December 24, 2005

SIX years ago, on December 23, 1999, the Shariat Appellate Bench (SAB) of the Supreme Court of Pakistan issued its well-known judgment on the question of riba. It was a comprehensive judgment, declaring that all financial transactions bearing any interest charge on them were contrary to the injunctions of Islam. The SAB therefore instructed the government to take necessary steps to transform the economy so that the owners of capital would earn their reward only if they took part in the risk of the enterprise. The financial transactions, in other words, must represent the real transactions, whether they pertain to the private sector of the economy or public sector including national saving schemes.

The chronology leading up to this judgment is worthy of note. It is the culmination of the process that started in the 1950s and reached its peak during the rule of General Ziaul Haq. It was during this period that the Council of Islamic Ideology prepared a report for the Islamic reform of banking in the country. The chairman of the council later became chief justice of the Federal Shariat Court.

The Federal Shariat Court (FSC) decided to act on the appeals which had been submitted to it against riba, and it announced its judgment in 1991. The Nawaz Sharif government filed an appeal against the judgment. This appeal had remained pending until Mr Nawaz Sharif in his second term decided to withdraw it in 1999. The explanation was that the government had decided to act on the judgment and, for this purpose, to seek further guidance from the FSC.

The Appellant Bench denied the request of the government, however. In its deliberations in February 1999, the chief justice of the SAB is reported to have observed: “We have to see what riba is. It is a matter of concern not only to Pakistan but to the whole of Muslim Ummat”. (Dawn, February 23, 1999): It was an important remark and was open to interpretation. The judgment certainly seems to have lived up to the expectation.

In responding to the 1999 judgment of the Appellant Bench, which had been delivered after about ten months of deliberations, the government of General Pervez Musharraf at first announced its intention to implement it in accordance with the SAB timetable. Later, however, it asked for a postponement and finally it became a respondent in the appeal to the Supreme Court (Shariat Review Jurisdiction) filed by the United Bank against it. The final act in this denouement took place in June 2000 when the Supreme Court set aside the SAB judgment and “remitted [it] to the Federal Shariat Court for determination afresh in the light of the contentions” of the petitioner and the respondent.

There has been no further development and, perhaps technically speaking, the matter has not yet come to a full circle. My objective here is to offer a few comments on the main recommendations of the judgment. My reflections in this regard will necessarily be guided by my familiarity with the subject which I have developed through my professional writings on this and related issues.

There is a vast body of literature on riba in Islamic jurisprudence. For convenience, I would identify some of its main trends into five categories which seem to be most relevant for my discussion, as follows:

First is the orthodox and the traditionalist school of thought dealing with this question. It is characterized by the view that riba includes all loan transactions which offer a reward for time, and that this interpretation is universally applicable. This view has received a new vigour since the 1970s.

Second is perhaps a sub-set of the above category. Some jurists follow Hanafi tradition in a broader sense and allow some flexibility in the application of the rules forbidding riba, generally known as ‘hiyal’ (plural of heela) in the relevant literature. Many of the Islamic modes have been developed as a result of this interpretation.

In the third category, the scope of riba is narrowed so that it is considered relevant only in the case of the practice of ‘riba al-nasia’, also known as the ‘riba al-jahlia’, and is defined in the framework of loan transactions made by the Arabs at the time of the first Quranic injunction.

In the fourth place, some writers claim that both the Quranic riba and the riba as mentioned in some Ahadith, riba al-fazl, are in fact a single phenomenon forbidden in Islam. The proponents of this approach believe that the riba injunction should be explained with reference to the usual al-fiqh, in order to derive the Divine Law, with no constraints of historical context and of modernity. They in fact share the traditionalist position which they believe needs to be streamlined.

In the fifth group may be included the contributions of Islamic economists. The objective of these contributions is to explain the injunctions against riba in economic terms. It is an attempt to straddle between the views of the jurists in the above first and second categories. A majority of writers in this category have relied on microeconomic analysis of interest by focusing on factors such as waiting, abstinence and time preference as rewards for saving, thus completely ignoring the real issue which belongs to capital theory. The SAB judgment falls in the first category and it is in line with the traditionalist thinking in Islamic jurisprudence. The bench in its formal hearings took an opportunity to acquaint itself with the Islamic economic view on the subject which was largely sympathetic to the traditionalist position. Some economists did hedge their statements with pre-conditions which they thought would be necessary for realization of an interest-free economy in Pakistan. They also took the opportunity to underline the role of risk aversion in financial transactions.

Coming to the appeal (June 2000) against the judgment of the appellant Bench, a number of issues were raised during the hearings, and two of them seem more relevant for my discussion. First, the question concerning the scope and range of juristic opinions on riba was raised by Dr. Syed Riazul Hasan Gilani, a counsel for the Government of Pakistan. He noted that there was considerable diversity of views on this matter which had not been duly taken into account by the SAB. An obvious inference of the counsel was to the fact that the SAB had arrived at its sweeping judgment by making selective use of the sources, thus ignoring others as irrelevant, weak, or being against what it called the ‘mentality’ of the Quran.

Given the fact that there is no unanimity among jurists about the definition riba, as underlined by Dr Gilani, why the traditionalists should have the exclusive right to interpret the Quran and the Ahadith is a question which requires a careful attention.

The counsel for the petitioner, Raja Muhammad Akram, submitted that it was important to give close attention to the Quranic injunctions which forbid riba and permit ‘bay’. The latter term, he claimed, covers quite appropriately the present-day business conducted by banks, such as sale, trade, investment, bargaining, etc.

The SAB had in fact taken a clear position on modern banking in its report. It noted that even though these banks do not have precedence in Islamic history, they still personify a group of individuals, thus implying a clear similarity with the activities of money lenders. This comment conveys a misunderstanding of the fact. Modern banks are chartered institutions, duly established under the authority of parliamentary rules, with an integral link with a central bank, and conducting their business in the framework of the market system. The money lender faces no such constraints.

The SAB judgment also claims that corporate finance in its rudimentary form was known to the ancient Arabs. There are no documents or even anecdotal references which would indicate that the mode of production among the Arabs of Makkah and the cities around it had reached a level of commercial or industrial activity to accommodate this kind of financial arrangement. If in fact this was the case, some prototype of this institution should have been familiar to the business community during the period of the Umayyad and the Abbasid dynasties. The reality, however, is that corporation is a modern innovation, with its principle of limited liability of shareholders. This would be contrary to the criteria of risk taking as defined by SAB.

It seems that in the debate concerning the elimination of riba in a modern economy, the financial terminologies which are currently in vogue have been a source of confusion. As mentioned above, the Quran does not define riba, but the reference to it in the verses would lead one to safely assume that the Arabs understood the message. There is no clear historical indication available, however, for our guidance. The verse 3:130 (referring to continued doubling), for example, describes the practice but not its form and formality. The anecdotal evidence is not of much help either for a meaningful economic discourse on the subject.

There are several parallel phrases available in world history to describe the age-old custom of money lending. In Hebrew law, for example, words such as “tarbit” and “marbit” convey the gain from loan of money which is forbidden. In Hindi, “bayaj” would literally translate into increase. The Persian word “sud” refers to gain or benefit. In Europe, however, the term interest (interesse = between) came in vogue when the expanding economy created competition among various alternative uses of money (lucrum cessans — money for a given purpose at the cost of alternatives forgone). The concept was further developed when it was linked to the rate of return on capital.

From this brief history, it seems that the use of riba and interest interchangeably is not a justifiable practice. Interest in modern economy is used not only as the market price for allocation of capital, but it also serves as a “numeraire” (to use the technical jargon) or a discounting device for calculating values of assets (including many traded in stock exchanges) and for identifying the current value of a future stream of income. No persuasive argument has been advanced by the advocates of an interest-free economy to show that a person accepting payment now at a discount rather than later at an expected value is contravening the injunctions against riba.

The only model available with real data concerning the rate of return and a “numairer” of social marginal productivity for the economy is that pertaining to the Soviet Union and its associated East European countries. Elegant mathematical formulations were built to define the role of social marginal productivity with considerable confidence, given what was considered to be the most suitable condition of state ownership of property. Gradually the mood of optimism changed as the reality did not fit into the equations. There are many lessons to be learned from this model which have been completely ignored by the advocates of interest-free system. The fundamental point which emerges is that there is no substitute for the market-based index, call it by any name.

Perhaps the recent move by the State Bank of Pakistan to have two types of banks operating in the economy is a move in the right direction, for two reasons. First, it will contribute to financial widening in the economy by catering to the needs of those who would prefer to avoid conventional banks for their business for religious reasons. Secondly, the Islamic banks will get an opportunity to build evidence concerning the scope and limits of the Islamic modes of financing in the country.

The conventional banks which already do their business in the framework of Islamic reforms introduced by General Ziaul Haq will have to compete with second type of banks conducting their operations according to the directions of the Shariat Boards.

The Islamic banks will face some paradoxes and some challenges in justifying their objectives, however. One of the most important paradoxes which will have to be resolved is that in spite of their claim to be Islamic, they are under secular rules and regulations determining their corporate authority, especially in regard to the liability of their officers and share holders.

Among the challenges, they will have to demonstrate that they can meet the financial needs of their clients without resorting to credit creation as practised by conventional banks. This would require that the balance sheet should clearly indicate some equivalence between their cash reserves and primary deposits on the one side and their financial/commodity transactions, on the other.

And, secondly, they will have to convince the sceptics that payment of profits to the investors part way through the period of contract does not constitute a subterfuge in lieu of interest. At present they manage to avoid this problem by concentrating on modes such as ijara, lease, and investments in real estate, etc., which provide them with reliable and continuing return on their lending. They will also have to explain that in the pool of investible funds at their disposal, they are able to clearly identify the risk incurred by individual owners of capital separately, in order to fulfil the condition of profit and loss sharing.

E-mail: izzud-din.pal@videotron.ca

Please Visit our Sponsor (Ads open in separate window)