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Islamic Banking: A Utopian Idea Hard to Implement, Part 2

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Islamic Banking is little Islamic, as it is basically twisting of the conventional banking sciences to give an Islamic colour.

Words of Allah must be followed

It has been mentioned in the first part of this article that Allah has condemned usury and receiving interest (riba) by revealing several verses like (2: 275-276) and (2: 278) in the Koran and denounced it as exploitative, unjust and evil. Prophet Muhammad has also condemned usury and receiving interest in strong words in several authentic hadiths. This attitude of Allah and His Prophet has inspired Muslim scholars and economists to develop interest-free Islamic banking and financial systems, because the words of Allah and His Prophet must remain supreme. The efforts of a few Muslim economists have also been discussed in the first part of this article.

Most Islamic scholars laud Allah’s act of castigating interest or riba. They say that it reflects the fundamental basis of the socio-economic justice for the Muslims, the most important characteristic of a true Muslim society. Through elimination of interest, Islam attempts to eliminate all sources of exploitation and undue advantage in business transactions. They also say, “The Koran strongly urges the Muslims not to acquire each other’s property wrongfully. Obtaining a monetary advantage in a business transaction without giving a fair counter value is an important source of unjustified earnings. Riba represents a conspicuous source of unjustified benefit in the value system of Islam,” [1]

“In recent years the meaning of Riba has attracted the attention of Muslim scholars. Haque (1989) raises the question what is Riba? Is it usury, unearned income, interest, or a pre-feudal phenomenon irrelevant to modern times? This is a question of increasing importance because an adequate answer will have a significant bearing on the functioning of the modern economy, especially financial institutions.” [1]

Islamic scholars have divided interest or riba into two categories: (1) Riba al-nasiah and Riba al-fadl. Riba al-Nasiah means to postpone, defer or wait, and it is in this sense that the word Riba has been used in the Holy Quran and refers to interest on loans. In fact, there were various types of loans and business transactions. When a person borrowed food, money, cattle, etc., he would pay back the principal with an increase after an agreed period. This increase was termed by Muslim jurists as Riba al-Nasiah. According to jurists, it was not a fair exchange because the lender exploited the borrower,” says a Muslim scholar.

Riba al-fadl deals with all spot transactions involving cash payment and the exchange of other commodities. Many believe that this kind of Riba originated from a saying of the Prophet that reads, “If gold, silver, barley, dates and salt are exchanged, they should be exchanged spot equal and alike.” However, there is difference of opinion regarding the nature and extent of Riba al-fadl. One opinion argues that all saleable commodities would be subject to Riba al-fadl. Second opinion holds that all edible commodities would fall in this category. “Riba al-fadl: Islam wanted to abolish not only the exploitation inherent in the institution of interest but also to close all doors of unfair and unjust transactions”, says an author [1].

Mudarabah System

Islamic scholars have so far managed to work out two interest-free Islamic banking systems, namely (i) mudarabah and (ii) murabaha.

Mudarabah System: According to the mudarabah system, the bank, instead of paying interest on deposits and charging interest on loans, aims to enter into a profit-and-loss sharing agreements with the depositors and the borrowers. The bank will advance money to the borrower on the understanding that it will share the future gains of the borrower according to a ratio agreed upon beforehand. The depositors, on the other hand, will get a share of the bank’s profits instead of receiving fixed interest. Muslim scholars claim that this system is superior to conventional interest-based banking, because under this system banks have to think more about future profits of the borrowers than about their present creditworthiness and hence lending decisions and terms are more likely to be prudent. But for the bankers, it is really hard to judge whether a company will make profits in future. On the other hand, it is much easier for them to make a decision on the basis of current ability of the borrower to repay a loan. As a result, far fewer people and companies qualify for loans from Islamic banks than from the conventional ones.

So, most of the Pakistani business houses apprehend that after the imposition of Islamic banking system, they will no longer be able to borrow with the degree of flexibility to which they are accustomed today. They are also afraid that this will provide an opportunity to the banks to play discriminatory role on a very wide scale in giving loans.

A few words are also to be said regarding the mudarabah system of banking. It is easy for the banks to deduct a portion of the profit from a profit-making borrower. But how the banks would handle the loss of a loss-making enterprise? Would the bank make good of the losses by providing more funds to the borrowers in such cases? Secondly, in this system, the borrowers would always try to hide their actual profits and submit forged documents projecting profits much lower than the actual figure. There is no doubt that it would give rise to widespread corporate crimes and the banks would have to shoulder the cumbersome task of scrutinizing the sales and expenditure proceedings of the borrower. So, the banks would be overloaded with these tasks of estimating the real profits of the borrowers at its own cost, and an almost impossible task to especially in disorganized Islamic countries.

Most importantly, in conventional interest-based banking, the borrowers are aware that they must generate profit for paying back the loan with interest. But in the mudarabah system, the borrowers would certainly be less hungry for making profits as more profits would mean more deduction of these profits by the banks. This would undoubtedly retard the national economy of the country. Finally, if banks under this system are bound to make good the losses of the loss-making borrowers, the business enterprises might be careless about maximizing profits.

Murabaha System: The murabaha system is not based on profit-and-loss sharing, but quite resembles the conventional interest-based banking. Under this system, the borrower has to make all its purchases and sales through the bank and the bank retains a portion of the bills. For example, a borrower wants to buy a piece of machinery costing say Rs 100,000. The bank procures the machinery from the market and resells it to the borrower at a price, say Rs 110,000. The borrower then paybacks that 110,000 over a period. Though the extra Rs 10,000 is called a ‘mark up’ in murabaha system, it works much the same as interest in all but the name.

This murabaha lending is likely to be the mainstay of future Pakistani banking as because from the banks’ point of view, it is relatively easy to handle – easier than the more complex mudarabah transactions based on profit-and-loss sharing”, says an observer.

Of all the Islamic countries in the world, only Iran and Sudan have imposed interest-free banking where both mudarabah and murabaha systems operate. In a few other countries, such as Malaysia and Kuwait, borrowers and depositors are free to choose between conventional and Islamic banking. Historically, first Islamic banks began to operate only about 25 years ago in Saudi Arabia and at present nearly 170 Islamic financial institutions are operating worldwide and managing over $150 billions of funds. In recent years, conventional banks such as HSBC and Citibank have also started offering Islamic financial services.


Despite all these prescriptions mentioned above, the government of Pakistan is finding it very tough to implement an interest-free Islamic banking system. The then military ruler of Pakistan, Pervez Musharraf had said that interest payments on government’s external debt of $36 billion would continue, but he kept silence about the vexed question of what it will do about its domestic borrowings of $25 billion. How unfortunate that Almighty and All-knowing Allah is incapable of initiating interest-free international borrowings!

However, the Pak economist Dr M Fahim Khan, entrusted to carry out the reform, had reportedly said, “Pakistan’s biggest challenge, after the implementation of Islamic fiscal system, will be to find out a way for the government to raise money domestically, without paying interest. There also remains the vital question – What to do about the old loans and deposits? “No final decision has yet been made in this regard”. At that time, many apprehended that if the domestic depositors are suddenly deprived of their accrued interest, legal havoc would certainly follow.

In the matter of Islamization of banking system, some countries are very strict in the interpretation of Islamic laws and some are liberal. Gulf countries like Saudi Arabia and Bahrain hold orthodox view and prefer the mudarabah system, while some other countries like Malaysia and Indonesia hold a flexible outlook and prefer a modified murabaha system.

To conclude, it should be said that, today’s economics has not been invented by an individual but it developed as a science based on the experience of economic dealings and transactions followed by man from time immemorial. It is ridiculous that some Muslim fanatics are toiling to mould that science to accommodate the dictates of an illiterate fellow, who lived in Arabia 1,400 years ago, whose economic wisdom was limited to plundering and looting the wealth and riches of the infidel kafirs. But these stupid Muslim economists are striving hard to establish a nonsensical economic theory that suited the 7th century Arabia. Beside that, these stupid economists are claiming that their nonsensical economic theory is far superior to the conventional 21st century economics. May Allah help them to develop their superior economic theory and lead them to prosperity, without moulding the conventional financial sciences to give Islamic color.



1. More than 14 centuries ago, Allah warned of usury

For Further Reading:

FISCAL POLICY AND RESOURCE ALLOCATION IN ISLAM (PDF), by Ziauddin Ahmed, Munawar Iqbal and M Fahim Khan

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