Interest-free banking, now in practice in some countries, is named as "Islamic Banking." This nomenclature is correct if the world "Islam" is used in the broader sense comprising the people who believe (i) in oneness of God, (ii) in the Holy Books revealed to mankind and (iii) all the Prophets (Peace be upon them) sent by God, The Almighty. But if the word "Islam" is confined to the religion of the followers of Prophet Muhammad (Peace be upon him) only, then this name doss not appear to be proper as it is not only the Holy Book of Quran which prohibits Riba but other Holy Books have also advised their believers to shun interest. Since usury has been condemned by all revealed religions, it is suggested that the nomenclature "interest-free banking" be changed to "Divine Banking System."  

Efforts being made presently to cleanse the banking system of interest are mainly in two directions. In some of the countries of the Middle East and Europe one or two banks have been-established to be run on the interest-free system totally, whereas the entire banking sector in those countries is based on interest bearing system. In Pakistan, instead of setting up a separate interest-free banking institution, efforts are being made to take the entire banking system of the country from interest-bearing system to interest free banking system, gradually.  

What is the Divine Banking System? The Holy Quran explicitly and emphatically forbids Riba. There is complete unanimity among all schools of thought in Islam that the term "Riba" stands for interest in all its types and forms. The phraseology of verses in which people are instructed to shun interest and the severity of the admonition administered to those who do not abide by the divine injunction in this regard, leaves no doubt in one's mind that the institution of Riba is wholly repugnant to the spirit of Islam. (The views expressed hereunder are the personal views of the author and do not necessarily represent the official views of the institution to which he belongs)  

A misgiving which has been expressed in certain quarters is that it is not the bank interest which is prohibited by Islam. They say that there was no banking system of the type that exists today when these verses were revealed in the Holy Book prohibiting Riba, and, therefore, the prohibition does not apply to the bank interest as it is known today. Similarly some writers on the subject have expressed the view that it is the compound interest which is usury and that is what is prohibited by Islam. Might be that these writers have thought that prohibition is for compound interest and not for simple interest because of the words "doubling" and "redoubling" appearing in Surah-Al-Imran verse 129 reading as : 

"O you, who believe, do not devour riba, doubling and redoubling and be careful of your duty to Allah that you may be successful."

But if one has to see the view of the Holy Book on the subject, one has to read all the verses. In the first instance, even simple interest, in course of time, doubles or redoubles the original loan amount. For instance, an amount with simple interest at the rate of 15 per cent per annum will double itself in 6 2/3 years' time. But in any case, there is one verse in the Holy Book which leaves no doubt that it is not only the compound interest which is prohibited by Islam but also all types and all manifestations of interest. And that verse occurs in verses 276, 278 and 279 of Sura-Al-Baqra. The translation is as follows:-

 "Allah hath blighteth riba and made alms givings fruitful Allah loveth not the impious and guilty.

 "O ye who believe observe your duty to Allah, and give up what remaineth (due to you) from riba if ye are (in truth) believers."

 "And if ye do not, then be warned of war (against you) from Allah and His Messenger. And if ye repent, then you have your principal (without interest). Wrong not, and ye shall not be wronged. "

 In this verse the significance of the words that "you have your principal" but not anything which is above the principal is quite clear. It covers simple as well as compound interest, and so only the taking back of the principal in the case of a loan is allowed in Islam. Apart from these verses, over the centuries, there have been a number of contributions by Fuqaha of various schools of thought and of one goes through them, one will find that in all schools of thought, there is complete unanimity that interest in all forms is prohibited by Islam. And here Fiqah-e-Hanafi, Shafai, Malaki and Jafari are unanimous. Some people have also expressed the views that perhaps interest on loans which are given for productive purposes was non-existent at the time of the Holy Prophet (Peace be upon him) and, therefore, they feel that interest on loans for productive purposes might be justified. But there is documentary evidence available in the researches made by various scholars that in the time of Holy Prophet (Peace be upon him) loans were given not only for consumption purposes but also for productive purposes. In fact, there is evidence that some tribes used to enter into some sort of partnership within their own tribe, but they used to borrow on interest from others while engaging in trade. So, from that point of view also, it is clear that loans for productive purposes were not unknown at that time and still the prohibition of Riba, which comes in the Holy Books, does not make any distinction between loans for production and loans for consumption.

 Some argue that banning of interest would cover only the physical persons and that interest practised amongst corporate bodies, viz., between two banks, between two governments or between a bank and a government, should not be taken as "Riba" prohibited by religion. This thinking appears to be based on various verses of the Holy Quran which, while dealing with prohibition of interest, speak of physical persons only. They, therefore, feel that Muslim organisations cannot be the subject of Quranic injunctions. For instance, they say that Muslims are ordained to offer prayers; are the government and organisation also ordained to do so? Will the governments and organisations as distinguished from their officers in their personal capacity be required to perform Haj? Since the answer in all such cases is in the negative, they feel that even Muslim governments and organisations are not bound by the Quranic injunctions like individuals. The concept of legal person as distinct from physical person is not very old, that is why the earlier sources of Islamic law do not distinguish between a man and a corporate body. Further, if their argument that a Muslim government or a corporate body is not bound to act on the Quranic injunctions like individuals is accepted, then it must also follow that since individuals are disallowed to rob or to exploit other fellow beings, a government or a corporate body would' not be bound to respect this prohibition and might organise robbery or exploitation of subjects/individuals. Similarly, there should be no ban on a government or a corporate body trading in alcoholic drinks or promoting prostitution. This assumption would lead to a very ridiculous situation. It is, therefore, apparent that governments and corporate bodies are also not exempt from the purview of prohibitions though they are not subjected to ordinances pertaining to rituals which are supposed to be performed by individuals like prayers and Haj.

 Some persons have argued in favour of taking of interest by an individual from corporate bodies like banks; as, according to them, the prohibition of Riba stems from its exploitative nature and since an individual cannot- exploit a bigger organisation like a bank, the ban on interest should not be applied to such cases. Similarly, in one non-Muslim country, Muslims are being given loans by the Government itself on interest basis and such payment of interest to the Government by Muslims is not considered to be banned by Islam. The reasons for such thinking (that payment of interest to a government does not come under the definition of Riba) perhaps seem to be that (i) banning of interest covers only the physical persons and (ii) a government cannot exploit its subjects. Argument for banning of interest between physical persons only has already been dealt with earlier. As for the exploitation aspect, if taking of interest by the State at a rate laid down in the country is not exploiting an individual, then it can be assumed that banking institutions recovering interest at the same rate should also not be considered as committing an act of exploitation. Persons who lay emphasis only on the exploitative nature of interest perhaps ignore the fact that another underlying reason for prohibiting interest is that Muslims should use their capital for trading rather than lending on interest so that capital should share the risk with labour and this is very clear from the following verse of Sura Al-Baqr : —

 Those who swallow usury cannot rise up save as he  ariseth   whom   the  devil  hath prostrated   by (his) touch.

 That is because they say:

Trade is just like usury; whereas Allah permitteth trading and forbiddeth usury. He unto whom an admonition from his Lord cometh and (he) re-fraineth (in obedience thereto) he, shall keep (the profits of) that which is past, and his affair (henceforth) is with Allah. As for him who returneth (to usury) — such are rightful owners of the Fire. , They will abide therein. "

Hence a banking system in which all its transactions are devoid of interest in all its forms would be called a "Divine Banking System."

 What is Riba?

 A question is generally asked as to under what circumstances, an increase in the principal amount received by the provider of the capital could be termed as 'Riba'. Any excess payment over and above the principal amount, (i) the rate of which is predetermined, (ii) has relation to the amount of principal, and (iii) while calculating, period of use of the principal is taken into account, is considered as 'Riba'. All these three conditions should be present for the excess payment to be termed as 'Riba.'

 Based on this, commission charged by banks on issuance of drafts cannot be considered as 'Riba' because although the rate of commission is pre-determined and it is calculated on the amount of the draft issued but since it does not vary with the period, it cannot be termed as interest and is, therefore, permissible under Sharia. Another case could be of penalty which although predetermined and relates to the period but if it does not relate to the amount of suit involved, it could also not be considered as un-Islamic. Similarly, since the rate of profit is not pre-determined although it has relation to the amount as well as the period for which the amount has been utilized, it is also permissible under Islam.

 ALTERNATIVES TO INTEREST

 What are the alternatives to interest if it is to be eliminated?

 Following alternatives have been considered as possible replacements of interest:

i) Zero Rate Interest:

 Under Zero Rate System, neither the depositors receive any return on their savings nor the borrowers pay any interest on their borrowings. Adoption of this form of interest-free banking cannot be commended as by not giving any return on the deposits it can lead to loss of deposits and consequently reduction in the investable resources of the banking system. At the same time by making bank resources available to entrepreneurs without claiming any part in their profits, it can lead to aggravations of income inequality.

 Supporters of Zero Interest Rate argue that interest does not influence savings. They quote instances of some west European countries, wherein if inflation rate was more than the prevalent bank deposit interest rate, deposits increased but when rate of inflation was less than the interest rates, deposits registered a fall. So they conclude that, regardless of the negative return on deposits, people will save, rather save more. Their argument seems to be based on the inflationary trends rather than on the interest rates. But inflation rate cannot be the best guide for determining the mood of the people to save.

 Interest bearing savings are generally of middle class people, the majority of whom do not possess even elementary knowledge of economics. While they may be aware of the rise in the prices of commodities commonly used by them, they do not have any idea about the rate of inflation prevailing in. the country and its impact on their savings. In developing countries even the governments cannot calculate the exact rate of inflation prevailing in the country, what to speak of the common man. The effect of inflation on savings, if there is any, is that more money is in the hands of the people and so they deposit more with banks. Deflation or fall in the rate of inflation, when compared with an earlier period, would bring contraction in money supply and so the people will have less money in their hands to save and deposit' with banks. Both these situations, i.e., more money with people under inflation and less money in the case of deflation are temporary. Prices would soon make adjustments therein. Besides, ratio of interest-bearing deposits to total deposits would show that a large number of people expect a return on their savings. For instance, in Pakistan interest bearing deposits account for more than 70% of the total bank deposits. If current account balances maintained by companies and business houses due to necessity of business requirements are ignored, the share of Interest bearine1 Deposits would work out to a substantially higher percentage than 70%. It, therefore, implies that if no return is paid to depositors, savers may withdraw their deposits from the banks and channel their funds into non-productive sectors of economy such as land, real estate, housing, etc. This would not only push up real estate prices but would also start a new inflationary spiral in the country. Promoters of the Zero Rate Interest System further argue that elimination of interest costs would give following benefits: —  

a)  There will be an expansion in trade and industry at a much higher rate than is possible with the interest rate system and so more goods mid services would be available at cheaper rates.  

b) Due to expansion in industry, etc., additional jobs would be created. 

c) Availability of goods and services at cheaper rates and creation of more jobs would benefit a much larger section of population, whereas, giving of return on deposits would benefit depositors only who are very small in number. 

d) If banks give up their present policy of providing loans to big businessmen/industrialists only and start accommodating small people also, the question of rich becoming richer would not arise.  

The central point in the above arguments is that cost-free funds would encourage more and more people to go for business or industry. But it may not be so. Investment in a business concern or an industrial project does not solely hinge on interest rate. Moods of sponsors play a very important part in the decision whether to invest or not. The environment prevailing around, for instance, fear of nationalisation or absence thereof, good labour management relationship or otherwise, etc., would determine the human mood to invest rather than the interest rate itself. Trade depressions occur not because the interest rates have become exorbitant but because moods of entrepreneurs undergo changes. The entrepreneurs start having an imaginary fear of losses or declining profits due to shrinkage of market for their goods or services. Interest rates passively follow rather than lead o changes in the business. They are effects and not causes of changes in the business environment. As for their point that banks should accommodate smaller people in larger number than at present, it may be mentioned that the prevailing age is that of mass production. Excepting a few products having artistic value, only those industrial concerns will survive which can produce goods at a competitive cost and this is possible only through large-scale production. People with limited means cannot compete with big industrial/business products/services. The fact hat deposits are held by banks in trust for depositors and that banks cannot give unless they are reasonably certain that they would be repaid in time should not also be lost sight of. Further, loans made available by banks are never recovered hundred per cent. A certain percentage is bound to go bad and banks would have to write them off. Presently, banks set aside a certain portion of their profits for such contingencies. If banks are not to recover anything from the loanees, then how are they going to meet such contingencies and, above all, how are they going to meet their administrative expenses,

ii) Indexation:

 Under the system of indexation, liability of a borrower to the banking system would be adjusted in monetary terms to reflect changes in the value of money, as measured by a price index, during the period the borrowing remains outstanding. Indexation on the side of bank advances is likely to create a number of problems. It is well-known that inflation affects profitability in various sectors in different ways. Recent experience in a number of developed and developing countries showed that profits of the commercial sector boomed in inflationary situations while profits in the industrial sector did not rise in consonance with the rise in the general price level. Indexation of bank advances under such circumstances can greatly impair productional activity. Agriculture sector is also likely to suffer because agricultural prices are often controlled by the Government or determined by international demand and supply factors. If the increase in prices of agricultural products is less than the rise in general price level, indexation of bank advances will place the agricultural sector in a disadvantageous position compared to the sector where price rise is equal to or more than the rise in general price level. As for indexation of deposits, it may constitute a favourable factor for the growth of savings in an inflationary situation by preserving the real value of money saved but it is neither practicable nor advisable. It is not practicable because:

 a)  There is no fool proof method to determine the exact rate of inflation which has constantly prevailed in a given period, say past six months in a country. Any rate announced by the Government would   always be challenged by the general public because it may have no relation to the general price rise of commodities commonly used by the people. Items of commodities generally used will differ from place to place and also amongst people of different income group at the same place.

 b)   Indexation   of bank loans is not advisable as mentioned above and if bank loans are not indexed, indexation of deposits may create a situation wherein banks may not have earned enough on their investments to provide extra money payable to depositors because of indexation. Indexation of deposits is also not advisable because it might lead to a demand by workers to increase their wages proportionately. The Government which is the major employer would feel a    pinch more because its revenue might not increase in the same ratio. Secondly, suppliers of commodities, prices of which    are    controlled,    would    also    justifiably   demand increases in the price of their respective products and this would lead to inflationary trends with no ending.

 iii) Time Theory/Fractional or Time Multiple Counter-loans-Shaikh Mahmud Ahmed in his book "Social Justice in Islam'' has developed a theory for replacement of interest. According to this theory use of Rs. 10,000 for one year should be equal to say use of Rs. 2,000 for five years. Accordingly if a person borrows from a bank a sum of Rs. 10,000 instead of paying any interest to the bank, he should keep Rs. 2,000 for five years with the bank free of any interest. It is a good way of replacement of interest but its application is limited. For instance, it cannot be applied to deposits nor could it be applied to loans for longer period. Besides, its application to all short duration loans would leave no profitable outlets for the banks. Time theory could be usefully applied by banks for consumption loans where the element of profit and loss does not exist. However, to be in conformity with Sharia, it would be necessary that there should not be any prior commitment in this regard. As a matter of convention, consumption and personal loans may be granted to only those persons who already have an account with that bank, rather that branch of the bank, and while considering the amount of loan and the period of its repayment, credit balance in the account of the borrower and the period for which the credit balance has remained in the account may be kept in view.

 iv)  Discounting of equity:

 Presently, if for some-reason or the other, it is not considered advisable to issue shares of a project for public subscription, the banks and financial institutions which have underwritten the issue, provide bridge financing against their portion of equity under-written and charge interest thereon. Under the new system of interest-free banking, banks and financial institutions, instead of providing a bridge loan, would actually take up the equity at a negotiated price which can be below the face value of the shares. Thus they would discount equity to the extent it is not taken by the general public. The amount of discount would be determined by future profitability of the company concerned.

 v)   Leasing:

 Leasing is a relatively new type of long term financing method which is progressively gaining ground in industrialised countries. 'Lease" is based on a contract between the lessor and the lessee for hire of a specific asset selected from a manufacturer or vendor of such assets by the lessee. The lessor retains ownership of the asset and the lessee has possession and use of assets on payment of specified rentals over a period. Though the lessor is the legal owner, the lessee is given exclusive rights to use the asset for the duration of the contract. Rentals during the fixed period are sufficient to amortise the capital outlay of the leasing company and provide an element of profit. Period is closely related to the estimated useful life of the asset and the lessee is normally responsible for all operating costs such as maintenance but cost of insurance would be on the account of the lessor. The period of lease may range from 5 to 15 years depending on the useful life of the asset. This method would be less risky and ensure to the bank a reasonable profit margin without having to look into the accounts of the firms. It is understood that this method does not violate the Sharia even though the rentals would be receivable by the leasing bank irrespective of whether the lessee earns a. profit or incurs a loss.

 vi) Hire-purchase:

 A variant of the hire-purchase system may be used in financing purchase of machinery and equipment as well as consumer durables on a small scale. Under this system banks may finance the purchase of these items under joint ownership arrangement subject to provision of security or surety. They would receive, in addition to repayment of the principal, a share in the net rental value (after allowing for depreciation) of these items in proportion to their outstanding share in total investment. The cost of insurance may also be shared between the bank and the other party proportionately on the basis of their outstanding investment. Similarly, cost of pre-determined wear and tear would be shared between the two proportionately on the basis of the respective outstanding investment in the equipment. However, maintenance may be entirely the responsibility of the user of the equipment.

 vii) Investment Auctioning.

 Another method for replacement of interest in the case of long and medium term financing in the industrial sector that is worth considering is the system of investment auctioning. Under this system, commercial banks may form a consortium with PICIC, ICP and IDBP and formulate industrial projects with complete details. Thereafter, the consortium may announce the project with the offer of sale on credit, of plant and machinery, etc. (with full details thereof) needed for the project and call for bids from prospective investors for the purchase of the project. The consortium may fix a reserve price which may include a reasonable profit margin. It may also reserve the right to accept or reject any bid. Plant and machinery may then be sold on credit to the highest bidder if the party is considered to be a sound one. Otherwise, the sale may be made to any other bidder considered capable of efficient implementation and running, of the project, provided the bid is higher than or at least equal to the reserve price. The agreement may provide for necessary safeguards for the consortium against undue delay in implementing the project or possible malpractices on the part of the investor. The amount of bid accepted would be repayable in instalments over an agreed period.

 A variant of this system may be that -the proposed consortium may invite the private sector to submit detailed projects to it. The projects may then be .examined to determine their feasibility. The "patent fee" of the project selected may then be negotiated and agreed with the proponent. Thereafter, the project containing among others, full details of plant and machinery, etc., to be sold on credit may be announced for inviting bids. The reserve price may include the "patent fee" as well as a reasonable profit margin for the consortium. The highest bidder or any bidder above the reserve price who is considered as the soundest party may be sold the plant and machinery on credit. In case the proponent of the project himself is the awardee, the "patent fee" may be adjusted from the amount of the bid. If the awardee is a different party, the proponent may be paid the "patent fee" by the Consortium in cash. However, if there is no response to the invitation to bid or the bids offered happen to be lower than the reserve price, no compensation would be paid to the proponent of the project. The liability of the investor whose bid is accepted by the consortium would be independent of whether he earns a profit or incurs a loss. However, this may not constitute a violation of the Sharia in view of the fact that the transaction would be in the nature of a sale on deferred payment basis as the ownership of the entire plant, and machinery would be transferred to the investor after full redemption of his liability to the consortium.

 viii) Bai-Mowajjal/Morabaha/Mark-up:

 Bai Mowajjal may be defined as a sale in which the margin of profit is mutually agreed upon between the buyer and the seller. The payment of sale price, inclusive of the agreed profit margin, may be immediate or deferred and either in lump sum or in instalments. Banks may resort to this method wherever Profit and Loss Sharing and other alternatives are not feasible. It could be of considerable use in financing current input requirements in industry and agriculture as well as domestic and import trade financing, and also for financing fixed investment of trade and industry, when Investment Auctioning, because of the nature of fixed investment to be financed, is not feasible and hire purchase or leasing is not considered advisable. But the important thing from the point of view of Sharia is that the commodity to be sold under Bai Mowajjal should be in possession of the seller. In the case of banks, however, Sharia may permit the transaction even though the commodity is not in bank's possession provided the dealer selling the commodity has earmarked the same for the bank and is ready to deliver the commodity sold by the bank under Bai Mowajjal to the person nominated by the bank. The latter person, i.e. person taking delivery of the commodity could be the businessman or the farmer to whom the bank has sold the commodity under Bai' Mowajjal. For instance, if the current cost of a bag of fertilizer to the bank is Rs. 50 the bank may sell it through its agent to farmers needing bank finance at Rs. 55 subject to actual payment of this price after an agreed period. The bank would, however, pay Rs. 50 to its agent prior to or immediately after the supply of the fertilizer under the bank's instructions.

 As for fixed investment financing the bank/financial institution may not be the owner of a particular fixed asset or whole of it. It may be a co-sharer in a particular fixed asset, say machinery, or in the total fixed assets, i.e. land, building plant and machinery,: of the concern, just as in the case with house building finances provided by House Building Finance Corporation. HBFC, i.e.; House Building Finance Corporation is not the sole owner of the house constructed or purchased with its funds and can also not stipulate its share in door and window panes, or articles fixed in bathrooms, etc. separately. HBFC's share is in the total house. The bank/financial institution would have acquired a fixed asset; or assets to the extent it has agreed to make payment to the machinery supplier and/or other charges thereon in the case of machinery, to the seller of the land in the case of land and/or; to the contractors either direct or through the business concern concerned, in the case of building etc. Bai Mowajjal commend; itself for its relative simplicity as well as the possibility of some profit for the banks without the risk of having to share in the possible losses. Although this mode of financing is understood, to be permissible under the Sharia, but it cannot be used widely in the case of working capital requirements particularly in those: cases where user of funds provided deals in more than one commodities.

 ix) Bai Salam:

 The Council of Islamic Ideology in Pakistan, while commenting on the report of its Panel of Bankers and Economists on interest, free banking has recommended the use of Bai Salam for agricultural financing by banks. Bai Salam is opposite of Bai Mowajjal: While in the case of Bai Mowajjal, the bank would sell an asset, in case of Bai Salam, the bank would purchase a commodity to be delivered to it at a future date, as agreed upon between the bank and the seller. In case of Bai Salam, the bank contracts to purchase a commodity to be delivered at a future date and pays the price in advance, in the case of Bai Mowajjal, the bank sells an asset in exchange for a price to be paid at a future date.

 Some persons have argued against the use of this alternative, as they feel that banks are not equipped for lending in commodities. The banks would suffer loss when the price of agricultural produce they have paid for in advance falls by the time of subsequent delivery thereof. But with the minimum prices of four major crops of Pakistan, viz., wheat, rice, cotton and sugar being Government controlled, risk is very much minimised if not altogether eliminated.

 x)   Profit & Loss Sharing:

 Profit and loss can be shared on the principle of:

 a) Partnership where all the partners contribute the capital, take part in the  management  of the  business,  share  the profit  and  loss   in   the  ratio   of  capital  contributed   but liability of each is unlimited.

Or

b) Mudaraba where one or more persons supply the capital and   some other person or persons manage the business, profit is shared between all the parties in a pre-determined ratio but loss is shared only by the suppliers of capital in the ratio  the capital is supplied.  The supplier of capital has no say in the management of business and his liability is   limited   upto   the   amount   of his   contribution   to the capital.

Or

c) Shirkat-e-Enan,  i.e.  Shirkat with limited liability. All the shareholders   do   not   actively   participate  in   the business management. Few of them manage the affairs of the joint venture.    Banks   would    provide   funds   to   industry   and business on  the  basis of Shirkat-e-Enan with the right to appoint   an   accountant   and/or   auditor  when   considered necessary. But they (banks) would accept deposits on Mudaraba basis, i.e. depositors would have no say in the management, not even the right to appoint an accountant, or auditor on the bank.

xi) Interest-free Loaning:

 Interest-free loans, without a service charge, may be provided by banks and other financial institutions in such cases in which neither Profit and Loss Sharing nor any of the other alternative methods, discussed above, is possible provided that the sectors/purposes for which finance is given are meant for general welfare of the community, or are otherwise of high economic or social priority. Some of the examples of such sectors/ purposes are infrastructure or social sector projects of the Government, procurement of foodgrains by the Government and subsistence farming. However, in order-to remove adverse impact of such loaning on the profitability of the financial institutions, it would be necessary that the Federal Government compensates these institutions during the accounting year in which such funds remain outstanding. As in such cases rate of profit or loss could not be determined, profit which the providers of funds, i.e. banks would have earned on an average by investing these funds in other sectors, should be taken into consideration while compensating these institutions. In the case of funds provided by a nationalised commercial bank average profit of the five nationalised commercial banks would be taken instead of that particular bank only. The other alternative is that the State Bank of Pakistan's rate of profit may form the basis of compensation. Yet another alternative could be the annual growth rate in the Gross National Product of the country, as the funds provided by banks have also stimulated this growth from which the country as a whole has benefitted.

 It may be mentioned that in respect of funds to be provided by banks for productive purposes, Profit/Loss Sharing is the only alternative to interest which is nearest to the spirit of Islam. Other alternatives like mark-up, Bai-Salam, Hire-purchase, leasing etc., are to be used only when Profit/Loss Sharing is not possible and that too with certain pre-requisites. Following verse of the Holy Quran is quite explicit in this regard.  

"O ye who believe! devour not your substance among yourselves unlawfully, but let it be a trading among you by mutual agreement (IV : 29).

Essential element of 'trading' is that the return on the capital employed depends upon actual operating results of the business undertaken. To apply this principle to modern modes of business and finance, it will be necessary to completely reorganise the prevailing banking practices and to replace interest by a system of Profit/Loss Sharing.

 CRITICISM AGAINST INTEREST

 It may be of interest to note that the criticism of interest appears to be as old as the institution of interest itself and is still continuing. Not only the Holy Quran, but other Holy Books and even the secular philosophers and the economists have criticised interest. The Holy Bible outlaws interest bearing loans to fellow Israelites. The medieval doctrine of interest which equated it with usury was derived from the teachings of the Holy fathers who in turn had found confirmation of their views in several passages of the Old Testament as well as in the words of Prophet Jesus, (Peace be upon Him) "lend freely, hoping nothing thereby". Aristotle, the Greek Philosopher, also considered exchange of money for a promise to pay back the principal with interest as the most unusual exchange. Even some modern economists, hold the interest responsible for trade and business cycles. Although they may not be advocating total elimination of interest but they do recommend placement of restriction on its upper limit. The question, therefore, arises as to what is so bad about interest that it has been condemned by the Prophets, the philosophers and modern economists alike and how replacement of "interest" by "Profit/Loss Sharing System" is advantageous to an individual/society.

 i) Theologians' objection to interest is perhaps based on the fact that money lent on interest does not suffer loss, whereas the user of money in the case of loss, has suffered a loss of his labour energy and a portion of his life span. The time spent in £he venture — business or industrial — is not going to come back to him. In the eyes of the man's Creator, i.e., God, the value of His own creation is more than the creation of His creation. Wealth is the creation of man who is God's creation. Much emphasis is indeed given by the Holy Bible to the dignity- and worth of human labour. Labour is considered a blessing that gives life. The dignity of human labour is derived from God's labour on man's behalf. In the case of fixed return on capital, as is the case with lending on interest, capital gets preference over man's labour.

 Philosophers have also criticised the institution of interest from the point of view of equity and justice. The rationale for prohibition of interest in the case of loans for production purposes stems from the concept of justice between man and man. Uncertainty is inherent in a business enterprise, irrespective of the time and space dimensions. Occurrence of profit or loss and its magnitude cannot be fully determined in advance. It is, therefore, sheer injustice, if the party providing money capital, is guaranteed  a  fixed  and pre-determined return  while the  party providing enterprise is made to  bear the  uncertainty all alone. On the other hand, a fixed interest can also be unjust to the lender of money in case the entrepreneur using his money earns a profit quite out of proportion to what he pays by way of interest.  Profit/Loss system would   remove this imbalance between reward for capital and that for human endeavours and initiative.

 ii) Even purely from the economic point of view, the institution of interest has not served the society well. It is generally stated that interest is a price like all prices and it performs the function of allocating "scarce" loanable funds among the "infinite" users of such funds in an objective manner on the basis of ability to pay the price. If the demand for, or supply of, loanable funds changes, a new equilibrium is reached at a different rate of interest. The "equilibrium" rate of interest is only a text-book phenomenon. In reality, such a "market clearing" rate does not exist and instead, there are a host of rates and the function of allocating resources optimally is not performed efficiently. The rate of interest tends to be a perverted price and reflects price discrimination in favour of some. Introduction of Profit/Loss Sharing System should be able to redistribute profits from big business to depositors and small enterprises, thus removing one of the major causes of inequalities. Hence the system of profit/loss sharing will be able not only to bring about greater efficiency in the allocation of resources but also reduce the concentration of wealth and power.

 iii) Profit/Loss Sharing System would not only enable the bank, an independent institution, to have a second critical look at the project feasibility before its implementation but also to do proper monitoring after its implementation. This extra care, both before and after implementation, would keep the project on sound footings. Although the banks, even now look into the feasibility of the borrowing venture, but their main concern is about the adequacy of the security they obtain to secure their loan. Under the Profit/Loss Sharing System banks would per force have to develop expertise within their own institution to study and appraise the feasibility submitted by the party seeking financial assistance from them. Even after disbursement of funds, banks would be required to ensure proper monitoring of the operations of the venture financed by them without interfering in the day to day operations of such ventures. By going back into the history, one may observe that even in medieval times prohibition of interest might have driven the capitalist to seek risk sharing investment in partnership, the lawful way to share the gain from the venture. Concentration on this type of investment, rather than on the use of loan funds, may have been the stimulus to economic expansion such as occurred on a wide scale during the later middle ages. Far more than a loan contract would have done, investment in a partnership encouraged the active participation of the capital owning partner in the management of the invested funds, bringing extra care and industry to a venture that otherwise would have vested only on the shoulders of the borrower.

 iv) By spreading risk more evenly, the Profit/Loss Sharing System would encourage more economic activity and thus improve welfare of the society. A happy and progressive society is that where all its members join in a process of production of goods and services for the society and bear the risk equitably. Anything contrary to this may breed discontentment among the society and this discontenment in the society may lead to its decay. Rise and fall of so many civilisations in known history has proved this point.

 v) As mentioned in one of the subsequent paragraphs, the malpractice of maintaining different sets of books is resorted to by the enterprises mainly for evading taxes. The entrepreneurs complain that rate of income tax is very high in Pakistan and if paid honestly it would not permit people to save for old age and comfortable living, particularly when the government is not able to provide the security and welfare as some of the modern states in the west do with comparable rates of taxes. Senior policy makers in the Government often, in justification of high rates of taxes, say that most of the people liable to pay tax do not pay tax and that the Government has to mop up revenues to meet its expenses for running the administrative machinery. Under the Profit/Loss Sharing System the enterprises borrowing funds from banks would show profit, if they have earned, at least to the extent of rate acceptable to the banks. This would, therefore, bring more enterprises under the Income Tax Net and thus increase the revenue collection for the government. With the increase in its revenue, the Government may be prepared to consider rationalisation of the existing Income Tax rate structure.

 vi) Because of regular monitoring by banks under Profit/ Loss Sharing System, the entrepreneur would perforce be required to maintain a high standard of efficiency. Otherwise in the event of unfavourable results, he is apt to be exposed to criticism. The monitoring by banks would also bring out deficiencies in the venture immediately they occur. The parties having interest in the venture would thus be able to take corrective measures in time.

 THE APPREHENSIONS

 Discussion on the subject would not be complete if mention is not made of the various apprehensions expressed about the new system.

i) A fear has been expressed that a system based on profit and loss sharing may lead to collapse of the entire banking system as banks will have to share in losses also. This fear seems to be misplaced. It is true that under the Profit/Loss Sharing System some of the concerns to which banks give financial assistance may make loss but important thing to bear in mind is that banks will be working on a system of pooling the risks. They will be giving financial assistance to a larger number of concerns in the country. While some may make loss others are expected to make profits and substantial profits. On the basis of principle of averaging even if some loss might be incurred, there is a probability, and a strong probability, that the situation will not arise in which there will be no profit at all in the banking system. And it is the diversified-investment-portfolio basis on which a number of institutions work and they are able to produce positive results.

The problem is not that the various enterprises to whom the banking sector would be providing funds, would riot be making profits. If it were so then new industries and establishments would not be coming up daily. The crucial point is that such enterprises should, show true position of their operations. At present these malpractices are resorted to mainly for evading taxes. Moral values being what they are, introduction of profit/loss sharing system in the financial dealings of the banks and financial institutions may aggravate such malpractices. But banks would be closely monitoring the operations through periodical returns to be called for from the enterprises concerned. Where results shown by the returns so submitted are at a great variance from those projected at time of applying for Musharika funds, banks would probe into their working. If it is found out that the operating results are being manipulated, banks would immediately recall their funds and the enterprise concerned would be black-listed from the entire banking sector, at least by the nationalised banking sector. The matter would also be reported to various other Government agencies such as Income Tax Department. The threat of not accommodating such parties who  deceive the banks and reporting their cases to other government agencies, should be a sufficient deterrent for any sensible entrepreneur, who wants to remain in business, from committing any such act of self-annihilation.

ii) Fears have also been expressed about the likelihood of collusion between the staff of the banks and the parties seeking finance. Malpractices of this type are known to exist even under the present system. However, it is apprehended that in view of the greater scope for ill-gotten gains, through the malpractices under the profit and loss sharing system, there may be stronger temptation for such collusion. To safeguard against it, a procedure would be laid down according to which no one individual even the chief executive of the bank would be in a position to accept the accounts of an enterprise showing lesser profits than those projected, not to speak of the loss. The Executive Board of the bank only would have the right to accept such accounts. Besides the State Bank of Pakistan and the Pakistan Banking Council-would also be probing into the accounts accepted by banks where the actual performance has been reported to have deteriorated beyond a certain limit from the one projected.

iii) Some businessmen have also expressed the fear that a system based on profit and loss sharing would involve too much interference in the affairs of the concern to whom assistance is provided by banks and this will interfere in the proper functioning of various business concerns. This fear seems to be misplaced as banks would not have adequate trained staff to sit on the management of thousands of enterprises to whom funds would be provided by banks under the Profit/Loss Sharing system. There would be temporary partnership between the bank and the party, wherein both agree to contribute their part of capital and labour. Whereas the party manages the whole operation/transaction, the bank would exercise monitoring and supervision only by calling certain returns periodically which the banks do even now under the Interest-bearing system.

The question arises that if (i) the interest is prohibited by the revealed religions, and (ii) criticized by the philosophers and the economist alike, then why the interest bearing system is prevailing in the world. If the claim is that the variable return as in the case of the divine banking brings with it an overall welfare in the economy higher than the fixed return as in the case of the interest bearing system, then why is it not being practised in the world. As for the religion, it has lost hold over man's imaginations long ago. People have become more worldly. They are religious only for performing certain religious rituals such as prayers, fasting and pilgrimage. Duties to fellow beings which are an important part of code of conduct under each revealed religion, are being totally ignored by the followers of all the religions. People are more concerned with their material well-being than they care for the moral values. Although as mentioned earlier, purely from the worldly point of view the divine system brings, a better over all welfare in the economy, but the interest bearing system is dominating the banking system because of the moral hazards or the problem of dishonesty on the part of the entrepreneurs borrowing funds from financial institutions.

In these circumstances one could rightly ask as to how in an age where the moral fibre is at its lowest ebb, the divine system would survive. One alternative is that we wait for an improvement in the moral values of human society. God has sent more than one hundred thousand messengers to improve the morality of mankind and according to the Holy Quran no further messenger of God is to come to improve the lot of mankind. Even during the times of Holy Prophets (Peace be upon them) human society remained pure only during the life time of the Holy Prophet and for a few decades thereafter. We cannot therefore expect any improvement in the morality. Given the moral fibre as it is, some safeguards will have to be laid down so that the new system takes root in the society. It is not that the project performance is not by the financial institutions to the degree required by the divine banking system. But it requires more monitoring cost. Since the Divine Banking entails some more cost to the society, the advocates of the present system point out that the prohibition of interest will lead to an inferior outcome. But one has to weigh the monitoring cost against the risk spreading benefits of divine banking. Besides there are some other gains associated with the new system.

Financial institutions under the new system will have a greater freedom of choosing investment projects with regard to riskiness since unlike the case in the present system the funds at their disposal will not carry fixed liabilities to the depositors. This will result in a greater overall fillip to investment activity. Furthermore, the divine financial system will be more stable in the face of drastic changes in the economic conditions. The stability again stems from the fact that financial institutions will not issue fixed liabilities to their depositors so that losses will spread throughout the credit market. Under this system no bank run or panic can ever occur which is inherent in the present system. It is ironic that the present system cannot even exist without the provision of deposit insurance or else without being owned by the state. No such conditions are required for the efficient working of a divine financial system. Furthermore because of (i) various types of information now available to banks about each and every industry and trade (b) sophisticated techniques now applied by banks and (c) with more closer cooperation within the banking sector, even the monitory cost would be reduced to a reasonable limit. It is also a pious hope that because of the frequent and prolonged economic recession now being faced by the world, mankind would be more ready than before to accept an alternative which is less immune to the trade cycles. Divine Banking System is one such alternative.