Some Misconceptions of Islamic Banking

It should be clear that Islamic banking is one of the several institutions of the Islamic economy. However, it is neither necessary nor sufficient condition for the existence of an Islamic economy. In certain quarters,.there is a misconception leading to the naive belief that advocates of Islamic economy want to establish the Islamic economic system but by establishing a few Islamic banks here and there. For example, a German observer of the Islamic banking scene remarks:

“The hope is that the Islamic banks will turn out so successful in economic terms, i.e. so profitable for capital owners as well as depositors and without any adverse (but a number of beneficial) effects for the funds demanding entrepreneurial partners of the bank that (in the long run) everybody will turn away from interest-based banks and towards Islamic banks. The result would be an evolutionary instead of a revolutionary transformation of the economic order, basical ly caused by individual decisions and market forces and not by political decisions and government interventions.”

One should keep in mind that banking activity is required only when economy has achieved a certain level of development resulting in the separation of savers and investors. Hence, it is possible to have an Islamic economy in which savers and investors are the same people. In such an economy, banking which is necessarily a form of financial intermediation, may become redundant. In this sense, Islamic banking is neither a necessary nor sufficient condition of Islamic economy which even may exist without Islamic banking. However, it remains one of its important ingredients. This assertion should not be confused with the prohibition of riba which is a necessary condition for existence of Islamic economy. An Islamic economy no matter how primitive or advanced could never be permitted to practise riba and still remain Islamic. Commercial banking is not the only way to organise financial activities on a non-riba basis. State ownership of banking institutions is another method of elimination of interest from the economy in which case the state will ration the credit according to requirements of various sectors.

Furthermore, Islamic banking cannot be regarded as a sufficient condition of Islamic economics cither. Mere presence of a few Islamic banking institutions w’ould not make the whole economy any more Islamic than the present, for which far- reaching structural changes and reforms would have to be carried out in almost all spheres of social and economic activities. Not only that, probably a number of new institutions will have to be created, Islamic banks being only one of them.

If Islamic banking is neither a necessary nor sufficient condition for the existence of an Islamic economy, then what is really the significance of Islamic banks?

The answer to this question depends upon correctly understanding the nature of banking business and prohibition of riba in Islam. Banks are financial intermediaries which function as a bridge between the savers and investors if they are not the same people. They mobilise the saving of the people and provide it to those who have productive outlet for these funds. Traditional commercial banks perform this function on the basis of interest. The significance of Islamic banking institutions is that they aspire to perform the same functions as those of modem commercial banks without indulging in riba. To this extent, Islamic banks provide an alternative to interest-based banking for religious reasons.

If there are certain other economic advantages accruing from their functioning on the basis other than interest, ... add to the usefulness of Islamic banks as an institution. Similarly, nothing forbids Islamic banks to carry out some other functions, in addition to their normal banking functions, as would contribute to establishing the Islamic economic order and propagating the most cherished Islamic values in the field of economic and business activities. But it would be presumptuous to think that mere establishment of a few Islamic banks would automatically lead, through market forces or otherwise, to the establishment of an Islamic economy.

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