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Bank as Business Partner

There seems to be an agreement among jurists and Islamic bankers on the issue that a bank can act as a business partner even though it has no prequalification to run a business. In case any of the partners is supervising this business the bank can act as a sleeping partner. Theoretically, the Shari‘ah does not object to this position because, in an Islamic shirka, all partners have a right to work but are not bound to work. But this cannot be claimed in the case of mudarba. Practising mu- darba would raise a number of issues, purely from Shari'ah point of view, before the bank involves itself into this contract. First, can the bank be treated a working partner in a contract of mudarba? If yes, will the bank be expected to work itself or allowed to pass on the mudarba funds to a third party for doing business or allow the third party to pass on the funds to a fourth party and so on? Then, can it legally undertake mudarba in any sector of the economy it likes?

In essence the rules of the Shari‘ah do not normally permit the contract of mudarba. The reason why the Prophet (pbuh) expressly did it in supersession of rules was that saving in the hand of inexperienced owner of funds and skill of a rc- sourccless entrepreneur do not remain idle. This means that the spirit behind legalising the institution of mudarba was transferring idle capital to an entrepreneur but not to a financier. In other words, mudarba is a combination of capital and entrepreneurship but not capital and financing intermediary by declaring the depositor as the owner of fund and the financial institution as a trader (mudarab). There is no doubt that the bank is the user of the fund but this use is simply a reallocation of this money among those panics who use these funds for their business. Thus a bank, although legally competent to contract a mudarba as an agent or a middle-man is incompetent to practically do so as a working party. The reason why the bank insists on taking this position is that it will thus shirk of the liability to bear any probable loss1 which it cannot do as a financier.

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The second point is that in case it can prove its competence to contract as a working partner to evade the risk of business it has to prove that it really performs the work or manages the work reassigned by it to a third party by way of sub-mu- darba. But practically it is not always necessary. The bank may advance the funds to another financial institution which itself may not be the last intermediary. Take an example.

Suppose a group of depositors, A, offers its funds to bank B on the basis of mudarba. But B advances it by way of sub- mudarba to a finance house, C. C enters into a sub-sub-mu- darba with a leasing company, D. D, in turn, purchases taxi cabs to lease out to the transporters E on the condition of sub-sub-sub-mudarba. The transporters distribute these taxis to drivers F who are the actual workers, on the condition of sub-sub-sub-sub-mudarba. It is the drivers who would ply these taxis and pass on a portion of their earnings to transporters. The transporters, retaining a portion of profits for themselves, would pass on the agreed portion to the leasing company; the leasing company would share it with the finance house; the finance house with the bank and the bank with the depositors or the owners of fund. The situation is not only ridiculous but is also bound to reduce the share of profit for the owner of fund to a ridiculous portion.


Sub-Mudarba Contracts

A advances Rs 1,000 to B at 50-50 share of accrued profit

B readvances        "       "   C

C "                    "       "    D                .........................

D "                    "       "    E                                         

E           "           "       "    F                                        


Distribution of Profit with a Hypothetical Earning at 24 percent (Rs 240) by F


passes on 50% of Rs 240 to E (Rs 120) retaining

Rs 120


" " of Rs 120 to D (Rs 60)

Rs 60


of Rs

60 to C (Rs 30)

Rs 30


of Rs

30 to B (Rs 15)

Rs 15


of Rs

15 to A (Rs 7.50)

Rs 7.5

The above situation can be tabulated in the following way:

A cams a total profit of Rs 7.5 over Rs 1,(XX) or 0.75%.

It may perhaps be due to this ridiculous situation that the discussions in books of fiqh do not go beyond the tier of sub-mudarba

Another question arises as to the scope of mudarba. The fiqh literature insists that mudarba is applicable in trade operations only but not in manufacturing, transport, agriculture, construction, etc. Thus, while a bank may qualify itself to become a business partner, it may not be practicable for it to venture the contract of mudarba.

As regards a bank’s competence to contract murabaha or mark-up etc, the legality of existing practice of a number of banks is also not very convincing. All these techniques involve the Islamic law of the sales of goods. A necessary condition of sales of goods is that the goods should be in possession of the seller. Possession also involves that the seller should transfer it from the premises of the first supplier. Another condition of sale of goods is that goods should be precisely defined. As long as small individual banks with insignificant share of funds and limited number of fund seekers requiring selected items are operating, these techniques would be found practicable conforming to Shari’ah requirements. But, the large banks with huge funds required to cater to the countless requirements of a hundred thousand customers can hardly manage to fulfil all the Shari‘ah requirements concerning murabaha. buy-back, bai’ salam, or mark-up.

The problem would be found all the more serious if the switchover encompasses the entire banking system. Take the example of Pakistan where five major Pakistani banks have a network of over 7,(XX) branches which meet most of the requirements of all the economic sectors. These banks have over 1.5 million loan accounts, and commodities and services which come under these economic sectors and should be precisely defined for transacting under the Shari‘ah-approved murabaha or mark-up must be in five figures. The general category of furniture or chemical cannot be the object of transaction unless the unit of the commodity is precisely determined. Thus, if a bank is required to resell furniture to a trader on the condition of murabaha or buy-back it has to define the unit of furniture, viz. table, chair, bed, etc. and its quality. Resale of toothpaste cannot be valid unless the brand name is specified. These examples would have to transact under murabaha or mark-up.

It emerges that practically it is impossible for large banks or the banking system to practise the modes like mark-up, bai’ salam, buy-back, murabaha, etc. in a way that fulfils the Shari‘ah conditions. But in order to make themselves eligible to a return on their operations, the banks are compelled to play tricks with the letters of the law. They actually do not buy; do not possess; nor actually sell and deliver the goods; but the transaction is assumed to have taken place. By signing a number of documents of purchase, sale and transfer they might fulfil a legal requirement but it is by violating the spirit of prohibition.

An interesting point is that all these techniques are not adopted in their normal course which involves prompt payment. Rather, all these techniques involve bank funds without which nobody would be tempted to transact with the bank. Even the banks are not found anxious to attract customers who can make prompt payment. This also shows that the real performance of the bank is advancing funds but not purchasing or selling of goods for trading, or receiving regular rent as a risk-bearing owner and earning by possession of a large number of real estates for speculation, renting or for developing. A large bank is and will never be anxious to really offer any goods for sale or offer its services for transport, development or construction to any other party than the one who actually needs funds for this purpose. A buyer, a seller, a developer, a land owner, a manufacturer comes to the bank not because the bank is a stockist, a seller, an importer or exporter but because it can advance funds to cater to these requirements.

To sum up, we come to the following conclusions:

  1. What the banks are really doing is pooling up idle monetary resources to reallocate them to useful na tional purposes.
  2. The reason why the banks have adopted a variety of financing techniques with least emphasis on profit- and-loss sharing is partly the fact that PLS does not seem to them practicable in all the economic activities and partly that it does not guarantee a return which is necessary for maintaining the institution and distributing it among the depositors which is one of the barometers of its solvency.
  3. All the techniques involve bank funds to finance the procurement of goods and services but not the other way.
  4. The techniques, claimed to have been adopted by these banks, do not often follow the procedure which is necessary in the Shari‘ah; it is rather assumed that the procedure has been acted upon.
  5. In all the techniques, without any exception, the profitability of the bank depends on the element of postponement of payment. In other words, earning depends on converting the transaction into a debt

These conclusions prove that banks are rendering a service and should be paid for it. But, this fact does not entitle the banks to claim a share by way of profit as is validly claimed by a seller of goods, a manufacturer or a transporter.

The above points take away the credibility of these techniques being an ideal system. This situation will persist unless the whole system is redesigned by recognising the purely financial role of the bank. A new approach to the role of bank in an interest-free economy is proposed in the following:

To ensure that Islamic modes of financing do not give way to the evils that interest is claimed to generate, it is necessary to shun mark-up, murabaha, buy-back, bai’ salatn, etc. all such techniques ensure a return for the bank without any consideration to the productivity of bank funds in the hands of the en- trcprcncur.

The banks first of all should specify those sectors where profit-and-loss sharing can be practicable.

Practice on mudarba would raise a number of issues before the bank involves itself in this contract. While contracting mudarba it would not be permissible for the bank to take the place of an entrepreneur or a working partner. It will be equally inadvisable for it to take the position of a co-financier and thus bear the risk of loss. Thus in all the sectors or transactions where musliarakah is not practicable or advisable a bank can at best take one of the following positions:

  • It may act as a amin (trustee) of deposits.
  • It may be treated as an intermediary between the savers and the users of bank funds.

As regards above, it is not possible to treat the bank as amin because under the rules of the Shari4ah, an amin has no right to make use of the funds of the owner without his permission. Presently, this permission may be treated to be implicit and customary. But the main problem will arise when the bank incurs a loss on this amount in which ease, as the Islamic law prescribes, the entire loss will have to be borne by the trustee — the bank. Similarly, in the ease of earning profit the bank will be entitled to take away the entire profit. This position will not be acceptable to the bank nor to the depositor.

S M Hasanuz Zaman


Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.