Monetary Policy Instruments
The monetary policy instruments that the central bank in Pakistan has been adopting would largely be unchanged. The penal interest which it charges from the banks on non-observance of minimum cash reserve or liquidity ratio requirement would also continue with replacement of the word interest because the penalty that it imposes on banks docs not come within the purview of prohibited interest. The same would be the case with default by bank in respect of observing overall ceilings on the lending and investment operations or of observing mandatory targets for providing finance to priority sectors.
Elimination of interest on borrowings by federal and provincial governments involves two elements outside the control of the central bank: sacrosanctity of the concept of interest for the federal government and federation-province politics. Thus State Bank docs not have any option to choose.
Interest payable through State Bank in dealings with international financial institutions and foreign aid agencies involves international economic and political constraints for which no convincing and viable solution has so far been found out.
Anomalies in Interest-Free Banking and Proposals for Reform
The most important point that Muslim critics of interest bring forward is a fixed return on lent out funds irrespective of the actual productivity of these funds in possession of the borrower. Another point relates to risk distribution which, in the case of lending at interest, is solely borne by the borrower who is generally the entrepreneur. Thus the owner or depositor of idle funds makes a sure earning while the producer is exposed to risk of loss. These characteristics of interest are treated to be unjust. As compared with it, profit-and-loss sharing in the form of musharakah and mudarba is proposed to be the most effective technique of doing away with these unjust aspects of interest. It was, however, realised that a bank could not contract musharakah or mudarba on behalf of its depositors in cases where financial return would not be calculable during the period of financing contract; where trade was not involved or where long gestation period of the project was involved after investment of huge funds.
As a result, in order to cover all the economic sectors many more modes of financing have been introduced to replace financing at interest. They are murahaha, mark-up (a variant of murabaha), credit sale (bai’ mu'ajjal), leasing, hire-purchase, rent-sharing, development charge, buy-back (bai’ wafa), deferred delivery against prompt payment (bai’ salam), in addition to induction of financial instruments like participation term certificate, term finance certificates, mudarba certificates, etc.
This paper aims at making an inquiry into the extent to which the present Islamic banks in different countries are investing their funds on the basis of PLS. The next point to examine is whether the modes other than PLS are capable of doing away with the criticised aspects of interest. This will be followed by a discussion whether PLS musharakah and mudarba are really practicable solutions from Islamic point of view. If it is not so what practicable alternative can be devised to conform to the Sharfah on the one hand, and to avoid interest in letter and spirit, on the other.
More than 50 interest-free banks have been set up in different parts of the world which claim to be operating on the basis of modes like musharakah, mudarba, murabaha, leasing, hire-purchase, etc. This is in addition to the complete change over of the entire banking system in Pakistan and in Iran which have adopted all the modes for financing different sectors of the economy as enumerated earlier. But for a few exceptions the most popular mode of finance adopted not only by individual interest-free banks but also by Pakistani banks is murabaha which is also termed as mark-up or bai’ mu'ajjal. The way in which murabaha is practised by banks is different in different banks. There are also differences in operational techniques of musharakah and leasing.
In spite of differences in operational modes of different banks there appears to be a remarkable affinity in their outlook and approach towards bank functions. It seems that first, there is an implicit consensus among them that a banking institution is competent to contract as a trader, manufacturer, lessor, hirer or owner of merchandise and retain a share of profit accrued in such transactions so as to satisfy the Shari‘ah requirements. Second, the profit assumed to be accruing to the sellers, entrepreneur, lessee or factory owner can validly be made an object of distribution between them and the bank. This has not only created a number of practical difficulties for the banks but has also introduced anomalies in the scheme they have adopted. It seems that in large number of cases the ghost of interest is haunting them to calculate a fixed rate percent per annum even in musharakah, mudarba, leasing, hire-purchase, rent sharing, murabaha (bai’ muajjal, mark-up), PTC, TFC, etc. The spirit behind all these contracts seems to make a sure earning comparable with prevalent rate of interest and, as far as possible, avoid losses which otherwise could occur.
It is observed that the designers of interest-free banks with all their good faith and intentions will be facing this dilemma unless and until they are ready to assign the bank a position which it really deserves. The question of a bank’s right to claim a share in profit or a remuneration for its services involves a number of practical issues. And it is here that the role of a bank needs to be carefully examined.
It is due to historical reason that banks have been evolved purely as a financial institution. They are suited to attract money, keep it in safe custody, lend it under safety, invest it profitably and enjoy the capacity to create the means of payment. A bank has to maintain a balance between income, liquidity and flexibility. While allocating its funds it has to be meticulously sensitive about the factors like capital position and rate of profitability of various types of loan, stability of deposit, economic conditions, influence of monetary and fiscal policy, ability and experience of bank’s personnel and credit needs of the area. So far these banks thrive on a fixed rate of return a portion of which is passed on by them to the depositor. Thus the entire effort of a bank is directed towards money management and it is not geared to act as an entrepreneur, trader, industrialist, contractor, hirer, lessor or caterer.
The question arises: with all these limitations can a bank claim any competence in trading or in entrepreneurship which is necessary for mushcirakah or mudarba contract, or can it act as an owner of a large variety of heavy machinery, transport vehicles or real estate to take the position of a lessor or, can it act as a stockist to buy and resell the entire stock of imports and exports that are actually needed by genuine traders? In case the bank is historically and practically not competent to do all these jobs its claim to share a portion of profits as a working partner, trader or lessor becomes questionable.
S M Hasanuz Zaman
Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.