Islamic Banking System - Deception vs. Reality

By:Shahbaz Farooq, Dubai

Today’s Economic Structure

Today, we are living in an era where there are two predominant (economic) systems controlling the overall social, political and monetary infrastructure of the world. They are Capitalism and Socialism. There are advocates and critics of both systems in the world.

Does Islam provide any alternative economic system?

In reality, the Muslim world today does not have any theoretical or practical economic system in place. There is no mainstream research going on which can claim to be a competitor of either Capitalism or Socialism. Was this the situation from the beginning or did we lose the economic race during the last centuries? Let’s take a look.

The human history shows us that all those prophets and revolutionary leaders who succeeded in bringing a change in their society covered all aspects of human life, especially the economic and social. Teachings of each religion or ideology, when truly implemented, provided a comprehensive solution of all the problems of society. Same was the case with Islam during first thousand years.

Why does Muslim hate banking system?

Logically speaking, if Islam can provide an economic system for 1000 years, then it can certainly provide economic solutions to today’s problems. But, unfortunately, our mainstream Islamic research has followed another path by bowing to either Capitalism or Socialism. As followers of Islam, we believe that interest is prohibited. Therefore, as a society we have developed hatred for the banking system. In our societies, we discourage our youth to work in banks or related financial institutions. Because of this hatred, we try to avoid dealing with banks to the maximum possible extent.

Under these circumstances, instead of providing a comprehensive economic solution, Muslim world came up with principles of ‘Islamic Banking’. The objective of Islamic banking was not to provide an alternative economic system in comparison to capitalism, but to capture the untapped wealth of Muslim population, which was not part of mainstream banking system. Therefore, we can see that major Western banks spend millions of dollars in research to open their Islamic banking arms, although they have no interest in Islam.

The deception of Islamic Banking System

In order to understand deception of Islamic Banking (IB) system, let us take a quick example of current IB system. The principles of IB are compiled without challenging the overall banking infrastructure. Therefore, the results received from IB are even worse than the outcomes of Conventional Banking (CB) system. The Islamic Banks or Islamic Windows of Conventional Banks are operating under the current international banking system. Here, each bank has to follow respective central bank’s monetary policy. This means that IB cannot lend to its customers with interest (mark-

up) rates less than the central bank’s monetary policy. In Pakistan’s case, any Islamic Bank today, cannot lend money on less than 13.5% interest (mark-up) rate (12 September 2019 – 1 year KIBOR).

As many preachers of IB believe that the difference between IB and CB is similar to the difference between “Marriage” and “Adultery”. In marriage, all matters are properly documented whereas in adultery documentation is missing. Unfortunately, the slavery of the last 200 years has taken our ability to understand the substance of the law instead of its form. All Islamic laws came with an objective; they are introduced to implement an outcome, not mere rituals. The primary objective (among others) of a marriage is to create a responsible society where a man takes responsibility for economic and physical security for his wife and children. If the institution of marriage fails to achieve this objective, then it is, in no way better than adultery, irrespective of the nature or comprehensiveness of its documentation. If the nature, content, context of documentation in IB have the same exploitative role as practiced by CB, then it is a mere deception to general public.

A shocking comparison…!

The principle of house loan in Islamic banking system is that the house will be owned by the bank and will be rented to the borrower. Based on a unit rate methodology, rent will be calculated for each unit. The borrower shall purchase the units from the bank through monthly instalments and pay the rent for the units owned by the bank. In this way, the borrower is paying the rent instead of the interest for the house or the funds supplied by the bank. Let us take an example of a house loan and see the comparison between a CB and an IB:

Source: mawazana.com (13 September 2019)

As per the above example, a borrower has to pay interest / mark up of PKR 21.3 million to an IB in comparison to PKR 19.9 million to a CB. Coincidently, the rent charged by an IB is very close to the interest charged by a CB. The mark up rate of an IB is very close to the interest rate of a CB. How can this be possible if Islamic Bank is following Islamic principles rather than CB principles? In reality, these outcomes of IB and CB are based on principles of interest, as both are part of the same monetary and economic system.

Generally, a person can purchase a 151 square yard (5 marla) double storey house for PKR 10 million in Lahore, Pakistan. In 2019, the average rent of this house is PKR 40k. If a bank charges PKR 40k as rent per month for the whole loan period, that is, 20 years, then the total rental payment will be PKR

9.6 million which is PKR 11.7 million (121%) less than the mark-up (interest) charged by an IB (in the above example). This rental amount of PKR 9.6 million can further reduce if we use proportionate ownership of borrower over the period of loan tenure. So, in substance, if IB system is truly based on Islamic principles or working under an Islamic Economic System, then extra payment from borrower would not be more than the market rent of the property purchased by the bank.

Where does the problem lie?

In the example above, it is clear that there is no difference between the outcome of an IB vs. a CB. If we do a little research, similar results would be received on other IB products. The issue does not lie with Islamic banks but it lies with the fundamental problem of economic system. In Capitalism, whatever Islamic principles one uses, the result will always be in favour of the base economic system. One cannot implement true Islamic banking unless the fundamental economic principles are redefined. Otherwise, the deception of IB is good for spiritual peace but in essence, it is a younger sibling of CB.

If the Muslim world thinks that its ideology of Islam provides a comprehensive solution for the society, then they need to come up with a practical economic system, which provides thorough guidance and alternative options to Capitalism. Otherwise, changing merely the name of conventional banking system to Islamic Banking system will not bring any change. It would be only a deception.

Way Forward

Malaysia is currently leading the research on this topic. There are many scholars who are sitting on boards of Islamic Banks or Central Banks - Shariah wings. The efforts, dedication and commitment of these scholars and others who are working to find solution to current economic problems is appreciable. However, they need to understand that their efforts are not bringing any positive change to the society. If we introduce the current IB system as an alternative of capitalism to our new generation, sooner or later they will come to believe that Islam does not have any solution to current economic problems.

In order to define a fair economic system based on principles of Islam, our universities need to play a big role in this transformation. They need to create economic research wings to explain teachings of Islam in order to formulate an interest free economic system as an answer to the present economic problems. It is inevitably a long journey but if we go towards the right direction, we can come up with a real IB system.