SHAIKH MAHOMED SHOAIB OMAR points out five key differences between conventional and Islamic banking.
- Function of money
THE first difference is in the function of money. In Islam, it is exclusively a medium of exchange. Money should not be traded as a commodity which fetches a price in the form of interest, as is the case in conventional banking practice. In other words, money cannot be the object of trade per se. To the extent that money is exchanged for money, such exchange should be effected at face or par value, with no discount or premium on either side.
The logical result of this, is that any contractually stipulated increase on a fixed debt arising from a recognised commercial contract, such as a sale, is deemed to be impermissible interest. This also means that a monetary debt cannot be sold at a premium or discount. The 2008 financial crisis in the USA, attributed to the sale of sub-prime mortgage debt at a premium, could have been avoided if the basic shariah principle prohibiting the sale of a debt had been adhered to.
It should be borne in mind that, from an Islamic perspective, a loan is deemed to be a gratuitous, humanitarian transaction to be resorted to in genuine need, generating no contractually agreed return or benefit thereon. To the extent that the lender wishes to generate a return on his loan, the lender must participate as an equity partner in the business of the borrower, and thereby share in the profits and losses of the joint venture.
- Concept of risk
Secondly, the concept of risk in Islamic banking is fundamental. It is intertwined with profit and loss. A trader is not entitled to make a profit unless the trader has correspondingly assumed the risk of loss in the underlying commodity. For example, when a bank buys a commodity and resells the same, in terms of a separate, independent transaction, at a profit to a client, the profit represents the return in lieu of the shari’ risk, that the bank, as owner, has assumed in the commodity.
In order to assume the requisite risk, the bank must take actual or constructive delivery of the commodity, and thereby assume the risk of destruction or deterioration, in any form, prior to its resale to a third party. This requirement that the acquisition of profit is intertwined with the assumption of risk, is expressed in a well-known fiqh maxim.
- Prohibition of commercial contract gain
The third difference is that shariah law prohibits a commercial contract of gain, founded upon intolerable gharar (the sale of that which is not yet present), as a foundational principle: manifest uncertainty of contractual result or outcome, which largely permeates the subject matter of the contract. A good example is a conventional insurance contract: the insurer undertakes to indemnify the insured against a future specified, uncertain event, which may or may not occur, in exchange for a premium. The insurer gains absolutely if the event never occurs. Even if the future contingent event were to occur, its timing, nature and extent is manifestly uncertain at the time the insurance contract is concluded.
- Shariah compliant commodities
Fourthly, the subject matter of all the financial instruments of an Islamic bank is shariah compliant commodities whose ownership and risk is transferred to the client, in accordance with the requirements of the specific recognised contract, such as a murabaha and a musharaka. In this regard, two points should be noted. First, the reciprocal consideration on both sides (delivery of commodity and payment of price, both deferred) should not be contractually stipulated and obligated to be deferred, on both sides, as this falls within the meaning of the well-known prohibition effectively, deferred in exchange for deferred, to prevent (interest and disputes). Second, one contract must not be conditional with another, in a single ‘binding’ transaction, such as, ‘I sell you my house, on the condition that you lend me R100 000.’ This falls within the meaning of the well- known prohibition whose rationale is to avoid interest in the guise of two interlinked conditional contracts, the one dependent upon the performance of the other. This prohibition should be distinguished from a situation where the one contracting party makes a unilateral binding promise to do something, outside the contract of sale, whose conclusion and effect is immediate, and is not dependent upon the prior or subsequent unilateral promise.
- Mudarabah partnership pool
Finally, the mudarabah partnership pool of an Islamic bank (or an Islamic window) is constituted by the total aggregate funds of investors (comprising all investment accounts), which funds are advanced to the bank upon trust, and employed by the bank to best advantage, in its capacity as the mudarib (working partner), in appropriate shariah compliant instruments and transactions, upon a pre-agreed profit-sharing ratio, as agreed between the investors, on the one hand, and the bank, on the other.
Losses in the ring-fenced, separate mudarabah pool, which are attributed to inter alia market fluctuations, are borne by the investors. However, the bank remains liable under all circumstances for losses attributed to proven negligence or misconduct. By contrast, depositors in a conventional bank make loans to the bank and receive in return a fixed rate of interest thereon.
- Shaikh Shoaib Omar is an attorney at MS Omar and Associates who specialises in Islamic law and Islamic finance.