African Journal of Social Sciences ISSN (Print) THE CASE FOR THE INTEGRATION OF ISLAMIC BANKING PRINCIPLES INTO THE NIGERIAN BANKING SYSTEM

Transcription

1 African Journal of Social Sciences ISSN (Print) Volume 2 Number 2 (2012) ISSN (Online) THE CASE FOR THE INTEGRATION OF ISLAMIC BANKING PRINCIPLES INTO THE NIGERIAN BANKING SYSTEM ABSTRACT AKANBI, Muhammed Mustapha Faculty of Law, University of Ilorin, Nigeria Islamic Banking Law is a relatively new subject which is not widely understood in non-islamic jurisdictions or even in jurisdictions with a very large Muslim population like Nigeria. Nigeria is home to the largest Muslim population in sub-saharan Africa, with around half of its 150 million population of the Islamic faith. It is also home to one of Africa's fastest growing consumer and corporate banking sectors. Thus given the population of Nigeria, the country is a potential African hub for Islamic banking. The paper advocates the integration of Islamic banking principles into the Nigerian banking system. Consequently, the paper examines the concept and financing techniques of Islamic banking, the products and services offered and the benefits and the challenges of the Shariah-based banking system. Keywords: Islamic Banking, Shariah, Nigeria JEL Classification: G21, G24, G28, G31 1. INTRODUCTION The conventional commercial banking system as it operates today is accepted in most countries except in Islamic States where it is received with some reservation. The reservation is on account of the fact thatt the conventional banking operations involve dealings in interest which is prohibited in Islam. Conventional banks have ignored this concern on the part of their Muslim clientele. Islamic banking aims to promote and develop the application of Islamic financial principles, law and traditions in relation to financial, banking and other related business and commercial affairs. It promotes business and commercial activities that are acceptable and consistent within ambit of Shariah principle, thus safeguarding the Islamic communities from activities which are regarded as forbidden in Islam. Islamic banking aims to promote and develop the application of Islamic principles, law and traditions to the transactions of financial, banking and related business and commercial affairs (Pheng, Lee and Ivan, 2007: 7). It promotes business and commercial activities that are acceptable and consistent within Shariah principle, safeguarding the Islamic communities and societies from activities which are forbidden in Islam (Pheng, Lee and Ivan, 2007: 7). However at the core of many scholars appreciation of the shariah lies a profound, if rarely spoken question which may be framed as follows: however sophisticated in its day, what relevance if any does the shariah really have in modern commerce, where rights and obligations are now fashioned by living legal systems that have developed and adapted with the benefits of years of practice and scholarship? (Majeed, 2004: 97). 41

2 Nonetheless, because change is the only thing that is constant, there are changing tides in the vast oceans of commerce and law. As a result, increasingly the relevancy and appropriateness of legislations and practices imported from western sources are gradually being questioned and calls (strident and muted) are now being made for a return to the shariah. Thus, in the historic Pakistani case of Khaki v. Hashim (2000: 225), the Supreme Court held in unmistakable terms that all forms of riba (interest), either in banking or private transaction, are contrary to the injunctions of Islam. Majeed (2004:98) therefore submitted that the table is now being turned against the anti-shariah proponents and it is the doubts about the significance of the Shariah that are now academic. Islamic banking has moved from a theoretical concept to embrace more than 100 banks operating in 40 countries with multi-billion dollar deposits world-wide. Islamic banking is widely regarded as the fastest growing sector in the Middle East financial services market. Exploding onto the financial scene barely four decades ago, an estimated $US 70 billion worth of funds is now managed according to Shariah. As at 1994, the deposited assets held by Islamic banks had risen to over $US 60 billion ( Principles of Islamic Banking, 1995). According to ISLAMTODAY 1 currently Islamic finance is estimated to be a $1 trillion global industry, but ratings agency Moodys forecasts that the industry could hit $5 trillion over time. Asian economies, in particular Malaysia and Indonesia, have seen rapid growth in Islamic banking. Nigeria is home to the largest Muslim population in sub-saharan Africa, with around half of its 150 million people members of the Islamic faith. It is also home to one of Africa's fastest growing consumer and corporate banking sectors. Thus given the population of Nigeria, the country can be the African hub for Islamic banking (ISLAMTODAY, 2011). As ascertained by Parker (2009: 12), there is undoubtedly a huge potential for Islamic finance in the real economy in Nigeria. It is in recognition of the benefits of Islamic banking that the Central Bank of Nigeria has initiated actions to develop a regulatory and supervisory framework for Islamic (non-interest) banking in Nigeria. It is expected that this will create the enabling environment for attracting multibillion dollar global Islamic finance industry in Nigeria and also enable Nigerians benefit from Shariah compliant banking services and products. 2 According to Sanusi Lamido Sanusi (in Ighomwenghian and Negedu), the Governor of the Central Bank of Nigeria, studies have shown that due to the Islamic banking nature, which is asset-linked as compared to the interest-based system which is subject to fluctuations in interest rate levels, an interest-free monetary system is more likely to lead to monetary stability. Consequently, this paper examines the concept and financing techniques of Islamic banking, the products and services offered and the benefits and the challenges of this Shariahbased banking system. 2. ELEMENTS OF ISLAMIC BANKING IN THE EARLY DAYS OF ISLAM In the early days of Islam, there are evidences to suggest that basic elements of banking and commercial investment practices took place among the Arab communities. Four practices which are mudharabah, musharakah, al wadiah and qard el Hassan stand out as very important (all these are considered elaborately later in this paper). Long before the advent of Islam, the city of Mecca had always been a commercial hub. Caravans used to make trips from Mecca up north to Syria and down south to Yemen. These journeys were known as the summer and winter trips (Homoud, 1985: 19). They took goods from their home port to sell at their destination, and with the proceeds bought other goods and brought them back to sell at home and/or to re-export Ighomwenghian and Negedu, 42

3 to another destination. 3 When a trading caravan is organised, it was the practice of the Meccans either to join it with their own goods and money or to send such through agents who did the business on their behalf. When a caravan returned home and the goods were all sold, the mission was complete and it was time to prepare the balance sheet and calculate the profit/loss (Abdul Gafoor). Traders who took their own money and goods assessed the success of the mission by the profit/loss they made and enjoyed the fruits of their labour or mourned their loss on their own. Those who combined their fortunes with that of one or more of their colleagues and undertook the project together had to go one step further and divide the fortune or loss among the partners, according to a pre-agreed pattern. The rules of this pattern had long been established by custom and had been known by the name musharakah. The agents who carried others goods and/or money had to give account to their principals and claim their share of the profit/loss according to a pre-arranged pattern. This kind of commercial transaction also had rules assigned by custom and was known by the name mudharabah (Abdul Gafoor). When the Holy Prophet Muhammad (PBUH) began his prophetic mission he did one of three things regarding the practices of the Arabs, to wit: (a) if it involved the denial of the existence or the uniqueness of the one God (Allah) or associating anything or anyone with Him or was against any command of God, he prohibited it outright; (b) if it did not involve any such action he did not interfere with it; (c) if some useful or essential practices involved some elements of the first and that could be removed, he removed the offending elements and allowed the modified version to be practised. Mudaraba and musharaka belonged to the second group. It is therefore safe to conclude that the concepts of mudharabah and musharakah which were customs and trade usages of the Arabs were the earliest modes of financing investment dating from pre- Islamic times (Kutty, 2005: 25; Kamali, 2002: 79). Apart from financing investments, the pre-islamic Arabs also engaged in deposits wadiah (this means custody or safekeeping) and interest free or benevolent loans (qard el Hassan) transactions. With respect to deposit taking, people took pride in their good reputation, which was adequate security for them to entrust their money and valuable to the care of those who were known for their trustworthiness and for the good discharge of their obligations. The Holy Prophet (PBUH) was known in Mecca as the trustworthy and before his migration to Medina, people kept deposits in his custody. Upon his emigration, he instructed Ali to return the deposits to their owners (El Humeiri, 1955: 485; Homoud, 1985: 19; Pheng, Lee and Ivan, 2007: 4). A significant event concerning deposits which require attention occurred during the time of the Holy Prophet (PBUH). It is noteworthy because of its connotations and importance, especially because it concerns a great companion of the Prophet, Az Zubair ben Al Awwam and the attitude of the companion in the use of the deposit in his care (Hamoud, 1985: 20; Pheng, Lee and Ivan, 2007: 4). Az Zubair was one of those entrusted with the safe keeping of money, but rather than take the money on as a deposit he preferred to take it as a loan. Abdalla ben Az Zubair quotes his father as saying that when a man brought money to be deposited with him, Zubair would say: No, it is a loan, because I am afraid it may be lost (Sa ad, 1957: 109). Inherent in Zubair s attitude are two objectives, to wit: (a) the custodian of the deposit reserves the right to dispose of the money being a loan and (b) it secures a guarantee to the owner because the custodian of a deposit is not liable in the event of a loss of the deposit (especially if the loss is not due to his negligent or malicious acts). However, if a loan, the borrower remains liable to repay (Hamoud, 1985: 20). What can be said to be an organised financial institution during the time of the Holy Prophet (PBUH) was called baitul mal (meaning: the exchequer of an Islamic state or public 3 Abdul Gafoor: 43

4 treasury). In his time, the Prophet used the mosque as the treasury. However, during the time of the second caliph, caliph Umar, it was run as a separate entity. The revenue for baitul mal came from both primary and secondary sources. Primary sources were Zakat (alms or wealth tax), Kharaj (land tax), jazia (poll tax), custom duties, tolls and sadaqah (donation). Secondary sources consist of properties with no known owners, property of apostates and estates of deceased persons without legitimate heirs. 4 Funds collected by baitul mal were used to fund state responsibilities such as army expenses and state officials salaries and to finance activities for the benefit of the public, such as road construction and water supply. In essence, the objective of the baitul mal was to manage the financial affairs of the Islamic State. There are no records of the baitul mal accepting deposits from members of the public. However, at least one instance shows that the baitul mal extended loans to members of the public. For instance, Loans were given to Umar s sons Abd Allah and Ubayd Allah which were used for trading. The loan contract was treated by Umar as mudharaba and therefore requested them to give half of the profit made to baitul mal. 3. CONCEPTS AND RATIONALE FOR ISLAMIC BANKING Islamic banking is banking based on Islamic law (Shariah). It is rooted in the Shariah, called fiqh muamalat (Islamic rules on transactions). These rules came directly from the Quran and Sunnah, and indirectly from other secondary sources of Islamic Law such as opinions collectively agreed among Shariah scholars (ijma), analogy (qiyas) and personal reasoning (ijtihad) 5. Among the most important teachings of Islam for establishing justice and eliminating exploitation in business transactions is the prohibition of sources of unjustified enrichment (akl amwal al- nas bai -al-batil). The Quran instructs Muslims emphatically not to acquire each other s property wrongfully. 6 Islamic banks are to make profits whilst conforming to Islamic business principles. It is however imperative to draw attention to the fact that geographical, political and historical differences amongst the various schools of thoughts in Islamic jurisprudence have led to different approaches being adopted with the understanding of the concepts and practice of Islamic banking by Islamic scholars and practitioners. The four major schools are named after the respective founders to wit: the Hanafi School (Abu Hanifah), the Malik School (Malik ibn Anas), the Shafi i School and the Hanbali School. Most importantly, Islamic banks are to be guided by Quranic injunctions. 7 The operations of Islamic banking are based on the concepts of honesty, justice and equity as enjoined by Allah and as practised by the Holy Prophet (PBUH). Muslims are taught that the godly man s business will never fail because Allah guarantees him return inclusive of His blessings and favour (Pheng, Lee & Ivan, 2007: 16-17). This sacrosanct principle is buttressed in several Quranic verses, one of which is reproduced below: Those who rehearse the Book of Allah, establish regular prayer, and send (in charity) out of what we have provided for them, secretly and openly, hope for commerce that will never fail (Quran, 35: 29) 4 Semblance Of Financial Or Banking Institution In The Early Days Of Islam (Pheng, Lee And Ivan, 2007: 4-5) 5 Danbatta, accessed on 16/05/11 also in Your Guide on Basic Concepts and Principles of Islamic Banking, 2009). 6 Quran, 2: 188; 4: 29; 4: 161; and 9: 34 7 Obey Allah and the Messenger; that ye may obtain mercy (Quran, 3: 132). O ye who believe! Obey Allah, and obey the Messenger (Quran, 4: 59) 44

5 Islamic banks are to balance between earning and spending in order to achieve a betterment of the whole community. Islam emphasises lawful earnings of livelihood. All unlawful means of acquiring wealth are prohibited. This is also supported by Quranic injunction thus: O ye who believe! Eat not up your property among yourself in vanities; but let there be amongst you traffic and trade by mutual goodwill; nor kill or destroy yourself: for verily Allah hath been to you most merciful. If any do that in rancour and injustice soon shall we cast them into fire: and easy it is for Allah (Quran, 4: 29-30) 3.1 KEY RULES OF ISLAMIC BANKING a) Any Predetermined Payment Over And Above The Actual Amount Of Principal Is Prohibited One of the important sources of wrongful or unjustified earnings is receiving any monetary advantage in a business transaction without giving a just counter value (Al-Omar and Abdel-Haq, 1996: 7). Islam expressly prohibits Muslims from taking or giving interest (riba) regardless of the purpose for which such loans are made and regardless of the rates at which interest is charged. Attempts have been made to distinguish between usury and interest and between loans for consumption and for production. It has also been argued that riba refers to usury practised by petty money-lenders and not to interest charged by modern banks and that no riba is involved when interest is imposed on productive loans. However, these arguments have not won wide acceptance (Hoque, in Pramanik, 2005: 44). The general consensus among Muslim scholars clearly is that there is no difference between riba and interest (Ariff, 1988: 46-62). The prohibition of riba is mentioned in four different revelations in the Qur'an as follows: Surah al-rum 30: 39; Surah al-nisa 4: 161; Surah al-imran 3: 130; Surah al-baqarah 2: That which you give in usury for increase through the property of (other) people, will have no increase with Allah; but that which you give to charity, seeking the Countenance of Allah, (will increase): it is these, who will get a recompense multiplied (Quran, 30: 39) This revelation emphasizes that profits should be made through a person s own exertions and at his expense, not through exploiting another or at another s expense. According to commentators, this verse specifically applies to those who give to others, whether gifts or services, in order to receive from them greater benefits in return. Such seemingly good acts are void of any merit and deserve no reward from Allah, since He knows the real intention behind such ostensibly good deeds ( The Ministry of Hajj and Endowments, 1413H: 1189). That they took usury, though they were forbidden; and they have devoured men s wealth wrongfully; - We have prepared for those among them who reject faith a grievous chastisement (Quran, 4: 161) The second revelation condemns usury and views its collection as amounting to the wrongful appropriation of property belonging to others. O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may really prosper (Quran, 3: 130). This third revelation enjoins Muslims to stay clear of interest for the sake of their own welfare. Believers are warned that real prosperity consists, not in greed of collecting interest. Those who devour usury will not stand except as stands one whom the satan by his touch hath 45

6 driven to madness. That is because they say: trade is like usury, but Allah hath permitted trade and forbidden usury. Those who after receiving admonition from their Lord, desist, shall be pardoned for the past; their case is for Allah to judge; but those who repeat the offence are companions of the fire: they will abide therein forever (Quran, 2: 275). Allah will deprive usury of all blessing, but will give increase for deeds of righteousness, and establish regular prayers and give zakat, will have their rewards with their Lord: on them shall be no fear, nor shall they grieve (Quran, 2: 276). O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers (Quran, 2: 278). If ye do it not, take notice of war from Allah and His messenger: but if ye repent ye shall have your capital sums: deal not unjustly and ye shall not be dealt with unjustly (Quran, 2: 279) The fourth revelation establishes a clear distinction between interest and trade, urging Muslims to take only the principal sum and to forgo even this sum if the borrower is unable to repay. It is further declared in the Qur'an that those who disregard the prohibition of interest are at war with God and His Prophet. The prohibition of interest is also cited in no uncertain terms in the Hadiths of the Holy Prophet (PBUH) wherein he condemned not only those who take interest but also those who give interest and those who record or witness the transaction, saying that they are all alike in guilt (Hadith compiled by Muslims (Kitab al-musaqat)). Stemming from the foregoing, it is clear that the prohibition of usury or interest is the most essential feature of Islamic banking. The banking system is interest-free; it prevents the taking and giving of interest regardless of the purpose for which such loan is made (Aburime and Alio, 2009: 324). Consequently, any predetermined payment over and above the actual amount of principal is prohibited. Islam allows only one kind of loan and that is qard-el-hassan (literally good loan) whereby the lender does not charge any interest or additional amount over the money lent. Traditional Muslim jurists have construed this principle so strictly that, according to one commentator, "this prohibition applies to any advantage or benefits that the lender might secure out of the qard (loan) such as riding the borrower's mule, eating at his table, or even taking advantage of the shade of his wall." The principle derived from the quotation emphasises that associated or indirect benefits are prohibited ( Principles of Islamic Banking, 1995). b) The Lender Must Share In The Profits Or Losses Arising Out Of The Enterprise For Which The Money Was Lent Another Islamic banking principle is that there should be no reward without risksharing (al-ghunum bi- l-ghurm). This principle is applicable to both labour and capital. As no payment is allowed for labour unless it is applied to work, so also no reward for capital should be allowed unless it is exposed to business risks. 8 Islam encourages Muslims to invest their money and to become partners in order to share profits and risks in the business instead of becoming creditors. Islamic finance is based on the belief that the provider of capital and the user of capital should equally share the risk of business ventures, whether those are industries, farms, service companies or simple trade deals. Translated into banking terms, the depositor, the bank and the borrower should all share the risks and the rewards of financing business ventures. This is unlike the interest-based commercial banking system, where all the pressure is on the borrower: 8 Islamic Banking Principles, 46

7 He must pay back his loan, with the agreed interest, regardless of the success or failure of his venture. The principle which thereby emerges is that Islam encourages investments in order that the community may benefit. Thus, Islamic banking is based on the concept of participation in the enterprise, utilizing the funds at risk on a profit and loss sharing basis (Aburime and Alio, 2009: 324). Businessmen are encouraged to engage in business with higher risks and higher returns. The objective is that high risk investments provides stimulus to the economy and encourage entrepreneurs to maximise their efforts (Al-Omar and Abdel-Haq, 1996: 22). c) Making Money From Money Is Not Islamically Acceptable Islam does not frown against making money. However, it is the inordinate love of money that is frowned upon (Baig, Online). Wealth itself is not bad. In fact the Qur'an refers to it as '... your wealth which Allah has made for you a means of support.' (Quran, 4: 5). Money is only a medium of exchange, a way of defining the value of a thing; it has no value in itself, and therefore should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or lent to someone else. The human effort, initiative, and risk involved in a productive venture are more important than the money used to finance it. In Islam, money in itself is not considered as actual capital. Actual capital only exists when money, along with other resources, is put into productive activities. Linking the use of money to productive purposes invariably brings into action the factor of labour, a process from which benefits pass on to society. 9 Thus, money advanced to a business as a loan is regarded as a debt of the business and not capital and as such not entitled to any return (i.e. interest). Hoarding money is unacceptable in Islam. Muslims are encouraged to purchase and are discouraged from keeping money idle. Under the Shariah, money represents purchasing power which is considered to be the only proper use of money. This purchasing power (money) cannot be used to make more purchasing power (money) without undergoing the intermediate step of it being used for the purchase of goods and services. d) Gharar (Uncertainty, Risk Or Speculation) Is Also Prohibited Under this prohibition, any transaction entered into should be free from uncertainty, risk and speculation (Kamali, 2001: 84-98; Saleh, 1992: ; El Gamal, 2006: 46-62). The unanimous agreement of jurists on this is that by failing or neglecting to define any of the essential pillars of contract relating to the consideration or the object, the parties to the transaction take an avoidable risk (gharar) (Al-Omar and Abdel-Haq, 1996: 9). Contracting parties should have perfect knowledge of the counter values intended to be exchanged as a result of their transactions. Also, parties cannot predetermine a guaranteed profit. This is based on the principle of 'uncertain gains' which, on a strict interpretation, does not even allow an undertaking from the customer to repay the borrowed principal plus an amount which takes inflation into account. The rationale behind the prohibition is the wish to protect the weak from exploitation (Saleh, 1992: 62). Therefore, options and futures are considered as un-islamic and so are forward foreign exchange transactions because rates are determined by interest differentials. A number of Islamic scholars disapprove the indexing of indebtedness to inflation and explain this prohibition within the framework of qard-el-hassan. According to those scholars, the creditor advances the loan to win the blessings of Allah and expects to obtain the reward from Allah alone (Saleh, 1992: 62). It is however important to note that a number of 9 Hairetdinov, 47

8 transactions are treated as exceptions to the principle of gharar. These include sales with advanced payment (bai Salam) and hire contract (Ijara). Even in this regard, it is legally required that the conclusion of contracts falling within these examples must be organised in a way that minimises risk. e) Investments Should Only Support Practices Or Products That Are Not Forbidden-Or Even Discouraged- By Islam. Under the Shariah, there is an obligation not just to invest in business but to also invest in only halal activities or transactions. This is a major basis for the Islamization of a society's economic life. Not every business idea or possible business enterprise is good for the society. And the decision regarding right and wrong is not decided by the society simpliciter or market forces. Under the shariah, right and wrong in the economic life and indeed in all spheres of life, is determined by a higher source. The Shariah guides Muslims as to the halal and haram business enterprises and practices, and at both individual and collective levels and Muslims are bound by the injunctions (Baig). At times that guidance may conflict with the prevailing practices. For example riba (interest), gambling, pornography, and liquor are haram, and no matter how attractive the financial rewards of engaging in those enterprises may seem to be, Muslims are expected to refrain from them. This is the economic struggle of a believer, and it is obvious why it should be carried out as a religious obligation. At the individual level the obligation is to engage in halal professions and businesses. At the collective level the obligation is to establish a system that facilitates such individual efforts and discourages their opposite (Baig). In summary, five features are of particular importance for Islamic banking (Al-Omar and Abdel-Haq, 1996: 24): Interest is forbidden in that it is a predetermined, fixed sum owed to the lender irrespective of the outcome of the business venture in which the fund is used; There must be some risk, whether the funds are used in a commercial or productive venture; Financial risk must lie solely with the capital provider and not with the manager or agents who work with the capital; It has to be asset-based financing. Profit is generated when something having intrinsic utility is sold or offered for use. Since money has no intrinsic value, dealing in money (same currency) cannot generate profit but a riba unless converted into real assets to be dealt with; and, Funds must be deployed only to finance halal transactions. 4. THE BASIC PRINCIPLES AND TECHNIQUES OF MODERN ISLAMIC BANKING 4.1 EVOLUTION OF MODERN ISLAMIC BANKING The late 19 th and early 20 th century marked the beginning of the era of Islamic resurgence. Writings by several notable scholars (al-afghani (1838/9-1897); Abduh ( ); Rida ( ); Iqbal ( ); al-banna ( ); Qutb ( ), Mawududi ( )) provided the impetus for Muslims to apply Islamic teachings in all aspects of life including political, social and economic aspects (Pheng, Lee & Ivan, 2007: 5). In particular, the earliest references to the reorganisation of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition in 1950/60 by Mawdudi (1961). Muhammad Hamidullah s 1944, 1955, 1957 and 1962 writings too should be 48

9 included in this category. They all recognised the need for the establishment of commercial banks that are interest free and therefore proposed a banking system based on the concept of Mudharabah - profit and loss sharing. 10 The first modern experiment with Islamic banking started in Egypt under cover, without projecting an Islamic image, for fear of being seen as a manifestation of Islamic fundamentalism which was anathema to the political regime. The pioneering effort, led by Ahmad El Najjar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in l963 and the experiment lasted until l967 (Ready, 1981), by which time there were nine such banks in the country. In line with Shariah principles, the banks did not charge or pay interest to their customers. However, they invested mostly by engaging in trade and industry, directly or in partnership with others, and shared the profits with their depositors. Thus, they functioned essentially as saving-investment institutions rather than as commercial banks. Even though the Nasir Social Bank which was established in Egypt in l971 was declared an interest-free commercial bank, its charter made no reference to Islam or the Shariah (Ariff, 1988: 46-62). In the seventies, changes took place in the political climate of many Muslim countries so that there was no longer any strong need to establish Islamic financial institutions under cover. The IDB was established in 1974 by the Organisation of Islamic Countries (OIC), though primarily as an Intergovernmental bank aimed at providing funds for development projects in member countries. Its operations were free of interest but it provides fee-based financial services and profit sharing financial assistance to member countries. During this period, a number of full-fledged Islamic banks came into existence in the Middle East, e.g., the Dubai Islamic Bank (l975), the Faisal Islamic Bank of Sudan (l977), the Faisal Islamic Bank of Egypt (l977), and the Bahrain Islamic Bank (l979). The wind of change also spreads to the Asia- Pacific region which led to the establishment of Islamic banking institutions in Muslimdominated countries like Iran, Pakistan and Malaysia (Pheng, Lee & Ivan, 2007: 5-9). It is important to note that Islamic financial practices and institutions also have a significant presence in countries where Muslims are a minority like India, Luxembourg, Denmark, Australia and the United Kingdom. 4.2 FINANCING TECHNIQUES AND SERVICES Islamic jurisprudence permits a wide range of financing techniques to be adopted by Islamic banks in delivering their products and services. Some of these techniques developed in the period of the first Islamic state, others have emerged recently to meet contemporary financing requirements in the light of the teachings of Islam (Igba and Mirakhor, 1987). Basically these techniques can be broadly classified into four categories viz: Profit and loss sharing principles (includes Mudharabah and Musharakah); Fees or charges based principles: includes (Murabahah; Bai mu ajjal, Ijara and Ijara wa-iktina); Free service principle (includes Qard Hassan); and, Ancillary principles (includes Wadiah) THE PROFIT AND LOSS SHARING PRINCIPLES (a) Mudharabah This is a financing technique in which the owner of capital (rabbul-mal) may 'invest' by allowing an entrepreneur with ideas and expertise to use the capital for productive purposes and 10 Abdul Gafoor: 49

10 he may share the profits, if any, with the entrepreneur-borrower (mudharib); losses, if any, however, will be borne wholly by the rabbul-mal (Pheng, Lee & Ivan, 2007: 48-50; Al-Omar and Abdel-Haq, 1996: 12; Ariff, 1988: 46-62). The central idea in the concept of mudharabah entails participatory financing in which two parties, one with capital and the other with know-how, get together to carry out a project. The financier provides the capital and plays no further part in the project. Specifically, he does not interfere in its execution, which is the exclusive province of the entrepreneur. If the project ends in profit they share the profit in a pre-arranged proportion. If it results in loss, the entire loss is borne by the financier, and the entrepreneur gains no benefit out of his effort, which was his part of the investment (Abdul Gafoor). There are various types of mudharabah, two of which are most commonly practised, namely: (i) al mudharabah al mutlaqah (unlimited mandate mudharabah); and, (ii) al mudharabah al muqayyadah, (limited mandate mudharabah with such limitations as limitation of time, territorial limitation, etc). Essential elements of mudharabah can be summarised as follows (Pheng, Lee & Ivan, 2007: 16-17): The existence of two contracting parties: rabb al mal and mudharib and the subject matter must consist of capital, labour and profit, that is; Capital must be in the form of money and not a commodity and must be specified, determined and known at the time of the contract. The cash must be available and delivered into the possession of the mudharib entirely; and, The distribution of the profit must be determined proportionately between the parties. Predetermined profit must be in ration form and not in a fixed amount. (b) Musharakah Another legitimate financing technique recognized in Islam is one based on equity participation known as musharakah. It is a process in which a capital owner finances investment in another party s business. Additional finance is provided to the party who already has some funds on the condition that he shares in the profits from the business. The ratio in which the capital owner shares the profit of the business with the business owner is fixed and pre-determined and made known in advance to all concerned. The loss however will be shared in the exact proportion of the capital invested by each party. The profit sharing ratio is left to be mutually agreed upon and may be different from the ratio in which the two parties have invested in the total capital of the project. This is because the two parties may share the work of managing the project in any amount mutually agreed upon (Al-Omar and Abdel-Haq, 1996: 13). There are several types of musharakah contracts which includes: shirkah al mulk (proprietary partnership/joint ownership of property); shirkah al aqd (commercial and contractual partnership: joint exploitation of capital and joint participation in profits and losses, based on partnership agreement); and, shirkah al inan (limited investment partnership: each partner may only transact with the partnership capital according to the terms of the partnership agreement and to the extent of the joint capital ). The essential elements of musharakah can be summarised as follows (Pheng, Lee & Ivan, 2007: 51): Contribution to capital need not be equal Division of work need not be equal 50

11 Distribution of profits and liability to losses is according to contribution to capital the techniques of mudharabah and musharakah constitute, at least in principle if not in practice, the twin pillars of Islamic banking. The two principles are similar in operation. This is because the provider of finance shares the profit directly and is contracted to the losses, if any, to the extent of his investment. That is why these two techniques are often categorised together as profit-and-loss-sharing (PLS) (Al-Omar and Abdel-Haq, 1996: 13). However, in musharakah, all partners contribute to both capital and management of the partnership, while in mudharabah, only one party provides the capital and the other management skills. 4.3 FEES OR CHARGES BASED PRINCIPLES MURABAHA This mode of Islamic finance is generally defined as the sale of a commodity for the price at which the vendor has purchased it, with the addition of a stated profit known to both the vendor and the purchaser (Saleh, 1992: 117; al Daril, 155). This is a cost-plus contract in which a client, wishing to purchase equipment or goods, requests a financier to purchase the items and sell them to him at cost plus a declared profit. By this technique, a party needing finance to purchase certain goods gets the necessary finance on a deferred payment basis. The finance provider does the purchasing of the goods and sells them on the basis of a fixed mark-up profit, agreeing to defer the receipt of the value of the goods even though the goods can be delivered immediately (Al-Omar and Abdel-Haq, 1996: 13). Even though sales by mutual consent are preferable, murabaha sales are legally approved by the majority of the schools of thought. However there are differences regarding some aspects relating to the implementation of the concept. For example, the schools differ on; 1) the sort of expenses incurred subsequent to his purchase that the vendor is allowed to add to the murabaha price and 2) the options that are open to a murabaha purchaser if he discovers that the murabaha price was unduly inflated (Saleh, 1992: 118). According to the Maliki school of thought, both partners are legally bound to fulfil the terms of the contract, while the other schools look at it as a religious obligation, which may be rendered legally binding if it is in the public interest (Darir). Generally, the conditions to be met for a valid murabaha contract are as follows (Pheng, Lee & Ivan, 2007: 52): Cost price must be known by the purchaser at the time of the contract. Profit over the cost price must be specified and known by both parties. Cost price must be quantifiable and substitutable. The contract must not involve anything that constitutes riba. The vendor must have bought the item for the contract invalid sale and purchase agreement. The use of murabaha as a finance technique has been criticised for being in breach of the shariah principle which frowns against earning a predetermined profit without bearing any risks (Siddiqi, 1983: 49 & 137). However a pro-murabaha view counters the argument to the effect that in conventional banking the determination of profit depends on the rate of interest in the market during the period of the loan or contract whereas with respect to murabaha, profit is pre-determined without considering any possibility of increasing it in the future whether or not there is any change in the market. 51

12 A variant concept of murabaha is bai mujjal or deferred payment sale. This involves the purchase and resale of goods and properties on a deferred payment basis. It is considered lawful in fiqh (jurisprudence) to charge a higher price for a good if payments are to be made at a later date. According to fiqh, this does not amount to charging interest, since it is not a lending transaction but a trading one (Ariff, 1988: 46-62). In theory, an attempt is made to distinguish between the contracts of bai mujjal and murabaha, but in practice there may be no difference in their operation BAI SALAM This is a technique whereby a person makes pre-paid purchase of goods. It is a financing means that can be used to fund production. Here the price is paid at the time of the contract but the delivery would take place at a future date. This mode enables an entrepreneur to sell his output to another at a price determined in advance (Ariff, 1988: 46-62). The conditions for the validity of such future sales are that the goods are not available or cannot be delivered at the time of contracting and that the consideration in lieu of advance payment must be paid, or the rate of it fixed, at the time of concluding the contracts. Failure to meet these conditions may invalidate the contract. A salam contract is also void if the buyer s consideration is in the form of a set-off or negation of an existing debt (Al-Omar and Abdel-Haq, 1996: 17) IJARA This is a recognised lease contract as well as hire/rental contract under the Shariah. It is a contract whereby usufruct rights to an asset are transferred by the owner, known as the lessor, to another person, known as the lessee, at an agreed-upon price called the rent, and for an agreed-upon period of time called the term of the lease. 11 The technique is normally used to finance the acquisition of assets. A financier purchases the asset required by the customer and then leases the asset to the customer for a fixed period of a lease. The customer then pays only rent and does not have to incur the capital investment involved in the purchase of the asset (Al- Omar and Abdel-Haq, 1996: 14). As described above, the leasing transaction simply denotes the transfer of the usufruct of a property from one person to another for an agreed-upon price called rent without transferring the corpus i.e. ownership of that asset. Accordingly, the contract of leasing appears similar to the contract of sale because in both cases something is transferred to second person for valuable consideration. However, unlike in the contract of sale whereby possession and ownership is transferred to the purchaser, in a lease contract only the use of the property and not the corpus or ownership of the property is transferred to lessee. 12 The concept of Ijara has been subjected to examination in a great detail by fiqh (Saleh, 1992: 121). There is a common consensus by the various schools of thought that leasing is lawful under the Shariah. What appears to be the bone of contention however is whether the concept is a binding (lazim) contract or a non-mandatory (ja iz) contract which can be cancelled at will by either party with no regard to the duration of the work agreed in the contract. The major schools i.e. Maliki, Shafi i, Hanafi and Hanbali agree on the bindings of the ijara contract. However, they disagree on the reasons which could cause the termination of the contract. According to Maliki and Shafi i, ijara can only be cancelled if there is a material defect affecting the corporeal object leased or hired, and also if the purpose of the lease or hire 11 Hairetdinov, 12 Hairetdinov, 52

13 is no longer practicable. For Hanafi, the ijara is cancelled by any reasonable excuse that the lessee may invoke. On the part of the Hanbalis, the ijara is cancelled, if the rented object is destroyed or affected by a material defect (Saleh, 1992: 121). The conditions 13 to be met for an ijara contract to be accepted as valid under the shariah includes: That it is a contractual obligation; That the service that the asset is supposed to provide and for which it is being rented should be defined and clearly known to both parties; That there has to be a valuable use of the asset and transferability; That the ownership of the asset is retained by the transferor or lessor throughout the lease period, consumable articles cannot be leased. That the risk and liabilities of ownership lie with the lessor. The leased asset shall remain the risk of the lessor throughout the lease period; Any loss or harm caused by factors beyond the control of the lessee shall be borne by the lessor. However, the lessee is liable to compensate the lessor for any harm to the leased asset caused by any misuse or negligence on the part of the lessee; That the risk and liabilities associated with the use of the asset shall be borne by the lessee. E.g. taxes and other government levies, utilities, etc. However, the contract must specify these items for clarity's sake; That the term of the lease, period of the lease, its renewal or early termination must be stipulated; That the lessee cannot use the leased assets other than for the purpose specified in the contract or agreed to by the lessor expressly; That the lease commences from the date of delivery of the asset to the lessee and not from the day of payment or lease agreement, with reference to the commencement of rentals; That the rent for the entire period of the lease must be determined at the time of the contract; and, That the price of an asset that may be sold to the lessee at the expiry of the contract cannot be pre-determined. It can be determined only at the time of the expiry of the contract IJARA WA-IKTINA (HIRE PURCHASE) This is a hire purchase agreement whereby a financier will buy and rent a building, equipment or other facility to another party, who will have to make agreed incremental payments over an agreed period into an account. At the end of each year profits are added to the instalments paid until such time as the investment account contains the identical amount the bank paid to purchase the asset. Eventually, the customer is able to offset the rental cost and to purchase the rented property. If he decides not to acquire the rented property, what remains of the profit, after rental cost and expenses rebated is remitted to the customer and the rented property is taken back by the financier (Saleh, 1992: 121). 13 Hairetdinov, 53

14 4.4 FREE SERVICE PRINCIPLE Qard Hassan Qard Hassan is a benevolent loan given to a borrower and the loan does not attract any form of interest. Essentially, a person borrows money from another, to be returned at a stipulated future date free of interest. However, upon return the borrower has discretion to reward the lender for the loan by paying any sum over and above the principal (Pheng, Lee & Ivan, 2007: 54). As earlier noted, traditional Muslim jurists have construed this principle so strictly that, the prohibition applies to any advantage or benefits that the lender might secure out of the qard (loan) such as riding the borrower's mule, eating at his table, or even taking advantage of the shade of his wall ( Principles of Islamic Banking, 1995). However, modern scholars allow the lender to charge for the cost incurred in the course of making the loan available to the borrower. It must be noted that these service charges are not profit; they are actual costs in respect of such items as rental of premises, workers salaries, stationery and cost of cheque books (Al-Omar and Abdel-Haq, 1996: 11). 4.5 ANCILLARY PRINCIPLES In the preceding part of the work, we discussed some various financing techniques that are recognised under the Shariah. The focus of this part of the work examines the services that may be offered by Islamic banks. The methods for operating the services are also highlighted in line with the techniques already discussed. By and large, all Islamic banks agree on the basic principles of interest-free banking services. However, individual banks differ in their application. These differences are due inter alia to several reasons including the laws of the country, objectives of the different banks and the individual bank s circumstances and experiences. In the same vein, Islamic banks like the conventional banks offer various services and products which in operation have some basic similarities. The main point of departure is the taking or giving of interest in the provision of banking services. Islamic banks can offer among others the following major services such as: Deposit accounts; Trade financing; and, Lending. These are in accordance with the Islamic principle of Wadiah. Wadiah is an age long technique for keeping money or assets in safe custody. It is the authorisation of a person to keep the property of another for safe keeping SOME KEY NOTES ON VARIOUS ASPECTS OF ISLAMIC BANKING Islamic banks have three kinds of deposit accounts: current, savings and investment accounts. (a) Current Accounts Current accounts are virtually the same as in all conventional banks. The deposit is guaranteed and there are no returns on the deposits (Abdul Gafoor). It is suitable for clients looking for safe custody of their funds, together with convenience and use thereof (Abdul Gafoor). It is essentially a safe-keeping (wadiah) arrangement between the depositors and the bank (Aburime and Alio, 2009: 327). The banks take permission from their clients to make use of their funds while these funds remain with the banks. The client may withdraw parts or the whole of their balances at any time and the banks guarantee the funds in such balances (Al- Omar and Abdel-Haq, 1996: 32). 54

15 All the profits generated by the banks from the use of such funds belong to the banks. For their part, the banks provide the clients with cheque books and the other usual services connected with current accounts (Al-Omar and Abdel-Haq). Such as the provision of a broad range of payment facilities - clearing mechanisms, bank drafts, traveller s cheques, money transfers, trade in foreign currencies, etc. More often than not, no service charges are made by the banks in this regard (Ariff, 1988: 46-62). This concept is normally used in deposit-taking activities, custodial services and safe deposit boxes. Below is a summary of how it works ( Principles of Islamic Banking, 1995): A customer places money in a bank and the bank guarantees to return the money to him. He is allowed to withdraw the money anytime. Subject to his authorisation, a bank may make use of the funds in its custody. The bank may charge him for providing safe custody, provision of cheque books etc. The bank may pay hibah (gift) to him if it deems fit. (b) Savings Accounts Savings accounts are similar to current accounts. It also operates on an al-wadiah basis, but the bank may at its absolute discretion pay the depositors a positive return periodically, depending on its own profitability. Such payment is considered lawful in Islam since it is not a condition for lending by the depositors of the bank, nor is it pre-determined. The savings account holders are issued with savings books and are allowed to withdraw their money as and when they please (Ariff; Al-Omar and Abdel-Haq, 31). Savings deposit accounts operate in different ways. In some banks, the depositors allow the banks to use their money but they obtain a guarantee of getting the full amount back from the bank, but no profit is promised (Abdul Gafoor). It is like a qard loan that is, it cannot generate any pre-agreed benefit or income to the depositor, over and above the principal amount of deposit (Pheng, Lee & Ivan, 2007: 72). In others, savings accounts are treated as investment accounts but with less stringent conditions as to withdrawals and minimum balance. Capital is not guaranteed but the banks take care to invest money from such accounts in relatively riskfree short-term projects. As such lower profit rates are expected and that too only on a portion of the average minimum balance on the ground that a high level of reserves needs to be kept at all times to meet withdrawal demands (Abdul Gafoor; Aburime and Alio, 2009: 327). (c) Investment Accounts Investment deposits are accepted for a fixed or unlimited period of time and the investors agree in advance to share the profit (or loss) in a given proportion with the bank. Capital is not guaranteed (Abdul Gafoor). Islamic banks employ a variety of instruments. The investment account is based on the PSL principle whereby the deposits are term deposits which cannot be withdrawn before maturity. The profit-sharing ratio varies from bank to bank and from time to time depending on supply and demand conditions. The mudharabah and musharakah techniques have been singled out as the most ideal mode or instrument of financing under this arrangement. 14 Summary of how mudharabah works in the modern Islamic banking system (Principles of Islamic Banking, 1995): 14 Hairetdinov, 55