04 - Newsletter: Islamic Banking or Capitalism in Disguise?

Islamic banking has expanded considerably in recent years, offering an alternative to traditional finance by adhering to the principles of Shariah law. It provides Muslims with the assurance of faith-aligned financial solutions that purport to circumvent the exploitation of interest (Riba). Nevertheless, beneath the facade of Arabic terminology and Islamic designations resides a troubling reality: Islamic banking frequently resembles conventional banking in its operations. This article exposes the structural flaws of Islamic banking and questions whether it is genuinely Islamic or simply a cleverly marketed facade.

The Dilemma of Risk-Free Islamic Banking:

Islamic finance was intended to provide a just and equitable economic system, free from riba and aligned with the values of fairness and risk-sharing. However, today’s Islamic banks are focused on avoiding risks while securing guaranteed profits - contradicting the very principles they claim to uphold. Instead of Musharakah (profit-and-loss sharing) or Mudarabah (partnership where one partner gives money to another his skills), banks prefer Murabahah (cost-plus financing) and Tawarruq (commodity-based financing). These products avoid market risks, allowing banks to operate just like their conventional counterparts while appearing compliant with Islamic law.

If Mudarabah/Musharakah accounts are offered to depositors, why are banks reluctant to extend the same partnerships to businesses?

Shouldn't business financing also follow risk-sharing principles, in line with Islamic teachings?

The overuse of Murabahah and Tawarruq, which minimize risk for banks, raises questions about whether these practices align with Shariah's intended spirit of justice.

Tawarruq: A Case from Malaysia - Lessons from the People of Sabbath (Ashab al-Sabt)

To understand how Tawarruq is being used in Islamic banking today, we can draw a parallel with a story from the Quran. The Quran narrates the story of the People of the Sabbath (Ashab al-Sabt) in Surah Al-A’raf (7:163-166). These people were tested by Allah SWT, as they were prohibited from fishing on Saturdays (Sabbath). However, fish would surface abundantly on that day, tempting them. To circumvent the divine command, they set traps on Fridays and collected the trapped fish on Sundays - technically obeying the letter of the law while violating its spirit.

This story is a powerful reminder that merely following legalistic interpretations of divine commands, while ignoring the ethical intent, is not accepted in Islam. The Tawarruq-based liquidity management practices of Islamic banks exhibit a strikingly similar pattern. Here’s how the process works:

How Tawarruq Works in Practice?

1. Liquidity Need: By 10:00 AM, the Islamic bank determines it needs $100,000.
2. Purchase: The bank calls a broker to buy crude palm oil (CPO). To meet Shariah compliance, the broker acts as an agent of the bank and takes possession of the CPO. An electronic certificate is generated to record this transaction.
3. Issuing Credit Facility: The electronic certificate is divided among customers applying for credit. For instance, if a customer seeks $1,000, the bank purchases CPO worth $1,000 on behalf of the customer. However, the bank sells the same commodity to the customer for $1,200, booking a profit. Here, the bank plays a dual role - it is both the seller and the agent of the customer, raising significant ethical questions.
4. Selling the CPO: At 10:10 AM, the bank, now acting again as the agent of the customer, resells the CPO to another broker for $1,000.

Within 10 minutes, the bank generates $200 in profit. Although no explicit interest is charged, the economic outcome mirrors that of a conventional interest-based loan. By layering the transaction with Arabic terms and intermediary steps, the bank creates an illusion of Shariah compliance - just as the People of Sabbath tried to bypass Allah’s command.

A Modern Parallel to the People of Sabbath’s Deception:

In the above example, the Islamic bank technically avoids riba by relabeling the interest as profit and engaging in a complex series of transactions. However, the underlying intention is the same: securing risk-free returns. Similar to how the People of Sabbath manipulated the prohibition against fishing on Saturdays, Islamic banks use Tawarruq to achieve interest-like outcomes, circumventing the intent behind the prohibition of riba.

The Quran warns about such behavior:

“And ask them about the town that was by the sea – when they transgressed in the matter of the Sabbath, when their fish would come to them openly on their Sabbath day, and the day they had no Sabbath, they would not come to them. Thus We tested them because they were defiantly disobedient.” (Surah Al-A’raf, 7:163)

The Ethical Dilemma: Are We Repeating the Mistakes of the Past?

Just like the People of Sabbath faced divine punishment for manipulating Allah’s command, Islamic financial institutions risk losing the moral essence of Shariah if they continue engaging in superficial compliance without ethical alignment. While Islamic finance aims to promote justice, fairness, and risk-sharing; products like Tawarruq demonstrate that profit often takes precedence over true Shariah compliance.

The key lesson from the People of Sabbath is that the ends do not justify the means - merely following the form of a rule without honoring its purpose is a violation in the eyes of Allah. Islamic banks must reflect on this story and rethink their approach to ensure that their operations align not only with the letter but also the spirit of Islamic law.

This example from Surah Al-A’raf serves as a stark reminder: Faith is not just about compliance - it is about intention and integrity. It challenges us to ask:

Is the modern Islamic banking system truly aligned with the divine vision of fairness and risk-sharing, or has it become a legalistic tool to justify riba-like profits?

Arabic Terminology: Stamps of Legitimacy or a Veneer?

The use of Arabic terms like Murabahah, Sukuk, Ijarah, and Mudarabah creates the illusion of legitimacy, convincing Muslims that these products are grounded in Islamic principles. Yet, when scrutinized, these financial instruments function almost identically to conventional products. For example:

• Sukuk (Islamic bonds): While marketed as profit-sharing instruments, they often mimic the mechanics of interest-bearing bonds.
• Murabahah: The bank purchases an asset on behalf of the client and resells it at a markup, mirroring the fixed interest charged on a conventional loan.
• Ijarah: This leasing arrangement resembles a mortgage, with “rent” substituting for “interest” but resulting in the same financial outcome.

These semantic shifts offer no real difference in substance. By playing on religious sensitivities, Islamic banks convince customers that they are engaging in Shariah-compliant transactions, even though the underlying mechanics remain the same.

The True Meaning of Riba:

The cornerstone of Islamic finance is the prohibition of riba, often narrowly defined as “interest.” However, riba encompasses more than interest - it refers to any unjust surplus that exploits, whether through loans or trade. The Qur'an emphasizes the creation of a circular economy where wealth circulates equitably, preventing it from accumulating in the hands of a few.

Today’s Islamic banks, however, promote wealth concentration among the elite through structured products that bypass the letter - but not the spirit - of Shariah. This practice contradicts the teachings of the Prophet Muhammad (PBUH), who warned against inequality and exploitation.

Shariah Boards: Gatekeepers or Enablers of Profit?

Shariah boards, composed of scholars tasked with ensuring that financial products comply with Islamic law, play a crucial role in this system. However, these boards often act as rubber stamps, legitimizing products that mirror conventional financial practices.

Are these scholars truly serving the faith, or are they influenced by the financial incentives provided by the institutions they oversee?

The reliance on Fatwas to justify questionable products further complicates the issue. If the Quran and Sunnah clearly prohibit riba, why seek Fatwas that allow for interest-like structures under new names? Scholars need to ensure that religious values are upheld, not compromised for profit.

Key Questions for Shariah Scholars

1. Why do Islamic banks prefer Murabahah and Tawarruq over Musharakah and Mudarabah?
2. If depositors can enter into Mudarabah accounts, why aren’t similar contracts extended to businesses?
3. Why do Islamic banks avoid taking business risks, despite risk-sharing being central to Islamic finance?
4. Does the use of Arabic terms justify a product as Shariah-compliant if the financial intention and outcome is identical to conventional finance?
5. Shouldn’t Shariah boards ensure that Islamic financial products promote community welfare rather than wealth accumulation?

Conclusion: A Call for Genuine Islamic Financial Reform

Islamic banking, as practiced today, often mimics the structure of conventional finance while hiding behind a veneer of Arabic terminology and Shariah certificates. The current system offers risk-free profits for banks, leaving customers to bear the financial burden - contrary to the Islamic principles of fairness and justice.

To align with the true spirit of Islam, financial institutions must embrace genuine risk-sharing models that promote community welfare and discourage wealth concentration. Muslims must demand transparency and accountability from islamic banks and scholars alike, rejecting products that merely replicate conventional practices under Islamic names.

The time has come for a new financial paradigm - one that reflects the values of Islam through equitable wealth distribution, real economic activity, and meaningful social impact. Only through true reform can Islamic finance rise above the profit-driven frameworks of the West and deliver on its promise of justice and fairness.