27 Feb Islamic Banking System and Conventional Banking System
SOMALILAND has been standing on its own two feet for the last twenty years. And it is doing relatively well! On the whole, self-rule and self-reliance has brought on its wake
congruous determination, and engendered respect for the current, as well as, to the previous government. This awakening, I think, is based on innate political sassiness on the part of the ordinary man on the street, which, in turn, emanates from seminal degree of respect for the rule of law, or at least, the realisation that only with the safeguarding of peaceful coexistence between various sub-clans, Somaliland may achieve its highly sought after goal of self-determination, despite of all exogenous obstacles. This, in turn, led to a commendable level of political stability of a nation, unrecognised internationally. This stability has led to the tangible prosperity of this nascent nation, post Mohamed Siad Barre’s Somaliland.
It is as a result of such determination that, today, the Government and Parliamentarians of Somaliland are seeking to build a consensus amongst its public to maintain estimable regard for the principles of the rule of law, and to indoctrinate the people of Somaliland to give due respect to the constitution of this nation, and in this pursuit are promulgating laws which are hoped to secure their revolution, long-term. It is in this regard, now, that a committee is debating widely the promulgation of laws that shall regulate the financial/banking contractual obligations and specifically debating whether such transactions should be based on Islamic principles (i.e. a banking based on Islamic principles of finance), or ‘conventional’ principles (i.e. banking principles in which banks will charge interest) or a mixture of the two.
It is my opinion, that this nascent nation will be well advised to promulgate banking laws based on Islamic principles of finance; the nation, unsupported and unrecognized internationally, is at a unique juncture to do the ‘right thing’, without being faced with any undue pressures from the ‘outside’ world. This is a unique opportunity, not to be missed.
The Somaliland people are inherently biased towards the tenets of Sharia, generally. They have a natural affinity towards Islamic law and jurisdiction, and this predisposition is reflected in their unwavering adherence to Islam, whence nearly 100% of the people are Sunni Muslims.
It is, furthermore, my opinion, that the people of Somaliland will support a banking system based on Islamic principles, and will show total disdain for ‘conventional banking’, and will fail to support wholeheartedly any promulgated laws promoting a banking system based on ‘conventional’ methods.
On the other hand, banking systems based on Islamic principles of finance are showing to be resilient (against failure) and it is shown worldwide that the world’s banking systems, which are based predominately on ‘conventional’ principles, are seeking out remedies based on Islamic principles to counteract the failures of their banking systems, which led to global downturn – near a melt down and global recession. For example, banking transactions, predominately of the ‘conventional/usurious’ principles led to the Government of Dubai owing nearly US$101.5 Billion to usurious banks. And as President Barak Obama put it when commenting on the risks of dealing with an interest/conventional based financial systems, it in his speech (December 2011).
Now, for many years, credit cards and home equity loans [both based on Riba transactions] papered over this harsh reality. But in 2008, the house of cards collapsed. We all know the story by now: Mortgages sold to people who couldn’t afford them, or even sometimes understand them. Banks and investors allowed to keep packaging the risk and selling it off [sale of debt to a third party]. Huge bets — and huge bonuses — made with other people’s money on the line. Regulators who were supposed to warn us about the dangers of all this, but looked the other way or didn’t have the authority to look at all.
It was wrong. It combined the breathtaking greed of a few with irresponsibility all across the system. And it plunged our economy and the world into a crisis from which we’re still fighting to recover. It claimed the jobs and the homes and the basic security of millions of people — innocent, hardworking Americans who had met their responsibilities but were still left holding the bag.
The term usury, in western oriented terminology/usage, defines a transaction in which the lending of money is made at an exorbitant rate of interest. Exorbitant interest refers to an usurious financial transaction, where the lender demands from the one to whom the money (or its equivalent) is lent, an unusually high or large rate of interest, or an unconscionable or exorbitant rate/amount of interest in exchange for the lent money; specifically: an interest in excess of a legal rate charged to a borrower for the use of money.
One therefore need be clear about the circumstances under which the two terms (usury and interest) are employed interchangeably: therefore, although one may, for the purpose of writing this legal opinion use the term interest interchangeably with the term usury (and vice-versa), occasionally, the reader should be aware and forewarned that the two terms are inherently unlike one another when previewed by an Islamic oriented terminology/usage.
When used by a western researcher/practitioner, this may imply that the lending transaction is made at ‘an illegal rate of interest, an exorbitant rate of interest, which is not sanctioned by a governmental policies and which may, therefore, imply that it is charged by, for example, a loan shark, charging others an exorbitant rate because these people are unable to borrow from the legal conventional banking system which abide by an interest rate set by that state’s Central Bank. One should be cognizant of this fact: a western bank (or an interest based banking system (conventional banking), generally) will charge a specific set interest rate to its customers (this may vary subject to the type of transaction), but the rate will not be considered to usurious, because it is ‘legal’ and set in obeisance to governmental policies.
On the other hand, interest, of whatever magnitude is forbidden (haram) and not sanctioned Sharia (Islamic Law), and in fact, all such transactions in which the element of interest is present are considered to usurious.
Riba (Arabic: ربا, [rɪbæː]):
Islamic fiqh (with reference to Islamic economic jurisprudence, in our case) forbids literally any add-on (onto the original amount), or, in other words, the addition of interest to be compounded onto any transaction undertaken in gold for gold, silver for silver, or foodstuff for foodstuff in a business transactions. Such transactions become usurious, only, if in exchange for the lent gold the lender receives more than he lent to the borrower, and therefore, the aforementioned transaction, to avoid becoming usurious, has to be carried out measure for measure.
Therefore, it is self-explanatory, and only mentioned here for the sake of emphasis, that one cannot exchange X amount of gold (money) for X-plus amount of gold (money) in exchange for the time elapsed, during which a borrower had the gold (money) in his possession. This type of transaction is haram, because the add-on/interest (the ‘plus amount’) received by the lender on top of the original lent amount is called Riba.
In fact, for the sake of being precise, there are two types of riba discussed by Islamic jurists: an increase in capital without any services provided and risk taking, which is prohibited by the Qur’an, and that prohibited in the Sunnah which comprises commodity exchanges in unequal quantities (aforementioned). The definition of riba in classical Islamic jurisprudence was “surplus valuewithout counterpart.” When currencies of base metal were first introduced in the Islamic world, paying a debt in a higher number of units of this fiat money was not considered riba; jurists were concerned with the real value of money (determined by weight only) rather than its numericalvalue. For example, it was acceptable for a loan of 1000 gold dinars to be paid back as 1050 dinars of equal aggregate weight of gold (i.e., the value in terms of weight had to be same because all makes of coins did not carry exactly similar weight) – therefore having the same real value.
Furthermore, financial transactions, which are referred to as non-Islamic (‘conventional’) are characterised by an element of Gharar ( (غرر(uncertainty); whence any financial transactions that lacks defined parameters of certainty are also forbidden by fiqh. The Prophet has forbidden Gharartransactions: لايجوز بيع الغرر
Etymologically, the word Gharar means uncertainty: transactions where the parameters on which the contractual transaction is based are unclear or ambiguous is therefore referred to as Gharartransactions. There many different transactions which maybe classified as Gharar transactions, however, here are two examples, which are relevant to ‘conventional’ banking way of business:
Interest – Conventional Banking transactions where a depositor deposits certain
amount of money in a bank and then awaits the accumulation an increase on the deposited amount – i.e. the usual method of dealing of ‘conventional’ banking, which is based on Riba interest; and
1. Debt – The sale by the bank of debt owed to it by the debtor to a third party.
The Qur’an states:
“ يَا أَيُّهَا الَّذِينَ آمَنُواْ لاَ تَأْكُلُواْ الرِّبَا أَضْعَافًا مُّضَاعَفَةً وَاتَّقُواْ اللّهَ لَعَلَّكُمْ تُفْلِحُونَ ”
3:130 O you who have believed, do not consume usury, doubled and
multiplied, but fear Allah that you may be successful.
“ وَأَحَلَّ اللّهُ الْبَيْعَ وَحَرَّمَ الرِّبَا ”
2:275 Allah has permitted trade and as forbidden interest.
Evidentially, there is no difference of opinion between any of the schools of thought on the subject matter of the prohibition of Riba in Islamic Sharia.
Islamic Sharia considers Riba as a tool of oppression and a means to unjustly take others’ money by exploiting their needs and circumstances. Hence it forbids a Riba based system altogether and promotes Charity as an alternative. Therefore, Prophet Mohammad (PUBH) said: “God has judged that there shall be no riba” [Last Sermon]. The crimes of dealing in Riba are so serious that God has declared war against those who deal in Riba. Prophet Mohammad (PBUH) has cursed anyone who deals with Riba, the one who takes it, the one who pays it and the one who records it, as their sins are considered equal under the Quran. Riba is considered to be a greater sin, for Muslims, than that of eating pork or drinking alcohol. Prophet Mohammad (PBUH) had declared the practice of Riba worse than adultery: worse than “to a man committing adultery with his own mother”.
The concerned committee will need to have the courage and foresight to instill a banking regime based on Islamic financial law. It is my opinion, that such a move will be most beneficial to the people of Somaliland who, I opine, are most likely to receive this system and to use it for their financial business. It is will a wasted opportunity, if the committee fails to make use, after careful study, the advantages and stability, provided by Islamic finance and business, particularly as the millions who are in the diaspora have a firsthand experiences of ‘conventional’ banking which, fortunately, they are reluctant to use and those who utilise the system are obliged to do so for lack of the desirable alternative – Islamic Finance.
Islamic Banking and Finance:
TYPE 1: MUDARABA (TRUST FINANCE):
(Rab-ul-mal or A) provides the capital.
(Mudarib or B) manages the investment using his expertise.
Profit and loss:
Profit is determined separately and distributed by applying a pre-fixed sharing ratio.
Any loss is carried by A (Rab-ul-mal) unless B (Mudarib) was negligent.
All the assets are owned by A (Rab-ul-mal).
B (Mudarib) can buy out A (Rab-ul-mal).
Mudaraba can be ‘restricted’ or ‘un-restricted’.
TYPE 2: MOSHARAKA (PARTNERSHIP FINANCE):
– All parties provide ‘Capital’ towards the ‘financing’ of the investment.
– The ‘profit’ is shared on a pre-arranged ratio.
– The ‘loss’ is shared on the exact proportion to the ‘capital’ invested by each party.
– All ‘parties’ participate in the management of the investment BUT not necessarily required to do so.
Bank (non-active Mosharik) invests 100,000 in a company established by A (active Mosharik) in a pharmaceutical company, where A invests 100 and manages the company.
Profit and Loss:
Profit is determined separately and distributed by applying a pre-fixed sharing ratio.
Loss is shared according to a pre-fixed ratio.
An extra-amount can be paid to the investor Bank to reduce its holding shares in the company.
TYPE 3: MORABAHA ( Cost-Plus Financing):
A (Financier) buys a factory on behalf of B, for in a ‘COST-PLUS’ agreement.
B (the buyer) agrees to purchase the factory from A (the investor) in one of two ways: (a) immediate payment or (b) a deferred payment.
The ‘mark-up’ is a means of ‘rewarding’ the bank for:
ü Seeking out the factory at best price.
ü Locating the factory at best price.
ü Purchasing the factory at best price.
The ‘mark-up’ does not relate to time – it does not increase with the passing of time and remains as pre-arranged.
The investor Bank owns the ‘property’ between the completions of the two sales and assumes all risk.
TYPE 4: IJAR ( LEASING):
Ijar is defined as sale of Manafa’a (i.e. sale of right to utilize the goods for a specific period.)
It is similar to a conventional ‘lease’.
‘Ijar’ is a contract under which a Bank (Lessor) buys and leases out an asset or equipment required by its client A (lessee) for a ‘rental’ fee.
Lessor assumes ownership right.
Lessor can intermittently re-negotiate the value of the rental to ensure the rental charge is in line with its equivalent mark value.
TYPE 5: SALAM (ADVANCE PURCHASE):
This type of finance usually refers to a finance contract of ‘Agricultural Products’. It involves forward purchase of specified goods for ‘full’ forward payment.
A forward sale is for property, the delivery of which is deferred, against a price payable immediately.
ISTISNA’A (COMMISSIONED MANUFACTURE):
Scenario: Banks finance Construction and Manufacturing Projects under this type of financing.
A (investor) buys goods from B
B undertakes to manufacture the goods according to pre-agreed specifications for a profit.
QUARD-HASSAN (INTEREST-FREE LOAN):
ü Security maybe taken
ü Nominal ‘Administration Fee’ maybe applied – this cannot be made proportional to the ‘amount lent’ or the ‘term’ of the ‘loan’.
TAKAFUL (MUTUAL INSURANCE) /INSLAMIC BANKING INSURANCE:
‘ Takaful’ is a method of creating a pool of payments contributed by a group of participants making up ‘an agreed sum’ which is put in turn into a ‘common fund’ that will be managed according to Sharia.
ISLAMIC INSTRUMENTS FOR PRIMARY MARKETS
COMPANIES FOR COMMON SHARES