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As
mentioned earlier, Islam does not deny
that capital, as a factor of production,
deserves to be rewarded. Islam allows
the owners of capital a share in a
surplus which is uncertain. To put it
differently, investors in the Islamic
order have no right to demand a fixed
rate of return. No one is entitled to
any addition to the principal sum if he
does not share in the risks involved.
The owner of capital (rabbul-mal) may
'invest' by allowing an entrepreneur
with ideas and expertise to use the
capital for productive purposes and he
may share the profits, if any, with the
entrepreneur- borrower (mudarib);
losses, if any, however, will be borne
wholly by the rabbul-mal. This mode of
financing, termed mudaraba in the
Islamic literature, was in practice even
in the pre-Qur'anic days and, according
to jurists, it was approved by the
Prophet.
Another
legitimate mode of financing recognized
in Islam is one based on equity
participation (musharaka) in which the
partners use their capital jointly to
generate a surplus. Profits or losses
will be shared between the partners
according to some agreed formula
depending on the equity ratio. Mudaraba
and musharaka constitute, at least in
principle if not in practice, the twin
pillars of Islamic banking. The
musharaka principle is invoked in the
equity structure of Islamic banks and is
similar to the modern concepts of
partnership and joint stock ownership.
In so far as the depositors are
concerned, an Islamic bank acts as a
mudarib which manages the funds of the
depositors to generate profits subject
to the rules of mudaraba as outlined
above. The bank may in turn use the
depositors' funds on a mudaraba basis in
addition to other lawful modes of
financing. In other words, the bank
operates a two-tier mudaraba system in
which it acts both as the mudarib on the
saving side of the equation and as the
rabbul-mal on the investment portfolio
side. The bank may also enter into
musharaka contracts with the users of
the funds, sharing profits and losses,
as mentioned above. At the deposit end
of the scale, Islamic banks normally
operate three broad categories of
account, mainly current, savings, and
investment accounts. The current
account, as in the case of conventional
banks, gives no return to the
depositors. It is essentially a
safe-keeping (al-wadiah) arrangement
between the depositors and the bank,
which allows the depositors to withdraw
their money at any time and permits the
bank to use the depositors' money. As in
the case of conventional banks, cheque
books are issued to the current account
deposit holders and the Islamic banks
provide the broad range of payment
facilities - clearing mechanisms, bank
drafts, bills of exchange, travellers
cheques, etc. (but not yet, it seems,
credit cards or bank cards). More often
than not, no service charges are made by
the banks in this regard.
The
savings account is also operated 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 to 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. The investment
account is based on the mudaraba
principle, and 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.4 In theory, the rate
of return could be positive or negative,
but in practice the returns have always
been positive and quite comparable to
rates conventional banks offer on their
term deposits.5
At
the investment portfolio end of the
scale, Islamic banks employ a variety of
instruments. The mudaraba and musharaka
modes, referred to earlier, are
supposedly the main conduits for the
outflow of funds from the banks. In
practice, however, Islamic banks have
shown a strong preference for other
modes which are less risky. The most
commonly used mode of financing seems to
be the 'mark-up' device which is termed
murabaha. In a murabaha transaction, the
bank finances the purchase of a good or
asset by buying it on behalf of its
client and adding a mark-up before
re-selling it to the client on a
'cost-plus' basis. It may appear at
first glance that the mark-up is just
another term for interest as charged by
conventional banks, interest thus being
admitted through the back door. What
makes the murabaha transaction
Islamically legitimate is that the bank
first acquires the asset and in the
process it assumes certain risks between
purchase and resale. The bank takes
responsibility for the good before it is
safely delivered to the client. The
services rendered by the Islamic bank
are therefore regarded as quite
different from those of a conventional
bank which simply lends money to the
client to buy the good.
Islamic
banks have also been resorting to
purchase and resale of properties on a
deferred payment basis, which is termed
bai' muajjal. 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.
Leasing
or ijara is also frequently practised by
Islamic banks. Under this mode, the
banks would buy the equipment or
machinery and lease it out to their
clients who may opt to buy the items
eventually, in which case the monthly
payments will consist of two components,
i.e., rental for the use of the
equipment and instalment towards the
purchase price.
Reference
must also be made to pre-paid purchase
of goods, which is termed bai'salam, as
a means used by Islamic banks to finance
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 the bank at a
price determined in advance. Islamic
banks, in keeping with modern times,
have extended this facility to
manufactures as well.
It
is clear from the above sketch that
Islamic banking goes beyond the pure
financing activities of conventional
banks. Islamic banks engage in equity
financing and trade financing. By its
very nature, Islamic banking is a risky
business compared with conventional
banking, for risk-sharing forms the very
basis of all Islamic financial
transactions. To minimize risks,
however, Islamic banks have taken pains
to distribute the eggs over many baskets
and have established reserve funds out
of past profits which they can fall back
on in the event of any major loss.
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