institutional Tawarruq: a products of ill repute
mabid al-jarhi
president,
international association for ISLAMIC
ECONOMICS
introduction
Islamic finance
has been introduced into a world of conventional finance. The allocation of financial resources is done
in the conventional world of finance according the rate of interest. In addition, the volume of conventional
finance is overwhelming and the use of the interest rate is prevalent. Islamic finance allocation introduces new
criteria based on the use of financial resources to finance consumption and
investment. On the one hand, it provides
fund owners with a share in the profits of the financial process. On the other hand, it provides finance users
with the goods and services they desire to obtain.
The criteria of
allocating financial resources applied by Islamic finance introduce real
benefits to the economy both at the macro level and at the level of the
financial sector itself.
Tawarruq is a
form of revisionism that replaces the Islamic allocation criteria with
conventional ones, while maintaining a symbolic badge of Islamic finance
attached to the whole process. It is
unfortunate that the successful expansion of Islamic finance is accompanied
with challenges that threaten to suffocate the whole process under the guise of
financial innovation.
In this paper, we
intend to show that institutional Tawarruq falls outside the paradigm of
Islamic finance. Its use, if
predominant, can be precipitous, leading to impose a conventional model onto
Islamic finance and therefore could make it an exercise in futility.
The exposition
relies on three previous publications by the author, which include a wider
selection of references.
The author is
especially grateful for Dr. Mohammad Elgari for energetically launching an active
discussion about the subject, for the Harvard Law
School
table of contents
salient features of Islamic finance
Islamic finance can be considered as the most important
contribution to human civilization in the twentieth century, and the most
important source of financial innovation in the twenty-first century. It has proven a sound and practical way to
revive ancient and long forgotten Jewish, Christian as well as Hindu and
Buddhist teachings[1].
However, Islamic finance has its subtleties. The reason is that it draws its logic from
both Fiqh and monetary and financial economics. Fiqh is a discipline based on textual
verification and analysis, while monetary and financial economics is a
discipline based on deduction and induction.
Both disciplines are quite different in methodology to the extent it takes
a big effort from a scholar trained in one discipline to gain substantial
expertise into the other.
Unfortunately, Shari'a scholars are at a great
disadvantage in this regard, because they are not equipped to use economists’
tools of analysis. Meanwhile, it is not
an impossible task for economists to learn Fiqh methodology. However, sufficient care must be exercised.
Usually economists working in the field of Islamic
finance, especially those well versed in Arabic are tempted to learn Fiqh,
expecting to be able to play the role of both economics and Fiqh scholars. Undoubtedly, some economists have been able
to write professional papers in Fiqh and could have a robust debate with Shari'a
scholars. However, it would be difficult
for Shari'a scholars to reciprocate.
Economics is a much tougher discipline for outsiders than Fiqh. However, if economists are not well equipped
in Arabic to the extent of being capable enough to handle classical texts, they
are well advised to keep their distance.
Anyone who does not have the right tools may end with a cloudy view of
both disciplines. The unwary will face
the fact that learning a methodology and practicing it influences one’s way of
thinking. Learning two diagrammatically
opposed methodologies, without taking extreme care could ultimately lead to one
of them taking rein and the other setting back.
Some economists that venture into Fiqh may never become a
Shari'a scholar while also loosing his economics panache, while others may
survive in their own field. Shari'a
scholars meanwhile would rarely be able to venture into the field of economics,
due to their textual training. It may be
safer for many economists to formulate their economist perspective of
Shari'a. However, Shari'a scholars
should contend with staying well within their own discipline, leaving the
economic consequences of Fatwa to be determined by economists.
A.
fulfillment and challenges
Taking interest is considered a grave transgression in
Islam. The success of Islamic finance in
a freely competitive market, where Islamic and conventional finance each has an
equal chance was postulated by “Islamic economists.” Such equal chance has been hard to come
by. However, wherever it is available,
especially in most Gulf countries, Islamic finance enjoys higher growth than
conventional finance. Islamic finance
assets in the Gulf have grown at an average annual rate of 30 percent during
2001-2006. In the UAE alone, the average
growth rate was 40 percent. The market
share of Islamic finance in the total assets of the finance industry increased
from 9 percent in 2001 to 17 percent in 2006.
It is expected to reach at least one third by 2010.
Had Islamic finance been a fake hope or a backward ancient
way of doing business, it would have failed right away. Then, believers would have withdrawn quietly.
However, Islamic finance faces serious challenges. One of such challenges is the products of ill
repute. Such products can be attributed
to the eagerness to provide finance products that can be good substitutes for
conventional products. However, such eagerness
to product substitution must be reined by the borderline that lies between
Islamic and conventional finance. Such
borderline can only be defined with the paradigm of Islamic finance.
B.
sources of misunderstandings
Certain
misconceptions that may cloud the difference between Islamic and conventional
finance must be pointed out. Some
conventionally minded experts use the word “loan” to mean “finance.” It must be stressed that Islamic banks
provide finance, but they do not provide interest-based loans. They may provide a limited number of interest-free
loans (Qard Hassan) as a social service or charitable activity. Only the Islamic Development Bank, IDB,
provides sizable finance to its member governments as loans, against which it
charges fees reflecting the actual administrative costs.
Some use the word “Islamic bonds” to mean “Sukuk.” However, since bonds are interest-based debt
claims, and since debt sale is generally against Shari’a, the term “Islamic
bonds” would be self-contradictory.
Sukuk are asset-based financial instruments, where
non-debt assets compose the majority.
Debt assets in Islamic finance are claims resulting from Shari’a
compliant sale finance.
Some use the expression of “personal finance” to mean
personal loans. This only applies to
conventional finance. In Islamic
finance, it would not be possible to provide personal loans on commercial
basis, as lending must be done without charging any interest (Qard
Hassan). This may be carried out by
Islamic banks on a limited scale as a philanthropic activity. Meanwhile Islamic banks can provide personal
finance to fulfill certain personal requirements, like education, travel and
health services. The bank purchases such
services from their suppliers and sells them to customers against deferred
installments under the “service-Ijarah contract.”
Misunderstanding has not been limited to writings but they
extended to practice as well. Islamic
finance has its own share of self-claimed theorists as well as
practitioners. On the theoretical side,
there are those who claim scholarship in Shari'a without any academic training
whatsoever. Some may have only a first
or a second university degree in Shari'a.
A well-seasoned Shari'a scholar must be able to take a
comparative view of all opinions involved in each subject he would handle. This requires at least a Ph. D. degree in Shari'a
from a well-known and highly accredited university. For this purpose, a ranking of universities
that teach Shari'a must be made and regularly updated. This would make it possible to include
Shari'a scholars with Ph D from one of the top ten or twenty universities in the
field.
Such requirement is often ignored by shareholders who
appoint members in their Shari'a boards.
In addition, Shari'a scholars are not supposed to master the economic
and financial side of the industry. Each
Shari'a board should therefore have a monetary and financial economist as a
nonvoting advisor who would explain things from his perspective.
Self-claimed experts as well as the absence of economists
from most Shari'a scholars, have lead to the presence products of ill repute
in Islamic finance. Such products start
in narrow alleys, but spread rather quickly.
They are structured outside the consensus of Shari’a scholars and are
based on minority or maverick opinions signed by self-claimed but
insufficiently qualified experts. They
expose Islamic banks to grave reputation risk.
They include debt based financial instruments circulating under the name
of “Islamic bonds” and Sukuk, so called “hedge products” based on multiple
promises, so called “Islamic hedge
funds” that use dynamic strategies based
on short sale and long purchase, as well as institutional Tawarruq.
C.
the basic STRUCTURE of
ISLAMIC FINANCE
Islamic finance is based on both equity and
commodity trade. However, it does not
deal in risk trading. In place of the
conventional loan contract, Islamic finance has a collection of modes of
finance. Such modes are contractual
relationships that delineate the relationship between finance providers and
users.
Equity-based modes of finance present funds to their users
in order to provide for necessary factors of production, and/or working
capital. Fund owners get in return a
share in profit or in profit and management.
No debt is created in this case.
In commodity finance, fund users obtain the commodities
they require for production or consumption.
Fund owners get mark-up, profit, or rental payments. Commodity finance results in debt, either
monetary or in real commodities. Such
debt is subject to strict rules regarding the prohibition of sale of debt,
except at its nominal value. The value
of debt is set at the outset of each transaction. Under no circumstances, it should be allowed
to increase. This sets it apart from
conventional debt.
D. the product MENU
Islamic finance uses about eleven modes of finance in
place of the conventional loan contract.
They include (1) Musharaka, (2) Diminishing
Musharaka, (3) Non-Restricted Mudaraba, (4) restricted Mudaraba, (5) Wakala, (6) Ijarah,
(7) Ijarah Muntahia Bittamleek, (8) Murabaha, (9) Deferred-Payment Sale, (10) Istisna’,
and (11) Salam[2].
Islamic finance has already passed the stage of “single
mode transactions.” A large number of
transactions now involve multiple modes, e.g., Musharaka, Ijarah and Istisna’
can all be packaged in one product. The
art of product structuring has been evolving quickly. Compared to conventional finance, Islamic
finance provides a much richer menu of products.
However, mixing modes of finance requires using multiple
contracts. This must be done with great
care in order to remain within Shari'a compliance. Shari'a scholars take a lot of care to keep
certain contracts from becoming conditional on others and not to slip into the
possibility of debt sale.
That is why it is important that Shari'a scholars working
in the area of finance must be highly specialized. Academic training at least to the level of
Ph. D. would be a minimum requirement.
They would also need to work with a team of economics and financial
experts, lawyers, and other documentation specialists.
Differences over Islamic financial products can arise from
the relative incompetence of Fiqh scholars, especially of those who lack
academic credentials, ignorance of the economic consequences of fatwas; as such
consequences must be taken into consideration[3]. Otherwise, formal legitimacy of contracts may
be satisfied, while legitimacy of purpose may not. In addition, certain contracts may be singly
lawful, but when mixed, they would compose a Shari'a non-compliant transaction.
E.
the benefits
According to the theory of the optimum supply of money,
developed in 1969 whose results gaining robustness overtime; a zero interest
rate is a necessary and sufficient condition for the optimum allocation of
resources (Pareto Optimality). By using
the Islamic modes of finance, spot money is never sold against future money and
the optimality conditions stands inviolate.
Islamic banking follows the pattern of universal banking,
i.e., it mixes equity finance with commodity finance. This is known in economics to reduce both the
risks of moral hazard and adverse selection.
Because investment deposits are not guaranteed, Islamic
banking withstands the downturns of economic cycles much better than
conventional banking, i.e., the former is more stable than the latter. This has been discussed in some IMF research
papers.
Conventional finance has only one ingredient to use in
structuring its financial products, viz., the conventional loan contract. Like a potato kitchen, it is a matter of how
you would like your potatoes: boiled, baked, fried, mashed, curried, etc. Islamic finance in contrast has several modes
of finance to use in product structuring.
The room for financial innovation is almost limitless. With numerous modes of finance, Islamic
finance is haute cuisine. Therefore, while you can eat almost anything
in an Islamic finance kitchen, except for potatoes (which refers here to
lending money at interest), the conventional finance kitchen serves only the
potatoes of your choice.
Islamic finance puts an accent on equity and ethical
business (rejecting the finance of tobacco, narcotics, weapons activities that
involve human trafficking as well production of distribution of material
leading to social or individual harm).
We can therefore conclude that the economist view of
Islamic finance is that it is a system that avoids trading money for
money. Viewed as such, it has certain
definite advantages when compared to conventional finance, in terms of
efficiency, stability and risks.
the paradigm of Islamic finance
Islamic finance
has a certain paradigm that can be deducted from the system as a whole. Such paradigm must be seriously considered by
Shari’a scholars and Islamic economists alike as defining the boarders between
Islamic and conventional finance. The
paradigm serves as a yardstick for the avoidance of Reba. The main features of Islamic finance as a
whole indicate that such features are all means to uphold the Qura’nic injunction against usury (Quran 2:279). The Prophetic injunctions not to sell cash
(spot/forward) for cash (forward/spot), except for equal amounts and spot delivery
supports and emphasizes the Qura’nic injunction.
A.
the concept of money
Monetary economists recognize that money is unlike other
commodities. However, to stop treating
money like any other commodity would require an ability to break old habits. It is true that all commodities can compete
with money to different degrees in being useful as a unit of account and a
store of value. Yet, only money can
serve as a means of exchange. This
should be taken as an indication that money should not be traded in the same
way as other commodities. However, this
is not recognized in conventional finance, where spot money is traded against
future money.
It is interesting to note that Islamic finance does not
treat money like other goods in the following manner.
1.
The exchange of each good
(including money) against itself (bartering) in unequal amounts is considered
as a Reba transaction. When there is a
quality differential, barter is discouraged and monetary exchange is
encouraged. This stresses the importance
of money as a medium of exchange.
2.
The price of non-monetary
commodities against deferred payment can be higher than its price against spot
payment. This is considered trade, which
is not only accepted but also religiously encouraged with blessings.
3.
The price of present money
against deferred payment must be strictly equal to its price against spot
payment. Any difference would be
considered Reba.
B.
Present cash is not
provided against future cash
Islamic finance
follows a certain paradigm whose most important feature is the
prohibition of selling present against future cash, either directly or
indirectly. This emanates from the
insistence that money is unlike other commodities. It can be exchanged against other goods, but
should not be exchanged (spot) against itself (forward). When traded against
itself, the whole transaction must be made spot and in equal amounts. Obviously such trade would generally have no
benefit.
When partnership finance is involved, cash is provided
against equity rights, which include sharing of both profit and
management. In Mudaraba finance, cash is
provided against the right to share profits.
Again, cash is not given against cash.
In commodity finance, present commodities are provided
against future cash. Alternatively,
present cash is paid against future goods.
Goods here may include non-durables, durables and services usufruct.
C.
Both formal structure and
purpose are critical for contract validity.
Contracts should be formally legitimates, i.e., all
formalities must be present. For
example, formal legitimacy of a sale contract may include:
¨
The seller must own and
possess the commodities.
¨
Both the buyer and the
seller must have legal capacity and exchange offer and acceptance.
¨
The object of sale must be
lawful.
¨
The sale contract itself
must include the goods to be sold, the price, the quantity, delivery and
payment conditions.
¨
One of the counter values
(goods or price) can be postponed but not both.
¨
The act of sale must not be
contingent.
Legitimacy of purpose is also central to the validity of
contracts. Contracts which satisfy
formal legitimacy conditions cannot be considered lawful if they are made for
non-Shari'a compliant purposes. This is
especially important when a transaction is structured form a multiplicity of
contracts, each of which has formal legitimacy.
However, in their total, they lead to illegitimate purpose, which is to
sell money for money at a price that is not one-to-one.
When transactions are intended to lead to certain
purposes, they are considered void, according to Shari'a. Some of such purposes include:
¨
Payment and/or receipt of
Reba,
¨
Trading in non-lawful
items,
¨
Harming someone
¨
Usurping people’s wealth
Legitimacy of purpose must encompass all things that can realize
or strengthen Maqassid al-Shari'a.
D. REVEALED intentions are considered
As far as intentions are concerned, we can think of the
following maxims:
1.
Deeds are judged according
to intentions.
2.
Muslims are supposed to
judge deeds not persons.
3.
Intentions cannot be
presumed, unless explicitly expressed.
4.
When intentions are
explicit or revealed, they must be considered.
Applying the above maxims to any transaction, we can say
that a person involved in exchange would have explicit intentions to get cash
in two cases:
¨
He sells commodities (goods
or services) he owns for cash.
¨
He has no goods to sell,
but he engages in buying and selling to get cash and not goods at the end. This is the case of Tawarruq.
The first transaction involves getting cash in return for
delivery of goods. Obviously this is
legitimate.
The second case involves buying goods which the person
does not want against deferred payment (for deferred cash) and then selling
the same goods for spot cash. This is
what is claimed here to be against Shari'a.
In the second case, exchange has no bearing on the real
sector. The commodity needs not move
from the supplier’s storehouse, if resold to the same supplier. Even when sold to a different supplier,
aggregate demand for the goods in question will not have increased.
The reason is that the first purchase against deferred
payment registers an increase in quantity demanded and the second sale against
spot payment registers an equal decrease in quantity demanded. The only net effect happens in the money
market, where spot money has been exchanged against future money, leading to an
increase in debt without an equivalent decrease in the aggregate inventory with
the suppliers of the same goods.
When both contracts are placed in one transaction
(purchase against deferred payment + sale against spot payment) we notice that
the buyer in the first instance who is also the seller in the second instance has
obtained spot cash against deferred cash.
This is the Reba that Shari'a has explicitly prohibited.
In this case, the same person cannot hide his
intention. The fact he sells right away
what he had purchased exposes him as cash and not commodity seeker. When intentions cannot be ascertained,
Muslims are supposed to judge things by appearance and not to speculate about
intentions. However, when intentions are
expressed in a certain way that makes them obvious, they must be considered in
judging the legitimacy of purpose of financial contracts.
tawarruq as a product of ill repute
I. individual tawarruq
A.
Ordinary Tawarruq
Tawarruq literally
means obtaining cash or currency. When
cash is obtained through the liquidation of ones property of goods and
services, it pauses no problems. Such
act can be termed ordinary Tawarruq which is considered lawful. In this case it makes no difference whether
the commodities sold had been purchased or acquired through other means. The only requirement for ordinary Tawarruq is
that it is done through one contract and not two or more contracts.
B.
contrived tawarruq (التورق التحيَلي)
In this type of Tawarruq, the person is interested in
getting cash without selling anything.
Therefore, he contrives a way through which he can fulfill his goals. The concerned individual purchases
commodities against deferred payment.
Then he sells those commodities to obtain cash. He may sell them back to the same supplier;
in this case, it would be a two-party ‘Einah Sale. Considering resale of commodities was done
right after their purchase, to the same supplier and is admittedly done to
obtain cash, such sale would be Shari'a non-compliant by consensus. The reason is that the intention to obtain
cash is not hidden; it is made explicit through the act of buying and then
selling back to the same supplier.
The individual may buy commodities from one supplier and
then turns to sell them to another supplier.
This is a three-party ‘Einah sale.
Since the intention is to get cash for cash and not commodities,
and since such intention has been exposed explicitly by the act of buying then
selling, it amounts to trading money for money and therefore involves Reba.
It is common to say that Tawarruq and 'Einah are not the
same. This opinion claims that ‘'Einah
involves two parties but Tawarruq involves three parties. However, Dr. Sami Al-Suwailem
stresses that the Hanafi
School
Most importantly, a major figure of the Hanbali School
Other Fiqh scholars have also disallowed Tawarruq,
including the Khalifa Omar Ibn Abdul-Aziz and the well-known Hanafi scholar,
Muhammad Ibn Ibrahim Al-Hassan Al-Shaibani.
Therefore, the common impression that Tawarruq is allowed by most Fiqh
scholars is incorrect, as the Malikis, the stronger opinion of the Hanafis and
the dominant figures in the Hanbali
School
II. INSTITUTIONAL tawarruq
A.
mechanism: BUSINESS TO
CUSTOMER
Here we find an Islamic bank that notes the following:
1.
There are customers who
want to get present cash in return for debt.
Such people may be concerned about Shari'a compliance, but they rely on
or trust the opinion of the Shari'a board of that bank. They may also be totally unconcerned with
Shari'a compliance.
2.
Both the bank and the
customer enter into an implicit contract through which the customer obtains an
amount of present cash against a higher amount of future cash. Both the offer made by the bank and the
acceptance made by the customer are made implicitly and not in writing. Such contract is invalid according to
Shari'a, as it explicitly involves Reba or interest.
3.
There is an opportunity to
make money twice by the bank. The bank
purchases commodities and then sells them through Murabaha or deferred-payment
sale to the customer, gaining a markup.
Then, it sells the commodities as an agent to the customer either to the
same supplier or to a different supplier, gaining an agency fee.
4.
Taken individually, the
Murabaha or deferred-sale contract, the Wakala or agency contract and the final
spot sale contract are all valid.
However, taken together, the contracts are made to implement an invalid
contract whose object is to provide present for future money.
Such organized Tawarruq done through the intermediation of
an individual or institution is a novelty.
Ancient Fiqh scholars have known such contrivance and declared it
impermissible. Dr. Sami Al-Suwailem
shows that organized Tawarruq has been known to Saeed Ibn Al-Musayyab,
Al-Hassan Al-Bassri, Imam Malik Ibn Anas, and Muhammad Ibn Hassan
Al-Shaibani. Each of those old scholars
has disallowed it.
We notice in our case above,
¨
The customer is committing
a contrived Tawarruq, in which his intention is explicitly exposed by
virtue of the contracts signed with the bank.
His intention is to purchase an amount of present cash against a higher
amount of future cash, in contrary to Shari'a explicit prohibition. In this case he is committing a serious
transgression.
¨
The bank is helping and abetting a customer to
commit a haram transaction. In
addition, the bank is making money through such arrangement.
Two things can be noted in this regard. First, even if we were to believe that
individual contrived Tawarruq is allowed, despite the revealed
intention, it does not follow that institutional Tawarruq would be allowed[6]. What applies to individuals does not
necessarily apply to society. Otherwise,
we fall into the fallacy of composition.
Such fallacy can be likened in fiqh to Fard Kefayah, like walking
in a funeral procession, which once some people do this, it would absolve the
whole society. However, this does not
apply to the group. When no one walks in a funeral procession, every member of
the society becomes a sinner, as this act becomes Fard Ayin. Therefore, if some opinions were to ignore
explicitly expressed intentions and to consider contrived (individual) Tawarruq
as permissible, this cannot be acceptable as a social act.
Second, Ma’alaat, or consequences cannot be the
same for the individual and the society.
This leads us to look into the consequences of the prevalence of
Tawarruq.
B.
MECHANISM: BUSINESS TO
BUSINESS
Islamic banks use international commodity exchanges, and
particularly the London Metal Exchange to place excess liquidity. Sometimes, the bank takes precautions that include:
¨
Dealing directly through
brokers and not through banks
¨
Verification of purchase of
metal warrants in their account
¨
Verification of ability to
deliver
In such case the bank appears to be genuinely purchasing
metal against spot payment and selling it against deferred payment. The resulting profit may be attributable to
taking ownership of metal. However, we
mentioned above that each of the sale, agency and purchase contracts might be
valid by itself. Nonetheless, when
combined together to implement an invalid Reba contract, they in themselves
become invalid.
Meanwhile, Islamic banks find it more convenient to deal
through conventional banks as agents.
This may be more costly, as it involves extra bank commission in
addition to broker’s commission.
However, the resulting debt may be guaranteed by the agent bank. However, the transaction in this case could
be reduced to a mere formality, where the conventional bank receives funds from
an Islamic bank through Wakala agreement and places them in conventional loans,
while passing an interest-rate differential to an Islamic bank.
This reduces the transaction to a Tawarruq operation in
which present money has been traded for future money.
C.
consequences of
institutional tawarruq
Shari’a has ultimate objectives, Maqassid, that
must be considered in making any judgement. All micro or macro consequences,
(Ma’alaat) must be taken into consideration when judging something as Shari `ah compliant or not.
The prevalence of institutional Tawarruq has serious implications
for the treatment of debt resulting form Islamic commodity finance. In addition, it has even more serious
implications for the whole Islamic finance industry.
D. ISLAMIC FINANCE debt acquiring CONVENTIONAL characteristics
One of the important distinguishing characteristics of
debt resulting from Islamic finance is that at times of insolvency (as opposed
to delinquency) the debtor is entitled to rescheduling the debt owed at no
increase, not even for the administrative costs incurred in rescheduling. In contrast, conventional finance always
results in debt and at times of insolvency; the customer must expect penalty
interest rates to be slapped over the debt.
Even if a conventional bank agrees to reschedule the debt, it would have
to be done at cost, in addition to penalty.
If Tawarruq were to be universally practiced, an insolvent
customer would be automatically advised to arrange settlement through Tawarruq,
which means that the debt would increase in value, and the bank would also make
an extra buck. Islamic finance debt
would then acquire some of the characteristics of conventional debt, like
ability to increase over time.
Indeed this has been happening. In some instances, one Tawarruq transaction
triggers another one and so on. Tawarruq
over Tawarruq may please the financiers that abuse Islamic finance, as it would
rid them from the obligation of providing free rescheduling to their insolvent
customer. However it could become the
nightmare of the whole Islamic finance industry.
E.
the black hole effect
Moreover, institutional Tawarruq is usually implemented
through organized commodity markets, with standardized contracts and routine
procedures. It is not done in the local
market, where a Muslim would be subjected to social pressure not to commit religious
faut pas. If it were to be considered lawful, Islamic
financial institutions would find it much easier to provide their straight
cash, along the pattern of conventional loans, rather than base their
transactions upon Islamic modes of finance which may appear cumbersome and
costly.
This would turn institutional Tawarruq into a black hole
in the in which all Islamic finance would be sucked in. Islamic finance would therefore cease to
exist. Instead, we would have Tawarruq
institutions. Muslims would therefore
engage in Reba-based transactions, as they would sell future cash for present
cash. Meanwhile, they may be lead to
believe that the Tawarruq procedures, which amounts to using commodities as a
camouflage and not as an object in itself, used would save them from the wrath
of God. This would introduce to our
economic behavior a substantial measure of hypocrisy.
F.
macroeconomic efficiency
Islamic finance being based on provision of goods and
services rather than money has certain benefits. The most significant in this regard can be
two categories of benefits:
1.
The first benefits relate
to the economy at the macro level, where the practical closure of the
integrated debt/money market and the cancellation of the role of the interest
rate as an allocation mechanism of financial resources[7]. In such case, the allocation of resources
would be based on investment and production criteria rather than debt
criteria. People will have no incentive
to economize on the use of money (which happens because the rate of interest is
above zero)[8]. The economy would reach optimal equilibrium
without contriving policies to reduce the rate of interest to zero.
By bringing back the money market, Tawarruq returns the
economy to the dilemma of having a positive return on cash, regardless of its
use. People would have an incentive to
economize on the use of cash in transactions and economic equilibrium would
fall back to suboptimal.
2.
The second benefits relate
to the efficiency of the finance sector itself.
Conventional finance is practiced through the money market where spot
money is traded against future money.
This process is subject to two major risks: adverse selection and
moral hazard. Such risks arise from
information asymmetry between the more informed fund user and the less informed
fund provider. Information asymmetry can
be significantly reduced through two means.
First participation in the management of the fund using enterprise, through
Musharaka would provide the fund provider with inside information at low
cost. Second, tying finance to specific
uses would provide more information to fund providers about how funds are
used.
Islamic banking, unlike commercial but very much like
universal banking, opens the door for partnership with fund users through Musharaka.
Moreover, Islamic finance involves
itself in the provision of goods and services and hence in the use of financial
resources by consumers and investors. By
its nature, it should be devoid of adverse selection and moral hazard[9].
G. the bridge between the real and financial sectors
A major consequence of practicing mainstream Shari'a-compatible
financing modes is to tie the financial and real sectors together and to reduce
the financial sector to size relative to the real sector. Tawarruq seriously undermines this. Tawarruq is just trading present for future
money. We can have a storehouse of goods
that would never be used, except only as a conduit to make conventional
financial transaction concluded through Tawarruq look Islamic.
Tawarruq, meanwhile, removes the financial process from
the goods market and places it back to the center of the money market. It brings back the risks of adverse selection
and moral hazard to the financial sector, thereby reducing its efficiency. In addition, the little tale of the economy
would grow back to exceed the size of the dog, exactly like what is happening
in a conventional economy. Now the tail
can have fun wagging its own dog.
Western bankers realize this dilemma and sometimes
complain about it. Consider Lamfalussy’s
remark on this phenomenon during his term in the Bank of International
Settlements, “…Our financial revolution has been accompanied by an
accelerated growth in financial transactions without any detectable link with
the needs of the non-financial economy.[10]”
We can therefore conclude that Tawarruq effectively
removes one of the major benefits of Islamic finance, which is to have a
strong, two-way, bridge between the real and financial sector.
III. some side issues
A.
parallelism between
Murabaha and tawarruq
The claim of parallelism between Murabaha and Tawarruq
lacks reasoned justification. Murabaha
is a legitimate mode of Islamic finance.
It places goods and services (not cash) in the hands of banks’
customers. It was criticized as bearing
similitude to the classical loan. In
addition, it requires a number of legal actions that must be taken in the
proper order. If not, it loses Shari’a
compliance. The practice of Murabaha has
helped the Islamic finance industry to survive for some time until innovation
has brought forward a large number of products that helped Islamic banks to
diversify their assets. Now, the
justification of predominance of Murabaha is getting weaker.
In addition, if an intention to use Murabaha is revealed
by a particular customer, the Islamic bank should refuse to provide him with
such finance. Such intention can be
discovered through repeated use of goods Murabaha, or blowing the whistle by
someone else in the market.
In comparison, Murabaha finance, where goods are sought
for themselves and not cash, reduces suppliers’ inventories and increases the
quantity demanded of the same goods.
When such trend persists (people tend to purchase the same goods using
Murabaha finance, an increase in the price of goods (in the real sector) and
markup (in the finance sector) thereupon would rise.
In the case of Tawarruq, no effects on the real sector,
while the financial sector would charge higher price differential on
deferred-payment sale. This is a purely
monetary change with no real counterpart.
This makes it a disguised rise in the rate of interest.
B.
Tawarruq as an
artifice:
An artifice is a pretense or ploy. Institutional Tawarruq is an artifice in that
sense. An artifice could imply
deception, deceit or cunning. However,
institutional tawarruq may not involve that, unless we mean
self-deception. It involves the deceit
of others to the extent that the majority of people are laymen when it comes to
Fiqh. In addition, many would assume
that everything practiced by an Islamic financial institution must be
legitimate, especially if Tawarruq is provided under a nice name.
C.
ISLAMIC BANKS operating at sec ond level
Some people may justify Tawarruq and other products of ill
repute as transitory. The argument
starts with postulating that Islamic finance is a new industry. It cannot therefore apply fully its paradigm
from the very beginning. It must start
at second level (perhaps what is meant is the basement) before moving higher.
Transitory modes of operations can be temporarily tolerated,
provided that:
¨
The transaction itself
should not be declared Shari'a-compliant.
Shari'a non-compliance should be admitted at the outset. Justification could follow for reasons of
dire necessity or darura.
¨
Permission to carry out
such transactions should be obtained from the Shari'a board on a case-by-case
basis.
¨
The use of such transaction
should be considered temporary, which would make it subject to review
periodically.
Second-level operations (or rather basement products)
should never be declared Shari’a compatible.
Only temporary tolerance is allowed as an exemption. In addition, in order to ascertain dire
necessity, there must not be any viable alternative to the exempted unlawful
transaction.
The case of institutional tawarruq does not involve the
admission of some Shari `ah incompatible
aspects while working on their gradual removal.
It rather involves claiming that tawarruq is lawful and the practicing
bank is already using first-best solutions.
In addition, almost all Islamic modes of finance can be used in place of
Tawarruq. When lawful alternatives are
present, exemptions become unjustified.
conclusions
We can conclude
from above the following:
First, Islamic
finance has an approach that is uniquely different from the conventional
approach. In addition, Islamic finance
leads to real gains both to the economy as a whole and to the financial sector
in particular.
Second, the
Islamic finance industry has come of age and is capable of competition if a
plain-level field is assured. This is
what is happening gradually in the Gulf area.
Third, the
Islamic finance industry is suffering from lack of human resources with the
right knowledge and experience. It is
also suffering from self-claimed yet hardly qualified Shari’a experts who have
no credentials to deserve to be called Shari’a scholars. The existence of this
group, coupled with the negligence of some Shari’a scholars of the economic
consequences of their Fatwa, has lead to sneaking some products of ill repute
into the Islamic finance industry.
Fourth, Tawarruq
is one of the most dangerous among the products of ill repute, for it threatens
the future of Islamic finance.
Fifth, the common
impression that individual Tawarruq has been sanctioned by a majority of Fiqh
scholars is a common mistake that has been perpetuated by one of the rate
careless passages of the Kuwaiti Fiqh Encyclopedia. The fact is that Fiqh consensus has been to
consider Tawarruq as 'Einah, which is strongly prohibited.
Sixth, contrary
to the common impression, organized Tawarruq was known to old scholars and was
considered by them as ‘'Einah, which they disallowed.
Seventh, the
banking regulatory authorities are strongly invited to set standards for the
corporate governance of Fatwa and Shari’a Supervisory Boards in Islamic banks. In particular, such standards must require a
Ph D in Shari'a from a well-known university for Shari'a scholars to qualify
for board membership. In addition, the
standards must envisage at least one monetary and financial economist with a Ph
D in his field as a none-voting member of such boards.
Eighth, a ranking of universities teaching Shari'a must be done and
updated regularly as a guide to ascertain the qualifications of Shari'a
scholars.
appendix a: a BRIEF list of Islamic financial products
Islamic financial
products can be simple or complex.
Simple products are based on a single mode of finance, while complex
products are structured using multiple modes of finance.
The following
list does not intend to provide the reader with a comprehensive menu of Islamic
financial products, but merely intend to give the reader a taste of the variety
and multiplicity of such menu.
I. Simple products of Islamic finance
A.
PARTNERSHIP PRODUCTS
1.
MUSHARAKA
1.1
In Musharaka, both
parties share in capital and management.
1.2
Permanent Musharaka is
exactly similar to equity finance.
1.3
Diminishing Musharaka
stipulates providing funds for a limited number of years, during which a part
of the partner’s profit is used to buy out the share of the finance provider.
1.4
Equity finance can make the
bank a permanent shareholder, to exit only through the sale of its share in the
stock market or OTC.
2.
DIMINISHING MUSHARAKA
2.1
In diminishing Musharaka,
the bank exits within a specified number of years.
3.
MUDARABA
3.1
In Mudaraba, the bank
provides capital and the entrepreneur provides management. Profit is shared in a preagreed formula. It
is usually used to finance working capital requirements for medium-term periods. It requires monitoring, whose cost is reduced
when both Musharaka and Mudaraba are used simultaneously.
4.
UNRESTRICTED MUDARABA
4.1
Mudaraba can be either
restricted or non-restricted.
4.2
Unrestricted Mudaraba
allows the bank to provide the customer with working capital that can be used
in all aspects of the customer’s business.
Profit is shared in pre-agreed ratios, but loss must be shared
proportionately.
5.
RESTRICTED MUDARABA
5.1
The bank provides funds to
invest under certain restrictions, which can be positive or negative.
5.2
Positive restrictions would
list all allowable investment outlets in which the funds provided can be used.
5.3
Negative restrictions would list all the
investment outlets in which the customer is prohibited from using the funds.
B.
PRODUCTS BASED ON SALE FINANCE
6.
DEFERRED-PAYMENT SALE
6.1
In deferred-payment sale,
the bank already owns the goods.
6.2
A price is negotiated
without reference to cost that would entail deferred payment in lump sum or
installments
7.
Murabaha
7.1
In Murabaha, the customer
signs a promise to buy the goods on installments at cost plus markup. The bank acquires the goods and sells them to
the customer as promised
7.2
Murabaha can be used to
finance raw materials, consumer goods or fixed assets, although it is used more
often in car finance.
8.
SALAM
8.1
Salam can be used to
finance working capital. The bank
purchases a quantity of future output and pays spot. The customer delivers later. The bank can sell the same products through
parallel Istisna’, or appoint the customer as its agent to sell them at time of
delivery.
8.2
In Salam, the buyer
finances the seller which is just the opposite of Murabaha and deferred-payment
sale. It can also be used as a means to
secure future commodity/raw material requirements for business enterprises at
given prices (product finance). This
provides a hedge against future price changes.
9.
ISTISNA’
9.1
In Istisna’, the
assets are not existent at the time. The
bank signs an Istisna’ contract. Such
contract commands the bank to build or manufacture the asset according to
detailed specifications. In order to
fulfill its obligations, the bank signs a parallel Istisna’ contract with the
manufacturer to do the same.
9.2
Payment in Istisna’
contract (by the customer) could range between 5 and 15 years. Payment to manufacturer or builder is done at
specified stages and upon the completion of each stage.
9.3
While in Murabaha and
deferred-payment sale, the seller finances the buyer. Meanwhile, in ISTISNA’ either party may finance the other (according
to Intl Fiqh Academy
C.
IJARAH FINANCE
10.
REGULAR IJARAH
10.1 This is used to finance the use of durable assets, as in home
finance, and in the finance of plant, equipment and means of transport
(airplanes, ships, etc.)
10.2 The bank leases the assets with a permission to sublease. The bank then leases the assets to its
customer against regular rental payments.
10.3 In this case, the customer is interested only in the usufruct
and not in title transfer.
11.
IJARAH MUNTAHIA BITTAMLEEK
11.1 The bank acquires the assets and then leases them to the
customer with a promise to transfer full ownership to customer by way of gift
or selling them to customer at a token price, provided he fulfills all
obligations.
11.2 Ijarah Muntahia Bittamleek is typically an intermediate to
long-term finance. It could go up to 15
or 20 years. Ordinary Ijarah that does
not involve title transfer is typically a short-term finance that ranges from
one to five years.
12.
WAKALA
12.1 The bank can provide the customer funds to be used in a specific
investment outlet.
12.2 The customer would be acting as an agent of the bank.
12.3 The bank obtains all the profit and bears all the losses.
12.4 The customer gets a fixed commission to compensate for his
efforts.
II. complex (structured) ISLAMIC FINANCE products
The number of
complex Islamic finance product enormous and cannot be listed. With 12 modes of finance to use as raw
material, which would be mixed in different ways and different proportions,
combinations can amount to hundreds.
However, using multiple modes of finance in one transaction is
tantamount to using multiple contracts. This requires acumen in both Shari'a and
law. The art of product structuring has
been made less tedious by using multi-disciplinary teams of Shari'a, finance
and law experts to do the job.
III. other products
13.
MUTUAL FUNDS SHARES
13.1 Islamic banks and finance institutions structure funds for
purposes similar to those of conventional funds. The mixture of liquidity, security and return
is measured to suit the requirements of fund shareholders. However, the fund must be structured to be
Shari’a compatible.
13.2 Islamic funds based on Ijarah dealing in high growth sectors
like real estate earn high rates of return, but the risk is also high.
13.3 Funds based on shares can become victims of stock markets
idiosyncrasies. Each Islamic bank in the
UAE has some high-profile funds in addition to marketing funds structured by
conventional and/or Islamic banks and financial institutions.
13.4 Like conventional funds. An SPV is constructed to mange the
fund. The brochure, prospectus and other
documents must be approved by the bank’s Shari’a Board. It is also subjected to Shari’a
auditing.
13.5 Most funds created are managed by SPV’s located in tax
havens. Bahrain
and the International Financial Market in Dubai
are increasingly attracting fund managers.
Fund assets must be evaluated regularly (usually quarterly) for profit
distribution. Islamic banks in the UAE
have become quite familiar with the process of distributing roles related to
fund establishment and management among themselves.
14.
SUKUK
Sukuk are created through several steps. First banks acquire real assets and bunch
them in a Shari’a compatible fashion.
They are sold in a bunch to an SPV.
Credit enhancement, promotion, underwriting and marketing is done in a
fashion similar to conventional securities.
The SPV manages the underlying assets for the interest of
shareholders. It distributes its net
profit to Sukuk holders in proportion to their holding.
references
1.
Mabid Ali Al-Jarhi (2004), “Islamic
Finance: An Efficient & Equitable Option,”
http://www.iaie.net/mabid/FINANCE%20FOR%20DEVELOPMENT2.pdf
2.
Mabid Ali Al-Jarhi (2003), “Islamic
Banks & Universal Banks: Need For Leveled Playing Field,” the International
Seminar on Islamic Banking: Risk Management, Regulation and Supervision, the
Ministry Finance Indonesia, the Central Bank Indonesia and the Islamic Research
and Training Institute (Member of IDB Group), Jakarta, Indonesia, September 30
- October 2. http://www.iaie.net/mabid/ISLAMIC%20&%20UNIVERSAL%20BANKS.pdf
3.
Mabid Ali Al-Jarhi (2005), “Islamic
Finance and Development,” in Munawar Iqbal and Ausaf Ahmad, Islamic Finance
and Economic Development, Palgrave, http://www.iaie.net/mabid/Islamic%20Finance%20&%20Development.pdf
4.
Wayne A.M. Visser and
Alastair McIntosh
(1998),
“A Short Review of the Historical Critique of Usury,” Accounting, Business
& Financial History, 8:2, Routledge, London , July 1998, pp. 175-189. http://www.alastairmcintosh.com/articles/1998_usury.htm.
[1] Wayne
and McIntosh (1998).
[2] Appendix
A gives a brief description of each mode of finance
[3] That can
be attributed to the incompetence of economists advising Shari'a scholars.
[4] Sami
Al-Suwailem, “The position of old Shari'a schools from Tawarruq, “(in Arabic),
2004>
[6]
Individual Tawarruq is considered as a Reba-based transaction by Umer Ibn Abdul
Aziz, Ibn Taymiah and Ibn Qayem Al-Jawziyah.
[7] Notice
that the debt market in Islamic finance is segmented by commodities. Each commodity has its own separate debt
market in which the demand for such goods against deferred payment, whether
through Murabaha or deferred-payment sale, and its supply determine the
equilibrium mark-up on Murabaha or the equilibrium price differential on
deferred-payment sale. Such mark-up or
price differential is not determined by the demand and supply of debt, as debt
is non-negotiable. It is rather
determined by the demand and supply of the goods concerned against future
payment.
[8] Notice
here again that the premium paid is not on present against future money, but it
is on goods for deferred payment against goods for spot payment.
[9] Risks of
adverse selection and moral hazard result in conventional finance from the
information asymmetry resulting from that the bank knows much less about the
use of funds, while the customer is well informed, as he himself spends the
loaned money. Conventional banks would
have to continuously monitor their customers in order to avoid such risks. However, monitoring is usually resisted or
dodged by customers and is rather costly to banks. Universal banks that practice equity finance
(Musharaka) side-by-side with lending are better equipped to monitor their
corporate customers by setting on their boards.
In Islamic finance, cash is given to customers only in cases of
partnership finance, when full monitoring is available. In sale finance, the bank directly provides
goods and services to its customer, thereby leaving no room to use the funds
for other purposes.
[10] Alexandre
Lamfalussy, general manager, BIS, “The Restructuring of the Financial Industry:
A central Banking Perspective”, SUERF Lecture, City
University , London , 5 March 1992.
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