CURRENT practices of non-con ventional banking in the name of Islamic banking are subject to criticism from several quarters. One of them is a group of economists. On September 27, Dr. Aqdas Ali's article on Islamic banking, published in this space, represented the dilemma these economists are subject to.

To them capital is one of the four factors of production without which production and economy cannot run. Since interest is the price of capital, talking of its elimination is nothing but fatuous. The reason these economists think interest indispensable is that they could not understand truly what Riba is.

The Islamic concept of Riba is not just what interest in economics is. Riba is a broader term in the sense that it also includes some other transactions that are not called interest in economics. At the same time it is a narrower term in the sense that it does not include some remunerations that are named interest in economics. In economics “capital is man-made production factor” so if Mr A provides a machinery to XYZ company on a monthly payment of ten thousand rupes, economists will say that Mr A is charging interest to XYZ but Islam does not call it riba.

But we do not mean here that interest and riba are entirely different concepts. This is because in economics capital also includes money so providing money on fixed or determinable remuneration is interest in economics and riba in Islam. This is also not true for riba that it is reward for waiting because riba is said to have occurred in the transaction where you exchange rupees hundred with rupees one hundred and one even on spot.

There is also a misconception that anything that guarantees fixed return is riba. So when it is observed that lessor has fixed his profit by leasing the asset and seller on deferred payment has booked his profit without assuming the business risk of the buyer, the return to lessor and seller is perceived by some people as interest. First fixing or flexing the return does not render the transaction Halal or Haram. If return on money lent is benchmarked with LIBOR or KIBOR, return is not fixed but it is Haram.

On the other hand if rent of a house let is fixed, return is though fixed transaction and is not interest based. These misconceptions have led to the perception in some minds that Islamic banks are charging interest in the name of profit and rent. And this lack of apprehension about the definition of riba let us to conclude that Islamic banking is a mythical and a contradictory concept. Secondly business relationships with other party is not always that of participatory (risk sharing), it might be trade based (where you buy or sell) it is sometimes rent based (where the owner does not transfer title but right to use) and at times it is service based. Islamic banks are using all these modes of business.

The claim that abolition of interest will result in economic disorder and disaster is yet to be tested practically but there are strong theoretical grounds to believe the contrary. As above discussion cleared that ban on interest will not stop owner of building and machinery to earn rent from their assets nor will it bar seller to sell on deferred payment at price higher than spot, half of the question that how financing needs of the business will be fulfilled, is solved. For rest of financial requirements where money rather than asset has to be provided financing on the basis of risk sharing gives perfect substitute of lending. Even interest based lending is not entirely free from risk as here also downside risk exists if borrower default which is not rare. However the writing is not meant to elaborate PLS model in detail. We will just try to demystify Islamic banking.

Interest is a major contributor to social and economic evils but no scholar has yet claimed that all economic problems such as unemployment, inflation, depression, income inequalities, poverty, etc have sole

reason; interest. Banking is a part of economic system and above-mentioned problems have their roots in fiscal and administrative policies as well. It is also wrongly understood that only interest is prohibited by Shariah in economic activities. Unjust taxation system, gambling, restricting trade practices favouring one or certain groups at the expense of general public etc are such activities the have no space in Islamic economic system. Even in Islamic banking not only riba is avoided but other restricted practices of gambling, short selling and financing non-permissible business is also abstained from.

If western secular companies are opening Islamic banking branches it should not be a wonder to us nor do we think that they are convinced of the superiority of Islamic banking over interest based model. They are willing to enter into any new but profitable venture. Exploiting opportunities is their business which they earn from. Islamic banking should not be taken as spiritual or religious product but rather a business product. So it is not like Salah that only Muslims can gain rewards by offering.

That risk sharing is truly an Islamic mechanism is without any doubt but can it replace interest norm is a matter of thinking. We argue that logic behind risk sharing has partially been accepted long ago when first limited liability company came into existence and borrowers liability was limited to assets of the business. It seems very logical that while lender is burdened with lower side risk he should share part of profit of the business that is above expected return.

Conventional practice of building risk premium in lending rate does not give optimal result because it depends on the nature of the security and not on the viability and desirability of the investment. Suppose Mr A wants Rs10mn for an investment expected to yield 20 per cent and offers security of Rs20mn. Now even if the chance of the success of the business is 50 percent bank will be inclined to lend because of strong security.

On the other hand if Mr B has a project expected to yield 30 per cent and lesser chances of failure, he will not get the loan in case he fails to provide security. What is the impact on economy? Resources have been utilised for a project having lesser utility while economics calls for application of resources in order of utility. Thus it is justified to claim that PLS rather than interest based model can give optimal results.

The link between Islamic banking and Islamic economic system is a matter that leaves many confused. Actually the statement that “true Islamic banking is contingent with the establishment of Islamic economic system” does not imply that current Islamic banking is false. It has two aspects; first, parallel running of conventional banking with Islamic banks sometimes puts the latter in a position less favourable competitively, especially where their conventional counterparts, owing to no Shari'ah constraint with them, are able to provide the facilities which Islamic banks are not allowed by their charter.

Second, even the presence of Islamic banks cannot remove the social and economic evils caused by prevalent economic system thus the environment which banking industry is working in, is polluted which no firm in the industry can remain free from.

The allegation that Islamic banks are camouflaging the norm of interest under esoteric nomenclature such as mark-up, rates of return, profit ratio etc, is just over-simplification of the situation. Matching features in two things does not mean that things are exactly the same. Could we say that salary, commission and performance bonuses of a director have no difference despite the fact that these all represent compensation?

Similarly rent of a building, profit of a sale and interest on money all, though fall within the category of “return”, do indeed show different nature transactions. There is nothing esoteric in Islamic banking. This is just lack of our knowledge in Shari'ah.

We are not in a state of self-conceit. We do realize that milestones have yet to be achieved, dust of riba has polluted the whole environment and financial system surrounding us is a major hurdle to purity and chastity we aspire for. Islamic banking is an attempt at micro level addressing those who are reluctant to interest. For coping with problems like inflation and poverty attempts at macro level will be more useful and abolishing interest altogether would be an important part of it.

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