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Islamic Banking
Prohibition of Ribā
MADIHA KHAN
Abstract
Islamic banking has become popular not only in Islamic world but also in non-
Islamic countries. The number of Islamic banking service providers is increasing due
to entry of new Islamic banks and some conventional banks have also opened units
designated to Islamic banking. It is therefore, crucial to analyse how much Islamic are
the products offered by Islamic banks. This paper makes critical analyses of Islamic
banking practices in the context of Islamic law and the prohibition of interest through
examining the product known as 'Murābahah.' It is found that certain features of
'Murābahah' are in direct conflict with Islamic law and need to be revised in order to
make it purely an Islamic product.
1. Introduction
The history of Islamic finance system goes fourteen years back when Arab
merchants frequently lent money with the intention to earn more money in
the shape of interest. It was usual practice to find people desperate to borrow
money. Those merchants lent money to them, charged higher interest and
made fortune out of the misery of the borrowers. The debtor and even
debtor's children then spent their whole life in paying back their loan.
However debt never gets paid back in full because every time an extra amount
was added to the previous amount as a penalty for late payment and hence
suffering of poor never ends.
To protect the poor debtor from the rich creditor, Islam introduced a
financial system based on the moral principles which promote justice, fair
trade, equality1 and ethics in order to create a healthy and supportive society.
1 1. Ahmad, and S. Baloch, Islamic Banking Bulletin (Islamabad: State Bank of Pakistan, 2006).
Available on line, http:/ / www.sbp.org.pk/ibd/IBB.pdf.
From the above, it can be concluded that receiving more than principal or
actual value either in case of loan or exchange of commodities is ribā which
causes injustice to or exploitation of needy people. Consistently, Ahmad and
Baloch comment that ribā refers to "any unjustifiable increase of capital
whether through loans or sales."9 Although Ribā is a very broad term and has
seventy different types but interest is a very basic and important element of
ribā. According to Iqbal "prohibiting the receipts and payment of interest is
the nucleus of system (sharī'ah)."10 In fact interest and ribā according to the
'school of equivalence' are interchangeable terms11 but ribā is actually more
than interest.12 However for the purpose of this paper, the definition of ribā is
confined to interest only.
In simple words, interest is the price of lending money. It can be defined
as any gain without sharing risk and by considering time value of money.
According to Ahmad and Baloch it is "any positive, fixed, predetermined rate
tied to the maturity and the amount of principal (i.e., guaranteed regardless of
the performance of the investment)."13 Interest is strictly prohibited in Islam
due to the following reasons. Firstly, Islam forbids the trading of money
because according to sharī'ah money is not itself a commodity; therefore there
should be no price to use it.14 Secondly it (sharī'ah) dislikes receiving monetary
advantage without putting efforts or labouring15 and strictly forbids such
earnings (interest). According to sharī'ah these earnings do not contribute to
economic development and hence lead to inflation. However Islam encourages
profit from trade and other productive businesses such as agricultural,
manufacturing etc.16 Thirdly, Islam forbids interest because it is certain, fixed
and predetermined. Lender receives this profit irrespective of the fact whether
borrower actually gained profit or not? Rizvi, a Muslim scholar and
philosopher "[P]osed the question of what was wrong with charging interest
when the borrower was going to employ the borrowed funds to earn a profit.
His well-considered reply to the question was: While the earning of profit is
uncertain, the payment of interest is predetermined and certain. The profit
may or may not be realised. Hence there can be no doubt that the payment of
something definite in re
(j bārām ).nV
Islamic banking is known to be based on the principles of Islamic finance
and economics and thus also based on prohibition of interest. These banks do
not lend money; instead they have devised interest free debt and equity based
products such as Mushārakah, Mudārabah , Murābabab etc18 Mushārakah (joint
venture) and Mudārabah (trust financing) are equity like products based on
profit and loss sharing mechanism.19 For example, in case of Mushārakah., bank
and client are supposed to be partners and bank invests in the client's business,
hence shares risk with the client. If business earns profit, it will be distributed
according to the predetermined ratio between partners and if business incurs
loss both have to bear this loss.20
The debt like products is Murābahah (cost-plus financing) Iājrah (operating
lease) and Istisnā' (Progressive payment). However Murābahah is most popular
form of financing in Islamic banks and in fact it constitutes greater percentage
comparing to other Islamic financial instruments.21 For example, almost 75%
transactions of Faisal Islamic Bank are Murābahah transactions.22 Due to its
popularity, the essay will discusses Murābahah contract with the help of a
Murābahah model used by a Sudanese bank in order to analyse its procedures
and reasons for being popular.
Murābahah Contract
17 Ibid., 9.
18 B. Hamwi and A. Aylward, "Islamic Finance: A growing international market," Thunderbird
International Business Review, 41 (1999), 4-5: 407-420.
" F. Al-Omar, and M. Abdel-Haq, Islamic Banking: Theory, Practice & Challenges.
20 S. Tarek Zaher and M. Kabir Hassan, "A Comparative Literature Survey of Islamic Finance
and Banking," Financial Markets, Institutions and Instruments, 10 (2001), 4: 155-199.
21 Tarik M. Yousaf, "The Murābaha Syndrome in Islamic Finance: Laws, Institutions and Politics."
Clement M. Henry, and R. Wilson, (eds.). The Politics of Islamic Finance. (Edinburgh: Edinburgh
University Press, 2004); A. Saeed, Islamic Banking and Interes: A Study of Prohibiton of Ribā and its
Contemporary Interpretation (Leiden: E.J. Brill, 1996).
22 Tarik M. Yousaf, "The Murabaha Syndrome in Islamic Finance."
do not lend money. They usually deal in commodities through buying and
selling contracts which is known as Murabahah contract and is similar to trade
finance commonly used to finance working or fixed capital.23 Murabahah
"literally means sale on profit. It is technically a contract of sale in which the
seller declares his cost and profit."24 In other words it is a contract between
buyer and seller in which seller sells the commodity to a buyer at an agreed
price.
For Murabahah contract, there are certain conditions that must be met by
both parties in order to make a trade valid or to comply with Sharl'ah. The
basic conditions are: firstly commodity must exist (tangible) at the time of the
deal, secondly, it must be owned by the seller and thirdly, price should be
agreed by both parties.25
Therefore, in Islamic banking system, when a person makes a request for
finance, he/she has to specify its purpose. For example, if a person wants to
buy raw material, he/she will provide its specifications in the application. The
Islamic bank purchases the specified raw material and sells it to the client on
agreed price. The bank usually sells the item at a price which includes cost and
profit margin. A model of Murabahah contract is shown in the table which is
applied in the Sudanese Islamic bank.
Table 3
Example of Murabahah on soap venture (Sudanese Islamic Bank, al-Girsh
Productive Family Branch). (LS).
The above table displays the Murābahah transaction between the bank
(seller) and its client (buyer). The bank buys the item at 500,000 Sudanese
pounds from the market and sells it to the client at 560, 000 Sudanese pounds
by adding its profit margin in the cost which is known as Murābahah profit.
The item is delivered at the spot while the payment is deferred over three
months.
However the deferred payment, monthly instalments, guarantee and
especially 12% profit make this transaction identical to the conventional loan
transaction. But the proponents of Islamic banking system frequently claim
that Murābahah transaction is purely according to the sharī'ah (Islamic law)
ancHs also different from the conventional loan transaction. They differentiate
it from conventional practices and to justify the Murābahah profit because
Murābahah is a selling transaction and not the lending transaction;26 the bank
did not lend money instead it earned profit through buying and selling
activities. According to them, lending money and charging extra price would
be interest but in Murābahah case, bank makes sale of an item and gains extra
amount as profit despite the fact that this 12% profit looks like simple interest
of 4% per month, in fact more than the conventional interest. This transaction
consists of certain and predetermined rate and hence apparently violates the
sharï'ah and sole purpose of Islamic banking.
Secondly, according to Al-Omar and Abdel-Haq, the jurists and Muslim
scholars agree that the extra amount {Murābahah profit) is not charged as a
compensation for time value of money and deferred payment.27 This
explanation is, however, unacceptable because it does not consider time value
26 G. Bilal, "Islamic Finance: Alternatives to the Western Moder The Fletcher Forum of World
Affairs , 23 (1999), 1: 145-160. A. Badr-El-Din Ibrahim, Poverty Alleviation via Islamic Banking
Finance to Micro-Enterprises.
27 F. Al-Omar, and M. Abdel-Haq, Islamic Banking: Theory , Practice and Challenges , 15.
of money. In that case, why one should pay more for an item that is available
in the market at less price? If we apply economic principles here, one pays
more for an item only if the supply of that item is short. But in the above case,
that the higher price is obviously charged because of time value of money and
deferred payment.
Thirdly, later in the same writing, Al-Omar and Abdel-Haq have further
explained the that bank is charging mark-up not because of time value of
money but due to the fact that it is providing services in the form of locating
and buying item at competent price on the request of client so it deserves to
charge mark up.28 On the other hand, several other writers mention that the
bank appoints the buyer as an agent who locates the item and negotiates the
price29 but it is not mentioned any where, whether buyer (bank's client) gets
paid or offsets certain debt as a compensation for his/her services? After all
seeking and locating item and negotiating price is the job of the bank and not
the bank's client.
Fourthly, Sharī'ah allows buyer to cancel the deal at any time and to
reject buying the item from the bank. This point is often used by the jurists to
justify the profit. They point out that seller remains at risk during the period
between purchase and sale because the price of item can decrease suddenly and
buyer may refuse to buy the item.30 However this element of risk is now
abolished by introducing a promise contract within the Murãbahah deal by
Islamic banks: promise from the buyer to buy the item.31 However it is against
the sharī'ah to bind the buyer but banks do it to decrease their risk.
Now the question is that if a debtor makes late payment then what
should creditor do in order to get compensation? Initially, the debtor will be
given grace period as shown in the Murãbahah model, without an additional
price32 but what if the debtor gets fail to make payment even after the grace
period. There is still no consensus over this issue. Islamic Fiqh Academy
concluded that it is not permitted in Islam to charge extra amount to debtor if
he gets late in making payment because charging more than principal is
interest which is prohibited.33 Similarly, El-Gamal described that "charging an
2* Ibid.
29 1. Ahmad, and S. Baloch, Islamic Banking Bulletin , and Zaher and Hassan, "A Comparative
Literature Survey of Islamic Finance and Banking."
F. Al-Omar, and M. Abdel-Haq, Islamic Banking: Theory, Practice and Challenges.
31 1. Ahmad, and S. Baloch, Islamic Banking Bulletin, 6.
A. Badr-El-Din Ibrahim, Poverty Alleviation via Islamic Banking Finance to Micro-Enterprises in
Sudan.
33 Islamic Fiqh Academy, Resolutions and Recommundations of the Council of the Islamic Fiqh
Academy 1985-2000 (Jeddah: Islamic Research and Training Institute, Islami Development Bank,
2000).
they are paid within specified period. But in Murãbahah deal, there is no way
to get rid of this extra amount after entering in the contract.41
According to Saeed "In both cases, it is a debt and the cost of financing,
whether it is called interest or profit, which is fixed and the time allowed for
repayment is also fixed."43
41 Ibid.
42 A. Saeed, Islamic Banking and Interest.
41 A. Saeed, Ibid., 89-90.
44 C. G. Bowker and L. S. Star, Sorting Thing Out: Classification and its Consequences (London: Mit
Press, 2000), 67.
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