It is observed that various misconceptions about Islamic banking are disseminated by many who criticise Islamic banking. Islamic banking is becoming an important part of today’s banking industry with increasing market share across the globe. It is therefore essential to know the basis of such misconceptions about this growing industry. In this article, Chowdhury Shahed Akbar attempts to discuss to a greater extent about some issues which are relevant to the origin of the misconceptions.
Some of the ideas that are cultivated and often argued by sceptics about Islamic banking include mainly the following:
- Riba and banking interest are not the same thing.
- There is no difference between Riba and trade.
- The Islamic prohibition of Riba is valid only for consumption loans.
- Whether financing contract can be implemented through a sale contract.
In order to fully understand the Islamic banking concepts, the following discussions are essential.
The meaning of Riba
The term Riba is derived from Raba which means excess, addition, increase, expansion, Augmentation or growth. A majority of Islamic scholars assert that the same meaning has been used in the holy Quran on several occasions. According to them, the essence of Riba in Islam is excess whether it is a commodity or money. They accept Riba as an increase in one of two homogeneous equivalents being exchanged without this increase being accompanied by a return.
The Hadith states that: "If gold, silver, wheat, barley, dates and salt are exchanged against themselves, they should be exchanged on the spot and be equal and alike." According to Dr Nejatullah Siddiki, out of the six specified commodities, gold and silver unquestionably represent money as Arabs in those days did not have their own currency. They also used Roman dinars, gold coins, Persian dirhams, silver coins and unmined gold and silver as a medium of currency while the other four represent staple food items.
Some scholars such as those of the Al-Azhar University of Egypt view Riba as categorically Haram and the modern banking interest does not resemble what was really meant in the Quran and Sunnah as Riba. On the contrary, in accordance with the consensus of the majority of jurists without any exceptions (Al-Harran, 1993), Riba has the same meaning as interest. Renowned Islamic economist and scholar Dr Umar Chapra pointed out that, in the case of lending, it technically refers to the ‘premium’ that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or for an extension in its maturity. According to his view, Riba is a predetermined excess or surplus over and above the loan received by the creditors conditionally in relation to a specific period. Other scholars hold the same view that Riba is an increase or excess which, in an exchange or sale of a commodity, accrues to the owner (lender) without giving in return any equivalent counter-value or recompense to the other party.
Riba versus trade (Bai)
There is another view taken by some which suggests that trade and Riba are both the same. But the opponents to this view do not subscribe to this notion and claim that there is a fine difference between trade and Riba which the Quran itself confirmed. According to them, trade has been ethically a recognised activity in human society for ages and all major religions approved it. Trade was the backbone of the Meccan economy in the pre-Islamic era and even Prophet Muhammad himself was a trader before assuming his responsibilities as a prophet.
Trade (Bai) occurs when there is a purchase and sale which is a lawful real economic activity where something is exchanged (money or goods) for something (goods) which creates value. Riba implies that money is loaned for an increase in itself without any real economic activity of sale. In trade, an entrepreneur also shares the possibility and occurrence of losses with the prospect of making a profit while interest is predetermined and certain irrespective of the outcome of the business.
Contemporary scholars have pointed out four fundamental differences between trade and Riba. Firstly, in trade, the buyer and seller exchange on the basis of equality where the purchaser derives a profit from what he has purchased and the seller gets a profit in consideration of the work he has done and the time he spends on obtaining the commodity for the purchaser. In a Riba-based transaction, the lender gets a definite amount of money for his loan while the borrower only gets the time to use the money. Therefore, there is no division of the profit on the basis of equality as time does not generate the borrower any profit. Secondly, in trade, the seller can demand a profit from the buyer only once while in a Riba-based deal, the lender can demand for his interest as long as the principal is not returned. Thirdly, in trade, the deal completes as soon as the commodity is exchanged for its price while in a Riba-based transaction, the borrower spends the borrowed amount and has to return the same with an addition by way of interest. Lastly, in trade, a person gains a benefit after providing the work, time and expertise whereas in the case of an interest-based deal, the lender benefits without providing anything in return.
Consumption versus production loan
One of the arguments about the prohibition of Riba is whether the prohibition is for consumption or investment loans. Some modernists tend to differentiate between these two and argue that the former is unlawful while the latter is lawful. Their claim is on the basis that the Quran prohibits Riba for those who borrow to fulfil basic human needs such as food, clothes and shelter, etc., as the Quran’s intention is to protect the poor from exploitation. Their view is that in the early Islamic era, the Quran only prohibited Riba on loans for money and food and anything beyond that is accepted to be a later development. They were also of the view that in the early Islamic period, borrowing for trading or commercial purposes never existed except to share in a partnership to increase the stock of capital and that in seventh century Arabia, people used to take loans mostly for consumption purposes and not for productive ventures.
However, this view of the modernists has been questioned by many. The opponents to this view draw on historical evidence to back up their argument. For example, Riba owed to Abbas Abdul Muttalib, the Prophet’s uncle, was mostly for the loan he financed in the production sector (Siddiki, 2004). Abbas together with Khalid Al Waleed and Usman Affan — who later became one of the four caliphs — used to finance the production of date crops in Madinah and Taif (Al Misri, 1991; Al Razi, 1978).
During the Prophet’s era, the Muslim society became sufficiently inspired by the Islamic way of life which encourages simple living and discourages ostentatious consumption. It also became sufficiently organised to fulfil the basic needs of the poor. Hence, there was no question of borrowing for consumption purposes (Chapra, 1984). Moreover, in implementing the Quranic injunction against Riba, the Prophet himself also did not make any distinction between consumption and production loans (Huq, 1987).
Besides, it is obligatory for the Muslim society to fulfil the basic consumption needs of the poor through various components such as Zakat, Sadaqah and Qard Hasan. Therefore, it is viewed by contemporary scholars that the argument of whether Riba is prohibited for consumption purposes or business purposes is irrelevant and borrowing in a Muslim society should be largely for business purposes.
Financing through a sale contract
A great many people actually wonder about how Islamic banks can provide financing and then claim that any return on it is not conflicting to Islam.
An analysis of an Islamic financing tool can clarify the matter. Take the case of Murabahah which is the most popular financing mode among Islamic banks. Under this mode, Islamic banks buy an asset and sell it to the clients by expressing the purchase price and adding some profit or mark-up. The clients may pay the price to the bank at one go or according to an agreed term.
A Murabahah transaction is completed through various stages and involves various contractual agreements which include the sale contract as well.
This financing technique raises a question in our mind that when somebody is in need of money to purchase something for himself or for his business and an institution provides this facility by making the purchase on behalf of him and then selling it to him with a mark-up, it is like indirectly giving him or her the money and charging interest on it when he or she makes repayment.
Besides, while fixing the selling price, banks can consider the time they allow a customer to make repayments and can charge a price which is higher than the market price. This has raised confusion and many claim that Islamic banks are not doing something different than what the interest-based banks are doing.
However, Shariah scholars who devised this technique and approved it have their logical explanation that favours their deduction and endorsement of this technique. According to them, this argument is based on a misunderstanding about the principles of Shariah regarding the prohibition of Riba and the ignorance of the fact that Islamic principles draw a distinction between money and commodity, as far as commercial transactions are concerned, whereas conventional banking principles treat both money and commodity as homogeneous and treat both at par. Under Murabahah principles, money is not being priced, rather it is the commodity which is being priced and sold.
The scholars also specified some rules and regulations this financing technique should abide by from the beginning to the end of the contract in order to be Shariah compliant and declared that any deviation from these rules and regulations may make the whole contract invalid. They asserted that this technique is suitable for commodity financing and it is essential for Islamic banks to limit this technique to commodity financing.
The discussions clearly demonstrate the fact that the Islamic banking system did not develop on a whim. It has a strong foundation and any misconception or confusion over the Islamic banking system is not justifiable. Rather, this sector needs to be appreciated due to its eff orts to offer a system that is compatible with religious beliefs on one hand and that facilitates modern banking needs on the other.
It is therefore essential to clear the misconceptions. The primary responsibility in this regard lies in the hands of Islamic banks. Islamic banks should address issues surrounding these misconceptions and publish and distribute the solutions to the people. They should strictly follow the rules that have been developed by Islamic bankers and Shariah scholars in conducting their business. They should be able to handle cases where confusion arises. As far as the regulatory authorities are concerned, they should ensure that Islamic banking is being practiced in line with the principles developed.
Chowdhury Shahed Akbar is attached to a private bank in Bangladesh and has a postgraduate degree in Islamic banking, finance and management from the UK.
This article first appeared in Islamic Finance News (20 January 2016, Volume 13, Issue 03, Page 17-18). For more information, please visit the website at www.islamicfinancenews.com.