Banking has evolved as an integral part of economics since long. Of late, correspondingly, Islamic banking has also occupied its position in Islamic economics. Now-a-days many academic curricula contain Islamic banking as an alternative to conventional or traditional banking. But when it comes to the genesis of banking and that of Islamic banking, one would admit that conventional banking has got much longer history and passed through many more phases of evolution than Islamic banking. As evident from history as well as different texts of economics, 'interest' had been a very important issue therein. Interest existed in economics, as return against capital, one of the factors of production. And banking is an industry basically based on interest.
On the other hand, interest is prohibited in Islam and hence Islam has always suggested an economy free from interest. In the economic theorem of Islam, there had been no space for interest and therefore no banking module was dreamed or visualised in Islamic economics. As the idea of banking was conceived on the very philosophy of interest, it (banking) can never be claimed to have belonged to Islam or the Islamic society. Banking is rather absolutely a creation of conventional economics.
As such the idea of prevelance of banking in the early days of Islam does not arise at all. But different business modules (of Islamic economics) were available at that time. Some of those modules were subsequently adopted in Islamic banking as well. That was done for the sake of avoiding interest of modern banking. Those modes were in the use of the ancient Islamic society, as different forms or modules of practical business, trade and mercantile or commercial ventures. Even Prophet Muhammed (SM) himself was also engaged in some of such businesses. This incident has subsequently been confused or mingled with various ideas. Thus the establishment of a just and balanced social order, exploitation- and poverty-free welfare society, attaining sustainable economic growth and other such virtues are integrated as objective or mission of Islamic banking. Practically, all these are nothing but the dreams of Islamic economics.
In fact, the right way to look for the origin or background of Islamic banking is to have a peep into the genesis of 'banking in general'. Primarily banking was merely a process of lending and borrowing of money. Perhaps the process originated in the hands of goldsmiths, merchants and Mahajans or any such affluent class of the society. Through evolution, it attained the institutional shape to bridge between the lender and borrower. Banking as of today is nothing but a corporatised, refined and extended shape of that intermediary function. However, at present, banking also encompasses many other ancillary services. Those services were adopted therein subsequently according to the demand of the day which was felt in phases.
In terms of corporate form of a banking institution, as we understand today, Islamic banking had never been a visible parallel organisation to conventional banking until, say the latter half of the last century. Then it became imperative to study the circumstances which led to the emergence of Islamic banking as a separate discipline. In doing this job, we reminisce those religious people who used to mark their erstwhile Bank Accounts with a noting of 'No-interest'. Many people were rather beyond the purview of banking channel for long to save themselves from falling into the religious curse. Banking and Islam were then treated mutually exclusive. Adopting one of them automatically rejected the other. At that time the two words Bank and Interest were synonymous.
In course of time, banking emerged as a very important activity of human civilization. At a point of time, it became simply absurd to remain associated with the economic wheel of the modern global village without taking part in banking. Such an emerged importance on banking activities made that pious group change their earlier view towards banking. They made up their mind not to stick to remain away or aloof from the purview of banking. They thought it better to get associated with the global finance industry; but obviously not at the cost of religion.
Consequently, in the realm of banking, 'interest' was diagnosed, and particularly targeted as the vital issue to address. Very rightly the scholars recognised that there remains no room for interest in (Islamic) economics, where banking prominently belongs to. Prohibition of interest in Islamic life then turned their concentration. 'Not to bank' was then revised as a move to 'Bank with religion' or 'Bank without interest'.
As the prime source of income of a bank is 'interest,' and interest arises from loan/lending and borrowing, loan transactions of conventional banking were identified first. Those transactions must be avoided as the way of earning in religious banking. It was perceived that loan or 'qard' might exist therein, only as an exceptional, non-business and non-earning benevolent transaction. But at large lending system was required to be replaced by any other permissible mechanism. Other subsequently extended ancillary functions and non-funded business activities of modern banks appeared in the second scene. These were regarded as non-prime issues, because interest as a direct element, was absent from most of those ancillary services.
Again, banking has emerged as a business. Now, to save a target group from interest-income, banking must not be transformed into a non-business charitable organisation. Interest-free banking must not mean cost-free, income-free banking. Banking is to remain a business or commercial organisation; but that business must be based on Islamic fundamentals. Every business must also have an expectation for a permissible return therefrom. Then the question comes, in Islamic banking business, what return we may expect, instead of interest. Very logically 'profit' has come as the first solution to replace interest. That idea opened the door of threadbare discussion and analysis which resulted in transparent differentiation between Interest (Riba) and Profit.
Interest in the Quranic language is 'Riba'. It is an Arabic word. Its literal meaning is excess, addition or increase etc. As a religious jargon Riba denotes an excess or addition related to loan. Riba, in English is called Interest. Interest is defined as a charge on borrowed money and its purview covers simple interest, compound interest and exorbitant interest or Usury as well. Interest implies a predetermined positiveness or mandatory increase from a deal in money.
On the other hand, 'Profit' is an English word. Profit means an advantage or benefit, financial gain or an excess of returns over outlay. Profit is the money gained in business or from selling something for more than its original cost and/or 'an excess of income over expenses'. Prominent dictionaries like Oxford and Chambers also define 'profit' in the same terms.
A deal exclusively in money, known as a financial transaction, is not enough to result in a profit. There must be a real transaction or an underlying asset related to that deal to enable the deal as an earning tool which may generate profit. When the concept of profit enters into the realm of business it gets the shape of an equation. The equation is 'Profit = Revenue minus Cost'. Thus a profit may possess any sign. Negative profit, if any, is termed as loss. So, profit is the result or outcome of a venture, business or trade etc. Outcome of a business is usually expected in the positive form of profit; but both way i.e. positive or negative (loss) is practical.
So unlike interest, profit does not originate from the money itself. Profit originates from a venture where money is used as a factor of production. Here money gets the form of capital/investment and bears the expectation of reward (profit) and at the same time the risk of incurring loss as well. Profit results from equity sharing and/or trade and hence permitted by Shariah but interest is not. The Quranic verse is '…And Allah has permitted trade and forbidden interest …' (Sura Baqara: 275)
After portraying a concrete demarcation between interest and profit, it was made clear that it would be possible to simultaneously remain with banking and religion. This expectation initiated collective drive to replace interest by profit. The drive suggested turning the loan transactions of conventional banks into equity sharing ventures to earn profit therefrom instead of interest. Therefore, in banking, loan form of transaction got the shape of flow of money as capital/equity. It became a partnership between the religious bank and its client/s. Conceptually Islamic banking became a value-based and ethically guided financial operation.
Achievement of the drive for Islamic banking primarily lies in washing out or gradually abolishing 'interest' in the realm of alternative banking. Interest-free banking is typically called Islamic banking. Yes, to be a true Islamic bank, it needs to possess other qualities, but the most essential criterion is to be free from interest.
Under the alternative banking system, as share of bank's income, the depositor is to get variable return instead of fixed interest. Similarly on the asset side, financial transactions of loans are also converted into capital or equity finance to share income between the bank and the client. However, on the asset side there were other permissible ways to finance. One such way is to make real transactions like trade, instead of loan or debt transactions. Each of these transactions has got specific modus operandi adopted from the respective discipline of Islamic Economics. There was customisation of the features while practising those in the banking arena because those were in fact hired or adopted from other fields. Concerned rules, therefore, followed their respective original discipline of business or trade of Islamic Economics. Renting leasable assets through Lease and/or hire-purchase was, in principle, found permissible in Shariah.
As already stated, initially Islamic banking was a project to make 'banking sans interest' possible; not to make it superior or competitive even. Alternative modes were adopted just to avoid interest. Out of such alternatives as stated above, the asset-based real transactions and profit/loss sharing features of Islamic banking transactions, have by this time been adjudged as better than those of the corresponding models in its conventional counterpart. Equity finance (partnering or profit sharing method) of Islamic banking transparently shows the difference and the inherent beauty of Islamic banking. Such a mode vividly distinguishes Islamic banking by way of its yielding variable return as opposed to the predetermined fixed rate of interest in conventional banking.
In the backdrop of global financial meltdown since 2007 we have already experienced the comparative resilience of conventional banking and Islamic style of banking worldwide, as commented even by the Vatican. Final fate of Islamic banking depends to a great extent on the quality of the people who are entrusted with the responsibility to implement the system. Islamic banking demands strict adherence to the rule of 'principle to override or prevail over practice'. It is the Islamic banking players who deserve credit for fair play as well as discredit for infringement.
If this equity sharing concept of Islamic Economics can be properly applied with legal support, it can turn around the greatest odd consequence of conventional banking. It can bring about a new paradigm of justice and equity in the society. It would change the irony of (banking) fate or the fallacy which is very surprising. The surprise of traditional banking is that it makes the deficit unit (borrowers) owner of the assets, businesses, mill-industries and what not; whereas the surplus unit or owner of fund (depositors) remains assetless. What a peculiar equation! Asset should belong to the owners of the fund which has made the concerned business or asset comes into existence and keeps it running. Here shareholding of joint stock companies can be cited as an example.
The writer is Vice President and Head of Islamic Banking of Bank Asia Limited. Opinion expressed in the article are of the writer and not necessarily of the organisation he is serving.
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