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Islamic Voice Logo
MONTHLY    *    Vol 11-06 No:125    *   JUNE 1997 / SAFAR 1418H

email: editor@islamicvoice.com

ISLAMIC ECONOMY


Merits and Demerits of Islamic Banking


Merits and Demerits of Islamic Banking

By D.G. Bokare

Mr. Abul Hassan’s article Perspectives On Islamic Banking (I.V.March 1997) was indeed very interesting in making the common man aware of the facets of Islamic Banking. I found it necessary to extend his view points from the corpus of present day economic development since we can’t afford to lose sight of the current realities while dealing with this important subject. I make my submission as under.

Islamic banking is known to non-Muslim countries more particularly during the last decade or so. In my opinion the said banking system if, implemented in its true spirit, will help us to solve many of the present economic and social ills. We need to take care while dealing with this system in strictly adhering to the guiding principles of Holy Quran. I get a feeling that the proponents of Islamic banking are enthusiastic to declare Islamic banking as being handled presently would resolve all the problems of the world.

Malaysia has claimed that it has successfully introduced and progressed in passing on the benefits of the system to her people. Similar claims are being made on and off by other Islamic countries also. The attempt of this article is to make aware to the proponents of this system about the weaknesses in the implementation of the system. As said earlier the system is capable of delivering the desired objectives provided it is implemented as guided by Holy Quran.

Interest-free banking system is being practised by about fifty financial institutions operating in many Islamic as well as non-Islamic countries, including India, Denmark, United Kingdom, Switzerland, Bahamas, Luxemberg, etc.

Economic development is our basic problem and it is sustained by continuous investments in the economy. Economy will progress only when such investments are encouraged with lower or no rate of interest.

It was Karl Marx who said that if all capital were in the hands of the industrial capitalists, there were no such thing as interest and rate of interest. However, economic history has developed financial capitalists and industrial capitalists, and the funds flow from the former to the latter at a cost necessary to collect funds. Since the emergence of this ‘increased income’ on the economic scene adds to the cost of production it further leads to building up of inflationary pressures in the economy. In this reference to context a question is being raised. Is the Islamic banking a sure way to the economic progress?

Origin of Islamic banking

Islamic economics has its own ideology of taxation as well as interest. Of late the Muslim scholars are laying down the corpus of Islamic Economics. The term is similar to Keynesian economics, Marxian economics, Hindu economics, classical economics, etc. The governing principle of Islamic economics is interest-free economic transactions. This has been duly discussed in the history of economic thoughts. Samuelson has fully reviewed this biblical view of interest-free economy and has disclosed how and when it was discarded. Published essays on fiscal and monetary policies in the realm of Islamic economics are elegant.

The proponents of Islamic banking had thought of interest-free banking sometime during 1940s. The Muslim scholars while developing the macro economic model of Islamic economics, gave some thoughts on interest-free banking at a micro economic level. Broad objectives of such models were economic development, partnership financing, industrial expansion through financial efficiency and economic stability.

Mr. Hassan has already dealt in detail about the methodology of Islamic banking. So I don’t want to repeat the same here. Methodology is not the point for discussion here but the philosophy is certainly important. Let us look at different opinions favouring such banking system.
1. More emphasis on project viability than securities as is done in conventional banking system.


2. Fund mobilisation is less bothersome for entrepreneurs as funds are available on Modarabah (Profit-Loss basis-PLS). More new entrepreneurs are likely to emerge leading towards fast economic development.


3. Deposit holders will have better chance to earn more than the interest paid under conventional banking system.
4. Disappearance of interest will reduce the prices of all commodities.

Shortcomings of the system

1. While competing with conventional banks, the PLS basis of Islamic banking makes the proposal unattractive to deposit holders under Modarabah.
2. Banks have to recruit highly competent persons in evaluating each proposal or project before entering into any partnership. Any collusion between entrepreneurs and experts will affect deposit holders.
3. Financial fraudulent practices will help in manipulating profit figures on lower side to reduce the share of the bank/shareholder in the profit of the business.
4. Gestation period of three to five years in generating profits from the business will discourage deposit holders in blocking funds in Modarabah accounts. As a result, only trading community and that too in big towns will enjoy the benefits of such facility. Small units will be worst sufferers. The claim of faster economic growth may not therefore be sustainable for a long time. Also due to uncertainty of weather God, financing to agricultural activities would not be profitable and as such this activity will remain outside the Islamic banking system.
5. Short term financing is a dominant factor in Islamic banking system. As such long term financing will have to be provided by the government itself or by the conventional banking system.
6. Most profitable enterprises would like to part with a fixed percent of interest than parting with higher profits under PLS scheme.

Position of Interest in economics

In the background of the above one can raise a question as to whether the interest is to be removed by the state from the economy(as done through Islamic banking) or whether it will disappear on its own by the forces of economic laws. Under the present inflationary economic conditions the Islamic banking system may not sustain for long. Holy Quran’s message is very clear in respect of economic activity. Every citizen should be provided with the means of production by the state as prime responsibility. Means of production include financing without interest. Profit earning should therefore not be motive in financing activity of the citizens. Every citizen as a matter of equality has a right to receive interest-free loans from the state for making his livelihood irrespective of whether he has any kind of security or not or whether he earns profit or not. As said earlier agriculture sector and long gestation projects will be deprived of the facility of Islamic banking. If the financing through Islamic banking is dependent on profit earning prospects of any entrepreneur, then this message of equality of Holy Quran gets defeated if we say that Islamic banking is being run as per the guidance of Holy Quran.

In a free competitive economy (not to be confused with the present day monopoly competitive economy) the prices will show a constant trend of diminishing prices of commodities. Abundance of supplies in the market will bring down the prices through innovation and competitive entrepreneurship. To achieve this economic position Islamic countries have to do away with all the monopolistic organisations including limited liability joint stock companies, stock exchanges (being gambling centres these are not permitted by holy Quran), trade unions, trade marks, patents, etc.

Paul Samuelson says that at the zero rate of interest, if we could ever quite reach this point on the horizon, the plateau of consumption would be as high as technically possible. With the given labour, land and primary resources, it would be a kind of Golden age. Interest will on its own disappear if the downward trend of prices through ‘free-competition’ is administered by the state. Optimum production out of optimum employment, including self-employment, will engender abundant supplies of goods, services and capital resulting in the falling prices as secular trend in a competitive economy. It is therefore requested that the Islamic countries should first establish free competition in the state in its true sense and enjoy benefits of interest-free banking instead of going through the process of interest-free banking as state programme.

(Dr. D.G. Bokare, was former Vice-Chancellor of Nagpur University and Author of the Book, ‘Hindu Economy’. M & M Colony, Zaheerabad-502220).
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