Is Islamic Banking Really Islamic?
We are often asked why we consider “Islamic Banking” to be un-Islamic, even though it enjoys approval of many eminent shariah scholars. Before we explain that, lets start with a digression.
Imagine travelling in the subway and overhearing the following conversation from someone in the next row.
“… yes, yes… you are so right. It is ridiculous how muslims ignore the very fundamentals of their religion nowadays just for a little convenience… just look at Rasheed and Haniya… you know Haniyah right.. the Arab couple who lives two blocks from us.. yes… they always eat non-zabiha meat saying its halal…. it’s so ridiculous… they pretend to be so religious otherwise, having a beard and all… and going to the mosque, and yet it all seems such an hypocrisy when you keep violating a clear injunction of the Islam to avoid food that is not slaughtered properly…”
Those who have lived or visited abroad have very likely come across this favourite dining table conversation topic among muslims: halal vs zabiha. I’ll shortly come to the point I want to make here regarding Islamic Banking, but doesn’t the above conversation also remind you on how issues of much lesser significance have somehow become our primary focus nowadays. Anyway, coming to the point, here is a subtle thing to notice in the above conversation, which I’m sure many of you may not have.
The person speaking in this conversation, is apparently very “shariah-compliant”, and meticulously takes care that whatever morsel of food goes into his belly, is both halal, as well as zabiah, slaughtered with the name of God taken, and in the prescribed manner. What this person is forgetting however, is another subtle mistake being made here: Engaging in backbiting against Rasheed and Haniya, which per the Prophet(sm), is tantamount to “eating the meat of your dead bother’s corpse”.
So how can a person so careful about his “zabiha halal” diet, enjoy eating “his dead brothers’ meat” so lightly? I’m sorry if the example is a little “distasteful”, but that exactly is my purpose: To make my readers feel the distaste of what an idiotic fallacy is being committed here!
Very similar is the case with Islamic Banks. We run to them in our quest to become “shariah-compliant”. Now this is a very good thing to do, no mistake about it. The Prophet(sm) has ordered us never to “belittle” a righteous act, no matter how small. It is commendable both to seek out reliable Shariah judgements on “non-zabiha” food, as well as “interest-free savings accounts”. But without belittling this individual effort, the irony we want to point out lies in the over all in-significance of this “compliance”, as opposed to the loss we are incurring, as an Ummah, by postponing the implementation of a true Islamic Economic System in the muslim world. Just like we neglect bringing our character and actions in accord with Islam and sit content by just fastidously adhering to a zabiha diet, so too, we sit content on getting ourselves a supposedly interest-free investment income, without bothering to understand how the very foundations of our financial system are grounded in un-Islamic principles, and make us loose much more than we can imagine.
The current banking and monetary regimes prevalent in the world are fundamentally opposed to the principles of Shariah. The only thing Islamic Banks offer is a “lesser evil” at an invidual level. Infact, according to one eminent scholar this lesser evil has also been introduced only to “capture the market” of those people who are otherwise still too committed to their religion not to sacrifice principles for commercial convenience.
Now lets turn to the subject at hand of why we consider Islamic Banks to be so Un-islamic.
Why do eminent Shariah Scholars permit Islamic Banking
This is very confusing for the common man. With so many learned shariah-scholars approving Islamic Banking, how can all of them be wrong. Again, the answer to this can best be explained by an example. Consider a thief who is very kind to his neighbour’s children. Now based on this, if the neighbour says, “He is a good man”, you would say “why is he calling a thief to be a good man”? The answer is, he is talking about something else - a different “aspect” of the same person, which perchance, is actually good. Same is the case with the “Islamic” aspect of these Banks. Our Shariah scholars have done a lot of research to come up with “contracts” that are permissible in Islam. These include Mudaraba, Musharika, Ijara, Salam, Istisna etc. These scholars are authorities on defining the specifications and qualifications for these types of contracts, and we salute them for doing an excellent job in researching and standardizing these rules. We do not attempt to portray ourselves as equivalent authorities to these scholars to challenge their findings, and nor do we claim that this research in Islamic financial arrangements is flawed.
But there is an important distinction between approving the forms of contracts to be adopted by a Bank (like being good to your neighbour’s children in our earlier example), and the over all scope and context of all the other activities which a Bank engages in (the habitual theft of the same person in our example). When an Islamic scholar says that he has “reviewed and approved” the functioning of an Islamic Bank, what he is really saying is that the “contracts” adopted by the Bank in relation to its depositors and borrowers have been endorsed by them. This does not imply a review and approval of the full gamut of activities that the Bank will engage in.
We, on the other hand, instead of challenges the findings of our Shariah scholars, only take their very same findings, and apply them on a bigger level to the over all Banking and Monetary regime in our country, and demonstrate how it fails the test of being fully Islamic by those same principles.
In other words, Shariah Scholars do not “approve” this banking regime. Anyone thinking otherwise can take the points listed below to any such scholar, and ask their opinion on them. The only problem is that adequate focus and attention has never been given to these issues, partially because they are too subtle, and partially because they are too difficult to resolve. And of course, the sponsors of Islamic Banking themselves have only to loose by highlighting them, so they don’t.
Bai Madum and Gharar - Fractional Reserve
The very first problem with the Islamic Bank is that it is, after all, a “Bank”. It adopts Islamic principles in only one aspect of its operations, (i.e. the nature of depositor and borrower contracts), but in all other ways, it acts just like a regular Bank. This means that any Shariah violation that the banking system as a whole is guilty of, applies equally to Islamic Banks also. The first of these is fractional reserve.
There is a concept in Shariah called “Bai Madum”, which means selling something which is not in your possession, or which does not exist.
Ja`far ibn Abi Washiyah reported from Yusuf ibn Mahak, from Hakim ibn Hizam (who said): “I asked the Prophet: O Messenger of God. A man comes to me and asks me to sell him what is not with me. I sell him (what he wants) and then buy the goods for him in the market (and deliver them). The Prophet replied: ‘Do not sell what you do not possess’. This hadith is narrated by Abu Dawud in his Sunan, 3/768, hadith No 3503; Al-Tirmidhi in his Sunan, 4/228, hadith No 1232 ; Al- Nasa’i in his Sunan, 7/289 , hadith No 4613.
There are different view points among the schools in how literally this needs to be taken, with further complications added by the permissibility of Salam contracts, but nevertheless, this much is universally agreed upon by all schools of thought that the underlying reason for the prohibition of Bai Madum is actually the wider principle of the prohibition of “Gharar”. Gharar is universally acknowledged by all scholars to be forbidden. Thus, if presence of gharar can clearly be demonstrated in a particular transaction resembling “Bai Madum”, then the prohibition would certainly take effect.
It is simply a common sense corollary of the Bai Madum principle to say “do not lend what you do not own”. Lending becomes infested with gharar when the liability being undertaken by the lender is such that the chances of fulfilling the obligation become very thin. Excessive risk is always a sign of gharrar. In the case of fractional reserve, the risk is not just “possible”, but concretely, factually, and officially present: It is a known fact about modern Banks that they do not hold enough funds to service all their obligations at one time. Thus the long history of Bank failings, and the creation of central banks to act as “lenders of last resort”. All Banks, including Islamic, operate on the principle of “fractional reserve” which means they really only own a “fraction” of the money which they lend to borrowers. By no stretch of imagination would any Shariah scholar ever disagree of gharar and bai madum injunctions being applicable here.
As if “gharar” in fractional reserve is not sufficient, there also exists the element of “Bai al-Dain”, to which we come next.
Bai al-Dain – Sale of Debt
Bai al-Dain means the “sale of debt”, and is forbidden. The overwhelming majority of Shariah scholars are unanimous in its prohibition. There are two ways in which Banks engage in Bai-al-Dain.
At the most fundamental level in our prevalent monetary system, Bai-al-Dain is inherent in the usage of the very currency notes that we carry in our hands. These notes, issued by the State Bank of Pakistan, actually represent the “sale of Government debt”, in the form of treasury bonds, which the State Bank purchased at a discount, and then extend further on in the form of currency notes. The State Bank itself fundamentally violates this Shariah principle in the manner in which it issues currency notes, a concept totally alien to Islam and taken in toto from Riba-based western financial tradition. Commerical Banks, an intrinsic part of this arrangement are thus complicit in this prohibited activity.
Apart from being involved in Bai-al-Dain owing to their relationship with the State Bank and dealing with “Currency Notes” (which is formally is a written promise of Bai-al-Dain contract), the Islamic Bank itself can also be said to be involved in Bai-al-Dain owing to its fractional reserve practice. If a Bank is lending money to someone, since that money is itself not in the Bank’s possession, but only a “receivable debt” that the Bank expects to collect in the future, lending that “receivable debt” further on to another borrower at a different rate, would fall under Bai-al-Dain prohibition also.
Riba
While Riba in Islamic Banks is “supposedly” eliminated in the Bank-t0-Depositor, and Bank-to-Borrower relationship, the relationship between the Islamic Bank and the State Bank continues to exist as normal, which means that the Islamic Bank itself borrows money on interest from the State Bank, thus engaging in Riba.
Murabaha - Back-Door Riba
While in theory, Islamic Banks engage in Musharika and Mudaraba contracts also, practically under the hood, the percentage of total lending based on this model is really a fraction of the lending done in the more controversial “Murabaha” model. Murabaha, (or “markup”, “cost-plus”) has been called “back-door” Riba by its more radical critics, and is considedred at-least controversial in the more moderate mainstream Shariah Scholars also.
Consider e.g. the historic judgement of the Supreme Court of Pakistan banning Riba and mandating its removal from the financial system. (This judgement was never implemented, and is currently in limbo thanks to the powers-that-be who do not want true Islamic finance to be adopted in Pakistan).
We quote some text out of this judgement, regarding “Murabaha”, also called Mark-up or Cost-plus.
(The Federal Shariat Court)… has held the “mark-up system as in vogue” to be against the Islamic injunctions and has expressed its apprehension that this mode will be subject to misuse and, applied without fulfilling the necessary conditions on a large scale basis, it will bring little difference to the present system. We have already observed that the “mark-up system as in vogue in Pakistan” is not a Murabahah transaction in the least. It is merely a change of name…..
The Murabahah when used as a mode of trade financing is borderline transaction with very fine lines of distinction as compared to an interest bearing loan. These fine lines of distinction can be observed only when all the basic requirements already explained are fully complied with. To ignore any one of them makes it an interest-bearing financing, therefore, it should always be effected with due care and precaution.
Notwithstanding the permissibility of the Murabahah transaction, it is susceptible to misuse and keeping in view the basic philosophy of an Islamic financial system it is not an ideal way of financing. Hence it should be used only where the Musharakah and Mudarabah are not applicable.
Since the above judgement was passed many years ago when Islamic Banking was not as mature as it is today, we cannot say if the Murabaha contracts of today have substantially improved in their Islamic character or not, but it is clear that there exists a bias among Islamic Banks to opt for this model as opposed to others. E.g. in 2008, 38% of financing by Meezan Bank was done on the Murabaha model, and only 0.2% on Musharika.
It is obvious that one of the most basic implications of the prohibition against interest (Riba) is negation of the time-value concept of money. Rs. 100/- today must be equal Rs. 100/- one year from now, and must be returned in the same amount. In this context, Murabaha is a very direct, naked associaton of time-value to money. If I can obtain a car for Rs. 0.5 million today, but I choose to buy the very same car for Rs. 1.0 million from a Bank under murabaha just because the Bank allows me to return it in 6 years, this is nothing other than associating the time of six years an extra value of 0.5 million. If I have cash, under no circumstance would I purchase the same car for an exorbitantly higher price. It is for this reason that this form of financing was disliked by the Shariat Court as well as many scholars, but is, unfortunately, the most popular among “Islamic banks”.
The main problem with Murabaha is not that it is forbidden. The problem is that in the Un-Islamic, inflationary context of the present day financial environment, this permissible contractual form lends itself easily to functioning as a Halal conduit to achieve exactly the same effect as Riba – a feature that it automatically looses when placed in a true Islamic financial environment. Therefore, our claim of the “impermissibility” of Murabaha is really the “impermissibility of using this legitimate Islamic contractual form in an un-Islamic financial context allowing it to be used in lieu of Riba”. In a true Islamic environment, Murabaha will cease to be exploitable as a Riba-disguise because the borrower will have real, interest-free credit alternatives available, at which point it would become pointless for him to purchase something at “cost-plus” when he can obtain interest-free credit and purchase the same thing at market price. In that environment, Murabaha will naturally degrade to its natural uses only, and no more be usable as a Riba alternative.
We have discussed elsewhere, that true Islamic finance cannot be brought about in a society unless the whole financial and monetary system is overhauled to conform to Islamic principles. This is a huge undertaking. We do not pretend to say its simple or easy to implement. But if we are not capable of implementing it, at least, lets be honest and not twist and turn our religious principles to justify what we currently have. We do not have true Islamic financing or Islamic banking, so lets openly acknowledge this sad truth.
Infact, it is our contention, that we never really can implement a true Islamic financial system, unless the Ummah switches back to a Gold or Commodity backed monetary system, which is devoid of inflation, and thus, no longer makes the time-value feature of money its intrinsic, inseparable characteristic forcing everyone to rely on Riba to offset the time-value loss.
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