Temple University
James E. Beasley School of Law
Guided Research Paper
From: Elwaleed M Ahmed
To: Prof. James J. McGrath
Re: Final Draft
Date: July 20, 2004
ISLAMIC BANKING AND FINANCE:
ITS OPERATION AND THE NECESSITY FOR
ITS ACCOMMODATION IN THE GLOBAL ECONOMY
ISLAMIC BANKING AND FINANCE:
ITS OPERATION AND THE NECESSITY FOR
ITS ACCOMMODATION IN THE GLOBAL ECONOMY
By: Elwaleed M Ahmed
[1]The recent phenomenon of Islamic banking and financial institutions
started in Egypt in the 1960s. These banks, which neither charged nor paid interest,
functioned essentially as a saving investment institution rather than commercial
banks, by engaging in trade and industry, directly or in partnership with others, and
shared the profit and loss with their customers and depositors. These banks systems
functioned under the mandates of “shari’a,” Islamic law that prohibits usury and interest.
[2]Thus Islamic finance is based on the principle of profit and loss sharing.
[3] Since then there have been growing demands from Muslims everywhere to have
their finance managed according to Islamic laws.
[4] Therefore, in the 1970s, Islamic
financial institutions really took off, due at least in part to the new oil wealth in the gulf.
[5]Since then, “Islamic banking in the Middle East is growing and becoming important in
mobilizing local and regional saving, as well as providing an important source of
capital.”
[6] Contributing to the growth of Islamic banking in the Middle East was the
establishment of the Islamic Development Bank by the “Islamic Organization
Conference” in the early 1970s. The Islamic Development Bank serves as a “World
Bank” for Muslim countries, with the aim to facilitate the expansion of the Islamic
banking and financial institutions in the Muslim countries and world wide.
[7] As a result,
the annual growth of the Islamic financial institutions has been an estimated almost 15%
worldwide over the last decades.
[8] To understand the principle on which the Islamic
banking and finance is based, It is essential to have some an overview of the Islamic law
and its sources and jurisprudence.
Therefore, to assess the importance of the Islamic banking and
finance in meeting the Muslims community financial need, this article will explain how
the Islamic banking and finance works and the justification of the prohibition of “Riba”
interest in the Islamic law. Moreover, it will explain how the major allowed types of
Islamic financial services work and recommend the best way for Islamic financial
institutions to improve and get acceptance globally by nationally and globally unified
sharia board. Sharia board decides what type of finance is expected in the Islamic law
and recommends the unified accounting and regulatory standard body to
govern the Islamic banking and finance operation in national and global basis. The paper
also recommends the establishment of liquidity markets to handle the operation of the
Islamic banking and financial institutions. Moreover, the paper will recommend how to
accommodate the Islamic banking and finance systems in a global economy, especially in
the non-Islamic countries so as to meets the need of the growing Islamic communities.
In Part I, the paper will purpose that to understand the justification of the Islamic
prohibition of Riba: “Interest” and how the Islamic banking and finance works some
knowledge about Islamic law, its sources and jurisprudence is necessary. Therefore,
include the sources and jurisprudence of the Islamic law: "Figh," such as “Qur’an:”
which is the God “Allah's” word and instruction to his Prophet Mohamed (peace upon
him.) “Sunna:” the prophet’s words and deeds Ijtihad: "Refer to the formulation of the
law by the individual's struggle for proper understanding," Ijm'a: " Consensus of opinion
and Quiyas: " analogical-deduction." And finally, Madahib: "the different schools of
Islamic law Jurisprudence" approach to the issues of Islamic Finance and the prohibitions
of the “Riba” Interest. Part II, includes the types and definition of Riba: the Islamic
jurisprudence divine Riba in two types: “Riba Al-fadil” and Riba: “Al’ Nasia.” The paper
will offer the justification of the prohibition of Riba in the Islamic law and how the
financial affairs are addressed in the Islamic law. Furthermore, the paper will explain
how the Islamic faith is a way of life as well as a religion. Muslims whenever they have
been they always have to adhered to the Islamic principle.
Part III, will include how the Islamic banking and financial institutions operate
and will describe the most common types of the permissible Islamic financial methods,
and how they work and the justification of accepting interest according to the principle of
loss and profit sharing. The expected types of Islamic finance include, Mudraba: “Trust
Financing,” Igra wa-igtin: “Lease/hire-purchase,” Murabaha: “Cost-plus Financing,”
Musharaka: “Venture Capital,” Bai’salam Transaction. Further types include:
“Manazile scheme:” Islamic mortgage housing, property finance a Istisna contract: “is a
contract to manufacture,” Bai’ bi thamin ajil: “sale by deferred payment,” Al-wadiah:
“non-fund transaction” and Qurde-Hasan: “ Benevolent financing.”
Part IV, will include a comparison between the Islamic banking and finance
systems and the conventional banking systems: "Western banks" and the major criticism
of the Islamic banking and finance.
Part V, the final section of this paper will include recommendations.
(I): How to improve the operation and effectiveness of the Islamic banking and finance
system by :
A: The necessity of the existence of the unified Sharia board in the national and global
based so as to unify the decision on what are permissible types of Islamic financial
globally.
B: The necessity of the unified accounting and regulatory standard body to govern the
Islamic banking and finance nationally and globally. For the Islamic financial institution
to succeed and to achieve global acceptability and continue its rapid expansion it needs to
establish universally accepted accounting, auditing and regulatory standard.
C: One of the major challenges to Islamic financial institutions remains how to
handle their liquidity. Therefore, there is a necessity of the establishment of liquidity
markets to handle the operation of the Islamic banking and financial institutions.
(II): How to accommodate the Islamic banking and finance systems in global
economy especially in the non-Islamic countries so as to meets the need of the
growing Islamic communities including:
A: Since the Islamic law did not require the banks to be Islamic bank or all its
resources to be Halal “permitted,” then the conventional institution can have subsidiaries
offer Islamic finance to Muslim and non Muslim alike as an alternative to the interest-
finance. Therefore, there is a possibility of establishing Islamic financial institution in the
US as a subsidiary for the conventional banks.
B: The possibilities of opening non- banking Islamic financial Institution dealing
mainly in providing the basic Islamic financial services in the non – Islamic countries.
Part I: The Source and Jurisprudence of the Islamic law: “Figh:”
The science of Figh is directed no less toward understanding and analyzing the
deeds and sayings of the prophet Mohamed (Peace upon him), as toward the written
word of the God’s ‘Allah’ Mandates, and to find and collect the different norms of
Islamic law.
[9] In order to understand the justification of the Islamic prohibition of “Riba”
interest and how the Islamic banking and finance works you have to have some
knowledge about Islamic law its sources and jurisprudence what follows are some
illustration:
A: Qur’ an: “the holy book of the Islamic faith,” The Qur’an is understood by
Muslims to be the infallible words of God “Allah” and contain instruction in both
religious and daily aspects of life.
[10] Thus the Qur’an consists of the revelation made by
God “Allah” to the prophet Mohamed (Peace upon him) and lays down the fundamentals
of the Islamic faith including beliefs and all aspects of the Islamic way of life.
[11]Therefore, the scholars have treated the holy Qur’an as a text that contain the general
principle by which all matter should be regulated. And where the meaning of the holy
Qur’an was imprecise they sought clarification from the “Sunna Hadeath.”
[12] B: Sunna: “Tradition of Prophet Mohamed” (Peace upon him). Because God
“Allah” was “revealed to the prophet Mohamed, his actions and sayings were and are
believed to be the best possible interpretation to God’s commandments contained in the
Qur’an.”
[13] Thus Sunna is the teaching of the Islamic principle by the prophet
“Mohamed,” recorded only after having been deemed valid by religious scholars in
decades after the death of the prophet “Mohamed.”
[14] C: Ijtihad: refers to formulations of the law reached via the individual’s struggle
for proper understanding, using reason and judgement to determine a course of action in
keeping with the spirit of the holy Qur’an and Sunna.
[15] Thus, Ijtihad “means the
independent interpretation of law by one who has learned to solve a situation that is new
or for which there is no precedent or authority or pronouncement in other sources of
Figh.”
[16] Ijtihad was based on the linguistic and religious knowledge and was conducted
piously and in good faith. The “Mujtahid,” the one who conducted the Ijtihad, didn’t
have to fear retribution from God “Allah.”
[17] D: Ijm’a: “ consensus of opinion,” is the informed consensus of the community
of scholars, and was established not for matter of faith or fundamental observances,
which were agreed upon, but on the application of the shari’a law to world’s affair.
[18] E: Qiyas: “ Analogical deduction” or analogy from established law mean that by
comparing two things one may be evaluated in the light of the other.
[19] F: Madahib: refers to “schools of thoughts in the Islamic law.” There are two
major schools of law in the Islamic jurisprudence: “Shia” and “Sunna.”
I: Shia, which has various sub –section is predominate in Iran Iraq, India and
many of the Gulf states. There are considerable doctrinal differences between Shia and
Sunni in terms of who is permitted to interpret the Islamic law. The shia believe the
living religious scholar, known as “Mujtahids, have an equal right to interpret the divine
law as the eminent jurist of the past and their judgement replaces the Sunni source of
deduction by analogy, Qiyas.”
[20]II: Sunni, The majority of Muslims follow Sunni school of thoughts. Sunni legal
doctrine has four main schools of thoughts, each with its own system of theory and
application of law. However, they all recognize the legitimacy of all the others. In Sunni
the four schools of thoughts are Hanafi “Rationalist,” Malki “Traditionalist,” Hunbali
“Fundamentalist” and the Shafii “Moderate.”
[21]Furthermore, these four schools of law
give different emphasis to the source of law, but all are anonymous in requiring that
Islamic law be God “ Allah,” is not man's creation and the holy Qur’an and Sunna are
fully binding. The other sources of authorities are in one way or another justified by
reference to these two basic laws.
[22] These schools of jurisprudence differ in their
interpretation of the importance of the Ijtihad, the component of the Ijtihad and Ijma’a,
and the importance of how certain individuals can interpret almost all-religious issue.
Individuals are given much freedom in choosing the particular of the law they wish to
follow.
[23]Part II: The Types and Definition of “Riba” the Justification of its Prohibition in the Islamic Law and How the Financial Affair Addressed in Islamic Law:
(I): The definition of the “Riba” in Islamic law:
Riba is defined as any increase over the nominal value of the sum lent.
[24]Moreover, according to the Qur’an, “Riba” is neither a sale nor voluntary charitable act,
“it is an equitable exchange destructive to and out of place in fair economic
order.”
[25]Thus, he definition of Riba as usury includes interest and other forms of profit or
gain that are not earned from work efforts.
[26] “Islamic law prohibits any profiting from
supply of capital without any personal engagement or exposure to financial risk.”
[27] Therefore, Riba prohibits any predetermined fixed positive return to the
loan as a reward for the delay.
[28] Also, considered Riba is any ‘excess to exchange of two
or more commodities of the same type taking place in the spot market. “This prohibition
aims to ensure that no legal trick or device will be used as back-door to Riba, associated
with deferred transaction.”
[29] Furthermore, the purchase of the government bonds and
firm securities with fixed rate of return are considered Riba and hence prohibited.
[30](II): Islamic Jurisprudence Divides Riba into Two Types:
A: Riba Al-fadl: “excess on exchange” defined as Riba arising out of barter or
sale. Riba Al-fadl involves an exchange of unequal quantities and qualities of the same
commodity simultaneously
[31].
B: Riba Al-nasia: “excess on loan” defined as Riba arising out of money
exchanges “Loan.”
[32] “Riba Al-nasia involves the non- simultaneous exchange of equal
qualities and quantities of the same commodity.”
[33](III): The justification of why the Islamic law prohibits the Riba:
The prohibitions of Riba in Islam seek to prevent usurious condition in exchange
and loan,
[34] because “the Islam’s economic ideal is one of legal fairness, of mercy, and
leniency in times of hardship.”
[35] By prohibiting certain classes of interest in either trade
or loan, Islam seeks to correct the usurious practice which is a desirable result,
[36] because
Riba is a raise from an unequal unfair exchange, namely an increase over the principle a
mount lent or the quantity traded.
[37] Thus, Riba is prohibited because “it is a contract that contains certainty, while
real life is not certain.”
[38] Riba is an unearned profit without expected normal business
risk.
[39]Moreover, “the practice of Riba enrich the class of money lenders and usurers who
accumulate wealth by impoverishing those who are forced to borrow money or
commodities from them for mere consumption, basic necessities, or for limited
production purposes.” Such lenders do so by charging interest or making uneven trades in
their favor.
[40]Furthermore, Riba was an unearned income in the sense that the owner of
the capital who loaned his capital for an increment without contributing any productive
activities, collects profits that are considered illegitimate, because they didn’t give any
equivalent recompense return or counter value “Iwad” to other party.
[41] The prohibition of Riba extends to any and all forms of interest and there is no
difference between interest bearing funds for purposes of consumption or
investment.
[42]Furthermore, interest as a predetermined cost of production can contribute
to unemployment and those interest charges can exacerbate business cycles and cause
international monetary crises. Because “interest involves a transfer of property without
counter value those who live on interest have little incentive to work and where
lenders are richer than borrowers interest result in increasing inequality and social
frictions.”
[43] Thus, the Islamic text does not distinguish between borrower and lender, and
supports the idea that the prohibition’s purpose is not redistribution of wealth but to
the assurance of fair economic exchange while allowing return of capital profit and
services charges.
[44] It is contrary to Islamic law to make money out of money and that
wealth should accumulate from trade and ownership of real asset.
[45] The reasoning that justifies the prohibition of the Riba is rooted in four
different verses in the holy Qur’an. The first of these verses emphasizes that interest
deprives wealth of God blessing. The second condemns it, “placing interest in
juxtaposition with the wrongful appropriation of property belonging to others.” The third
verses enjoins Muslims to stay clear of interest for the sake of their own welfare. Finally,
the fourth “establishes a clear distinction between interest and trade, urging Muslims first
to take only the principle sum and second to forgo even this sum if the borrower is unable
to repay.”
[46] Moreover, Prophet Mohamed (peace up on him) condemns, the one who
takes the Riba, the one who pays it, and the one who writes the agreement for it and the
one who witness to the agreement.
[47]Riba is prohibited in holy Qur’an: Chapter II verse 275 from holy Qur’an state:
Those who devour [riba]
Will not stand except
As stand one whom
The Evil one by his touch
Hath driven to madness
That is because they say:
“[Sale] is like usury [(riba)].”
But Allah hath permitted [Sale]
And forbidden [riba].
[48]And the Qur’an further warns:
O ye who believe!
Fear Allah, and give up
What remain of your demand
For [Riba], if ye are
Indeed believers.
If ye do it not,
Take notice of war
From Allah and his Messenger:
But if ye turn back,
Ye shall have
Your capital sums.
Deal not unjustly,
And ye shall not
Be dealt with unjustly.
[49] (IV): How Financial Affairs are addressed in Islamic law:
Under most schools of Islamic law an Islamic financial system would comply
with at a minimum the following principle: (1): the prohibition of Riba. (2): Risk –
sharing. (3): Prohibition of speculative behavior. (4): Sanctity of contract. (5): Activity
that conforms to Sharia
[50]. Because man is an agent, not an original owner, he is not a free
agent in his exploitation of resources and must use methods and means within a frame
work given to him in the satisfaction of his economic means. And the guiding principle of
economic activity is the over all good of the society and nature. Moreover, individual
man being part of the over all fabric, must be given consideration for his wellbeing. Also,
“equitable reward must be given to man according to his effort, to all people according to
their efforts, and from all according to their abilities.”
[51] Therefore, Islam permits the development of wealth, but through socially
conscious means. Successful enterprises that earn a profit are laudable, but the
practitioner must not forget that Islamic principles direct that financial resources should
be utilized for bettering the condition and well being of other.
[52] Furthermore, while Islam
permits the individual’s rights to seek his economic well being, Islam makes a clear
distinction between the “Halal:” what is lawful and “Haram:” what is forbidden in
pursuit of such economic activity. In broad terms, Islam forbids all forms of economic
activity, which are morally or socially, injurious.
[53]Part III: Operation of Islamic banking and financial institutions and the types and justification of the allowed Islamic finance:
(I): Operation of the Islamic banking and financial institutions:
On the surface, Islamic banking systems differ greatly from all Western banking
systems. Imagine being able to borrow money without paying interest and having the
financial institutions assume half the risk; this is a common transaction in the rapidly
growing world of Islamic banking.
[54] All Islamic banks or financial institutions have a religious supervisory board
(RSB), consisting of an Islamic scholar, who acts as advisory council to the official of the
Islamic institutions. The “RSB” is set up as permanent institutions located and financed
by the Islamic financial institution “IFI”. The “SRB” oversees the Islamic financial
institution activities according to Islamic law and publishes its opinion in the
Islamic financial institutions annual reports.
[55] Thus, the business section of the Islamic
banks works in connection with the supervisory board of religious “SBR” to review
proposed financial transactions to conform to Islamic principle.
[56] The fundamental principle underlying the Sharia approach to finance is that
no one wishing to earn a return on money has any rights to retain the initial sum intact; in
order to earn profit in Islamic finance, it is necessary to take risk. Moreover, the
foundation of the Islamic banking is asset management.
[57] Although, Islamic finance rests
on two main principles: (1): the main financed asset must exist. (2): “the financier must
bear the risk associated with this asset for some period of time, and that what will justify
a rate of return on the basis of this risk exposure.”
[58] Investment agencies in the Islamic financial systems work according to a contract,
in which an agent invests funds on behalf of the principal in exchange for a fixed wage or
share in profit.
[59] “The principal owns the invested fund, therefore is entitled to the profit
of the investment and liable for its losses, while the agent is entitled to a fixed wage if the
agency stipulates that.”
[60] Furthermore, Islamic-banking systems are based on sales agreements; “Islamic
bank sells you the money, making a profit on that sale. On the other hand, the depositors
in the Islamic banking systems do not earn any return on their deposit while those
holding ‘investment accounts’ earn a shared of the profit and exposed to potential
losses.”
[61]In project finance, Islamic banks will lend against the title of a key parts of
given project. Technically it is not a loan, but a purchase and sale agreement.
[62]Moreover,
the Islamic bank can pursue sale by order such as “Salam and Istisna” financing, and
then can buy the non- existent goods at a discount such as “ the salam and Istisan price”
and sell the goods later on delivery at retail price.
[63](II): The Types and Justification of the Allowed Islamic Finance:
The basic role of all Islamic finance is that there must be profit and loss sharing
between the financier and the entrepreneur to justify the interest collected from any
financing operation under Islamic law. Therefore, there has to be some kind of risk
sharing to justify any Islamic finance. Here are some types of the most accepted methods
of Islamic finance:
A: For the Islamic financial institution to succeed in obtaining profit they
concentrate in some specific types of finance, which is easy for them to control the
operation of the financed services so as to minimize the risk of losses. What follows is
the most Frequently used type of Islamic finance:
1:Mudraba: “Trust Financing” is financing transaction equivalent to
“venture capitalism.” It allows the entrepreneur with a business plan to make use of
investor’s capital
[64]. Therefore, “Mudraba, in turn is a profit sharing agreement between
two parties in which one provides the finance and the other provides entrepreneurial and
management skill. The profit in this finance is divided on a pre-determined ratio and the
loss borne by the provider of the capital.”
[65] In contrast, the bank can’t require any
guarantee such as security or collateral to secure his capital against any loss in the
transaction. But “if there is any negligence or mismanagement or any action beyond those
originally provided for in the contract from the entrepreneur, the entrepreneur will be
responsible for the financial loss and may be obligated to reimburse the financier.”
[66] This
financial transaction is permitted because of the risk sharing involved: the investor risks
loss of his capital while the entrepreneur risks his time and effort.
[67]2: Murabaha: “Cost-plus financing” is one of the most familiar and commonly
used finance transactions, mostly in trade and commodity finance. “This finance
transaction involves the purchase of goods by the bank as requested by its client.
Therefore, it is a sale contract between the bank and its client for sale of goods for price
that include profit margin for both parties.”
[68]The bank should have the custody of the
goods before signing the sales contract with the client and the bank also should not seek
any collateral that may make the client committed in any way towards the bank.
[69] “The
bank in Murabaha bears the risk during the period between the purchasing of the goods
and reselling of it to the customer,”
[70]also by the risk of allowing the client to refuse to
accept the goods procured on their behalf by the bank. Thus those risks are what justify
this transaction
[71].
3: Igra wa-igtin: “Lease/hire-purchase.” In this transaction if the client requests
“the banks to purchase the equipment or goods and resell them to him, the bank will be
the owner of these items and the client pay a fixed amount for its use.”
[72] “If the client is
committed to purchase the equipment from the bank at the end of the rental period, the
price is determined in advance and thus the installment payment would include both the
rental price and the purchase fee of the equipment.”
[73] The fund on these financials is
secure, because in order to obtain the fund the investor must offer collateral
[74].
Furthermore, the bank in this finance transaction bears the risk throughout the life of the
lease contract
[75]. Therefore, the bank takes the owner obligation and that will justify its
return in accordance with Islamic law.
[76]4: Musharaka: “Venture Capital” “is an equity participation arrangement and
equivalent to a partnership arrangement. In this finance arrangement all partners share in
finance and management, and the profits are distributed according to pre-agreement ratio,
but losses are shared on the basis of equity participant.”
[77] “This a true partnership where
investor and the agent have a joint profit and loss –sharing and decision making.”
[78] Furthermore, this involves active participation from both the financial institutions
and its client since all of them depend on the revenue sharing in the form of the
percentage of the net profit rather than the interest. And this will encourage close scrutiny
and assessment of the viability and the implementation of the their investment. On the
other hand since the client also contributes capital and becomes partner, he will be eager
for the success of the investment.
[79]B: In the following types of Islamic finance, the risk of loss is high because the Islamic
financial institution has no very effective procedure to monitor the operation of the
financed services, therefore, the following financial services are not frequently followed:
1: Bai’salam Transaction: “In this finance transaction the goods purchased are
paid for in advance at the time of the execution of the contract, but the delivery of the
goods is delayed until a later date.”
[80] In order for this contract to be valid all conditions
associated with the contract such as price, quality and quantity of the goods have to be
determined when the contract is signed.
[81] Hence, “this Salam contract is considered as an
exception to the general role of the Islamic law which prohibits the sale against advance
payment for future delivery of the goods, in order to meet the instant need for the
farmer’s sale,”
[82]and to serve the public need. Therefore, this contract should be applied to
goods transactions and not to the transaction of currencies.
[83]2:Manzile Scheme: “Islamic Mortgage and Housing property finance:” This
finance is based on Musharaka and Ijra wa’ Igtina “lease and partnership” concept and
requires the financier and the client to participate in the joint ownership of the
property. “The share of the financier is divided into a number of units, and the client is
able to purchase those units one by one periodically.”
[84]Therefore, “in the Islamic
mortgage, the repayments were based on the implicit rental value of the property rather
than on the basis of the interest. And that will provide a fixed repayment mortgages for
homebuyers and investors in private property.”
[85]3: Istisna contract: “a contract to manufacture” is a new concept in Islamic
finance. “In this finance transaction the manufacturer agrees to produce, build and to
deliver a well described good at given price on a given date in the future and the price
does not need to be paid in advance. It may be paid in installments while the job is being
completed or the asset being manufactured or constructed.”
[86] “In this contract it should
be ensured that the goods subject to the contract are manufactured and not in their raw
status. Therefore, the Istisna contract is not applicable to grain millet and rude oil.”
[87] 4: Bai’ bi thamin ajil: “sale by deferred payment:” This finance involves the
bank purchasing the asset, equipment or goods desired by its client to whom it then
resells the items for an agreed of cost-plus profit.
[88] Therefore, this transaction involves
purchase and resale of property for a higher price on delayed basis
[89]. It justifies that
because of the risk the bank had if the client refused to take the goods after the bank
purchased the good.
5:Al-wadiah: “non-fund transaction:” This is similar to a saving or investment
account in a conventional bank. “In these accounts the bank does not give interest and
they are in essence a safe keeping arrangement between the depositor and the bank. They
allows the depositors to withdraw their money at any time and to permits the bank to use
the depositor’s money.”
[90]6: Qurde-Hasan: “Benevolent financing:” This finance falls under the charitable
activities of these Islamic financial institutions. “It happens when the financial
institutions provide loans free of charge, basically with intent to provide financial
assistance to failing institutions or humanitarian assistance to individuals. Therefore, for
the financial institutions to make sure it is repaid they may require from the customer to
provide collateral and those institutions may charge a small fee to cover their
administration fee.”
[91]Part IV: Comparison to criticism of the Islamic financial institution:
A: The Comparison between the Islamic Banking System and Conventional Banking
System:
There are some basic differences between the Islamic banking system and the
Western banking systems “the conventional banks.” First Islamic banking systems do not
charge or pay interest and they will not invest in enterprises they believe to be immoral,
where the banker shares in the management of the borrowed fund during the life of the
loan.
[92] Moreover, Islamic banks, unlike their counterpart “conventional banks” have to
share in the risk of their transaction.
[93] “In capitalist society, the ability for one to reap profit from investment is the
most valued concept of the economics and interest is a pivotal concept.
[94] Therefore, The
capitalist motivational system is market oriented with particular emphasis on profit
motive. On the other hand, in the Islamic finance, the motivation is profit but guided by
moral and spiritual concerns rather than market concern.
[95]Furthermore, it is accepted that
“the capitalist system uses profit not as a means but as an end that will satisfy the
individual, while the Islamic system uses profit as a mean to achieve its spiritual end.”
[96] In conventional banks the client is obligated to repay the bank, the principle amount
of the loan, plus a set rate of interest over a term of monthly installments.”
[97] Thus, the
conventional banks is based on borrowing and lending and Islamic bank is based on
selling.
[98] Furthermore, Islamic finance is asset –based, or based on “money for asset,”
opposite to “money for money” in the conventional banks.
[99] In contrast, there are differences between a conventional leasing and ajara in
Islamic finance. “In Islamic finance, a lease/hire begins the date the asset is delivered to
the client not the date the contract is signed as in the conventional banks. In Islamic
finance, the lessee is not liable for the full rent if the asset is destroyed and the factors in
the cost of insurance at the time the rent is fixed. Moreover, the purchase in Islamic
finance at the end of the contract can not be made binding.”
[100]Furthermore, what
distinguishes “Mudaraba:” cost plus finance from traditional interest based –finance that
the recognition of the risk that assumed by the banks as a titleholder of the goods in
“Mudaraba:” cost plus finance transaction.
[101]B: Criticism of Islamic banking and finance:
It would seem that a banking system that is based on the moral and spiritual
principle could have no critics, but this not the case. In Islamic banking and finance,
loans tend to have a complicated buy and lease instruction and the interest-free financing
carries numerous services and finance charges that can make the cost equal to fund
advanced from the conventional banks.
[102] This is true despite the fact that the Islamic
model of finance in some cases seems to guarantee a fixed rate of return, and in reality
no risk is shared by the financier with entrepreneur.
[103] Furthermore, the inflexible interpretation of Riba imposes on the borrower the
need to hire a legal advisor to instruct them on complex finances methods. On
the other hand, “the fee charged on the profit sharing simply replaces in form of thought
not in name the interest charges.”
[104] Moreover, when Riba is interpreted broadly to
include all interest, the Islamic financial institution used the methods of trust financing,
equity participation and leasing to circumscribe the Riba’s problems.
[105] In consequence, Islamic financial institution is exposed to greater liability under
national and international law, because it assumes the ownership responsibilities. These
include not only the risk of the losses or damages to the asset being funded but also any
liability arising out of the use of the asset.
[106] Therefore, “the Islamic banking and
financial systems can not survive and grow solely on the basis of committed ethical
depositors or investors.”
[107] On the other hand, Since the risk costs are shared in the
Islamic banking and finance systems, as a result their products and services can be
competitive.
[108] “The US government criticizes the Islamic banking systems as being a soft touch
for money laundress and terrorism financier.”
[109] On the other hand, the Islamic banking
and finance supporters argue that, money laundering is hard through Islamic banking
systems, because the element of risk sharing means there is “a closer know-your
customer” approach, and that may deter the money laundering.
[110]Moreover, “high
transaction cost and low-level of capital will keep the Islamic bank from being
competitive with conventional banks.”
[111]Part V: Recommendation and Conclusion:
(I): How to improve the operation and effectiveness of the Islamic banking and finance system:
A: The necessity of the existence of the unified Sharia board in the national and
International levels in deciding what types of financial services are conforming to the
Islamic law:
There is a need for setting up Sharia board at global and central banks level, so as
expedite and perhaps assist in developing some standard guidelines for conducting
Islamic financial transaction.
[112] Sharia board at individual banks actually defines what is
and is not Islamic banking. Thus, transaction will be interpreted differently and that will
lead to uncertainty about what is the acceptable way to do business in Islamic banking
and finance systems, which in turn will complicate the assessment of risk for both the
financial institution and its customer.
[113]B: Necessity of the unified accounting and regulatory standard body to govern the
Islamic banking and finance nationally and globally:
For an Islamic financial institution to succeed it needs to establish universally
accepted accounting, auditing and regulatory standard in order to achieve global
acceptability and continue its rapid expansion.
[114]Therefore, “there is a need to develop
uniform accounting and reporting structures among Islamic financial institutions.
Furthermore, the Islamic financial institution needs to recognize the responsibilities of
regulators to apply national supervisory principle to all Islamic financial institutions
especially the effective liquidity management, the definition of a deposit and the
standardization of accounting and disclosure.”
[115]The lack of a thorough comprehensive,
and consistent a counting standard and the lack of the effective regulation is vital for
Islamic banking to continue grow is to overcome those problems.
[116] Therefore, there is a need for unified Islamic accounting standard covering areas
such as the presentation of financial statement and disclosure in the Islamic financial
institutions. Thus, the Islamic accounting standard must seek to comply with international
accounting standard.
[117]C: Necessity of the existence of liquidity markets to handle the operation of the
Islamic banking and financial institutions:
“One of the major challenges to Islamic financial institutions remains how to
handle their liquidity, because those banks have been more successful in attracting
deposit than in identifying funding opportunities.”
[118]Thus, liquidity has always been the
most critical issue for Islamic financial institutions, because there are only small
secondary market that exist to enable the Islamic financial institutions to manage their
liquidity, because the Islamic banks asset generally not saleable in any secondary
market.
[119]Therefore, “the establishment of genuine inter-bank markets would be a
significant step towards providing Islamic financial institutions with the ability to
maintain an adequate liquidity without holding excessive amount of very short-term
asset.”
[120] There is a need to establish international Islamic financial market “IIFM” to
facilitate the development of the an international Islamic money market and to harmonize
the standard regulation and the practices in the Islamic financial industry.
[121](II): How to accommodate the Islamic banking and finances systems in global economy
especially in the non-Islamic countries so as to meets the need of the growing Islamic
communities:
A: Possibilities of establishing Islamic financial institution in the US:
The US remains relatively closed to Islamic financial institution, because the
federal banking law bars banks in US from holding stakes in their cooperate borrower,
and Islamic banks share in the management risk of any operation they finance.
[122] On the
other hand, the Islamic law doesn’t require that the seller of the product be Muslim or
that his own income be “halal” permitted,
[123]but the relationship with the seller must be
in line with the sharia but the seller relationship with other parties is not the
responsibilities of the purchaser. Therefore, the conventional banks “ interest-based banks
can offer sharia compliant financial services to both Muslims and non-Muslims
customers as alternative to the interest- based finance.
[124] Furthermore, the advantage of using Islamic finance affiliated with Multinational
institutions, is in their substantial size, perceived solidity and the possibilities of cross
selling Islamic services to existing Muslim clients. Moreover, the wealth of the in-house
expertise available and the efficiency with which they provide their services.
[125]Some conventional banks both within and outside the Muslim world have started to offer
Islamic financial services as an alternative to the interest –based finance. Thus, City Bank
became the first major US bank to venture into Islamic banking, by opening a subsidiary
in Bahrain.
[126] Furthermore, several big international financial institutions set –up Islamic
financial subsidiaries such as HSBC’s “Amanah” Islamic financial institutions, and the
UBS’s Noriba had Islamic financial subsidiaries targeting Islamic mortgages and car
finance. Moreover, the Dow Jones established stock market of sharia compliant
companies.
[127]B: Possibilities of Opening Non- Banking Islamic Financial Institution Dealing
Mainly in Providing the Basic Islamic Financial Services to the Muslim Communities in
Non – Islamic Countries:
Since sharia permits using the conventional market as a benchmark or as standard
to Islamic financial services, some Islamic financial services could exist to the
Muslim communities in the US. “Amana Vehicle finance” for example could use a fixed
payment scheme that is competitive with conventional vehicle loans available in the
market.
[128]Conclusion:
Since the Cold-War era, there has been a massive Islamic movement within the
Islamic countries and the minorities Muslims communities around the glob. This
movement has demanded that the Islamic law governs all aspects of their life from
political, economic and daily life according to the Islamic principle.
Therefore, the need to expand the Islamic financial institutions services to
accommodate the Islamic communities needs will continue to grow rapidly in the near
future. There is need for collective efforts from the bankers, economists and the
Islamic legal scholars to develop financial solution that meet the religious requirement to
the Muslim’s communities.
[129]Moreover, “the Islamic financial community must accept
that their institutions have to be regulated and supervised to meet the international
standard. Ultimately their ability to grow and compete will depend on international
acceptance of the regulatory regime.”
[130] There is need for universally accepted principal governing Islamic financial
dealing, before the system can be accepted internationally, because the weakness of the
Islamic financial market has also resulted from the lack of the common Islamic
accounting and legal framework governing the Islamic financial market.
[131] Since the
Islamic law does not require the banks to be Islamic banks or all its resources to be Halal
“permitted” then the conventional institution could have subsidiaries offer Islamic
finance to Muslim and non-Muslim alike as an alternative to the interest-finance. This
might be used mainly to offer the most needed financial services such as mortgages and
car financing to the minorities’ Muslim community in the non-Islamic countries. Such
efforts are needed to meet the needs of an ever-growing Muslims communities trying to
live their lives according to their beliefs.
[1] Elwaleed M Ahmed, International LL.M (Master of Laws) student, James E Beasley School of Law, Temple University, Philadelphia-Pa U.S.A.(2004), B. A. (Sharia & Law) Omderman Islamic University, Sudan (1995).
[2] T. S. Twibell, Implementation of the United Nation Convention on Contracts for the Sale of Goods (CISG) Under Shari’a (Islamic Law); Will Article of (CISG) be Enforced when the Forum is in Islamic State? 9 Int’l Legal Persp.25 at 72 (Spring-Fall1997).
[3] Mahmoud A. El-Gamal, Fourteen Annual Philip D. Reed Memorial Issue, Islamic Law and Finance, ‘Interest’ and the Paradox of the Contemporary Islamic Law and Finance, 27 Fordham Int’l L. J. 108 at 124 (December, 2003).
[4] Wilson Rodney, Islamic Banking: Going Global-the Muslim Banking Worlds Faces the Challenge of Expanding International while Remaining True to Islamic Principles. The Banker. (March 1, 1995). (Available at LexisNexis ‘Magazine and stories/ combine’).
[5] Wilson Rodney, Islamic Banking, Book Review; Islamic Banking by Mervyn K. Lewis and Latifa M. Algaoud, Economic Society of Australia, Economic Record Vol. 78 at 375. (September 1, 2002). (Available at LexisNexis ‘Magazine and stories/ combine’).
[6] Ali Nazim, Points of law; Middle Eastern Banking, Business Intersperse Ltd. (UK). The Banker, Vol. 149 at 67 (February 1, 1999). (Available at LexisNexis ‘Magazine and stories/ combine’).
[7] Supra Note 4.
[8] Anouar Hassoune, Says Standard & Poor’s, Key Rating Factors for Islamic Banks-Although Sometimes Complex; Analyses Islamic Financial Institutions on the Same Basis as Conventional Financial Institutions. The Banker at 1 (February 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).
[9] M. Cherif Bassiouni, Gamal M. Badr, Saad El-Fishawy, Farooq A. Hassan and Erik Peterson, Islamic Law, A survey of Islamic International Law, Contract and Litigation in Islamic Law the Source of Islamic Law. 76 Am. Soc’y Int’l L. Proc.55 at 65 (April 22-24, 1982).
[10] J. Michael Taylor, Islamic Banking – the Feasibility of Establishing an Islamic Bank in the United States, 40 Am. Bus. L.J. 385 at 416 (winter 2003).
[11] Munawar Igbal, David T. Llewellyn, Islamic Banking and Finance; New Prospective on Profit Sharing and Risk. Edward Elgar Publishing Limited at xii (2002).
[12] Mervyn Lewis, Latifa Algaoud, Islamic Banking, Edward Elgar Publishing Limited at 22 (2001).
[13] Supra Note 9 at 65.
[14] Supra Note 10 at 416.
[15] Supra Note 12 at 22.
[16] Supra note 9 at 67.
[17] Supra Note 2 at 61.
[18] Supra Note 12 at 22.
[19] Id.
[20] Id. at 23.
[21] Id. at 24.
[22] Id.
[23] Id.
[24] Barbara L. Seniawski, Riba Today: Social Equity, the Economy and Doing Business under Islamic Law. 39 Colum. J. Transnat’l L. 701 at 717(2001).
[25] Id. at 707.
[26] Supra Note 10 at 416.
[27] Elias G. Kazarian, Islamic Versus Traditional Banking; Financial Innovation in Egypt. West View Press Inc. At 53 (1993). (Available at LexisNexis ‘Magazine and stories/ combine’).
[28] Id. at 50.
[29] Id.
[30] Id. at 53.
[31] Supra Note 21 at 35.
[32] Supra Note 24 at 710.
[33] Supra Note 21 at 35.
[34] Supra Note 24 at 717.
[35] Id. at 704.
[36] Id. at 707.
[37] Id.
[38] Supra Note 11 at 31.
[39] Supra Note 10 at 391.
[40] Supra Note 24 at 704.
[41] Id. at 728.
[42] Supra Note 10 at 385.
[43] Supra Note 5 at 373.
[44] Supra Note 24 at 711.
[45] Michael Ainley, Islamic Banking Under A veil of Regulation, Financial Times Business Limited, The Banker at 1 (October 1, 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).
[46] Supra Note 24 at 728.
[47] Id. at 36.
[48] Supra Note 24 at 728.
[49] Id.
[50] Supra Note 24 at 704.
[51] Supra Note 10 at 388.
[52] Id.
[53] Id. at 416.
[54] Martin Josh, Islamic Banking Raises Interest; Including Related Article on Islamic Business. American Management Association, Management Review, vol. 86 at 25 (November 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).
[55] Supra Note 27 at 54.
[56] Supra Note 10 at 394.
[57] Fitch, Islamic Banking Unveiled, Financial Times Business Limited, Pension Management, (January 1, 2002), (Available at LexisNexis ‘Magazine and stories/ combine’).
[58] Supra Note 3 at 129.
[59] Id. at 145.
[60] Id.
[61] Id. at 127.
[62] Supra Note 54 at 26.
[63] Supra Note 5 at 373.
[64] Id. at 168.
[65] Supra Note 54 at 28.
[66] Supra Note 27 at 163.
[67] Supra Note 64 at 168.
[68] Supra Note 54 at 18.
[69] Supra Note 6 at 68.
[70] Supra Note 3 at 129.
[71] Supra Note 64 at 170.
[72] Hesham M. Sharawy, Understanding the Islamic Prohibition of Interest. 29 Ga. J. Int’l & Comp. L. 153 at 170 (fall, 2000).
[73] Supra Note 54 at 18.
[74] Supra Note 27at 164.
[75] Supra Note 3 at 129.
[76] Supra Note 11 at 200.
[77] Supra Note 54 at 28.
[78] Supra Note 24 at 723.
[79] Supra Note 29 at 107.
[80] Supra Note 64 at 170.
[81] Supra Note 27 at 52.
[82] Kamal M. Amjad Main, Book Review. Specific Application: Commercial Transaction and Financing, Islamic Law and Finance; Religion Risk and Return. By. Frank E. Vogel & Samuel L. Hayes III. The Hague and Boston: KLumwer Law International. I5 J L. & Religion 475 at 477 (2000-2001).
[83] Supra Note 27 at 52.
[84] Supra Note 29 at 58.
[85] Supra Note 11 at 199.
[86] Id. at xii.
[87] Supra Note 6 at 68.
[88] Supra Note 24 at 728.
[89] Supra Note 62 at 170.
[90] Id. at 168.
[91] Supra Note 10 at 399.
[92] Supra Note 54 at 26.
[93] Id.
[94] Supra Note 64 at 153.
[95] Id.
[96] Id.
[97] Supra Note 64 at 153.
[98] Supra Note 54 at 28.
[99] Supra Note 3 at 129.
[100] Supra Note 10 at 396.
[101] Id at 416.
[102] Supra Note 54 at 25.
[103] Supra Note 64 at 170.
[104] Supra Note 24 at 727.
[105] Id. at 720.
[106] Supra Note 11 at 208.
[107] Supra Note 82 at 477.
[108] Supra Note 54 at 26.
[109] Nigel Dudley. Report From Bahrain, Islamic Banking –Structure is Necessary Target- Anew Institution Aim to Set Industry- Wide Standards for Islamic Banking. The Banker at 1 (March 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).
[110] Id.
[111] Islamic Banking’s Exposure to Risk, The Edge “Malaysia”(November 23, 1998). (Available at LexisNexis ‘Magazine and stories/ combine’).
.
[112] Supra Note 57 at 1.
[113] Michael Ainley, Islamic Banking Under A veil of Regulation, Financial Times Business Limited, The Banker at 1(October 1, 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).
[114] Supra Note 109 at 1.
[115] Id. at 3.
[116] Richard Dean, Islamic Banking; The Payoff Does the Stanching Rise of Islamic Banking in the Middle East Threaten the Region’s Conventional Banks? Arabia Trends (May 1, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).
[117] Financial Reporting Islamic Institutions A risk –free return? -It’s Forbidden. Accountancy (April 30, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).
[118] Supra Note 5 at 1.
[119] Supra Note 8 at 1.
[120] Supra Note 113 at 1.
[121] Islamic Banking in Malaysia, Euromoney Vol.33 Pg. SSSS4 (September 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).
[122] Supra Note 64 at 153.
[123] Supra Note 3 at 147.
[124] Id. at 148.
[125] Supra Note 11 at 1.
[126] Supra Note 54 at 26.
[127] West Meets East, The Economist “ U.S Edition,” (October 25, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).
[128] Supra Note 3 at 148.
[129] Supra Note 121 at 3.
[130] Supra Note 116 at 1.
[131] Sidek Kamiso, Islamic Financial Market Needs Universal Accepted Principles. The Edge “Malaysia” (February 20, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).
