P L d 2000 s c 225 (Riba prohibition stayed)

 

Abdul Wadood Khan, Economic Expert reappeared to contend that inflation would reduce by 42 per cent. if interest system is abolished and TMCL based interest-free banking system is introduced, and there will be more amount available in money market which might be used to repay the loans. He claimed that level of bank deposit would rise with the elimination of interest and referred to Keynes’s philosophy of lowering the rate of interest, the higher the level of investment. According to him the elimination of interest would also increase Government’s earnings. He also dealt with encashment of premature commercial and treasury bills, liquidity agreement and profit earning by banks. He argued that both Islamic and non-Islamic Banking Systems should be run parallel so that people can choose the system of their liking. According to him counter-loan scheme is not against Shariah and it is according to the Hanafi school of thought, and under the Counter Loan Scheme replacement of interest with Time Multiple Counter Loan (TMCL) would convert existing banking system into interest free banking system without any disruption, and upon banning of interest, the existing banks would stop giving loans on interest or mark-up and would commence providing loans on TMCL basis and would start negotiations for converting existing interest-based or mark-up based loans into TMCL-based interest-free loans. In the context of conversion of depositors accounts he argued that the depositors would be given the option to keep their money in demand-deposit or investment deposit. Demand deposit, according to him, would not get any profit or incur any loss but in investment deposit the bank would share the profit and loss with the account holders.

 

 

 

Maulana Hafiz Abdur Rahman Madani, a religious scholar argued on prohibition of Riba in Islam by the Holy Prophet (peace be upon him) narrating the background and time of prohibition of Riba. According to him Riba was evolutioned in four stages as four different verses of’ the Holy Qur’an were revealed at different times and one of the last verses of Qur’an revealed oil Holy Prophet (p.b.u.h.) includes the prohibition of Riba strictly. It was contended that all the verses related to prohibition of interest (Riba) are incumbent upon Muslims; that it would be wrong to say that the Holy Prophet (p.b.u.h.) had left anything unexplained while teaching the people about prohibition of all kinds of Riba. Talking about the definition of Riba, Maulana Hafiz Abdul Rahman Madani referred to Imam Sarakhsi’s definition of Riba to the effect that Riba is a conditional increase in sale agreement which has no counter value and proposed certain amendments in the same. According to him Riba is the agreement where conditional increase is without matter of right. He argued that time and currency have wrongly been defined as means of productivity as currency will become asset when it will be changed into, commodity and that it only represents value. He insisted on promoting “Ijtehad” in Islam which is an essential part of Shariah but it needs a big effort and brain storming. According tar him there are few aspects which were not properly addressed by the Federal Shariat Court and it is now the duty of the Supreme Court to take care of them while resolving the issue. Hr was of the view that existence of Western laws besides Islamic laws is creating problems.

 

 

 

Prof. Khurshid Ahmed of Jamate Islami who is heading Institute of Policy Studies and Islamic Foundation in UK appeared to state that Europe was considering the interest-free banking system, given by Islam as an alternative for a number of credit-related problems. He referred to a Drench Nobel Laureate who had given a new concept of banking system specializing only in three sectors, including banks accepting deposits, investment banks and banks for business purpose, whereby the credit problem created throughout the world could be overcome. He argued that it is the foremost duty of the Parliament to Islamize the existing financial system of the country; that the Governments in Pakistan lacked political will and neglected the work already done for the transformation of the existing banking transactions into interest-free system; that the plea of the Government against the Federal Shariat Court judgment to suggest alternative banking and financial system without usury was unconstitutional and by filing an application in the Federal Shariat Court for suggesting measures to implement its judgment, the Government did try to unload its burden: that the Council of Islamic Ideology and different institutions had done; a lot of work in this regard and the efforts by these institutions were appreciated abroad and many awards were given by the Islamic Banks to them but the Government was paying no heed to it; that Islam approved profit or kiss sharing on any investment for the purpose of production as it ensured growth, distribution of justice and stability, but the present interest-based economic system had only encouraged exploitation; that the IPS Chief insisted that the authority to create credits should be with the central bank and the Government only, and not with other banks and interest system had created a havoc in the world specially in the third world. He cited the example of Brazil and Pakistan. In 1985, according to him, Brazil’s total debt was $80 billion out of which it had already payed back $21 billion but still indebted to $221 billion and Pakistan, which owed a total foreign debt of $6 billion in 1978 and had paid $22 billion but still indebted to $35 billion. According to him 40 per cent. of the total loans in the world was non-performing and in Europe 97 per cent. money in circulation was the bank created money because of which rich had become richer while poor dipped to new lows. He also cited the example of 200 banks practising interest-free banking to 40 countries having assets of $600 billion with $80 billion of deposits and asset transaction of $200 billion. It was urged that 15 per cent. of Kuwait and 5 per cent. of Malaysia’s economy was based on interest-free banking; and that it was wrong to suggest that our economy would collapse if we adopt the interest-free system instead it would collapse if we fail to adopt the transition phase. As Pakistan is normally bound to honour the international commitments, he was, therefore, not in favour of cancelling the same. He was of the view that it would take a year to completely transform the domestic debt into the new system while two to three years in respect of international agreements. He suggested that we should endeavour for debt restructuring with the World Bank with open minds as the World Bank has already been dealing with 31 countries on debt restructuring because the loan giving agencies benefited 70 per cent. by the loans they advanced, while the countries which received loans benefited only to 30 per cent. Besides, these loans were also used for corruption purpose.

 

 

 

Prof, Nawab Haider Naqvi, an Economist, argued that we do need an Islamic economic system if only to end the current schizophrenic confusion between what we believe in and what we practise; that it is possible to construct an Islamic system, complete with its own ethical values, policy objectives and policy instruments, which alone can satisfactorily explain the economic and social behaviour of Muslims but it has to be kept in view that the Islamic system to be constructed will be as man-made as any other system and as such the task of translating the timeless, institution-free Divine ethical and economic principles into a workable economic system will have reference to specific time and applicable within the matrix of specific institutions and will have infirmities as it will be made by men/women themselves and naturally the end-product of these efforts will bear the mark of human imperfection. This necessitates the gradual approach ac Islamic economic system will emerge gradually out of a prolonged interaction between the Islamic ideal and the reality in the Muslim countries. Professor Naqvi argued that the two issues which arise before this Court are (i) equivalence of Riba and the bank interest in modern times and (ii) the optimal replacement of interest-based banking by profit based banking i.e. by a banking system raised on the principle of universal Profit and Loss Sharing (PLS), unsupported by any guaranteed return on bank deposits or bank advances. He added that both these questions are very difficult to answer as interest-free banking is a property of a fullfledged Islamic economic system but not of capitalism, where interest and profits are inter-linked like the Siamese twins and economic studies show that changes in the profit rates have been caused by changes in the interest rates, speculative trading, and in productivity. Separating the two would require nothing less than an intricate surgical operation upon the economic structure, of which the consequences are not known with certainty. He explained that once fixed rate of return instruments are altogether abolished in a capitalist economy, we do not know the outcome of such a step; so that the new profit-based system may as well take us nearer to, or farther from the Islamic ideal of Adl-o-Ihsan. He posed himself the question: “Does the PLS system offer a ready-made workable Islamic alternative to the modern-day banking interest?” His answer was that contrary to the widely held opinion which is also reflected in the impugned judgment, the PLS alternative alone does not necessarily guarantee an Islamically acceptable outcome in terms of its efficiency and equity. The theoretical reason in support of the answer that a negative outcome is more likely when profits are substituted for interest is the empirical evidence on the working of the Islamic Banks in the last 15 years or so. According to him a shift from the present interest-and-profit financial system to an all-profit financial system will, in general, lead to a worse equity outcome. It may increase, rather than decrease, the size of the perverse flow from the poor to the rich, even more than the present capitalist system does. He maintained that in the new system the risk averse savers/investors will be crowded out of the market unless, of course, they can anticipate with complete confidence that they will always get a higher reward in such a system which has a contradiction. So the reform of the banking system in the name of Islam may take us from one capitalist hell to an even hotter hell, and that too without interest. Professor Naqvi was also of the view that a system based on profits i.e. variable rate of return is not likely to be more efficient than the one based on interestcum-profits in view of the following prevailing circumstances:--

 

 

 

(i) In monopolistic/oligopolistic market structures, which also characterise Pakistan, profits impose an “excess burden” on the society in the form of lower production and higher product prices than would be the case in the textbook capitalist world of free and perfect competition.

 

 

 

(ii) The Islamic Banks will tend to under-invest in a large number of projects where social profitability is higher than private profitability i.e. public infrastructure. education and public health etc  for the reason that investment in them does not yield immediate and large profits. So, more investment will be made in high profit-yielding projects whose social profitability is very low or negative e.g. investment in wasteful luxuries. Such high-profit investments may not be sanctioned by Islam because they come in the category of Tabzeer.

 

 

 

(iii) The moral hazard problem i.e. when due to information asymmetry, the Mudharib cheats the Raul-mal is large in a banking system based on the PLS principle.

 

 

 

Professor Naqvi’ pointed out that without finding a reasonable solution of the fore-noted problems, the PLS-based system will neither be efficient nor equitable. Moreover. PLS system will not be preferred by the public unless perfect honesty prevails a condition which is observed more in the breach than in the observance in the real world and the situation where the investors almost never share true information about their profits with the banks, as is the case of Pakistan, a universal PLS banking would almost certainly face a complete break-down. Mr. Naqvi further stated that in the Survey conducted by Islamic Research and Training Institute of Islamic Development Bank, 29 major problems which are being faced by the Islamic Banks have been listed. The essence of these findings/problems are:----

 

 

 

(a) The rate of return offered by the Islamic Banks has been generally lower than the interest-based banks where they coexist with the interest-based banks; as well as in Pakistan, Iran and Sudan, where they have completely replaced the interest-based Banks.

 

 

 

(b) The loan defaults have increased dramatically since the introduction of the Islamic Banks which appears to be powerless in dealing with such cases as effectively as the interest-based Banks used to do and the size of the involuntary resource transfer from the poor to the rich is much bigger in a PL.S system than in an interest-based system.

 

 

 

(c) The incidence of the moral-hazard problem is pervasive. Indeed, it threatens the very fabric of Islamic Banking„ especially in Pakistan. In Iran, the banks have not been able to invest more than 3Rr% of their total assets after the introduction of Islamic Banking.

 

 

 

(d) Due to moral hazard phenomenon, the Islamic Banks have generally lavoured fixed rate of return type financial instruments like Murabaha and leasing. According to the i996 issue of “the Directory of Islamic Banks (Jeddah)”. the sale of lease based financing account for more than 80% of total financing of the Islamic Banks, and the PLS type financing represents only 20% . His conclusion was that notwithstanding the optimality of these modes from Shariah point of view, the PLS financing has not been preferred by the public and the banks so far.

 

 

 

(e) Heavy concentration of the Islamic Banks’ portfolios has made their asset structure highly unstable, as they cannot minimize their risks.

 

 

 

(f) The investment portfolios held by the Islamic Banks are typically loaded by trade-related activities. As of 1996, agriculture and manufacturing together accounted for only 26% of their lending activities. while 74 % was accounted for by Trading (31 % ). Services (13.12 % ), Real Estate (11.67 % ), and others (17.62 % ). Also, the investments made by the Islamic: Banks are of even shorter duration than is the case with the interest-based banks. The longer-term investments have generally suffered.

 

 

 

Professor Naqvi submitted that despite the fore-noted empirical evidence about the working of the Islamic Banks he is not claiming that the Islamic Banking should be scuttled as his point of view is that we should do everything feasible to improve its efficiency and equity, but it is important that undue haste is avoided in making it perfectly acceptable from an Islamic point of view. So, no precipitate steps should be taken to further Islamize the Islamic Banks until the relevant information on their actual working has been fully analysed and that it should be accepted that the PLS-based financial instruments, like Mudhariba and Musharika are totally inadequate to meet all the financial needs of a modern society and minimum element of fixity is essential for modern financial institutions, including the Islamic ones; and that the present mark-up and other sale-related instruments should be treated as essential aspects of Islamic Banks, at least for now. According to him these are presumably second-best options for the Islamic Banks to safeguard the depositor’s money in view of the widespread moral hazard problem, and to meet the borrower’s preferences. He argued that if as decreed in the impugned judgment, the mark-up system is abolished forthwith and replaced by the PLS principle, then it will seriously destabilise the banking system. Mr. Naqvi was of the opinion that the guiding principles of Islamic Banking should be---

 

 

 

(a) to safeguard the interests of the depositors as opposed to those of the borrowers of the loan able funds;

 

 

 

(b) to minimize the information cost of its operations by not relying excessively on the borrower’s honesty, which is a scarce resource in any society, but especially so in Pakistan;

 

 

 

(c) to do risk minimization and perform such essential functions as financial intermediation, increasing private saving etc.

 

 

 

On the question of indexation of public borrowing Professor Naqvi criticized the observation made in paragraph 42 of the impugned judgment that inflation did exist in the early Islamic period as prices rose by 15% during the period of Khulafa-e-Rashideen and Imam Yusuf. He pointed out that such an observation could not have been recorded had any Economist pointed out that 15% increase in the price level over a period of more than 100 years comes to less than 0.145 per cent. per annum, which is really a zero inflation rate. He referred to page 136 of his book titled “Islam, Economics, and Society” wherein the Scheme proposed to meet the problem is that the rate of indexation should be equal to the current or expected rate of inflation plus an amount equal to the increase in the Gross Domestic Product due to the contribution of capital. The results of the calculation on the basis of this formula are given in the following Table:------

 

 

 

“Table I

 

Calculation of Rate of Indexation (Return)

 

 

 

 

 

Year                 Inflation            GDP Growth                K Share in                    Rate of

 

                        Rate                 Rate                             GDP**                        Indexation

 

1990-91           12.66               5.57                             0.69                             16.50

 

1991-92           10.58               7.71.                            0.69                             15.90

 

1992-93           9.83                 2.27                             0.69                             11.40

 

1993-94           11.27               4.54                             0.69                             14.40

 

1994-95           13.02               5.24                             0.69                             16.63

 

1995-96           10.79               5.19                             0.69                             14.37

 

1996-97           11.8                 1.30                             0.69                             12.7

 

1997-98           7.81                 5.44                             0.69                             11.57

 

Averages          10.97               4.66                             0.69                 `           14.18

 

 

 

@Estimated by the World Bank

 

 

 

** Rate of Indexation = Inflation Rate + (GDP * K share in GDP)”

 

 

 

This Table shows:

 

 

 

(i) The rate of indexation does not necessarily increase with time alone so it is not true that the longer the period the higher the rate of indexation. It was pointed out that the rate of indexation would have been 16.50% in 1990/91 when the GDP and the inflation rate were higher, but only 11.57% in 1997-98 when both were lower.

 

 

 

(ii) The rate of return due to indexation is not pre-determined in any way nor can it be predicted with complete certainty.

 

 

 

(iii) The rate of indexation is related to the increase in the flow of goods and services in the economy.

 

 

 

So, the proposed indexation formula does not satisfy any of the features of Riba identified by the Fuqaha.

 

 

 

On the question of equivalence of interest and Riba, Mr. Naqvi maintained that in view of the clear Qur’anic injunction there is not much room left for intellection or debate if we accept that interest, including bank interest, is Riba but it can still be asserted, as it is his case, that Riba is not just interest, muchless only bank interest; but that it signifies all exploitative relationships which have the effect of transferring resources from the poor to the rich. He added that there may be an identification problem here because bank interest does not satisfy at least some of the basic criteria of Riba. Professor Naqvi though seemed reluctant to enter this controversy as to the meaning and scope of the term Riba but after dealing with the characteristics of Riba noted in paragraphs 94 and 113 of the impugned judgment which are-----

 

 

 

(i) the amount to be repaid in excess of the principal amount at the end of the contract period is fixed in advance in relation to time by the lender as an essential condition of the loan;

 

 

 

(ii) the amount so stipulated is risk-free;

 

 

 

(iii) it involves no uncertainty; and

 

 

 

(iv) it causes a net transfer of resources from the poor to the rich, which is considered as the raison de etre for the prohibition of Riba in Islam, made the following comments:----

 

 

 

(i) Contrary to popular conception, the interest rate need not always be fixed in advance and be risk-free. Such is the case only if the investor makes decisions under conditions of perfect certainty, which is seldom the case; but will not be so if uncertainty prevails, which is almost always the case. In the latter case, the interest rate will consist of a risk-free rate plus a risk premium, which will be variable depending on the degree of uncertainty at a given time and on the changes in it over a period of time. Indeed, Euro-dollar syndicated borrowing, which includes a tisk premium over the London Inter-Bank Offer Rate (LIBOR), is both variable and risky; which makes it worse than the borrowing done at a fixed rate, on a Government-to-Government basis.

 

 

 

(ii) Risk and uncertainty do not necessarily constitute an Islamically legitimate characteristic of interest in the meaning of Riba. Indeed, if these were desirable characteristics of an Islamic instrument then these would have to be maximized. But this is not the case, because Islam has declared gambling, betting, speculation as Haram (Just think of the State of Monaco and the city of Las Vegas shining examples of an Islamic economy).

 

 

 

(iii) While fixing of the rate of return in advance may attract Shariah’s prohibition, it is not generally true that bank interest causes a perverse transfer of resources from the poor to the rich. This is difficult to establish one way or the other; but whatever evidence exists shows that, because of an initial unequal distribution of income and wealth, both the profit and interest incomes accrue, more to the rich than to the middle and lower middle-income groups. More shall be given to those who have more! However, Table 2 makes clear that, relatively speaking, interest income is more important for the low income group than profit income; the reverse is the case for the high income group.