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

 

 

 

It should not be difficult to restructure our present banking system into a mixed banking system, which our banks are already to some extent, to perform the dual work of commercial banks making both long-term and short-term financing to the industries, commerce and agriculture but also to serve holding companies establishing their own commercial enterprises, industrial concerns and agricultural projects. Their role should not, therefore, be confined to the supplying of money for short-term requirement of trade and commerce. Traditionally, the commercial banks have been refraining from supplying long-term credit to industries. This trend has been prevalent in Britain from where it influenced our bankers. On the other hand, in some countries of Central Europe, particularly in Germany, the commercial banks have reportedly contributed in a substantial way to the industrial development by providing. long-term finances to industries. The experience of this mixed banking system is that they have quite successfully promoted the industrialization of their respective countries and have also provided initial capital to the newly started industries. It may be pointed out here that the factors which had led to the development of mixed banking in Germany are also found in our country. It was the scarcity of capital, the reluctance of the foreign investors and the absence of suitable entrepreneurs and such other reasons which led the commercial banks in Germany to develop the concept of mixed banking and to closely collaborate with the local needs in the interest of country’s rapid industrial development. The shortage of capital was mostly because of the downfall in the savings which was, in turn, due to the absence of mobilization and motivation. This situation was remedied by the mixed banking system which provided capital to industries not only by providing long-term finances but also by floating debentures of joint stock companies. This made the banks active partners in the economic development of the country and promoted big industrial projects. Some banks provide help to German industries by underwriting their equity and debenture issues and also by granting them advances in anticipation of such issues in future. Expert financial advice and consultancy was also provided by the banks to big industrial projects about the issues related to the investment market. In some cases where large amounts of liquidity were available with the banks they invested them in long-term industries credit and earned high dividends. The role of the State Bank of Pakistan would become pivotal in controlling and streamlining the process of funding and financing short-term and long-term projects. It has to be ensured that capital resources are not blocked in such long-term finances which do not yield sufficient dividend or in sick industries under political pressure which is, unfortunately, riot uncommon in our country. If such situations are not avoided the loss in major industrial concerns is bound to affect the performance of the banks.

 

 

 

An important function performed by the State Bank in relation to commercial banks is the authority to control credit and thereby to regulate the working of the banks and flow of capital. The main purpose of credit control is to ensure the stabilization of exchange rate and to maintain the stability of the national currency in relation to foreign exchange. In the past when the currency was on the gold standard there was little fluctuation in the value of the currency and it was easy to retain the fluctuation with the narrowest possible limits. But with the abolition of gold standard the fluctuation in exchange rates has become a major problem which has to be dealt with at the central level by the State Bank. Different techniques are adopted in different countries to control the credit and the flow of capital. These techniques and policies are considered to be unavoidable in the modern complex economic organization. Generally, it is the interest rate and the safety regulations or prudential directions of the State Bank which are considered to be effective tools used by the State Bank to exercise influence to control bank credit and money supply. There are a number of instruments used by the State Bank to control the credit and the bank rate or the interest rate. The most important of these, which have a direct relevance to the abolition of interest include open market operation, rationing the credit, minimum statutory cash reserve ratio, regulations to control consumers credit and margin requirements. Of these, two need fuller discussion, namely, the bank rate and the open market operations.

 

 

 

Open market operations have now become the most important instrument of credit control. Previously, it was bank rate which was considered to be the primary tool of exercising control over the credit flow. It seems that the role of bank rate in controlling the credit and streamlining the flow of liquidity in the money market will continue to be marginalized in future and the role of open market operations will continue to expand in various directions and different dimensions. This is because of the fact that the world is moving towards a direction which may ultimately lead to either total abolition of interest or to reduce it to a minimum rate. This tendency is visible in some leading economies of the modern world wherein the interest rate is continuously on the decrease. It is now mostly through the open market operations that the State Bank exercises its control. It withdraws funds from the market primarily either by borrowings from the market or by selling its securities, assets and documents. The bank sells consolidated Government’s stocks for cash and repurchases them on a deferred payment till the date fixed for the monthly settlement of the stock exchange. In this manner it withdraws cash from the market temporarily for the unexpired period of monthly account. Borrowing of the bank include borrowing from discount houses and bill-brokers against the pledge or mortgage of Government securities, this also helps reducing the available volume of funds in the market and thus the market rate stands controlled to the extent of banks operations. The increased popularity and the rising importance of the open market operations is indicative of the fact that the policy of bank rate or discount rate has not been successful in controlling the credit and streamlining the cash flow in the market. The sale or purchase of securities and other instruments available in the market by the State Bank is not objectionable in itself from the Islamic point of view. Rather, it is something which contributes to the proper and balanced functioning of the money market in the country. As long as these operations are done keeping in view the independent interplay of market forces and avoiding involvement in Riba; positively or negatively, these operations are allowed subject to observations made above.

 

 

 

Moreover Council of Islamic Ideology has warned time and again that interest-free banking cannot be successfully operative unless a total change does not take place in the society. There is no denying the fact that elimination of interest is only a part of the overall socio-economic system of Islam and, to quote from the report of the Council of Islamic Ideology, this major change alone cannot transform the entire system in accordance with the Islamic vision, as simultaneously with the introduction of interest (free Banking System strenuous efforts shall have to be made on a wide front to inculcate in the society, basic virtues such as fear of Allah, honesty, trustworthiness, sense of duty and patriotism. There are wide range of steps to be taken by all concerned for the realization of this objective, namely, the establishment of socio-economic ideal of Islam. These steps shall have to be taken jointly by the individuals, the business community, the banks, the industrialists, the tax collectors and the Government in power. Unless the entire machinery and the Government and the entire business life is geared with full dedication in this direction, the curse of Riba cannot be eliminated. The challenge is undoubtedly colossal and the task is tremendous and it requires a serious and dedicated efforts.

 

 

 

At this stage, we propose to discuss the apprehension expressed and the objections raised by western capitalists to the effect that an interest-free economic system would face difficulties and is bound to meet failure, The most important objection raised is that mobilization of resources will be possible with the elimination of Riba to generate resources at an optimum level. The basis of the apprehension is the belief that capital is a factor of production in itself. Therefore, it must have a price and should perform the functions of a price, namely, it should control and regulate the allocation of loanable funds to different users keeping in view the ability of the respective user or users to pay the price. This argument presupposes that the loanable funds are scarce and the number of users is unlimited and the relationship between them should be regulated by law of demand and supply and that the interest rate should be adjusted as a result of operations of these forces. Those who advance this argument presume that the loanable funds will be available to the users totally free in the absence of interest and that this free availability of loans would encourage unlimited number of borrowers to make their demand for funds and that in the absence of any available mechanism for balancing the demand and supply, the situation will lead to a chaos. They also presume that the interest-based system has been proved to be a faultless and just mechanism to allocate the resources optimally, an assumption whose fakeness and baselessness is too obvious to need any arguments. The upholders of this point of view either forget or do not take into consideration that the legitimate profit calculated on the basis of the actual success and productivity of an enterprise actually performs function of allocation of resources successfully, efficiently and justly. The assumption that funds will be available free is also based on non-recognition of the role and functions the genuine profit will perform in the national economy. In an interest-free system the allocation of funds shall be regulated by the share in the profit which will, for practical purposes, be the ‘cost’ of funds. It means that rate of profit and the viability of the project will be the deciding factor not only for the allocation of resources but also for performing of functions of balancing between demand and supply. The enterprise and the users showing greater dividend or anticipating greater rate of profit will receive larger funds. It will be the actual combination of the market and the performance in terms of profit and dividend that will decide the fate of a business and its entitlement to receive further funds. The banks and the financiers will ensure that their funds are invested in such enterprises and business whose success has highest expectancy. No financier will be ready to invest in a project without careful evaluation and due vigilance. The door of getting money in the name of inefficient and unproductive projects will be closed, This is because a lender in an interest-based system does not share any risk in the business he finances. The entire risk is shifted to the entrepreneur while the finance is guaranteed not only the safe return of the principal amount but also a pre-determined rate of interest. In the present system the financier has no concern about the legitimate outcome and fate of the business. When a financier in an Islamic framework would know that not only his principal amount is at risk but also his profit is dependent on the success of the enterprise he is bound to undertake as thorough an evaluation as possible. For this purpose either the banks and non-banking financial institutions may themselves create expert advisory cells or may establish consultancy consortium to get such requests and feasibility reports examined. As soon as the system starts working and takes of, consultancy firms will come into existence to help the financier examine and decide the viability of an enterprise or a business.

 

 

 

The assumption that interest has served as an effective and efficient mechanism for the allocation of resources is a weak assumption. Without going into experience of other countries, even a cursory glance over the history of the performance of our own banks is sufficient to steal away the carpet from beneath this argument. Almost all the experts who appeared before us have produced detailed evidence supported with facts and figures to show that present system has failed to ensure a just and equitable distribution of resources which may be considered to be equitable and just at any standard.

 

 

 

In the book Towards A Just Monetary System, Dr. Muhammad Umar Chapra quoted the views of western experts who have found compelling evidence to conclude that in the United States the existing capital stock is misallocated - probably seriously - among sectors of the economy and types of capital. Such allocation of resources can take place only in a dream world of perfectly competitive equilibrium models the market economies have theoretically formalized. On the authority of another leading western expert Dr. Chapra establishes inadequancy of the capitalist models for proper allocation of resources. He quotes yet another western authority who says that the money rate of interest does not rule the roost and feels that the rate of interest is irrevocable to investment decision and should be replaced by the price of existing equipment (or share price).

 

 

 

Other scholars have also thrown light on the question of the so-called equilibrium in the rate of interest which is only something theoretical and bookish. Such a rate does not exist in the actual market. Moreover, the determination of the equilibrium rate is such a complicated and complex exercise that it is very difficult to effectively observe it, if any body wants to. The real deciding factor in the market is neither equilibrium nor equity It is, rather, creditworthiness of a borrower which is the main consideration for the release of credit. This is so obvious in favour of the rich and against the poor that hardly needs any explanation. The richer the person more creditworthy he would be. The more creditworthy a borrower the lower the rate of interest. The lower the rate of interest, the greater the borrower is beneficiary. That is why the biggest businessmen in the country always manage to get larger chunks of funds at lower prices because of their highest creditworthiness. This results in a situation where the richest borrower has the less burden and the poorest, if ever allowed in the club of privilege of borrower, bears the highest burden. This makes the whole business atmosphere extremely and increasingly unfriendly to a small and even medium businessmen and the country is deprived of their contribution an profitability which may be more as compared to the so-called creditworth; entrepreneur. In this entire game, honesty and integrity of a person, viability of a project, feasibility of a scheme, needs of the country, requirements of justice, all are relegated to the background and carry no weight in the scale of creditworthiness. The financier is always prone to release his funds to secure rather than productive hands. According to Dr. Muhammad Anas Zarqa, this state of affair is the logical outcome of an interest-based financing, only because it does not share the risk of the business. Thus he naturally feels inclined to lend his money to the richer in order to ensure that the payment of the principal amount along with the interest without incurring any risk. But if he is made to share the risk he would be more concerned about the viability and profitability of the business, in which case the borrower will be on the same footings as rich to try a chance. Now, it has been widely acknowledged by the western experts that the interest-based system ensures greater flow of credit to the rich.

 

 

 

The upshot of the discussion is that the interest-based credit system is by nature and definition a handicap in the establishment of the distributive justice initiated by Islam. It has failed to give any objective criterion for credit rating. Its criterion is totally biased in favour of the tiny rich minority of the society. Even in the leading economies of the western world, system has provided constant impetus to big businesses which have grown bigger and bigger; but in return, have created invincible monopolies which control both the borrower and the money in the country. The whole economic and political life becomes a hostage in the hands of the few. The entire nation finds itself at the mercy of the few who dictate their policies for their own benefits and to the determinant of the common man. Small businessmen constituting the overwhelming majority of country’s business life never get anything from the lenders, both from banks and non-banks financial institutions. Even if some small businessmen manage to get loans they are constantly looked with suspicions and indignation on any sign of trouble and difficulty, loans given to them are recalled adding to and accelerating their problems. On the other hand, big businessmen are allowed default after default under the honourable title of rescheduling.

 

 

 

Moreover, in an Islamic system the share of the financier is always linked with the profit and success of the entrepreneur. The higher the success and profit the greater the share of the financier and vice versa. Thus, contrary to the interest-based capitalist system, if the profit of a business is bigger it should pay higher return both to the financiers as well as the entrepreneur. According to the teaching, policy and spirit of Islam, the resources allocated should not only be more effectively utilized but also be equitably distributed.           

 

 

 

Another objection that savings and capital formation in the private sector will come down in an interest-free economy and the erosion of purchasing borrower of money as a result of inflation will further reduce the savings. This objection is based on the traditional western concept that interest motivates savings and the abolition of interest is bound -to reduce savings. On a closer examination this objection seems to be baseless, if not, totally ill-founded. There is abundant empirical evidence collected both by western and Muslim scholars that there is no relationship between savings and interest. If we take the example of our own country we find that almost 80% of the savings in our banks have been deposited by lower middle class who do not put their money in the banks for sake of any return but for security. Even those who want to invest their money in return-yielding sources do not deposit them in commercial banks. They rather deposit them in such investment schemes which offer greater returns such as Defence Savings Scheme etc. The large scale investment in finance companies established in mid 80’s in Karachi and Lahore is inductive of the fact that banks are not the proper place for yielding the profits, at least in the perception of the overwhelming number of savers. A number of western scholars have discussed the relationship between interest and savings and have come to the conclusion that the impact of the interest rates on savings is extremely negligible. However, it does not mean that in Islam savers, small or big, should not expect any return on their savings. .If the savers find the required friendly atmosphere in small business they will invest in small businesses and will look for more and more profitable finance for investment of their savings to offset the erosive effect of inflation and meet any future uncertainty and the need of a rainy day in future.

 

 

 

Another objection often raised in pathetic term is the future of such savers who are not in a position to organize businesses for themselves or to participate in any active business enterprise or commercial activity. Retired Government servants, widows and orphans and the disabled who have no option except to invest money as sleeping partners must have to receive regular income by investment in some profit-yielding enterprises. Undoubtedly, such sleeping partners should have avenues for investment, and participation in any partnership or equity. It is also necessary that the savings available with such people should be as less risky as possible. We shall discuss the possible options later. The scope for sleeping investors is wide enough under Shariah to accommodate their special needs keeping in view their special situation. There are modes of investment with varying degrees of risk, maturity and amount of finance involved which may be of use for such investors. Once the interest is abolished and Islamic economy sets in motion there will be a host of instruments of various modalities to satisfy the needs of different investors in terms of level of risk arid the amount and scope of liquidity. Moreover, the concern expressed by the upholders of the problems of the old, the widows and the orphans is based on the presumption that Islamic State does not have any responsibility for this section of the society. They are not left at the mercy of their own fate in any Islamic framework. The State is under an obligation to create a fund in the Baitul Mal, far or less on the patron of Benevolent Fund, where the contribution of these people of the society are invested along with contribution of the public exchequer which may be bigger or smaller or equal according to the resources of the country. This fund which will keep on increasing with the passage of time will be an amount of trust, the proceeds of which will be regularly paid to those who can invest and also to those who cannot, of course, with varying degrees keeping in view the amount and the resources available. But one should not forget that the attitude of the Baitul Mal is not to create a class of parasites who sit ideally at home only to receive monthly pension or stipend from the public exchequer. Such facility is available only to those who are not in a position to earn because of their physical or other incapacity. For such people the Baitul Mal should have exclusive fund from Zakat and other contributions both from the Government as well as the public which should be invested exclusively to meet the needs. The Zakat fund may also be separately invested in suitable enterprises which may become the sole property of such deserving people. The Islamic emphasis on partnership and equity will generate funds and encourage people to save for investment in their own business. The experience of smaller businessmen in our market is indicative of the success of this fund. There are hundreds of thousands of investors and, self-employers who save for the investment for their own businesses are operating in an informal and non-corporate business. In fact, a large chunk of informal business in the country is already, by and large, interest-free. The rapid success of small traders and business in our market is indicative of the fact that it is not interest but elimination of interest which provides real impetus to economic success. Another objection, rather apprehension is that the abolition of interest will lead to an instability in the system that the equity-based market will not be able to bring stability in the system. This apprehension is not based on any empirical study. Rather, it is the interest which has been one of the important destabilizing factors in the capitalist economies.

 

 

 

Now we propose to deal with borrowing by the Government and the effect of the borrowing on economy of the country and steps needed to be taken for interest-free economy. The note submitted by Mr.Muhammad Ashraf Janjua, Chief Economic Adviser, State Bank of Pakistan shows that the Government of Pakistan is the biggest borrower as it is continuously borrowing to finance its fiscal deficit. As of 5th May, 1999 its total domestic borrowing stood at Rs.1258 billion from the following