
Trade and Management Consultancy
Safe Vault
Other Banking Business
Commission from merchants
Other commission
Total Operating Income (excluding investment income):
Investment Income:
Dividend from Profit-sharing
Rents from Housing Projects
Total Income
SURPLUS : Income minus Expenses
PROFIT AND LOSS APPROPRIATION ACCOUNT
Depositors share in profit
Borrowers share in profit
Bank Employees' share
Reserve Fund
Shareholders Dividend
Retained Profit
BALANCE SHEET
1. Capital Reserve and other Liabilities
Authorized Capital
Issued and Paid-up Capital
Allotted as follows:
Government
Multilateral & Bilateral
Islamic Development Banks
Other Regional Riba-Free non-hanks
Open to public subscription, individuals and institutions
Long- Term Rihti-l-rcc Loans from the Government
Capital Account Balance from Unit Investment Plan
Capital Account Balance of Mutual funds
Reserve Funds and other Reserves.
Deposits:
Demand Deposit
Joint Venture Account
Unit Investment Plan
Housing Plan Deposit
Government Deposit
Inter-bank Deposit
Trade Creditors under:
Factor Accounts
Joint Ventures
Consignment
Other Trading Operations
Borrowings from other Banks
Miscellaneous Liabilities
Profit & Loss Account as per last Balance-sheet
TOTAL LIABILITIES
2. Property and Assets:
Cash in Hand and with Central Monetary Authority of the country
Balance with other banks
Advances to Debtors under:
Consignment
Joint Venture
Factoring
Other Trading Accounts
Loans and Investment:
Loans:
Housing Plan Schemes
Charge Account Scheme
Check Credit Plans
Other Business Loans
Other Consumption Loans
Investment:
Profit-sharing Interests
Real Lstate Project
(a) Residential
(b) Commercial
Other Assets:
Premises
Furniture and Fixtures
Other Miscellaneous Assets:
Gold + Silver
Non-banking Assets
Profit and Loss
TOTAL ASSETS
SUMMARY AND CONCLUSION:
In this study an attempt has been made to present a viable model of Interest Free Commercial Banking. The model assumes that interest in every firm and at any rate is prohibited in Islam. Substitute for rate of interest is suggested not by crude and subtle maneoeuvers to circumvent the prohibition of interest on loans by such devices used in the past as Bay'al-Wafa or Mukhat'tarah, but by drawing from examples set out by the Prophet (peace be upon him), i.e., resorting to such business partnership as Muzur'ah, Musaqah, Mugharsah, and Qirad/Mudarabah. The various deposit schemes and investment outlets suggested in this model are based on those methods and practices which are approved by the Shari'ah.
Interest rate in modern banking is said to perform two important functions, i.e. as a means of attracting deposits and as a criterion for determining the investment activities. But empirical studies indicate that there is no direct relationship between the rate of interest and volume and form of personal savings.13 It now appears that the success of any financial institution in the mobilisation of savings depends upon its ability to meet the taste and requirements of the people.14 Besides, capital market itself is highly imperfect where 'product differentiation' is based upon salesmanship advertisement and personal approaches. In such a market it will be possible for the RFB to devise saving schemes distinctly different from those offered by modern banks.
Similarly, the structure of modern commercial banks consist partly of profit-yielding assests such as equities and partly of interest-yielding assets such as debentures and loans. This, again, is related to the banks circumstances and preferences. In some countries the government has prescribed rules governing the portfolio structure. Banks have on their own, however, avoided marketable securities, since the marketable corporate securities in general, and the ordinary shares in particular, carry additional risk of valuation. This risk is absent in the case of loans, the duration of which can be tailored to match the term of the banks' liabilities and hence their preference for loans.
There is, however no uniformity in the ratio of loans to equities. It depends on the availability of different types of investment opportunities and also on the circumstances of the banks. There is no standard mixture which can be imposed on the RFB.
In short, the high proportion of interest in the operating income and expenditure Hows of modern banking is mainly due to the peculiar nature of the exchange economy which encourage the use of interest and the preference of the banks to indulge in transactions involving buying and selling of money at a price. Even in an exchange economy, it will be possible for the RFB to select such 'income' and 'expenditure' flows which do not involve the use of interest. It can blend, in other words, its own mixture of 'commission', 'fees' and 'charges' by performing such functions and services without the interest component, without in anyway violating any sound banking principles. The RFB must, howevec. ensure that the funds do not remain idle. The funds should always be put to work. At the same time, liquidity should be taken care of, and accordingly adequate areas of 'secondary assets' must be found after a careful identification of the nature of the transaction.
Keeping in view the additional constraints involved in interest-free banking, several savings schemes for the RFB have been suggested in this paper. They include Demand Deposits, Joint Venture Plan. Unit Investment Plan and Housing Scheme. Each of these schemes has distinctive character and differ from those offered by modern commercial banks. In this regard, it is imperative to create as much diversity as possible through product differentiation to suit taste and needs of various income and age groups.
Savings mobilised by the RFB will be its liabilities and it must bring in corresponding assets to: (a) meet the de facto and dc jure requirements of cash, (b) fulfill the expectations of the depositors and borrowers, (c) cover the administrative cost of the banking and non-banking operations (d) yield a syrplus to satisfy the depositors and (e) contribute to its reserve for future expansion and growth. These objectives have to be realized within the framework of the Shari'ah and should be consistent with the stage of economic development of the country.
Modern commercial banks solve these problems by dividing their assets into three categories - i.e., primary reserves, secondary reserves and earning assets. Primary reserves consists of cash, balances with central banks, etc. to meet the day-to-day requirements. They are seldom maintained in amount much larger than necessary for routine operations.
Secondary reserves consist of short-term, low-risk and highly marketable obligations that can he converted into cash quickly. Besides ensuring liquidity, the secondary reserves, which mainly consist of treasury bills, also yield some income.
It is true that the RFB cannot have such a wide option to keep all its resources profitably committed in the short period, because government securities and commercial papers are interest-bearing. In fact, short-term loaning will not be easily available the RFB. We have, therefore, suggested short-term trading in consignment and joint ventures as appropriate sources of income for the RFB. These, however, entail greater risks than loans, but simultaneously the prospects of earning profits are good.
In the management of earning, assets which will be a source of medium and long-term investments, the RFB will be in a relatively comfortable position. The avenues of investment suggested here include direct investment in business based on profit-sharing, direct investment in real estate, and business, consumption and housing loans linked with the Unit Investment Plan. It, however, appears that direct investment will be primarily in real estate - housing and commercial property - rather than in profit-sharing business, the scope for which is at present limited.
In this manner it has been shown that a viable model of banking without rate of interest can be designed. But there are illusions such as the following passage:
"The crux of the problem is that, after allowance is being made for such elements as the premium of risk, the objections against interest reduces itself in the final analysis to what economic theory call pure interest, i.e., to an intangible factor. Each time when attacked this factor could freely move in any direction, trying to disguise itself as premium of risk or as a normal profit, with the loan act being changed to trading act That is why most of the experiments up to the present time focussed attention on limiting rather than eliminating interest. To construct a model of an economy where interest does not exist while the premium of risk and normal profit are tolerated, and then to call it an 'interest-less economy' would be too naive an experiment to rely upon seriously".15
It cannot he denied that under the modern capitalist system and exchange economy it is hard to conceive a banking system without rate of interest: but it not impossible. However, our task has been made difficult not by the actual prevalent circumstances, but on account ot the wrong interpretation of economic values. For example, in carving out a model for an interest-tree banking we must make a distinction between 'trading' and Moaning' operations and between 'real investment' and 'financial investment' and we should be aware of the type of risk associated with them in a static as compared with a dynamic economy.
For example, in consignment business and short-term joint ventures, the RFB will be engaged in actual trading. If the venture is successful, it earns a profit: and if unsuccessful, it bears the losses. Modern commercial banks, in financing trading operations through commercial papers, insist upon a prior claim: interest free banking being residual claimant wait till all charges are paid and a real surplus emerges out of the trading activity.
Besides, the loaning operation of modern banking and the trading operation of the RFB have different social and economic consequences. Loaning operations encourage stock hoarding and speculation. Since expected price increases enhance the profitability of the borrowing firm, the banks risk rating in such cases will be reduced, and the banker will be prepared to renew the loans for further stock hoarding even at reduced rates of interest. Consequently, this expected price-profit spiral suits the lending policy of the commercial banks. In a market economy when the conditions become 'too bad' such tendency is controlled byttnc direct intervention of the central bank.
In contrast to this, the RFB is not allowed to 'hoard' or 'speculate' in trading. This is likely to produce a better influence on the general price level in the economy. Thus its trading operation must be distinguished from the loaning operation of modern banks in terms of both economic and social implications.
Likewise, an economic analysis be intelligent enough to draw a distinction between 'real investment' and 'financial investment' and the type of risk and rewards. It appears the critics of interest-less economy have failed to draw this obvious distinction. Financial investment simply involves a financial transaction to facilitate real investment. The risk involved in such transaction is related to the paying capacity of the borrower. But the users of capital who borrow to make real investment are not sure of the outcome of their investment decision. In this manner, both 'interest' and 'profit' represent compensation for the assumption of risk, paid out of the surplus generated from the productive process. There is, however, a fundamental difference in their nature and as a factor of economic cost.
Besides, interest and profit have different implications for economic growth. The development process itself has an element of 'uncertainty' and 'risk'. The users of capital who raise funds for real investment are not certain about the result of their investment activities, yet the contractual nature of loan requires that the borrower must pay a fixed rate of interest irrespective of changes in his paying capacity and without knowing the result 'of his efforts. This prior commitment undoubtedly constrains the productive process. The significance of interest, profit and their relationship within the development process has been very well explained by Schumpeter16 as follows:
"Interest is not, like profit for example. a direct fruit of development in the sense of a price for its achievements. It is on the contrary rather a brake - in an exchange economy a necessary brake - on development, a kind of'tax'on entrepreneurial profit"16.
According to same time of thinking, profit or economic surplus is itself a temporary phenomenon in a dynamic economy,17 while interest is a permanent charge that flows to a particular class of people.
Islam recognises the productivity of capital but at the same time does not allow its prior claim on productive surplus. It insists upon a fair distribution of risk and reward. The fixed rate of interest charges on a surplus, the origin of which is temporary and uncertain, can create serious impediments in growth process. In contrast, profit acts as a stimulant to growth, and "without development there is no profit and without profit no development (and) in capitalist economy ... without profit there would be no accumulation of wealth."18
It should be clear, therefore, that by eliminating interest, the Islamic doctrine of distribution of economic surplus ensures uninterrupted growth and steady accumulation of capital.
The preceding analysis drives home the point that the RFB will be able to compete with its rival modern banks in the mobilisation of savings and the purchases of assets. Apparently. those who advise us to "codify interest-bearing loans by treating them as new norms"19 are not aware of the tendencies related to the changing practices of banking and the ability of the RFB to design its product which can be differentiated in the 'imperfect market'. In a competitive market, the RFB will be distinguished for combining economic and social aspects of money transactions. This is possible to attain without imparing the financial viability of the bank in any way.
The RFB must take adequate safeguard that its interest-free loans do not in any way instigate inflationary tendencies in the economy. Borrowing should encourage 'thrift'. Thus it is suggested that, in granting loans, the borrower should ultimately become a saver in the group, if not immediately, at least at the time of repayment of loans. This will be arranged through 'Unit Investment Plan'. The RFB, while meeting the current needs of the borrower, will also establish an 'asset' in his favour so that he may be better off in the future.
However, the operation of the RFB will not be free from problems. But the problems are, in fact, opportunities in disguise. As it is, these opportunities permeate the entire fabric of the RFB. one of its problems is proliferation, especially arising on account of the non-availability of suitable investment opportunities without rate of interest. But problems of this nature can be solved through continuous search for investment opportunities.
COMMENTS
Dr. Mohammad Uzair (Discussant)
Prof. Mohsin's paper on Riba-free Banking is a very detailed 'profile', perhaps more detailed then the word 'profile' would suggest. He has chosen the term 'Riba-Free Banking' in place of 'Interest-free Banking', presumably because the word 'Riba' has been used in al-Qur'an. However, there is a conceptual problem. Some translators, including the ones that Prof. Mohsin has cited, have translated the word 'Riba' as 'usury' rather than 'interest'. In the English language the term 'usury' has been usually employed to mean 'excessive' or 'compound' interest rather than the 'normal' or simple interest. Prof. Mohsin himself has mentioned the point of difference in this connotation.
He has also made it clear that according to him interest in all forms is forbidden. However, he has used the term Riba which has been interpreted by some scholars to mean 'compound' or excessive' interest. Perhaps the term 'Interest-free Banking' would have been more pertinent and desirable, because by this time the term has gained- currency and acceptance in the current literature on the subject. This is, perhaps, a matter of semantics, but it is mentioned here mainly as a precautionary observation.
Prof. Mohsin has gone into great detail about the operations of the Riba-Free Bank or the RFB, as he calls it throughout his learned paper. He has given a very elaborate picture of various types of business activities in which the RFB might engage itself. In fact. Prof. Mohsin has gone even into such details as the prospective shape of the Balance Sheet and the Income Statement or Profit and Loss Account of a RFB. However, no illustrations have been used. That would have made the presentation of balance sheet and income statement more meaningful. The effort is laudable, meticulous and impressive. An important conceptual point in this regard is that Prof. Mohsin has extended the principle of profit-sharing to include not only depositors or customers but also the employees of the bank. Perhaps, there may be some conceptual justification for including the employees in the profit-sharing in the sense that the origiinal literature in 'Fiqh' refers to Rabbul Maal (Owner of Capital) and Amil (One who uses it) in the context of Mudarabah'. However, there is a room for difference in this respect, because the basic Mudarabah is between the owners of the capital, the owners of the banks and the ultimate users of the capital. Perhaps the bank employees in an Islamic society would not be different from the employees of other enterprises engaged in manufacturing or other fields of business.
The scheme of bonus which is prevalent in business enterprises, financial as well as non-financial, is in a way an arrangement to share the profits. The question arises: will the employees of banks in the RFB system be entitled to a bonus like the employees of other businesses or will they be treated differently? My own view is. that, perhaps, the extention df the profit-sharing principle to include the employees is not necessary or obligatory.
There are various kinds of banking institutions, i.e.. Investment Banks, Development Banks and Commercial Banks. In any discussion on banking, unless otherwise specified the term 'banks' usually refers to 'commercial banks' rather than 'investment banks' or 'development banks'. Prof. Mohsin seems to combine all three in one RFB. This seems to be both unfair and unnecessary. Many developing Muslim countries have already got Investmetn Banks and Development Banks'operating as specialised institutions. There is no reason why investment Banks and Development Banks should not be permitted to continue to operate separately, especially since it will be a lot easier for these two kinds of banks to operate on an interest-free basis than it will be for the commercial banks in the transition phase. In fact, the Investment Banks and Development Banks can take a lead in the process of transforming the modern banking into interest-free banking.
According to Prof. Mohsin, the earning assets of the RFB fall into two broad categories:(1) loans which come under the lending scheme linked with the Unit Investment Plan, and (2) direct investments. Under the first category he includes the "Unit Investment Plan" loans to business concerns, the Charge-Account plan or the Credit Card Scheme. The second category includes direct profit-sharing arrangements with companies having limited liabilities, and real estates. Prof. Mohsin also mentions 'non-financial' activities including consignment business, factoring, joint ventures, technical assistance and consultancy, trustee business, safe deposit vaults, etc.
A brief look at this wide spectrum of activities would show that the RFB. according to his 'profile' or thinking, is going to be a very complex business. We will discuss some of the problems associated with some of these activities. The Unit Investment Scheme belongs to investment banking rather than commercial banking. To say that interest-free banking must operate Unit Investment Plan is going too far. After all, the distinction between the investment banks and commercial banks has to be maintained, and to force commercial banks to do investment banking is questionable. The Unit Investment Plan partakes of the character of Mutual Funds or Investment Trusts which are regarded as non-bank financial intermediaries. Likewise, trust banking scheme is a developed field in the United States. It is not likely that most of the developing Muslim countries would see a flourishing business in trust banking in the foreseable future.
As mentioned earlier. Prof. Mohsin has given a very detailed exposure of various kinds of business activities which can be undertaken by the RFB. He has made it obvious that he is very familiar with the American financial institutions. In an attempt to underscore the economic viability of the RFB, he has included in the purview of banking almost every kind of financial services rendered by various kinds of institutions in the United States. As is well known, there is a clearcut distinction between banks and other financial intermediaries. To include all the activities which are the functions of non-banking institutions within the ambit of the RFB is perhaps far-fetched.
Prof. Mohsin mentions factoring and real estate business as examples of such non-banking activities. But it is not certain that there will be enough room for'factoring'. Real estate, on the other hand, is not only a specialised business but is also an unsafe business for commercial banks as we know them today, investment in real estate is appropriate for insurance' companies which have long-term funds. It appears that Prof. Mohsin has been influenced by studies on insurance business. This is evident from some of the references he has cited. If the RFBs operate bv and large as commercial banks, which I think they have to, activities like real estate business are contra-indicated.
In the case of factoring, the "factor" or 'credit collector' charges an amount a remuneration in proportion to the amount to be collected on behalf of the clients That there is a time dimension to it implies a predetermined rate of return or remuneration over a time period, for which there is no room in the RFB. Similarly in the case of 'Charge Account' or 'Credit Cards' scheme, suggested by Prof. Mohsin there is a certain percentage, usually 1 per cent of the amount of credit involved associated with a certain time span, usually one month. This for all practical purposes is also a kind of interest. Thus on the whole, some of the schemes suggested by Prof. Mohsin particularly 'factoring' and 'charge account' scheme would amount to retaining interest.
The proposition that the RFBs should engage in 'joint ventures' presents a point for pondering. To prove the economic and business feasibility of the RFB as commercial banks we do not have to resort to extremely unusual types of activity. Assistance from commercial banks in the new enterprises at the formative stages in the form of investment either on the basis of profit-sharing or buying equity shares and stocks is an accepted practice in many countries. However, joint ventures on a long-term basis is an unfamiliar, and perhaps even unadvisable. business activity. No doubt the history of German banking has shown a close linkage between banks and industrial enterprises, but this development in Germany took place in the context of a peculiar set of circumstances. Moreover, this practice of German banks was subject to the criticism that it led to a heavy concentration of economic power in the hands of the banks and to the creation of 'cartels'. Thus, the RFB's participation in joint ventures may not be consistent with the present-day emphasis on public control of business and anti-trust measures. After all. Undue monopolistic power in the hands of banks would also be objectionable from the Islamic point of view.
Another unusual field of activity for the RFB suggested by Prof. Mohsin is the consultancy business. In the modern world consultancy is a highly developed and sophisticated and independent business activity. Whether the RFB should or can successfully handle consultancy business is an open question. It is true that large commercial banks do maintain large research departments not only to guide the management but also to provide information service to the clients. However. to carry on large scale consultancy as a part of the main business operations of the proposed commercial banks under the RFB system would be far-fetched.
Prof. Mohsin speaks of 'non-banking services of the banks'. I thought he was referring to subsidiary services of the banks. But, he also refers to 'non-financial activities of the banks'. The relevant question is: should we or should we not attach so much importance to non-banking or non-financial services of banks in the context of the RFB? Prof. Mohsin has spent space and time more on these non-banking or non-financial services than on banking services. This I find questionable. Moreover, must we prove the viability and feasibility of interest-free banking by converting the banks into something that resembles a modern departmental store carrying all kinds of items in one huge building? We have to prove the viability or feasibility of interest-free banking in the present-day world in such a manner that banks remain as they are understood to be at present. Deviations in the bank's objectives and functions must be minimised so as to eliminate interest from all transactions. In other words, the difference between modern and Islamic banks should be found in the technique or principle of operation, i.e., substitution of interest by profit-sharing, and not in the nature of business and functions, which characterises commercial banks..
The way Prof. Mohsin has squeezed all 'non-banking' scrvices of financial intermediaries prevalent in the United States in an interest-free banking system poses two other fundamental questions. The first question relates to the feasibility or advisability of transplanting peculiar American institutions and businesses in Muslim countries which are in different stages of economic development. It is true that about seven Muslim countries have per capita incomes comparable to sixteen most developed countries in the West, and at least four Muslim countries (Kuwait, Libya, UAE. and Qatar) have per capita incomes exceeding those of the advanced countries of the West.
Most of these rich Muslim countries have relatively small populations with a limited scope for large-scale operations. Limited market size also means limited room for division of labour and specialisation. It is questionable whether these countries are ready for the most sophisticated non-banking financial institutions to be transplanted into their banking system. Even if this were feasible, hypothetically speaking, what about the rest of the Muslim countries whose number exceeds forty? I strongly feel that the institutional framework of any business should be allowed to evolve itself, given the peculiar set of circumstances - geographical, historical, cultural, social, etc. Artificial transplanting of institutions would almost amount to fixing a jet engine to a bullock-cart.
The second question revolves around the administrative aspect. The process of transformation of modern banking into an interest-free banking has to be administratively practicable. As a former teacher of Business Administration. I feel that Prof. Mohsin's scheme involves serious administrative problems as well. If he is talking about the creation of department-store-like banking, it has to be applicable and, practicable not only for new institutions but also for existing ones. Many Muslim countries have had well-established banking institutions for almost three-quarters of a century. The average age of the bankers manning these banks would be around forty. It is really practicable to re-train or. what is worse, to replace these bankers by new ones who can run all the new businesses in vogue in USA in their respective developing countries? I have my doubts. In fact. I feel it is likely to create a great deal of administrative problems. Thus, on both the counts. Prof. Mohsin's scheme of complex banking business, introduced along the change in the principle or technique of replacing 'interest' by 'profit-sharing', would lead to unnecesary complexities. From a strategic point of view, too. it-will not be desirable to do so.
Prof. Mohsin refers to the allocative function and role of banks. But he neglects some important aspects of the allocative role of the commercial banks, e.g.. 'inter-sectoral' and 'regional' allocations. Most of the developing countries, where the Riba-Free Banking is likely to be introduced, require a balanced economic growth. The central bank and all leading agencies and institutions in these countries have to maintain a balance between sectors and between regions in the larger economic interest of the country. The nature of the commercial banks' businesses is such that every single investment or loan made by them has repercussions on sectoral as well as regional allocations of the nation's financial resources. Commercial banks, therefore, either under the guidance of the central bank of the country, or on their own, have to observe this aspect of their allocative role. The allocation of the financial resources actually belonging to others has to be made in a judicious manner from the socio-economic point of view. on the whole. Prof. Mohsin has not paid much attention to the socio-economic responsibilities of the banking system. This is an important aspect keeping in view the role of the banks as well as the thinking of the experts on banking in most developing countries and even in some developed countries. The omission is especially noticeable because he goes into the question of judicious allocation of profits in banking in the micro and macro sense, and even speaks of allocation of profit among the the employees of the banks.
Prof. Mohsin says that interest-free banks can 'co-exist' and 'compete' with the present-day banks. This raises a fundamental question of some interest to the participants of this Seminar. The question is as to what would be the strategy for Muslim countries interested in introducing interest-free banking. Would it be desirable to establish one interest-free bank or RFB in each country to serve as a 'model' leaving the rest of the banking sector as it is? This is the approach of 'coexistence'. The other alternative is to work out a detailed strategy for a phased programme of gradually transforming the entire banking system. This approach is ideologically oriented. My personal view is that there is no harm in establishing 'model' banks, but that alone is not enough, the reason being that the creation of one or even a couple of 'models' does not, conceptually speaking, absolve the governments of the Muslim countries of their obligation to inject Islamic principles into banking. Moreover, even this 'clean' and 'pure' 'model' bank inevitably has to deal with other banks and, of course, the central bank. This raises conceptual and ideological objections.
My approach is that side by side with establishment of 'model' banks - whether commercial or investment or development banks - each country should initiate a phased programme of partial reforms for the entire banking system into an interest-free one. This, in my opinion, is a realistic approach. If the participants agree, this could form one of the recommendations of this historic Seminar on Monetary and Fiscal Economics of Islam. May Allah bless us all.
GENERAL DISCUSSION
1. Dr. K. T. Hosain remarks that Dr. Mohsin's description is lucid but his arguments are not well fashioned. According to him the strength of the paper lies in the fact that it presents a model which can be operated in a society which is not predominantly Muslim.
He expresses disappointment, as the author has not discussed in his paper the role and contribution of the RFB in the process of economic development. To Dr.Hosain, this represents an important issue for Muslim countries most of which are underdeveloped. He also expresses some doubts as to whether strict supervision and control of banks suggested by the author, would work efficiently in practice.
Finally. Dr. Hosain points out that the Qur'anic principles may be implemented with greater ease internationally than at the personal level. However, he does not elaborate. The point he is trying to drive at is that international development banks may be more feasible than the RFBs as conceived by Dr. Mohsin.
2. Dr. Nejatullah Siddiqi raises a methodological point. He is particularly struck by the situation posed by the author where interest-free banks and interest-free banks and interest bearing banks coexist. He is of the view that it would have heen instructive had the author studied the interactions of these banking institutions. He notes that
the vision given by the author in this regard is extremely blurred.
Dr. Siddiqi also points out that Dr. Baqr-as-Sadar has also adopted this methodology but claims that the whole issue has heen thoroughly confused and urges the house to discuss both the situations.
Finally, he suggests that a reasonable time-table he drawn to phase out interest-bearing hanks.
3. Dr. Syed Nawab Haider Naqvi poses the question whether we should opt for a complete change in the whole banking system right from the beginning or go for a gradual towards an interest-free system. He says that assumptions of these two approaches need to be examined before a choice can be made. The first approach, which calls for a complete change, assumes that everything about the system has been discussed and that it is completely viable. Dr. Naqvi thinks that it would be dangerous to assume so in the absence of facts and figures. The alternative course of action would then be to discuss different sets of alternatives which would bring about a gradual transformation of the existing structure.
Dr. Naqvi then goes on to impress upon the participants the need for a device that would reflect the scarcity price of capital. He notes that the inability to interest to fully reflect the scarcity price of capital in capitalist economics has led to the computation of the shadow price of capital. He however finds nothing unique about it. He then urges Muslim economists to search for an answer which is acceptable in Islam. He, however, feels that equity participation is not the answer as it would make the system crisis-prone.
Dr. Mohamed Ariff expresses serious doubts about the viability of interest-free banks which "coexist" with interest-bearing banks in societies where non-Muslims have a strong hold on the banking sector. He makes a specific reference to Malaysia where the banking sector is dominated by non-Muslims and where the bulk of the banking transactions is acounted for by non-Muslims. The question Dr. Ariff poses is: will the interest-free banks, set up by Muslims survive the competition from the well-established banks on interest?
5.Dr. Mabid Al-Jarhi suggests that, instead of studying interest-free banking in a total Islamic environment, it would be more worthwhile if we conceive interest-free banking in the contemporary situation and spell out the problems that are likely to be faced. Dr. Al-Jarhi mentions short-run placement ot funds as one of the immediate problems as no return on the basis of Mudarabah can be calculated. He does not rule out the possibility of the Islamic banks establishing holding companies, but he cautions that commercial activities may land the banks in difficulties. He says that arrangements must also be made to ensure that the central bank does not require the Islamic banks to place some of the their funds in interest-bearing government securities.
Finally, Dr. Al-Jarhi takes to task those who believe in interest-rate mechanisms and at the same time suggest a gradual reduction in the interest rate. He points out that the proponents of this argument forget that a continuous reduction in the interest rate would mean a restructuring of the banking system and of the saving-investment mechanism. He thinks that this would produce a different mechanism to replace the existing one based on interest rate.
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Notes & References
1. Ulgener. Sabri F. "Monetary Conditions of Economic Growth and the IslamicConcept of Interest "The Islamic Review. Vol. 52. No. 12. pp. 4-7. Also see: Austroy, Jackques. "Non-Muslim Scholar Approach to Islamic Key Problems - Economic Development. Islamic Review. Vol. 56. No. 28. February, March, 1968. PP. 30-31
2 In this study the abbreviations RFB is used for Riba-free Bank (Islamic Banks or banks without rate of interest)
The term "modern banks" is used for interest-based counterparts
3. Translation of Al-Qur'an 2:275. Ayahs quoted in this study are from the translation: Pickthall, Marmaduke - The Meaning of the Glorious Qur'an - Vol. 1 & 11 - The Islamic Literature Publishing House. Basavangudi. Bangalore-4 (Idian), 3rd Edn. ll)52.
4. Translation of Al-Qur'an 2:280.
5. Translation of Al-Qur'an 2:82.
6. Robinson, R.I., The Management of Bank Funds, Mc-Graw Hill Inc. (New York) 1961, Chapter 4-5.
7. Rodkey. R.G. Sound Policies for Bank Management. Ronald, (New York;) I960. pp. 122.
8. Duesenberry, J.S., Income Saving and the Theory of Consumer Behaviour, Harvard University Press (Cambridge) 1952. p. 9.
9. Lewis, A.W., The Theory of Economic Growth, George Allen &. Unwin Ltd.. (London.) 1966. p. 228.
10. Mohsin, Mohammad. Investment of Life Insurance Corporation Funds, Aligarh Muslim University, 1966, pp.223
11. Shay, Robert P. and Greer. Carl C. "Banks Move into High Risk Commercial Financing". Harvard Business Review. November/December 1968.
12. IDBs can enter into profit-sharing arrangements in setting up new concerns, although the social and political conditions in developing countries may limit the scope for profit-sharing. This might be overcome if IDBs concentrate on the hatching of new enterprises which will eventually he passed on to local interests. IDBs can also sell technical, financial and managerial consultancy services. Moreover, IDBs can introduced he "credit card plan" for the import of capital goods financed by them. This plan will not only ensure etlective control on the use of funds, hut also generate additional income in the lorm ol commissions from the exporters.
13. Kuznets, Simon. "International Differences in Capital Formation and Financing" in Capital formation and Economic Growth - National Bureau of Economic Research (New York) Princeton University Press. Prinston, 1955. pp. 47
14 Gonner, E.C.K. Interest and Saving- Macmillan (London.) l904.p.6
15. Ulgener, Sabri F., op, cit
16. Schumpeter. Joseph. A, The Theory of Economic Development. Oxford University Press. (New York.) 1961. pp. 210.
17. Ibid., pp. 130
18. Ibid., pp. 154
19. Austruy. Jacques. "A Non-Muslim Scholar's Approach to Islamic Key Problems - Economic Development" The Islamic Review ami Arab Affairs. Vol. 56. No. 2-3. February- March 1968. pp. 31.
