Issues in Pakistan Supreme Court Response

Definition of Riba: The judgement is based upon some assumptions or concepts at the conceptual level. Riba have been defined in clear terms. While doing this, the Court has taken into account the controversy that has been taking place about riba in different circles, giving due consideration that all viewpoints being presented were not insincere, many think honestly about the differences. Yet, the court has rightly come to the conclusion that riba covers all forms of interest, usury, bank interest, public utilities and government schemes if they are based on a pre-determined fixed return related to time. It is also very clear that there could be other forms of exploitation and Islam is as much against those forms of exploitation as the exploitation in the form of riba. This should not in any way make the riba concept flexible, yet extension to new situation is not ruled out.

Indexation: Secondly, the verdict has clarified that indexation is not the answer; serious problems and injustices arise from inflation and the menace must be fought. May I submit that there can be two possibilities - one, which is most preferable and pragmatic is that Inflation has to be controlled at its source and that is possible only if we have a monetary policy in which stabilization of prices is the primary objective. The government should live within its means. It is a question of living beyond its means that creates a situation because of which excessive borrowings take place, and inflationary pressures are generated. Today in Pakistan, we do not have just M1, M2 and M3, there are dozens of categories of virtual money. And this explosion of money and credit and the erosion of their real value is not particular with Muslims only, economists the world over are seized of this issue. European Common Market has laid down as one of its fundamental principles that member countries must contain inflation below 3%. Japan has been able to contain inflation to around 1%. So, it is through monetary policy addressing at the source that the problem has to be checked. But for argument sake, if it is not possible then we can develop certain programs and packages in the interest of justice because inflation in its real terms, is a tax upon the poor and the under-privileged. This is the way to face it and not by going for indexation of return on credit.

Search for Alternative: The judgement is based on the belief that there is an alternative to interest; both at the theoretical level and at the operational level. Not that at the practical level things are perfect or all problems have been solved. Economist and bankers who appeared before the court had also been conscious of these problems, in fact they emphasized those problems. Hail to the verdict it has recorded these concerns. As said earlier, elimination of riba is not just an act or an event, it is a process through which all the problems would be addressed. Every effort may not necessarily succeed, even failures would also be met in the way. Islam is guidance in the perfect form but human efforts to approximate towards that ideal would remain human and as such subject to error. There can be errors in human judgement, of competence, of not cognizant of ground realities. We have to learn from the mistakes and rectify the wrongs. This process is within the framework of Islam which has taken place in the past and which will take place in the future as well. The Supreme Court judgement is clear that alternatives are available and one must not be obsessed by the apprehension of the unknown. The realization that there are issues and challenges, which would have to be faced, only suggests that we should be realistic, innovative and creative. There is no cause for despondency.

Dishonesty and Moral Laxity: The court has also addressed one of the issues - which is often but not justifiably presented as an obstacle. That is the issue of dishonesty, moral laxity, information asymmetry. All these are genuine problems, but not insolvable. These are problems not merely for a riba free Islamic economy; they are problems for any economy. Moreover, the question of dishonesty is not merely a Muslim society syndrome, it is universal and a menace to banking anywhere in the world. Transparency, accountability, enforceability of contracts, credible ratings - both of borrowers as well as of lenders - are ingredients of a good economic order. There is no reason when we are talking of elimination of riba we must not address these issues and develop policies, institutions legal framework and viable business practices that are needed for that. So none of these can be an excuse for not moving in the direction of riba elimination. Judgement has discussed all these issues.

The Macro-dimension: Now let us come to the future. Islamic Banking and elimination of riba are essential pillars of an Islamic economy. However, mere elimination of riba in an otherwise capitalistic system is not going either to achieve the objectives or even produce a just system. So, the target should not be merely elimination of riba; it should be to see that elimination of riba takes place in the context of movement towards a different model of economy which has clear socio-moral objectives and where different parts of economy help and support each other to create a welfare and just society and network of relationship ensuring fair-play for all. With that as objective, it is more important particularly for the bankers and economists to be clear as to what is Islamic Banking?

The key issue in this context is the role of money in the economy. Discovery of money was a revolutionary development, even more important than discovery of the wheel that led to the whole technological revolution in history of humankind. No doubt, money can be a facilitator and a helper for exchange, production and economic development. Yet, it has the potential to become an instrument of exploitation if it abdicates its original role and is used to beget more money without real value creation. If money becomes the objective and money attracts money without developing economic activity, asset creation, flow of goods and services, it will create nothing but trouble. So in Islamic framework money is the means of exchange, not a commodity and an instrument for mere amassment of wealth.

In this regard, it may be useful to point out that in the classical formulation, the formula was CMC i.e. Commodities via Money leading to production of Commodities. The capitalistic system changed this into MCM. Focus moved from commodity to money, yet commodity and asset creation was there at the centrepiece and money was used to produce commodities and services. And this circle continued. But now the grossly exploitative capitalism has created a situation where the formula has been reduced to MMM. Now it is a process where money is generating money without creating assets. The make-believe world of derivatives, options and claims on assets has created a fiduciary world unrelated to the real assets and productive efforts in the economy. Daily transactions in foreign exchange derivatives are to the tune of $1.3 trillion, fifty times more than the physical trade in funds and services. It is only the big players who are milking billions without contributing to the physical growth of the economy. Thus, this is the most exploitative phase and interest is the kingpin in this process. In the Islamic context, there is no objection to have money, but money as an intermediary, not money as an objective and an instrument of exploitation.

On that basis, the question of investment can be at two levels. One, direct investment where anybody who has money and resources, can make them available to anybody who has expertise, projects, and can run the business. And historically, this has been a very important process for promoting economic activity and development. The second step is that of financial intermediation. In more sophisticated arrangement, investment is through financial intermediation and that is where the contemporary banking system comes into foreplay; where mutual funds, pension funds and all similar schemes lie. Since this is a natural transition, there is no harm in it. In the Islamic system, there are institutions of financial intermediation but with a difference. The Islamic banking is banking proper. It has clear economic, commercial, profit-oriented objectives. It is not charity or simple social service. It has to operate professionally with clear objectives in view; not following in the footsteps of the capitalistic model of banking. Along with that it has some distinct characteristic; while it is banking proper, professional and geared to productive, commercial and economic objectives, it operates in an ethical framework. This is the distinct characteristic of all Islamic institutions. Along with that, the most important characteristic in Islamic banking is that it is equity-based. While there is some scope for credit and near-fixed return based financial instruments, the real thrust of Islamic banking has to be towards promoting an equity-based investment culture. It has to move towards a more equity-sharing, stake-taking, risk-sharing arrangement.

Movement Towards Investment and Equity-based Instruments: One genuine concern also shown in the judgement and needs to be addressed is that though experiments in Islamic banking so far have made a remarkable beginning in the direction of elimination of riba, by and large bulk of the operations are still close to debt-based instruments. Movement towards investment-based equity-sharing and stake-taking instruments is slow. A recent report of International Islamic Banks reveals that the role of Musharaka and Mudaraba has increased from 5-6% to around 18-19% over the last 10 years. This is a slow movement particularly while the main operation of the Islamic banks remain debt-based. In this context, the Islamic banker has to realize that he will have to take a bold stop to move towards an equity-based financial system. There is no denying that some need for debt and credit would stay and as such some kind of debt-based instruments may remain. This, however should not be the main business of the banking. Instead, we should move towards the new model not only in the banking but subsequently whole of the economy, because that has to be a more equitable and stake-taking society, a participatory society and not merely a debt-based economy.

The Islamic vision of economy is not one of predominantly debt-based one or is an equity-based economy. And as such the role of the bank is not merely of a lender but also rather more of an investor and a partner in the enterprise it is financing. Bank is a participator in the process and let’s just as a foot-note add that one must not be allergic or too apprehensive about it, because even in the Western banking tradition there are very profound historical traditions of commercial banks involved in investment banking. In this respect, the German Banking System of the 19th century and the Service Banking System of France are two important examples where commercial lending and investment banking have gone side by side. Definitely, the expertise that is needed by the bankers would change. Attitudes and stakes would also change, but that is the kind of transition Islamic banking has to make. So while trade-based and debt-based instruments would remain, investment-based and equity-based instruments must gradually become the back bone of the system.

Collateral and Inflation: That the Islamic system is more entrepreneur-friendly is not mere heresy. The focus shifts from collateral to the project, to the entrepreneur, i.e. the viability of the project and credibility of the entrepreneur. As such, it becomes more just. Operating it in this spirit will essentially result in asset-creation and increase of production and providing resources to those who have ideas, who have skills, who have projects, but who may not have the sole merit of collateral. It does not mean that collateral is ruled out. Collateral would be there, but as one of the many - not as the only or the most important factor. After all, rehn (mortgage) is one of the Islamically accepted modes of security. But the attitude has to change. Let it be entrepreneur-friendly. Profit-sharing has another merit. It would be production-oriented and as such non-inflationary. Return based on profits would capture the wageries of price change. Elimination of riba and production of profit-sharing has the potential to keep the inflationary pressures in check, particularly when easy borrowing would be curtailed and discouraged at all levels. It is submitted for the economists and bankers to reflect on this idea that profit would essentially capture inflation in the society. Interest has to capture it artificially, arbitrarily, but profit would capture it automatically. And as such a system in which the main stream is profit-sharing and equity-sharing, then the inflationary pressures, right from their generation can be contained.

That Islamic banking system along with the monetary system of the government has to be non-inflationary, is my humble submission. It has to have a human face characterized by deep human concerns; it cannot be merely profit-oriented.

These are some of the important considerations because of which Islamic economic system is destined to be more just system. It should have a policy objective to see that the resources of many are utilized for the well being of all. Its investment and lending policies as well should have this dimension. That is why it is hoped if this system is operated with the moral and social objectives in view - and the banking system runs professionally - it would lead to the creation of a welfare-based society with equitable system of wealth and income.

Source: Towards Islamic Banking: Experience and Challenges, Institute of Policy Studies. Republished with permission.