Reconstruction of banking in Islam – I

I.A. Farooq

It is part of every Muslim’s faith and belief that all knowledge emanates from Allah Almighty. The system preferred by God Almighty has been.

a) Revelation in the form of Holy Book(s)

b) Revelation on Prophet(s) who were physical form of the book(s)

After the Prophet (PBUH) the two sources of knowledge did not remain very easily accessible, more particularly the physical book. The one source left relatively easier to approach thereafter is the holy book. Since the book has to answer and solve all questions arising, the historic procedure has been through derivation from the verses of the holy book and actions of the physical book. 

The Islamic financial system was revealed, explained, and implemented during the life span of the Holy Prophet (PBUH). The details of fundamentals of this system are preserved and available. The system is founded on two principles: Resource mobilisation and utilisation. This, in turn, is based on three facts: a) Every Muslim has to ideally voluntarily re-cycle all his surplus tangible assets in the Muslim society.

a) He has the right to save, i.e. (retain with him) the sum equivalent to his needs for one accounting period. The Prophet (PBUH) opted for accounting period of one day or less, and therefore, did not retain anything in his house overnight and during the day something (cash or kind) was available at home he opted to spend the night in the Holy Mosque.

b) Maximum accounting period for a Muslim is one year.

The resources generated form part of Ummah’s wealth generally held in Bait-ul-mal. The use of Bait-ul-mal funds (cash or kind) is specified in the book and forms the dividing line between an Islamic state and a Muslim state.

In the historic process, the financial system continued in various forms and there were no visible derivations attempted by the religious stalwarts. Again, historically, the era of Hazrat Abu Hanifa required awareness and knowledge about problems arising in the Muslim society more particularly relating to jurisprudence. This required large-scale resources outside the then Bait-ul-mal controlled by the rulers and not volunteered otherwise by the Muslim society. Hazrat Abu Hanifa opted to utilise resources (then known as amanat (trust) left with him by the Muslim society on the strength of his integrity and financial honesty that had developed over his lifespan. He rightly transformed this concept of amanat in Islamic society into deposits and used the same as equity in his business, the return on which was applied for financing the mammoth task undertaken by him. This mechanism remained at rest after his death possibly for the following reasons.

a) The financial system followed by the Muslim states worked efficiently.

b) An emergency to raise large volume of funds in the private sector did not arise.

c) The infrastructure to service the system was lagging.

With the turn of the 14th Century, the Western world experienced industrial, economic, and social revolutions one after the other. The backward Europeans developed the concepts from the stage at which these were left by the Muslim scholars.

Three of these concepts were:

i) Concept of juridical person

ii) Accounting

iii) Banking

The coupling of these concepts and later developments in line with the political influences generated by these developments in the subsequent years brought about the development in the banking structure to the point where it stands today.

Banking as prevalent in Pakistan has been defined under Section 5 of Banking Companies Ordinance as, “Banking: means the accepting for the purpose of lending or investment of deposits of money from public, repayable on demand or otherwise and withdraw-able by cheque, draft, order, or otherwise.”

In this generic form, a bank is an intermediary that raises resources against the strength of its integrity, financial honesty, efficiency, and competence and utilises the same for investment, lending, or other purposes. The Western financial philosophers clearly departed from the Islamic concepts at two points, re-linking their path to pre-Islamic days.

a) They promised a fixed return to the source of resources

b) They demanded a fixed return from the users.

Thus, they managed a supra safe margin for their services depending on the difference in receipt and payments above as also ensuring political control through the process. This philosophy, historically, developed from their disbelief in undertaking of Allah as the sole just authority feeding all human being.

The situation in which we find ourselves today threatens us of dire consequences of our continuous battle against the Almighty and his messenger on principles, which we mortals are bound to lose as also facing the displeasure of Allah and be punished in the life hereafter. The solution lies in adopting the principle derived by Hazrat Abu Hanifa hundreds of years back and save the Muslim Ummah from the wrath of Allah.

The discussions and reaction of Ummah have raised two main objections to the existing banking system, terming it as riba-based though it has much deeper effects resulting in dismantling the Islamic thought and Muslim society.

The objections include:

a) Fixed rate of returns on deposits and facilities,

b) Absence of essential risk requirement relating to profit and loss sharing.

The people in power have been trying to bring about changes in the existing methods to bring it in conformity with the Quran and the Sunnah.

Following is an attempt to reconstruct the existing system on a pattern of riba-free banking that essentially fulfils all the above requirements. In the new set-up the person, assets, and liabilities of bank will consist of:

a) Corporate set-up

b) Resources

c) Application of funds.

Every banking company shall be a public limited company whose share capital shall consist of ordinary and preference shares (deposits).

All shares will be listed on stock exchange and freely traded. The company will be governed by company law. Any provisions in the Company Law repugnant to Islam shall be ironed out by the Religious Board in the Corporate Law Authority to begin within specified span of time. However, no major problems exist at the moment and the laws relating to company formation and the operations largely conform to shariah.

The Board of the Company will consist of:

i) The directors from the company share holders group responsible for running of the affairs of the company.

ii) Three directors representing preference shareholders having a role for dividend declarations.

Those depositors who intend to continue their deposits and also hold the deposit equivalent to 1 percent of voting rights on account of preference shares will be eligible to contest for directorship of the Board of Directors of the Company the Deposit equivalent to nisab may form one vote (1 percent in not a fixed limit but minimum safety level).

Alternate-A: Equity (Ordinary Share Capital):

This will consist of the share capital allowed by the Corporate Law Authority necessary for the operations of a banking company as per rules. This stock will be quoted on Stock Exchange. i) Borrowing (in the local market)

Inter-company borrowings will be on the basis of musharika only. These musharika will strictly be in accordance with the shariah. The musharika mode of transactions has already been declared in accordance with the shariah.

ii) Current deposits: These deposits will consist of business/trading accounts as well as accountings of individuals operated freely. No accruals will be paid on these accounts (may share profit and loss as per theme of this paper).

iii) Term deposit: These will be in the form of preference shares freely traded on stock exchange.

v) Interim Dividend: Interim dividend (profit or loss) on the shares of restructured companies could be paid at periods or intervals operationally convenient to the company subject to final adjustment within the same accounting period.

vi) The remaining sources of funds are already interest free,

vii) Borrowing (in the international market)

The-borrowings in the international market will be on the balance sheet strength on musharika basis.

2. Alternate-B

All resources will be kept in current accounts on rolling basis called equity accounts. The dividend will be distributed on the basis of products on annual daily summations.

Continent liabilities:

Existing system of contingent liabilities is by and large in accordance with the principles of shariah. Mechanics has also been developed to support to stock exchange in trading of preferential shares.

(to be continued)

The writer is an ex-Advisor Banking State Bank of Pakistan

Source: The Post, 8/9/2008

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