Observations of Professor Dr. Muhammad Anwar (P-II):

Introduction:    Professor Dr. Muhammad Anwar at that time with Department of Economics at ‘International Islamic University of Malaysia’ (IIUM) read a paper on ‘Islamicity of Banking Modes of Islamic Banking’ (IBMIB) on October 31, 2000. For the convenience of readers, this author has humbly highlighted some important observations made by Professor Dr. Anwar with regards to ‘IB&F’ for the ease of readers, which are being reproduced in parts. The second part in this series is given below.

Reproduction of an article by Professor Dr. Muhammad Anwar ‘Islamicity of Modes of Islamic Banking - Part – II (Continued from Part - I):

Both types of banks, Islamic and interest-based, issue credit to seek returns. Islamic banks do not engage in trading activities because they are not interested to become entrepreneurs. Instead they prefer to loan money to the entrepreneurs, like the interest-based banks. Therefore they must find ways and means to charge time value of money, like interest. One way is to pose as traders by engaging in a fictitious purchase, adding profit component to the purchase price to arrive at a selling price of the purchased item and then sell the item to the customer at deferred price. So treat the selling price as a credit (loan) due. The difference between the sale price and the purchase price is time value of money that is equivalent to interest. This is the essence of all financing transactions based on trading modes including bai ad-dayn, murabaha, bai bithaman ajil, ijarah and bai eenah. The difference is that the interest-based banks treat the amount advanced (equivalent to the purchase price) as principal loan while Islamic banks treat the amount due at maturity (selling price) as principal loan. However, any observer shall have no qualm about agreeing that the principal has to be the amount that a bank advances in favor of the customer and not the amount the bank expects to retrieve. In this way it is clear that the profit added to the principal is nothing but riba. It is also true because Islamic banks use the same formulas and annuity tables for computing amount due and monthly installments for (say) bai bithaman ajil and ijarah transactions[1] which are used by the interest-based banks.

In sum, the loan from an Islamic bank represents the amount advanced plus time value of money. Normally the customer is asked to purchase the desired item but in the name of the bank. If the selling price (debt) is payable in lump sum then the transaction (in Malaysia) is called a murabaha (instead of bai mu’ajjal). If the debt is payable in installments then the transaction is called a bai bithaman ajil. Sometimes a customer is interested in buying use of a commodity and not the commodity per se. So the utility of a commodity may be sold to a customer by an Islamic bank under an ijarah (lease) contract. There are two types of lease: operating lease and financial lease. Banks practice only financial leasing because it is convenient to embed time value of money, as in case of bai bithaman ajil, so the amount due on the financial lease becomes a debt due[2].

All these financing transactions fall under the category of bai ad-dayn because bai ad-dayn refers to a transaction whereby a commodity (or service) is bought at a deferred price. Bai ad-dayn is permitted in the Qur’an[3]. In Malaysia, bai ad-dayn refers to a situation of buying and selling a debt, without engaging a commodity (BIMB, 1994, 104-105). Scholars outside Malaysia do not accept this interpretation because an authentic hadith prohibits sale of kali bil-kali, that is, debt against debt (PLD, 2000, 566)

Sometimes the bank may buy an item from the customer himself (instead of requiring him to buy something on behalf of the bank) at a lower spot price and sell the same back to the same customer at a higher deferred price. This is a bai eenah transaction. The bank, in order to conduct a bai eenah transaction may reverse the buying and selling role. That is, a bank may sell something to the customer at a higher deferred price and buy it back from the same customer at a lower spot price. Bai eenah is prohibited on the basis of an authentic hadith that refers to a conversation between a lady, Umm Muhibbah, and Aisha (raa). The lady sold an item to Zaid bin Arqam (raa) at a deferred price of 800 dirhams. Later on he decided to sell that item and the lady bought the same item for 600 dirhams. On hearing this, Aisha (raa) became furious and said it was a wrong deal. She shall inform Zaid bin Arqam (raa) that he has wasted his hajj and jihad by doing so. (Kakakhel, 1984, 10)[4].

Notice that these are apparently two heterogeneous exchanges yet they are prohibited because these two exchanges boil down to a single gainful exchange of money with money. Commodity may be brought into the picture to put a trading label on a lending transaction that yield riba. If bai eenah is prohibited for this reason then other transactions like murabahah involving debt are also subject to prohibition.

It is instructive to judge these transactions in the light of the following hadith. Imam Awzai reported that prophet (pbuh) has said: “A time shall come to mankind when they will legalise riba under the garb of trade” (PLD, 2000, 518). The main problem in each of these transactions is that time value of money (riba) creeps into the banking transactions whenever a trading device is applied to render a financing facility. One of the difficulties faced in Islamization of the banking system, argues Ebrahim Sidat, is that people consider murabahah as a financing instrument instead of treating it as a trading device (PLD, 2000, 373).

Allah has made it obligatory to document bai ad-dayn transactions (see al-Baqarah, 2: 282-283 in footnote 12 above). The documentation shall be witnessed by at least two persons. The debtor shall dictate contents of the document. Allah deems the documentation to be just, suitable for evidence and convenient to prevent doubts. Collateral, to serve these aims, is permitted provided preparation of documentation is not feasible. Therefore collateral (rehn) is meant to serve as a proof of the deferred transaction in lieu of documentation, not as a surety to recover the debts. Islamic banks require collateral[5] as surety. Lawyers and solicitors prepare sophisticated documentation at the behest of the bank, not the debtor. Yet documentation cost is charged from the debtor because “preparation of the document of loan has been held to be the responsibility of the borrower which naturally means that if the documentation involves some expenses, they will be borne by the borrower.” (PLD, 2000, 315). These transactions are also justified on the pretense of a willing buyer willing seller situation to comply with the injunction on “trading with mutual consent” (Nissa, 4:29).

Trading with mutual consent, a condition that is dictated in the Qur’an, shall not be violated. However, fulfillment of this condition is not sufficient to legitimize every transaction. It is well known that transactions involving riba, gambling and illegitimate sex are prohibited even if the condition of willing seller willing buyer is met. In case of murabahah, for example, the fact that a customer agrees to buy an item (say a house) from an Islamic bank at an exploded price of $227,644.80[6] that he himself bought at a much lower price of $100,000 on behalf of the bank from the market is itself a proof that the transaction is made under duress because the customer lacks funds to buy the item. This arrangement provides him a debt against time value of money of $127,644.80. Therefore mutual willingness of an Islamic bank and its customer for conduct of transactions containing charge over and above the principal (market price) due to consideration of time is not a sufficient reason for validity of the transactions. Moreover, in Malaysia, the customers are entitled to a discount, calculated on the basis of the same formulae applied to calculate bank profit, for the period of early payment if the debt is cleared before maturity. This confirms that there is no difference in the profit charged by the Islamic banks and the interest charged by the conventional banks. Hence, by all counts, Islamic banks are operating on the basis of time value of money that, of course, is riba.

Banks may acquire deposits on the basis of mudarabah and advance the same to a third party to conduct business on the basis of another mudarabah. This is called two-tier mudarabah in the literature. This way the banks can benefit by exchanging money with money in different amounts. Otherwise the banks will have to directly channel deposits into trading activities themselves to make profits. mudarabah financing was a commonplace during the life of the prophet (pbuh). However, no instance can be traced whereby one party obtained funds on mudarabah from another party and forwarded the same on mudarabah to a third party to conduct business. In this regard, Khattab writes, “fuqaha are in agreement that a mudarib is not entitled to forward mudarabah money to a third party for business” (Khattab, 1998, 58)[7]. Naturally, the validity of the two-tier mudarabah is questionable.

In Islamic banking, qardhul-hasan refers to a zero-interest loan. Under this view, hasan is seen as a forgone interest that banks could make otherwise. Calling interest as a hasan is problematic because that would mean recognition of interest as legitimate earnings. Qardhul-hasan is mentioned in the Qur’an at least six times[8]. Qur’an uses it to imply spending in the way of Allah because every time it is commanded to “lend qardhul-hasan to Allah”. So it refers to loans from people to Allah only. In fact, hasan refers to the sacrificed principal, not the interest that is sacrificed when a loan is given to Allah. In other words, qardhul-hasan is a form of sadaqah. [9] It does not represent loans among the people. Therefore, it is suggested, that use of qardhul-hasan for zero-interest loans shall be avoided.

The principle of Hasan-e-ada (better repayment) refers to reimbursement of loans with voluntary additional amount to the lenders. Paying an extra amount voluntarily on a borrowed sum is encouraged by the prophet who has himself set the precedent by paying more than the borrowed sum (PLD, 1992, 70). Under the Islamic banking practices the voluntary payments have been so institutionalized that they have assumed the status of interest. For example, Islamic banks regularly pay returns on current and savings deposits, like the conventional banks pay interest. Similarly, Malaysian government regularly pays returns to holders of Government Investment Securities issued on the basis of qardhul-hasan. Hence, Islamic banking has assumed the practice of interest in the name of ‘voluntary’ payments by the borrowers to the lenders.

In sum, all the practices analyzed here being contrary to the Islamic injunctions are of doubtful validity. However, it would be found below that it is a minor problem compared with problems related to the functions of central banks and the banking system as a whole.

[1] Please refer to BIMB Institute of Research and Training Sdn. Bhd (1996)

[2] Compare formulas for computing monthly rentals given on page 10 with the formulas for monthly installments on a bai bithaman ajil contract given on page 13. Both formulas are identical. In case of financial lease the commodity is in the control of the customer while ownership is with the bank. In case of bai bithaman ajil the customer is the owner but bank keeps the title of ownership as collateral.

[3] Qur’an states “O ye who believe! When ye deal with each other in transactions involving future obligations in a fixed period of time, reduce them to writing. Let a scribe write down faithfully between the parties: and let not the scribe refuse to write as Allah has taught him, so let him write. Let him who incurs the liability dictate, but let him fear Allah and not diminish aught of what he owes. If the party liable is mentally deficient or weak or unable himself to dictate let his guardian dictate faithfully. And get two witnesses out of your own men, and if there are not two men then a man and two women. Such as ye choose for witnesses so that if one of them errs, the other can remind her. The witnesses should not refuse when they are called on. Disdain not to reduce to writing (your contract) for a future period, whether it is small or big. It is more just in the sight of Allah, more suitable as evidence, and more convenient to prevent doubts among you. But if it is a transaction that you carry out on the spot among you, there is no blame on you if you reduce it not to writing. But take witnesses whenever you make a commercial transaction and neither scribe nor witnesses suffer harm. If you do (such harm), it would be wickedness in you. So fear Allah because it is Allah that teaches you. Allah is well acquainted with all things. If you are on a journey and cannot find a scribe then a pledge with possession (may serve the purpose). And if one of you deposits a thing on trust with another let the trustee (faithfully) discharge his trust, and let him fear his Lord. Conceal not evidence; for whoever conceals it, - his heart is tainted with sin. And Allah knows all that you do. (Al-Baqarah, 2: 282-283)

[4] Fiqh Academy of the Organisation of Islamic Conference (OIC) has permitted such sale on the condition the second sale transaction should be concluded with a party other than the party in the first sale (PLD, 2000, 359). Can this condition be a barrier to exchange of money with money by the banks? Is it difficult for banks to circumvent this condition by indulging a fictitious customer as a third party?

[5] Collateral is also justified on the pretense that the prophet himself had mortgaged his armor to a Jew. The question is whether the collateral was submitted in lieu of documentation because the prophet (pbuh) was on journey or was it submitted in addition to the documents.

[6] Figures cited here are taken from an example given in the BIMB Institute of Research and Training Sdn Bhd (1996)

[7] Khattab also notes that fuqaha allow such arrangement provided the depositor grants permission to do so. This is the basis for recommending two-tier mudarabah. Islamic banks do not practice much of it, anyway.

[8] See al-Baqarah:245, al-Maidah: 12, al-Hadid: 11 &18, al-Taghabun 17 and al-Muzammil:20.

[9] A comparison of the contents of al-Baqarah:261 with any of the verses on Qardhul-Hasan assures that qardhul-hasan represents nothing but spending (infaq) in the way of Allah.

To be Continued (refer; Part - III)..........