Islamic Banking & Finance; Its Operation and the Necessity for It's Accomodation in The Global Economy

Islamic Banking & Finance; IT'S Operation and The Necessity for It's Accommodation In The Global Economy
Temple UniversityJames E. Beasley School of Law
Guided Research Paper
From: Elwaleed M Ahmed
To: Prof. James J. McGrathRe:
Final DraftDate: July 20, 2004
ISLAMIC BANKING AND FINANCE:ITS OPERATION AND THE NECESSITY FORITS ACCOMMODATION IN THE GLOBAL ECONOMYISLAMIC BANKING AND FINANCE:ITS OPERATION AND THE NECESSITY FORITS ACCOMMODATION IN THE GLOBAL ECONOMY
By: Elwaleed M Ahmed[1]

The recent phenomenon of Islamic banking and financial institutionsstarted in Egypt in the 1960s. These banks, which neither charged nor paid interest,functioned essentially as a saving investment institution rather than commercialbanks, by engaging in trade and industry, directly or in partnership with others, andshared the profit and loss with their customers and depositors. These banks systemsfunctioned under the mandates of “shari’a,” Islamic law that prohibits usury and interest.[2]Thus Islamic finance is based on the principle of profit and loss sharing.[3]Since then there have been growing demands from Muslims everywhere to havetheir finance managed according to Islamic laws.[4] Therefore, in the 1970s, Islamicfinancial institutions really took off, due at least in part to the new oil wealth in the gulf.[5]Since then, “Islamic banking in the Middle East is growing and becoming important inmobilizing local and regional saving, as well as providing an important source ofcapital.”[6]Contributing to the growth of Islamic banking in the Middle East was theestablishment of the Islamic Development Bank by the “Islamic OrganizationConference” in the early 1970s. The Islamic Development Bank serves as a “WorldBank” for Muslim countries, with the aim to facilitate the expansion of the Islamicbanking and financial institutions in the Muslim countries and world wide.[7] As a result,the annual growth of the Islamic financial institutions has been an estimated almost 15%worldwide over the last decades.[8] To understand the principle on which the Islamicbanking and finance is based, It is essential to have some an overview of the Islamic lawand its sources and jurisprudence.Therefore, to assess the importance of the Islamic banking andfinance in meeting the Muslims community financial need, this article will explain howthe Islamic banking and finance works and the justification of the prohibition of “Riba”interest in the Islamic law. Moreover, it will explain how the major allowed types ofIslamic financial services work and recommend the best way for Islamic financialinstitutions to improve and get acceptance globally by nationally and globally unifiedsharia board. Sharia board decides what type of finance is expected in the Islamic lawand recommends the unified accounting and regulatory standard body togovern the Islamic banking and finance operation in national and global basis. The paperalso recommends the establishment of liquidity markets to handle the operation of theIslamic banking and financial institutions. Moreover, the paper will recommend how toaccommodate the Islamic banking and finance systems in a global economy, especially inthe non-Islamic countries so as to meets the need of the growing Islamic communities.In Part I, the paper will purpose that to understand the justification of the Islamicprohibition of Riba: “Interest” and how the Islamic banking and finance works someknowledge about Islamic law, its sources and jurisprudence is necessary. Therefore,include the sources and jurisprudence of the Islamic law: "Figh," such as “Qur’an:”which is the God “Allah's” word and instruction to his Prophet Mohamed (peace uponhim.) “Sunna:” the prophet’s words and deeds Ijtihad: "Refer to the formulation of thelaw by the individual's struggle for proper understanding," Ijm'a: " Consensus of opinionand Quiyas: " analogical-deduction." And finally, Madahib: "the different schools ofIslamic law Jurisprudence" approach to the issues of Islamic Finance and the prohibitionsof the “Riba” Interest. Part II, includes the types and definition of Riba: the Islamicjurisprudence divine Riba in two types: “Riba Al-fadil” and Riba: “Al’ Nasia.” The paperwill offer the justification of the prohibition of Riba in the Islamic law and how thefinancial affairs are addressed in the Islamic law. Furthermore, the paper will explainhow the Islamic faith is a way of life as well as a religion. Muslims whenever they havebeen they always have to adhered to the Islamic principle.Part III, will include how the Islamic banking and financial institutions operateand will describe the most common types of the permissible Islamic financial methods,and how they work and the justification of accepting interest according to the principle ofloss and profit sharing. The expected types of Islamic finance include, Mudraba: “TrustFinancing,” Igra wa-igtin: “Lease/hire-purchase,” Murabaha: “Cost-plus Financing,”Musharaka: “Venture Capital,” Bai’salam Transaction. Further types include:“Manazile scheme:” Islamic mortgage housing, property finance a Istisna contract: “is acontract to manufacture,” Bai’ bi thamin ajil: “sale by deferred payment,” Al-wadiah: “non-fund transaction” and Qurde-Hasan: “ Benevolent financing.”Part IV, will include a comparison between the Islamic banking and financesystems and the conventional banking systems: "Western banks" and the major criticismof the Islamic banking and finance.Part V, the final section of this paper will include recommendations.(I): How to improve the operation and effectiveness of the Islamic banking and financesystem by :A: The necessity of the existence of the unified Sharia board in the national and globalbased so as to unify the decision on what are permissible types of Islamic financialglobally.B: The necessity of the unified accounting and regulatory standard body to govern theIslamic banking and finance nationally and globally. For the Islamic financial institutionto succeed and to achieve global acceptability and continue its rapid expansion it needs toestablish universally accepted accounting, auditing and regulatory standard.C: One of the major challenges to Islamic financial institutions remains how tohandle their liquidity. Therefore, there is a necessity of the establishment of liquiditymarkets to handle the operation of the Islamic banking and financial institutions.(II): How to accommodate the Islamic banking and finance systems in globaleconomy especially in the non-Islamic countries so as to meets the need of thegrowing Islamic communities including:A: Since the Islamic law did not require the banks to be Islamic bank or all itsresources to be Halal “permitted,” then the conventional institution can have subsidiariesoffer Islamic finance to Muslim and non Muslim alike as an alternative to the interest-finance. Therefore, there is a possibility of establishing Islamic financial institution in theUS as a subsidiary for the conventional banks.B: The possibilities of opening non- banking Islamic financial Institution dealingmainly in providing the basic Islamic financial services in the non – Islamic countries.Part I: The Source and Jurisprudence of the Islamic law: “Figh:”The science of Figh is directed no less toward understanding and analyzing thedeeds and sayings of the prophet Mohamed (Peace upon him), as toward the writtenword of the God’s ‘Allah’ Mandates, and to find and collect the different norms ofIslamic law.[9]In order to understand the justification of the Islamic prohibition of “Riba”interest and how the Islamic banking and finance works you have to have someknowledge about Islamic law its sources and jurisprudence what follows are someillustration:A: Qur’ an: “the holy book of the Islamic faith,” The Qur’an is understood byMuslims to be the infallible words of God “Allah” and contain instruction in bothreligious and daily aspects of life.[10] Thus the Qur’an consists of the revelation made byGod “Allah” to the prophet Mohamed (Peace upon him) and lays down the fundamentalsof the Islamic faith including beliefs and all aspects of the Islamic way of life.[11]Therefore, the scholars have treated the holy Qur’an as a text that contain the generalprinciple by which all matter should be regulated. And where the meaning of the holyQur’an was imprecise they sought clarification from the “Sunna Hadeath.”[12]B: Sunna: “Tradition of Prophet Mohamed” (Peace upon him). Because God“Allah” was “revealed to the prophet Mohamed, his actions and sayings were and arebelieved to be the best possible interpretation to God’s commandments contained in theQur’an.”[13] Thus Sunna is the teaching of the Islamic principle by the prophet“Mohamed,” recorded only after having been deemed valid by religious scholars indecades after the death of the prophet “Mohamed.”[14]C: Ijtihad: refers to formulations of the law reached via the individual’s strugglefor proper understanding, using reason and judgement to determine a course of action inkeeping with the spirit of the holy Qur’an and Sunna.[15] Thus, Ijtihad “means theindependent interpretation of law by one who has learned to solve a situation that is newor for which there is no precedent or authority or pronouncement in other sources ofFigh.”[16] Ijtihad was based on the linguistic and religious knowledge and was conductedpiously and in good faith. The “Mujtahid,” the one who conducted the Ijtihad, didn’thave to fear retribution from God “Allah.”[17]D: Ijm’a: “ consensus of opinion,” is the informed consensus of the communityof scholars, and was established not for matter of faith or fundamental observances,which were agreed upon, but on the application of the shari’a law to world’s affair.[18]E: Qiyas: “ Analogical deduction” or analogy from established law mean that bycomparing two things one may be evaluated in the light of the other.[19]F: Madahib: refers to “schools of thoughts in the Islamic law.” There are twomajor schools of law in the Islamic jurisprudence: “Shia” and “Sunna.”I: Shia, which has various sub –section is predominate in Iran Iraq, India andmany of the Gulf states. There are considerable doctrinal differences between Shia andSunni in terms of who is permitted to interpret the Islamic law. The shia believe theliving religious scholar, known as “Mujtahids, have an equal right to interpret the divinelaw as the eminent jurist of the past and their judgement replaces the Sunni source ofdeduction by analogy, Qiyas.”[20]II: Sunni, The majority of Muslims follow Sunni school of thoughts. Sunni legaldoctrine has four main schools of thoughts, each with its own system of theory andapplication of law. However, they all recognize the legitimacy of all the others. In Sunnithe four schools of thoughts are Hanafi “Rationalist,” Malki “Traditionalist,” Hunbali“Fundamentalist” and the Shafii “Moderate.”[21]Furthermore, these four schools of lawgive different emphasis to the source of law, but all are anonymous in requiring thatIslamic law be God “ Allah,” is not man's creation and the holy Qur’an and Sunna arefully binding. The other sources of authorities are in one way or another justified byreference to these two basic laws.[22] These schools of jurisprudence differ in theirinterpretation of the importance of the Ijtihad, the component of the Ijtihad and Ijma’a,and the importance of how certain individuals can interpret almost all-religious issue.Individuals are given much freedom in choosing the particular of the law they wish tofollow.[23]Part II: The Types and Definition of “Riba” the Justification of its Prohibition in the Islamic Law and How the Financial Affair Addressed in Islamic Law:(I): The definition of the “Riba” in Islamic law:Riba is defined as any increase over the nominal value of the sum lent.[24]Moreover, according to the Qur’an, “Riba” is neither a sale nor voluntary charitable act,“it is an equitable exchange destructive to and out of place in fair economicorder.”[25]Thus, he definition of Riba as usury includes interest and other forms of profit orgain that are not earned from work efforts.[26] “Islamic law prohibits any profiting fromsupply of capital without any personal engagement or exposure to financial risk.”[27]Therefore, Riba prohibits any predetermined fixed positive return to theloan as a reward for the delay.[28] Also, considered Riba is any ‘excess to exchange of twoor more commodities of the same type taking place in the spot market. “This prohibitionaims to ensure that no legal trick or device will be used as back-door to Riba, associatedwith deferred transaction.”[29] Furthermore, the purchase of the government bonds andfirm securities with fixed rate of return are considered Riba and hence prohibited.[30](II): Islamic Jurisprudence Divides Riba into Two Types:A: Riba Al-fadl: “excess on exchange” defined as Riba arising out of barter orsale. Riba Al-fadl involves an exchange of unequal quantities and qualities of the samecommodity simultaneously[31].B: Riba Al-nasia: “excess on loan” defined as Riba arising out of moneyexchanges “Loan.”[32] “Riba Al-nasia involves the non- simultaneous exchange of equalqualities and quantities of the same commodity.”[33](III): The justification of why the Islamic law prohibits the Riba:The prohibitions of Riba in Islam seek to prevent usurious condition in exchangeand loan,[34] because “the Islam’s economic ideal is one of legal fairness, of mercy, andleniency in times of hardship.”[35] By prohibiting certain classes of interest in either tradeor loan, Islam seeks to correct the usurious practice which is a desirable result,[36] becauseRiba is a raise from an unequal unfair exchange, namely an increase over the principle amount lent or the quantity traded.[37]Thus, Riba is prohibited because “it is a contract that contains certainty, while real life is not certain.”[38] Riba is an unearned profit without expected normal businessrisk.[39]Moreover, “the practice of Riba enrich the class of money lenders and usurers whoaccumulate wealth by impoverishing those who are forced to borrow money orcommodities from them for mere consumption, basic necessities, or for limitedproduction purposes.” Such lenders do so by charging interest or making uneven trades intheir favor.[40]Furthermore, Riba was an unearned income in the sense that the owner ofthe capital who loaned his capital for an increment without contributing any productiveactivities, collects profits that are considered illegitimate, because they didn’t give anyequivalent recompense return or counter value “Iwad” to other party.[41]The prohibition of Riba extends to any and all forms of interest and there is nodifference between interest bearing funds for purposes of consumption orinvestment.[42]Furthermore, interest as a predetermined cost of production can contributeto unemployment and those interest charges can exacerbate business cycles and causeinternational monetary crises. Because “interest involves a transfer of property withoutcounter value those who live on interest have little incentive to work and wherelenders are richer than borrowers interest result in increasing inequality and socialfrictions.”[43]Thus, the Islamic text does not distinguish between borrower and lender, andsupports the idea that the prohibition’s purpose is not redistribution of wealth but tothe assurance of fair economic exchange while allowing return of capital profit andservices charges.[44] It is contrary to Islamic law to make money out of money and thatwealth should accumulate from trade and ownership of real asset.[45]The reasoning that justifies the prohibition of the Riba is rooted in fourdifferent verses in the holy Qur’an. The first of these verses emphasizes that interestdeprives wealth of God blessing. The second condemns it, “placing interest injuxtaposition with the wrongful appropriation of property belonging to others.” The thirdverses enjoins Muslims to stay clear of interest for the sake of their own welfare. Finally,the fourth “establishes a clear distinction between interest and trade, urging Muslims firstto take only the principle sum and second to forgo even this sum if the borrower is unableto repay.”[46] Moreover, Prophet Mohamed (peace up on him) condemns, the one whotakes the Riba, the one who pays it, and the one who writes the agreement for it and theone who witness to the agreement.[47]Riba is prohibited in holy Qur’an: Chapter II verse 275 from holy Qur’an state:Those who devour [riba]Will not stand exceptAs stand one whomThe Evil one by his touchHath driven to madnessThat is because they say:“[Sale] is like usury [(riba)].”But Allah hath permitted [Sale]And forbidden [riba].[48]And the Qur’an further warns:O ye who believe!Fear Allah, and give upWhat remain of your demandFor [Riba], if ye areIndeed believers.If ye do it not,Take notice of warFrom Allah and his Messenger:But if ye turn back,Ye shall haveYour capital sums.Deal not unjustly,And ye shall notBe dealt with unjustly.[49](IV): How Financial Affairs are addressed in Islamic law:Under most schools of Islamic law an Islamic financial system would complywith at a minimum the following principle: (1): the prohibition of Riba. (2): Risk –sharing. (3): Prohibition of speculative behavior. (4): Sanctity of contract. (5): Activitythat conforms to Sharia[50]. Because man is an agent, not an original owner, he is not a freeagent in his exploitation of resources and must use methods and means within a framework given to him in the satisfaction of his economic means. And the guiding principle ofeconomic activity is the over all good of the society and nature. Moreover, individualman being part of the over all fabric, must be given consideration for his wellbeing. Also,“equitable reward must be given to man according to his effort, to all people according totheir efforts, and from all according to their abilities.”[51]Therefore, Islam permits the development of wealth, but through sociallyconscious means. Successful enterprises that earn a profit are laudable, but thepractitioner must not forget that Islamic principles direct that financial resources shouldbe utilized for bettering the condition and well being of other.[52] Furthermore, while Islampermits the individual’s rights to seek his economic well being, Islam makes a cleardistinction between the “Halal:” what is lawful and “Haram:” what is forbidden inpursuit of such economic activity. In broad terms, Islam forbids all forms of economicactivity, which are morally or socially, injurious.[53]Part III: Operation of Islamic banking and financial institutions and the types and justification of the allowed Islamic finance:(I): Operation of the Islamic banking and financial institutions:On the surface, Islamic banking systems differ greatly from all Western bankingsystems. Imagine being able to borrow money without paying interest and having thefinancial institutions assume half the risk; this is a common transaction in the rapidlygrowing world of Islamic banking.[54]All Islamic banks or financial institutions have a religious supervisory board(RSB), consisting of an Islamic scholar, who acts as advisory council to the official of theIslamic institutions. The “RSB” is set up as permanent institutions located and financedby the Islamic financial institution “IFI”. The “SRB” oversees the Islamic financialinstitution activities according to Islamic law and publishes its opinion in theIslamic financial institutions annual reports.[55] Thus, the business section of the Islamicbanks works in connection with the supervisory board of religious “SBR” to reviewproposed financial transactions to conform to Islamic principle.[56]The fundamental principle underlying the Sharia approach to finance is thatno one wishing to earn a return on money has any rights to retain the initial sum intact; inorder to earn profit in Islamic finance, it is necessary to take risk. Moreover, thefoundation of the Islamic banking is asset management.[57] Although, Islamic finance restson two main principles: (1): the main financed asset must exist. (2): “the financier mustbear the risk associated with this asset for some period of time, and that what will justifya rate of return on the basis of this risk exposure.”[58]Investment agencies in the Islamic financial systems work according to a contract,in which an agent invests funds on behalf of the principal in exchange for a fixed wage orshare in profit.[59] “The principal owns the invested fund, therefore is entitled to the profitof the investment and liable for its losses, while the agent is entitled to a fixed wage if theagency stipulates that.”[60]Furthermore, Islamic-banking systems are based on sales agreements; “Islamicbank sells you the money, making a profit on that sale. On the other hand, the depositorsin the Islamic banking systems do not earn any return on their deposit while thoseholding ‘investment accounts’ earn a shared of the profit and exposed to potentiallosses.”[61]In project finance, Islamic banks will lend against the title of a key parts ofgiven project. Technically it is not a loan, but a purchase and sale agreement.[62]Moreover,the Islamic bank can pursue sale by order such as “Salam and Istisna” financing, andthen can buy the non- existent goods at a discount such as “ the salam and Istisan price”and sell the goods later on delivery at retail price.[63](II): The Types and Justification of the Allowed Islamic Finance:The basic role of all Islamic finance is that there must be profit and loss sharingbetween the financier and the entrepreneur to justify the interest collected from anyfinancing operation under Islamic law. Therefore, there has to be some kind of risksharing to justify any Islamic finance. Here are some types of the most accepted methodsof Islamic finance:A: For the Islamic financial institution to succeed in obtaining profit theyconcentrate in some specific types of finance, which is easy for them to control theoperation of the financed services so as to minimize the risk of losses. What follows isthe most Frequently used type of Islamic finance:1:Mudraba: “Trust Financing” is financing transaction equivalent to “venture capitalism.” It allows the entrepreneur with a business plan to make use ofinvestor’s capital[64]. Therefore, “Mudraba, in turn is a profit sharing agreement betweentwo parties in which one provides the finance and the other provides entrepreneurial and management skill. The profit in this finance is divided on a pre-determined ratio and theloss borne by the provider of the capital.”[65] In contrast, the bank can’t require anyguarantee such as security or collateral to secure his capital against any loss in thetransaction. But “if there is any negligence or mismanagement or any action beyond thoseoriginally provided for in the contract from the entrepreneur, the entrepreneur will beresponsible for the financial loss and may be obligated to reimburse the financier.”[66] Thisfinancial transaction is permitted because of the risk sharing involved: the investor risksloss of his capital while the entrepreneur risks his time and effort.[67]2: Murabaha: “Cost-plus financing” is one of the most familiar and commonlyused finance transactions, mostly in trade and commodity finance. “This financetransaction involves the purchase of goods by the bank as requested by its client.Therefore, it is a sale contract between the bank and its client for sale of goods for pricethat include profit margin for both parties.”[68]The bank should have the custody of thegoods before signing the sales contract with the client and the bank also should not seekany collateral that may make the client committed in any way towards the bank.[69] “Thebank in Murabaha bears the risk during the period between the purchasing of the goodsand reselling of it to the customer,”[70]also by the risk of allowing the client to refuse toaccept the goods procured on their behalf by the bank. Thus those risks are what justifythis transaction[71].3: Igra wa-igtin: “Lease/hire-purchase.” In this transaction if the client requests“the banks to purchase the equipment or goods and resell them to him, the bank will bethe owner of these items and the client pay a fixed amount for its use.”[72] “If the client iscommitted to purchase the equipment from the bank at the end of the rental period, theprice is determined in advance and thus the installment payment would include both therental price and the purchase fee of the equipment.”[73] The fund on these financials issecure, because in order to obtain the fund the investor must offer collateral[74].Furthermore, the bank in this finance transaction bears the risk throughout the life of thelease contract[75]. Therefore, the bank takes the owner obligation and that will justify itsreturn in accordance with Islamic law.[76]4: Musharaka: “Venture Capital” “is an equity participation arrangement andequivalent to a partnership arrangement. In this finance arrangement all partners share infinance and management, and the profits are distributed according to pre-agreement ratio,but losses are shared on the basis of equity participant.”[77] “This a true partnership whereinvestor and the agent have a joint profit and loss –sharing and decision making.” [78]Furthermore, this involves active participation from both the financial institutionsand its client since all of them depend on the revenue sharing in the form of thepercentage of the net profit rather than the interest. And this will encourage close scrutinyand assessment of the viability and the implementation of the their investment. On theother hand since the client also contributes capital and becomes partner, he will be eagerfor the success of the investment.[79]B: In the following types of Islamic finance, the risk of loss is high because the Islamicfinancial institution has no very effective procedure to monitor the operation of thefinanced services, therefore, the following financial services are not frequently followed:1: Bai’salam Transaction: “In this finance transaction the goods purchased arepaid for in advance at the time of the execution of the contract, but the delivery of thegoods is delayed until a later date.”[80] In order for this contract to be valid all conditionsassociated with the contract such as price, quality and quantity of the goods have to bedetermined when the contract is signed.[81] Hence, “this Salam contract is considered as anexception to the general role of the Islamic law which prohibits the sale against advancepayment for future delivery of the goods, in order to meet the instant need for thefarmer’s sale,”[82]and to serve the public need. Therefore, this contract should be applied togoods transactions and not to the transaction of currencies.[83]2:Manzile Scheme: “Islamic Mortgage and Housing property finance:” Thisfinance is based on Musharaka and Ijra wa’ Igtina “lease and partnership” concept andrequires the financier and the client to participate in the joint ownership of theproperty. “The share of the financier is divided into a number of units, and the client isable to purchase those units one by one periodically.”[84]Therefore, “in the Islamicmortgage, the repayments were based on the implicit rental value of the property ratherthan on the basis of the interest. And that will provide a fixed repayment mortgages forhomebuyers and investors in private property.”[85]3: Istisna contract: “a contract to manufacture” is a new concept in Islamicfinance. “In this finance transaction the manufacturer agrees to produce, build and todeliver a well described good at given price on a given date in the future and the pricedoes not need to be paid in advance. It may be paid in installments while the job is beingcompleted or the asset being manufactured or constructed.”[86] “In this contract it shouldbe ensured that the goods subject to the contract are manufactured and not in their rawstatus. Therefore, the Istisna contract is not applicable to grain millet and rude oil.”[87]4: Bai’ bi thamin ajil: “sale by deferred payment:” This finance involves thebank purchasing the asset, equipment or goods desired by its client to whom it thenresells the items for an agreed of cost-plus profit.[88] Therefore, this transaction involvespurchase and resale of property for a higher price on delayed basis[89]. It justifies thatbecause of the risk the bank had if the client refused to take the goods after the bankpurchased the good.5:Al-wadiah: “non-fund transaction:” This is similar to a saving or investmentaccount in a conventional bank. “In these accounts the bank does not give interest andthey are in essence a safe keeping arrangement between the depositor and the bank. Theyallows the depositors to withdraw their money at any time and to permits the bank to usethe depositor’s money.”[90]6: Qurde-Hasan: “Benevolent financing:” This finance falls under the charitableactivities of these Islamic financial institutions. “It happens when the financialinstitutions provide loans free of charge, basically with intent to provide financialassistance to failing institutions or humanitarian assistance to individuals. Therefore, forthe financial institutions to make sure it is repaid they may require from the customer toprovide collateral and those institutions may charge a small fee to cover theiradministration fee.”[91]Part IV: Comparison to criticism of the Islamic financial institution: A: The Comparison between the Islamic Banking System and Conventional BankingSystem: There are some basic differences between the Islamic banking system and theWestern banking systems “the conventional banks.” First Islamic banking systems do notcharge or pay interest and they will not invest in enterprises they believe to be immoral,where the banker shares in the management of the borrowed fund during the life of theloan.[92] Moreover, Islamic banks, unlike their counterpart “conventional banks” have toshare in the risk of their transaction.[93]“In capitalist society, the ability for one to reap profit from investment is themost valued concept of the economics and interest is a pivotal concept.[94] Therefore, Thecapitalist motivational system is market oriented with particular emphasis on profitmotive. On the other hand, in the Islamic finance, the motivation is profit but guided bymoral and spiritual concerns rather than market concern.[95]Furthermore, it is accepted that“the capitalist system uses profit not as a means but as an end that will satisfy theindividual, while the Islamic system uses profit as a mean to achieve its spiritual end.”[96] In conventional banks the client is obligated to repay the bank, the principle amountof the loan, plus a set rate of interest over a term of monthly installments.”[97] Thus, theconventional banks is based on borrowing and lending and Islamic bank is based onselling.[98] Furthermore, Islamic finance is asset –based, or based on “money for asset,”opposite to “money for money” in the conventional banks.[99] In contrast, there are differences between a conventional leasing and ajara inIslamic finance. “In Islamic finance, a lease/hire begins the date the asset is delivered tothe client not the date the contract is signed as in the conventional banks. In Islamicfinance, the lessee is not liable for the full rent if the asset is destroyed and the factors inthe cost of insurance at the time the rent is fixed. Moreover, the purchase in Islamicfinance at the end of the contract can not be made binding.”[100]Furthermore, whatdistinguishes “Mudaraba:” cost plus finance from traditional interest based –finance thatthe recognition of the risk that assumed by the banks as a titleholder of the goods in“Mudaraba:” cost plus finance transaction.[101]B: Criticism of Islamic banking and finance:It would seem that a banking system that is based on the moral and spiritualprinciple could have no critics, but this not the case. In Islamic banking and finance,loans tend to have a complicated buy and lease instruction and the interest-free financingcarries numerous services and finance charges that can make the cost equal to fundadvanced from the conventional banks.[102] This is true despite the fact that the Islamicmodel of finance in some cases seems to guarantee a fixed rate of return, and in realityno risk is shared by the financier with entrepreneur.[103] Furthermore, the inflexible interpretation of Riba imposes on the borrower theneed to hire a legal advisor to instruct them on complex finances methods. Onthe other hand, “the fee charged on the profit sharing simply replaces in form of thoughtnot in name the interest charges.”[104] Moreover, when Riba is interpreted broadly toinclude all interest, the Islamic financial institution used the methods of trust financing,equity participation and leasing to circumscribe the Riba’s problems.[105] In consequence, Islamic financial institution is exposed to greater liability undernational and international law, because it assumes the ownership responsibilities. Theseinclude not only the risk of the losses or damages to the asset being funded but also anyliability arising out of the use of the asset.[106] Therefore, “the Islamic banking andfinancial systems can not survive and grow solely on the basis of committed ethicaldepositors or investors.”[107] On the other hand, Since the risk costs are shared in theIslamic banking and finance systems, as a result their products and services can becompetitive.[108] “The US government criticizes the Islamic banking systems as being a soft touchfor money laundress and terrorism financier.”[109] On the other hand, the Islamic bankingand finance supporters argue that, money laundering is hard through Islamic bankingsystems, because the element of risk sharing means there is “a closer know-yourcustomer” approach, and that may deter the money laundering.[110]Moreover, “hightransaction cost and low-level of capital will keep the Islamic bank from beingcompetitive with conventional banks.”[111]Part V: Recommendation and Conclusion:(I): How to improve the operation and effectiveness of the Islamic banking and finance system:A: The necessity of the existence of the unified Sharia board in the national andInternational levels in deciding what types of financial services are conforming to theIslamic law:There is a need for setting up Sharia board at global and central banks level, so asexpedite and perhaps assist in developing some standard guidelines for conductingIslamic financial transaction.[112] Sharia board at individual banks actually defines what isand is not Islamic banking. Thus, transaction will be interpreted differently and that willlead to uncertainty about what is the acceptable way to do business in Islamic bankingand finance systems, which in turn will complicate the assessment of risk for both thefinancial institution and its customer.[113]B: Necessity of the unified accounting and regulatory standard body to govern theIslamic banking and finance nationally and globally:For an Islamic financial institution to succeed it needs to establish universallyaccepted accounting, auditing and regulatory standard in order to achieve globalacceptability and continue its rapid expansion.[114]Therefore, “there is a need to developuniform accounting and reporting structures among Islamic financial institutions.Furthermore, the Islamic financial institution needs to recognize the responsibilities ofregulators to apply national supervisory principle to all Islamic financial institutionsespecially the effective liquidity management, the definition of a deposit and thestandardization of accounting and disclosure.”[115]The lack of a thorough comprehensive,and consistent a counting standard and the lack of the effective regulation is vital for Islamic banking to continue grow is to overcome those problems.[116]Therefore, there is a need for unified Islamic accounting standard covering areassuch as the presentation of financial statement and disclosure in the Islamic financialinstitutions. Thus, the Islamic accounting standard must seek to comply with internationalaccounting standard.[117]C: Necessity of the existence of liquidity markets to handle the operation of theIslamic banking and financial institutions:“One of the major challenges to Islamic financial institutions remains how tohandle their liquidity, because those banks have been more successful in attractingdeposit than in identifying funding opportunities.”[118]Thus, liquidity has always been themost critical issue for Islamic financial institutions, because there are only smallsecondary market that exist to enable the Islamic financial institutions to manage theirliquidity, because the Islamic banks asset generally not saleable in any secondarymarket.[119]Therefore, “the establishment of genuine inter-bank markets would be asignificant step towards providing Islamic financial institutions with the ability tomaintain an adequate liquidity without holding excessive amount of very short-termasset.”[120] There is a need to establish international Islamic financial market “IIFM” tofacilitate the development of the an international Islamic money market and to harmonize the standard regulation and the practices in the Islamic financial industry.[121](II): How to accommodate the Islamic banking and finances systems in global economyespecially in the non-Islamic countries so as to meets the need of the growing Islamiccommunities:A: Possibilities of establishing Islamic financial institution in the US:The US remains relatively closed to Islamic financial institution, because thefederal banking law bars banks in US from holding stakes in their cooperate borrower,and Islamic banks share in the management risk of any operation they finance.[122] On theother hand, the Islamic law doesn’t require that the seller of the product be Muslim orthat his own income be “halal” permitted,[123]but the relationship with the seller must bein line with the sharia but the seller relationship with other parties is not theresponsibilities of the purchaser. Therefore, the conventional banks “ interest-based bankscan offer sharia compliant financial services to both Muslims and non-Muslimscustomers as alternative to the interest- based finance.[124]Furthermore, the advantage of using Islamic finance affiliated with Multinationalinstitutions, is in their substantial size, perceived solidity and the possibilities of crossselling Islamic services to existing Muslim clients. Moreover, the wealth of the in-houseexpertise available and the efficiency with which they provide their services.[125]Some conventional banks both within and outside the Muslim world have started to offerIslamic financial services as an alternative to the interest –based finance. Thus, City Bankbecame the first major US bank to venture into Islamic banking, by opening a subsidiaryin Bahrain.[126] Furthermore, several big international financial institutions set –up Islamicfinancial subsidiaries such as HSBC’s “Amanah” Islamic financial institutions, and theUBS’s Noriba had Islamic financial subsidiaries targeting Islamic mortgages and carfinance. Moreover, the Dow Jones established stock market of sharia compliantcompanies.[127]B: Possibilities of Opening Non- Banking Islamic Financial Institution DealingMainly in Providing the Basic Islamic Financial Services to the Muslim Communities inNon – Islamic Countries:Since sharia permits using the conventional market as a benchmark or as standardto Islamic financial services, some Islamic financial services could exist to theMuslim communities in the US. “Amana Vehicle finance” for example could use a fixedpayment scheme that is competitive with conventional vehicle loans available in themarket.[128]Conclusion:Since the Cold-War era, there has been a massive Islamic movement within theIslamic countries and the minorities Muslims communities around the glob. Thismovement has demanded that the Islamic law governs all aspects of their life frompolitical, economic and daily life according to the Islamic principle.Therefore, the need to expand the Islamic financial institutions services toaccommodate the Islamic communities needs will continue to grow rapidly in the nearfuture. There is need for collective efforts from the bankers, economists and theIslamic legal scholars to develop financial solution that meet the religious requirement tothe Muslim’s communities.[129]Moreover, “the Islamic financial community must acceptthat their institutions have to be regulated and supervised to meet the internationalstandard. Ultimately their ability to grow and compete will depend on internationalacceptance of the regulatory regime.”[130]There is need for universally accepted principal governing Islamic financialdealing, before the system can be accepted internationally, because the weakness of theIslamic financial market has also resulted from the lack of the common Islamicaccounting and legal framework governing the Islamic financial market.[131] Since theIslamic law does not require the banks to be Islamic banks or all its resources to be Halal“permitted” then the conventional institution could have subsidiaries offer Islamicfinance to Muslim and non-Muslim alike as an alternative to the interest-finance. Thismight be used mainly to offer the most needed financial services such as mortgages andcar financing to the minorities’ Muslim community in the non-Islamic countries. Such efforts are needed to meet the needs of an ever-growing Muslims communities trying tolive their lives according to their beliefs.[1] Elwaleed M Ahmed, International LL.M (Master of Laws) student, James E Beasley School of Law, Temple University, Philadelphia-Pa U.S.A.(2004), B. A. (Sharia & Law) Omderman Islamic University, Sudan (1995).[2] T. S. Twibell, Implementation of the United Nation Convention on Contracts for the Sale of Goods (CISG) Under Shari’a (Islamic Law); Will Article of (CISG) be Enforced when the Forum is in Islamic State? 9 Int’l Legal Persp.25 at 72 (Spring-Fall1997).[3] Mahmoud A. El-Gamal, Fourteen Annual Philip D. Reed Memorial Issue, Islamic Law and Finance, ‘Interest’ and the Paradox of the Contemporary Islamic Law and Finance, 27 Fordham Int’l L. J. 108 at 124 (December, 2003).[4] Wilson Rodney, Islamic Banking: Going Global-the Muslim Banking Worlds Faces the Challenge of Expanding International while Remaining True to Islamic Principles. The Banker. (March 1, 1995). (Available at LexisNexis ‘Magazine and stories/ combine’).[5] Wilson Rodney, Islamic Banking, Book Review; Islamic Banking by Mervyn K. Lewis and Latifa M. Algaoud, Economic Society of Australia, Economic Record Vol. 78 at 375. (September 1, 2002). (Available at LexisNexis ‘Magazine and stories/ combine’).[6] Ali Nazim, Points of law; Middle Eastern Banking, Business Intersperse Ltd. (UK). The Banker, Vol. 149 at 67 (February 1, 1999). (Available at LexisNexis ‘Magazine and stories/ combine’).[7] Supra Note 4.[8] Anouar Hassoune, Says Standard & Poor’s, Key Rating Factors for Islamic Banks-Although Sometimes Complex; Analyses Islamic Financial Institutions on the Same Basis as Conventional Financial Institutions. The Banker at 1 (February 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).[9] M. Cherif Bassiouni, Gamal M. Badr, Saad El-Fishawy, Farooq A. Hassan and Erik Peterson, Islamic Law, A survey of Islamic International Law, Contract and Litigation in Islamic Law the Source of Islamic Law. 76 Am. Soc’y Int’l L. Proc.55 at 65 (April 22-24, 1982).[10] J. Michael Taylor, Islamic Banking – the Feasibility of Establishing an Islamic Bank in the United States, 40 Am. Bus. L.J. 385 at 416 (winter 2003).[11] Munawar Igbal, David T. Llewellyn, Islamic Banking and Finance; New Prospective on Profit Sharing and Risk. Edward Elgar Publishing Limited at xii (2002).[12] Mervyn Lewis, Latifa Algaoud, Islamic Banking, Edward Elgar Publishing Limited at 22 (2001).[13] Supra Note 9 at 65.[14] Supra Note 10 at 416.[15] Supra Note 12 at 22.[16] Supra note 9 at 67.[17] Supra Note 2 at 61.[18] Supra Note 12 at 22.[19] Id.[20] Id. at 23.[21] Id. at 24.[22] Id.[23] Id.[24] Barbara L. Seniawski, Riba Today: Social Equity, the Economy and Doing Business under Islamic Law. 39 Colum. J. Transnat’l L. 701 at 717(2001).[25] Id. at 707.[26] Supra Note 10 at 416.[27] Elias G. Kazarian, Islamic Versus Traditional Banking; Financial Innovation in Egypt. West View Press Inc. At 53 (1993). (Available at LexisNexis ‘Magazine and stories/ combine’).[28] Id. at 50.[29] Id.[30] Id. at 53.[31] Supra Note 21 at 35.[32] Supra Note 24 at 710.[33] Supra Note 21 at 35.[34] Supra Note 24 at 717.[35] Id. at 704.[36] Id. at 707.[37] Id.[38] Supra Note 11 at 31.[39] Supra Note 10 at 391.[40] Supra Note 24 at 704.[41] Id. at 728.[42] Supra Note 10 at 385.[43] Supra Note 5 at 373.[44] Supra Note 24 at 711.[45] Michael Ainley, Islamic Banking Under A veil of Regulation, Financial Times Business Limited, The Banker at 1 (October 1, 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).[46] Supra Note 24 at 728.[47] Id. at 36.[48] Supra Note 24 at 728.[49] Id.[50] Supra Note 24 at 704.[51] Supra Note 10 at 388.[52] Id.[53] Id. at 416.[54] Martin Josh, Islamic Banking Raises Interest; Including Related Article on Islamic Business. American Management Association, Management Review, vol. 86 at 25 (November 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).[55] Supra Note 27 at 54.[56] Supra Note 10 at 394.[57] Fitch, Islamic Banking Unveiled, Financial Times Business Limited, Pension Management, (January 1, 2002), (Available at LexisNexis ‘Magazine and stories/ combine’).[58] Supra Note 3 at 129.[59] Id. at 145.[60] Id.[61] Id. at 127.[62] Supra Note 54 at 26.[63] Supra Note 5 at 373.[64] Id. at 168.[65] Supra Note 54 at 28.[66] Supra Note 27 at 163.[67] Supra Note 64 at 168.[68] Supra Note 54 at 18.[69] Supra Note 6 at 68.[70] Supra Note 3 at 129.[71] Supra Note 64 at 170.[72] Hesham M. Sharawy, Understanding the Islamic Prohibition of Interest. 29 Ga. J. Int’l & Comp. L. 153 at 170 (fall, 2000).[73] Supra Note 54 at 18.[74] Supra Note 27at 164.[75] Supra Note 3 at 129.[76] Supra Note 11 at 200.[77] Supra Note 54 at 28.[78] Supra Note 24 at 723.[79] Supra Note 29 at 107.[80] Supra Note 64 at 170.[81] Supra Note 27 at 52.[82] Kamal M. Amjad Main, Book Review. Specific Application: Commercial Transaction and Financing, Islamic Law and Finance; Religion Risk and Return. By. Frank E. Vogel & Samuel L. Hayes III. The Hague and Boston: KLumwer Law International. I5 J L. & Religion 475 at 477 (2000-2001).[83] Supra Note 27 at 52.[84] Supra Note 29 at 58.[85] Supra Note 11 at 199.[86] Id. at xii.[87] Supra Note 6 at 68.[88] Supra Note 24 at 728.[89] Supra Note 62 at 170.[90] Id. at 168.[91] Supra Note 10 at 399.[92] Supra Note 54 at 26.[93] Id.[94] Supra Note 64 at 153.[95] Id.[96] Id.[97] Supra Note 64 at 153.[98] Supra Note 54 at 28.[99] Supra Note 3 at 129.[100] Supra Note 10 at 396.[101] Id at 416.[102] Supra Note 54 at 25.[103] Supra Note 64 at 170.[104] Supra Note 24 at 727.[105] Id. at 720.[106] Supra Note 11 at 208.[107] Supra Note 82 at 477.[108] Supra Note 54 at 26.[109] Nigel Dudley. Report From Bahrain, Islamic Banking –Structure is Necessary Target- Anew Institution Aim to Set Industry- Wide Standards for Islamic Banking. The Banker at 1 (March 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).[110] Id.[111] Islamic Banking’s Exposure to Risk, The Edge “Malaysia”(November 23, 1998). (Available at LexisNexis ‘Magazine and stories/ combine’)..[112] Supra Note 57 at 1.[113] Michael Ainley, Islamic Banking Under A veil of Regulation, Financial Times Business Limited, The Banker at 1(October 1, 1997). (Available at LexisNexis ‘Magazine and stories/ combine’).[114] Supra Note 109 at 1.[115] Id. at 3.[116] Richard Dean, Islamic Banking; The Payoff Does the Stanching Rise of Islamic Banking in the Middle East Threaten the Region’s Conventional Banks? Arabia Trends (May 1, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).[117] Financial Reporting Islamic Institutions A risk –free return? -It’s Forbidden. Accountancy (April 30, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).[118] Supra Note 5 at 1.[119] Supra Note 8 at 1.[120] Supra Note 113 at 1.[121] Islamic Banking in Malaysia, Euromoney Vol.33 Pg. SSSS4 (September 1, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).[122] Supra Note 64 at 153.[123] Supra Note 3 at 147.[124] Id. at 148.[125] Supra Note 11 at 1.[126] Supra Note 54 at 26.[127] West Meets East, The Economist “ U.S Edition,” (October 25, 2003). (Available at LexisNexis ‘Magazine and stories/ combine’).[128] Supra Note 3 at 148.[129] Supra Note 121 at 3.[130] Supra Note 116 at 1.[131] Sidek Kamiso, Islamic Financial Market Needs Universal Accepted Principles. The Edge “Malaysia” (February 20, 2001). (Available at LexisNexis ‘Magazine and stories/ combine’).
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Saturday, July 14, 2007