|
Articles & News
Islamic
Financial System
INTRODUCTION
Islamic finance is an old concept but a very young discipline in
the academic sense. It lacks the required extent and level of
theories and models needed for expansion and implementation of
the framework provided by Islam. In these circumstances,
unawareness and confusion exist as to the form of the Islamic
financial system and instruments.
The main difference between the present economic system and the
Islamic economic system is that the later is based on keeping in
view certain social objectives for the benefit of human beings
and society. Islam, through its various principles, guides human
life and ensures free enterprise and trade. That is the reason
why the conventional banker does not have to be concerned with
the moral implications of the business venture for which money
is lent.
Socio-economic justice is central to the Islamic way of life.
Every religion has the same basic aim. In an Islamic
environment, an individual not only lives for himself, but his
scope of activities and responsibilities extend beyond himself
to the welfare and interests of society at large. The Qur'an is
very precise and clear on this issue. There are basically three
components of an Islamic economic paradigm:
That as viceregent, man should seek the bouties of the land that
God has bestowed on humanity. From the wealth thus obtained, he
should enjoy his own share.
That he should be magnanimous to others and use a part of the
wealth so obtained also for the benefit of his fellow-beings.
That his actions should not be wilfully damaging to his
fellow-beings.
Human society in Islam is based upon the validity of law, of
life and the validity of mankind. All these are natural
corollaries of the faith. Islamic laws promote the welfare of
people by safeguarding their faith, life, intellect, property
and their posterity. God nurtures, nourishes, sustains, develops
and leads humanity towards perfection. Even though an individual
may be making a living because of his efforts, he is not the
only one contributing towards that living. There are a number of
divine inputs into this effort and therefore, the results of
such an effort obviously cannot be construed as entirely
proprietary.
Whereas the Islamic banker has a much greater responsibility.
This leads us to a very fundamental concept of the Islamic
financial system i.e. the relation of investors to the
institution is that of partners whereas that of conventional
banking is that of creditor-investor.
The Islamic financial system is based on equity whereas the
conventional banking system is loan based. Islam is not against
the earning of money. In fact, Islam prohibits earning of money
through unfair trading practices and other activities that are
socially harmful in one way or another. [ 1 ]
Those who swallow down usury cannot arise except as one whom
Shaitan has prostrated by (his) touch does rise. That is because
they say, trading is only like usury; and Allah has allowed
trading and forbidden usury. To whomsoever then the admonition
has come from his Lord, then he desists, he shall have what has
already passed, and his affair is in the hands of Allah; and
whoever returns (to it) - these are the inmates of the fire;
they shall abide in it [Sura 2:275].
Not that there was any ambiguity in the Command of Allah. Far be
it from Him to give any order to His Servants, which they can
not comprehend. The fact is that those who had surplus money and
wanted to earn profit did so either by lending it through riba
(usury) or by investing it in trade and hypocrites were not
prepared to forgo the first option. Hence, they argued that
since both were means of earning profit, they were alike and the
prohibition of riba did not stand to reason.
The practice of riba i.e. usury was so deep-rooted in society
and continuance of the practice was so undesirable, that Allah
warned the believers that if they did not desist, they should be
prepared for a war against Allah and His Apostle. This warning
was heeded by the Muslim Ummah and for more than a thousand
years the economies of Muslim states were free from riba. With
the ascendancy of Western influence and its suzerainty over
Muslim states, the position changed and an interest-based
economy became acceptable. Efforts in Muslim countries to revert
to an interest-free economy were hampered by many obstacles. [ 2
]
The Role of Money
The traditional definition of the time value of money leads one
to assume that profit maximisation is the objective of investors
irrespective of whether or not the earning of profit has made
someone else worse off. Some economists have termed the
maximisation of profit as the sole objective of corporations.
This view cannot be supported or defended since the profit
maximisation process may lead to perverse outcomes. When
financial operations are removed of moralistic tone, competitive
markets fail to achieve the efficient allocation of a country's
resources.
In Islam money in itself is not considered, as actual capital
only exists when money, along with other resources, is sunk into
productive activities. Linking the use of money to productive
purposes invariably brings into action the factor of labour, a
process from which benefits pass on to society.
Types of Islamic Financial Instruments
Demand for monetary instruments is influenced by the variation
and level in the market rate what is meant as the market rate of
return. The demand for household monetary instruments is mainly
for the purpose of circulation of income. Banks need these
instruments for:
transaction purposes;
precautionary purposes, in that some unexpected payments have to
be made while some expected inflows may not be forthcoming on
their due date, and;
not only to avoid loss but also to obtain gains in the capital
value of financial assets under the expectation that the market
rate of return may move in a certain direction.
What differentiates a traditional financial market from others
markets is that no tangible good or service is exchanged for any
monetary consideration; only a "financial claim" changes hands
in the form of a promissory note or a title to any future flow
of income adjusted for any capital appreciation. Not all Islamic
instruments are purely financial claims. Some of the instruments
also represent ownership of the underlying assets together with
a claim to underlying cash flows. Basically there are the
following four types of Islamic financial instruments:
Type "A" is a financial claim of monetary value with recourse to
underlying durable assets and related cash flows. This type has
a predictable future income stream, is marketable and can be
discounted since with the changing of hands, the instrument
passes title to the goods and not to the debt. It is basically
lease-based.
This instrument is partly backed by durable assets and its
income is not predictable, but evaluated through an asset
valuation process at the end of an agreed and declared duration.
The underlying transactions can be a mix of ijara, modaraba,
musharaka etc., contracts. This Type may be traded in the
secondary market at its fair market price acceptable to the
parties involved but not discounted.
Type "C" is purely a monetary claim to an expected income stream
forthcoming from underlying commercial transactions. Income is
evaluated through an asset-valuation process at the end of an
agreed and declared period. A transaction of this type may
comprise morabaha, istasna etc., contracts which are debt claims
against third parties in respect to actual commercial
transactions. The Type may be traded at its face value declared
at the end of each accounting period but cannot be discounted.
The Type "D" is purely a financial claim of monetary value but
with recourse to certain precious metals such as gold, silver,
platinum, etc., or commodities quoted on exchanges. The
instrument entitles the holder to take delivery of the
underlying asset but does not carry any attached revenue stream
except that its price is pegged to the price of the underlying
precious metal or commodity quoted at recognised international
exchange rates. It can be traded but not discounted. [ 3 ]
[Table of Contents ]
Risk Mitigating Features
The phenomenon of risk plays a pervasive role in economic life.
Without it, financial and capital markets would consist of the
exchange of a single instrument each period, the communications
industry would cease to exist in so far as this market is
concerned and the profession of investment banking would be
reduced to that of accounting. Risk is further segregated from
uncertainty. A situation is said to involve risk if the
randomness facing an economic agent can be expressed in terms of
specific numerical probabilities (these probabilities may either
be objectively specified, as with lottery tickets or else
reflect the individual's own subjective beliefs). Situations
where the agent cannot (or does not) assign actual probabilities
to alternative possible occurrences are said to involve
uncertainty.
While it is not always true that a riskier asset will pay a
higher average rate of return, it is usually return. Risk is an
opportunity in financial markets and also a problem. Risk-averse
investors require additional return to be at additional risk
and, in effect, in a competitive market higher return is
accompanied by higher risk. An investor evaluates an asset in
terms of its marginal contribution to his/her portfolio.
The fundamental principal of valuation is that the value of any
financial asset is the present value of the cash expected. The
process requires two steps:
estimating the cash flow, and;
determining the appropriate interest rate that should be used to
calculate the present value.
The
following are the Shari'ah compliant risk mitigating features:
By prior arrangements in the instrument, the investing company,
through its banker, would have a priori right in profit sharing
up to an agreed upon ratio.
The profit will be paid on account on a monthly basis to the
investing company as provided in the projected accounts.
The final accounting and settlement is accomplished at the end
of the term of the instrument when the profit and loss accounts
are finalised.
In order to mitigate the risk and as per the terms of the
instrument, a Takaful fund is established for the term of the
instrument.
In this Takaful fund where the investee company earmarks a part
of their reserves for the Takaful fund.
The investing company will contribute 1% of the invested amount.
This 1% contribution is made through an advance by the investee
company on account of future profits.
In case of any loss during the tenancy of the instrument, it
will be adjusted against the Takaful fund.
The balance will be distributed between investor and the at the
end of the term of instrument.
Through a valuation, value of the investment would be
established for the purpose of exercising the put option.
The investing company shall have the option to exercise its put
option at the value price and the company shall buy this
instrument. [ 4 ]
Islamic Leasing
But before describing leasing, as aforesaid, let me very briefly
touch upon two of the basic or fundamental principles of Islamic
finance in order to develop a premise for meaningful discussions
on leasing.
It has to be asset-based financing:
The first fundamental principle of Shari'ah is that as opposed
to conventional monetary dealing, profit is generated when
something having intrinsic utility is sold or offered for use.
Money has no intrinsic value. As such dealing in money (same
currency) cannot generate profit but a Riba unless converted
into real assets to deal with.
There has to be an element of risk:
The second basic element of Shari'ah is that one cannot claim a
profit or fee for a property/transaction, the risk of which was
never borne by him.
Based on the above fundamental principles, the most ideal mode
or instrument of financing in Shari'ah are Musharaka and
Modarabah followed by Salam and Istinsa.
Morabaha and leasing are not originally modes of finance.
However, to meet certain specific needs where ideal modes like
Musharaka or Mudaraba are not workable for whatever reasons,
they have been reshaped and allowed in Shari'ah subject to
certain conditions.
Leasing described For leasing, IJARAH is an Arabic term with
origins in Islamic Fiqah, meaning to give something to rent.
There are two types of Ijarah. One relates to employing or
hiring the services of a person for wages whereas the second
type relates to the hiring of any asset or property in order to
reap its benefits without the transfer of ownership, or what is
called in English "Usufrukt". The price or consideration of this
is the rent.
It is the second type of Ijarah which is the subject matter of
the discussion here because it is generally used as a form of
investment and also as a means of finance.
As described earlier, in the light of the two basic cornerstones
of Shari'ah, leasing is a contract whereby usufruct rights to an
asset are transferred by the owner, known as the lessor, to
another person, known as the lessee, at an agreed-upon price
called the rent, and for an agreed-upon period of time called
the term of lease.
Lease as a mode of financing Strictly speaking leasing is not a
means of finance as originally envisaged. It is simply a
transaction much as a sale/purchase. As described above, the
leasing transaction simply denotes the transfer of the usufruct
of a property from one person to another for an agreed-upon
price called rent without transferring the corpus i.e. ownership
of that asset. Accordingly, the rules of "leasing" closely
resemble the rules governing "sale" because in both cases
something is transferred to second person for valuable
consideration.
Leasing differs from sale only in-so-much-as not transferring
the corpus or ownership of the property which remains with the
transferor. As such in Shari'ah, a lease transaction is governed
by a separate set of rules, which we shall outline in the
following paragraphs.
Although leasing, as originally conceived, is not a means of
finance, the financial institutions and the corporate world have
adopted it as such. Due to several factors (including tax
concessions, etc.), instead of providing an interest-bearing
loan, certain financial institutions in the West started to
provide requisite equipment to their customers. To arrive at the
rent, the total cost of the asset is calculated plus interest or
mark-up to be recovered during the period of lease on a monthly
or quarterly basis. This type of lease in the West is known as a
finance lease, to be distinguished from an operating lease,
wherein various basic features of the leasing transaction are
ignored which is tantamount to Riba.
Knowing that leasing is lawfully allowed under Sharia'h, since
it meets one of the basic criteria of asset-based finance, a
number of Islamic financial institutions have adopted leasing on
this model as carried out by conventional financial institutions
without making the necessary modifications that really conform
to the rules under Sharia'h, particularly in regards to assuming
the risk of ownership in the leased asset. Great care needs to
be exercised to ensure various Sharia'h requirements, as
rendered below, based on the basic two principles of:
Asset based finance, and;
Assuming a risk element connected to the ownership of the asset.
Basic Rules of Leasing
The description or definition given above, under part A,
contains the following essential ingredients for outlining the
basic rules under Shari'ah:
That it is a contractual obligation.
That there has to be a valuable use of the asset and
transferability of that usufruct.
That the ownership of the asset is retained by the transferor or
lessor throughout the lease period. Consumable articles cannot
be leased.
That the risk and liabilities of ownership lie with the lessor.
The leased asset shall remain the risk of the lessor throughout
the lease period. Any loss or harm caused by factors beyond the
control of the lessee shall be borne by the lessor. However, the
lessee is liable to compensate the lessor for any harm to the
leased asset caused by any misuse or negligence on the part of
the lessee.
That the risk and liabilities associated with the use of the
asset shall be borne by the lessee. For instance, taxes and
other government levies, utilities, etc. However, the contract
must specify these items for clarity's sake.
That the term of the lease, period of the lease, its renewal or
early termination must be stipulated.
Purpose of use. The lessee cannot use the leased assets other
than for the purpose specified in the contract or agreed to by
the lessor expressly.
Commencement of lease. The lease commences from the date of
delivery of the asset to the lessee and not from the day of
payment or lease agreement, with reference to the commencement
of rentals.
Determination of rental. The rent for the entire period of the
lease must be determined at the time of the contract. Different
rates of rent for different phases during the lease period are
permissible. This point will be elaborated in the following
discussion of the issues.
Issues
While operating a leasing business, a number of practical issues
have cropped up which warrant discussion and interpretation
under Sharia'h. An exhaustive and conclusive list of such issues
is impossible to make. However, certain important and salient
issues need to be taken up in these discussions as follows:
Joint ownership (Lessors)/Joint Lessees - (permissible)
Insurance - Islamic Takaful - (by the owner)
Renewal of or variation in the lease period - (permissible if
mutually agreed-upon)
Future date. Agreement to commence lease on some future date is
allowed. However, the rent has to commence from the date of
delivery. If the lessee has paid the price and delivery of the
asset is delayed by the supplier, then no rent is liable to be
paid for the period of delay. It must be noted that future or
forward sale in sale/purchase transaction is not permissible in
Sharia'h. This is another major point after ownership transfer
which differentiates leasing from a sale/purchase transaction
under Sharia'h.
Acquisition of an asset by the lessee. For various reasons, the
asset subject to lease may be acquired by the lessee and payment
may be dibursed? through him by the lessor. This is permissible
under Sharia'h on the principles of agent and principal. Here
there are two relationships separate from and independent of one
and other. The first relationship is that before becoming a
lessee, an individual acts as an agent for and behalf of the
lessor to acquire the asset. This is an independent arrangement.
Once the asset has been acquired with all the risk and reward of
ownership to the lessor, then a second relationship is created
i.e. the lessor and the lessee under the lease agreement. That
cost of acquisition shall be borne by the lessor being owner and
not by the lessee.
Rentals.
Advance rentals are admissible subject to the condition of
adjustment against the actual rental when due upon commencement
of the lease as discussed before.
Unilateral increase by the lessor is not permissible even if
stipulated in the contract.
Bench marks. The fixing of any bench mark for determining the
amount of rent, as with an inflation index etc., is permissible
provided that the lease agreement clearly stipulates the same
e.g. if the inflation rate as declared by an authoritative body
like the State Bank etc. is said to be 10% per annum, then the
rent can be increased every year by that percentage.
Penalty for late payment of rentals. Penalty or compensation for
late payment is not permissible. Rentals once due become a debt
obligation or monetary asset which cannot generate profit under
Sharia'h. This situation has been exploited by unscrupulous
lessees. In such circumstances, contemporary scholars have
provided a solution whereby a penalty can be charged to the
lessee for delayed payment though the amount recovered is only
to be used for charitable purposes by the lessor. In other
words, the late payment charges cannot be taken as income by the
lessor. A suitable clause, therefore, is to be incorporated into
the lease agreement to avoid any misunderstanding in this
regard.
Premature termination of lease. Premature termination of lease
is allowed provided that the lessee has violated or contravened
the terms of the lease or it is by mutual consent of the lessee
and the lessor. Any unilateral or unconditional termination of
the lease either by the lessor or the lessee without prior
notification is contrary to the principles of justice and
equity, hence not allowed under Sharia'h.
Repossession of an asset. In the event of early termination, or
upon maturity of the term of lease, assets have to return to the
lessor unless he voluntarily relinquishes his rights or makes a
gift of the leased assets to the lessee. However, rent would be
payable only upto the date of termination and not beyond.
Entitlement or the right of the lessor to claim rent from any
period after termination, even if expressly stipulated in the
contract, is not valid under Sharia'h.
Residual value. It is accepted under Sharia'h that ownership of
the asset belongs to the lessor and, therefore, assets should
revert back to him upon expiry of the lease. Any stipulation to
the contrary in the contract that the lessor can sell or
transfer the asset to the lessee upon the expiry of the term of
the lease at a pre-determined price called residual value is not
considered valid from the point of view of Sharia'h. However,
this point is currently a subject matter of debate among
contemporary scholars. They are of the view that if a lessor
unilaterally undertakes or promises to transfer the ownership to
the lessee as a gift or at a token price separate from the lease
agreement, then this can be considered validly binding on the
lessor at the option of the lessee.
What is imortant is that under Shari'ah the leasing and
sale/purchase transactions are two separate things and should
not be mixed up in one contract, as both are independent and
governed by separate rules. Nothing, however, in Sharia'h stops
the lessor from giving away the ownership of his assets at his
own discretion or good will toward the lessee at any mutually
agreed-upon price or as a gift upon the expiry of the leasing
contract.
Sale and lease back. This is allowed, but only as two separate
transactions. That in the first place there is a sale of assets
to be purchased by the lessor. This is governed by Sharia'h
rules of sale/purchase at a fair market value. Once the
ownership title is validly passed on to the lessee, a lease
transaction can then be executed separately through a lease
agreement.
Sub-lease. Sub-lease by the lessee is permissible under Shari'ah
subject to the consent of the lessor and can be expressly
outlined in the lease agreement. In Sharia'h, however, there are
divergent views if the rent arising from the sub-lease is higher
than the rent payable on the original lease. Some scholars allow
the differential to be retained by the lessee while others feel
that the surplus received from the sub-lease should be passed on
to the owner i.e. main lessor.
Assigning of the lease. Also permissible under Shari'ah, the
lessor can sell the leased assets to a third party along with
his rights and obligations. The relationship between lessor and
lessee in this case will be determined between the new owner and
the lessee. However, the lessor cannot assign the lease without
transferring the ownership for monetary consideration. Here the
basic Sharia'h cornerstone of asset-back transaction is not
there. Rent receivable are debt obligation which cannot
therefore be transacted for a monetary price. Assignment of
lease rentals without monetary consideration is, however, not
prohibited in Shari'ah.
Securing of the lease. Leased assets can be secured along the
same principles governing the assignment i.e. ownership of
assets along with the rent. Rent alone without ownership of the
assets cannot be secured for the reason of being a debt
obligation as discussed before. Securing a lease can be made
wholly or partly to one party or to a number of persons.
Documentation has to be carefully prepared to ensure the
securing instrument represents assets and not the debt or
monetary obligation alone. [ 5 ]
Some Difficulties (Pakistan)
Major hurdles faced by Islamic finance houses are the absence of
a necessary legal framework and the lack of adequate
infrastructure in the banking and investment fields. [ 6 ]
The modern banking system is based on the concept that money
should be treated like any other factor of production and must
earn some return over a period of time. It is argued that the
establishment of large-scale enterprises, and hence material
progress, is not possible unless there is an agency that can
mobilise financial resources from the public by paying them some
interest, while lending these resources to entrepreneurs. By
charging these entrepreneurs a higher interest, these agancies
were able to utilise the difference (called a spread) to meet
their expenses and to make some profit for the owners of the
agency ( i.e. share-holders). Banks were established to fulfil
this need and from the beginning were only authorised to perform
this function. They were legally prohibited from entering into
trade or industry. When the Government of Pakistan decided to
introduce an interest-free banking system, this prohibition was
removed. After a lot of in-house the banks were told in June
1984 that they were allowed to deal in only 1 to 12 means of
financing (only two were classified as "Financing by Lending").
These two permitted lending without interest by charging the
actual expense incurred by the banks to meet their cost of
operation and Qarde Hasana. All the rest were either
trade-related or investment-type models. These included the
purchase of goods by banks and their sale to clients at an
appropriate mark-up price on a deferred payment basis, in case
of default there being no further mark-up. This sale of goods on
mark-up is known as Murabiha. Other types of financing were
hire-purchase, leasing, Musharika or profit- and-loss-sharing,
equity participation and purchase of shares, etc.
Since Murabiha was the type nearest to lending and since it did
not requre any expertise in buying and selling commodities,
bankers limited most of their financing to this type. In order
to eliminate the risk of prospective buyers refusing to accept
goods purchased by the banks by reason of not being strictly in
accordance with the specifications, banks were allowed to
appoint the prospective buyer as their agent for the purchase of
the goods and later for the sale of the goods to the buyer's
firm. Furthermore, to give as much leeway to the banks, as
safeguards of public money, as possible, the Ulama did not fixe
a waiting period between the two stages of buying and selling.
The banks did not assume the role of trader and Morabiha
degenerated into lending on mark-up. The banks rarely hired
persons who knew even the basics of trading, nor did they train
their existing staff to learn the art. They did not even bother
to find out whether their agents had actually purchased the
goods or not. The inability, or reluctance of banks and
financial institutions to change over their operations from
lending to trading has been a serious impediment to the
Islamisation of the economy.
The blame does not entirely fall on the bankers. Depositors have
become so accustomed to their money remaining safe and yet
earning profit that if a bank had really ventured to trade and
incurred a slight loss, then the depositors would have
immediately demanded their money back causing the bank to go
bankrupt. In the existing state of morality this was more likely
to happen. It actually did happen to a few investment companies
that had started with good intention, but could not go on giving
away handsome profits to their depositors.
A lack of seriousness and dedication in those responsible for
the implementation was also another great impediment to the
achievement the goal of an interest-free economy. Many of these
individuals thought that in the present world, there was no
alternative to interest, yet something had to be done because of
demands from the government. Some, who were more influenced by
Western education and culture, thought that interest banking was
not prohibited by Islam. Yet others thought that the efforts
being made were only superficial and in reality the new system
was no different from the existing system.
One weakness in the implementation of the proposals to eliminate
interest from the system was that people were not sufficiently
motivated to sacrifice a part of their financial interests for
the sake of carrying out the commands of Allah (SWT), and The
Prophet (SAW). Anyone attempting to change a well-established
practice must be prepared to make some sacrifice for this, as
arguably no noble cause has been achieved without any sacrifice.
The prevailing level of public morality within the existing
legal and taxation system of the state made it an up-hill
struggle to rid the banking system of interest. And it remains
so. Beyond this, there are many avenues of making profit that
would have to be forgone and many types of modern banking
services which which also could not be provided by a bank
working strictly on Islamic principles. For example, they could
not keep their surplus cash in fixed or saving deposits. In
spite of these difficulties, those who were engaged in the task
of Islamisation took it upon themselves to portray as successful
the reforms, while those who pointed out the difficulties were
labelled as either a cynic or an opponent of the new system.
Anyone who uttered a word of caution was regarded as someone who
did not want the experiment of Islamisation to succeed. As a
matter of fact, reward in the Hereafter (aakhirat) should have
been the main purpose of Islamisation. It might not have
attracted many people, but the foundation would have been firm.
One great obstacle in the realisation of the goal of an
interest-free economy has been absence of a proper environment.
Unfortunately nothing has been done to produce an ideal or a
near ideal Islamic environment by government or public leaders.
The most important pre-requisite for the enforcement of Sharia'h
is a'dl [translation!!!!!!]. Establishment of the rule of law
and ensuring justice to aggrieved persons should be the first
task of an Islamic state, yet nothing has been done to achieve
this end.
One very important requirement of an ideal evironment is an
inflation-free economy. Inflation erodes the real value of
money, meaning that when a person gives a sum of money on loan
and receives the same amount back after one year, he has made a
net loss. A major source of inflation is deficit financing. The
printing of notes to meet budgetary deficit is in fact an
injustice to the public, since the real value of their money is
consequently eroded. In this respect too, the government's
performance is very discouraging. Government borrowings at high
interest rates and the quantum of the government's domestic and
foregn debts has reached a level which cannot be sustained.
There has also been no effort to change the taxation structure
so as to bring it to conform with Shari'ah. [ 7 ]
Musharika
Musharika represents the most desirable form of Islamic
financing arrangements. Yet, in terms of its ability to be an
effective and efficient instrument for replacing interest-based
transactions, it poses formidable problems.
The salient features of the Musharika agreement, as practised by
the commercial banks, were as follows:
It was a short-term financing arrangement specific only to the
parties to the contract.
Investment by the banks was made in the form of the sanctioning
of a funding limit to the client and the degree of employment of
funds was determined on the basis of daily product of
outstanding balances due to the bank.
All participative funds, including equity, reserves and other
non-debt capital was included in the definition of capital
qualifying for profits.
Profit sharing ratio was determined through negotiations within
the boundaries specified by the SBP.
Profits for the purpose of sharing were to be determined after
apportioning a share of net-income as a management fee to the
firm.
Provisional profits, based on projected profits, were to be paid
to the bank on quarterly basis, subject to a final adjustment on
the basis of actual profits or losses.
Shortfalls or excess profits were to be settled through the
creation of a [participation] reserve fund, which would attempt
to smooth out the payments to the bank.
Losses, if any, were to be shared in strict proportion to the
bank's investment in the total capital of the firm.
Against the apportioned loss of the bank, ordinary shares were
to be issued, which qalified for reconversion in Musharika
investment under the original terms of the agreement in case
profits accrued in future.
Standard securities in the form of pledging and hypothecation
stocks or the mortgaging of properties were required against
Musharika financing.
Some of these features of the instrument attracted criticism.
For example, the profit sharing arrangement did not strictly
conform to the requirements of Sharia'h particularly in the
treatment of losses and the payment of provisional profits or
their adjustment through the participation reserve. Secondly,
despite being a sharing arrangement, the actual agreement was
cast within the framework of a creditor-debtor relationship, and
was also protected as such in law. Three, Musharika also
demanded securities which were akin to the relationship between
a creditor and debtor. Finally, in the absence of a legal
framework regulating the operation of Musharika, there was no
standardisation of the agreement, and the terms and conditions
of various agreements varied considerably.
Modaraba
Modaraba represents another of the more desirable forms of
Islamic financing arrangements.
The salient features of Modaraba companies and their operations
are as follows:
Only registered companies or those established under specific
laws are eligible to register as Modaraba companies.
Modaraba can either be specific purpose or multi-purpose and can
either be for a fixed term or in perpetuity.
On fulfilment of certain conditions, and with the prior approval
of the Registrar, Modaraba companies may float Modarabas on the
stock exchange, and their certificates of issue will be tradable
securities.
Each Modaraba will be a separate business and its operations
must conform to those approved under the injunctions of Sharia'h.
A Religious Board, to be periodically constituted under the
ordinance, will be empowered to declare whether the operations
of Modaraba were in conformity with the provisions of Sharia'h
or not.
Many disclosure requirements, similar to those applicable to
listed companies, are applicable to Modarabas, including
statutory audit, annual meetings and investments and loans to
and from the directors of the Modaraba company.
Evidently, the entire scheme was an elegant formulation of the
simple relationship required under a modaraba contract between
labour (darib) and capital (rabbul ma'l). The management company
was to be renumerated through a fixed management fee paid out of
the net income of the modaraba and the remainder was to go to
modaraba certificate holders, with adequate provisions for
retained earnings to ensure future growth.
CONCLUSIONS
To outline the broad features of a strategy which holds the
promise of successfully implementing an Islamic system of
finance are as follows:-
The process has to be guided by basic legislative efforts
covering all the essential elements of the proposed programme.
The legislation would define Riba and prohibit transactions
connected with Riba.
The application of the law would be unqualified and without
exception, thus the entire financial sector, covering banking
government finance and foreign transactions would be covered in
its ambit.
Given the unqualified and non-exceptional nature of the proposed
law, even existing relations will have to be converted into
permissible forms, for which a suitable time frame, within a
phasing-in period, will be allowed.
The law should also provide for the Constitution of a Sharia'h
Board which would assist the SBP to formulate permissible means
of financing. Such means, specified with the prior approval of
the Board, will only be illustrative and no restrictions will be
placed on banks and financial institutions to design means of
financing which are free of Riba.
A major portion of the law will have to be devoted to a plan of
restructuring the fiscal policy which comprises a scheme for the
privatisation of public sector assets and the use of its
proceeds for the settlement of the outstanding stock of public
debt.
The proposed strategy is based on the clear recognition of the
scope implied by the prohibition of Riba. This is critical, for
otherwise the solution will continue to elude us. [ 8 ]
BIBLIOGRAPHY
[ 1 ] Lahkani, Mohammad Yasin. Development of Secondary Market
for Islamic Instruments / Conference on Islamic Corporate
Finance "Shari'ah Based Solutions", November 21th-22th, 1998,
Karachi.
[ 2 ] Ashraf , S.M.A. Impediments in Islamisation of Economy /
Conference...
[ 3 ] Pervaiz, Imtiaz Aymad. Securitisation in Islamic Corporate
Finance / Conference...
[ 4 ] Saleem, Ahsan M. Short Term Islamic Corporate Financing: A
case study / Conference...
[ 5 ] Rahi A.W. Lease Financing in Islamic Corporate Finance /
Conference...
[ 6 ] Lahkani, Mohammad Yasin. Development...
[ 7 ] Ashraf, S.M.A. Impediments...
[ 8 ] Masood, Waqar. Islamization of Financial Sector: Role &
Perfomance of Islamic Financial Institutions Operating in
Pakistan / Conference...
Written By Ravil Hairetdinov
|
