Friday, November 30, 2007

Islamic Banks : Another Destructive Tool

1. The above caption sounds odd but it is true and demands an explanation from IDB. Islamic Research and Training Institute–IRTI established in 1981 to undertake research and training for enabling the economic, financial and banking activities in Muslim countries to conform to shariah.

2. Rationale of Islamic banking: IRTI occasional paper no:2 holds “People need banking services. Now, since the banking services are needed but interest is prohibited, Islamic economies have to find alternative ways of performing various banking functions. This challenge provides the rationale of Islamic banking”. Thus Islamic banks must perform the following functions totally free of interest and the like:
(i) Financial intermediation between savers and fund users
(ii) Offer loans for genuine needs of all sectors of the economy and government without any service charge which is prohibited by Quraanic tennet: “you are entitled to your principal amounts.” Hadeeth qudsi declares “reward for qard is 18 times” implying that Islam wants vast use of loans. An article in Sept.2002 issue of ‘Islamic Economic Studies’ held “Dayn financing plays an important role in Islamic financial system”. Dayn includes both loan and debt.
(iii) Limit profit earning to genuine risk-taking financing modes avoiding risk-free fixed-return modes resembling interest.

3. Shortcomings and misdeeds of ‘Islamic Banks’:- Islamic banks avoid giving loans–the most needed primary banking service. They do not encash commercial papers and do not open letters of credit. They exploit Islamic sentiment of their clients and neither promote Islamic economic ideals nor do they contribute to economic development of Muslim countries. By transferring funds mobilized from Muslims to western financial markets they deprive Muslim countries of their due share in economic development. Their misdeeds and shortcomings as identified below render them unworthy of their name:-

(a) “The case of Islamic banking cannot be advanced unless a strong system of inter bank transactions based on Islamic principles is developed. The lack of such a system forces the Islamic banks to turn to conventional banks for their short term needs of liquidity which the conventional banks do not provide without either an open or camouflaged interest”-‘Introduction to Islamic Finance’ by M.Taqi Usmani chairman / member of a dozen Shariah advisory boards of ‘Islamic Banks’.
(b) “In order to effectively replace interest, the Islamic economy needs a comprehensive financing mechanism defined as a mechanism which provides monetary financial accommodation to enterprises but remains neutral with respect to their longer-run ownership structure”- IRTI Research Paper 29.
(c) “… some IBs hold temporarily idle balances whereas other IBs need these balances and both groups are unable to benefit from these funds due to the lack of short-term financial instruments” – IRTI Research Paper 41.
(d) “But what if the government needs cash (to pay salaries or buy services) and needs it now. The option available, so far, is borrowing from public or banking sector on interest. Almost all Islamic governments borrow on interest” – ‘IRTI Seminar Proceedings no 39’.
(e) “The modes of financing used by Islamic banks are dominated by fixed-return modes especially Murabahah… The profit sharing modes account for less than 14% financing. While Islamic banks and investment funds have so far mobilized huge financial resources, a large part of these resources have found its way into western financial markets. There is no Islamic (or for that matter, conventional indigenous) financial institution which has been able to channel savings from western countries into Muslim countries”-IRTI Occasional Paper no 2.
(f) “The asset side of Pakistan’s interest-free banks mirrors that of Islamic banks elsewhere. Approximately 80-90% of return-bearing assets have been devoted to trade related mark-up techniques with some participation in equity investment and musharika partnerships. The mark-up contracts used bear striking resemblance to interest-bearing trade credits”-‘Islamic Finance – Theory and Practice’ by Paul S. Mills and John R. Presley.
(g) “Islamic banking in practice is often very different from Islamic banking in theory. The majority of actual Islamic transactions involve disguised interest rather than genuine sharing of risk, profit and loss”. – ‘Islamic Banking and Finance’ by Andrew Cunningham.
(h) “Murabahah has become by far the most widely used Islamic financing instrument accounting for over 80% of Islamic financing. Some Shariah boards have questioned the extensive use of Murabaha in view of the limited risks involved to the financier and the similarity of the percentage mark-up to interest. Islamic finance is often approached from the perspective of the service provider rather than the needs of the client. The financial instruments have largely been developed from what is practicable and convenient for the bank… often it has been a case of adapting and modifying conventional instruments so that they can be seen to be Islamically legitimate” – ‘Islamic Finance’ by Rodney Wilson.
(j) “Mark-up does not, in essence, differ from the interest system”–IDB–IRTI Islamic Translation Series no 8. Pakistan Federal Shariat Court Judgment on interest (Riba).
(k) “Originally Murabahah is not a mode of financing. It is only a device to escape from interest and not an ideal instrument for carrying out the economic objectives of Islam”.–‘Introduction to Islamic Finance’ by M.Taqi Usmaini.
(l) “What is being done [in Murabahah] is a fictitious deal which ensures pre-determined profit to the bank without actually dealing in goods or sharing any real risk”–‘Elimination of interest’ by Prof. Khurshid Ahmad.
(m) In an interview published in ‘Arab News’ of 17 Jan. 2004 Prince Al-Waleed ibn Talal chairman of $20 billion worth Kingdom Holding company said: “My point is why do the profits of Islamic banks go down when world interest rates fall and their profits go up when the interest rates go up. In the light of my seven years experience as chairman of Saudi United Bank, I can tell you that there is no such thing as an Islamic bank”.

4. Claim of the advocates of Interest and their challenging questions: The misdeeds and shortcomings of Islamic banks cited above prompted advocates of interest in Pakistan to claim that interest- free banking is not feasible and that Islamic banking is heela banking. They also raised the following challenging questions about ‘Islamic Banks’:-

(i) Is there any single bank in the Islamic or non-Islamic world that is truly run on an interest-free basis?
(ii) Can a central bank conduct its monetary policy without a norm of interest?
(iii) Are not the practices of Islamic Banks a queer blend of interest-based modes of finance carrying a façade of Islamic names?
(iv) What are exactly the Islamic compliant instruments of finance? Can these instruments meet the myriad and diverse needs of modern trade, finance and banking?
(v) When and where have these instruments been applied and with what degree of success?
(vi) Does the Islamic Development Bank as the model Islamic bank operate on interest-free basis? If that is the case why did it offer to extend a loan to Government of Pakistan after nuclear detonation at an interest rate of 5% above LIBOR?
(vii) By what mechanism can Islamic banks undertake financial intermediation that is the primary function of all commercial banks throughout the world?

5. IDB President’s recognition of the necessity of resolving the problems faced by ‘Islamic Banks’: My personal request to IDB President during 4th International Conference on Islamic Economics and Banking held in UK in Aug.2000 for solving the problems faced by ‘Islamic Banks’ brought the following response in IDB letter of 2nd Oct. 2000 “Referring to the documents submitted to H.E The President of Islamic Development Bank (IDB) about your observation on the Islamic Banking movement, we appreciate very much your good efforts and insights. The Islamic Banks’ Office of IDB will try to do its best to communicate to the Islamic Banks the shortcomings that you had mentioned in your document”.

6. IRTI’s slack attitude towards resolving the problems faced by ‘Islamic Banks’: Since early 1999 I have been requesting IRTI officials to solve the problems faced by ‘Islamic Banks’ as they bring disrepute to Islamic banking and damage the cause of elimination of interest. I pleaded that TMCL is the comprehensive financing mechanism needed by Islamic economy for replacing interest effectively. I argued that use of TMCL as lending instrument would solve the problems faced by ‘Islamic Banks’, effectively replace interest and pave the way to economic co-operation among Muslim countries. They neither accepted my pleas nor found their own solution of the problems. They remained unmoved even by the plea that the problems remaining unresolved for years after identification were weakening the case for elimination of interest. My last fully substantiated plea to solve the problem by way of TMCL brought the following unreasoned responses’ from IRTI not mentioning any strategy or intention to solve the crucial problems:-

Chief, Islamic Banking & Finance Division:
“We have discussed the matter of Time Multiple Counter Loan on several occasions. We have different views about the scheme. While I respect your views, I do not subscribe to them. We have previously agreed that no productive result will come out of further discussions surrounding the scheme. I therefore, regret not being able to continue this discussion with you.

Director IRTI:
“I regret to inform you that presently IRTI is not in a position to hold any discussion meeting, symposium, seminar or conference on the subject of TMCL as suggested by you. Nevertheless I am thankful to you for the consideration you have shown to IRTI by thinking of us for this task”.

These responses signify the misfortune and decadence of Muslim Ummah. While others are conducting research on planets and space, premier financial Islamic Research Institute officials decline to explore the potential of an innovative financial instrument for replacing interest – the worst crime in Islamic jurisprudence!

7. Damage done by ‘Islamic Banks’ to the cause of elimination of interest: Due to the problems faced by ‘Islamic Banks’ remaining unresolved they continued functioning defectively. The claim of the advocates of interest remained unrefuted and their challenging questions remained unanswered. Consequently they succeeded in getting the Supreme Court Judgment of 23 Dec 99 ordering elimination of interest set aside on 24th June 2002.

8. Remedy for the damage done by ‘Islamic Banks’: Now the riba case is again with Federal Shariat Court of Pakistan for readjudication. Pro-interest lobby may win in that court also unless it is shown that interest-free banking is feasible. It is therefore incumbent upon Islamic economists specially Directors of IRTI, International Institute of Islamic Economics–Islamabad, Islamic Foundation–UK, Malaysian Institute of Economics and Research, General Council for Islamic Banks and Financial Institutions–Bahrain, Institute of Islamic Banking and Insurance–UK and Centre for Research in Islamic Economics–King AbdulAziz University–Jeddah, to devise, for presentation in the court, feasible interest-free banking plan that can satisfactorily refute the claim of the advocates of interest and answer their challenging questions. However, if they are unable to do so, then in fulfillment of their religious and professional duty, they must endorse TMCL plan for interest-free banking described in my book ‘Interest-free Banking’ available on website The novel idea of TMCL for replacing interest was the fruit of about 50 years’ intensive research by late Prof. Shaikh Mahmood Ahmad applauded in Supreme Court of Pakistan Judgment in Riba case as “our country’s most outstanding economist and researcher and a leading thinker... had devoted a considerable part of his life to the study of the theory of interest”.

Mr.Muhammad Akram Khan in his book ‘Islamic Banking in Pakistan–The Future Path’ says” The financial institutions have not explored the potential of TMCL --- the concept is loaded with infinite possibilities of application in interest-free finance”.

e-mail from Dr.Ismail Sirageldin (John Hopkins University USA):
“I find your suggestion for a TMCL system to replace the conventional interest based system and your elaboration on its mechanism and merits most stimulating and careful. Your paper and proposal goes a long way in elucidating the problems and the roads to perfecting an Islamic banking system that acts as an effective vehicle for sustained development while adhering to the Islamic ethical system. I congratulate you on that, but more essential, I congratulate you on starting free thinking dialogue in this important issue, a truly Islamic way to advance and exchange knowledge and development.

e-mail from Dr.Zubair Hassan (International Islamic University Kuala Lumpur):
“Personally I do find TMCL a sound instrument as replacement of interest, more so after reading your reply to clarify certain doubts”.

e-mail from Dr.M.Kabir Hassan (Deptt. Of Economics and Finance University of New Orleans USA–“Your proposal appears logical to me --- I will incorporate this idea in my recent work on ‘Innovations in Islamic Finance”.

All those who want Muslim Ummah to get rid of interest are requested to do what they can to strengthen the case of Islamists in Federal Shariat Court. Any suggestions as to what should be done in this connection will be gratefully received.
(By Abdul Wadood Khan who can be reached at,

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