Why Is Riba Al-Fadl Unacceptable?

by Dr. Khalid Zaheer

Abstract

An important instruction found in narrations of the prophet of Islam (ahadith) regarding riba (interest) is reported in the following way: "If you give gold, then receive back the same gold: the same weight and the same quality; and if you give silver, then receive back the same silver: the same weight and the same quality, because the one who gives more or expects more, then (he should know that) that is exactly riba." In another narration he is reported to have said: "If you will sell gold for silver then there is a danger of interest in it. (Likewise, if you will sell) wheat for wheat, barley for barley and dates for dates, the result would be no different; (there is no way of avoiding the danger of riba in a barter transaction) except that the exchange be spot".

The two narrations mentioned above along with many other similar ones have led many Muslim writers to conclude that apart from interest on credit transactions (called riba al- nasia), the prophet in these narrations, has prohibited another kind of riba: riba al-fadl (interest in excess). In their opinion this kind of riba is associated with spot exchange of dissimilar commodities. According to them, the prophet had strongly emphasized that while exchanging the same commodities like gold for gold, silver for silver, wheat for wheat, barley for barley etc. on spot it is extremely important that equal quantity and the very same quality of these goods should exchange hands. Many Muslim writers find themselves at a loss to appreciate the very suggestion that two individuals can ever contemplate the possibility of entering into an exercise of exchanging two identical commodities on spot. However, most of them still accept that riba al-fadl is another form of riba prohibited in Islam by presenting one unconvincing rationale for their understanding of the concept or another.

This author very strongly believes that the narrations claimed to be condemning riba al-fadl have been incorrectly understood and that if their correct context is properly explained, they would appear to be clearly explaining the idea of the same concept of riba that is mentioned in Qur'an (riba al-nasia). This clarification about riba is extremely important for the academic world to acknowledge, because as it stands today, the literature on Islamic Finance and Economics is presenting very strange applications of the concept of riba al-fadl, which are not only unnecessarily confusing but are also being applied in areas of business and finance where their application was never intended. This paper is an academic case for unacceptability of riba al-fadl as an Islamic term.

1) Introduction

Qur’an, the primary book of guidance for Muslims, prohibits believers from entering into riba-based financial arrangements.2 The understanding of a vast majority of Muslim scholars on this injunction is that it outlaws all forms of interest-based borrowing and lending (Siddiqi 1983, 9).3 However, most Muslim scholars include within the scope of the prohibition of riba4 another type of it, which they call riba al-fadl. Since the entire understanding of the notion of riba al-fadl is based on the incidents from the life of the prophet, God’s mercy be on him,5 reported in ahadith,6 and the Qur’an is completely silent on the subject, the alleged understanding of riba is also called riba al-Sunnah (riba, whose understanding has been derived from the example of the prophet).7 This paper attempts to show that the prophet clarified only the meanings of the Qur’anic concept of riba. Furthermore, it also explains that some of the statements of the prophet and incidents reported from his life relevant to this area have been erroneously construed as conveying the understanding of another category of riba, the traditional Muslim understanding of which has caused unnecessary confusions.

2) What Is Riba Al-Fadl

Riba al-fadl is described as an unlawful excess in the exchange of two counter-values where the excess is measurable through weight or measure. The concept is based on some ahadith according to which if gold, silver, wheat, barley, dates, and salt are exchanged against themselves, they should be spot and be equal and specified. If these conditions are not found, this transaction will become riba al-fadl. (Usmani, I. 2002, p.253)

3) Ahadith Mentioning Riba al-Fadl

Although there are myriad ahadith on the subject of riba al-fadl mentioned in the books of hadith, the following represent almost all of them, since many of those others only repeat what has been mentioned in these ahadith.8

Riba Al-Fadl in Gold, Silver, Wheat etc.:

ia)9 Narrated ‘Umar: The Prophet said, "The selling of wheat for wheat is riba except if it is handed from hand to hand and equal in amount. Similarly the selling of barley for barley is riba except if it is from hand to hand and equal in amount, and dates for dates is riba except if it is from hand to hand and equal in amount.” (Bukhari 1985, h. 2026)

iia) Narrated Ibn Shihab: that Malik bin Aus said, "I was in need of change for one-hundred Dinars. Talha bin 'Ubaidullah called me and we discussed the matter, and he agreed to change (my Dinars). He took the gold pieces in his hands and fidgeted with them, and then said, ‘Wait till my storekeeper comes from the forest.’ 'Umar was listening to that and said, ‘By Allah! You should not separate from Talha till you get the money from him, for Allah's Apostle said, 'The selling of gold for gold is riba except if the exchange is from hand to hand and equal in amount, and similarly, the selling of wheat for wheat is riba unless it is from hand to hand and equal in amount, and the selling of barley for barley is riba unless it is from hand to hand and equal in amount, and dates for dates, is riba unless it is from hand to hand and equal in amount.’” (ibid. h. 2029)

iiia) Narrated Abu Hurairah: The prophet said: “If you give gold, then receive back the same gold: the same weight and the same quality; and if you give silver then receive back the same silver: the same weight and the same quality, because the one who gives more or expects more, then that is exactly riba” (Muslim 1981, p. 211)

iva) Narrated by Talha bin Ubaidullah: Umar bin Khattab said that the prophet said: “If you will sell gold for silver then there is a danger of interest in it. (Likewise, if you will sell) wheat for wheat, barley for barley and dates for dates, the result would be no different; except that the exchange be spot.” (ibid., p. 208)

Riba Al-Fadl in the Trade of Dates:

ib) Narrated Ibn Abbas: The Prophet came to Medina and the people used to pay in advance the price of dates to be delivered within two or three years. He said (to them), "Whoever pays in advance the price of a thing to be delivered later should pay it for a specified measure at specified weight for a specified period." (Bukhari op. cit., h. 2086)

iib) Narrated Abu Said Al Khudri and Abu Huraira: Allah's Apostle employed someone as a governor at Khaibar. When the man came to Medina, he brought with him dates called Janib. The Prophet asked him, "Are all the dates of Khaibar of this kind?" The man replied, "(No), we exchange two Sa's of bad dates for one Sa of this kind of dates (i.e. Janib), or exchange three Sa's for two." On that, the Prophet said, "Don't do so, but sell the dates of inferior quality for money, and then buy Janib with the money". The Prophet said the same thing about dates sold by weight. (Muslim op. cit., p. 215)

iiib) Narrated Abu Said al Khudri: Once Bilal brought Barni (i.e. a kind of dates) to the Prophet and the Prophet asked him, "From where have you brought these?" Bilal replied, "I had some inferior type of dates and exchanged two Sas of it for one Sa of Barni dates in order to give it to the Prophet to eat." Thereupon the Prophet said, "Beware! Beware! This is definitely riba! This is definitely riba ! Don't do so, but if you want to buy (a superior kind of dates) sell the inferior dates for money and then buy the superior kind of dates with that money." (ibid.)

ivb) Narrated Zaid bin Thabit: The Prophet permitted selling the dates of the 'Araya for ready dates by estimating the amount of the former (as they are still on the trees). (Bukhari op. cit., h. 2044)

4) Consequences of Accepting Riba al-Fadl?

The following are some of the implications of riba al-fadl in the contemporary commercial dealings that have been imagined by some Muslim writers:

1. There should be a ban on money-changers trading the same currency (dollar for dollar for instance) on unequal terms.10
2. Goldsmiths should be required to exchange old jewellery for the new on the basis of weight (after separating the precious stones) without applying a cut for any impurity in gold or making a claim for their manufacturing costs.
3. Indirect means should be adopted to exchange goods belonging to the same category but having different qualities. (IIIE’s Blueprint 1999, p.41)

5) Rational Justifications and Reasons for their Unacceptability

There are numerous explanations attempted by scholars to offer rational justifications for the proscription of riba al-fadl. This section mentions only a few of them, with each mention followed by my comments.

Hardie and Rabooy have suggested that the injunction on riba al-fadl had the effect of discouraging barter, unless it could fulfil very specific requirements, and encourage people to use cash transactions in business deal” (Hardie and Rabooy, op. cit., p.58). Indeed if the ahadith on riba al-fadl are accepted the way many of them appear in the books of hadith, then no barter trade can ever be undertaken by Muslims since the only barter that seems to have been allowed in these ahadith is the exchange of similar goods on spot.11 Muslims have, however, never considered barter trade illegitimate. Moreover, the ‘very specific requirements’ suggested in the explanation have not been clarified by the authors any further. The only type of barter that seems to be legitimate on the basis of these ahadith would require the commodities to be identical in all respects, which is a condition that can fulfil no business requirements at all.

Another explanation presented is this: “Debasing of currency was widely practised; to protect ignorant people from deception and fraud [,therefore,] it was necessary to establish certain measures to introduce well defined criteria” (Kabbara 1988, 81). Without any supportive evidence, this argument cannot be accepted as valid. The onus of proving that at the time of the prophet, debasing of currency was actually widely practised and that he condemned exchange of debased coins with the genuine ones is on those who have made that claim. Moreover, it is not just gold and silver which are mentioned in the ahadith of riba al-fadl; wheat, barley, dates, and salt have also been involved in the list of items prohibited in the exchange allegedly causing riba al-fadl. How do these commodities help remove the problem of debased currency?

Mawdudi has attempted to rationalize riba al-fadl differently. He has argued that the commodities proposed to be exchanged in the ahadith, although falling under the same category, are those with slight variations in quality. In other words, according to him, if one quality of gold is to be exchanged with another one of a different quality, then the ahadith require that the differences of quality be ignored and the very same quantity or weight of both should be exchanged on spot (Mawdudi 1992, p.174). The difficulty one finds in accepting this explanation is that the hadith of the prophet quoted above does mention the same quality to be exchanged along with the same quantity.12 Secondly, it looks even more unacceptable to imagine that a person would knowingly commit himself to a bargain whereby he is required to give a superior quality of his gold to another person for inferior quality gold of exactly the same weight. It would indeed be unfair to expect the former to agree to any such deal. Surprisingly, the same author allows the exchange of the same category of animals in dissimilar numbers because he believes that there can be huge variations in the quality of the same category of animals (ibid., 181-2).

According to another explanation presented to rationalize riba al-fadl, it was a significant step to elevate trade from narrow regional and national limits to international horizons. This injunction was meant to discourage exchange of metallic coins with face values different from their real intrinsic values in international trade (Sioharvi 1984, p.275). The same author, a few pages later, reveals another reason behind the apparent injunction: to discourage people from accumulating the commodities mentioned in the hadith because “by prohibiting riba al-fadl, situation has been created whereby people do not sell gold, silver, and identical commodities, because exchanging a like commodity for another identical one is a futile exercise” (ibid., p.280). It seems as difficult to understand what these ahadith have to do with the exchange of face value of coins with their intrinsic values as it is to appreciate how by banning unequal spot exchange of gold and silver their accumulation could be discouraged.

Ghazzali understood from the apparent restriction of riba al-fadl yet another purpose. According to him, since gold and silver were meant to be used as currency in the divine scheme, their sale for each other in dissimilar quantities was considered contrary to that purpose (Ghazzali n.d., pp.68-9). Use of gold and silver as currency is, however, now a thing of the past. Its use as a currency has become extinct because the two metals are available in far less volume than would be necessary to meet the growing needs of the world. It could not have been an unalterable part of the Divine Scheme. Moreover, if that is the explanation for prohibition of sale of gold for gold, silver for silver, and gold for silver then what about the other non-metallic commodities mentioned in the ahadith in whose case similar exchange has likewise been prohibited?

Ibn Qayyim, on the contrary, believes that riba al-fadl has been prohibited not for its own sake but because, if allowed, it could lead to the real riba al-nasia13 (Ibn Qayyim 1374 H., Vol. 2 pp.99-100). Although this explanation seems to be the least unacceptable of all, the trouble with accepting it is that, as mentioned in a hadith quoted later, riba is to be found in credit transactions alone and has nothing to do with spot exchange of commodities.14Far from helping in consolidating the prohibition of riba,, the so-called riba al-fadl has helped in confusing the entire concept of it.15

It is interesting to observe that some modern Muslim economists mention riba al-fadl but carefully omit to make any comments on it.16 I heard the late Shaikh Mahmud Ahmad, an enlightened Muslim economist, expressing his inability to appreciate the reasons behind the concept of riba al-fadl and its alleged prohibition.17 Ibn Qayyim writes that many people in his days were oblivious of the real rationale behind the prohibition of riba al-fadl. So much so that some of the scholars did openly admit that they failed to appreciate the logic behind it. (Ibn Qayyim 1374 H., Vol.3., p.204) Likewise in the contemporary Muslim writings on the subject there is a strong need expressed to do something about this concept. The Report of the International Institute of Islamic Economics Workshop on Islamization of the Financial system says this: “ Riba is riba. The traditional dichotomy between Riba al-Nasi’ah and Riba al-Fadl (sic.), in the Fiqh literature needs reconsideration. It does not serve any new purpose, to say the least.” (IIIE’s Report 1999, p.41)

6) The Correct Understanding

It is my firm opinion that ahadith have not attempted to define riba. Qur’ãn has done that quite adequately.18 Any further attempt in a relatively less reliable source of knowledge would have been, at least, unnecessarily repetitive or, worse still, confusing because of the danger of misreporting. Hadith has, well within the jurisdiction given to it by the Qur’an19, clarified Qur’anic teachings about riba by removing misunderstandings about it and explaining its application in certain areas of business.

If the ahadith of riba al-fadl are properly interpreted, they serve to clarify two important aspects relevant to the prohibition of riba: one that riba is only applicable to credit dealings and, two, that while dealing with loan transactions, it is absolutely essential that what is returned by the borrower should be identical to the item he borrowed, otherwise it is very likely to cause the transaction to be riba-ridden.

The following presentation of ahadith would clarify my understanding on the subject. In order to properly understand the meanings of the ahadith, the translations given below arrange to insert within brackets the words that either seem to have been implied when the prophet made the statements or else were missed out in the process of communication between the individuals forming the chain of narrators during the two centuries when only the memories of the narrators were accommodating them.20 Thus my understanding is that the following is a more correct presentation of hadith iiia:21. “If you give [on credit] gold, then receive back the same gold: the same weight and the same quality; and if you give silver [on credit], then receive back the same silver: the same weight and the same quality, because the one who gives more or expects more, then [he should know that,] that is exactly riba.” Likewise, a more correct translation of iva is this: “If you will sell gold for silver [on credit] then there is a danger of interest in it. [Likewise, if you will sell] wheat for [another kind of] wheat, barley for [another kind of] barley and dates for [another kind of] dates, the result would be no different; [there is no way of avoiding the danger of riba in a barter transaction involving the same commodity] except that the exchange be spot.”22

Likewise the prophet has also been reported to have prohibited people from selling silver on credit to receive gold (hadith iva). The prophet categorically stated that the question of riba is relating to exchanges involving credit and has nothing to do with spot exchanges. He is reported to have said: “What is [exchanged] on spot, there is no problem [of riba] in that but that which is [exchanged] on credit [and there is a variation in the value of commodities exchanged] then that is riba” (Muslim, op. cit., Vol. 4, p.211).23

Likewise, the following two ahadith can’t be accepted unless we accept that the question of time lag was implied in the statement. If that is not accepted then these ahadith are in direct conflict with the ahadith ib and ivb.

iib) Narrated Abu Said Al Khudri and Abu Huraira: Allah's Apostle employed someone as a governor at Khaibar. When the man came to Medina, he brought with him dates called Janib. The Prophet asked him, "Are all the dates of Khaibar of this kind?" The man replied, "(No), we exchange two Sa's of bad dates for one Sa of this kind of dates [on credit], or exchange three Sa's for two [on credit]." On that, the Prophet said, "Don't do so, but sell the dates of inferior quality for money, and then buy Janib with the money". The Prophet said the same thing about dates sold by weight.

iiib) Narrated Abu Said al Khudri: Once Bilal brought Barni (i.e. a kind of dates) to the Prophet and the Prophet asked him, "From where have you brought these?" Bilal replied, "I had some inferior type of dates and exchanged two Sas of it for one Sa of Barni dates in order to give it to the Prophet to eat." Thereupon the Prophet said, "Beware! Beware! This is definitely riba ! This is definitely riba ! Don't do so, but if you want to buy (a superior kind of dates) sell the inferior dates for money and then buy the superior kind of dates with that money."

In the hadith ia)24 the word selling should be read as “selling on credit”, which is clarified in the subsequent part of hadith that allows selling them “hand to hand and equal in amount.” This expression is clarifying only the unacceptability of a commodity on credit for an inflated return.25 In other words, “except hand in hand” is disallowing what is not “hand in hand” i.e. credit. Likewise “except … equal in amount” is disallowing what doesn’t fall into this category i.e. unequal amount.

What proceeds from this explanation is the fact that it is allowed to go for a financial deal or a business transaction which involves anyone of the two conditions mentioned, but not both. Thus it is allowed to exchange identical commodities and therefore values on credit (the possibility of indexation in a loan agreement)26 and it is allowed to exchange unequal weights and qualities of commodities on spot.27

7) Consequences of this Understanding

i) Conceptual Clarity:

The correct understanding of ahadith on the subject would enable the debate on riba to be focused on the real issue of the prohibition of interest. Unnecessary references to an imagined notion would clear the minds of distractions which only serve to confuse. For instance, Vogel and Hayes have concluded after mentioning the complexities of issues emerging from the concept of riba al-fadl that it “vetoes a naïve understanding of riba as simply a ban on compensation of credit.” (Vogel and Hayes 1998, p.76). What has emerged as a consequence of accepting the notion of riba al-fadl is a weird, quite often incomprehensible, set of rules of riba and their moral and logical justifications that normally escape comprehension of a normal, intelligent mind.28

ii) Freedom from Unnecessary Restrictions:

Although the difficulties posed by the concept of riba al-fadl are primarily conceptual, the few uncalled for restrictions mentioned in Section 4 above will become unnecessary./a>

iii) Prohibition of Certain Forms of Financial Arrangements:

Another consequence of this understanding would be that inflated price for credit sales (bay‘ murabaha) and pre-paid purchases for deflated price (bay‘ salam) will have to be considered prohibited. The reason for this conclusion is that as a result of the proper placement of ahadith that were hitherto alleged to be proscribing the imaginary notion of riba al-fadl it has become obvious that in a loan transaction the obligation a borrower must discharge is the return of the same value. In bay‘ murabaha and bay‘ salam the borrower (euphemistically called the buyer in bay‘ murabaha and seller in bay‘ salam) returns more. A vast majority of the present-day Muslim scholars accept both as Islamically legitimate. In fact the contemporary banking in the name of Islam (the so-called Islamic Banking) is based on bay‘ murabaha to a great extent and on bay‘ salam to a lesser degree.29

8) What Are The Reasons of Misunderstanding?

i) Sidelining the Qur’an:

The supporters of the concept of riba al-fadl don’t accept Qur’an as the unchallengeable original text whose meanings can’t be altered by any external source.30 As a result, they don’t have any problems in allowing ahadith to insert meanings into the Qur’anic text that its unbiased understanding can’t accept The fact of the matter is that the Qur’an cannot be altered in any manner by an external source.31 Alterations in Qur’anic text allowed by Muslim scholars have taken many forms, like restricting meanings of its message, inserting into its text what it refuses to accept, or explaining a term used in Qur’an in a manner that runs contrary to its own basic understanding. The notion of riba al-fadl attempts to alter the Qur’an in the last way. The prophet’s obligation was to explain the Qur’an. The traditional understanding of riba al-fadl is not explaining it; instead, it is adding a dimension in the scope of its meanings which has nothing to do with the original injunction.32

The correct approach in pursuing to understand the meaning of riba al-fadl should involve, as has been attempted in section 6, an explanation of the meanings of the ahadith on the subject that promise consistency with the Qur’an. In other words, instead of allowing ahadith to dictate meanings to the Qur’an, it is the Qur’an that should have been allowed to give meanings to ahadith.

ii) Elevating Hadith to the Status of Unchallengeable Source:

The reason why the simple and clear-cut guidance of the prophet has been so badly misunderstood is that many Muslims have tended to be too credulous in the matter of hadith. Although the ahadith of the prophet quoted above make it quite obvious that the arrangement condemned is relating to credit transactions alone, there are many other ahadith in the books of hadith on the same subject which do not make that point clear.33 Some Muslim writers insist on accepting each word in the ahadith as if they were the very words of the prophet instead of trying to make sense out of them by carefully studying all the ahadith relating to a subject. The result is that they find themselves in difficulty in understanding some of the concepts of Islam properly.34

The correct way of dealing with hadith literature is to collect all ahadith on a subject together in such a way that the ones promising to be consistent with the Qur’an should be accepted while others not in line with it should be explained away in some acceptable way. The following are some of the reports that clarify that riba al-fadl is unacceptable:

Ibn ‘Abbas quotes Usama bin Zaid who said that the prophet of Allah, may Allah’s blessings be upon him, said: “There is no riba in spot exchanges” (Muslim op. cit., 219). He is also reported to have clarified that “There is no riba except on credit.” (Bukhari op. cit., h. 2023)35 Moreover, the prophet is reported to have bought a slave for two slaves in a spot transaction (Abu Dawud 1985, p.954). It is reported that Ibn ‘Abbas, a companion of the prophet did not accept riba al-fadl because, as he said, the prophet had clarified that there was no riba except in credit (al-nasia) (Ibn Rushd 1983, p.153). No wonder, then, that all differences of opinion among the earlier Muslim jurists with regard to riba have been concerning riba al-fadl alone.36

iii) Blind Acquiescence to the Views of Elders (Taqlid)

The tendency amongst Muslim scholars of the later times to consider the views of earlier scholars as sacred has contributed greatly in perpetuating the concept of riba al-fadl. When the right of forming opinions is reserved exclusively for the people of the earlier generations and any inclination to critically review their understanding is considered almost a sin, it is quite understandable that a mistake like the incorrect understanding of riba al-fadl, once committed by the elders continues to pass on from generation to generation unchallenged.

The present body of knowledge that has been conferred the title of Islamic Economics accepts the views expressed by the earlier jurists, especially in areas where they all tend to agree, as authentic beyond the scrutiny of all critical examination. When a concept becomes sacred through taqlid, it hardly matters to the people of later generations whether it runs contrary to the Qur’anic understanding of riba, or it clearly creates contradiction in the text of hadith literature, or there is a strong disapproval expressed by a knowledgeable companion of the prophet on it.37The very fact that it has been approved by the earlier people is considered enough reason to dispel all contesting arguments against it.38

9) Conclusion

The only riba prohibited in Islam is the one mentioned in the Qur’an, which is, simply stated, interest charged by lender from the borrower, whether the loan is taken for commercial purposes or for personal needs. The prophet applied the understanding of riba in the practical life and taught his followers various aspects of its application.39His teachings and practices were later mentioned in books of hadith. Since these ahadith involved chains of narrators involving four or five individuals belonging to different generations spread over a period of more than two hundred years, the contents of some of these reports got altered in a way that the basic understanding of the message was affected. As a result, some ahadith on the subject conflicted with Qur’an and other ahadith. Instead of finding consistency between Qur’an and ahadith on the one hand and different ahadith on the subject on the other, many Muslim scholars insisted that all ahadith that satisfied the condition of reliability established by the doctors of hadith called muhaddithun should be acknowledged as fully acceptable.

As a result, the concept of riba al-fadl has come to be accepted by a vast majority of Muslim scholars, even though it is illogical and, as a result, apparently extremely complex when attempts are made to bring out a consistent law of riba on the basis of it.40

This paper has proposed to either do away with or modify those aspects of ahadith on the subject that threaten to be inconsistent with the Qura’nic concept of riba and read through them a message that promises to explain clearly the Qur’anic verses on the topic as a coherent message instead of confusing it. The most plausible explanation that emerges as result of the above-stated concern is that the ahadith on riba are clarifying two things: i) Qur’anic prohibition of riba is concerned with credit exchange. ii) In case of an arrangement of credit, when the loan period lapses, it is necessary that the borrower should return absolutely the same value to the lender otherwise the arrangement would be riba-ridden.

---

References

1. Some of the ideas mentioned in this paper were presented in their preliminary form in my Ph.D. thesis “An Enquiry Into The Basic Concept of Banking As Perceived By The Spirit of Islamic Economic Justice.” This paper is a considerably modified version of those initial ideas. See Zaheer 1994, pp. 50-54

2. See Qur’an, 2:275-281

3. Also see Judgement of Federal Shari’a Court on Riba 1992, pp. 206, 219, and 224.

4. Arabic words have been italicized in this paper except names of individuals, places, and books. While mentioning the title of a book or article and quoting a text, the original wordings have been reproduced exactly as ‘it’s there’.

5. Muslims are expected to invoke God’s mercy for the prophet when his name is mentioned.

6. Hadith (plural ahadith) is a report that claims that the prophet of Islam said or did something. The claim is supported by the evidence of the names of the individuals who were involved in the different stages of the process of its communication from the prophet to the compiler of hadith (muhaddith). When placed together in the chronological sequence these names form a chain of narrators. This chain is normally mentioned in the books of hadith before the actual text of a hadith is quoted.

7. Interestingly, some scholars include riba al-jahiliyya as a third category to the list of ribas condemned in Islam. They believe that whereas the Qur’an prohibited riba al-jahiliyya, hadith dealt with the other two categories of it: riba al-nasia and riba al-fadl. See Saleh 1985, p.13. My understanding is that riba al-jahiliyya – where in a lender would ask a borrower at the time of maturity if he will settle the debt or increase it for a delay – is one form of riba al-nasia, the real riba. The distinction between the two is unnecessary. Encyclopaedia of Islamic Banking and Insurance has done the same classification as I have suggested. See Ausaf 1995, p.16. The distinction attempted by some writers between riba al-qurud (riba involving loans) and riba al-buyu‘ (riba involving trade) is likewise unnecessarily adding to the already existing confusion in the discipline. See Lewis and Algaoud 2001, p.35.

8. Any event or statement of the prophet that has been reported by a unique chain of narrators qualifies to be categorized as an independent hadith. The uniqueness in the chain may sometimes involve only one new name which is distinct from those mentioned in another. Thus one finds at times scores of ahadith reported in the books of hadith on a single incident or statement.

9. The ahadith on the subject are being numbered with a view to conveniently refer to them in the later parts of the paper.

10. Another version of the understanding is this: An economic transaction is inflicted with riba al-fadl when: “money is exchanged for money hand-to-hand, but in different quantities.” (El-Gamal 2000, p.4)

11. As a matter of fact the understanding is quite unclear in this area of riba al-fadl as well, like it is in others. While some ahadith suggest that no unequal exchange of commodities is allowed even on spot (see hadith iva) there are others that suggest exchanges of unlike commodities on spot is allowed.

12. See the words “the same weight and the same quality” in hadith number iiia. The following is the relevant Arabic text: waznan biwaznin mithlan bimithlin

13. It is the real riba. It refers to the premium that must be paid by the borrower to the lender along with the principal amount as a condition for the loan or an extension in its maturity. It is thus equivalent to interest. (Usmani op. cit. p.254)

14. “What is [exchanged] on spot, there is no problem [of riba] in that but that which is [exchanged] on credit [and there is a variation in the value of commodities exchanged] then that is riba” (Muslim op. cit., p. 211).

15. Abduh, Rida, and Sanhuri, three of the most outstanding Egyptian scholars of the early twentieth century had somewhat similar opinions on the relationship between riba al-fadl and the real riba .See Saleh op. cit., pp.28-29.

16. See, for instance, Khan, W.M 1985, p.25

17. Despite being one of the most outstanding defenders of the Islamic law proscribing riba, Shaikh Mahmud Ahmad hasn’t even mentioned riba al-fadl in the over five hundred pages of his book “Man and Money: Towards an Alternative Basis of Credit”, which was primarily written to defend the case of Islamic condemnation of riba.. See Ahmad 2002, p.553

18. See Zaheer op. cit., pp. 82-88.

19. The Qur’an tells the prophet to clarify the meanings of its text to the people: “And now We have sent down the reminder to you (O Muhammad), so that you may explain clearly to mankind as to what was sent to them.” (Qur’an, 16:44)

20. Bukhari (d. 242 H) and Muslim (d. 252 H), widely acclaimed to be the two most authentic compilers of hadith, presented their books more than two centuries after the death of the prophet.

21. While translating this hadith and the next one, I have benefited greatly from Ghamidi’s translation of the same ahadith in Urdu. See Ghamidi, 1991, p.26.

22. Although the words inserted in brackets are not translating any Arabic equivalents in the original text, they are necessary to give text the right meanings which cannot be correctly understood by a literal translation. For literal translation of the ahadith, the words within brackets should be omitted. Some of the verses of the Qur’an also follow the same style of presentation wherein some words obviously implied in the text are omitted from being mentioned. The following is an example of a Qur’anic statement falling into this category: “He is the One Who has made the night [dark] for you to rest therein and the day bright [so that you can seek His grace by making a living]. Indeed, there are signs in this for those who listen to His message.” (Qur’an, 10:64)

23. Those writers who insist on accepting riba al-fadl as a definitely distinct entity find no acceptable way of accommodating this hadith. One of the explanations offered is this: “The Ahadith with an emphatic mention of riba being in nasi’ah (or loans) are not to be taken literally. The message is that chances of riba arising are greater in loaning than in other cases…” (IIIE’s Blueprint 1999, p.41)

24. “The selling of wheat for wheat is riba except if it is handed from hand to hand and equal in amount. Similarly the selling of barley for barley is riba except if it is from hand to hand and equal in amount, and dates for dates is riba except if it is from hand to hand and equal in amount.”

25. The expression “except if it is hand to hand and equal in amount” is just emphasizing the same point and is not meant to allow an exchange of identical commodities on spot, which nobody would contemplate doing.

26. Interestingly, some writers have employed the same concept of riba al-fadl to prove that indexation of financial assets is disallowed in Islam. See Chapra 1986, p.40-1 The line of argument these writers follow is that since the six commodities mentioned in the ahadith of riba al-fadl (see hadith iia and iva) are themselves subject to price changes over time, they cannot be used as measures of value to return loans. In case they are used, what will be returned will either be more or less than the original value lent, which is a clear violation of the purpose of these ahadith. However, the reason why their point of view appears weak is that all Muslims scholars of jurisprudence, except a tiny minority belonging to the Zahiris, agree that the six commodities mentioned in ahadith of riba al-fadl are not the only ones that are applicable for the purpose. (ibid., 59). These commodities have only been mentioned by way of example. The real message of these ahadith is that whenever a credit exchange takes place, every attempt should be made to return the very same value. In attempting to do so through indexation, any list of relevant commodities could be chosen to make the arrangement fair to both parties.

27. The question of exchange of unequal values on spot is not a religious issue. People buy and sell commodities on the basis of their assessment that what they are buying is more valuable to them than what they are selling. Islamic teachings would not normally interfere in the freedom of the individual in such commercial decisions, unless there is a danger that one of the parties is being exploited because of its weak position.

28. See Vogel and Hayes op. cit., pp. 72-87

29. Bay‘ Murabaha constitutes more that 70 % of the value of items on the asset side of the balance sheet of the banks that describe themselves as Islamic (See Adeel, Danial etc. 2003, p.65)

30. A similar example of a change accepted in the Qur’anic text is in the case of the punishment of stoning to death for adultery. Whereas the Qur’an states that the punishment for zina (extra-marital sex) is hundred lashes (Qur’an, 24:2), a vast majority of Muslim jurists believe, on the basis of ahadith, that the punishment for the married individual committing zina is stoning to death while that of unmarried individual committing the crime is hundred lashes and banishment.

31. See Al-Shatibi n.d., p.7.

32. One prominent example of the prophet’s explanation of the Qur’anic text which is well within the limits allowed to him by Qur’an is his practical guidance to believers on how to say salah (formal prayers). The Qur’an doesn’t go beyond requiring believers to pray. The prophet’s example clarifies what exactly has been required of them practically. The two are mutually bound in a coherent way in that the Qur’anic text is giving the basic guidance, whereas the prophet’s example is explaining it.

33. See sections 3 and 6.

34. See for an example of this approach the claim of an eminent Muslim economist, Muhammad Umer Chapra, that even activities like of an unsophisticated entrant entrant into a market and the rigging of prices in an auction with the help of agents are riba. (Chapra op. cit., p.60). The eminent author has quoted a hadith indirectly (ibid., p.240) from a less reliable book (Sunan al Bayhaqi) to make his point. Had he relied on the Qur’an, the most reliable book, for unfolding the truth of such crimes in the marketplace, he would have certainly concluded that these activities come under the category of eating each other’s wealth wrongfully (aklummal bil batil). The Qur’an says, “O believers! Do not consume one another's wealth through unlawful means; instead, do business with mutual consent; do not kill yourselves by adopting unlawful means. Indeed Allah is Merciful to you.” (Qur’an, 4:29) As for the mention in hadith, one can easily imagine that some narrator might have got it wrong. However, a clear understanding of Qur’anic concepts should never be compromised at the expense of accommodating each and every hadith on the subject.

35. Exactly the same words have been reported in the book Sahih Muslim. See Muslim op. cit., p. 219.

36. See Mawdudi op. cit. p.307

37. See Ibn ‘Abbas’s opinion in 8 ii) above.

38. The Qur’an mentions that the tendency to blindly follow the elders led to the misguidance of many people of the earlier generations. It says: “When it is said to them: ‘Follow what Allah has revealed.’ They reply: ‘Nay! We will follow what our forefathers practiced.’ Well! Even if their forefathers had no sense at all and lacked guidance?” (Qur’an, 2:170) The idea in quoting this verse is not to suggest that the elders who formed the opinion on riba al-fadl were misguided; however, what emerges from the understanding of this verse is that it is a highly erroneous principle that the opinion of the elders can’t be reconsidered even if strong evidence from religious sources is available to refute it.

39. The claim made by some authors that during the times of the prophet, riba was also charged on exchange of commodities in barter transactions is correct provided that riba in barter should be understood to mean unequal exchange on credit. See Chaudhry 1999, p.35.

40. In a way, the views expressed in this paper are a reiteration of the strong protestation made by the Egyptian scholar Rashid Rida, who believed that it was wrong to consider that Qur’anic prohibition of riba included both riba al-nasia and riba al-fadl. He believed that the large body of legal rulings developed by the jurists on riba was “irrational and unsubstantiated by scriptural authorities.” See The Text… 1999, p.233. The significant difference between the views expressed in this paper and Rashid Rida’s is that while the latter accepted riba al-fadl as a condemned practice only as a preventive measure (ibid.), this paper emphasizes that riba al-fadl is a mistaken view that was never intended by the prophet as another, completely different, kind of riba.

---

Bibliography

Abu Dawud (1985) SunanAbuDawud, English Translation with Explanatory Notes by Prof. Ahmed Hasan, Al-Madina Publications, New Delhi

Adeel, F. B., Danial, M.etc. (2003), Islamic Banking and Finance in Pakistan, MBA Project, Lahore University of Management Sciences

Ahmad, S.M. (2002), Man and Money: Towards an Alternative Basis of Credit, Oxford University Press, Oxford

Ahmed, A. (1995), The Evolution of Islamic Banking in Encyclopaedia of Islamic banking and Insurance, Institute of Islamic Banking and Insurance, London

Al-Shatibi, Abu Ishaq (n.d.), Almuafqat fi usul al-shari‘ah, Darul Ma‘rifah Littaba‘ati wannashri, Beirut, Vol. 4

Bukhari, A.‘A.M.I. (1985), Sahih al Bukhari, Darul Isha ‘at, Karachi, Vol. 1

Chapra, M.U. (1986), Towards a Just Monetary System, The Islamic Foundation, Leicester

Chaudhry, M.S. (1999), Fundamentals of Islamic Economic System, Burhan Education and welfare trust, Lahore

El-Gamal, M.A. (2000), A Basic Guide to Contemporary Islamic Banking and Finance, ISNA, Plainfield, Indiana

Ghamidi, J.A. (1991), Qanun-e-Ma‘ishat, Ishraq, Lahore

Ghazzali, Abu Hamid Muhammad Bin Muhammad (n.d.), IhyaUlum al-Din, Beirut, Al-Daral-Nadwatual-Jadidah, Vol. 2

Hardie, A.R. and Rabooy, M. (1991), Risk, Piety, and The Islamic Investor in British Journal of Middle Eastern Studies, Vol. 18 No. 1, pp.

Ibn Qayyim, A.J. (1374 H.), ‘Ilamul Muwaqqi’in ‘an Rabbil ‘Alamin, Matba‘atus Sa‘adah, Egypt, Vol. 2 & 3

Ibn Rushd, M.A. (1983), Bidayatul Mujtahid wa Nihayatul Muqtasid, Darul Kutub al-Islamia, Cairo

Kabbara, A.H.S. (1988), Islamic Banking, A Case Study of Kuwait, Loughborough University

Khan, W.M., Towards an Interest-Free Islamic Economic System, The Islamic Foundation, Leicester

Lewis, M.K. and Algaoud, L.M. (2001), Islamic Banking, Edward Elgar, USA

Mawdudi, A.‘A. (1992), Sud, Islamic Publications Ltd., Lahore

Muslim, B.H. (1981), Sahih Muslim Sharif, Khalid Ihsan Publishers, Lahore, Vo. 4

Saleh, N.A. (1985), Unlawful Gain and Legitimate Profit in Islamic Law, Cambridge University Press, Cambridge

Siddiqi, M.N. (1983), Issues in Islamic Banking, Islamic Foundation, Leicester

Sioharvi, H.R. (1984), Islam Ka Iqtisadi Nizam, Idara-e-Islamiat, Lahore

The Text of the Historic Judgement on Riba (Interest) 1999 Given by the Supreme Court of Pakistan (23 December, 1999)

Vogel, Frank E. and Hayes, Samuel L. (1998), Islamic Law and Finance: Religion, Risk, and Return, Kluwer Law International, The Hague, The Netherlands

Usmani, Muhammad Imran Ashraf (2002), Meezan Bank’s Guide to Islamic Banking, Daul Ishaat, Karachi, Pakistan

Zaheer, K. (1994), An Enquiry Into The Basic Concept of Banking As Perceived By The Spirit of Islamic Economic Justice, University of Wales

Trade Credit:

Trade liability owed to supplies which is short term financing for business firms & great source of short term financing for business. In business cash play a very vital role without the optimal use of cash operations cannot perform easily. When business entity deals with credit (which should be available with the help of lender/creditor) to meet their raw material deficiency, it is spontaneous financing because first manufacturer purchase raw material on credit and after the sale of finish good they return their outstanding balance. there are three types of trade credit

1.      Notes payable:

It is most secure form of payable in the context of supplier because buyer sign a note which is prove debt note, should be claim in case of credit stretching.

2.      Account payable/open account payable:

In this type of liability buyer does not sign note/evidence. It is less secure liability then notes payable. In case of company liquidity preference given to note payable after notes payables. Because of this reason in liquidity base balance sheet accounts payable record after notes payable

3.      Trade acceptance:

When seller draws a draft on buyer,ordering the buyer to pay their obligation in future. The seller does not release the goods until the buyer accept the draft. This draft can be discounted from mentioned bank if it has marketable value which is due to credibility of buyer.

A Critical Look at the Alternatives to the Popular Models of Interest Free (IF) Banking

by Dr. Khalid Zaheer

Introduction

Conventional banking is unacceptable to Islam for many reasons, not just because interest is a part and parcel of its operations. IF banking was the ambitious response of many Muslims to the challenge which Islamic rejection of conventional banking had necessitated. Since the response was concerned primarily with the elimination of interest in the legal sense, it has failed to remove the real evils of banking in the reformed versions of commercial banks they have created. The objective of elimination of interest has also been achieved, at best, only partially.

It has been said that Muslims have no alternatives other than the interest-free banking they have already presented to fill the void which the withdrawal of conventional banking will create. This claim is incorrect at least insofar as the theoretical presentation of models is concerned. Alternative proposals can be found, among others, in the writings of Rabooy; Ahmad, S. M.; Ghamidi, Javed Ahmad; and Khan, Muhammad Akram. These proposals are substantially different from what has already become well-known as the model of Islamic banking. All these writers find themselves in disagreement with the popular version of IFBs and believe that radical changes are essential to bring the financial system of modern Muslim economies into conformity with Islamic teachings. There are other writers who believe that adequate reforms in the conventional banking structure will enable Muslims to get rid not only of interest but all or most of the flaws of banking.

In this article some of these proposals are critically examined. It begins with a look at the Time Multiple Counter Loan mechanism presented by Shaikh Mahmud Ahmad to replace interest as the basis of bank lending. Banks are very much an integral part of this proposal. Then, it takes up the recommendations of Muhammad Akram Khan to reform IFBs so as to bring them closer to Islamic teachings. Although banks do still find a place in the considerably reformed model, their role is a much changed one.

Time Multiple Counter Loan (TMCL)

Shaikh Mahmud Ahmad (d. 1989), the proposer of the concept of TMCL, was also one of the earliest proponents of the popular IFB model. His book Economics of Islam: A Comparative Study which was first published in 1947 contained a full chapter on Islamic banking. That chapter does not contain any mention of TMCL but proposes that borrowers, banks, and depositors should agree to share the results of businesses on a PLS basis -- a concept that was the cornerstone of the theoretical model of IF banking. However, later he strongly opposed that proposal. The concept of TMCL was presented for the first time by the author in October, 1960 in thaqafat, an Urdu language journal of the Institute of Islamic Culture, Lahore. Later, he presented his ideas to the Panel of Economists and Bankers which was constituted by the Council of Islamic Ideology of Pakistan in 1977 to propose ways to actualise the objective of IF banking in Pakistan. Although the author himself was a member of the panel, his proposal was not accepted nor did his note of dissent appear along with the report of the panel. He published that note later in an Urdu book in 1986 (Ahmad, S.M. 1986, 7-8). The proposal was reproduced in an English book later in 1989. The author has claimed that TMCL is ‘the only concept available so far with whose help it is possible to introduce interest-free banking’. 

The Model

The TMCL model is based on the basic premise that in a loan arrangement not only is the amount of loan important but equally the duration for which it is lent. Thus, if the amount of any loan is multiplied by the period for which it is extended, the result would be a unit -- loan value (LV) -- which will be the measure of deprivattion of the lender as well as the measure of gain of the borrower. Thus an amount of £1000 for one year, for instance, has the same loan value as £100 for ten years i.e. 1000 LVs. In fact, there could be a large number of combinations whereby different amounts of a currency could be multiplied by appropriate units of time period to give the same loan value.

Ahmad has proposed that borrowers should exchange equivalent loans with such combinations of amount and duration that the bank receives only a fraction of the amount it pays to the borrower, but receives it for such a multiple of time that, as a result, equivalent loan values are exchanged. The suitable fractions of loan and time for which loans are to be given should be decided by a government as a part of its monetary policy, keeping in view the exigencies of a given situation.

Apart from the claim of eliminating interest from banks by exchanging loans of equivalent loan value, the proposer does not envisage any other substantial changes in the way banks function. He has not only supported the idea of requiring collateral security from borrowers but has suggested that a collateral of 110 per cent of the value of the loan should be demanded for all loans. In fact, he believes that the collateral margin can go higher than 110 per cent but should not be lowered to less than 100 percent. The author has admitted that in his model "loans cannot be advanced to people who possess neither the requisite collateral nor the requisite counter-loan", and has pre-empted his response to such possible criticism which he believes is likely to originate from socialists by emphasising that "this is a model for a viable and profitable interest-free banking system and lays no claim to be regarded as a substitute for charity houses".

The author believes that there can be no objections raised against his proposal from the point of view of Islamic law (sharee‘ah) and that his model holds the promise of institutionalising qarDay Hasan. The exchange of equivalent time multiple counter loans, to him, is in the true spirit of the message of this verse of Qur'an:

 "Is there any reward for good other than good?" (Qur'an, 55:60).  

Comments and Objections

The concept of counter loans has been presented by some other scholars as well, the difference being that these others propose that the borrower should, after returning the principal to the bank, deposit the same amount with the bank for exactly the same duration as the period of his loan. Indeed, there can be no objection against this type of counter loan of equal loan value except for the fact that no remedy for erosion in the value of loan has been suggested in it. As regards the counter loans of equal loan values suggested by Shaikh Mahmud Ahmad, there are some other objections as well.

Whereas the concept of TMCL is based on the premise that money ought to have time value, the Islamic prohibition of riba requires that money should not be allowed to have any time value at all. Consequently the TMCL proposal is contributing to resurrect exactly the same evil which Qur'an wants to see condemned to extinction.

There could be no objection to lending interest-free loans to individuals provided such lending is not accompanied by a condition of counter lending. When a counter loan of smaller value is presented by the borrower for a longer duration, it creates the problem of uncertain business results for both the parties in the duration of loan. The proposer of the idea believes that the parties exchanging counter loans will exchange, in reality, equivalent possibilities of earning profits; whether they will actually do so will depend on the quality of their respective productive efforts. The proposer has, in fact, committed a crucial error in assuming that. In reality, differences in people's achievements are usually attributable to two factors.

The first is that people differ in their ability. The second is that although circumstances may appear similar, they are actually not, and there is some stochastic external influence which produces the diversity of outcomes. The essential distinction between these two is that in the first case people's accomplishments are consistent over time, whereas in the second they are unrelated. If achievements in business were based on the first factor alone, there would not have been much justification in prohibiting interest, as investors could have given their funds to borrowers on the condition of fixed return knowing full well that they would earn a certain percentage of profit even after paying them interest. Since it is not known beforehand whether a business will flourish in a certain period of time or not, demanding fixed returns on capital is considered to be an immoral arrangement by Islam.a The proposal of exchanging loans of differing values and durations, therefore, far from being equivalent and fair, will turn out to be, in many cases, highly unfair. If the spirit behind the prohibition of riba is to be followed, then the proposal of TMCL cannot be considered acceptable to Islam.

Even if the question of uncertain business circumstances is overlooked for the sake of argument, the prospects of achieving justice for both parties in the proposal by exchanging counter loans of equivalent loan values will be frustrated by the constantly changing value of currency. In an inflationary period -- which is a rule rather than an exception in the modern times -- the party that receives a smaller amoount for a longer duration will clearly be the loser since the real loan value of the money it will have over that period will be less than the real loan value of the money it will lend to the other party.

Moreover, as mentioned earlier, the TMCL proposal envisages that borrowers will be required to advance a collateral of a value which is 110 percent of the loan and this value should in no case be less than 100 percent of a loan. In Islam security as a condition of loan is allowed only in circumstances when writing a contract in the presence of witnesses is not possible. The TMCL proposal which lays down the condition of demanding security from all borrowers cannot, ipso facto, be acceptable to Islam.

Furthermore, the proposer of TMCL model concedes that the elimination of interest envisaged in his model is not intended to provide fair opportunities to all members of society. In his model, as in the case of commercial banks, funds cannot be presented to the poor at all; to the less rich too, the opportunity of getting loans as large as the rich is non-existent. For the one who, owing to his lack of affluence, cannot get loans from his proposed model of  banks, Ahmad proposes that he should "seek a job, work hard at it, save necessary means of securing a loan, and then let him have the satisfaction of becoming his own boss [by getting a bank loan]. Till that happens, he has to content himself with a job which the market is prepared to offer to him". The fact is that any arrangement which provides additional wealth to the already wealthy by disregarding the deprived sections of a society is just the opposite of what Qur'an has desired in an Islamic society.

The view of the proposer that his proposal of TMCL is approved by Qur'an is also unacceptable. His suggestion, for instance, that his proposed counter loans belong to the category of qarDay Hasan is based on an incorrect understanding of the term. The term qarDay Hasan has been used in Qur'an for spending to please Allah without expecting any worldly gains in return. Similarly unacceptable is his claim that his idea of exchanging equivalent loan values is supported by the following Qur'anic verse: "Is there any reward for good other than good?" (Qur'an, 55:60).

If the context of the verse is considered to construe its meanings, then it is suggesting that Allah Almighty, after describing some of the blessings His faithful believers will get in the life hereafter, is informing the reader about the reason why they will get them. To do that, He has posed the question as to why He should not reward goodness for goodness? In other words He is asking the reader how he thinks it was possible for Allah not to reward the righteous. Clearly, the verse cannot be understood to support a scheme of exchanging loans whereby the parties are prompted by their respective self-interests.  

Agency Services by Commercial Banks

Muhammad Akram Khan (b. 1945) has proposed for commercial banks a new role along with his other proposals for elimination of interest from the Pakistani economy. Although the role of commercial banks is substantially changed in his proposal, the institution itself is retained, allowing it to carry on its traditional functions in a different, restricted way. These recommendations are preceded by the author's analysis of the various long-term financing instruments used in Pakistan after the so-called Islamisation of banking in Pakistan. His conclusion is that the attempt at Islamisation of banking in Pakistan has failed, as most of the financing arrangements are still based on interest, although various terms are used to camouflage their interest-bearing nature. On account of that reason, he has presented his proposals which, if implemented, will, in his opinion, make the process genuinely Islamic.  

The Proposal

The recommendations of the author are divided into two main parts. In the first part he has proposed Islamic instruments for long-term finance. In the next one, he has described the institutions which he believes are necessary to make his proposed instruments effective.

The author proposes that interest-free economy should have common stock as a popular mode of financing. He also pleads for revival of the scheme of Participatory Term Certificates (PTC), which were tried and abandoned in Pakistan, to replace interest-bearing debentures. These certificates were issued by business enterprises to financial intermediaries which financed those business organisations on the basis of those certificates for a definite duration. The author proposes that these certificates should not have any pre-determined return nor should they be allowed to be redeemed before due date. The certificates, moreover, should be tradable on the stock exchange. He has also proposed that mudaraba certificates (MCs) should continue to be patronised in Pakistan. These certificates are not different from common stock except that their sponsors are required to be a company registered under the Modaraba Companies and Modaraba (Floatation and Control) Ordinance 1980. This condition implies that only those businesses are allowed to float modarabas which are sound and whose business plan prospectus is approved by a Religious Board appointed for the purpose. Moreover, if 90 percent of the pre-tax profits for a year of the modaraba are distributed to their certificate holders, no income tax is required to be paid by the modaraba. The modaraba certificate holder is also exempt from tax on profits from modaraba. Likewise, Khan has proposed Leasing Certificates (LC), a new instrument, for leasing business. These certificates are to be issued by the companies needing assets on lease to banks or specialised financial intermediaries who would invest savers' funds specifically entrusted with them for investing in leasing business. The financial intermediaries would act as agents of savers and would be entitled to a fixed commission paid once for each service. All profits or losses will be passed on to the leasing certificate holders who will assume all risks as lessors. The certificates will be tradable on the stock exchange. Similarly he has also proposed other instruments like Instalment Sales Certificates (ISC) and Mutual Funds Certificates. All these schemes involve banks and/or specialised financial intermediaries in such a way that savers are required to deposit funds with these institutions knowing full well that their funds are going to be invested in a specified form of business on the basis of profit and loss sharing. Financial intermediaries are to act as agents of savers and the certificates are required to be tradable on the stock exchange.

In the second main part of the presentation, the proposal mentions the institutions which are necessary in the opinion of the proposer to actualise the scheme. Apart from other institutions, the author has proposed new roles for commercial banks and investment banks.

The model of commercial bank proposed by him gives the institution the right to accept current accounts from depositors who will pay a fee for receiving the service of safe custody of their funds. The banks will provide short-term, interest-free loans to their depositors from these funds whereby the limit and period of loans would depend on the average balance held by a client throughout the year. Moreover, banks can invest a part of the funds from current accounts in safe investments provided they feel confident about their liquidity. Since they will invest these funds at their own risk, banks will be entitled to the entire profits and liable for any losses incurred.

Apart from rendering other secondary banking services not involving interest, commercial banks will provide agency services to various types of savers for investing in the real sector. They will supervise and monitor operations of various businesses on behalf of savers and earn service charges for doing that. The implication of these suggestions is that banks will not be allowed to earn interest or profit by lending these funds to businesses at their own discretion without involving savers, as happens now. The only exception will be in the case of current accounts, where they will have limited opportunity to use funds at their own risk and will retain all profits.

Besides commercial banks, the author proposes that a large number of investment banks be opened as well. These banks will collect household and corporate savings and act as agents or trustees to invest them in the real sector in consideration for agency fees. The only difference between these and commercial banks appears to be that the latter would receive current accounts and render the secondary banking services not involving interest like chequeing, remitting of funds, foreign exchange arbitrage, brokerage etc. The investment banks, on the contrary, would concentrate on investing funds in the real sector on behalf of savers.

Muhammad Akram Khan's scheme for elimination of interest from the Pakistani economy is not restricted to the proposals I have mentioned above. However, they constitute the more important part of his suggestions and, moreover, are directly relevant to this study.

Rabooy's proposal of creating an institution which he calls Islamic Intermediary Investment Company (IIIC) is not very different. He has proposed this institution because he too believes that the Western conventional banking system cannot possibly be adapted to make it Islamically acceptable. The IIIC he has proposed would link savers and entrepreneurs and would manage and control the financial affairs of their businesses. He suggests that IIIC be allowed to accept only one sort of account which could be traded and transferred among individuals and corporations like shares. The funds of this account should be invested in profit and loss sharing investments and the proceeds distributed amongst account holders, IIIC itself getting charges for its services. 

Comments and Objections

Financial Instruments

As regards Khan's proposal of introducing interest-free financial instruments, little can be said in disagreement, apart from the condition of limited liability associated with shares. Indeed, it seems perfectly legitimate to have common stocks and similar instruments which give the bearers of certificates a right to participate in the ownership of businesses proportionate to the value of their shares. There is nothing wrong in allowing shareholders to sell their shares in a secondary market if they wish, just as partners in a partnership firm should be allowed to sell their interest in the firm to another party provided the other parties agree to the arrangement. In the case of common stock of joint stock companies free trading of shares by the shareholders is allowed by other shareholders by implication. Moreover, shareholders participate in profits and losses of the business too in that when the company is doing good business they receive dividends as well as, on many occasions, a higher value in the stock market; if the business runs into losses, they do not receive any dividends and the value of their shares goes down.

The shareholders are able to participate in the affairs of the business not only through their voting right but they can also indirectly influence the management by the potential threat of selling the shares in the stock market and bringing down the stock prices, thereby putting pressure on the business management.

As regards the limited liability of shares, the condition is unacceptable to the Islamic teachings which expect owners of businesses to take absolute responsibility of the loan they take in case of default. In the case of joint stock companies that requirement would entail that shareholders ought to be responsible to the creditors for all the loans taken by the company even beyond the face value of their shares, proportionate to their respective share holdings. In the context of Islamic teachings, however, that condition would not alarm the shareholders, since, in that context, borrowing by businesses, if any, would be far more limited. Moreover, the increased responsibility is likely to make shareholders more involved in the affairs of the business of their companies, which will be a welcome development.

The proposal of the author to introduce redeemable stocks -- Participatory Term Certificates (PTC) -- is also unacceptable. One of the objections against the popular IFB model is that they have confused the distinction between debt and equity. Whereas interest is the return a lender gets on debt, legitimate profits are earned by owners of a business who have invested an amount in a business and bear the risk of losses. When an investment is temporary i.e. not intended to stretch over the lifetime of the project and yet participates in the returns of the project, it seems to be neither debt nor equity. Such arrangements can at best be described as doubtful if not completely forbidden.

The reason why temporary participation needs to be condemned is that it creates a debt-like situation whereby the owners and management are under pressure to return the amount apart from what they have already given as profits. On the contrary, the creditors will not be fully interested in the project because of their temporary participation. In a truly Islamic economy such temporary arrangements would only serve to create riba-like situation which would serve the interests of those rentiers only who would not like to take full responsibility of a business project. After all why should not investors participate fully in a project with the intention of staying with it over its lifetime? The sort of security which temporary investments seek to provide to capital is the very opposite of the objective of the Islamic teachings which expect capital to take most of the risk. If investors are in need of liquidating their share in the business at some later stage, they should be allowed to do so at their own risk.

Banks

Khan's proposal to reduce the function of banks to agency services for savers is based on the true spirit of Islamic teachings. Indeed, most flaws of banking emerge from the fact that they are entrusted with huge funds by savers to be used almost at will. Whereas banks wield tremendous economic power, savers are kept completely in the dark about the whereabouts of their funds. By confining the role of banks to that of agents of investors, the author has attempted to remedy the problem from the right place. Indeed, if savers are given full responsibility to choose their preferred business and invest their money, banks would lose all the unreasonable advantage they enjoy today. In fact, in that case banks would completely change their role and would, perhaps, have to be called by a different name. Although Rabooy's model prevents the financial institution from getting a share from the profits of savers' funds, yet it allows the institution considerable, if not total, liberty to invest available funds within Islamic limits. That liberty would confer upon the institution a financial power which is the cause of many evils if improperly used. I, therefore, propose that these institutions should not be given the right to invest funds at will.

The proposal of Muhammad Akram Khan makes a significant concession to commercial banks when it allows them to use funds at their disposal from current accounts at their own risk with all returns to be retained by them. If the author is keen to restrict the powers of banks, however, the concession is not appropriate. Indeed the proposer has suggested measures to restrict the financial liberty of the banks by suggesting strict supervision by the central bank to ensure that banks' investments are safe and by suggesting that banks should not be allowed to invest beyond the limit of their own equity capital. If these measures are strictly implemented, it will only restrict the evil instead of completely eliminating it. The ability of banks to use savers' funds at their disposal wherever they choose to is the root cause of many evils of banking.

Perhaps the author fears that if even that 'limited' right of banks to use savers' funds is withdrawn, then no real incentive would be left for these institutions to carry on doing business. That fear is perfectly justified. A theorist should, however, look for the best solutions to remedy the problems at hand rather than look for lesser evils. If banks do not solve the problem of economic injustice in an Islamic society, they should be wrapped up instead of being allowed to continue to do whatever limited damage they can.

The proposal of the author that commercial banks should provide interest-free loans to depositors in a way that the duration and volume of loans should be based on the average annual balance held by the borrower is also unacceptable to the spirit of Islamic teachings of economic justice. If depositors have sufficient funds, they should use their own funds to satisfy their needs. If they want funds in addition, they should either exploit their own contacts for the purpose or involve other parties in PLS contracts. They have no right to get funds belonging to others and that too in proportion to their relative wealth. Few things can be more unacceptable to Islam than the suggestion that the privileged sections of the society should be helped to get more privileges simply because they are rich. Moreover, providing any incentive to a creditor is similar to riba according to sunnah of the prophet.

In conclusion, it could be said that whereas Muhammad Akram Khan's proposal does contain many useful suggestions, there are still some objectionable aspects of the traditional financial system retained which do not fit into the ideals of Islamic economic teachings.

a. Knight has argued that where uncertainty is absent, the imputation of product values to product services will always be perfect and exhaustive, and profit will be absent except stochastically.