02 January, 2015

The Goals of Islamic Banking

The present-day world is experiencing a number of economic ills including poverty of a large proportion of mankind, social and economic injustice, gross inequalities of income and wealth, high rates of unemployment, economic instability, inflation and erosion of the real value of monetary assets. All these maladies, in spite of being in conflict with the value system of Islam, are as prevalent in the Muslim world as elsewhere. No doubt they have a number of root causes. However, the failure to provide a stable and just money and banking framework has been one of the major contributing factors. No economic system can sustain its health and vigour or contribute positively to the achievement of its socio-economic goals without the support of a same equitable money and banking system.

The philosophical underpinnings
The money and banking sector of any economic system does not operate in an ideological vacuum. It has its own philosophical background and objectives. Its institutions evolve gradually to perform the functions necessary for enabling the system to realize its basic goals and to perpetuate itself by surviving the recurring shocks of history. The capitalist money and banking system is also essentially an integral part of its parent ideology. It serves the objectives of capitalism.

There is nothing inherently wrong in borrowing institutions from other cultures, provided that they are reformed appropriately to serve the goals of the guest culture. The question is whether the capitalist money and banking system, gradually adopted by Muslim countries over the last two centuries, can be made to serve the goals of Islam instead of those of capitalism without any fundamental reform. The answer could be positive only if it is assumed that the goals of capitalism and Islam are the same or that the institutions constituting the capitalist money and banking system are ideologically neutral and do not help the system realize its ‘inherent’ objectives.

The GoalsThe money and banking system should, like other aspects of the Islamic way of life, not only contribute to the achievement of the major socio-economic goals of Islam but also perform the functions that relate to its own special field. The principal goals and functions are:
1. Broad-based economic well-being with full employment and optimum rate of economic growth;
2. Socio-economic justice and equitable distribution of income and wealth;
3. Stability in the value of money to enable the medium of exchange to be a reliable unit of account, a just standard of deferred payments, and stable store of value;
4. Generate adequate savings and mobilize these efficiently goals; and
5. Render effectively all services normally expected from the banking system.

It may be asked at this point whether the goals of Islam, as stated above, are not the same as those of capitalism. On the surface they may appear to be the same but in essence there is a fundamental difference arising from the differences in the roots of the two systems, the Islamic economic system is morally-based while capitalism is secularist and morally-neutral. The ensuing discussion should help to make this point clearer.

1) Broad-based economic well-being with full employment and optimum rate of economic growth:
Islam is not an ascetic religion. It takes a positive view of life as the natural outcome of the belief that human beings are the vicegerents of God. They must lead a life that befits their status, and the Divine Guidance embodied in Islamic Teachings is intended to help them in the realization of this objective. It is designed to serve as a ‘blessing’ for mankind and aims to make life richer and worth the living, not poorer and full of hardships. Hence Muslim jurists have unanimously held the view that welfare of the people and relief of their hardships are the basic objectives of the Shariah. This view, when applied to the economic aspect of life, implies economic well-being through satisfaction of all basic human needs, removal of all sources of hardship and discomfort and improvement in the quality of life. In fact, any struggle intended to fulfill basic human needs, to remove misery and to make life a blessing has been equated by Islam with an act of virtue. Hence full and efficient employment of human resources is an indispensable goal of the Islamic system, because it helps realize the objective of board-based economic well-being and also imparts to human beings the dignity demanded by their status as God’s vicegerents. Full and efficient employment of material resources is also essential because according to Islam all resources in the heavens and the earth are meant for human welfare and need to be exploited adequately, without excess of wastefulness for the purpose for which they have been created.

While a high rate of economic growth should be the natural result of policies leading to full and efficient employment of human and material resources and broad-based economic well-being, it is not of prime importance if it is attained through the production of inessential or morally undesirable goods and services, leads to an excessive and everly rapid use of God given resources at the expense of future generations who are equal owners of these resources, and harms present or future generations by degenerating their moral or physical environment. A high rate of growth is not essential to the extent to which it contributes to full employment and broad-based economic well-being, but beyond this its importance would have to be carefully weighed against all its other implications.

2) Socio-economic justice and equitable distribution of income and wealth.

The goals of socio economic justice and equitable distribution of income and wealth are an integral part of moral philosophy of Islam and are based on its unflinching commitment to human brotherhood. The capitalist conversion to socio-economic justice and equitable distribution of income is, on the contrary, not based on a spiritual commitment to human brotherhood, but rather is the outcome of group pressures. Accordingly, the system as a whole, particularly its money and banking arrangement, is not geared to these goals, are glaring disparities of income and wealth continue to be generated.

Nevertheless, because of the influence of socialism and pressures, some of these inequalities are being partly reduced by taxation and transfers. In contrast Islam tries to uproot the causes of gross inequalities at their source, also using zakat, taxation, and transfers as additional measures to reduce inequalities over further to bring about distribution of income which is in conformity with its concept of human brotherhood. Hence it is essential that even the money and banking system and monetary policy are so designed that they are finely interwoven in to the fabric or Islamic values and contribute positively to the reduction of inequalities. 

3) Stability in the value of money

Stability in the value of money should be an important goal in the Islamic frame of reference because of the unequivocal stress of Islam on honesty and fairness in all human dealings and the adverse effect that inflation tends to have on social justice and general welfare. Inflation implies that money is unable to serve as a just and honest unit of account. It makes money an inequitable standard of deferred payments and an untrustworthy store of value, and enable some people to be unfair to others, even if unknowingly, by stealthily eroding the purchasing power of monetary assets. It thus imposes a welfare cost on society to the extent to which it reduce the efficiency of the monetary system. It tends to pervert values, rewarding speculation (discouraged by Islam) at the expense of productive activity (idealized by Islam) and intensifying inequalities of income (condemned by Islam). Moreover, inflation conflicts with a riba-free (Interest) economy because it corrodes its raison deter of social justice. Although Islam urges justice to the borrower it does not approve of injustice to the lender. Inflation undoubtedly does injustice to the riba-free lender by eroding the real value of qard hasan a loan extended without interest or profit-sharing (qurud hasanah).

It may be suggested that, in the current worldwide inflationary climates, the Islamic imperative of socio-economic justice could be satisfied by indexation, or monetary correction, of all income and monetary assets including qurud hasanah. Proper monetary correction would, however, require the indexation not of income or monetary assets but of purchasing power, which is determined by the consumption and investment pattern of individuals. Socio economic justice would require the indexation of income and monetary assets by the use not of only universal index but of several indices based on different expenditure patterns. In contrast with this, widespread index-linking of incomes and monetary assets based on one universal index has not been found to be feasible because of the complexities involved and the high administrative costs of implementation. Hence indexation of only some income and monetary assets has been tried. The widest use of indexation has been in the field of wages, salaries and pensions. Indexation has also been tried for some financial assets (e.g. bank loans and deposits, Government banks), taxes, rents and mortgages.

While indexation might help ameliorate partially the inequities arising from inflation, it is not a cure of inflation. Tt may, in fact, tend to accelerate inflation and be self-defeating unless inflation is on the decline and remedial monetary,  fiscal and incomes policies are being adopted. It seen therefore, that while indexation may be feasible to a limited scale and may be resorted to as a temporary sedative for the pain of inflation, the policy alternative which would best conform to the norm of socio-economic justice emphasized by the Shariah is price stability and not indexation.

Indexation of Qurud Hasanah has so far been rejected by the fuqaha because they generally consider it similar to riba in its essence. Their opposition to indexation of riba-free loans is also defensible on economic grounds because, even though it is proposed with the innocent objective of doing justice to the riba-free lender, it has the potential of initiating gross injustice to the borrower.

While inflation is in conflict with Islamic values, prolonged recession and unemployment are also unacceptable because they bring misery to certain sectors of the population and also act counter to the goal of broad-based economic well-being. A recession also tends to increase uncertainty and discourages investors from undertaking risks associated with projects that earn a return over many years. Hence, in the interest of achieving the overall objectives of Islam, it should be considered obligatory for the Islamic state to eliminate or minimize economic fluctuations and to stabilize the value of money by cutting at the roots of inflation as well as recession.

A generally accepted principal in capitalist economics is a tradeoff between unemployment and inflation. In the context of Islamic values, the concept of trade-off is questionable. While inflation is iniquitous and against the interest of long run well-being, unemployment of human resource is inequitable. It not only conflicts with the value of dignity of God’s vicegerent but also vitiates the realization of equitable distribution of income. Moreover, it is doubtful weather it is essential to have inflation to achieve full employment or to have unemployment to avoid inflation.

In the Islamic system both unemployment and inflation are undesirable, and both need to be eschewed oven though this may require fundamental changes in economic relationships. If aggregate demand is to be contained or lowered to avoid inflation, then in the overall interest of social justice and broad-base economic welfare a value judgment needs to be made about which demand should be contained or reduced an how. In a value-oriented system it would be indefensible to allow demand to expand in essential directions to attain a high rate of economic growth and, if this generates inflation, it would be equally indefensible to try to control it by reducing aggregate demand in a general, across-the board manner by crating human unemployment. Similarly, full employment must be ensured even if this demands a restructuring of production and designing of suitable technology. Hence it would be essential to regulate aggregate demand, restructure production, design a suitable technology and have an appropriate mix of monetary, fiscal and income policies to avoid both inflation and unemployment and to ensure broad-based economic wellbeing with a realistic rate of economic growth.

4) Mobilization of savings

The goal of mobilization of savings is essential because Islam categorically condemns hoarding of savings and demands their productive use for the realization of the socio-economic goals of Islam. Nevertheless, it is not possible for every savers to employ his savings productively. It would, therefore, be in the nature of fulfilling Islamic teachings if efficiently organized financial institutions could mobilize idle savings and channel them efficiently into productive uses. Such institutions should be properly equipped to be generally able to meet the genuine, non-inflationary financing needs of both the public and the private sectors for the realization of the economy’s goals.

However, riba or interest has been prohibited by Islam and neither the saver nor the user of saving is allowed to receive or pay riba, defined by the fuqaha as a predetermined positive rate of return on savings or loans. The fuqaha have, however, recognized profit which may be positive or negative and which is not predetermined like riba. Hence, in the interest of implementing Islamic teaching it is necessary to organize a banking system which mobilizes savings and yet operates, not on the basis of riba like the capitalist system, but by sharing the net outcome, whether profit or loss.

Moreover, if the economy is unable to generate adequate demand to enable the gainful employment of the idea physical and human resources, then the system should be able to bring about a sufficient monetary expansion within a non inflationary framework.

5) Rendering other service
The system should not only be able to mobilize savings effectively and allocate them efficiently for their optimum productive use to meet the needs of a growing and healthy economy but should also be able to develop primary and secondary money markets, render all banking services to the public at least as efficiently as the existing banking institutions and fulfill the non inflationary financial needs of the Government.

The development of both a primary and secondary market is essential for efficient mobilization of financial resources. While the existence of primary markets is needed for providing financial resources to those who can employ them productively, the existence of secondary markets is essential to help savers and investors ‘Iiquify’ their investments whenever they feel the need to do so. The absence of secondary market should  compel severs to hold larger balances for precautionary motives, thus increasing hoardings and reducing the rate of economic growth by preventing savings from performing their natural role.

Stable, riba-free and social-welfare oriented
Is it possible to organize adjust, stable, riba-free and social welfare-oriented money and banking system for the present-day Muslim countries, all of which have developing economics? The scheme presented should be realistic and consist of a set of feasible and practical proposals which would not only solve the existing difficult financial problems of the governments but also stimulate the savings of the private sector and mobilize them efficiently for the accelerated growth of the Muslim economic system within the framework of the socio-economic goals of Islam.  
Reference: An extract from the paper ‘Money and Banking in an Islamic framework’
By Dr. M. Umar Chapra.

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