Towards the International Franchise, License, Business Concept Expo & Conference (IFRA) at 1-3 June 2012, Islamic banking was getting ready to capture the customer with full support for the franchise business.
This was evidenced by, among others, held a pre-event Business Matching between the Islamic banking business franchise and business opportunity in Indonesia. Business matching the theme of "Financing the Sharia, the Right Solution for Capital Business Franchise."
With this event, expected to occur mutually beneficial cooperation between the Islamic banking franchise business owners making it easier for business owners in business development, and facilitate potential business partners of the franchise to get a business loan.
Franchise business opportunities in Indonesia more wide open after the introduction of clear rules regarding the criteria of the Ministry of Commerce of the franchise business. Moreover, in terms of formal law, franchise or franchises in Indonesia Government Regulation (PP). 42 of 2007 which contains rules regarding the franchise in Indonesia.
See a big opportunity, the Islamic banking took the opportunity to encourage SMEs, especially those that were involved in a franchise business, by providing financing to the perpetrators of the franchise
Islamic Bank, The Right Solution for Franchise Financing
Label: Capital Business Franchise, Financing the Sharia, Islamic Banking, Islamic FinanceA DISCUSSION WITH PROFESSOR SIDDIQI, About The Islamic Banking & Commodity Money
Label: Commodity Money, Islamic Banking, Islamic FinanceThe following is the text of an email dialogue with Professor Nejatullah Siddiqi on the subject of Islamic banking and commodity money, reproduced with Professor Siddiqi's kind permission.
Tarek El Diwany:
Assalamu `Alaikum Professor Siddiqi.
It is a long time since we last spoke. I hope you are well, insha'Allah.
I read your recent Harvard paper, discussing tawarruq, among other things.
Contract combinations have been practiced by "Islamic" bankers to create quasi interest-based loans for at least thirty years. At first they were doing it with murabahah, now they take the more direct route of using tawarruq. When people like myself risked our careers to state in public that these practices were a ruse, deployed to misdirect Islamic financial rejuvenation, we were mocked for so doing and few grandees came to our defence. In recent months I have noticed that two of the Shari`ah scholars who once opened the door to this Trojan Horse are now calling for a re-evaluation. But what is required is something more fundamental than that. Modern commercial banking grew from the foundation of usurious money creation, it could not grow in a truly Islamic soil, and that is why the Islamic commercial banking experiment has largely failed. Your suggestion, many years ago, for a two tier mudarabah based on genuine profit and loss sharing was a vision that could easily be made to work. But it would need a different monetary and institutional framework to do so and, most importantly, an elite that had the vision and courage to implement it. Alas, some of our elite are signing one page fatwas for tens of thousands of dollars (and sometimes not even looking at the contract). Others make grand-eloquent speeches on the conference floor, but afterwards are found seducing the secretary in a quiet corner of the hotel restaurant. These are some of my experiences from the shop floor. You have your experiences too, no doubt.
Over breakfast in Pasadena, you advised me "not to become involved in what is happening" and to "get on with producing an alternative instead". But look what has happened because of our detachment. A monster has been created, very purposefully, and it will now require a huge effort to overcome. As for the idea that we only need to devise a workable alternative to the present paradigm, this I am afraid ignores the present political realities. The most powerful patrons of Islamic banking are not interested in such a thing. Their whole purpose is to suppress workable interest-free alternatives, and thus protect their golden goose.
Looking forward to hearing your thoughts insha'Allah.
Wassalam
Tarek El Diwany
London
Muhammad Nejatullah Siddiqi:
I am so glad you read that paper.
When I was in Jeddah I had discussions with, among others, the late Sami Homoud, the supposed introducer of murabaha in Islamic finance. From his practical experience in Amman he told me there are things that cannot be done through 2 tier mudarabah. One example: financing the laying down of a sewage system in part of Amman. The benefits for which charges can be collected from users are spread over, say, 75 years but the cost has to be met NOW. Think how problematic it is to mobilize capital on a profit-sharing basis. So they opted for a murabaha model.
Modern financing needs can not all be met by a simple 2 tier model. Secondly debt or credit has always played a role in financing. The real question is of discovering a proper mix, a balanced model.
Many of the ills of modern monetary and financial system can be cured by reforming the monetary system by making new money creation FIRMLY linked to real wealth generation, to production of goods and services. I tried to make this point in my Riba, Bank Interest and Rationale of its Prohibition (available at www.irti.org).
Who are the 2 scholars willing to look back?
M.N.Siddiqi
California
TED:
[Like you] I have also made the point regarding "theory following practice". This has been a typical feature of the interest-based sector for some time. Here, the theories that are promoted most are the ones that provide the establishment with the justifications it needs to carry on with business-as-usual. They are excuses more than theories, of course. Last time I was at the IDB, I witnessed a gathering of scholars responding to a request from upon high that they find a way of justifying a murabahah price that could be fixed after contract signing. The words "according to a benchmark" stuck in my mind especially. You can guess what the benchmark was, and indeed the purpose of the whole exercise.
We both know that monetary reform is a cornerstone of our escape from usury, and it is therefore unsurprising that the major banking organisations are pouring substantial resources into educational propaganda that favours the current monetary system. Hence it is a great disappointment to find that many of the academics and institutions of the Muslim world, far from providing an effective alternative to that propaganda, have incorporated it into their own framework. We therefore face the rather ironic situation in which the most practical opposition against usury comes not from the Muslim world, where the ideology is still formally against usury, but from the West where the prohibition of usury was defeated long ago. So, while the Gulf countries have appointed the ECB to advise upon their currency union, several Members of Parliament in Britain have signed a motion requesting a debate on the use of interest-free money. Isn't it strange that I should be invited to speak in favour of money reform in both the House of Commons and the House of Lords, whilst barely finding an opportunity to do so in gatherings of the Ummah?
What are we to do about this? Write more papers? I do hope that your gentle encouragement towards a re-evaluation will work, but then again people have been writing cogent criticisms of commercial banking for a long time and where did it get them? William Cobbett went to prison for it in London, two centuries ago. The way I see it, you are an academic and so the Islamic banking bandwagon will ignore you. And if a scholar on the inside attempted to implement a genuine paradigm, the Islamic banks would dump him, eventually. What we have is partly a problem of education, but more one of ensuring that the right people are defining the vision for the industry. If we had the latter, practice would begin to follow the theory, and a wholesome institutional framework would in due course build itself.
However, the present Islamic banking establishment will not address these problems for us. They have shown themselves to be institutionally incapable of doing what is necessary. That is why we have tawarruq. It is the end result of applying principles that were established in the formulation of murabahah many years ago, despite opportunities to chart a different course in the meantime. The moral hazard in the selection of Shari`ah has operated frequently here, such that even if ninety-eight out of one hundred scholars judge that a product is haram, the Islamic bank will employ the two who say that it is halal. The banks are in effect able to pick and choose the rules for themselves, while telling everybody that they are only following the rules laid down by the Shari`ah scholars. This is no way to carry on. We cannot leave commercial forces to determine the law. There needs to be a higher imperative.
With regard to your question, I have been told by people close to him that **** has recently been in contact with some of the larger Islamic banks in the Gulf and elsewhere warning them that the direction in which things are moving is not a wholesome one. His remarks are directed particularly at tawarruq, this I know, and perhaps also at the nascent Islamic hedge fund industry. **** has recently commented on the volatility of the Saudi stock market and the fact that such volatility took place despite the widespread Islamisation of the banking sector. He too questioned the direction of Islamic banking, but his substantial participation in its promotion within KSA over recent years does not leave him in a strong position to criticise.
Finally, two specific points arising from your paper and e-mail comments:
1) I occasionally hear the argument that the Islamic banking system is more stable because money is only created against real assets, and that therefore the connection between the real and financial sectors is largely maintained. This is the argument that was deployed by the Bank of England in its defence of money creation during the British government's Bullion Committee hearings of 1810. The Bank's argument was largely rejected by Committee members who found that money creation was not limited by lending against productive assets because entrepreneurs could concoct an unlimited supply of new real-world investment projects for the banks to lend into. The committee found against the Bank of England and recommended curbs on paper money creation for private profit (recommendations that were sidestepped when they were in due course implemented). The Bank's arguments are being resurrected now by Islamic bankers in Muslim countries to justify (or in some cases deny the fact of) money creation.
2) I am in favour of separating payment transmission services from investment management, placing the latter off-balance sheet perhaps and structuring it so that asymmetrical risks are avoided. I don't see any difference between us here. Investors could share profits and losses with the investment manager (tier-one), and the investment manager could invest into various projects (tier-two). Many Islamic banks use a tier-two structure that contains two elements, one in which they fund an SPV using a mudarabah contract, the second in which the SPV in turn funds assets using Islamic contracts (that need not be confined to mudarabah). In the example you cited of funding a 75 year infrastructure project, there need be no problem in using mudarabah if tradability is introduced via securitisation of the tier-two assets. Buyers in the secondary market would bid for the SPV's securities at a price that reflected the increase in present value as the duration of the securities decreased, and this would eventually be sufficient to provide a capital gain for those who bought at issue stage, even if no coupons/dividends were paid in the meantime. Liquidity is already being provided by the arrangers of some Islamic funds, and sukuk are being quoted with bid-offer spreads by the larger banks. If Islamic bankers and policy makers devoted as much effort to improving tradability for Islamic securities as they have done to "perfecting" murabahah, there need be no major problems in funding 75 year infrastructure projects.
MNS:
I confine myself to a single point:
The virtue of tying new money creation to real assets.
I presume you agree to the need for an increasing money supply in a world characterised by increasing population, increasing production of goods and services and expanding market. Ideal would be to match each new unit of money with its equivalent in new wealth, but new wealth comes tomorrow while money for mobilising resources for its production is needed today. We need a proxy for wealth yet to come, that proxy is an existing asset. Whatever the problems involved we have to overcome them.
In the model of narrow banking you are suggesting, the problem does not go away.It is not an accounting problem, it is a real one.
TED:
For the record, I believe that pre-Classical theories are largely appropriate in describing the money supply process under a truly interest-free system. I have summarised this elsewhere as follows:
"In the monetary system I envisage, anyone can produce money. All they need do is go out and dig for it. Then, if the amount of gold obtained by digging is more than the amount of gold that it costs to do the digging, the people will produce money. Otherwise they won't produce money. This is a simple, market-driven mechanism for the supply and demand for money, one that features an in-built tendency towards price stability. It has nothing to do with interest, nor with the arbitrary creation of money for no effort. And if people want to dig for platinum, let them. If one man feels that another will accept copper as payment, let him dig for copper. When the people have true freedom in money, what will they tend towards? Gold and silver, of course. This is because Allah has created us with a love for 'heaps of gold and silver' (Qur'an 3:14). He has created everything for a purpose and the purpose of gold and silver is to act as money (Ibn Khaldun, Muqaddimah)."
The concerns we have as economists in an interest-based monetary system may become far less relevant under a truly interest-free alternative. For example, it is entirely possible that the price level will tend to fall over time, relieving much of the current pressure towards money supply expansion. There would then exist a commercial force that encouraged people to delay their purchases. A nice counter-balance to consumerism, and the death knell for at least one modern argument in favour of interest.
MNS:
I think you got it all wrong.
Digging gold and silver is not possible for everyone everywhere all the time ---- as your ideal would require. Gold mines are very unevenly spread, they tend to exhaust as time goes on and so is silver or XYZ. What a colossal waste commodity money would involve, more so a thousand years from now!
What is more intriguing is that even if all this is ignored, money, any kind of money, cannot manage itself. It has to be managed by us, human beings with all their failings. So we are back to square one.
What pains me most is your quoting Qur'an. That verse does not describe human nature. It describes a kind of person, oblivious of life after death and the Creator, indulging in worldly wealth. Read it in context.
Ibn Khaldun was an empiricist. He wrote what he observed, in the language of his times, stating observed facts as eternal truths. The reality has changed. We are moving towards a money with no corporeal existence. Ibn Khaldun today would have said, Lo! God created computers to usher in electronic money!
TED:
When I presented a paper at the Gold Dinar conference in Malaysia in 2002, I highlighted as part of my presentation various views that oppose commodity money. I was accused then of putting up "straw man arguments" in order to win easy victories in front of the audience. But now you come repeating some of those arguments as intellectual criticisms. Strange world, heh?
For example:
>> Digging gold and silver is not possible for everyone everywhere all the time----as your ideal would require. Gold mines are very unevenly spread, they tend to exhaust as time goes on and so is silver or XYZ.
Surely you recognise the slight element of metaphor in my argument? A person need not physically dig gold himself. He can find someone else to do it for him, for example by buying shares in a gold mining company, or by buying bullion through a dealer. Oil fields are also unevenly spread in this world, but that doesn't stop people using oil for its intended purposes.
>> What a colossal waste commodity money would involve, more so a thousand years from now!
Which is the greater waste. To keep 30,000 tons of gold beneath the earth in the vaults of central banks, or to release it so that people can use it as money? I have not seen the latest figures for global gold production, but let us say it is very approximately 2,000 tons per year. At today's prices this amount of gold is worth less than USD20 billion. We can say that this is the approximate worldwide resource cost of mining, refining and distributing gold bullion to the markets. But USD20 billion is less than the profit that banks in the United Kingdom alone have made in each of the last three years. It is probably less than 3% of the interest spread earned by banks globally on the money that they create out of nothing through credit creation. So if it is a waste of resources to produce gold for use as money, then it is a massively greater waste to use the current system of money creation.
>>What is more intriguing is that even if all this is ignored, money, any kind of money, cannot manage itself. It has to be managed by us, human beings with all their failings. So we are back to square one.
I have always advocated the imposition of suitable quality standards and audit procedures in the event that a commodity currency is adopted, just as we regulate the present monetary system. We are not back to square one. We just have to adopt sensible prudential measures.
>> What pains me most is your quoting Qur'an. That verse does not describe human nature. It describes a kind of person, oblivious of life after death and the Creator, indulging in worldly wealth. Read it in context.
Ibn Kathir's tafsir of verse 14 in Surat al-'Imran ("Beautified for men in the love of things they covet, women, children, heaps of gold and silver ...") gives no indication that it relates to any particular kind of person. In fact he is rather clear that it describes the nature of man in general. Mawdudi's tafsir translates the verse into English as "Men are naturally tempted by the lure of women and children, treasures of gold and silver ...", which is my point precisely.
>> Ibn Khaldun was an empiricist. He wrote what he observed, in the language of his times, stating observed facts as eternal truths. The reality has changed.
When in Muqaddimah ibn Khaldun writes that "God created the two mineral stones gold and silver as the measure of value for all capital accumulations" this sounds to me very much like someone who is stating what he sees as an eternal truth. I remember being in Indonesia in 1997 when the Rupiah fell 50% in a few days, and inflation rocketed. In what form would you have wanted to hold your savings in those days? Paper money, or gold? I know of no instance in history when money "with no corporeal existence", as you describe it, has not eventually been debased to a state of worthlessness by those who had the authority to manufacture it. It is happening today before our very eyes. For Indonesians, and indeed for most of the developing world, the reality has definitely not changed. Commodities cannot be manufactured from nothing, they have a factor cost, and that is exactly the protection that society needs against monetary manipulation.
It would be a sad day if you saw no redeeming features in my position. I can't have got it all wrong, surely? Anyway, if I have, may Allah forgive me and help you to expose the flaws in my arguments. To this end, I would very much appreciate a written record of your responses to the above points.
MNS:
Salam alaikum and thank you for your patience.
I may try a written response later as I am currently very busy researching for a book in URDU on Maqasid e Shari`ah. Meanwhile may I in all humility refer to what I wrote already on this subject. The name of article I will be able to give later as I am not responding to your mail from my office but from another place. But I think it was titled: An Islamic Approach to Economics, presented in Islamabad in 1982, published in my book (Economics, An Islamic Approach) published from Islamabad but also available at Islamic Foundation, Leicester, UK.
About the verse of Qur'an, we face this problem in other places too. Qur'an depicts men as found (especially in the Meccan society of the time) and then says: ...illa al- musalleen[ Quran,70:22] or illa al-lazeena aamanu [Quran,26:227;38:24;95:6 and 130:3].
Someday I may clarify further with reference to Surah and verse, but despite the translation from Mawlana Mawdoodi that you quoted, believe me it is not valid to claim: Qur'an says this is human nature.
If you are in search of human nature go to verses which specifically describe FITRAH (fitratallah allati fatarannas alaiha) [Quran, 30:30].
TED:
I was looking back over our dialogue with the idea of publishing it at www.islamic-finance.com for the benefit of others, with your permission of course.
What comes through rather strongly from the discussion is your dismissal of my position. Most of my points remain unanswered. If the weight of opinion was that one-sided then perhaps such a treatment would be warranted, but I continue to find scholars who support commodity money or view modern Islamic banking as a Trojan Horse. For example, I discussed verse 14 in Surah al-'Imran with a Shari`ah scholar in London. He pointed out that the meaning of the Arabic is that "man has been created" with a love for women and sons, heaps of gold and silver, and so on. Your restriction of inferring man's nature only from verses in which the word "fitrah" appears was something new to him. So can we at least agree there is a case to answer?
By the way, I know you have been described in the past as the "father of modern Islamic banking", so please don't think I'm trying to get at you when I call the industry a Trojan Horse. I just happen to think that's what it has become, despite some honourable intentions at the outset.
MNS:
For the sake of clarity let us first take the issue of commodity money, apart from our discussion on current state of Islamic banking on which my survey article and Harvard paper has already given you my thinking, for the present.
Efficiency and fairness are the two major criteria on which our choice of what should constitute money should be based. If you think commodity money is more efficient you have to counter the arguments in economic literature against it, especially since man did have commodity money most of his history till now. As regards fairness you would appreciate that free working of market is incapable of ensuring fairness. Social authority (exercised in different ways in different times and places) has to intervene and regulate in order to ensure (a degree of) fairness. If you think commodity money is easier to regulate, argue your case, empirically as well as theoretically. I hope you do NOT think no regulation to ensure fairness is needed in case of commodity money. Such a stand is wrong.
I have objected to your ascribing to Islam the position that we should have commodity money. Such a position is not established on the basis of Text, Qiyas, or Ijma'. If you think it can be established on the basis of Maqasid al-Shari`ah or Masalih, you have yet to argue your case.
I do not think agreement or disagreement on the implications of verse 14 of Surah Aal e Imran has much to do with this debate.
TED:
Thank you for this speedy response. I now think I see what the problem is.
You believe that I subscribe to the view that commodity money is required in Islam. In fact, my argument is that the people should have freedom (within the regulations of Islam) in choosing what sort of money to use. If they are given that freedom, they will tend to choose gold and silver because of their natural preference for these items. For me, that is the relevance of the aya in Surah al-`Imran, and it is borne out by empirical evidence across the ages.
Conversely, for much of the last century the British and American governments have prohibited the purchase of gold bullion by domestic residents. They have prohibited what Allah has allowed, which is a certain sign of dysfunction within an economic system. If a man is faced with a choice between selling his goods in exchange for a deflating piece of paper or a piece of gold, he will tend to choose the gold. The commercial banks cannot manufacture gold out of nothing, but neither can their own form of money compete with it. Hence, much of banking history has been about the efforts of the banks to remove precious metals from the circulating medium and replace it with their own token money. A reading of 19th century politics in America strongly indicates the existence of these efforts, as the statements of Jefferson, Jackson and Lincoln make very clear.
There is a great deal of empirical evidence to recommend commodity money over token money as a store of value, from the data in Jastram's "Golden Constant" to the ahadith of the Prophet, pbuh. In the latter we can find a series of dinar and dirham prices for such items as dresses, axes, houses and sheep that wouldn't be out of place today. Such maintenance of purchasing power has never been achieved over even a few decades with a token based monetary system, let alone over 1400 years. Presumably you do agree that a money which holds its value is fairer than one that doesn't? But given your aversion to commodity money, could I ask you to name one period of fifty years in history, anywhere in the world, when token money has held its value as well as gold or silver?
MNS:
A natural preference for any thing does not necessarily imply its suitability as money. Anyway, in the light of your clarification, there remains no quarrel between us. As long as you do not claim an Islamic mandate for commodity money, it is fine with me. The matter is left to what serves MASLAHA best. You have every right to the views you propound. I already indicated to you what little I wrote on the subject. If and when I do more I will send it to you, inshaAllah.
I am not aware of any study of ahadeeth that demonstrates price stability during early Islamic history. What is well documented is that after the influx of gold and silver from conquered regions, prices rose sharply during the rule of Syedna Umer Farooq and Syedna Usman.
June 2006
Source : Islamic Finance
ISLAMIC BANKING - ISN'T ISLAMIC...???
The contractum trinius was a legal trick used by European merchants in the Middle Ages to allow borrowing at usury, something that the Church fiercely opposed. It was a combination of three separate contracts, each of which was deemed permissible by the Church, but which together yielded a fixed rate of return from the outset. For example, Person A might invest £100 in Person B for one year. A would then sell back to B the right to any profit over and above say £30, for a fee of £15 to be paid by B. Finally, A would insure himself against any loss of wealth by means of a third contract agreed with B at a cost to A of £5. The result of these three simultaneously agreed contracts was an interest payment of £10 on a loan of £100 made by A to B.
I had read about the contractum trinius some months before first encountering the full documentation behind an Islamic banking murabahah contract. It was the kind of contract that Person A might use in order to finance the purchase of good X from Person B. The bank would intermediate in the transaction by asking A to promise to buy good X from the bank in the event that the bank bought good X from B. With the promise made, the bank knows that if it buys good X from B it can then sell it on to A immediately. The bank would agree that A could pay for good X three months after the bank had delivered it. In return, A would agree to pay the bank a few percent more for good X than the bank had paid to B. The net effect is a fixed rate of financial return for the bank, contractually enforceable from the moment that the bank buys good X from B. Money now for more money later, with good X in between.
The above set of legal devices is nothing other than a trick to circumvent riba, a modern day Islamic contractum trinius. The fact that the text of these contracts is so difficult to come by is one shameful fact of Islamic banking. If so clean, why so secretive? The following is an excerpt from a murabahah contract that was used frequently by two major institutions during the 1990's. The 'Beneficiary' is the client that needs finance, and earlier clauses require that the Beneficiary acts as the agent of the Bank in taking delivery of the goods.
Promise to Purchase the Goods
1 The Beneficiary undertakes to purchase the Goods from the Bank immediately after it has taken delivery thereof on behalf of the Bank on the terms specified in this Agreement.
2 The contract of sale of the goods to the Beneficiary shall be concluded by an exchange of telexes or telefax messages as soon as the Beneficiary has taken delivery of the Goods on behalf of the Bank.
3 If, for any reason whatsoever, the Beneficiary shall refuse or fail to take delivery of the Goods or any part thereof or shall refuse or fail to conclude the Sale Contract after taking delivery of the Goods, then the Bank shall have the right to take delivery, or cause delivery to be taken, of the Goods and shall have the right to sell, or to cause the sale of, the Goods (but without obligation on its part to do so) in a manner determined by it in its sole discretion and shall have the right to take whatever steps it deems necessary (including demand from the Guarantor to pay) to recover the difference between the price realised upon sale and the price paid by the Bank plus any other expenses incurred by it in relation to the Goods and/or any damage caused to the Bank as a result of the breach of undertaking by the Beneficiary to take delivery of the Goods or to conclude the contract of sale of the goods.
We see here that there is even a guarantor used to ensure that the bank does not lose money on the deal in the event that the Beneficiary defaults. So much for profit-sharing.
Yet the words 'profit-sharing' are to be heard constantly at all of the conferences. Some of the scholars, if pressed, will talk about moving towards more satisfactory products such as mudaraba. But then everyone goes home and works on another murabahah contract. We are told that Muslims must work within the existing banking system and change it from the inside. But we have been trying this for over forty years and nothing has changed. We are still fixing financial rates of return in advance using the Islamic triple contract.
One head of Islamic Trade Finance admitted to me over lunch not long ago that there is no practical difference between the murabahah business that he does now and the conventional letter of credit business that he used to do in his previous job. Just the labels are different. Then there's the Islamic banking department that uses interest-bearing financial instruments for the purpose of closing some of its deals. When deals are done the funds often go to lubricate the trading operations of large corporations such as BMW and General Motors. Meanwhile, in many countries, small and medium sized Muslim-owned businesses are offered no Islamic finance facilities at all. When they do finally encounter a financing proposal from an Islamic bank, many of these businessmen quickly become cynical because the financing cost is fixed at the outset of the financing agreement.
These are all signs that something has gone badly wrong in this industry. But I'm not saying that it is all the fault of the people on the inside. The Western academic establishment is at least partly responsible for the way that the Islamic financiers are thinking. For example, because Brealey and Myers have written a standard text on corporate finance, they are probably as big a force in Islamic finance as Judge Taqi Usmani. It is awfully hard to escape from the value judgements that the overwhelming mass of usury-based finance books contain. That's why an educated Muslim in Islamic finance can ask his client a shocking question such as 'what cost of finance are you looking for?' without thinking twice. He's been taught by Brealey and Myers that fixed-rate finance plays a part in any 'good' financing structure and so off he goes in search of a way to do fixed-rate finance Islamically. The possibility that fixed-rate finance may be completely incompatible with Islam in the first place may not even occur.
But there are two other reasons that prevent Islamic banks from giving up on the doubtful fixed rate products and adopting profit and loss sharing instead. The first is that the clients often prefer to take finance on a fixed rate basis. The second, more overwhelming problem, is the nature of the very business process underlying commercial banking itself.
To explain the first reason, let me tell you about a discussion I had with the Chairman of a major construction company in Asia. His company specialised in building toll roads. It had borrowed heavily at fixed interest in the middle of an economic boom. I told the Chairman that we could develop a toll revenue-sharing financing package. We would part-finance the toll road and share the toll receipts. No toll receipts, nothing for us to share. This would be good for his company because if no one used the road, there would be no financing cost. With the interest based alternative, whether the toll road was full or empty, there would still be a financing cost.
But the Chairman felt that 7% interest was a good deal and so our suggestion was not adopted. Probably this was because he knew that the toll road was going to provide profits of 30%, and there's no point paying out 30% in profit share when you can pay out 7% in interest instead, is there?
Well, the economy turned down, fewer motorists than predicted used the toll roads, but the interest still had to be paid. And so the company had to be rescued. The Financial Times commented a few days later that the rescue was required because 'interest costs exceeded toll revenues'. I kept that article because it summarised with a real life example everything that true profit-sharing would have avoided. The moral of the story is that the chairman wants to fix his financing cost because he believes his business is going to be profitable and he wants to keep most of the profit to himself. He's practicing financial leverage like all those un-Islamic textbooks tell him to.
The unfortunate fact is that even if the Chairman had given the go ahead for profit-sharing, no Islamic bank would have offered it to him. This brings me on to the second of the two reasons for the general failure of Islamic banking to provide profit-sharing finance.
When the first banks began lending paper money, they knew that they were taking a huge risk. They had spent many years promoting their paper money. Some of the phrases they used to persuade the public are still with us today ... 'as good as money in the bank' ... 'prudent' banking. Bankers were respectable chaps who only wanted to conduct honest business and make a reasonable profit in the process. Your paper, they promised, could be converted into gold simply by presenting it at the bank.
So the public came to believe this promise and put their trust in the bankers' paper money. And then the bankers did their little trick and began to print more paper than there was gold in the bank to redeem it with. They could then lend this paper money at interest and make a fat profit.
The banker's promise to redeem this extra paper money with the state's gold coinage was an empty promise, but one that he took because it gave him the power to manufacture money. The crucial idea that Muslims everywhere must understand is that, because this process was in itself risky, the bankers did not want to take any further risks. So they therefore avoided investing money on a profit sharing basis. Why take the additional risk that the borrower's business would fail? Better instead to create money, lend it at interest and take a mortgage on the borrower's assets as security. Then a profit would be much more likely for the banker. This has always been the business process underlying commercial banking.
Today of course the banks practice their 'business' in a different way. Remember, the bank still manufactures your cheque book and cheque card, and sends you an account statement with numbers printed on it at the end of the month. The bank tells you that these numbers can be converted into state money, but if everyone held the banks to their promise on the same day, the banks would all collapse just like the banks of old.
I propose that if banks couldn't manufacture money, they could not survive commercially. They could not survive if all they did was to rent out the entire stock of money created by the state. The banks must create extra money on which to collect interest in order to have a viable business. And they must fix their financial rate of return in advance because profit sharing is one risk too many when you're in the business of money creation. Today, at least 91% of UK money supply is manufactured by the banking system. State money supply is £30 billion, bank money supply is at least £300 billion. Even if the banking system charged a clear 20% interest on the whole £30 billion, it still could not generate sufficient revenue to survive. Hence it has manufactured an extra £300 billion on which it can charge interest.
An Islamic bank is no different. It must partake in the money creation business. And it must therefore fix its financial rate of return at the outset in most of its business. That's why Islamic banking cannot succeed in being Islamic. At least, not in the way that we understand the terms 'banking' and 'Islamic' today.
It gets worse. Because the banks create money by agreeing new loans, society must be in constant debt to the banks by an amount approximately equivalent to the total of a nation's money supply. But when the banks create money, they do not create the money needed to repay the loan plus the interest charge. The loans that the banks make are therefore unrepayable. The unrepayable debt in turn forces society to compete instead of co-operate since the borrowers in aggregate experience a constant shortage of money. Only one thing can save current borrowers, and that is the creation of more money, either by the state or by the banks. This provides sufficient new money with which current borrowers can repay old debts. When the banks and the state don't create enough new money, we have a recession. If they create too much, then we have inflation. And always we have more debt.
Wherever you live in the 'developed' world, look at your country's monetary statistics. You will see a steady expansion of total debt (private plus public) accompanied by expansion of money supply to a similar degree. More telling is the fact that total debt is in almost all cases showing substantial growth as a proportion of Gross Domestic Product. So despite decades of hard work, using ever more productive technology, the people are more in debt than they have ever been. Net, they own less of the wealth in their possession than they have ever done. Does this make any sense to you? Only when we understand that modern money is manufactured mostly by the banks for the sake of profit, can we understand the modern economy. Then it will all make sense.
Islamic finance is not a product to be offered to a niche market. It is a system. It must be promoted and implemented as a system. Where the monetary system is concerned, I am beginning to feel that this is something that cannot be achieved by the private sector alone, Islamic or otherwise. A lead is required from the State since we must redefine the meaning of the words 'legal tender'. We must somehow overturn the monetary system as it is. And that will require us to defeat the monster that faces us.
Some of our scholars have yet to recognise the monster for what it is. They think of the banking system as a necessary part of economic activity. They do not connect the deaths of millions of children in Africa every year with the burden of debt repayments to the banks (the United Nations Development Programme's annual Human Development Reports 1997 - 1999 do show this connection). We need a payment transmission system, a safekeeping service, and investment advisory services. To all these things, yes. To money creation for the sake of profit, no.
Which politician will be brave enough to challenge the wealthy bankers and their friends in the leveraged corporate boardroom? The prize awaiting a successful challenge will be huge. Such a nation will be a light for the world to follow. Imagine no more debt. Imagine all those bankers being released from their unproductive industry (the largest by value on the London Stock exchange) to do something useful instead. Imagine a world free of dominance by a few huge firms, huge and dominant because they have been leveraged with the bankers created money. Imagine what we once had before all of this. A world of small businesses, a world of variety, of individual responsibilities and co-operating communities.
Failure to defeat the monster means a never ending necessity for growth. A world awash in the dust of riba, ruled by the 'Money Power', paying perpetual interest on an unrepayable debt.
Oh, I know they'll say I'm being extreme, it's just that these other fellows have all been saying it too ...
"The Bank hath benefit of interest on all moneys which it creates out of nothing".
Statement of William Paterson, first Director of the Bank of England, upon receiving the Charter of the Bank in 1694: quoted in Tragedy and Hope, Carroll Quigley, MacMillan New York (1966)
The unlimited emission of bank paper has banished all specie .... private fortunes, in the present state of our circulation, are at the mercy of those self-created money lenders, and are prostrated by the floods of nominal money with which their avarice deluges us.
Thomas Jefferson in a letter to John Wayles Eppes on June 1813, Jefferson, Writings (1984) New York: Literary Classics of the United States
And I sincerely believe with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale
Thomas Jefferson in a letter to John Taylor 28 May 1816, Writings (1984) New York: Literary Classics of the United States
The distress and alarm which pervaded and agitated the whole country when the Bank of the United States waged war upon the people in order to compel them to submit to its demands cannot yet be forgotten. The ruthless and unsparing temper with which whole cities and communities were oppressed, individuals impoverished and ruined, and a scene of cheerful prosperity suddenly changed into one of gloom and despondency ought to be indelibly impressed on the memory of the people of the United States. If such was its power in time of peace, what would it have been in a season of war, with an enemy at your doors? No nation but the free men of the United States could have come out victorious from such a contest; yet, if you had not conquered, the government would have passed from the hands of the many to the few, and this organised money power, from its secret conclave, would have dictated the choice of your highest officials and compelled you to make peace or war, as best suited their own wishes.
President Andrew Jackson, Address to the American people, 4 March 1837, recorded in Richardson's Messages, volume 4, p. 1532
The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of the consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government's greatest creative opportunity. By the adoption of these principles, the long-felt want for a uniform medium will be satisfied. The taxpayers will be saved immense sums of interest, discounts and exchanges ... money will cease to be the master and become the servant of humanity. Democracy will rise superior to the money power.
President Abraham Lincoln, Senate Document 23 1865
I am afraid that the ordinary citizen will not like to be told that the banks or the Bank of England can create and destroy money.
Post-war Banking Policy, p. 93 (1928) William Heinemann, by Reginald McKenna, Chancellor of the Exchequer of Great Britain, later Chairman of Midland Bank
In the abstract it is absurd and monstrous for society to pay the commercial banking system interest for multiplying severalfold the quantity of the medium of exchange when a) a public agency could do it all at negligible cost, b) there is no sense in having it done at all, since the effect is merely to raise the price level, and c) important evils result, notably the frightful instability of the whole economic system.
Saturday Review of Literature, p. 732 (1927), Frank Knight
By allowing private mints to spring up, Parliament has fundamentally and perhaps irretrievably betrayed democracy. Before the War it was customary even in the works of apparently respectable economists to find absolutely dishonest hair-splitting distinctions between the invisible money so created and paper notes. The latter were really money and the former was not! In fact the reader can always tell in such standard works on the subject when he is approaching the fishy part of the business. The essential fact, the creation of new money, becomes obscured in a cloud of anticipatory justification and special pleading.
The Role of Money (1933), Frederick Soddy, Nobel Laureate in Chemistry
Despite the accusations of neo-imperialism leveled at the IMF and the World Bank, in the same way that a country's domestic banking system is carried out with apparently scrupulous honesty, the financial conduct of the IMF and World Bank appears above reproach. If a nation borrows, it must repay. Naturally! What other conclusion can there be? The true injustice of the IMF and World Bank only become apparent when the fraudulent nature of these 'loans' is understood, and how they relate to the debt-based banking system ... It is an injustice amounting to international slavery and extortion; it is an aggressive injustice, involving the subjugation of whole nations and their sovereign peoples, operated on a scale that exceeds the total of all the more obvious efforts at dominance by individual nations indulging in warfare over the centuries.
The Grip of Death (1998), Michael Rowbotham
by Tarek El Diwany
Original Summer 2000; updated June 2003
An abridged version of this article was published in Banker Middle East during November 2002
Source : Islamic Finance
Launch of International Islamic Finance Journal from Dubai
Label: Islamic Finance, Islamic Finance Journal, Launch of International Islamic FinanceLaunch of International Islamic Finance Journal from Dubai
Today sees the launch of a new Journal on Islamic finance from dedicated Islamic finance media entity Yasaar Media.
The Journal, called So Far – the Journal of Strategic Thinking in Islamic Finance, is written and edited by members of an Islamic finance Think Tank and is modelled on traditional academic journals. The difference with So Far is that the members of the Think Tank are predominantly practitioners rather than academics.
Member of the Think Tank are drawn from the ranks of committed Islamic finance professionals around the world and range from the Gulf and the Far East to the USA and Europe.
Each issue of So Far is dedicated to a single topic of core importance to the Islamic finance industry – and the launch issue looks at the thorny issue of the problems facing the Sukuk market. Unlike many other journals So Far is distributed free in PDF format and is available from a variety of sources including Yasaar Media thus guaranteeing maximum readership and exposure.
Paul McNamara, editorial director of Yasaar Media, says, ‘While global markets reel from the effects of the global financial crisis, the Islamic finance industry is trying to cope with challenges of its own. But one of the things that the industry is not good at doing is giving or receiving criticism. The purpose if this new Journal, So Far, is to try to help the industry improve by addressing some of the hitherto taboo subjects with frankness and honesty. Every member of the Islamic finance Think Tank wants to help the industry improve – and we feel this is an important initiative in doing that’.
And the name of the Journal - So Far? ‘We wanted something that hinted that the industry had come a long way – but that it still has a long way to go. It’s about honesty and recognition of the marvellous opportunity the industry has to make a real difference’ according to Mr. McNamara.
Source : yasaar media Download or Islamic Finance
A Higher Law for Lending (THE WASHINGTON POST)
Label: Islamic Finance, The Washingtong Post Writte Islamic Finance, University Islamic Financial
At University Islamic Financial, which began in Ann Arbor, Mich., and expanded its operations to Maryland, Virginia and five other states last year, officials said the number of home-financing applications quadrupled from last March to this March.
Representatives of the four major Islamic home-finance institutions in the United States said they do not track the reasons customers choose them over conventional mortgage brokers. Several speculated that it was due to the natural growth of what is still a fledgling retail industry, as well as two side effects of the mortgage crisis: The drop in prices in many regions has brought homes back within reach of first-time buyers, who make up a sizable chunk of Islamic financiers' customers. And the drumbeat of negative publicity about the practices of subprime mortgage lenders has amplified the distrust and discomfort the conventional mortgage industry already inspired in many Muslims.
That was the prevailing sentiment among potential customers who approached an advertising booth staffed by Guidance representatives at the annual spring fair held by the All Dulles Area Muslim Society in Sterling on a recent weekend.
Nabila Zerrarka, an Algerian-born woman wearing a white-and-green headscarf and pushing a stroller, wanted to find out if Guidance's home-finance options were more straightforward than those offered by traditional mortgage brokers.
"Deep down, I don't feel comfortable paying interest because it is against my beliefs," said Zerrarka, 29, who is searching for her first home and has already obtained a prequalification letter for a conventional loan from Bank of America. "But I also feel it's against my financial interests to pay interest. . . . What we've seen is that with interest-bearing loans, there are all these gimmicks and hidden costs and tricks that they can surprise you with. . . . If there is a possibility of doing it the Islamic way, we'd like to explore it."
Mounir Elhaj, 45, a native of Sudan who works at a moving company, wanted to know how Guidance deals with customers who fall behind on their payments. He said he recently helped move a woman whose house was foreclosed on after she missed payments.
"She had been paying her mortgage for 17 years, and the bank still took her house," Elhaj said to the Guidance sales representative. "So I want to know if I bought a house and then fail to pay, can you help me?"
The representative, Amr Mohamed, smiled magnanimously. "Yes, we can," he said, adding that Islamic law, known as sharia, forbids businesses from profiting from a customer's financial hardship. So if a customer is late on payments, Guidance charges him or her a flat administrative fee to cover processing costs but none of the percentage-based penalties and additional fees that conventional mortgage companies can pile on.
Islamic home financing aims to offer Muslim buyers the same opportunities as conventional lenders but with a twist that gets around sharia's prohibition against the payment of riba. Generally defined as excessive gain, riba has over the years come to be considered the equivalent of making money by renting money -- in other words, charging interest -- because the borrower shoulders risk while the lender is guaranteed a return.
In one of the alternative arrangements offered by Islamic finance companies, the company buys the house, then sells it to the home buyer in fixed monthly installments at an agreed-upon marked-up price. The markup rate is kept competitive with the prevailing interest rate on a conventional mortgage. So apart from a few additional transaction costs from the atypical nature of the arrangement, the buyer's monthly payment is roughly equivalent to what it would be with a conventional mortgage.
A second option is for the financier and the home buyer to enter a lease-to-own contract similar to those used to buy cars. Once again, the rental portion of the monthly payment is kept equivalent to prevailing interest payments. The third model, which is favored by Guidance, is also based on a lease-to-own arrangement, except that the buyer and the finance company form a limited-liability entity to own shares of the property.
All three arrangements got a major boost in 2001 when Freddie Mac agreed to begin buying them on the secondary market, ultimately including not just Guidance and University Islamic, but also Devon Bank in Chicago and American Finance House Lariba of Pasadena, Calif. Last year, Freddie Mac bought more than $250 million in Islamic home loans -- a tiny fraction of the corporation's $1.77 trillion business but nonetheless a slight increase over previous years, according to spokesman Brad German.
While Islamic finance companies have convened boards of prominent scholars to certify that their finance arrangements comply with sharia, not all Muslim thinkers are convinced that they are necessary.
Mahmoud Amin el-Gamal, an economics professor at Rice University specializing in Islamic finance, noted that even in Muslim countries, sharia-based financing was developed in only the past several decades. And he argued that because conventional mortgages are secured by a physical good, namely the home, that is usually the only asset the lender can repossess if the borrower fails to repay, such loans should not be considered the equivalent of making money by renting money.
In any case, el-Gamal maintained, Islamic home-finance products are so closely modeled on conventional mortgages as to constitute a distinction without a difference.
"This is an industry that preys on people's religious insecurities by selling them a product that they claim is different when it's not. It's false advertising, and it's a case of supply creating demand," El-Gamal said.
But Hirsi Dirir, a Somali-born technology analyst who recently obtained financing from Lariba to buy a townhouse in Annandale, said such objections pale in comparison with the peace of mind he has gained from making the extra effort to adhere to his faith.
"I wish I could avoid everything that Islam doesn't allow, but I can't," said Dirir, 32. "So if I have the opportunity and the choice to avoid interest, then it's very important to me not to mess with it."
Rizwan Jaka, 35, president of the All Dulles Area Muslim Society and one of the first to buy a home with Islamic financing in the Washington area, also said the emergence of such arrangements constitutes an important milestone in the integration of Muslims in the American mainstream.
"It definitely marks a coming of age for us. . . . It's part of the whole process of being a part of this country while being able to have our faith accommodated," he said. "The American dream is to purchase a house, and the American Muslim dream is to be able to do so in an Islamic manner."
Source : The Washington Post
Banks adopt several modes of acquiring assets or financing projects. But they can be broadly categorised into three areas: investment, trade and lending.
Investment financing
This is done in three main ways: a) Musharaka where a bank may join another entity to set up a joint venture, both parties participating in the various aspects of the project in varying degrees. Profit and loss are shared in a pre-arranged fashion. This is not very different from the joint venture concept. The venture is an independent legal entity and the bank may withdraw gradually after an initial period. b) Mudarabha where the bank contributes the finance and the client provides the expertise, management and labour. Profits are shared by both the partners in a pre-arranged proportion, but when a loss occurs the total loss is borne by the bank. c) Financing on the basis of an estimated rate of return. Under this scheme, the bank estimates the expected rate of return on the specific project it is asked to finance and provides financing on the understanding that at least that rate is payable to the bank. (Perhaps this rate is negotiable.) If the project ends up in a profit more than the estimated rate the excess goes to the client. If the profit is less than the estimate the bank will accept the lower rate. In case a loss is suffered the bank will take a share in it.Trade financing
This is also done in several ways. The main ones are: a) Mark-up where the bank buys an item for a client and the client agrees to repay the bank the price and an agreed profit later on. b) Leasing where the bank buys an item for a client and leases it to him for an agreed period and at the end of that period the lessee pays the balance on the price agreed at the beginning an becomes the owner of the item. c) Hire-purchase where the bank buys an item for the client and hires it to him for an agreed rent and period, and at the end of that period the client automatically becomes the owner of the item. d) Sell-and-buy-back where a client sells one of his properties to the bank for an agreed price payable now on condition that he will buy the property back after certain time for an agreed price. e) Letters of credit where the bank guarantees the import of an item using its own funds for a client, on the basis of sharing the profit from the sale of this item or on a mark-up basis.Lending
Main forms of Lending are: a) Loans with a service charge where the bank lends money without interest but they cover their expenses by levying a service charge. This charge may be subject to a maximum set by the authorities. b) No-cost loans where each bank is expected to set aside a part of their funds to grant no-cost loans to needy persons such as small farmers, entrepreneurs, producers, etc. and to needy consumers. c) Overdrafts also are to be provided, subject to a certain maximum, free of charge.Source : http://users.bart.nl/
