Discussion on the Elimination of Interest from Economic & Finance System

There are three major areas, which have come up before us and I just want to identify them to facilitate discussion. First, abolition of interest is not the be-all and end-all of Islamization of economy and a number of supplementary and very fundamental changes would have to be needed. Some have been identified by our discussants, which relate to moral and motivational change, institutional and structural change and providing guidelines to the institutions keeping in view the socioeconomic objectives of Islam. We have to further reflect in this respect and suggest whatever transformation or modification is needed even in the functions of the central bank and the commercial banks. This is one area. Some points have already come up. If some brothers want to supplement, then, please feel free to do so but please avoid repetition because on this part we can say a lot but I do not want our central issue to be clouded by being over-concerned about this area.

The second area which is the cruse of the problem is that the Council of Islamic Ideology has come up with this idea that during the period of transition we have to move towards profit-sharing to be the major alternative, but it has to be supplemented by a number of other instruments. They have been identified. I want you to reflect upon this and guide us as to what extent you feel this provides a viable alternative.

I emphasise that we have to keep in view that the situation which we are discussing is a phase of transition. We cannot neglect this phase of transition which has been emphasized again and again by the Panel and the Council of Islamic Ideology and by a number of other people who are trying to discuss these issues. The third area on which I want your guidance and help is as to what are the issues which have been rather left by the Panel or by the Council but which are integral to the evolution of this new financial system, e.g. the point brought in sharp focus by Prof. Siddiqi about consumption loan outside the present financial institution. If there are some other such areas which you want to identify we would like to be guided by you. So I may submit once again that we have these three major areas: Reforms which may not have been covered by these documents but which are essential; viability of alternatives that these Reports suggested and identification of supplementary areas which are integral to new financial system but which have not been touched. With these few submissions, I now open the discussion to the floor.

Prof. Khurshid Ahmad


First of all I extend my compliments to the members of the Panel who prepared this excellent Report which is a very lucid, logical and frank report on the subject. I would like to refer to three points which, I think, were not deeply dealt within the Report. First, for the interest- free banking system in this country, I think, it is necessary to simultaneously bring the structural changes in the banking system in Pakistan. With the existing banking system, which seems to me rather based on the British understanding of the banking method and the concept, it will be very difficult to implement this new banking system. In my view the shape of the present banking system should be changed to an investment banking system rather than of a commercial type. I give the example of the banking of my own country. The banks which are in the investment field and which are doing their own investments are making much greater profit than those banks which confine themselves to only commercial operation. Secondly, I saw less emphasis on investment in shares. Banks can invest in selective companies by purchasing their shares. If the firms do not seem to be working satisfactorily you can sell their shares in the market.

Also a Mutual Fund for the small business can be encouraged all over the country — small funds created by the small businessmen themselves and with the help of the government. This can be organised by mutual cooperation on interest-free basis. Lastly, I have a suggestion for that part of the society who are obliged to borrow money for consumption purposes.

In Turkey, we observed that a lot of low income people acquire loan from the government or banks on the pretext of using it for building of houses or for farming. But they actually never used the funds for this purpose and instead financed their personal consumption from these loans. We, therefore, initiated a project according to which the banks will provide small loans to the low income groups for consumption purposes free of any interest. The government will, however, meet the banks’ cost of providing these loans by paying these banks a serivce charge from the government’s own budget. This scheme can be implemented in Pakistan also.

Dr. Nevzat Yalcintas

I would like in the start to compliment the people who have participated in the Panel as well as the Ulema of the Council and the Government of Pakistan for the efforts which they made for this Report. I, however, would like to make a few remarks.

I would support what our brother Chapra has mentioned about the strength of commercial banks at the present time. Actually this is one aspect which should get more attention in our countries because we see commercial banks at the present time realising profits of 100 per cent of their capital in one year and this is an exploitative aspect of the community which contradicts the Islamic principles of social solidarity and consequently the Islamic principles of sharing the responsibilities. These powers of the commercial banks should be curtailed.

The other point which has been mentioned by brother Abdul Jabbar Khan is important. The businessmen and banks should cooperate in order to make the experience succeed and not that each partner should exploit the other. This is important in order to make it a successful experience. In this respect actually comes the point that abolition of riba is not the only thing which would lead to the Islamization of the society. It is true that our concern is mainly about hudood and riba is one of them but social atmosphere also should get more consideration in establishing the Muslim community. If riba is abolished then we have other principles and other values which can guarantee to a great extent that there will not be an excess demand for loan and the other fears which have to be sounded by economists that you will not be able to allocate scarce capital. We have other Islamic principles which would guarantee that this would not be realised.

In fact I would like to raise two other points which are related directly to the subject. One is the mark-up scheme. When the commercial banks, instead of giving letters of credit and loans for businessmen to finance their imports and the international trade would enter with them into a mark-up scheme, as I understand, this would mean that the businessmen will always sell the commodity at a higher price than its cost while at the present time we see there are instances where the internal prices might go lower at a certain stage than the price of this imported commodity. In that case, the businessmen might incur a loss. What would the bank bear in this case? Is the bank going to share the loss also or what shall we do? Under the present interest-bearing system the banks grant letter of credit and get their interest and charges. The banks do not have to do anything with the prices at which the goods will actually be sold. But when we adopt the mark-up system, are not we necessarily forcing the importer to sell at a higher price and thus are not we creating inflation in the economy? While reading the Panel’s Report quickly I get the impression that the letter of credits would continue to be issued by the banks with interest. How would this be justified under an Islamic state?

Dr. Sultan Abu All


I will be very brief and I will concentrate on the profit-sharing. 1 have been thinking for quite a long period of time on what is the alternative to the riba system and I will advance an idea which I have not yet fully developed but I would request the brothers to think over this idea. Suppose the state or the monetary authority could act as the sole Mudarib and the other banking system could collect the savings the contract would be a general contract between the state as the sole Mudarib and the community as a whole as Arbabal Mai. In this case the concept of normal rate of profit could come into the system whereby the risk would be shared by all the community since it seems to me that diversification lessens the risk element involved and it seems to me that in this scheme there will be no losses and there will be profit-and- loss-sharing in the sense that the community as a whole will share the losses and profits as well. Of course, this is the bare idea. It could be worked out and developed. I think the Fiqh and the jurists would not object to this because it really amounts to what the essence of the Fiqh is that it is not only profit-sharing but also loss-sharing as well but in essence the risk element is as well as the profit shared by all the community.

Dr. Omar Zubair


I have got three questions:

  1. It is not very clear whether deposits obtained under the PLS scheme will also be invested on the same basis.
  2. What measures are being taken to ensure that these PLS funds would be kept in a watertight compartment. I raise this question because there is a danger of these accounts being polluted by the interest-bearing operations as the same will be existing in the same institution.
  3. It appears to me that PLS partakes the functions and operations of investment banking and if it is true then are not we duplicating the functions which are already being performed by investment corporations or is it that there is going to be credit creation from the PLS accounts in the fashion of commercial banking operations?

I have some comments also:

We were told that the Panel and the Council considered the idea of a model Islamic bank but it was rejected because it would not be viable as it would be located in a hostile environment. Pre- - viously I also used to subscribe to this idea but the other day we were told that the model banks have performed very successfully in other countries like Sudan, Kuwait and elsewhere. I wonder why we could not initiate it here. We can consider it as an alternative. Why cannot we take it as a possible complement to the prevalent vertical phasing out of the present system? The present scheme, I think, is a vertical phasing programme. One by one you phase out the existing institutions. But side by side 1 think you can set a model bank. It might hasten the process. Instead of considering it as an alternative we can consider it as a complementary step.

  1. The second comment is with respect to the concept of normal rate of profit which was just mentioned. It is a normal idea, to minimise cheating. I do not think there is anything un-Islamic about it because this rate is not predetermined and will vary from year to year. But I do see the danger that some borrowers or users of funds may bring down the actual profits to the normal rate of profits to escape a query. But one way out will be not to declare this figure and it should be an internal management thing.
  2. Finally, we were told about the Penalty for those who would not be behaving properly. I think side by side we should also have a reward or an incentive scheme for those who are making the system a success.

Dr. Mohamed Ariff


It is unavoidable that we have a phased programme. But I think if somehow government sector operations were not directly to be amended in the immediate future at least a beginning should have been made. First comes the State Bank. If State Bank had started the Islamization process before commercial banks, it would have been logically consistent and operationally it would have forced the commercial banks to follow the example set by State Bank.

It would have been desirable to start from the assets side but if the government and the experts on banking had chosen to start the phased programme it should have been started simultaneously from the liabilities side as well as assets side, i.e. a partial beginning from both the sides.

A beginning could also have been made by categories of deposits rather than by opening counters. For example, we could have started from the long-term deposits where the determination of profit is easier than say, in the case of saving bank account.

To allow the two schemes — interest-bearing bank and the interest- free counters under the same ceiling — seems a little contradictory as it places an unnecessary burden on the conscience and the faith of the people to make a clear choice between the two systems.

A mention has been made about the consumer credit or non-commercial credit as I would like to put it. From our distinguished friend Mr. Jabbar Khan I would like to be enlightened as to what percentage of the consumer credit constitutes out of the total business of commercial banks. If you know the real magnitude of the problem perhaps, it will be easier to solve the problem. I have discussed it in detail in the other session.

Dr. Muhammad Uzair


The elimination of interest means getting rid of a mechanism by which monetary equilibrium is established. Now we, as Muslim economists, have to see that how can we realize our objective after putting an interest-free system in practice. At theoretical level very few things are impossible. We face the problems on the practical side.

By freeing economy from interest we eliminate a mechanism as well as a policy instrument. We, therefore, need either another policy instrument which can be used by the government to intervene in the market or we need a consistent mechanism which would work smoothly without needing any intervention from the government. In this field it seems necessary:

  1. to build a sophisticated model of interest-free economy which would be working with market mechanism, and government policies will be reconciled in a consistent manner;
  2. to educate people in general and administrators in particular; and
  3. to establish new institutions which could make the working of interest-free economy possible.

Furthermore, as some of the participants put it clearly, elimination of interest as an institution is not the whole thing. Islamic philosophy and principles require a new economic model, where not only material but also spiritual values should be combined into one and consistent model.

Dr. Ahmet Calicbay


I disagree with Dr. Omar Zubair for calling a system where government is to be the Mudarib and the general public to be the financier, because this suggests that everything will be in the hands of the government hands thereby involving the government in the real activities and business of the country.

Secondly, I wonder if the Government of Pakistan has taken any step to educate businessmen and bankers to tackle the problem and to see what could be the solution of different problems. The basic solution always comes from the field and we have to involve practical businessmen and bankers in preparing programmes for the Islamization of the economy.

Dr. Muhammad Tahir


I agree with Dr. Nejatullah Siddiqi that if the losses are eliminated, then they can change the name of the counter also. My second point is that when clients of the bank are also asked to have this type of accounts, i.e. the profit-and-loss-sharing accounts then, I think, some mechanism should be developed to allow them to have a say in the management as well as its whole investment activity. I am afraid that this has been not the case till now. I do not agree that it is difficult to have a model Islamic bank in Pakistan. It is time that a model Islamic bank should be established in Pakistan.

Dr. Hussain Mullick


I agree with Dr. Nejatullah Siddiqi on the question of investment auctioning that such devices may become a cover for normal interest- based transactions. I also agree with him that we should have started the programme of eliminating interest from the assets side rather than from the liabilities side. I have a suggestion to make. The type of experiments which are taking place these days in the Yugoslavian mixed economy where some sort of a framework of the collectivity of ownership of capital goods exists, I wonder if the same could be permissible under Islamic Shari‘ah.

Dr. Syed Aftab Ali


One thing which has been pointed out here is that there should be a rationalisation of expenditure both in the private and the public sector essentially to cut down unnecessary wasteful expenditure and eliminate what we may call Israf in the Islamic sense. I think this should be given a priority. We, however, need to establish some norms by which we may define that expenditure on certain items is unnecessary or wasteful. There has to be some department or division or some unit to establish the norms to distinguish between the necessary expenditure and Israf.

The second point relates to the emphasis on the teaching of the ideas that we are developing here. The general student, both at the policy in order to have a sound policy. The rate of interest, regardless of its criticism, plays a role in regulating the creation of credit and supply of money. But now since this instrument is no longer applicable in an interest-free economy, then there should be more integration of the monetary and fiscal policy. It could have been much better, if a separate report dealing with this issue was also prepared. The second point is financing consumer credit. In the present setting, this cannot find a place. A new way has to be found. Qard-hasanah is not the function of any commercial bank. Special arrangements can be made in order to satisfy the needs of this kind.

The mark-up is very dangerous because we cannot cover up interest by giving it another name. Either we have to say interest and stick to it until you find a way out. A sale should be a final sale.

The mudarabah or profit-sharing means sharing loss also in Islam. So the name should be profit-sharing not profit-and-loss-sharing because a mudarabah should go all the way and all the way means profit-sharing but in case of loss, the loss should be incurred according to the ratio of capital. There is nothing in Fiqh which could permit us to change this rule. If I contributed 10 per cent to the capital, can my loss be 15 per cent? In no Fiqh we can find a solution. I have been associated with the preparation of rules for the Islamic bank of Jordan. We spent 3 months in order to find a way out. There is no way out.

Dr. Wasim Ahmad


My first comment relates to the motivational aspect of non-interest- bearing finance, particularly the banking operations. Unfortunately the name given to our dealers in short-term credit, i.e. commercial banks is very misleading. The name orginally implied that these are the institutions that finance trade and commerce. But now it seems that the commercial bank means to run the bank on commercial lines, i.e. essentially for a profit motive. This is true that replacing interest rate with profit-sharing will take away the riba element in our financing operations but the banks need not operate strictly on profit motives. Many complications that have been posed and many difficulties indicated in these two Reports stem from the fact that we take for granted that our banks have to be profitable. In my view, in a nationalised banking sector profitability should be the least criterion. Banks should be looked upon as service institutions and even if they incur deficit on the profit side, this deficit should be met out of the public exchequer as a subsidy to this service sector. However, even if we allow for a moderate profitability in the banking sector, the bank need not make profit on every transaction it undertakes. Therefore, we have to identify a class of transactions where profit is not the motive. My other comment relates to the introduction of profit-and-loss-sharing counters and windows in the banks which have a significant portion still based on interest. This is putting the new experiment at a serious disadvantage.

Equity finance is expensive to begin with. The minimum required rate of return on equity capital far exceeds the going rate of interest in any money market or capital market. The reason is that the return on equity incorporates a price for risk taking also whereas the prime rate of interest has no element attributable to risk. Naturally in capitalistic economies, investors and entrepreneurs take advantage of the financial leverage and this debt capital being cheaper adds to the profits of the owners. So from users of funds point of view, given a choice, they will naturally prefer debt finance to equity finance. Thus our riba-free counters of profit-and-loss-share counters will have a serious disadvantage.

The other disadvantage stems from the fact that a significant interaction between monetary and fiscal aspect has not been taken into consideration. Under the present taxation laws, interest is tax deductable whereas dividend is not tax deductable. This makes equity financing more expensive. I would like to propose that for the time being, at least till such time as interest based and interest-free system co-exist, dividend payments may also be declared as tax exempt as in the case of interest. The alternatives that have been suggested to the profit-sharing system in the Panel’s Report, sometimes come very close to the rate of interest and we have to guard against them. The Report recognises that problem, and is cautious at various points but when it comes to practice and it discusses the various sectors which will be covered by various alternatives it has a long list to be covered by alternatives, which they said they will be using very very sparingly. They have included a whole range of activities where they think they can use the alternatives. We have to watch against them so that we do not fall into a trap.

Mr. Sharafat Ali Hashmi


I would request the Panel to consider the idea of investment auctioneering once again because this may be very dangerous. First of all it may lead to concentration of wealth because if the investment funds are auctioned in a competitive market then the big industrialists will get most of the funds. What we should be trying to do as one of the objectives of Islamic system, is the reduction in inequality of income and concentration of wealth. Just as in the theory of international trade we have infant industry argument, we may, perhaps, have the same argument for infant entrepreneur. We have to encourage small entrepreneurs and small investors. This cannot be done in open auctioning. Secondly, this method will create a tendency to earn higher profits because whatever price they pay in getting the capital by bidding its price, they will have to earn profit over and above that. This will lead to profiteering and falsify the objectives of Islamic economy.

Dr. Munawar Iqbal


I disagree with Dr. Ali that we should not allow the banks to earn high profits. High profits mean efficiency and there is nothing un- Islamic about being efficient.

I also disagree with taking assets and liabilities separately in the elimination of interest rate. What we are trying to do is to eliminate interest rate on loans but this does not mean providing free money.

I would also mention that all banks’ interest is riba and is prohibited. Nobody can say anything other than that. I was misunderstood the other day and I apologize for that.

It is important to establish a follow-up department so that people do not get away with the bank’s money and its share in the profit.

Mr. Fouad Abdul Gadir Agabani


I like to highlight some problems specially for the private enterprise. Under the profit-and-loss-sharing system, we can visualise a more intensified competition among the major five banks not only to attract deposits under the new terms but also to seek out potentially successful and profit making commercial firms and industrial ventures. This is most welcome from the point of view of efficient allocation of resources. However, there is also a danger of production in the private sector either not increasing or even decreasing during the transitory period of the introduction of the interest-free monetary system. Take the case of the “sick” textile mills which are far from making profit and there are some other industries also but they are not getting adequate credit. Thus private sector may be unable to convince the banks to provide them capital. Meanwhile, the commercial banks which are accepting PLS savings and Term Deposits would always be under pressure to maximise their profit earnings and may actually prefer to lend to Government’s trading operations in grains, TCP’s imports, I; Cotton Corporation’s export, Commercial Mark-ups and other public Agencies operations which carry profit-returns without much risk. If bank resources are limited and if the above analysis is applicable, then the lending to the private sector will decline. This may lead to a decline in deposits also. We will then face a vicious circle of low deposits and low lendings on profit-and-loss-sharing basis especially in private sector. Therefore, the role of the State Bank of Pakistan becomes much more crucial in its policy for credit ceilings as well as for allocations between various sectors under the profit-and-loss-sharing system than under the interest-oriented system. I am sure that the State Bank of Pakistan is fully alive to all these consequences.

Agha Mohammad Ghouse


I should definitely congratulate the people of Pakistan and its Government especially the banking system of this country for its big venture to eliminate the interest.

I hope that the interest-free counters will really be independent inside the banking or are autonomous and I know it is possible. We have made a feasibility study at one time in this field of establishing that kind of thing. In some of the commercial banks it is possible to make completely autonomous department based on interest-free transactions. I definitely subscribe to the idea of requesting these banks in Pakistan to extend the interest-free counters to their branches overseas.

The second point that I want to refer is for the essence of elimination of interest in Islam. The essence is prohibition. If we keep the same existing forms of lending by renaming them, I do not think we will be fulfilling the spirit of the prohibition of interest. I can see two major substitutes that are Islamic and within limit provided in Islam - the profit-sharing in all its forms and the qard-hasanah. In case of qard-hasanah, I agree with Dr. Sakr that we may need some different institutions than we have now. From the concepts like investment auctioning, I am, however, very much worried. It seems to me that it is nothing but finance auctioning and if it is so then this is nothing but an interest rate in a different form. The same is for Mark-up and the normal profit rate.

Dr. Monzer Kahf


I want to mention only one of the proposals which is time multiple counter-loans. I want to point out that the scheme of time multiple counter-loan seems to be quite exploitative and, therefore, it should not be considered as an alternative to interest. If we can take a simple numerical example which the Panel’s Report has mentioned and work out the expected profit on the amount lent and borrowed, we will see that the borrower has to pay much more than what he receives. I do not have the time to explain it on the blackboard but I think that can be worked out very easily.

Dr. M. Fahim Khan


I would say that multiple counter is hundred per cent un-Islamic. This amounts to selling a loan for a loan which is un-Islamic. Selling a loan for a loan has been specifically prohibited by the Holy Prophet (peace be upon him).

Dr. Sharafat Ali Hashmi


I would like to point out that in our discussions we need to take care of the Baitul Mai along with taking into account the matter of the Islamic Bank. If Islamic banks want to do anything they will do so on commercial basis but as far as the provision of qard-hasanah and collection of Zakah are concerned, they have to be done by the Baitul Mai. We have to make some kind of studies about the importance of creating Baitul Mai in all the Islamic countries.

I like to point out that we can classify the borrowers from banks into three groups. First, there are the very big companies. I do not think they really need to borrow money from the international banks because they can afford to finance their projects through shares and through the Government support. The second group is the middle sized businessmen. I think it is better for them if they group themselves according to their specialisation. This group will get equity from U'5 Islamic banks and not from the Government. Third is the private sector in small business. It is the responsibility of the Government to give them loans free of interest.

Dr. Darwish Saddig Gastaniah


I do not agree that excessive rate of profit is allowed in Islam as mentioned by Mr. Agabani because it obviously does not reflect efficiency. Excessive profits reflect only the monopoly power which is not Islamic. This is simply usurption. I disagree completely with Dr. Monzer Kahf also on his approach to the idea of normal rate of profit. If we follow his advice then we have to close all the banks because the pooling system will not be workable. Each project has its own normal rate of profit and it will be very difficult to get the parties agree upon the idea of the pooling of profit rates.

Dr. Omar Zubair


I feel a great deal of gratitude to the people and the Government of Pakistan for doing what nobody else has dared to do even though many would like to do viz take up any serious systematic and scientific querry for eradicating interest from society. I feel that this is really a very historic event and its importance should not be underestimated. I really wish that they would receive maximum publicity throughout the Muslim World for which it would need to be translated in Arabic and distributed widely. I am, however, not saying that everything in this Report is acceptable to every student of Islamic economics or to every man of Shari‘ah. My major point is that in these Reports we find a systematic approach to a very delicate and important policy question from both the economic and Shari‘ah side. The way the Panel was set up and the Council of Islamic Ideology was operating on this question should be considered a model for any Muslim society which want to deal with an important policy question having Islamic or other social implications. This sort of combination of men of Shari'ah and economists and bankers working in close collaboration for the solution of a problem is unique. I honestly feel that if there is a prize in the Muslim World for Islamic achievements and service then it must go to the people who worked for this Report and to the Government and to the people of Pakistan for taking this great historic step. I really wish that the Faisal Prize should go to the people who worked for this Report. Of course, a tremendous effort has been put in this and the amount of interest generated thereby is so much that now it is time to go ahead and apply.

As regards the application there are two frames of mind — one is timid and cautious. They are not sure that what Allah has prescribed can work. They would only wish others to take the initiative and if they win, then these people will follow in their footsteps. Nothing good happened in the world out of the people with this frame of mind. The people of Pakistan have taken a very courageous step and have tried to be first and Allah subhanahu wa ta‘ala will have the reward for them that He promised for those who are willing to take the risk and take the first step and face the challenge of the unknown. Such people will be rewarded much much more than the people who wait and see.

I wish that this matter of application be taken very seriously. The people in Pakistan do not realise the importance of what they have achieved and perhaps they take it more lightly than they should. They have achieved something outstanding and they should be very proud of it. They should now attend to the application of the Report and it should not be a timid application. It should be both an honest and full application.

I would first of all give support to Dr. Sharafat Hashmi’s suggestion, who has made the point that when we have both the interest-free counters and the interest bearing banking co-existing with the existing tax laws, then we are putting Halal at a disadvantage and Haram at an advantage. The suggestion made by Dr. Hashmi is practical and should be implemented. I would like to point out the importance of the suggestion made by my brother just a while ago regarding the formation a group of certain companies or the market structure of industrial and commercial concerns. We know that the big companies are easy to audit and consequently since they have to keep record and so on, providing them the equity capital or mudarabah funds etc., would be rather easy to control. So is the case of medium size companies. It would be, therefore, desirable to encourage the formation of such companies as much as possible through various means. Of course, when he suggested the formation of large- and medium-size companies, this is not to say that ownership and control has to be large and concentrated.

The other suggestion is regarding speedy drafting of an audit and account authority. Dr. Chapra’s previous paper has suggested a very very important thing that an independent audit company be established which will audit the accounts of the various companies which draw funds from banks. It wiif operate for the benefit of the banks and the businessmen but it will be an independent and very honest set-up so that the records of the businessmen will be unavailable even for the income tax authorities. Also sqme very severe penalty must be imposed on those'who can be shown to have acted dishonestly. The third suggestion is the matter of short-term financing. Now we must understand that the matter of short-term financing is related to the way the business is built. We know that in the capitalist set-up banks essentially provide short-term loans. They will come to long-term loans only on exception. With the present type of banking, the businessmen have maintained the habit that when they set up an enterprise, they do not set sufficient amount of equity for the continuous needs of the working capital of the company. They always finance it from the short-term loans from the banks. Consequently, an artificial need of finance is created. Thus if I need to borrow every month Rs. 500 and pay it back every month it means I have not maintained sufficient funds for my continuous short term needs. Such continuous (or permanent short term) needs should be forced to be financed by equity participants.

The banks can say them that they keep coming to them for short-term loans implying that they do not have sufficient funds with them and, therefore, they should increase their equity rather than raising shortterm loans.

Jr. Anas Zarqa


Abolishing interest would result in at least five problems:—

  1. How to achieve equilibrium in the money market?
  2. What rate of discount can be used if such discount is desirable?
  3. How is capital to be priced so that resources are optimally allocated within the economy?
  4. What criterion can be used in allocating funds to Government Projects?
  5. What alternatives would be available to replace short-term bonds or near money?

Equilibrium in the money market in economies where interest is abolished, can no longer, in my point of view be achieved, by the use of the monetary policy. This is particularly so since there will still be some demand for money for purposes other than the transactions or precautionary motives. Also profit ratios cannot be used as a monetary tool to clear the money mark as long as short-term bonds (or near cash) are not available and in particular if these ratios are not easy to change. To clear the money market in this situation you need a fiscal tool, perhaps along the lines suggested in my paper Fiscal Policy in an Islamic Economy, namely, a tax on idle cash.

If future discounting is necessary and desirable then you would need a global or macro rate of discount. The rates of profits on different equities can only be used at project or micro basis. The availability of a global or, as some prefer to call it, a representative rate of profit would also help in solving the third problem, namely, allocation of capital efficiency between different uses in the economy. It could also be used, as a criterion for allocating funds, by the Government.

The fifth problem, i.e. to find alternatives to short-term bonds is a serious one and may require a radical change in the structure of the economy particularly the ownership of industries.

Dr. M. M. Metwally


In spite of the great value of technical working out of the manner in which various substitutes of interest can take over the function of interest, many of the alternatives suggested are undistinguishable from interest. If we are not merely concerned with form, but also with eradication of the exploitative content of interest which manifests itself in unemployment, inflation, polarization of wealth, social tension etc., a lot more of thinking will have to be done.

The only alternative which so far commands general acceptance, the one of profit-sharing, is not without its shortcomings. It was a form of personal credit, whereas we need a basis for impersonal, institutionalised credit. It can easily serve the corporate sector, but becomes unwieldy when we extend our operation to medium and small productive loans. From its very nature, it is incapable of application in the case of consumptional loans and Government loans.

The only alternative, so far suggested, which appears to be capable of responding to the various requirements of interest-less banking, namely Time Multiple Counter Loan Concept (TMCL), has not yet won wide enough acceptance. The objections against this concept are of two kinds: firstly, from persons who are very rightly concerned that it may not violate any provision of Fiqh, and secondly, from the bankers. Many of the objections raised from the religious point of view appear to have been met by the amendment made in this concept by the Islamic Advisory Council of Pakistan, before according its approval to it. It has stipulated that the counter loan should already be available to the credit institution, before any loan is advanced to the borrower, which appears substantially to water down the objections from the standpoint of Fiqh. It is for persons well versed in Fiqh to evaluate the extent to which any objection survives. For instance, one of the objections is that it is a conditional loan, which is not permissible. But mudarabah is also, perhaps, a conditional loan, granted on the condition of a specific percentage of profits. If after evaluating various objections and answers that come to mind, some residue of objections survives; it has to be evaluated against the possibility that in the absence of an allembracing alternative to interest, interest may continue to dominate our economics. Either we should evolve a substitute which is equally simple, workable, all-embracing, and free of all objections from the standpoint of Fiqh, or we should accept TMCL arrangement, until we evolve something better than this, in preference to continuing in a state of war with Allah and His Prophet, (peace be upon him).

[ The General Discussion ends here, and the chairman asked the two official discussants and then the speakers to make concluding remarks. 

Shaikh Mahmood Ahmad


Dr. Zarqa just raised the issue of short-term needs of business of the present day. He is right that there is nothing sacrosanct about these short-term needs. They are a creation of inherited system. I would, however, suggest that some of us might look into the matter, before we have it in empirical terms. It deserves scrutiny at the logical or theoretical level to see whether it is true that the need for short-term loans will decline in an interest-free system.

Then I am reinforced in my own views about investment auctioning and I think Dr. Munawar Iqbal has added to it quite a new point which deserves serious consideration by all those who still have a soft corner for that kind of approach. I think his point about likely concentration of wealth and the auction finance being swallowed by few big business houses is well taken and deserves consideration. Also his point relating to the forcing up of the rate of profit in economy as a whole deserves attention. This is the likely outcome. I think we will all agree with the suggestion of Dr. Sharafat Hashmi that now there is a discrimination between those who will receive dividends from profit and loss accounts and those who hold interest-bearing accounts and that this discrimination should be eliminated.

Dr. Nejatullah Siddiqi


Two of the questions were from Dr. Aftab Ali. One was about the reduction of the power of commercial banks so that they are not able to utilise their huge resources for benefitting a few individuals or families in the economy. I think this I have covered at length in my paper on Money and Banking in the Islamic Framework and to some extent in my comments on the Panel’s Report.

The other question was about the stock market. How is it possible to make the stock prices reflect the underlying economic conditions? This is, of course, a very difficult question and I do not think at the moment I have the answer. How the prices can be regulated? Who will regulate them? Whether or not it should be some government authorities or some institutional set-up that will automatically take care of such problems? These are some of the questions to be answered. We, however, know that there is a substantial degree of speculation in the stock and commodity markets. So much so that some individuals are able to manipulate the market to their advantage. We know the recent incidence in the silver market by the Hunt Brothers who manipulated the market to the extent to which they were able to take up the price from $ 8 to $ 50 and they were able to make billions. They unfortunately faUed as the God Almighty intervened for the small users of silver and they did not succeed. So how people are able to manipulate the market? There are a number of things that have been done. Some people sell the things that they do not even have them.

There is a Hadith that you cannot sell that you do not possess. But on the other hand, the Fiqh have also allowed Bai Salam and these things have to be studied together with the questions of purchases on margins and settlement of differences. Sometimes the people do not have the intention to pay at all or sell but they go to the market and to make speculative gains and they settle the difference. Whether or not these practices will be allowed in Islam are the questions that we have to examine and to propose a programme for a sane-stock market. I have suggested in my comments that the Government of Pakistan should establish a Panel to study the working of stock market in an Islamic framework but if this is not done then I would suggest that Muslim scholars should take up the task of preparing a comprehensive paper on this. Dr. Wasim asked me a question about how to determine the necessary spending of the government to save it from Israf. Of course, this is a very difficult issue but if any government want to do it I think they can easily determine where are the areas where savings can be done. I do not think you and 1 can go into it here. Dr. Raddadi also talked about the strength of the commercial banks. I think the term itself probably might have caused confusion. I am not against the strength of the commercial banks. They should be as strong as possible from the point of view of safety to the depositors. To that extent, the strength is desirable. But using this strength to benefit a few individuals is undesirable and this is what I am against.

Winding up by Dr. Umer Chapra


I find that most of the points raised here are in fact suggestions and therefore I do not have much to say. The suggestions made by the participants will surely be considered. There are, however, two important points needing some discussion. One is what sort of procedure be evolved for the valuation of inventories and the other question is how the profits would be determined because balance sheet has many items which can be used to show lower profits. Because we have here Mr. Abdul Jabbar Khan who is much more competent to answer the practical questions I request him to answer these questions on my behalf.

Winding up by Dr. Ziauddin Ahmed


As far as the valuation of the inventories is concerned I feel that it is perhaps in connection with the mark-up or Bai Muajjal. In the case of mark-up, let me frankly admit that the present prevalent interest rato will be made on the basis of the valuation. But as I have suggested in my presentation that in due course of time the concept of normal rate of profit should make the basis because in due course of time there would be no interest rate structure in the Islamic society.


The second point is about the profits appearing in the balance sheet. I suggest that the profit-and-loss-sharing should be on half-yearly basis and a trial balance should be prepared by the company or by the borrowers. The sharing of profits and loss on half-yearly basis should be on the basis of income and expenditure statement or profit-and- loss-statement which is generally prepared by every business concern in a little more detail on half-yearly basis. My friend Sulaiman has mentioned about the normal rate of profit. Actually it will not be one rate of profit. It will be a set of different rates for different categories of industries. Even within the industry there would be different rates for different sectors of that industry. Some of the brothers have suggested that the structure of the banks be changed from commercial banks to investment banks. Let me first explain the trend in the business practices and procedures in Pakistan. The entrepreneur likes to keep the control of his enterprise in his hand and that means that in the equity he should a* least hold a majority. If he has to hold the majority of equity, he would not like to broaden the base of the equity which has been so much advocated by most of the delegates and that is why in Pakistan for sometimes to come the loans for working capital will continue to be a major portion of the investment rather than the equity in our commercial banks. This being so the commercial banks will have to play an important role. Commercial banks will remain commercial banks rather than investment banks because investment banks, I understand, share only in equity. Another point is that the commercial banks should make more investment in the shares. The distinguished delegates need study of our stock exchange position. The stock market is not able to absorb even the surplus funds of the Investment trust and ICP. If we pump over commercial banks’ deposits of 6 billion U.S. dollars into the stock, you can very well imagine the fate of the stock market in the country. The limitation is that the equity base of most of the companies is small compared to their loans. This is the trend of business in the country and we annot change it overnight. It will take some time. Let us hope if this trend changes.

Another point was about higher profits of banks. I think the distinguished delegates have overlooked the great services the banks are rendering in mobilizing the savings in the country.

Let me tell you that the banks are not making that much profit and our margin of profit is very small. The reason is that we have to make provision for all bad and doubtful debts. We have to write off after not only the interest but sometimes even the principal amount. We have to make provision for them.

Another point was about the letter of credit. In the case of letters of credit actually no financial accommodation is involved because it is just a sort of the promise the banks undertake through a letter to the importer that if he presents the documents then he will get payment. No money is involved until the documents are presented. After they are presented then they are not letters of credit and instead they are called import bills of exchange, and import bills of exchange have been based on mark-up basis. It is only a sort of service and we charge only a commission for this. This has been cleared by the Council of Islamic Ideology.

Now I take the case of marked-up imports. A delegate indicated that there is no risk involved because the bank would get the marked- up amount. In theory it is true there may not seem to be any risk. But in practice supposing if there is a fall in the market price and the goods have been imported, I will say hundred p*r cent chances are that the importer will leave the goods and the goods-will fall to the share of the bank and the bank will have to sell whatever may be the marked-up price. The loss whatever is not recovered from the importers and from his securities. The loss will be of the bank. However, I agree that in the case of mark-up there are very little chances of loss. But there is one point in the case of mark-up. If the person or if the importer does not pay that price on the date on which he is supposed to make delivery, any period in excess of that he is utilising the banks’ funds free of interest. To that extent the bank is undergoing a loss.

As regards PLS deposits, I would like to assure the delegates that our accounting is such that we will keep absolutely a separate account of PLS deposits and their deployment would not contain any element of interest. Although you may say that mark-up is another form of interest, yet since mark-up has been cleared by the Council we are abiding by it.

As regards commercial banks, I may assure, that we like to cover our transactions under profit-and-loss-sharing basis but you please keep in mind the three difficulties which I explained in my presentation this morning. The bankers in Pakistan would like to assure you that they would like to bring more and more transactions under the profit-sharing scheme.

Winding up by Mr. Abdul Jabbar Khan


This is a very pleasant duty to sincerely thank the two main speakers and the discussants who have no doubt done their jobs very well and I am satisfied that the contributions from the floor have also been immense. I am sure, the time we have spent in the discussion has been an investment for all of us. Those of us who are acting as theoreticians and those of us who are acting as practitioners, both have benefitted from the points raised, questions posed and responses offered about the problem of the elimination of interest from our economy.

I am deeply impressed by the fact that a distinguished gathering like this has shown a kind of near consensus on this new approach which is being developed in this country and some other countries. Though profit-sharing is to be supplemented in the transitional phase by a number of other instruments, it has emerged as the chief alternative to the present interest based transaction in the banking and other financial institutions.

The other point that I would like to emphasize is that the House recognises the fact that the new destination that we want to reach is very different from the socio-economic realities with which we deal today and therefore, total change cannot come in one big leap. Hence a piece-meal approach may be needed. But this approach should be such that each step leads to the next step. We must not stop midway and we must not just substitute change ignoring the substance. Every step should take us away from the present model and bring us nearer to the new model.

This discussion has also shown that there are very important areas on which new work is needed at theoretical as well as practical level for which a feedback from the practitioners will also be needed.

Finally, I would like to say that the Panel of Economists and Bankers and the Council of Islamic Ideology have done a wonderful job on which we compliment them warmly and whole-heartedly and we lend our support and we pray for the success of this approach. We, however, hope that the Council of Islamic Ideology will not feel that they have done their job and that is it. We hope that they would have another Panel or a number of Panels which would on the one hand keep a constant eye on the experiment being made in the light of their retommendations, to see whether these steps being taken are bringing us nearer to the goal that we have in mind including the obstacles coming up and how they are to be tackled and on the other hand, they would take up those issues which have been raised but which needed further thinking, research, discussion, and dialogue. For this purpose three areas come to my mind very prominently. One is the question of indexing. In spite of the interest shown by economists and reservations expressed by Fuqaha I sincerely feel this is an area which deserves further investigation from the SharVah point of view as well as from the viewpoint of economic and banking practices. This is an area where working groups should be formed to undertake the study. The second area is of credit creation about which brother Siddiqi complained that it has not been taken up to the extent we had discussed it in the Makkah Seminar. I do feel that here is another potential area for further research and examination and a working group for this might be useful to undertake an in depth study of the issue. Then there is the question of normal profit. I do not think this should be disposed of or accepted off hand. I think it is an important area for further study and reflection. I hope that the Council of Islamic Ideology, International Centre for Research in Islamic Economics and other institutions would try to take up these issues and study them in depth and come up with reports for further discussion.

Other areas have also emerged from today’s discussion where I think the Council of Islamic Ideology should apply themselves:

(a) The success of elimination of interest will depend on a number of changes in the economy at the level of formulation of our objectives of economic policy; at the level of formulating our development strategy; at the level of seeing how in the light of these objectives it will be necessary to bring about changes in the nature of certain institutions e.g. the profit motives. How it is to be modified in the Islamic framework? In the Islamic framework, the profit motive will have to be modified by altruistic considerations. The egoistic approach is not the only approach in Islamic framework. The institution of Hisbah also deserves to be attended to in order to act as a kind of a national vigilance on the system to see where are the violations taking place. As Dr. Umer Chapra pointed out, there are other forms of exploitation which may not be in the form of bank interest, which should also be attended to. The changes in the taxes, changes in the functions of central and commercial banks are other areas requiring immediate attention. All these areas need to be studied.

  1. The transformation of the existing structure into an Islamic structure will require establishment of certain new institutions. One important suggestion that has come up from the discussion is the institution of qard-hasanah. Whether this should be developed within the system of commercial banking or outside need to be studied. Other institutions required for the transformation should also be identified and studied.

With these few submissions I now conclude. I sincerely thank all of you and above all I very sincerely express our Shukr to Allah subhanahu ta'ala for enabling us to meet to discuss and giving taufiq to our brothers to make this intellectual effort and providing us so much food for thought and reflection. Without His mercy we could not have met and spent this time reflecting on an issue which is of immense importance for the future of Ummah in the 15th Century Hijra.

Final Winding up by the Chairman: Prof Khurshid Ahmad


Source: Money and Banking in Islam, Ziauddin Ahmed; Munawar Iqabal; M. Fahim Khan. Republished with permission. 

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