Meezan Bank's Guide to Islamic Banking PDF

Meezan Bank’s Guide to Islamic Banking Meezan Bank’s Guide to Islamic Banking 1 Meezan Bank’s Guide to Islamic Banking Meezan Bank’s Guide to Islamic Banking Written by Dr. Muhammad Imran Ashraf Usmani Ph. D. Islamic Finance Assistance in translation, editing and compilation by Zeenat Zubairi DARUL-ISHAAT Urdu Bazar Karachi Ph: 021-2631861 2 Meezan Bank’s Guide to Islamic Banking Copyright Regd. No. Publications Rights Reserved with DARUL - ISHAAT KARACHI FIRST EDITION 2002 PRINTED AT ILMI GRAPHICS PUBLISHER DARUL - ISHAAT URDU BAZAR KARACHI-1 PAKISTAN. E-mail : [email protected] Ph: 021-2631861 AVAILABLE AT IDARATUL MA’ARIF, DARUL ULOOM, KORANGI, KARACHI DISTRIBUTOR IN U.K. AZHAR ACADEMY LTD., at continenta (London) Ltd.. Cooks Road, London E-15 2pw This copy cannot be sold in the U.K., unless sold by or authorised by the 3 Meezan Bank’s Guide to Islamic Banking TABLE OF CONTENTS Preface 7 SECTION I INTRODUCTION TO ISLAMIC ECONOMIC SYSTEM 1 Chapter 1: The Islamic Economic System 11 2 Chapter 2: Factors of production in Islam 19 3 Chapter 3: The objectives of the 29 distribution of wealth in Islam SECTION II RIBA, ITS PROHIBITION & CLASSIFICATIONS 4 Chapter 4: Riba in the Qur'an 34 5 Chapter 5: Riba in Hadith 36 6 Chapter 6: Riba and its types 42 7 Chapter 7: Commercial interest and 53 usury 8 Chapter 8: Simple and compound interest 62 SECTION III ISLAMIC CONTRACT 9 Chapter 9: Islamic contract 66 10 Chapter 10: Sale 68 11 Chapter 11: Valid Sale 70 12 Chapter 12: Five khiyars 77 SECTION IV ISLAMIC MODES OF FINANCING 13 Chapter 13: Musharakah 81 14 Chapter 14: Mudarabah 98 4 Meezan Bank’s Guide to Islamic Banking 15 Chapter 15: Diminishing Musharakah 108 16 Chapter 16: Murabaha 118 17 Chapter 17: Salam 126 18 Chapter 18: Istisna’ 131 19 Chapter 19: Istijrar 135 20 Chapter 20: Ijarah (Leasing) 138 21 Chapter 21: Ijarah Wa Iqtina 151 SECTION V BANKING IN ISLAM 22 Chapter 22: The features of a conventional 155 Bank 23 Chapter 23: Musharakah in bank deposits 161 SECTION VI APPLICATIONS OF ISLAMIC FINANCING 24 Chapter 24: Project financing 171 25 Chapter 25: Working capital financing 175 26 Chapter 26: Import financing 180 27 Chapter 27: Export financing 182 SECTION VII ISLAMIC INVESTMENTS 28 Chapter 28: Securitization 187 29 Chapter 29: Islamic Investment Funds 193 30 Chapter 30: The principle of limited 207 liability 5 Meezan Bank’s Guide to Islamic Banking PREFACE 6 Meezan Bank’s Guide to Islamic Banking PREFACE Today the world economic system, that is based on interest, has resulted in concentrating the wealth in the hands of selected few creating monopolies and widening the gap between the rich and the poor. In contrast Islam encourages circulation of wealth and regards its role as important to an economy as the flow of blood to our human body. Just as clotting of blood paralyzes human body, concentration of wealth paralyzes economy. The fact is that today 10 richest men in the world have more wealth than 48 poorest countries of the world. Millions are malnourished, lack access to safe water, cannot read or write, in short the quality of life has decayed and the graph continues to go down. Economic justice requires a viable economic system supported by an efficient banking system. Interest based banking has proved to be inefficient as it fails to equitably distribute wealth which is necessary for the well being of mankind. On the other hand Islamic banking is efficient and ensures equitable distribution of wealth thus laying foundation for an inflation free economy and socially responsible banking. Last few years have witnessed a dramatic increase in Islamic banking the world over. At least two hundred Islamic banks and financial institutions have been set up. According to a research report, the growth rate of these institutions is 15% per annum. At least two hundred billion US dollars are invested in this system. Many multinational banks have opened Islamic banking windows or subsidiary of Islamic banking. The information on Islamic banking is also available 7 Meezan Bank’s Guide to Islamic Banking in books, CDs and websites in the form of database, multimedia directories, and encyclopedias. On the Shariah side, there are a number of scholars on Shariah boards of Islamic banks who have compiled Fatwas, resolutions and articles on various issues of Islamic banking and finance. In Pakistan, we have at least two very comprehensive reports on Islamic banking system produced by Islamic Ideological Council 1980 and the Commission for Islamization of Economy in 1992. Therefore Islamic banking is not a utopian idea. There is a need to develop insight, educate and train the bankers in the Islamic economic and banking system. Without having a deep understanding of the principles of Islamic banking, it is difficult to offer its products and services that conform to the true spirit of Islamic shariah. In July 1998, I joined Meezan Bank as a Shariah Consultant with a vision to make the bank a model Islamic bank. With the encouragement of Mr. Irfan Siddiqui, our Chief Executive Officer, I carried a comprehensive training course for the staff of the bank. The series of lectures included topics such as Islamic economic system, Riba, its prohibition and classifications, Islamic contract, Islamic modes of financing and their applications, banking in Islam and Islamic Investments. Various handouts related to the lectures were distributed to the participants of the course that were mainly taken from my thesis on Musharakah, Mudarabah and Kitab- ul-Buyoo (rules of Islamic Sale relevant to Islamic banking and finance). Some handouts were adapted from the books and articles written by my respected father Maulana Mohammad Taqi Usmani. Our participants of the course were of the view that these handouts and notes from my lectures should be organized, edited and properly translated into English to develop a proper Guide on Islamic Banking. I am grateful to all team members who helped me prepare this Guide and gave me some very good suggestions. I am 8 Meezan Bank’s Guide to Islamic Banking especially grateful to our colleague Mrs. Zeenat Zubairi for assisting me tirelessly in the translation work, editing and compilation of this project. I am also grateful to Mr. Irfan Siddiqui and Mr. Pervez Said for not only participating in these lectures actively from inception but also encouraging us in the preparation of this Guide. We are Alhamdollillah running this course successfully at The Institute of Business Administration, (IBA) Karachi. We have already trained two batches and now the third batch is getting its formal education on Islamic banking. In the end I pray to Allah Subhanahu Wa Tallah to accept our efforts in His cause, and give us the guidance and ability for such humble efforts in future as well to free the world from Riba and revive Islamic values all over the world. Ameen. Imran Usmani 10 Moharram 1423 9 Meezan Bank’s Guide to Islamic Banking SECTION I INTRODUCTION TO ISLAMIC ECONOMIC SYSTEM 10 1 INTRODUCTION TO ISLAMIC ECONOMIC SYSTEM Introduction One of the forms of capitalism, which has been flourishing in non-Islamic societies, is the interest-based investment. There are normally two participants in such transactions. One is the Investor who provides capital on loan and the other Manager who runs the business. The investor has no concern whether the business runs into profit or loss, he automatically gets an interest (Riba) in both outcomes at a fixed rate on his capital. Islam prohibits this kind of trading and the Holy Prophet enforced the ruling, not in the form of some moral teaching, but as the law of land. It is very important to know the definition and forbiddance of Riba and the injunctions relating to its unlawfulness from different angles. On the one hand, there are severe warnings of the Qur’an and Sunnah and on the other, it has been taken today as an integral part of the world economy. The desired liberation from it seems to be infested with difficulties. The problem is very detail oriented and has to be taken up in all possible aspects. First of all we have to deliberate into the correct interpretation of the Quranic verses on Riba and what has been said in authentic ahadith and then determine what Riba is in the terminology of the Quran and Sunnah, what transaction Meezan Bank’s Guide to Islamic Banking it covers, what is the underlying wisdom behind its prohibition and what sort of harm it brings to society. We will start from looking at the economic philosophy of Islam vis-à- vis interest. The economic philosophy of Islam Vis-a-Vis Interest The economic philosophy of Islam has no concept of Riba because according to Islam, Riba is that curse in society, which accumulates money around handful of people, and it results inevitably in creating monopolies, opening doors for selfishness, greed, injustice and oppression. Deceit and fraud prospers in the world of trade and business. Islam, on the other hand, primarily encourages highest moral ethics such as universal brotherhood, collective welfare and prosperity, social fairness and justice. Due to this reason, Islam renders Riba as absolutely haram and strictly prohibits all types of interest based transactions. The prohibition of Riba in the light of economic philosophy of Islam can be explained with the cost of distribution of wealth in a society. Distribution of wealth The distribution of wealth is one of the most important and most controversial subjects concerning the economic life of man, which has given birth to global revolutions in today’s world, and has affected every sphere of human activity from international politics down to the private life of the individuals. For many a century now, the question has been the center not only of fervent debates, oral and written both, but also of armed conflicts. The fact, however, is that whatever has been said on the subject without seeking guidance from Divine Revelation and relying merely on human reason, has had the sole and inevitable result of making the confusion worse confounded. 12 Meezan Bank’s Guide to Islamic Banking Islamic perspective of distribution of wealth In this chapter, we propose to state as clearly and briefly as possible the point of view of Islam in this matter, such as we have been able to deduce from the Holy Qur'an, the Sunnah and the writings of the “Thinkers” on distribution of wealth in the Islamic context. Before explaining the point, it seems to be imperative to clarify certain basic principles which one can derive from the Quran, and which distinguish the Islamic point of view in economics from non-Islamic systems of economy. 1. The importance of the economic goals No doubt, Islam is opposed to monasticism, and views the economic activities of man quite lawful, meritorious, and some times even obligatory and necessary. It approves of the economic progress of man, and considers lawful or righteous livelihood an obligation of the secondary order. Notwithstanding all this, it is no less a truth that it does not consider “economic activity” to be the basic problem of man, nor does it view economic progress as the be-all and end-all of human life. Many misunderstandings about Islamic economics arise just from confusion between the two facts of considering economics as the ultimate goal of life and considering it as a necessity in order to have a prosperous life through lawful means. Even common sense can suffice to show that the fact of an activity being lawful or meritorious or necessary separate from it being the ultimate goal of human life and the center of thought and action. It is, therefore, very essential to make the distinction as clear as possible at the very outset. In fact, the profound, basic and far-reaching difference between Islamic economics and materialistic economics is just this: According to materialistic economics: "Livelihood is the fundamental problem of man and economic 13 Meezan Bank’s Guide to Islamic Banking developments are the ultimate end of human life” While according to Islamic economics: “Livelihood may be necessary and indispensable, but cannot be the true purpose of human life” So, while we find in the Holy Quran the disapproval of monasticism and the order to: "Seek the benevolence of Allah." At the same time we find in the Quran to restrain from the temptations or delusion for worldly life. And all these things in their totality have been designated as "Ad-Dunya" ("the mean") — a term which, in its literal sense, does not have a pleasant connotation. Apparently one might feel that the two commands are contradictory, but the fact is that according to the Quranic view, all the means of livelihood are no more than just stages on man's journey, and his final destination lies beyond them. That destination is the sublimity of character and conduct, and, consequently, the felicity of the other world. The real problem of man and the fundamental purpose of his life is the attainment of these-two goals. But one cannot attain them without traversing the path of this world. So, all those things too which are necessary for his worldly life, become essential for man. It comes to mean that so long as the means of livelihood are being used only as a path leading towards the final destination, they are the benevolence of Allah, but as soon as man gets lost in the mazes of this pathway and allows himself to forget his real destination, the very same means of livelihood turn into an "temptation, or delusion" into a "trial": “And know that your possessions and your children are but a trial” ( 8:28). The Holy Quran has enunciated this basic truth very precisely in a brief verse: "Seek the other world by means of what Allah has bestowed upon 14 Meezan Bank’s Guide to Islamic Banking you" (28:77). This principle has been stated in several other verses too. This attitude of the Holy Quran towards "the economic activity" of man and its two aspects would be very helpful in solving problems of man of Islamic economics. 2. The real nature of wealth and property The other fundamental principle, which can help to solve the problem of the distribution of wealth, is the concept of “wealth” in Islam. According to the illustration of the Holy Quran “wealth” in all its possible forms is a thing created by Allah, and is, in principle His "property". Allah delegates the right of property over a thing, which accrues to man, to Him. The Holy Quran explicitly says: "Give to them from the property of Allah which He has bestowed upon you." (24:33). According to Quran the reason for this philosophy is that all a man can do is invest his labor into the process of production. But Allah alone, and no one else, can cause this endeavor to be fruitful and actually productive. Man can do no more than sow the seed in the soil, but to bring out a seedling from the seed and make the seedling grow into a tree is the work of some one other than man. The Holy Quran says: "Have you considered what you till? Is it you yourselves who make it grow, or is it We who make it grow?" And in another verse: "Have they not seen that, among the things made by our own hands. We have created cattle for them, and thus they acquired the right of property over them?" (36:71) All these verses throw ample light on the fundamental point that "wealth", no matter what its form, is in principle ”the property of Allah”, and it is He who has bestowed upon man the right to exploit it. So Allah has the right to demand that 15 Meezan Bank’s Guide to Islamic Banking man should subordinate his exploitation of this wealth to the commandments of Allah. Thus, man has the “right of property” over the things he exploits, but this right is not absolute or arbitrary or boundless, it carries along with it certain limitations and restrictions, which have been imposed by the real owner of the 'wealth'. We must spend it where He has commanded it to be spent, and refrain from spending where He has forbidden. This point has been clarified more explicitly in the following verse: “Seek the other world by means of what Allah has bestowed upon you, and do not be negligent about your share in this world. And do good as Allah has done good to you, and do not seek to spread disorder on the earth.” (28:77) This verse fully explains the Islamic point of view on the question of property. It places the following guidelines before us: (1) Whatever wealth man does possess has been received from Allah. (2) Man has to use it in such a way that his ultimate purpose should be the other world (3) Since wealth has been received from Allah, its exploitation by man must necessarily be subject to the commandment of Allah. (4) Now, the Divine Commandment has taken two forms:- a) Allah may command man to convey a specified production of "Wealth" to another man. This Commandment must be obeyed, because Allah has done good to you, so He may command you to do good to others - "do good as Allah has done good to you". 16 Meezan Bank’s Guide to Islamic Banking b) He may forbid you to use this “wealth” in a specified way. He has every right to do so because He cannot allow you to use “wealth” in a way which is likely to produce collective ills or to spread disorder on the earth. This is what distinguishes the Islamic point of view on the question of property from the Capitalist and Socialist points of view both. Since the mental background of Capitalism is, theoretically or practically, materialistic, it gives man the unconditional and absolute right of property over his wealth, and allows him to employ it, as he likes. But the Holy Quran has adopted an attitude of disapprobation towards this theory of property, in quoting the words of the nation of Hazrat Shu’aib. They used to say: "Does your way of prayer command you that we should forsake what our forefathers worshipped, or leave off doing what we like with our own property?" (11:87) These people used to consider their property as really theirs or "Our property", and hence the claim of "doing what we like" was the necessary conclusion of their position. But the Holy Quran has, in the chapter "Light” substituted the term "the property of Allah" for the expression “Our possessions”, and has thus struck a blow at the very root of the Capitalistic way of thinking. But at the same time, by adding the qualification "what Allah has bestowed upon you", it has cut the roots of Socialism as well, which starts by denying man's right to private property. Similarly, ("thus they acquired the right property over them") - a verse in the Chapter “Seen", explicitly affirms the right to private property as a gift from Allah. Difference between Islam, Capitalism and Socialism Now we are in a position to draw clear boundary lines that separate Islam, Capitalism and Socialism from one another: - 17 Meezan Bank’s Guide to Islamic Banking Capitalism affirms an absolute and unconditional right to private property. Socialism totally denies the right to private property. But the truth lies between these two extremes - that is Islam admits the right to private property but does not consider it to be an absolute and unconditional right that is bound to cause "disorder on the earth”. 18 Meezan Bank’s Guide to Islamic Banking 2 FACTORS OF PRODUCTION IN ISLAM THE CAPITALIST VIEW In order to understand the Islamic point of view fully, it would be better to have a look at the system of the distribution of wealth that is obtained under the capitalist economy. This theory can be briefly stated like this: wealth should be distributed only over those who have taken a part in producing it, and who are described in the terminology of economics as the factors of production. According to the Capitalistic economics, these factors are four:- 1. Capital: which has been defined as "the produced means of production" - that is to say, a commodity which has already undergone one process of human production, and is again being used as a means of another process of production. 2. Labour: that is to say, any exertion on the part of man. 3. Land: which has been defined as ''natural resources'' (that is to say, those things which are being used as means of production without having previously undergone any process of human production). 4. Entrepreneur, or Organization: The fourth factor that brings together the other three factors, exploits them and bears the risk of profit and loss in production. Under the Capitalist economy, the wealth produced by the co-operation of these four factors is distributed over these very four factors as follows: one share is given to Capital in the shape of interest, the second share to Labor in the shape 19 Meezan Bank’s Guide to Islamic Banking of wages, the third share to Land in the shape of rent (or revenue), and the fourth share (or the residue) is reserved for the Entrepreneur in the shape of profit. THE SOCIALIST VIEW On the other hand under the Socialist economy, capital and land instead of being private property, are considered to be national or collective property. So, the question of interest or rent (or revenue) does not arise at all under the philosophy of this system. Under the Socialist system, the entrepreneur too is not an individual but the state itself. So profit as well is out of the question here - at least in theory. Now, there remains only one factor namely labor. And labor alone is considered to have a right to wealth under the Socialist system, which it gets in the shape of "Wages". THE ISLAMIC VIEW The Islamic system of the distribution wealth is different from both. From the Islamic point of view, there are two kinds of people who have a right to wealth: 1. Those who have a primary right that is to say, those who have a right to wealth directly in consequence of participation in the process of production. In other words, it is those very "factors of production" which have taken a part in the process of producing some kind of wealth. 2. Those who have a secondary right, that is to say, those who have not taken a direct part in the process of production, but it has been enjoined upon the producers to make them co-sharers in their wealth. Let it be made clear that we are here concerned with the basic philosophy or theory of socialism, and not with its present practice, for the actual practice in socialist countries is quite different from this theory. 20 Meezan Bank’s Guide to Islamic Banking ISLAMIC THEORY Those who have a primary right to wealth As indicated above, the primary right to wealth is enjoyed by "the factors of production." But "the factors of production'' are not specified or technically defined, nor is their share in wealth determined in exactly the same way as is done under the Capitalist system of economy. In fact, the two ways are quite distinct. From the Islamic point of view, the actual factors of production are three instead of being four:- 1. Capital: That is, those means of production which cannot be used in the process of production until and unless during this process they are either wholly consumed or completely altered in form, and which, therefore, cannot be let or leased (for example, liquid money or food stuff etc.) 2. Land: That is, those means of production, which are so, used in the process of production that their original and external form remains unaltered, and which can hence be let or leased (for example, lands, houses, machines etc.). 3. Labor: That is, human exertion, whether of the bodily organs or of the mind or of the heart. This exertion thus includes organization and planning too. Whatever "wealth" is produced by the combined action of these three factors would be primarily distributed over these three in this manner: one share of it would go to Capital in the form of profit (and not in the form of interest); the second share would go to Land in the form of rent, and the third share would be given to Labor in the form of wages. Socialism and Islam As we said, the Islamic system of the distribution of wealth is different from Socialism and Capitalism both. The distinction between the Islamic economy and the Socialist economy is quite clear. Since Socialism does not admit the idea of private property, wealth under the Socialist system is distributed 21 Meezan Bank’s Guide to Islamic Banking only in the form of wages. On the contrary, according to the Islamic principles of the distribution of wealth, which we have outlined above, all the things that exist in the universe are in principle the property of Allah Himself. Then, the larger part of these things is that which He has given equally to all men as a common trust. It includes fire, water, earth, air, light, wild grass, hunting, fishing, mines, un-owned and un- cultivated lands etc., which are not the property of any individual, but a common trust. Every human being is the beneficiary of this trust, and is equally entitled to its use. On the other hand, there are certain things where the right to private property must be recognized if only for the simple reason that without such a recognition it would not be possible to establish the practicable and natural system of economy to which we have alluded while discussing the first object of the distribution of wealth. If the Socialist system is adopted and all capital and all land are totally surrendered to the state, the ultimate result can only be this: we would be liquidating a large number of smaller Capitalists, and putting the huge resources of national wealth at the disposal of a single big Capitalist - the state, which can deal with this reservoir of wealth quite arbitrarily, thus, leads to the worst form of the concentration of wealth. Moreover, it produces another great evil. Since Socialism deprives human labor of its natural right to individual choice and control, compulsion and force becomes indispensable in order to make use of this labor, which has a detrimental effect on its efficiency as well as on its mental health. All this goes to show that the Socialist system injures two out of the three objects of the Islamic theory of the distribution of wealth namely, the establishment of a natural system of economy, and securing for everyone what rightfully belongs to him. These being the manifold evils inherent in the unnatural system of the Socialist economy, Islam has not chosen to put an end to private property altogether, but has rather recognized the right to private property in those things of the 22 Meezan Bank’s Guide to Islamic Banking physical universe which are not held as a common trust. Islam has, thus, given a separate status to Capital and to Land, and has at the same time made use of the natural law of "supply and demand" too in a healthy form. Hence Islam does not distribute wealth merely in the form of wages, as does Socialism, but in the form of profit and rent as well. But, along with it, Islam has also put an interdiction on the category of' 'Interest'', and prescribed a long list of the people who have a secondary right to wealth. It has thus eradicated the great evil of the concentration of wealth, which is an essential characteristic inherent in Capitalism, an evil, which Socialism claims to remedy. This is the fundamental distinction of the Islamic view of the distribution of wealth, which sets it apart from Socialism. Islam and Capitalism It is equally essential to understand fully the difference that exists between the Islamic view of the distribution of wealth and the Capitalist point of view. This distinction being rather subtle and complicated, we will have to discuss it in greater detail. By comparing and contrasting the brief outlines of the Islamic and the Capitalist systems of the distribution of wealth, we arrive at the following differences between the two:- 1. The entrepreneur, as a regular factor, has been excluded from the list of the factors of production, and only three factors have been recognized, instead of four. But this does not imply that the very existence of the entrepreneur has been denied. What it does mean is just that the entrepreneur is not an independent factor, but is included in any one of the three factors. 2. It is not "interest" but "profit" that has been considered as the "reward" for Capital. 23 Meezan Bank’s Guide to Islamic Banking 3. The factors of production have been defined in a different manner. Capitalism defines' 'Capital'' as "the produced means of production." Hence, Capital is supposed to include machinery etc. as well, beside money and foodstuff. But the definition of "Capital" that we have presented while discussing the Islamic view of the distribution of wealth, includes only those things which cannot be utilized without their being wholly consumed, or, in other words, which cannot be let or leased - for example, money. Machinery is to be excluded from "Capital", according to this definition. 4. In the same way, “land'' has been defined in a more general way. That is to say, all those things have been brought under this head, which do not have to be wholly consumed in order to be used. Hence, machinery too falls under this category. 5. The definition of Labor too has been generalized so as to include mental labor and planning. Let us now go into the details of this discussion. Under the Capitalist system, the most important characteristic of the entrepreneur (which entitles him to "profit") is supposed to be that he bears the risk of profit and loss in his business. That is to say, from the Capitalist point of view, “profit'' is a kind of reward for his courage to enter into a commercial venture where he alone will have to bear the burden of a possible loss, while the other three factors of production will remain immune from loss, for Capital would get the stipulated interest, Land the stipulated rent and Labor the stipulated wages. On the other hand, the Islamic point of view insists that the ability to take the risk of a loss should, in reality, inherent with Capital itself, and that no other factor should be made to bear the burden of this risk. Consequently, the Capitalist, in 24 Meezan Bank’s Guide to Islamic Banking so far as he takes the risk, is an entrepreneur too, and the man who is an entrepreneur is a Capitalist as well. Now, there are three ways in which Capital can be invested in a business venture:- 1. Private business: The man who invests Capital may himself run the business without the help of any partners or shareholders. In this case the return which he gets may be called "profit" from the legal or popular point of view; but, in economic terms, this "reward" would be made up of (1) "profit", in as much as Capital has been invested, and (2) "wages", as earnings of management. 2. Partnership: The second form of investment is that several persons may jointly invest capital, jointly manage the business and jointly bear the risk of profit and loss. In the terminology of the Fiqh, such a venture is called "Shirkat-ul-Aqd" or Partnership in contract. According to the terminology of economics, in this case too all the partners will be entitled to “profit” in so far as they have invested capital and also entitled to "wages" in so far as they have taken part in the management of the business. Islam has sanctioned this form of business organization too. This form was quite common before the time of the Holy Prophet until he permitted people to retain it, and since then there has been a consensus of opinion on its permissibility. 3. Co-operation of Capital and Organization (Mudarabah): The third form of investment is that one person may invest Capital while another may manage the business, and each may have a share in the profit. In the terminology of Fiqh, it is called "Mudarabah". According to the terminology of economics, in this case, the person 25 Meezan Bank’s Guide to Islamic Banking who invests his capital ("Rabb-ul-Mal") will get his share in the form of "profit", while the person who has actually managed the business will get it in the form of "wages". But if the person who has been managing the business ("Mudarib") eventually suffers a loss in the business, his labor will go wasted just as the capital of the investor would go wasted. This form of business organization too is permissible in Islam. The Holy Prophet himself has made such an agreement with Hazrat Khadijah before their marriage. Since then there has been a complete consensus of opinion on this too among the jurists of Islam. Money Lending Business The fourth form of investing Capital, which has ever since been practiced in non-Islamic societies is the money-lending business. That is to say, one person lends out capital in the form of a debt, and a second person puts in his labor; if there is a loss it has to be borne by labor, but, profit or loss, interest does accrue to Capital in any case. Islam has interdicted this form of investment. “O, believers, fear Allah, and give up what is still due to you from the interest (usury), if you are true believers. (2:278) The Holy Quran also says: “If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it.” (2:279) In these two verses, the phrases ''what is still due to you from the interest" and "you shall have the principal" makes it quite explicit that Allah does not condone the least quantity of interest, that "giving up the interest" implies that the creditor should get back only the principal. Thus, one can clearly see 26 Meezan Bank’s Guide to Islamic Banking that Islam considers every rate of interest (except zero%) to be totally inadmissible. In the pre-Islamic period, certain Arab tribes used to carry on their trade with the help of money borrowed on the basis of interest from other tribes. Islam puts an end to such transactions altogether. Ibn Juraij says: "In the pre-Islamic period, the tribe of Banu Amr bin Auf used to take interest from the tribe of Banu-al-Mughira, and the Banu-al-Mughira used to pay this interest. When Islam came, the later owed a considerable amount of money to the former". And further on: ‘’The Banu-al-Mughira used to pay interest to the Banu Thaqif" Let it be understood that the position of every Arab tribe was like that of a joint company, carrying on trade with the joint Capital of its individual members. So, when a tribe would borrow collectively from another tribe, it would usually be for the purposes of trade. The Holy Quran prohibited even this practice. Thus, under the Islamic system of economy, if a man wants to lend his money to a businessman for being invested in business, he will have first to decide clearly whether he wishes to lend this money in order to have a share in the profit, or simply to help the businessman with his money. If he means to earn the right to a share in the profit by lending his money, he will have to adopt the mode of "partnership" or that of “Co-operation'' (Mudarabah). That is to say, he too will have to bear the responsibility of profit or loss - if there is eventually a profit in the enterprise, he shall have a share in the profit; but if there is a loss, he shall have to share the loss too. On the other hand, if he is lending this money to another person by way of help, then he must necessarily regard this help as no more than help, and must forgo all demand for a "profit”. He will be entitled to get back only as much money as he has lent out. Islam considers it not only unjust but also meaningless that he should fix a rate of "interest" and thus place all the burden of a possible loss on the debtor. 27 Meezan Bank’s Guide to Islamic Banking This discussion makes it clear that Islam places the responsibility of ''taking the risk of loss'' on Capital. The man who invests capital in a risk-bearing business enterprise shall have to take this risk. 28 Meezan Bank’s Guide to Islamic Banking 3 THE OBJECTIVES OF THE DISTRIBUTION OF WEALTH IN ISLAM If we consider the injunctions of the Holy Quran, it would appear that the system for the distribution of wealth laid down by Islam envisages three objects: a) The establishment of a practicable system of economy: - The first object of the distribution of wealth is that it would be the means of establishing in the world a system of economy which is natural and practicable, and which, without using any compulsion or force, allows every individual to function in a normal way according to his ability, his aptitude, his own choice and liking, so that his activities may be more fruitful, healthy and useful. And this cannot be secured without a healthy relationship between the employer and the employee, and without the proper utilization of the natural force of supply and demand. That is why Islam does admit these factors. A comprehensive indication of this principle is to be found in the following verse: - The condition of "proper utilization" has been assumed because it is possible to make an improper use of forces, and it has been the case under Capitalism. Islam has struck at the very root of such an improper use and has thus eradicated the unbridled exploitation of private property. 29 Meezan Bank’s Guide to Islamic Banking ''We have distributed their livelihood among them in worldly life, and have raised some above others in the matter of social degrees, so that some of them may utilize the services of others in their work." (43:32) b) Enabling every one to get what is rightfully due to him:- The second object of the Islamic system of the distribution of wealth is to enable everyone to get what is rightfully his. But, in Islam, the concept and criteria of this right is somewhat different from what it is in other systems of economy. Under materialistic economic systems, there is only one way of acquiring the right to ''wealth'', and that is a direct participation in the process of production. In other words, only those factors that have taken a direct part in producing wealth are supposed to be entitled to a share in "wealth", and no one else. On the contrary, the basic principle of Islam in this respect is that "wealth" is, in principle the property, of Allah Himself and He alone can lay down the rules as to how it is to be used. So according to the Islamic point of view, not only those who have directly participated in the production of wealth but those to whom Allah has made it obligatory upon others to help, are the legitimate sharers in wealth. Hence, the poor, the helpless, the needy, the paupers and the destitutes - they too have a right to wealth. For Allah has made it obligatory on all those producers of wealth among whom wealth is in the first place distributed that they should pass on to them some part of their wealth. And the Holy Quran makes it quite explicit that in doing so they would not be obliging the poor and the needy in any way, but only discharging their obligation, for the poor and the needy are entitled to a share in wealth as a matter of right. Says the Holy Quran: "In their wealth there is a known right for those who ask for it and those who have need for it.” (70:24-25) 30 Meezan Bank’s Guide to Islamic Banking In certain verses, this right has been defined as the right of Allah. For example: “And pay what is rightfully due to Him on the day of harvesting." (6:142) The word "right" in these two verses makes it clear that participation in the process of production is not the only source of the right to ''wealth'', and that the needy and the poor have as good a right to "wealth" as its primary owners. Thus Islam proposes to distribute wealth in such a manner that all those who have taken a part in production should receive the reward for their contribution to the production of wealth, and then all those too should receive their share that Allah has given a right to "wealth". c) Eradicating the concentration of wealth: The third object of the distribution of wealth, which Islam considers to be very important, is that wealth, instead of becoming concentrated in a few hands, should be allowed to circulate in the society as widely as possible, so that the distinction between the rich and the poor should be narrowed down as far as is natural and practicable. The attitude of Islam in this respect is that it has not permitted any individual or group to have a monopoly over the primary sources of wealth, but has given every member of the society an equal right to derive benefit from them. Mines, forests, un-owned barren lands, hunting and fishing, wild grass, rivers, seas, spoils of war etc., all these are primary sources of wealth. With respect to them, every individual is entitled to make use of them according to his abilities and his labor without anyone being allowed to have any kind of monopoly over them. "So that this wealth should not become confined only to the rich 31 Meezan Bank’s Guide to Islamic Banking amongst you”. (59:7) Beyond this, wherever human intervention is needed for the production of wealth and a man produces some kind of wealth by deploying his resources and labor, Islam gives due consideration to the resources and labor thus deployed, and recognizes man's right of property in the wealth produced. Every one shall get his share according to the labor and resources invested by him. Says the Holy Quran: “We have distributed their livelihood among them in worldly life, and have raised some above others in the matter of social degrees, so that some of them may utilize the services of others in their work". (43:32) But, in spite of this difference among social degrees or ranks certain injunctions have been laid down in order to keep this distinction within such limits as are necessary for the establishment of a practicable system of economy, so that wealth should not become concentrated in a few hands. Of these three objects of the distribution of wealth, the first distinguishes Islamic economy from Socialism, the third from Capitalism, and the second from both at the same time. 32 Meezan Bank’s Guide to Islamic Banking SECTION II RIBA, ITS PROHIBITION & CLASSIFICATIONS 33 Meezan Bank’s Guide to Islamic Banking 4 RIBA IN THE QUR'AN 1. First Revelation (Surah al-Rum, verse 39) “That which you give as interest to increase the peoples' wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold.” (30: 39) 2. Second Revelation (Surah al-Nisa', verse 161) “And for their taking interest even though it was forbidden for them, and their wrongful appropriation of other peoples' property. We have prepared for those among them who reject faith a grievous punishment (4: 161)” 3. Third Revelation (Surah Al 'Imran, verses 130-2) “O believers, take not doubled and redoubled interest, and fear God so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey God and the Prophet so that you may receive mercy.” 4. Fourth Revelation (Surah al-Baqarah, verses 275-81) “Those who benefit from interest shall be raised like those who have been driven to madness by the touch of the Devil; this is because they say: "Trade is like interest" while God has permitted trade and forbidden interest. Hence those who have received the admonition from their Lord and desist, may keep their previous gains, their 34 Meezan Bank’s Guide to Islamic Banking case being entrusted to God; but those who revert shall be the inhabitants of the fire and abide therein for ever.” (275) “God deprives interest of all blessing but blesses charity; He loves not the ungrateful sinner.” (276) “Those who believe, perform good deeds, establish prayer and pay the zakat, their reward is with their Lord; neither should they have any fear, nor shall they grieve.” (277) “0, believers, fear Allah, and give up what is still due to you from the interest (usury), if you are true believers.” (278) “If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it.” (279) “If the debtor is in difficulty, let him have respite until it is easier, but if you forego out of charity, it is better for you if you realize.” (280) “And fear the Day when you shall be returned to the Lord and every soul shall be paid in full what it has earned and no one shall be wronged. “ (281) 35 Meezan Bank’s Guide to Islamic Banking 5 RIBA IN HADITH A. General 1. From Jabir : The Prophet, , may cursed the receiver and the payer of interest, the one who records it and the two witnesses to the transaction and said: "They are all alike [in guilt]." (Muslim, Kitab al-Musaqat, Bab la'ni akili al-riba wa mu'kilihi; also in Tirmidhi and Musnad Ahmad) 2. Jabir ibn 'Abdallah , giving a report on the Prophet's Farewell Pilgrimage, said: The Prophet, , addressed the people and said "All of the riba of Jahiliyyah is annulled. The first riba that I annul is our riba, that accruing to 'Abbas ibn 'Abd al-Muttalib [the Prophet's uncle]; it is being cancelled completely." (Muslim, Kitab al-Hajj, Bab Hajjati al-Nabi, ; may also in Musnad Ahmad) 3. From 'Abdallah ibn Hanzalah : The Prophet, , said: "A dirham of riba which a man receives knowingly is worse than committing adultery thirty- six times" (Mishkat al-Masabih, Kitab al-Buyu', Bab al- riba, on the authority of Ahmad and Daraqutni). Bayhaqi has also reported the above hadith in Shu'ab al-iman with the addition that "Hell befits him whose flesh has been nourished by the unlawful." 36 Meezan Bank’s Guide to Islamic Banking 4. From Abu Hurayrah : The Prophet, , said: "On the night of Ascension I came upon people whose stomachs were like houses with snakes visible from the outside. I asked Gabriel who they were. He replied that they were people who had received interest." (Ibn Majah, Kitab al-Tijarat, Bab al-taghlizi fi al-riba; also in Musnad Ahmad) 5. From Abu Hurayrah : The Prophet, , said: "Riba has seventy segments, the least serious being equivalent to a man committing adultery with his own mother." (Ibn Majah) 6. From Abu Hurayrah : The Prophet, , said: "There will certainly come a time for mankind when everyone will take riba and if he does not do so, its dust will reach him." (Abu Dawud, Kitab al-Buyu', Bab fi ijtinabi al-shubuhat; also in Ibn Majah) 7. From Abu Hurayrah : The Prophet, , said: "God would be justified in not allowing four persons to enter paradise or to taste its blessings: he who drinks habitually, he who takes riba, he who usurps an orphan's property without right, and he who is undutiful to his parents." (Mustadrak al-Hakim, Kitab al-Buyu') B. Riba an Nasiyah 1. From Usamah ibn Zayd : The Prophet, , said: "There is no riba except in Nasiyah [waiting]." (Bukhari, Kitab al-Buyu', Bab Bay' al-dinari bi al-dinar nasa'an; also Muslim and Musnad Ahmad) "There is no riba in hand-to-hand [spot] transactions." (Muslim, Kitab al-Musaqat, Bah bay'i al-ta'ami mithlan bi mithlin; also in Nasa'i) 37 Meezan Bank’s Guide to Islamic Banking 2. From Ibn Mas'ud : The Prophet, , said: "Even when interest is much, it is bound to end up into paltriness." (Ibn Majah, Kitab al-Tijarat, Bab al-taghlizi fi al-riba; also in Musnad Ahmad) 3. From Anas ibn Malik : The Prophet, , said: "When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favours mutually." (Sunan al-Bayhaqi, Kitab al-Buyu', Bab kulli qardin jarra manfa'atan fa huwa riban) 4. From Anas ibn Malik : The Prophet, , said: "If a man extends a loan to someone he should not accept a gift." (Mishkat, on the authority of Bukhara's Tarikh and Ibn Taymiyyah's al-Muntaqa) 5. From Abu Burdah ibn Abi Musa : I came to Madinah and met 'Abdallah ibn Salam who said, "You live in a country where riba is rampant; hence if anyone owes you something and presents you with a load of hay, or a load of barley, or a rope of straw, do not accept it for it is riba." (Mishkat, reported on the authority of Bukhari) 6. Fadalah ibn 'Ubayd said that "The benefit derived from any loan is one of the different aspects of riba." (Sunan al-Bayhaqi) This hadith is mawquf implying that it is not necessarily from the Prophet; it could be an explanation provided by Fadalah himself, a companion of the Prophet,. C. Riba al-FadI 1. From 'Umar ibn al-Khattab : The last verse to be 38 Meezan Bank’s Guide to Islamic Banking revealed was on riba and the Prophet, , was taken without explaining it to us; so give up not only riba but also raibah [whatever raises doubts in the mind about its rightful-ness]. (Ibn Majah,) 2. The Prophet, , said, "Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sell barley for date anyway you please on the condition it is hand-to-hand (spot).” 3. From Abu Sa'id al-Khudri : The Prophet, , said: "Do not sell gold for gold except when it is like for like, and do not increase one over the other; do not sell silver for silver except when it is like for like, and do not increase one over the other; and do not sell what is away [from among these] for what is ready." (Bukhari, Kitab al- Buyu', Bab bay'i al-fiddati bi al-fiddah; also Muslim, Tirmidhi, Nasa'i and Musnad Ahmad) 4. From 'Ubada ibn al-Samit : The Prophet, , said: "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt - like for like, equal for equal, and hand-to-hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand-to-hand." (Muslim, Kitab al-Musaqat, Bab al-sarfi wa bay'i al-dhahabi bi al-waraqi naqdan; also in Tirmidhi) 5. From Abu Sa'id al-Khudri : The Prophet, , said: "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt - like for like, 39 Meezan Bank’s Guide to Islamic Banking and hand-to-hand. Whoever pays more or takes more has indulged in riba. The taker and the giver are alike [in guilt]." (Muslim, ibid; and Musnad Ahmad) 6. From Abu Sa'id and Abu Hurayrah : A man employed by the Prophet, , in Khaybar brought for him janibs [dates of very fine quality]. Upon the Prophet's asking him whether all the dates of Khaybar were such, the man replied that this was not the case and added that "they exchanged a sa' [a measure] of this kind for two or three [of the other kind]". The Prophet, , replied, "Do not do so. Sell [the lower quality dates] for dirhams and then use the dirhams to buy janibs. [When dates are exchanged against dates] they should be equal in weight." (Bukhari, Kitab al-Buyu', Bab idha arada bay'a tamrin bi tamrin khayrun minhu; also Muslim and Nasa'i) 7. From Abu Sa'id : Bilal brought to the Prophet, , some barni [good quality] dates whereupon the Prophet asked him where these were from. Bilal replied, "I had some inferior dates which I exchanged for these - two sa's for a sa'." The Prophet said, "Oh no, this is exactly riba. Do not do so, but when you wish to buy, sell the inferior dates against something [cash] and then buy the better dates with the price you receive." (Muslim, Kitab al-Musaqat, Bab al-ta'ami mithlan bi mithlin; also Musnad Ahmad) 8. From Fadalah ibn 'Ubayd al-Ansari : On the day of Khaybar he bought a necklace of gold and pearls for twelve dinars. On separating the two, he found that the gold itself was equal to more than twelve dinars. So he mentioned this to the Prophet, , who replied, "It [jewellery] must not be sold until the contents have been valued separately." (Muslim, Kitab al-Musaqat, Bab bay'i al- qiladah fiha khara-zun wa dhahab; also in Tirmidhi and Nasa'i) 40 Meezan Bank’s Guide to Islamic Banking 9. From Abu Umamah : The Prophet, , said: "Whoever makes a recommendation for his brother and accepts a gift offered by him has entered riba through one of its large gates." (Bulugh al-Maram, Kitab al-Buyu', Bab al- riba, reported on the authority of Ahmad and Abu Dawud) 10. From Anas ibn Malik : The Prophet, , said: "Deceiving a mustarsal [an unknowing entrant into the market] is riba." (Suyuti, al-Jami' al-Saghir, under the word ghabn; Kanz al-'Ummal, Kitab al-Buyu', al-Bab al-thani, al- fasl al-thani, on the authority of Sunan al-Bayhaqi) 11. From 'Abdallah ibn Abi Awfa : The Prophet, , said: "A najish [one who serves as an agent to bid up the price in an auction] is a cursed taker of riba." (Cited by Ibn Hajar al-'Asqalani in his commentary on al-Bukhari called Fath al-Bari, Kitab al-Buyu', Bab al-najsh; also in SuyutT, al-Jami al-Saghir, under the word al-najish and Kanz al-'Ummal, op. cit., both on the authority of Tabarani’s al-Kabir) 41 Meezan Bank’s Guide to Islamic Banking 6 RIBA AND ITS TYPES Definition of Riba or Interest The word “Riba” means excess, increase or addition, which correctly interpreted according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money). This definition of Riba is derived from the Quran and is unanimously accepted by all Islamic scholars. There are two types of Riba, identified to date by these scholars namely ‘Riba An Nasiyah’ and ‘Riba Al Fadl’. ‘Riba An Nasiyah’ is defined as excess, which results from predetermined interest (sood) which a lender receives over and above the principle (Ras ul Maal) ‘Riba Al Fadl’ is defined as excess compensation without any consideration resulting from a sale of goods. ‘Riba Al Fadl’ will be covered in greater detail later. During the dark ages, only the first form (Riba An Nasiyah) was considered to be Riba. However the Holy Prophet also classified the second form (Riba Al Fadl) as Riba. The meaning of Riba has been clarified in the following verses of Quran: “O those who believe, fear Allah and give up what still remains of the Riba if you are believers. But if you do not do so, then be warned 42 Meezan Bank’s Guide to Islamic Banking of war from Allah and His Messenger. If you repent even now, you have the right of the return of your capital; neither will you do wrong nor will you be wronged.” Al Baqarah 2:278-9 These verses clearly indicate that the term Riba means any excess compensation over and above the principal which is without due consideration. However, the Quran has not altogether forbidden all types of excess; as it is present in trade as well, which is permissible. The excess that has been rendered haram in Quran is a special type termed as Riba. In the dark ages, the Arabs used to accept Riba as a type of sale, which unfortunately is also being understood at the present times. Islam has categorically made a clear distinction between the excess in capital resulting from sale and excess resulting from interest. The first type of excess is permissible but the second type is forbidden and rendered Haram. “Seized in this state they say: ‘Buying and selling is but a kind of interest’, even though Allah has made buying and selling lawful, and interest unlawful.” Al Baqarah 2:275 Classification of Riba 1. The first and primary type is called Riba An Nasiyah or Riba Al Jahiliya. 2. The second type is called Riba Al Fadl, Riba An Naqd or Riba Al Bai. Since the first type was specified in the Quranic verses before the sayings of the Holy Prophet , this type was termed as Riba al Quran. However the second type was not understood by the Quranic verses alone but also had to be explained by the Holy Prophet , it is also called Riba al Hadees. Riba An Nasiyah This is the real and primary form of Riba. Since the verses of Quran has directly rendered this type of Riba as haram, it is called Riba Al Quran. Similarly since only this type was considered Riba in the dark ages, it has earned the name of 43 Meezan Bank’s Guide to Islamic Banking Riba Al Jahiliya. Imam Abu Bakr Hassas Razi has outlined a complete and prohibiting legal definition of Riba An Nasiyah in the following words: “That kind of loan where specified repayment period and an amount in excess of capital is predetermined.” One of the ahadith quoted by Ali ibn at Talib (RAA) has defined Riba An Nasiyah in similar words. The Holy Prophet said: “Every loan that draws interest is Riba.” The famous Sahabi Fazala Bin Obaid has also defined Riba in similar words: “Every loan that draws profit is one of the forms of Riba” The famous Arab scholar Abu Ishaq az Zajjaj also defines Riba in the following words: “Every loan that draws more than its actual amount” Riba An Nasiyah refers to the addition of the premium which is paid to the lender in return for his waiting as a condition for the loan and is technically the same as interest. The prohibition of Riba An Nasiyah is one of those issues which have been confirmed in the revealed laws of all Prophets (AS). Some of the old testaments has rendered Riba as haram (See Exodus 22:25, Leviticus 25:35-36, Deutronomy 23:20, Psalms 15:5, Proverbs 28:8, Nehemiah 5:7 and Ezakhiel 18:8,13,17 & 22:12). The Quran has also stated the prohibition of Riba in various verses, has warned those who persist in practicing it of a war which is certain to be declared on them by Allah Himself and His messenger and has seriously threatened those engaged as writer, witness and dealer in Riba transactions. These verses and ahadith will be discussed 44 Meezan Bank’s Guide to Islamic Banking at length in a separate chapter called “The prohibition of Riba in the light of Quran and hadith”. According to the above definition of Riba An Nasiyah, the giving and taking of any excess amount in exchange of a loan at an agreed rate is included in interest irrespective whether at a high or low rate. It has been proven through ahadith that the Holy Prophet paid excess at the loan repayment time but since this excess was not paid through an agreed rate, it cannot be called interest. This clarifies that the word “draws” in the hadith definition“ The loan that draws interest is Riba.” has been used to highlight the giving and taking of excess amount through an agreed rate in the loan contract. Due to this, Imam Abu Bakr Hasas has added the word “condition” to the definition. The fact that Riba An Nasiyah is categorically haram has never been disputed in the Muslim community. In short, the Riba of today which is supposed to be the pivot of human economy and features in discussions on the problem of interest is nothing but this Riba, the unlawfulness of which stands proved on the authority of the seven verses of the Quran, of more than forty ahadith and of the consensus of the Muslim community. Wisdom behind the prohibition of Riba An Nasiyah First of all, we should realize that there is nothing in the entire creation of the world, which has no goodness or utility at all. But it is commonly recognized in every religion and community that things which have more benefits and less harms are called beneficial and useful. Conversely, things that cause more harm and less benefit are taken to be harmful and useless. Even the noble Quran, while declaring liquor and gambling to be haram, proclaimed that they do hold some benefits for people but the curse of sins they generate is far greater than the benefits they yield. Therefore, these cannot be called good or useful; on the contrary, taking these 45 Meezan Bank’s Guide to Islamic Banking to be acutely harmful and destructive, it is necessary that they be avoided. The case of Riba An Nasiyah is not different. Here the consumer of Riba does have some casual and transitory profits apparently coming to him, but its curse in this world and in the Hereafter is much too severe as compared to this benefit. The Riba consumer suffers such a spiritual and moral loss that it virtually takes away the great quality of being ‘human’ from him. An intelligent person who compares things in terms of their profit and loss, harm and benefit can hardly include things of casual benefit with an everlasting loss in the list of useful things. Similarly no sane and just person will say that personal and individual gain which causes loss to the whole community or group is useful. In theft and robbery for example, the gain of the gangster and the take of the thief is all too obvious but it is certainly harmful for the entire community since it ruins its peace and sense of security. Riba Al Fadl The second classification of Riba is Riba Al Fadl. Since the prohibition of this Riba has been established on Sunnah, it is also called Riba Al Hadees. Riba Al Fadl actually means that excess which is taken in exchange of specific homogenous commodities and encountered in their hand-to-hand purchase & sale as explained in the famous hadith: The Prophet said, "Sell gold in exchange of equivalent gold, sell silver in exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (Riba). However, sell gold for silver anyway you please on the condition it is hand-to- 46 Meezan Bank’s Guide to Islamic Banking hand (spot) and sell barley for date anyway you please on the condition it is hand-to-hand (spot).” This hadith enumerates 6 different commodities namely: 1) Gold 2) Silver 3) Dates 4) Wheat 5) Salt 6) Barley These six commodities can only be bought and sold in equal quantities and on spot. An unequal sale or a deferred sale of these commodities will constitute Riba. These six commodities in fiqh terminology are called “Amwal-e- Ribawiya”. Does this hadith apply only to the items mentioned in it? Does it concern sales of barley or wheat but not rice? Of dates but not raisins? A complete legal definition differs in every fiqh. Scholars such as Taoos and Qatada hold that Riba Al Fadl includes these specified types only, however a majority of Islamic scholars believe that some other commodities should also be included. In order to answer the question, which other commodities should be included, some fiqhs hold that the characteristics which are common amongst these items can be used as basis (illat) for Riba Al Fadl. An illat is the attribute of an event that entails a particular divine ruling in all cases possessing that attribute; it is the basis for applying analogy. Ribawi goods are therefore goods that exhibit one of the efficient causes occasioning application of Riba rules. Various schools define these causes differently: 47 Meezan Bank’s Guide to Islamic Banking Imam Abu Hanifa Imam Abu Hanifa sees only two common characteristics namely: 1) Weight 2) Volume Meaning all these six goods are sold by either weight or volume. Therefore all those commodities, which have weight or volume and are being exchanged, with the same commodity will fall under the rules of Riba Al Fadl. Imam Shafi The two characteristics observed by Imam Shafi are: 1) Medium of Exchange or 2) Eatable Therefore this law will apply on everything edible or having the natural ability of becoming a medium of exchange (currency). Imam Maalik Imam Maalik identified the following two characteristics: 1) Eatables and 2) Preservable Imam Ahmad Bin Hanbal Three citations have been related to him: i) First citation conforms to the opinion of Imam Abu Hanifa. ii) Second citation conforms to the opinion of Imam Shafai. iii) Third citation includes three characteristics at the same time namely edible, weight and volume. 48 Meezan Bank’s Guide to Islamic Banking After a detailed study of the above schools of thought, it has been declared by Islamic scholars that if a commodity bears both of the two characteristics namely; it has weight and can be used as a medium of exchange, then the following two kinds of transactions are not allowed when the same goods are being exchanged: A deferred sale of goods (A deferred sale is when the goods are returned/or paid for after some undetermined period) A sale of unequal quantities of the same goods However, when only one of the two characteristics is present to term the sale as Riba Al Fadl, then exchange of unequal goods are allowed but deferred sale is not allowed. Wisdom behind the prohibition of Riba Al Fadl The prohibition of Riba Al Fadl is intended to ensure justice and remove all forms of exploitation through ‘unfair’ exchanges and to close all back-doors to Riba An Nasiyah because in the Islamic Shariah, anything that serves as a means to the unlawful is also unlawful. The laws of Riba Al Fadl After closely analyzing the meaning and interpretation of the above ahadith and their explanation in further ahadith along with issues raised in reference work of Hanafi fiqh, the following rules and laws governing Riba Al Fadl are derived: 1. It is evident that the exchange of homogeneous commodities will only be required if they differ in quality and characteristic e.g. different genus of rice and wheat, superior quality gold and inferior quality gold, mineral salt and sea salt etc. The exchange of any of these six commodities with itself, but differing in types/quality (which is called barter in modern terminology), even when considering market rate, is prohibited in unequal 49 Meezan Bank’s Guide to Islamic Banking amount. The reason being that by exchanging these commodities in unequal amounts there is a fear of developing the rationale in a person eventually leading to interest (sood) based earnings and illegal benefits. Such transactions might also lead to defrauding. For example, a shrewd trader may claim that a kilogram of a specific brand of wheat is equivalent to 3 kilograms of the other kind because of the excellence of its quality, or this unique piece of gold ornament is equivalent in value to twice its weight in gold; in such transactions there undoubtedly is defrauding of people and harm to them. As a step to prevent this state, the Shariah has made it a law that exchange of any of these six commodities with itself but differing in quality, is allowed in only one of the following forms: a) Any difference in value/quality should be ignored and the commodities should be exchanged in equal amounts (equal weight and volume). b) Instead of direct exchange of commodities of the same kind, a person should sell his commodity against cash at the market value and buy someone else’s commodity in exchange of cash proceeds at the market value. 2. One of the ways of transacting commodities of the same kind is that a person has a raw material and someone else has a product made of that material and both decide to exchange their product. In this case, one has to see whether: a) The characteristics of this product has been totally changed by the industry: For eg. the remarkable changes that transform raw cotton into cloth or iron into machinery. In this case, it is permissible to transact lesser amount of cloth against greater amount 50 Meezan Bank’s Guide to Islamic Banking of raw cotton or raw iron having more weight against machinery having lighter weight. b) Little difference has been made to its original form after its formulation: For eg. gold which changes its shape in the form of jewelry. In this case, the Shariah’h holds that such a transaction should not happen in the first place or if it does, the exchange should be in equal weights in order to discourage unfair deals. Another alternative would be to sell gold against cash and the cash proceeds are used to buy the needed jewelry. This is because it is not possible in a barter transaction, except for an expert, to visualize the fair equivalent of one commodity in terms of all other goods. Hence, the equivalent may be established only approximately thus leading to some injustice to one or the other party. The use of money could therefore help reduce the possibility of an unfair exchange. 3. Different commodities can be unequally exchanged but deferred payment is not allowed. For eg. one kg wheat can be sold against 2 kg date or one gram of gold can be exchanged against 4 grams of silver on the condition that they are spot transactions reason being that such a transaction will surely be carried on the market rate. For eg. a person who wants to exchange silver for gold on spot will only transact as per the market rate. However, if the transaction is on credit, there is a possibility, no matter how minor, of stepping into interest that cannot be ignored. For eg. a buyer who has traded 80 tolas silver on credit today on the understanding that it will be exchanged against 2 tolas gold after a month has in fact no means to find in advance that 40 tolas silver will be equivalent to one tola gold after a month. Therefore this ascertaining of value in advance actually signifies its roots in interest and gambling. Similarly the seller who has accepted credit has in fact yielded to gambling by hoping that the ratio of gold and silver might come down from 51 Meezan Bank’s Guide to Islamic Banking 1:40 to 1:35. The law of exchanging different commodities only at spot has been established due to this reason. The general conditions of sale, however, should be borne in mind while making a trade transaction so that the goods are specified in addition to the cash aspect of the transaction. The correct way of specifying is that gold and silver should be under the possession of the sellers or delivered at the place of contract because both goods have the original (natural) price, which cannot be specified until they are delivered. This rule applies to only exchange of gold and silver. Other goods can be exchanged against each other without delivery and can be specified any other way but will be restricted to cash transaction. For eg. Zaid made a spot sale of one kg wheat to Bakar with 2 kg salt against future delivery after having identified their goods, this transaction is allowed in Shariah since it meets both conditions: The transaction is on spot. It is also specified. However, if Zaid was selling one tola gold to Bakar against 40 tola silver, then it is necessary that both take delivery of their purchased goods at the place of contract because without delivery, goods cannot be specified. To sum up, the Hanafi jurists maintain that in case of commodities that weigh or measure, it is illegal to transact unequally or on credit. But in case of different commodities unequal exchange is legal but credit remains illegal; the transaction in this case too should be spot. 52 Meezan Bank’s Guide to Islamic Banking 7 COMMERCIAL INTEREST AND USURY In the 17th century, two new technical terms of interest emerged after the establishment of banking system, namely: 1. Tijarti Sood (Commercial Interest): Interest paid on loan taken for productive & profitable purposes. 2. Sarfi Sood (Usury): Interest paid on loan taken for personal need and expenses. THE BACKGROUND OF BOTH TYPES: The present day banking system, which has given interest the moral and legal license, is the backbone of the prevalent capitalism. When Muslim countries became subjugated to west in their economic field, some westernized Muslims in the 19th century, on one side, saw the increasing progress of the west in trade and industry and on the other side saw the shattering economic condition of fellow Muslims states. They also became conscious of the fact that banking is inevitable in the field of trade and industry not only on national level but also internationally. This prompted them to say that only usury is haram (illegal) but not commercial interest because rendering commercial interest haram would pose irresolvable problems to their way up to industrialization and economic progress. They only included usury in the term “Riba” as categorically prohibited in Qura’n and sunnah and freed commercial 53 Meezan Bank’s Guide to Islamic Banking interest from it calling it totally different from the western concept of interest. Therefore, it was concluded that the prohibition of Riba was restricted to usury while commercial interest was perfectly Islamic. There are two schools of thought on this issue. A detailed analysis of their arguments is discussed as under: 1. First School: This school presents two arguments to support their point that only usury (not commercial interest) is prohibited in Islam: Argument 1 “Riba as practiced during the days of the Prophet was only Usury” Counter argument This claim is groundless, since Islam when prohibiting something does not only prohibit one form of it that is prevalent, but all forms that might erupt in future. The changed state does not change the ruling for eg. Qura’n has prohibited the following: a) Liquor (Khamar): During the time of Prophet its form and the way of production was totally different from that of the present day liquor but the ruling remains unchanged even though the form has changed. b) Pork (Khinzeer): Irrespective how clean the present day breeding of pigs in high class farms may be, pork will stay prohibited and cannot be rendered halal (legal). c) Corruption/Immorality (Al Fahsha): Although a lot of sophisticated ways have been developed of this evil from the time of Qura’nic revelations prohibiting it, the ruling stands forever. 54 Meezan Bank’s Guide to Islamic Banking The same applies to interest and gambling. By claiming that it was in a different form during Prophet’s time does not change its ruling. It remains unchanged just as in case of Khamar, Khinzeer and Al Fahsha. Argument 2 “Commercial interest did not exist in the days of Prophet ” Counter argument This claim is also wrong. If one glances through the Islamic and pre Islamic history of Arabia, it will be evident that the interest type at that time was not restricted to usury but loans were granted for commercial and profitable purposes. To quote some examples: a) “The tribe of Umro bin Aamir used to take interest from the tribe of Mughairah. At the advent of Islam, Mughairah owed heavy interest to Umro bin Aamir.” In this narration, the transaction of interest between 2 tribes of Arabia have been pointed out who actually operated as trading companies; both tribes were very wealthy. Could it be that 2 wealthy tribes transacted interest just for personal need and expenses? The interest was simply commercial! b) History of the city of Ta’if tells us that it was only second to Makkah in trade (their main exports being liquor, raisins, currants, wheat, wood etc) and industry (major being leather and dyeing). The tribe of ‘Saqeef’’ (Jewish tribe) advanced cash on interest, not only to the natives of Ta’if, but the business community of Makkah as well eg. the tribe of Mughairah who were their permanent customer. This advancement, which was not only restricted to cash but also to commodities between wealthy tribes of Taif and Makkah who were usually traders and businessmen, was only for their commercial purposes 55 Meezan Bank’s Guide to Islamic Banking and not for their consumption and personal needs. One of the ways of receiving interest was to double the principle amount plus interest in case of non payment of loan and this practice was applied to both cash as well as commodities. They had become accustomed to it. At the time of signing the peace treaty with the people of Ta’if, the Prophet imposed conditions: i) Total elimination of interest based transactions. ii) Giving up of interest owed to and from them. c) The practice of making 2 trade trips, one to Yemen in winters and the other to Syria in summer was started by the tribe of Quraish of Makkah. These trips proved to be very profitable especially since being custodians of Kaa’ba, Quraish were looked at with respect, granted special concessions and protected in transit which was a necessity at that time. This way business & trade became their only means of livelihood. Investment became the order of the day in which women also took part and its circulation flourished and multiplied. With this background in mind, one can easily visualize that the city of Makkah more or less became the clearing house or the banking city and accustomed to their related amenities. It was only natural that interest was one of them. Since they advanced cash for commercial purposes and charged compound interest incase of default by the traders, and this earning of interest was their trade, they argued when Qura’n rendered interest haram (illegal) that the transaction of interest based loans is a type of trade in which the return on capital can be earned as in the case of rent received from assets. They could not differentiate between excess in shape of profit during a trade and excess in the shape of interest at the time of repayment of loan. 56 Meezan Bank’s Guide to Islamic Banking d) Therefore in pre Islamic days, we see that Syedna Abbas bin Abdul Muttalib and Syedna Khalid bin Waleed formed a company with joint capital whose prime business was cash advancement on interest. Similarly Syedna Usman was one of the wealthy businessmen who lent money on interest. There were many other traders dealing full time in interest extending a network of interest based transactions. e) The way Syedna Zubair bin Awwam, who was famous for his trustworthiness, operated was quite similar to that of modern banking system. People used to deposit with him their capital as Amanah (trust or security). However, Syedna Zubair used to make it clear to the depositors that he would accept the deposits as a ‘loan’ and not as ‘security’ (Amanah). Because he knew that he will not be fully liable according to Shariah in case these Amanahs got destroyed but in case of having them as a loan, he will be fully liable to pay them back. He was afraid that in case of losing any deposited amount, his image as the trustworthy caretaker would be damaged. He therefore used the term ‘loan’ for such deposits to ensure guaranteed payment so that he enjoys everyone’s confidence in him. Another reason for using the word ‘loan’ was to legalize trading and earning profits on such deposits. Because if he got those deposits as Amanah, he could not utilize it for his business, as it is not permissible in Shariah to use Amanah. This clearly shows that borrowing in those days was not only for consumption purposes but for commercial purposes as well. Syedna Zubair left a will with his son Syedna Abdullah bin Zubair before he died to sell his property to repay the loan, if required. The total amount calculated after his death for repayment by his son was 22 lacs. It is obvious that a rich Sahaba such as Syedna Zubair did not owe this loan of 22 lacs out of any need; rather it was an 57 Meezan Bank’s Guide to Islamic Banking investment of securities that was circulating in trade. 58 Meezan Bank’s Guide to Islamic Banking ANOTHER CLEAR ARGUMENT Syedna Abu Hurairah narrated that the Prophet said, “He who does not abandon Mokhabara, will be caught in a war against Allah & His Prophet.” In this narration Prophet has rendered Mokhabara illegal just like riba and has declared a war against those who indulge in it just like riba. What is Mokhabara? Its actually a division of the crop by agreement between the landlord and cultivator in which the landlord gives his land to cultivator for cultivation purposes in order to get his pre- agreed amounts of the crop irrespective whether the production is low or high. For eg. “A” lends his land to ‘B’ for cultivation on the condition that he will get a predetermined portion on each crop eg. 5 mounds. Such a transaction is called Mokhabara. Prophet had called Mokhabara a form of riba. Now one should think over whether he referred to usury as the form of riba or he referred to commercial interest. It is similar to commercial interest as both Mokhabara and commercial interest are used for productive businesses. Whereas in the case of usury, the borrower uses the loan for personal use and not productive purposes. To sum up, Prophet included Mokhabara in riba that has no similarity with usury, rather with commercial interest. The fact that during Prophet’s time, the dealing in commercial interest was common is proven and also that this form is prohibited. 2. Second School: This group present two arguments justifying their point of view that are mentioned below: 59 Meezan Bank’s Guide to Islamic Banking Argument 1 The factor leading to prohibition of Riba (Interest) is that if a borrower faces a loss, he still has to pay an excess amount over the principal, which is basically an exploitation of his need whereas the lender on the other hand gets an increase on his surplus capital without any effort which is unjust. But this factor is not found in commercial interest since both the borrower as well as the lender gets profit; the borrower on the amount he has circulated in business and the lender in shape of interest over his principle amount. Therefore, no one faces unfairness or injustice in this transaction. Counter argument This argument is quite appealing and attractive at the face value, as it is based on the assumption that no one suffers in case of commercial interest. But after analysis, it is proven that Quran has not only prohibited that one party faces a loss and the other gets profit but has also prohibited one party getting confirmed profit and the other party unconfirmed profit from the same investment as we have studied above in the case of Mokhabara. Argument 2 This argument is based on the Qura’nic verse “O believers do not devour one another’s possession wrongfully; rather than that, let there be trading by mutual consent” (Al Nisa verse 29). In the above verse, Qura’n has prohibited “Wrongful devouring” which will only arise if the consent of one of the parties is absent and naturally the party who is devouring consents, the other party never consents; he only gives in since he has no other option. So we come to the conclusion that if the consent and satisfaction of both parties is present in a deal, it cannot be called “Wrongful devouring”. According to this logic, commercial interest is permissible since the mutual consent is present of both parties whereas riba is prohibited only when one party is getting the excess out of his selfishness and the other party is encountering the loss, as he has no other alternative. 60 Meezan Bank’s Guide to Islamic Banking Counter argument: This argument is of superficial nature. Mutual consent is not the criteria to render anything prohibited or not in Islam. Would the act of adultery be allowed if the condition of mutual consent is fulfilled? Similarly, there are many transactions in business, which are rendered illegal even with mutual consent. For reference see “Abwab ul Buyu al Batila” where Muhaqila and Talqi al Jalab being forms of Bai where the mutual consent and satisfaction is present and is prohibited by Prophet. Similarly, mutual consent is present in commercial interest and gambling too but in spite of that, it has been prohibited. Therefore no such criteria exist in the legality of any transaction that both parties approve; rather the approval should be on the transaction, which has not been prohibited by Shariah. To quote the words of Qura’n “Except the legitimate business…….” 61 Meezan Bank’s Guide to Islamic Banking 8 SIMPLE AND COMPOUND INTEREST Riba an Nasiyah can be classified into two types: ♦ Simple Interest ( Sood-e-Mufrid) ♦ Compound Interest (Sood-e-Murakkab) Definition of Simple Interest: Interest calculated only on the initial investment. Definition of Compound Interest: Reinvestment of each interest payment on money invested, to earn more interest. During the pre-Islamic era, when a borrower used to fail to pay back the principal and interest charged on him, then the lender used to extend the loan on the condition that the interest will also become part of the loan (essentially Compound Interest). The following verses of Quran were revealed in order to stop the people from such practices: “O believers, take not doubled and redoubled interest, and fear God so that you may prosper.” (Surah Al ‘Imran, verses 130-1) To eradicate this abominable practice of the period of ignorance, this verse was revealed. By mentioning the practice of doubling and redoubling, it was condemned and declared unlawful in view of its adverse impact on the community and the selfishness that it bred. It does not mean that if there is no doubling and redoubling (i.e., if there is 62 Meezan Bank’s Guide to Islamic Banking simple interest, in today's jargon), then it is lawful. No. In Surah Al Baqarah (The Cow) and Surah An Nisa (The Women), the prohibition of interest in its entirety and in absolute terms is clearly mentioned, whether or not there is doubling and redoubling. Since the aforementioned verse prohibits the compound interest only, some people misinterpret it even today that compound interest alone is forbidden in Islam, not the simple interest. They fail to see that there is absolute prohibition of simple interest in a number of other Quranic verses. The reason that the above verse specifically uses the words “doubled and redoubled interest “ is to highlight the shameful aspect of compound interest and not to limit the scope of riba only to compound interest. This is similar to Allah's command “Do not bargain on my orders for paltry gains in this world.” The reason for mentioning paltry gains is that even if all conceivable material goods and luxuries of this world are obtained in exchange for ignoring Allah's commands, even then this is a paltry gain. It does not obviously mean that it is prohibited to obtain paltry gains but permissible to obtain (by one's standard or judgment) a hefty price. Similarly, in the Ayat under consideration, the mention of doubling and redoubling is to condemn the shameful practice rather than limit its permissibility. Verses on absolute prohibition of Simple and Compound Interest “O believers, fear God and give up the interest that remains outstanding (i.e. whether it is simple interest or multiplied interest) if you are believers.” (Surah Al-Baqarah, verse 278) “If you do not do so, then be sure of being at war with God and His Messenger. But, if you repent, you can have your principal (only - not any kind of interest or premium). Neither should you commit injustice nor should you be subjected to it. 63 Meezan Bank’s Guide to Islamic Banking (Surah al Baqarah, verse 279) The above two verses demand to abandon the amount of riba and directs that only the principal amount should be paid back, nothing in excess. The second verse explains that any excess on principal, no matter how insignificant, is cruel. The following hadith also proves that both simple and compound interest are forbidden: “Listen! all Riba liable to you in the pre-Islamic days have been completely eliminated. You have to pay back the principal amount only. Neither hurt someone nor get hurt by someone. And the first riba to be completely eliminated is Abbas bin Mutalib’s. The above evidence proves that the claim that ‘only compound interest is prohibited and any riba less than that is allowed in Islam,’ is wrong. Any amount in excess of the principal fixed in the contract of a loan is called Riba An Nasiyah. If simple interest is accepted, it can also be used to give out additional loans, which will again pay out simple interest. In effect, the interest will keep on becoming part of the principal, which is essentially compound interest. 64 Meezan Bank’s Guide to Islamic Banking SECTION III ISLAMIC CONTRACT 65 Meezan Bank’s Guide to Islamic Banking 9 ISLAMIC CONTRACT In Islamic jurisprudence what is the ruling of putting a condition on a contract or agreement? There are four basic rules for judging the validity of conditions in a contract: 1) A condition, which is not against the contract, is a valid condition. 2) A condition, which seems to be against the contract, but it is in the market practice, that type of condition is not void, if its voidness is not proven with the clear injunctions of the Holy Quran and Sunnah. For example ‘A’ buys an air conditioner on a condition that the seller will provide him five-year guarantee and one year free service. This type of condition does not invalidate the contract. 3) A condition that is against the contract and not in the practice of market but it is in favor of one of the contractors or subject matter, this type of condition is void. For example if ‘A’ says he sells a car with a condition that he will use it on a fixed date every month, this contract will be void. 4) A condition, which is against the contract, not in the market practices and not in favor of any contractor, is not a void condition. Now a question arises what is the ruling of void condition, whether it invalidates the contract or not? 66 Meezan Bank’s Guide to Islamic Banking The answer is that there is a detail about the impacts of void condition. Sometimes a void condition invalidates the contract and sometimes it does not invalidate the contract, however, the condition itself is annulled. To elaborate this, Islamic jurists and scholars have written that the compensation (Uqood Muawadha) like sale, purchase, lease agreements become void by putting void condition. However, non-compensatory (voluntarily) agreements (Uqood Ghair Muawadha) like contract of loan (Qard-e-Hasanah), do not become void because of void condition. The void condition, however, becomes itself ineffective. For example if ‘A’ gives to ‘B’ a loan with a condition of premium at the time of repayment, this condition of interest is void. However, this condition does not invalidate the contract, therefore all transaction done by this borrowed money, will be valid. But the condition of interest itself is revoked; therefore ‘B’ is not liable for the payment of interest. Rights, Responsibility and Obligation in a contract: In Islamic Fiqh, some contracts are such that rights and obligations are also attached to the Agent doing the contract on behalf of the Contracting Party eg. Sales Contract, Ijara, Istisna, Salam etc. While in others Principal has all the responsibilities, rights & obligations eg. Nikah. 67 Meezan Bank’s Guide to Islamic Banking 10 SALE Sale (Bai) is commonly defined in shari’ah as “the exchange of a thing of value by another thing of va

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