The International Journal of Finance 8

Vol. 14 No 4, 2002, pp. 2428-2443

INTEREST-FREE ISLAMIC BANKING: IDEALS AND REALITY M. Raquibuz Zaman Ithaca College Hormoz Movassaghi Ithaca College Abstract This paper reexamines the concept of usury (riba) in Islam and tries to show that neither all the practices of conventional banks are usurous, nor the financial instruments used by today's Islamic banks are significantly different from those of conventional banks. The study suggests ways to standardize Islamic banks to allow them to avoid riba while at the same time providing meaningful banking services to all concerns. I. Introduction The establishment of the Dubai Islamic Bank in 1975 heralded the arrival of a new age in Islamic finance. By the end of 1996, the number of Islamic banks (IBs) rose to 166 with a total paid-up capital of $7.3 billion and total assets of $137 billion (Timewell 1998). These numbers appear impressive if one ignores the size of a single large commercial bank in many developed economies of the West (Business Week, July 13, 1998). Moreover, if one excludes the Iranian and Pakistani IBs, the countries that operate under the Islamic system of banking (along with Sudan), only 40 percent of the paid-up capital and 30 percent of total assets are commanded by those from other countries. These percentages do not paint the whole picture. The 19 Gulf Cooperative Council, GCC, states command 18 percent of the total paid-up capital, and 13 percent of total assets of all IBs. In other words, 10 Iranian, 46 Pakistani, and 19 GCC IBs totaling 75 out of 166, command 78 percent of total paid-up capital and 83 percent of total assets for the IBs. Thus, it is quite obvious that IBs are relatively very small and a few of them are not even profitable (Timewell, Op. Cit.). The soundness of IBs was possibly worsened considerably by the 1997 and 1998 collapses in the financial markets in Asia and elsewhere. Exogenous economic and related socio-political factors usually adversely affect all sectors of the economy. but the effects can be more severe for the IBs which are not financially or conceptually sound to begin with. Except for Iran, Pakistan, and Sudan where there are no alternative forms of banking, the ills have not attracted a significant portion of the overall business of banking from the general public, possibly because they cannot satisfy their banking needs. This situation may not change much unless IBs make some changes in their modes of operation and the financial instruments they use to avoid usury (riba).

This paper reexamines the concept of riba in light of Islamic jurisprudence (Shariah) and purports to show that while riba is undoubtedly prohibited in Islam, not all conventional banking transactions are usurous (i.e., riba transactions), and there are merely superficial differences between the profit/loss-based transactions of IBs and the interest-based transactions of conventional banks. The study urges Muslims to look deeply into the basic objective of Islamic economics, which is to ensure equitable and fair dealings for all participants in economic transactions and come up with financial institutions that implement that goal. An attempt is made here to present an alternative plan for financial institutions that put claims into practice and ensure a transparent system that allows clear evaluation for conformity with Islamic teachings. II. Riba in Shariah and its Relevance to Banking That riba is prohibited in Islam is acknowledged by all Muslims because it is clearly mentioned in the Quran, the Islam's holy book, and the traditions of Prophet Muhammad (sunnah). The Quran states: "Believers! Do not consume riba, doubling and redoubling" (3.130); "God has made buying and selling lawful, and riba unlawful (2:274). Except for the quote above on "doubling and redoubling, the Quranic verses do not define riba. Parenthetically, it should also be noted here that riba, the English translation of which is usury, is also prohibited in Judaism and Christianity, which ask their followers to refrain from usurous transactions to avoid burning in hell fire (Homer 1997: 69-81). The classic commentators on Quran, such as, al-Tabari (d. 923 A.D.), Zamakhshari (d. 1144 A.D.) And Ibn Kathir (d. 1373 A.D.) contended that the Quranic verse 3:130 on riba essentially talks about riba-a/-Jahiliya (i.e.. usury practiced in the pre-Islamic period in Arabia). AI- Tabari in his Jami (4:49) points out that riba in the pre-Islamic period referred to doubling and redoubling of the principal amount lent in commodities over a period of time. At the due date, if the borrower could not repay the amount borrowed the loan was extended for another year for double the quantity originally lent. If at the end of the second year, the borrower failed to repay the loan the loan was extended again for double the quantity of the second year to be repaid next year. Thus, in two years' time, the insolvent borrower would owe the original lender four times the quantity lent to him at the outset. AI-Zamakhshari in his al-Kashshaf (p. 234, no date of publication), gives a similar interpretation which points out that even a small debt could consume all the wealth of a debtor because of repeated doubling of the unpaid loan. Ibn al-Arabi, (d. 1240 A.d.) in his Ahkam al-Quran (no date, V I 241), gives a similar interpretation of riba that is riba al- Jahaliya. The Prophet (PBUH), in his farewell Hajj, clearly proclaimed that, "riba al-Jahiliya is null and void from this day and that riba of Abbas bin Abdul-Muttalib has been waived." Ibn al-Arabi, (Op. Cit.: 241) states that: "Riba was well known among the Arabs. A person would sell something on a deferred payment basis and upon maturity the creditor would ask: 'Will you pay (now) or add an amount to the bill'?" Those who equate riba with interest seek support from aI-Jassas (d. 981 A.D.), who claimed that pre-Islamic Arabia practiced a form of riba where money was lent at a predetermined sum over the principal amount (Ahkam al- Quran, V. I :465). However, there is no historical evidence to suggest that riba al-Jahiliya also consisted of

transactions that were similar to modern loans on interest (Suhail 1936, Tantawi 1989. Afzal 1996, et al.). The Quran uses riba while referring to debt, whereas the sunnah refers to riba in the context of various types of sales. In the hadith literature (sayings and the practices of Prophet Muhammad), we do not find any mention of qard (loan) or dayn (debt). Moreover, "almost all authentic narrations about Riba appear to relate to sales during or immediately after the battle of Khaibar long before the final prohibition of Riba came." (Afzal. Op. Cit. 3). One common example of such ahadith (plural of hadith), the six commodities" hadith, was narrated by Abu Sa'id al-Khudri on the authority of the Prophet as follows:
"Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, salt by salt, like by like, payment being made hand to hand. He who made an addition to it, or asked for an addition, in fact dealt in usury. The receiver and the giver are equally guilty." (Muslim, no 'date, v. m: 834).

However, various versions of this hadith use terms such as mithlan bi- mithlin, sawaan bi-sawain, and aynan bi-aynin which create confusion as to whether or not the exchanges could be between various qualities, sizes, weights, and measures. Exchange of commodities on the spot (hand to hand") is called riba al Fadl. Despite the attention riba al-Fadl has been receiving from the Muslim jurists (fuqaha), it is difficult to see the significance of such transactions. Why would anyone try to exchange one commodity for another at a single point in time except for barter trade? Surely. Islam does not consider bartering one product for another or one service for another as riba. Barter trade is the common form of exchange of products and/or services in an inadequately monetized economy. And this is still very much in vogue in the Third World countries as well as in Russia and in some of the former centrally planned economies. The "six commodities" hadith (and its variations) that was narrated above was apparently meant for the Muslims of Medina who were eager to exchange their shares of war booty from the Khaibar expedition for different commodities they needed and in the process were being cheated by the defeated hypocrites (munafiqun). It was to prevent the Muslims from becoming victims of fraud that the Prophet is said to have instructed them to refrain from the type of exchanges narrated by the above hadith. Caliph Muawiah is said to have questioned the relevance of the so-called "six commodities" hadith to riba that is prohibited in Islam (Suhail 1936). It is important to remember that when one borrows one commodity to return it later, it is no longer under the purview of riba a/-Fad/, since the latter deals with exchange "hand to hand" Whenever there is an elapsed time, that is, from one point in time to another, the transaction would come under the category of riba a/-nasia (deferred payment). As explained above, if one accepts assertion such as the "sixcommodities" hadith, all uneven or unequal transactions (even riba a/-Fad/ in some commodities was permitted by the fuqaha) that do not involve money as the medium (i.e.. barter trade) would automatically be usurous. This is completely unacceptable from the point of view of religious, moral, and economic reasoning
The type of riba that may likely be common is usury involving elapsed time (riba al-nasia). Most transactions involving borrowing and lending are over

a time period such as days, weeks, months or years. Depending on how the transactions are worded", it seems some fuqaha consider nasia transactions like salam sale (installment payments at a higher price) and murabaha transactions that allow pre-determined mark-up on the amount lent (price for, say, a car, a computer, etc) to be permissible in Islam: others contend that nasia transactions are usurous. However, there is hardly a specific hadith dealing with borrowing and lending of money by institutions such as banks and other types of depository institutions, which were non-existent until the last century Fuqaha simply deduced their arguments through analogy (qiyas) about monetary transactions from those on the exchange of commodities.

The transactions that are characterized as riba by the fuqaha are based on the principle of "efficient cause" (illa) without much of any attention being paid to the underlying rationale (hikma). For example, the Quranic verse lakum ru 'usu amwalikum (2:279) (that is you shall be entitled to the return of your principal") was used as illa, whereas the continuation of the verse la tazlimuna wa-Ia tuzlamun (i.e., "you will do no wrong and neither will you be wronged") which provided the hikma, was ignored. If one takes the first part of the verse literally then the question of loss sharing by the lender does not arise. Yet Islamic banks claim to share loss as well as profit! To quote Afzal (1996):
"In many cases the 'Illa' approach appears superficial and devoid of moral considerations. For example, coins like 'fals' did not involve Riba in Maliki and Shafi'i schools Thus 100 'fals' (which were used as a unit of currency but were not made of gold or silver) could be exchanged for 200 either on the spot or on a deferred delivery basis (Why today's fiat money could also be not counted in this category, is u good question to ask). Commodities which were countable like apples and eggs did not involve Riba, and hence could be exchanged less for more according to Hanafis. A piece of cloth could be exchanged for two pieces of the same quality and measure since it was neither measurable. or weighable. or gold or silver .or foodstuff.

It seems the fuqaha have developed "narrow" interpretations of what are usurous (riba) and not usurous transactions, to suit their own purposes and lines of thinking. Some substitute the term interest" wherever the Arabic term riba appears (for example, Siddiqui 1978 and 1986: Chapra 1985: Naqvi 1993: Faridi 1991: Wohles-Scharf 1983: Anwar 1987, just to name a few) and argue that Islamic banking institutions cannot deal with interests. Others (for example, Sanhuri 1954- 1959; al-Saud 1985: Tantawi 1989: Salus 199 I: Suhail 1936; Yousuf Ali 1946, in his commentary on Quran 2:275. commentary 324: Shah 1967; and Rahman 1980) make a clear distinction between usury (riba) and interest and explain what types of interest-based transactions qualify as riba and which do not. Afzal (1996) details the opinions and debates on riba from the point of view of the sunnah and the fiqh in the various regions of the world from the time of the Prophet leading up to modem times. It is a noteworthy contribution to the understanding of riba and its implications for Islamic financial institutions. Unlike the earlier centuries of Islam, money is no longer just a medium of exchange but also a commodity in its own right. Money can be saved and invested, lent and borrowed, and traded like other commodities. To facilitate the flow of money from the savers to the ultimate users, financial institutions such as banks came into existence

over the past century and a half and have been performing various functions for the economy. Even though such institutions, like any business, seek profit for their shareholders (for depositors in "mutually" owned financial institutions), they are not in the business to exploit one party or the other. In order to appreciate this point we need to examine the financial instruments used by conventional banks and compare them to those used by IBs. To this, we turn next. III. Financial Instruments Used by Conventional Banks in Advanced Market Economies A typical commercial bank in the U.S. is owned by shareholders and run by employees hired by the executive officers of the bank who in turn are hired by the Board of Directors--the elected representatives of the shareholders. Approximately 8 percent of the bank's assets come from shareholders' capital and the remaining assets are generated through the deposits of customers and fee-based services the bank renders to its clientele. (According to the Basle Agreement of 1988, there are two tiers of capital which need not be discussed here.) The bank accepts ordinary passbook savings accounts time deposits (i.e.. certificates of deposit), and demand deposits (i.e.. checking accounts). There is no promise of any return on the passbook savings accounts-whatever interest is paid on such accounts is based on the market demand and supply of funds and the cost of operations of the bank. On time deposits, the bank will guarantee a rate of return for the time of the deposit, but the rate varies according to the maturity of the instrument, when the deposit is made and the conditions of the market. The longer the maturity .the higher the promised rate because of the problems of interest rate risk arising out of the level of inflation and maturity risk. Demand deposits usually require payment of fees by the depositors. At times these are waived (i.e.. if the balance in the account is above a certain minimum limit, or for those whose paychecks are directly deposited by the employer to the bank, and for senior citizens). When fees are charged, they are usually based on the bank's cost of funds and cost of operations. On the asset side, the bank keeps some cash for meeting the legal reserve requirements and meeting the needs of cash transactions and deposit withdrawals. This is a non-earning asset for the bank. The next most liquid asset of the bank is marketable securities, such as U.S. Treasury Bills, which can be quickly liquidated when cash is needed on a short notice the return from such assets is relatively low because such securities are virtually default risk- free and liquid. The most important asset instrument for a commercial bank is the commercial loan. Commercial loans are mostly short term (i.e., a year or less in duration). These loans are used by businesses to cover costs of accounts receivables, inventory, and accruals (payments not yet made for services such as employee paychecks, taxes owed, etc.). In general, most businesses in the U.S. establish lines of credit with their commercial banks to cover routine transactions. The borrowing firm usually has to maintain a compensating balance (a non-interest- earning time deposit) to the tune of 1020 percent of the line of credit with the bank for ensuring the safety of depositors' money. The rate of interest the bank charges to its customers for short-term loans depends on the bank's cost of funds (expected payments to depositors, costs of rendering services such as employee costs, material costs, etc.), the nature of the loan (i.e..

financing of accounts receivables versus inventory or accruals), the riskiness of the borrower, and the competitive rates charged by other providers. Medium-term loans (between 1-5 years) are extended for the purchase of equipment, the remodeling of plants and facilities. etc. on all installment basis. These rates can be variable (flexible) or fixed. Banks also provide consumer loans for financing the purchase of automobiles, furnishings, and other durable goods. The rates charged are based on the quality of the collateral pledged, the credit history of the customer (which determines the riskiness of the loan), and the usual cost considerations. Mortgage loans for commercial real estate and housing loans for families and individuals are the principal long-term loans offered by a commercial bank. Once the qualification of the borrower is determined by the usual criteria, the length of the loan and the interest rate charged can either be flexible (certain percentage points above the risk-free Treasury security rate) or fixed. Banks carry insurance policies against loan losses and the cost of the insurance premium is borne by the borrower and the bank. Some commercial banks also provide trust services for minimal fees. The bank can manage properties of trustees under the specific legal and moral guidance of the state where it operates. All banks are subject to examination by either state banking authorities or the Federal Reserve Bank or the Comptroller of the Currency of the U.S. Treasury Department. Such examinations provide the checks that are needed to ensure that public trusts upon banks are properly met. Increasingly, commercial banks are earning substantial revenues from fee-based services such as consulting and facilitating transactions between various parties. These services are contractual, and the fees are determined by negotiations between the bank and the buyer of the service. Investment banking and lease financing are typically carried out by non-bank financial intermediaries that are funded by shareholders. At times, commercial banks may own subsidiaries that perform such activities; however these operate as separate commercial ventures without direct access to the depositors' money. IV. Financial Instrument Used by Islamic Banks The financial instruments used by IBs appear to be quite different on paper. The question is: Are they? Let us examine the operation of IBs in the market. IBs offer checking accounts as well as savings accounts. These are defined as qardal-hasanah deposits by the Iranian banking laws (Naqvi 1993: 155-165). The Iranian IBs do not pay any interest on these deposits. However, the depositors are paid bonuses and prizes (i.e.. extras) in cash to attract them to these accounts. It is not clear author how the sizes of these payments are determined or how they compare with the prevailing market rates of interest offered by conventional banks in the neighboring countries. In general, IBs offer investment accounts, term investment accounts (in Iran), and mudaraba accounts. These are savings deposits for various lengths. In Iran, short-term investment deposits against passbook account for a minimum of three-months, and the long term is defined as a year or longer (Ibid. : 157). The holders of these accounts, the depositors, share profit/losses with the bank and its clients who utilize the funds under mudaraba system (Siddiqui 1986: 47). Interestingly enough, the rate of profit that the depositors earn is consistently higher for longer terms as the annual reports of Bank

Islam Malaysia Berhad for 1994 through 1996 show (see 1996 report, p. 13; 1995, p. 17; 1994, p. 12). One would expect conventional banks to pay higher interest rates for longer maturities to compensate the depositors for maturity risk (and possibly purchasing power risk), but not from IBs. This is because it is not always possible to have higher profits from long-term investments. Long-term investments suffer from myriad risk factors inherent in economic activities. The posted rates of profit suspiciously look like predetermined interest rates! Timur Kuran's study of the practices of the Turkish conventional and Islamic banks proves the point (Kuran 1995). The principal instrument used by IBs are the mudaraba accounts, which are of various forms in terms of participation by the depositors, the banks, and the entrepreneurs borrowing the funds. The shariah council of each bank determines what qualifies as a mudaraba account, what conditions the parties in the contract must fulfill, and what should be the distribution of profits, and supposedly, losses. The depositors, the suppliers of capital (rabb al-ma/), entrust their funds to the bank, the mudraib, to invest on their behalf. The mudraib is to distribute the profits/losses according to the following general conditions: 1) profits to be shared must be proportional to the funds contributed to the mudaraba account and these cannot be paid in lump sums or in guaranteed amounts: 2) the loss to the rabb a/-ma/, the depositor, cannot be more than the amount of deposit: and 3) the mudraib, the bank does not share in the losses, except for the time and effort put into the management of the mudaraba funds (DeBelder, and Khan 1993). These stated conditions raise questions about fairness. Why cannot profits be paid in lump sums? Should the depositor, rabb a/-mal, lose any money when the funds have been put to use by a borrower with the consent of the bank? Does it not go against the Quranic injunction of "Lakum ru 'usu amwalikum" ("you are entitled to your principal")? Why should the bank not take some responsibility for the loss if it was a party to the decision? After all, the bank is the agent of the shareholders who are supposedly responsible for hiring the bank executives. Moreover, the way the mudaraba contracts work, it is entirely possible for borrowers to claim losses, even if their own actions brought such results, and avoid repayment of the principal amount. Again, this goes against the very principle of Islamic teaching of "lakum ru 'usu amwalikum ". The practice of some IBs in mudaraba transaction related to housing that this author observed in Saudi Arabia in 1981-82 raise serious questions about the Islamicity of such actions. Lending two-hundred thousand riyals to a borrower for one year to build a residential quarter without interest", but deducting forty thousand riyals as profits" beforehand (i.e.. actually lending one-hundred and sixty-thousand riyals and collecting the full two hundred thousand at the end of the year) does not amount to interest-free banking. In reality, it is worse than a regular interest-based loan where, the borrower at least gets to use the full amount of the loan and then pays the interest along with the principal after the completion of the project. In finance this sort of loan, as practiced by the IB, is called discount loan. which is generally costlier than an ordinary loan. In the above example, a regular loan would have cost 20 percent interest, whereas the housing loan by the IB cost 25 percent (i.e.. forty-thousand riyal over one hundred and sixty thousand actually received) to the borrower! Of special interest is another IB-used financial instrument called murabaha. In this case, the bank buys a product to resell to the borrower at a mark-up and collects back

the amount in installments. The mark-up is a predetermined profit to the bank and apparently IBs do not see this as interest! Let us look at a simplified example of a murabaha financing of a car purchase. In conventional car financing, the buyer would shop around and find a car at the best possible price and go to a bank (often a car dealer can arrange this for the customer right in the showroom) that will quote a competitive rate of interest for the loan. If the buyer of the car, the borrower, agrees to the terms and conditions, a contract is written up showing the monthly installments, the interest rate applied to the payment calculations, and the total amount to be paid by the time the loan is paid off. Suppose the car is priced at $20,000 and the bank charges 11.2 I percent interest on the 2-year loan. This will mean a monthly installment of $934.11 and total payment of $22.418.59 ($934.1 x 24 months) in two years. Under murabaha transactions, the IB will sell the car to the borrower at $25,000 to be paid back in two years either by installments or in lump sum. Even though no interest is said to have been added to the loan, this "profit" of $5,000 over a two-year period implies a rate of earning of 11.21 percent for the bank-the same as the loan by the conventional bank. However, notice that the latter only costs $22,418.59, or a savings of $2,581.41 for the borrower for the same car. For the privilege of not calling it "interest" the customer of the IBs is overcharged, which cannot be justified on any ground. No matter how we look at it, murabaha transactions that this author has observed can only be called usurous by even Western standards. Such transactions do not belong to IBs no matter what justification the shariah councils provide. Like murabaha ijara (leasing) is another popular financial instrument for IBs. There are two types of leases used by IBs--one where the installment payments made by the lessee go towards ultimate purchase of the equipment by the lessee (Wohabe 1997: 11), and one where the lessor maintains the ownership and leases the equipment for a specified period of time. The first is known as ijara wa-iqtina (Martin 1997). The ijara contracts seem to have been fashioned in line with the leasing contracts in the conventional leasing business in the West. DeBelder and Khan, commenting on the Pakistani practice of leasing contracts, observe "current Pakistani business practice results in monthly lease rentals generally working out to be equal to installments of principal plus about an amount equivalent to interest of 22 percent per annum" (Op. Cit., p. 6 of the electronic version). Lease financing is generally a separate business from banking in the modern world. True, some banks may own a finance subsidiary, but such an institution is separately managed by professionals whose specialty is in this field. Finance companies and insurance companies are the principal owners of such operations. Because of a general shortage of expertise in IBs, as evidenced from their poor performance (Timewell 1998), it appears that they will be better off to separate these from banking operations. This instrument is another example of IBs imitating poorly Western business practices under the disguise of profit sharing. The next financial instrument used by IBs is musharaka. a form of equity financing. The IB not only provides the capital, but also joins in with the borrower in managing the financed venture (Chapra. Op. Cit.: 165). For the IBs to be an impartial partner while working as the banker to the depositors and a partner to the borrowers business seems unrealistic. Conflict of interest" is likely to arise frequently. Even the

well-trained finance operatives in the West seldom perform such varied tasks under the umbrella of one single financial institution. V. An Alternative to the Current Form of Islamic Banking The goal of an Islamic bank ought to be to provide financial services that adhere to the basic Quranic teachings in the verses quoted earlier, and the message the Prophet (PBUH) left behind in the last pilgrimage. For this to be accomplished, we need a system that is just and fair to both the lenders (depositors) and the borrowers. The bank is to be an intermediary only--the one that brings the two parties together, facilitates their negotiations, and provides the expertise and services called for. An Islamic commercial bank should provide the basic deposit accounts (checking, savings and time deposits) and pay and charge variable rates of interest based on the actual profit earned in the immediate past and the expected profit in the near future. When the actual costs and returns are properly determined, all depositors and borrowers are to be notified of the change in rates, if such changes do occur. There cannot be longterm fixed interest rates since performance and profits vary from one period to another. Calling interest rate "interest and not profit takes the false notion of piety out of the picture. It is not simple interest rate but excessive rate (high rate without any relationship to cost and profit) that must be avoided. Since no one can guarantee that a loan will not get defaulted because of little or no fault of the borrower, the bank must take out insurance policies, premiums for which are to be jointly borne by the depositors, the bank's shareholders (via the bank), and the borrower. Mutually owned and operated insurance companies should form part and parcel of the Islamic financial system. With adequate regulatory supervision and through checks and balances offered by analysts under a system of free flow of information, fraudulent schemes by any party can be minimized and even eliminated. The principal function of a commercial bank is not only to receive and nurture deposits, but also to provide loans to business and the consuming public either on a short-term, medium-term ( 1-5 years) or long-term basis. Short-term commercial loans are needed to finance accounts receivables, inventory, and possibly to meet other shortterm needs. Graduated rates of interest could be developed to match risks, but these rates must reflect the bank's cost of funds plus a reasonable rate of profit. With strict accounting standards in place, it should not be difficult to ascertain such costs. Medium-term loans for remodeling, expansion of facilities, purchase of equipment and the like should be based on variable rates of interest. Long-tern loans for such purposes as plant expansion or new factories and facilities should also have variable rates. Maturity risk and default risk will require that different customers and/or projects be charged different rates of interest without being unjust to anyone. All loans should be backed by collateral as is done in conventional banking. Written contracts on all forms of loans and/or investment transactions are routine in conventional banking. The argument that today' s Islamic banks provide written contracts that allow all parties to see what is involved and, as such, the transactions are not interest based, is a weak defense of the instruments they use. Conventional banks are also vigorously doing this, and it does not make them Islamic.

What would be the basic difference between the alternative Islamic banks and the conventional banks then? The basic difference is that conventional banks provide longterm fixed interest-based deposits as well as loan accounts that do not necessarily have any close relationship with their overall costs of operation and desired level of profit. The alternative Islamic bank will not have any fixed rate of interest and the interest charged or paid must closely reflect the actual costs and returns of the bank. This will be different from the current IBs in that they will not be dealing with fixed or imaginary profits that are really interest rates. The experience of the Faisal Islamic Bank of Egypt, FIBE, between 1979-91 shows the contradiction between claims and reality. more than half of the assets of FIBE were deposited at other banks, particularly abroad, and the bank received interest rate. This business policy strongly contradicts the Islamic injunction against interest, which is the raison d'etre of Islamic banks" (Kazarian 1993: 225). Also, the alternative IB with not deal with murabaha, musharaka, or ijara transactions. In their present form, transactions like these should be carried out by nondepository institutions, if at all. Murabaha transactions are difficult to justify under the Islamic system of fair play. Most of the murabaha dealings that this author examined in the U.S. charge excessively high prices (i.e., high rates of interest under the guise of profit"). Musharaka transactions should be carried out by joint stock companies with the funds of the shareholders. True, such companies could borrow occasionally from Islamic banks if funds are available, ijara should also be run by publicly held finance companies in the same fashion as the proposed musharaka companies. It is difficult to justify a bank, Islamic or otherwise, engaging in the trade of commodity or currency futures, options, and derivatives. These are highly speculative transactions even by the Western standards. Since Islam is vehemently opposed to gambling, these instruments should not be part of a bank's portfolio of investments. A bank is a fiduciary institution and it must maintain this responsibility of public trust by not engaging in highly risky ventures. For a truly Islamic bank to function and succeed in the business world, there ought to be freedom of information, and the publics right to know must be upheld. Under the guise of secrecy, any organization may be tempted to engage in questionable dealings. The financial turmoil that enraged in East, South and Southeast Asia in 1997 is a prime example of the problems that may arise because of lack of transparency. For a smooth functioning of the financial institutions, there is a need for responsible governments to watch over and regulate them for the good of the general public. VI. Conclusion A successful financial system needs clear-cut standards that all parties can conform to across state boundaries. The idea of setting up a shariah council for each Islamic bank to determine whether a transaction is or is not Islamic simply points to the lack of consistency and standards in the practices of such banks. The use of financial instruments that bear a striking resemblance to interest-based instruments but are called profit/loss" sharing is a deception that the IBs can live without. Prohibition of usury (riba) is part of not only Islam but also of Judaism and Christianity. The followers or the two religions of the books also deliberated at length on

what is usury or what is not. After centuries of deliberations they came to the conclusion that interest" in banking is not usurous (Homer 1977). It is instructive to examine their deliberations on the subject. Unlike the West, where the religious teachings have now been completely separated from the life of the financial world, and banks and other financial institutions can charge any rate of interest their governments and the populace allow them to, the Muslim world must insist that the rates charged and paid must bear relationship to actual costs and profit. Moreover, it is imperative that financial institutions in the Muslim countries do not engage in dealings (such as gambling) that are clearly prohibited under Islamic shariah. Until the IBs can demonstrate that what they claim and what they actually practice are above board, it is not likely that they will attract the general Muslim public to embrace their institutions wholeheartedly. Business and commerce can only operate when the general practices and standards are clearly known and understood. At present, it is difficult to fathom what is permitted by one IB but prohibited by another. References Afzal, O. Riba Usury or Interest or Both. A Conference paper for the Islamic Chamber of Commerce and Industry (ICCI), San Jose, California. November 7-9. (1996) AI-Jassas, A.R.. Ahkam al-Quran. I: / Istanbul. Turkey: 1916. (no date). al-Saud, A.M, Bain al-Faida wa al-Riba. Al-Shuran al-Islam. April 1985: 18-20. (1985) al-Tabari, A.J.M., Jami al-bayan an ta wil ay al-Quran- English translation of the abridged Version by Cooper- J.- New York: Oxford University Press 1987, (no date). al-Zamakhshari, M.I.U., al-Kashshaf ah Haqaiq al-tahzil wa-uyun al-aqawil fi wujuh alta wil. (no date). Ali. A.Y. the Holy Qur'an: Text. Translation and Commentary. Washington. D.C.: The American International Printing Company (no printing date). (1946) Anwar, M., Modelling Interest-Free Economy: .A Study in Macroeconomics and Development. Herndon, Virginia: The International Institute of Islamic Thought. (1987). Bank Islam Malaysia Berhad, Annual Report Kuala Lumpur: Malaysia. (1994, 1995, 1996). Business Week. The Global 1000 The Worlds Most Valuable Companies, Business Week, Jul. 13, 1998: 52-93, (1998). Chapra. MU. Towards A Just Monetary System. London: The Islamic Foundation. (1985).

DeBelder, RT. and Khan. M.H.. "The Changing Face of Islamic Banking:' International Financial Law Review. V.12. No.11: 23-29. (1993). Faridi. FR. Essays in Islamic Economic Analysis. Edited volume. New Delhi: Genuine Publications (P) Ltd. (1991). Homer, S., A History of Interest Rates (Second Edition). New Brunswick. New Jersey" Rutgers University Press, ( 1977). Ibn al-'Arabi, Ahkam al-Quran, Beirut Dar-al-ikzat al-Arabia. 1968. V 1 :24. (no date) Kazarian. E.G., Islamic Versus Traditional Banking: Financial Innovations in Egypt. Boulder, Colorado Westview Press, (1993). Kuran, Timur, "Islamic Economics and the Islamic Subeconomy," The Journal of Economic Perspectives, V9, No.4, Fall 1995: 155-173, (1995). Martin, J., "Islamic Banking Raises Interest." Management Review. Nov. 1997 V. 86, N. 10: 25-29, (1997). Muslim, I., Sahih Muslim (Volume III). Translated into English by Siddiqi. A.H. Lahore. Pakistan: Sh Muhammad Ashraf, ( 1990). Naqvi, S.R., History of Banking and Islamic Law. Karachi. Pakistan: Hayat Academy, (1993). Rahman, F., Major Themes of the Quran. Chicago: Bibliotheca Islamica, 1980} Salus, A.A., a/-Rad 'a/a Kitab Mufti Misr. Cairo: Dar al-Manar al-Hadithah, (1991). Sanhuri, A., Masadir al-Haq fi al-Fiqh al-Islam. 6 parts in 2 volumes (no other information available), (1954-1959). Shah, Y., Chand Ma'ashi Masail our Islam, Lahore: Idara-I Thaqafat-i Islamiya, (1967). Siddiqui, M.N., Some Aspects of the Islamic Economy. Second Edition. Lahore Pakistan: Islamic Publications Ltd, (1978). Siddiqui, M.N., Model of an Islamic Bank. Chicago: Kazi Publications, (1986). Suhail. I. Haqiqat al-Riba (no other information available). (1936) Tantawi, M.S. Arbah al-bunuk baina al-Halal wa al-Haram. Cairo. Dar al- Ma'arif, et. al. (1989).

Wohabe, D., "Why Islamic Leasing is Popular." The American Journal of Islamic Finance, Summer 1997: 11-12. (1997). Wohlers-Scharf. T., Arab and Islamic Banks: New Business Partners for Developing Countries. Paris: OECD Development Centre Studies, (1983).

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