MOBILISATION OF FUNDS ON ISLAMIC PRINCIPLES
FAHIM KHAN
The experience of Islamic banks all over the world, the successful floatation of Mudaraba funds by Islamic and non-Islamic banks, and the experience of investment companies and of co-operatives operating on a profit-and-loss sharing basis in Muslim countries are enough to suggest that the application of Islamic principles of financing and banking in the private sector does not pose any problem with respect to mobilisation of domestic resources in a Muslim economy.
The only issue that is required to be tackled in this context is the monitoring and regulation of the private sector financial institutions so that the money of the depositors (who are often small savers) is not unnecessarily put at risk or mis-appropriated.
Public Sector Requirements
The public sector, however, is our main concern when discussing the mobilisation of domestic resources under the Islamic principles. The problem is very simple. The public sector needs funds to carry out its various activities, and because the sector is usually large, its fund requirements are also large. Though some quarters may justify large public spending in an Islamic economy, that is a separate issue.
Irrespective of this is the question of whether there is a Sharia limit on government expenditure, and how the public sector can mobilise resources to finance its activities on Islamic principles. This simple problem does not have a simple answer.
So far, the following two sets of answers have been offered.
Commercialisation of Activities
The first set of answers includes several suggestions. One suggestion is that the public sector should try to commercialise its activities as far as possible and these activities can then easily be financed through the use of profit-and-loss-sharing techniques or output sharing techniques, or techniques based on such principles as Murabaha, Salam or Ijara.
It is suggested that government activities may function as public enterprises and corporations, whose shares can be sold and quoted on stock exchanges. The use of Mudaraba or Musharaka (i.e., profit-and-loss-sharing or income-sharing) certificates has also been suggested, for such sectors as transport communication, mass-media and tourism.
The negotiability of such certificates will develop secondary markets for these certificates which will play a catalytic role in mobilising resources for the public sector from small savers in the economy.
Leasing – Based Instruments
In the same spirit, it has been proposed that leasing-based instruments may also be developed to mobilise resources to finance infrastructural projects. The infrastructure, including buildings and equipment and other physical assets, can be leased to appropriate government agencies and this rental income can be shared by the holders of the certificates.
The negotiability of these certificates in the secondary markets is expected to mobilise small savers to contribute to the resources needed to build up the infrastructure.
This solution, however, is not sufficient, because with the current state of Muslim economies only a very small part of the public sector can possibly be commercialised to successfully apply these modes of financing for the purpose of mobilising resources.
Sectors like defence, health, education and infrastructure development for the benefit of the poor consumers is almost the bulk of the public sector expenditure and so could hardly be run on a commercial basis.
Deferred Payments
An alternative suggestion, which would mean a more comprehensive solution, is to apply the concept of mark-up-based deferred payments for all government needs that otherwise cannot be financed from the government’s available resources. Th e purchase of all supplies, goods and equipment needed for government activities can be made on the mark-up basis, with payments deferred for a year or a number of years.
It has been proposed that even part of the salaries and wages can be financed by offering employees the chance to receive part of their wages with a certain mark-up. All building and construction projects could be offered to private parties on a cost-plus basis which could be paid in instalments. Islamic principles of forward sale have also been proposed as a means of financing for several activities.
All these suggestions, though in principle practical and feasible, have not received adequate attention from government circles, probably because they require a different institutional set-up, which presently does not exist and will require time to develop, with few suggestions as to what to do during the interim period.
Compensation on Loans
The second set of answers is based on the principle of allowing the government to pay some compensation, on its loans, to the lenders. One suggestion in this respect is to link the government loans to the cost-of-living index.
If government borrowing from the public is linked with the rate of inflation, this will induce the savers to lend their money to the government, because it protects the real value of their loans.
This solution, which is often considered by planning and policy-makers as a viable solution to mobilising domestic resources for the public sector, still fails to receive endorsement from the Sharia scholars. Indexation of loans is prohibited according to the Sharia rules.
An alternative suggestion is to apply the concept of indexation, but in such a way as to make it more acceptable to the Sharia. This could be done by issuing loan certificates in denominations other than, the prevailing currency units. Several variants of this proposal have already been mentioned.
One suggestion calls for issuing loan certificates whose value is defined in terms of a well-defined basket of goods. Th e government will then sell these certificates at the prevailing market price of the basket of goods. The holder of the certificate can cash this certificate at any time he so wishes and he will be paid the value of the basket according to the actual market price of that basket at the time of redemption of the certificate. Another suggestion calls for issuing loan certificates in terms of a unit of a basket of currencies. Still another suggestion requires the issuing of loan certificates in terms of units of one single universally acceptable and stable commodity like gold. However, these suggestions have not yet gained the support of the Sharia, and their viability from the economic policy perspective is also doubtful.
One condition for the Sharia to accept these suggestions is that the exchange of these loan certificates should not be merely a paper transaction. The possibility of real exchange of goods or currencies underlying these certificates should always actually exist. Thus, if the holder of the certificate denominated in a basket of goods demands the basket of goods itself, then the borrower should repay his loan immediately. This condition, though feasible in private transactions, is not, of course, practical from the government borrowing point of view.
A Related Solution
A related solution is that the government may give some extra return on its borrowing and that this return will not be announced in advance and will not be guaranteed and will only be a sort of gift from the government to the people who purchase its non-interest-bearing securities. This solution has not so far received the Sharia’s approval. Some of these suggestions – in particular a straightforward linkage with the rate of inflation or payment of any positive rate of return, though not guaranteed – receives more attention in government circles because they do not require any new institutions to be developed; the existing institutions will continue to exist and there will be no problem about what to do in the interim period.
Institutional Set-Up
The basic Sharia principle to be observed on this issue is that financing can only be built on a trading transaction. What is needed, therefore, is for the financial institutions, responsible for raising funds for the government to assume a trading role. Once this is done, the government will not merely be looking for finances but will rather be looking for the financing of specific purchases which the institution will supply on a mark-up or cost-plus basis. The financing of these purchases can be made to extend for anywhere between a year and ten years, depending on the needs of the government and the markup may vary depending on the period of payment involved.
For their part, the financial institutions will mobilise resources from the private sector on a Mudaraba basis and will share with them the mark-up income that it will receive from the government.
The practice of Islamic banks presently operating in different parts of the world suggests that banks do not themselves have to purchase and procure goods from the market. The actual purchase and procurement of goods can be done by the offices that need the goods. However, the ownership of the goods will be in the name of the financial institution for a small period of time and the financial institution will bear the risks associated with ownership.
So, there are two fundamental points to be kept in mind:
a) Financing will be sought for specific purchases only, and cannot be general-purpose financing or borrowing, and b) the financial institution will have formal ownership of the specific goods or equipment before passing them on to the relevant government office on a mark-up, but deferred payment basis.
The financial institutions can be decentralised to the extent required for acquiring the goods and sei-vices for the government, but the mobilisation of resources, determination of mark-up and expected and actual rate of return can remain centralised.
Limitations on Government Expenditure
The limits faced by the government when using this method of financing its expenditure will be twofold. First, it will not be possible to get a purchase refinanced if the government is unable to honour its commitments. Second, the flexibility of budgetary allocations will be reduced. The budget allocated for purchasing goods on mark-up, for example, cannot be utilised for hiring people. Both these factors will require a degree of discipline on the part of the government vis-a-vis its expenditure, which in any case will be a welcome development given the ever-increasing government expenditure encouraged by the easy availability of interest-based financing.
Since the theory and practice of Islamic modes of financing are both clear and well-established, it is only a matter of establishing a committee comprising of officials from the economic and finance ministries, public sector financial institutions and experts in system development to develop a system, using the established Islamic modes of financing, that would meet the needs of each government.
Interim Solution
A change to the system described above and the subsequent adjustments to government expenditure procedures and policies need not take much time and effort. There will, however, be a need for some interim measures. The suggestion of indexation of government loans with the rate of inflation or paying some extra amount (without guaranteeing anything in advance) is an acceptable solution as far as government needs are concerned. Whilst, so far, Sharia scholars have rejected this concept as a tool for general application, the case for a special application to achieve a specific purpose is yet to be made.
Principles to be Considered
There are two principles of Fiqh which would allow the Sharia to consider an application permissible. One is the principle of necessity (Dharura) and the other is the principle of public interest (Masala al Mursala). The case should only be for the indexation of government loans and only until the new system is properly developed. The case should also focus on the needs of the economy. By applying this principle during the interim period, the danger of an economic crisis will be averted.
Furthermore, the objectives of the Sharia include the protection of Maal. Since inflation reduces the value of financial resources, safeguarding them against inflation is, therefore, an objective acceptable to the Sharia. When financing on the basis of mark-up, leasing (ljara), profit-sharing or equity participation, the issue of protection against expected inflation is taken care of by negotiating the rate of mark-up, rent or profit-sharing. It is worth remembering that the shorter the period of the transaction, the greater the chances for acceptance by the Sharia. The salient points may be summarised as follows:
a) Although the issue of protection of Maal does not arise when the financing is on an Islamic basis, it is relevant when:
i. It is government expenditure that is to be financed,
ii. Islamic ways of financing government expenditure are not available as the system is still being developed, and
iii. the financing required by the government is essential and without it the economy is in danger of collapsing.
b. The issue of indexation (which is otherwise not permissible) deserves consideration because:
i. Its use is confined to government financing only,
ii. Its use is only for a limited period until the system of government financing on an Islamic basis becomes available,
iii. Serious efforts are being made by the government to develop an Islamic system for government financing and there is a definite time schedule for the completion of this task,
iv. As soon as the Islamic system of government financing is developed, the use of indexation as a tool for government financing will be immediately discontinued. It is likely that a joint committee comprising of Sharia scholars and government economists and policy makers appointed to consider these cases will come up with a workable solution acceptable to both the government and the Sharia.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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