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Financing on Normal Rate of Return

Under this method a specialised public agency may determine the normal rate of return in each industry, business etc., and the banks may provide funds to the entrepreneurs with the assurance that the ascertained minimum rate of profit would be payable to the bank on the amount provided by it. The agreement should also provide that if the actual rate of profit exceeds the designated normal rate of return, the difference would be voluntarily paid by the entrepreneurs to the financing institution. In case, however, the rate of profit turns out to be lower, or if there is a loss, the entrepreneur concerned would have to prove the same to the satisfaction of the specialised public agency in which event the bank will accept the lower rate of profit or share in the loss. The main advantage of this method is that the financing institution would not be burdened with the scrutiny of accounts of the parties to be so financed while the risk of fraud would be minimised. Moreover, it would facilitate financing of small business and industry which are generally not in a position to maintain proper accounts.

The Council, however, feels that although this method conceptually does not violate the principles of the Shari‘ah because the basis of transactions is sought to be the actual operational results, while the normal rate of return has largely an indicative value, there is a strong possibility that its wide-spread use may in practice degenerate into pure interest with the passage of time. This is because if the actual profit turns out to be more than the normal rate of return, it would be unrealistic in view of the existing moral standards in the society to expect that this difference would be surrendered by the entrepreneur voluntarily to the bank. On the other hand, if the actual rate of return turns out to be lower than the normal rate, it would very often be difficult for the trader to prove it to the satisfaction of the agency concerned. Thus under both the situations the normal rate would tend to be the only basis of transactions. It is, therefore, apprehended that gradually there would cease to be any difference between the normal rate of return and interest. The Council, therefore, recommends that this method may be applied on a very limited scale and only wherever unavoidably necessary. Its use should be restricted to financing only those small entrepreneurs whose means are limited and who cannot be expected to maintain proper accounts or get them audited. It would be necessary that the proposed official agency keeps the normal rate of return continually under review in the light of changes in business conditions and notifies the revised rates so that the parties involved are not put to unnecessary inconvenience.

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