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On 14 Ramadan 1420, the Shariah Appellate Bench of the Supreme Court of Pakistan gave its landmark decision of banning interest in all its forms. The full judgment of the court consists of about 1100 pages. We reproduce here the summary of the text written by Maulana Justice Taqi Usmani (250 pages).

Section Written by Justice Muhammad Taqi Usmani

The Federal Government of Pakistan and certain banks and financial institutions filed 67 appeals against this judgment in the Shariah Appellate Bench of the Supreme Court. Most appellants tried to prove that the modern interest-based transactions do not fall within the definition of riba prohibited by the Holy Qur'an. Others tried to prove that the commercial interest of modern financial system can be allowed on the basis of necessity. In order to resolve these issues we invited a number of experts consisting of Shariah scholars, economists, bankers, accountants and representatives of modern business and trade who have provided assistance to the Court in their respective areas of specialization.

There are four different sets of verses which were revealed on different occasions. First, in Surah Ar-Rum, a Makkan Surah wherein the term riba finds mention in the following words:

"And whatever riba you give so that it may increase in the wealth of the people, it does not increase with Allah." [Ar-Rum 30:39]

The second verse is of Surah Al-Nisaa where the term riba is used in the context of sinful acts of the Jews in the following words:

"And because of their charging riba while they were prohibited from it." [An-Nisaa 4:161]

In the third verse of Surah Al-i-'Imran the prohibition of riba is laid down in the following words:

"O those who believe do not eat up riba doubled and redoubled." [Al-i-'Imran 3:130]

The following set of verses is found in the Surah Al-Baqarah in the following words:
"Those who take interest will not stand but as stands whom the demon has driven crazy by his touch. That is because they have said:
'Trading is but like riba'. And Allah has permitted trading and prohibited riba. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is up to Allah.
And the ones who revert back, those are the people of Fire. There they remain forever.
Allah destroys riba and nourishes charities. And Allah does not like any sinful disbeliever. Surely those who believe and do good deeds, establish Salah and pay Zakah, have their reward with their Lord, and there is no fear for them, nor shall they grieve.
O those who believe, fear Allah and give up what still remains of the riba if you are believers. But if you do not, then listen to the declaration of war from Allah and His Messenger. And if you repent, yours is your principal. Neither you wrong, nor be wronged. And if there be one in misery, then deferment till ease. And that you leave it as alms is far better for you, if you really know. And be fearful of a daywhen you shall be returned to Allah, then everybody shall be paid, infull, what he has earned. And they shall not be wronged." [Al-Baqarah 2:275-281]

The Time of Prohibition of Riba

The third verse is of Surah Al-i-'Imran is estimated to have been revealed sometime in the 2nd year after Hijra, because the context of the preceding and succeeding verses refers to the battle of Uhud which took place in the 2nd year after Hijra. This verse contains a clear prohibition for the Muslims and it can be said that it is the first verse of the Holy Qur'an through which the practice of riba was forbidden for the Muslims in express terms. That is why Hafidh Ibn Hajar Al-Asqalani, the most famous commentator of Sahih Al-Bukhari, has opined that the prohibition of riba was declared sometime around the battle of Uhud.
This study of the verses of the Holy Qur'an in the light of their historical background clearly proves that riba was prohibited at least in the 2nd year of Hijra.
However, some appellants and juris-consults have assailed this statement and urged that the prohibition of riba was imposed in the last year of the life of the Holy Prophet, Sall-Allahu alayhi wa sallam. They said that Prophet Mohammed has declared the prohibition of Riba in his last sermon which means that theprohibition of riba was not effective before the last Hajj of the Holy Prophet, Sall-Allahu alayhi wa sallam, i.e. before 10th year after Hijra. In fact the prohibition of riba was effective at least from the 2nd year of Hijra but the Holy Prophet, Sall-Allahu alayhi wa sallam, deemed it necessary to announce the basic injunctions of Islam at the time of his last sermon which was the most attended gathering of his followers.

What is Meant by Riba?

The Holy Qur'an did not give any definition for the term for the simple reason that it was well known to its immediate audience. Not only Arabs but all the previous societies used to practice it in their financial dealings and nobody had any confusion about its exact sense.

The Definition of Riba as given by the Exegetes of the Holy Qur'an

The literature of Hadith while explaining the word riba has mentioned in detail the transactions of riba which were used to be effected by the Arabs of Jahiliyya on the basis of which the earliest commentators of the Holy Qur'an have defined riba in clear terms. Imam Abubakr Al-Jassas (D.380 AH) in his famous work Ahkamul Qur'an has explained riba in the following words:

"And the riba which was known to and practiced by the Arabs was that they used to advance loan in the form of Dirham (silver coin) or Dinar (gold coin) for a certain term with an agreed increase on the amount of the principal advanced."

The same author has defined the term in the following words:

"The riba of Jahiliyya is a loan given for stipulated period with a stipulated increase on the principal payable by the loanee."

The Detailed Account of Riba al-Jahiliyya

Mr. Riazul Hassan Gillani, the learned counsel for the Federation of Pakistan, argued that riba prohibited by the Holy Qur'an was restricted to claiming an amount for giving an additional time to the debtor. If an increased amount is stipulated in the initial transaction of loan, it is not covered by riba al-Qur'an. For example, he cited the well-known Tafseer of Ibn Jarrir At-Tabari who on the authority of Mujahid has explained the riba of Jahiliyya as follows:

"In the days of Jahiliyya a person used to owe a debt to his creditor then he would say to his creditor, 'I offer you such and such amount and you give me more time to pay.'"

This contention of the learned counsel did not convince us at all. Ibn Jarir himself on the authority of Qatadah explained Riba of Jahiliyya in the following words:

The Riba of Jahiliyya was a transaction whereby a person used to sell a commodity for a price payable at a future specific date, thereafter when the date of payment came and the buyer was not able to pay, the seller used to increase the amount due and give him more time."

The same explanation has been given by al-Suyuti on the authority of Faryabi in the following words:

"They used to purchase a commodity on the basis of deferred payment, then on the date of maturity the sellers used to increase the due amount and increase the time of payment."

It is clear from these quotations that the transaction in which the creditor used to charge an additional amount on the date of maturity was not a transaction of loan. Initially; it used to be a transaction of sale of a commodity on deferred payment basis in which the seller used to fix a higher price because of deferred payment, but when the buyer would not pay at the date of maturity, the seller used to keep on increasing the amount in exchange of additional time given to the buyer.

The common feature of the transactions practiced by the Arabs of Jahiliyya is that an increased amount was charged on the principal amount of a debt. At times, this debt was created through a transaction of sale and it was created through a loan. Similarly, the increased amount was at times charged on monthly basis, while the principal was to be paid at a stipulated date, and some time it was charged along with the principal. All these forms used to be called Riba because the lexical meaning of the term is increase. That is why, the commentators of the Holy Qur'an like Imam Abubakr al-Jassas have defined the term in the following words:

"The Riba of Jahiliyya is a loan given for a stipulated period against increase on the principal payable by the Loanee."

Now we come to the different arguments advanced before us against the prohibition of the modern interest.

The Statement of Sayyidna Umar, Radi-Allahu anhu, About the Ambiguity in the Concept of Riba

Mr. Abu Bakr Chundrigar, the learned counsel for Habib Bank Ltd said that the term Riba as used in the Holy Qur'an is an ambiguous term, correct meaning of which was not understood even by some companions of the Holy Prophet, Sall-Allahu alayhi wa sallam. He referred to the statement of Sayyidna Umar, Radi-Allahu anhu, that the verses of Riba were among the "last verses of the Holy Qur'an and the Holy Prophet, Sall-Allahu alayhi wa sallam, passed away before he could explain them to us, therefore, avoid Riba and everything which is doubtful." In addition, he and other appellants argued that the Holy Qur'an has asked us to follow only those verses which are clear in meaning (Muhkamaat) and not to follow Mutashabihaat. The verses of Riba being of the second category, according to the appellants, they are not practicable.

This argument is fallacious, because in the verse of Surah al-Baqarah Allah almighty declared war against those who do not avoid the practice of Riba. How could one imagine that Allah Almighty, the All-Wise, the All-Merciful, can wage war against a practice, the correct nature of which is not known to anybody?
In fact, Mutashabihaat in Quran never refers to a practical precept of Shariah. The word always refers to non practical issues whose understanding will never affect the Muslim’s life such as Allah attributes not something totally forbidden by Allah.

Productive and Consumption Loans

Some appellants claimed that Riba of Holy Quran includes posing increase in the case of consumption loans where the borrowers used to be poor person's borrowing money to meet their day to day needs of food and clothes etc. On the contrary, posing increase on the rich borrowers who borrows money to develop their commercial enterprises is not considered Riba.

This argument is not tenable for many reasons. First, Validity of a transaction is not based on the Financial Status of a Party. It rather depends on its intrinsic nature. For example, Bribery is unlawful regardless of whether the bribe is charged from the rich or from the poor. The second reason is that the verses which prohibit riba do not at all differentiate between consumption and a commercial loan, nor does this difference find any mention whatsoever in Sunnah. The Holy Qur'an has prohibited riba in general terms which includes all the forms of riba whether or not prevalent at the time of its revelation. For instance, when qimar (gambling) was declared as haram, the purpose was not to restrict the prohibition only to those forms of gambling which were in vogue at that time. The prohibition, in fact, encompassed all its present and future forms, and no one can argue that the modern forms of gambling are not covered by the prohibition. Thirdly all kinds of loans based on interest were discovered to be prevalent before the Christ and accordingly when Riba was prohibited. Before the coming of Islam, Arabs, especially of Makkah, had business relationship with the Roman Empire which was dealing with loans and transactions based on interest. Besides, the Arabs’ prosperous commercial atmosphere shows how much they were familiar with commercial loans. Therefore, it is not correct to say that the prohibition of riba was restricted to the consumption loans only and it did not refer to the commercial loans.

Excessive Rates of Interest

Another argument was that the prohibition of riba is applicable only to those interest transactions where the rate of interest is exorbitant or excessive. This argument is supported by the verse of Surah Al-i-'Imran:

"O ye who believe! devour not Usury, doubled and multiplied; but fear Allah; that ye may (really) prosper." [Al-i-'Imran 3:130]

The verse has qualified the prohibition by the words "doubled and multiplied" to denote that the practice of riba is forbidden only when the rate is so excessive that it makes the payable amount twice that of the principal. If the rate of interest is not so high, the prohibition is not applicable. The interest charged in the present banking system, it is argued, is not normally so high as to make the payable amount double the principal, and, therefore, the banking interest is not covered by the prohibition.
This argument overlooks the fact that no verse can be interpreted in isolation from the other relevant material available in other parts of the Holy Qur'an. The subject of riba is found in Surah Al-Baqarah with the following command:
"O those who believe fear Allah and give up whatever remains of riba, if you are believers." [Al-Baqarah 2:278]
This indicates that every amount over and above the principal has to be given up. In addition, the words “doubled and multiplied” are not the restrictive conditions for the prohibition of Riba, but rather they refer to the worst kind of practice of Riba rampant at that time. For instance when Allah said:

"Do not sell my verses for a little price." [Al-Baqarah 2:41]
He, the Almighty, does not mean that the blame is directed towards the "little price" they gain; rather the blame is directed to the selling of verses itself. Hadith also inserts that the prohibition of Riba was meant to cover every amount charged in excess of the principal, however small it may be. It is reported by Hammad b, Salamah in his Jame from Sayyidna Abu Hurairah, Radi-Allahu anhu, that the Holy Prophet, Sall-Allahu alayhi wa sallam, has said:
"If the creditor received a goat as mortgage from the debtor, the creditor may use its milk to the extent he has spent in providing fodder to the goat. However, if the milk is more than the price of the fodder , the excess is riba."

Riba al-Fadl and Bank loans

Riba al-Fadl is related to certain barter transactions prohibited by Prophet Mohammed as the Arabs used some commodities to purchase other things. Prophet Mohammed said
"Gold for gold, silver for silver, wheat for wheat, barley for barley, date for date, salt for salt, must be equal on both sides and hand to hand. Whoever pays more or demands more (on either side) indulges
in Riba."
Mr. Riazul Hasan Gilani, the learned counsel for the Federation argued that any increase stipulated in the initial transaction of loan is riba al-fadl, rather than riba al-Qur'an. Since the most banking transactions of today stipulate interest right from the beginning of the transaction, they are not covered, according to the learned counsel, by the prohibition of riba al-Qur'an but rather governed by the principles of riba al-fadl whose prohibition is not the obligation of the state.
He based his argument on Riba al-fadl Prophet Mohammed Hadith mentioned above which clarified that sale of certain commodities like gold and silver is only permissible on condition that the exchange is effected on the spot since the value of these commodities is changeable. Thus both interest-based and interest-free loans being based on deferred payment fall within the definition of ribaal-fadl.

This argument is not tenable either. The hadith of riba al-fadl is meant to cover the transactions of sale only, and has nothing to do with the transaction of loan which are covered by the rules of riba al-Qur'an or riba al-Jahiliyya and where it is clearly mentioned that the creditor in a transaction of loan is entitled to claim only his principal amount, and if he does so, it has never been prohibited. It is, therefore, not correct to say that a transaction of interest-bearing loan fixing an amount as interest right from the beginning of the transaction is covered by the prohibition of riba al-fadl rather than the riba al-Qur'an and that the banking interest being a transaction of riba al-fadl is not haram.

Basic Cause of Prohibition

The next argument advanced by some appellants is that the basic cause (illat) of the prohibition of riba is Zulm (injustice). The Holy Qur'an says:

"And if you repent (from charging interest) then you are entitled to your principal. You neither wrong nor be wronged." [Al-Baqarah 2:279]
Thus in case there is a zulm, the transaction should be taken as riba, hence prohibited, but if there is no zulm, it should not be taken as haram. The appellants of this argument focused on zulm as the basic cause behind the prohibition of riba and did not visualize the Hikmat (wisdom) which is the benefit intended to be drawn by enforcing a law. Hikmat is not limited to Quran laws only but it also recognized in secular laws. For instance, the law has made it compulsory for the vehicles running on the roads to stop when the red street light is on. The Illat of this law is the red light, while the Hikmat is to avoid the chances of accidents. The application of this law will not depend on whether or not there is an apprehension of an accident. Yet, still the law will be applicable in its full force, because the red light which was the real Illat of the law is present. After prohibiting the transaction of riba, the Holy Qur'an has mentioned the Zulm as a Hikmat or a philosophy of the prohibition, but it does not mean that prohibition will not be applicable if the element of Zulm appears to be missing in a particular case. The Illat (the basic feature) on which the prohibition is based is the excess claimed over and above the principal in a transaction of loan, and as soon as this Illat is present, the prohibition will follow regardless of whether the philosophy of the law is or is not visible in a particular transaction. In addition, Zulm is not the only hikmat or purpose of the prohibition of riba. Generally, Human reason, despite its wide capabilities, cannot claim to have unlimited power to reach the truth in addition to the human conflict between cause and desire. That is exactly what happened in the case of riba when humans try to justify it according to the human causes and desires. The secular rationalists were fully content with their belief that riba transactions practiced by them were quite justified, because the income they earn through interest is very similar to the profit they earn through sales.
Moreover, the argument contends that no element of injustice is found in the commercial or banking interest.

Nature of Money

One of the wrong presumptions on which all theories of interest are based is that money has been treated as a commodity. It is, therefore, argued that just as a merchant can sell his commodity for a higher price than his cost, he can also sell his money for a higher price than its face value, or just as he can lease his property and can charge a rent against it, he can also lend his money and can claim interest thereupon. However, Islamic principles clarify that Money and commodity have different characteristics and therefore they are treated differently. The basic points of difference between money and commodity are as follows:

a) Money has no intrinsic utility. It cannot be utilized in direct fulfillment of human needs. It can only be used for acquiring some goods or services. A commodity, on the other hand, has intrinsic utility and can be utilized directly without exchanging it for some other thing.

(b) The commodities can be of different qualities while money has no quality except that it is a measure of value or a medium of exchange. Therefore, all the units of money of the same denomination i.e. are hundred per cent equal to each other. An old and dirty note of Rs.1000/= has the same value as a brand new note of Rs.1000/=.

(c) In commodities, the transactions of sale and purchase are effected on an identified particular commodity. If A has purchased a particular car by pin-pointing it, and seller has agreed, he deserves to receive the
same car. The seller cannot compel him to take the delivery of another car, though of the same type or quality. Money, on the contrary, cannot be pin-pointed in a transaction of exchange. If A has purchased a commodity from B by showing him a particular note of Rs.1000/- he can still pay him another note of the same denomination.

Based on these basic differences, Islamic Shar'iah has treated money differently from commodities, especially on two scores:
Firstly, money (of the same denomination) is held to be restricted to its basic purpose i.e. to act as a medium of exchange and a measure of value.
Secondly, if for exceptional reasons, money has to be exchanged for money or it is borrowed, the payment on both sides must be equal, so that it is not used for the purpose it is not meant for i.e. trade in money itself.
Imam Al-Ghazzali (d.505 A.H.) the renowned jurist and philosopher of the Islamic history has discussed the nature of money in an early period when the Western theories of money were non-existent. He says:
It is not an objective in itself, but it is an instrument to lead to all objectives…
So, the one who is using money in a manner contrary to its basic purpose is, in fact, disregarding the blessings of Allah. Consequently, whoever hoards money is doing injustice to it and is defeating their actual purpose. He is like the one who detains a ruler in a prison… And whoever effects the transactions of interest on money is, in fact, discarding the blessing of Allah and is committing injustice, because money is created for some other things. So, the one who has started trading in money itself has made it an objective contrary to the original wisdom behind its creation, because it is injustice to use money for a purpose other than what it was created for…. If it is allowed for him to trade in money itself, money will become his ultimate goal and will remain detained with him like hoarded money. And imprisoning a ruler or restricting a postman from conveying messages is nothing but injustice."

Imam Al-Ghazzali has taken the concept of "medium of exchange" to its logical end. He has concluded that when money is exchanged for money of the same denomination, it should never be made an instrument generating profit by such exchange. This approach of Imam al-Ghazzali, fully backed by the clear directives of the Holy Qur'an and Sunnah, has however been admitted to be true by some realistic scholars, even in societies dominated by interest. Many of them after facing the severe consequences of their financial system based on trade in money have admitted that their economic plight was caused, inter alia, by the fact that money was not restricted to be used as a medium of exchange. During the horrible depression of 1930s, an "Economic Crisis Committee" was formed by Southampton Chamber of Commerce in January 1933. After discussing the pitfalls of the existing financial system, one of the committee's recommendations was that:

"In order to ensure that money performs its true function of operating as a means of exchange and distribution, it is desirable that it should cease to be traded as a commodity."

The issue is now increasingly recognized by the modern economists. James Robertson observes in his latest work, Transforming Economic Life in the following words:

"Today's money and finance system is unfair, ecologically destructive and economically inefficient. The money-must-grow imperative drives production (and thus consumption) to higher than necessary levels. It skews economic effort towards money out of money, and against providing real services and goods…
…(It) also results in a massive world-wide diversion of effort away from providing useful goods and services, into making money out of money. At least 95% of the billions of dollars transferred daily around
the world are for purely financial transactions, unlinked to transactions in the real economy."

This is exactly what Imam Al-Ghazzali had pointed out nine hundred years ago. The evil results of such an unnatural trade have been further explained by him at another place, in the following words:

"Riba (interest) is prohibited because it prevents people from undertaking real economic activities. This is because when a person having money is allowed to earn more money on the basis of interest, either in spot or in deferred transactions, it becomes easy for him to earn without bothering himself to take pains in real economic activities. This leads to hampering the real interests of the
humanity, because the interests of the humanity cannot be safeguarded without real trade skills, industry and construction."

Thus To make money an object of profitable trade disturbs the whole monetary system and brings a plethora of economic and moral hazards to the whole society.

The Nature of Loan

Another major difference between the secular capitalist system and the Islamic principles is that under the former system, loans are purely commercial transactions meant to yield a fixed income to the lenders. Islam, on the other hand, does not recognize loans as income-generating transactions. They are meant only for those lenders who do not intend to earn a worldly return through them. They, instead, lend their money either on humanitarian grounds to achieve a reward in the Hereafter, or merely to save their money through a safer hand. So far as investment is concerned, there are several other modes of investment like partnership which may be used for that purpose. The transactions of loan are not meant for earning income.
The basic philosophy underlying this scheme is that the one who is offering his money to another person has to decide whether:
(a) He is lending money to him as a sympathetic act or
(b) He is lending money to the borrower, so that his principal may be saved or
(c) He is advancing his money to share the profits of the borrower.

In the former two cases (a) and (b) he is not entitled to claim any additional amount over and above the principal. However, if his intention is to share the profits of the borrower, as in case (c), he shall have to share his loss also, if he suffers a loss. In this case, his objective cannot be served by a transaction of loan. He will have to undertake a joint venture with the opposite party, whereby both of them will have a joint stake in the business and will share its outcome on fair basis. Conversely, if the intent of sharing the profit of the borrower is designed on the basis of an interest-based loan, it will mean that the financier wants to ensure his own profit, while he leaves the profit of the borrower at the mercy of the actual outcome of the business. This is indicated especially in the situations of great loss or huge profit that bring injustice to either of the two parties. In order to limit the use of loans, the Shar'iah has permitted to borrow money only in cases of dire need, and has discouraged the practice of incurring debts to grow one's wealth.
Once the interest is allowed and advancing loans, in itself, becomes a form of profitable trade, the whole economy turns into a debt-oriented economy which not only dominates over the real economic activities and disturbs its natural functions by creating frequent shocks, but also puts the whole mankind under the slavery of debt. It is no secret that all the nations of the world, including the developed countries, are drowned in national and foreign debts to the extent that the amount of payable debts in a large number of countries exceeds their total income. Just to take one example of UK, the household debt in 1963 was less than 30% of total annual income. In 1997, however, the percentage of household debt rose up to more than 100% of the total income. It means that the household debt throughout the country, embracing rich and poor alike, represents more than the entire gross annual incomes of the country. Peter Warburton, one of the UK's financial commentators and a past winner of economic forecasting awards, has commented on this situation as follows:

"The credit and capital markets have grown too rapidly, with too little transparency and accountability. Prepare for an explosion that will rock the western financial system to its foundation."

Interest-based loans have a persistent tendency in favor of the rich and against the interests of the common people. It carries adverse effects on production and allocation of resources as well as on distribution of wealth. Some of these effects are the following:

(a) Evil Effects on Allocation of Resources

Loans in the present banking system are advanced mainly to those who, on the strength of their wealth, can offer satisfactory collateral. Consequently, capital will be distributed in a non equal way.

(b) Evil Effects on Production

Interest encourages people to live beyond their means. The rich people do not borrow for productive projects only, but also for conspicuous consumption. Similarly, governments borrow money not only for genuine development programs, but also for their lavish expenditure and for projects motivated by their political ambitions. According to the budget of 1998/99 in our country 46 percent of the total government spending is devoted to debt-servicing, while only 18% is allocated for development which includes education, health and infrastructure.

(c) Evil Effects on Distribution

We have already pointed out that when business is financed on the basis of interest, it may bring injustice either to the borrower if he suffers a loss or to the financier if the debtor earns huge profits. Although both situations are equally possible in an interest-based system, and there are many examples where the payment of interest has brought total ruin to the small traders, yet in our present banking system, the injustice brought to the financier is more pronounced and much more disturbing to the equitable distribution of wealth.

Almost all the giant business ventures are mostly financed by the banks and financial institutions. In numerous cases the funds deployed by the big entrepreneurs from their own pocket are much less than the funds borrowed by them from the common people through banks and financial institutions. If the entrepreneurs having only ten millions and acquire 90 million from the banks and embark on huge profitable enterprises, it means that 90% of the projects is created by the money of the depositors while only 10% was generated by their own capital. If these huge projects bring enormous profits, only a small proportion (of interest which normally ranges between 2% to 10% in different countries) will go to the depositors whose input in the projects was 90% while all the rest will be secured by the big entrepreneurs whose real contribution to the projects was not more than 10%.

How the present interest-based system works to favor the rich and kill the poor is succinctly explained by James Robertson as follows:
"The transfer of revenue from poor people to rich people, from poor places to rich places, and from poor countries to rich countries by the money and finance system is systematic.... One cause of the transfer
of wealth from poor to rich is the way interest payments and receipts work through the economy."

(d) Expansion of Artificial Money and Inflation

Since interest-bearing loans have no specific relation with actual production and the financier, after securing a strong collateral, normally has no concern how the funds are used by the borrower, the money supply effected through banks and financial institutions has no nexus with the goods and services actually produced on the ground. It creates a serious mismatch between the supply of money and the production of goods and services. This is obviously one of the basic factors that create or fuel inflation.

This phenomenon is aggravated to a horrible extent by the well-known characteristic of the modern banks normally termed as "money creation." Even the introductory books of economics usually explain how the banks create money.
The history of "money creation" refers back to the famous story of the goldsmiths of medieval England. The people used to deposit their gold coins with them in trust, and they used to issue a receipt to the depositors.
In order to simplify the process, the goldsmiths started issuing "bearer" receipts which gradually took the place of gold coins and the people started using them in settlement of their liabilities. When these receipts gained wide acceptability in the market, only a small fraction of the depositors or ever came to the goldsmiths to demand actual gold. At this point the goldsmiths began lending out some of the deposited gold secretly and thus started earning interest on these loans. After some time they discovered that they could print more money (i.e. paper gold deposit certificates) than actually deposited with them and that they could loan out this extra money on interest. They acted accordingly and this was the birth of "money creation" or "fractional reserve lending" which means to loan out more money than one has as a reserve for deposits.
Overtime, this fraudulent practice turned into the fashionable standard practice of the modern banks under the "fractional reserve" system and the net result is that the modern banks are creating money out of nothing. The proportion of real money issued by the governments has been constantly declining in most of the countries, while the proportion of the artificial money created by the banks out of nothing is ever-increasing. Taking the example of UK according to the statistics of 1997 the total money stock in the country was 680 billion pounds, out of which only 25 billion pounds were issued by the government in the form of coins and notes. All the rest i.e. 655 billion pounds were created by the banks. It means that the original debt-free money remained only 3.6% of the whole money supply while 96.4% is nothing but a bubble created by the banks.

According to an estimate, over 150 trillion US dollars are circulating in the world, whereas the combined GDP of all the 188countries of the world is around 30 trillion US dollars only. Almost 80% of this trade is in the hands of some two dozen big banks and hedge funds. The whole economy of the world has thus been turned into a big balloon that is being inflated on daily basis by new debts and new financial transactions having no nexus whatsoever with the real economy. This big balloon is vulnerable to the market shocks and can be burst any time. In fact the universal horrors brought about by the commercial interest are far greater than the individual usurious loans that used to affect only some individuals.

Interest and Indexation

Some appellants have tried to justify the interest charged and paid by the banks on the ground that the value of money is decreasing constantly; the interest should be taken as a compensation for the erosion of the value of money during the period of borrowing. Since the inflation would have eroded a substantial part of the real value of money, they argue that the interest is paid to compensate the loss the financier has suffered through inflation.

This argument is without force. Although the rates of interest are a major cause of inflation among other factors, they are not based on the rate of inflation. Had it been compensation for inflation, the rate of interest should have always matched the rate of inflation, and obviously this is not the case. The rates of interest are determined by the demand and supply of money and not by the rate of inflation at the time of the contract. If at any given time both rates match each other, it may be only by chance.

Others suggest that indexation of loans can be a suitable substitute for the present interest bearing loans. They argue that the financier should be compensated for the erosion of the value of money he had advanced to the borrower and therefore he can claim an additional amount matching the rate of inflation. Thus, according to them, indexation may be introduced into the banking system as an alternative for interest. Yet, the concept of indexation of loans is to give the real value of the principal to the financier based on the rate of inflation, and therefore, there is no difference between depositors and borrowers in this respect. It means that the bank will receive from its borrowers the same rate as it will have to pay to its depositors; both being based on the same measure i.e. the rate of inflation. Thus nothing will be left for the banks themselves, and no bank can be run without a profit. Thus taking indexation as a substitute of interest is not practicable from banking point of view.

Mark-up and Interest

Some appellants have argued that although the interest is prohibited by the Holy Qur'an and Sunnah, the present banks do not deal in interest. Instead, they charge mark-up from their customers. Mr Haafiz S.A. Rahman, the learned counsel for the Agricultural Development Bank of Pakistan gave a detailed history of the legal steps taken by the government of Pakistan to eliminate interest from its economy. According to him, effective 1 April 1998, all types of finance to all types of clients including individuals were obligated to be designed on interest-free basis. On 1 July 1995 interest bearing deposits ceased to be accepted and the deposits were ordered to be based on PLS (profit and loss sharing) basis except the current accounts which do not attract any return. In order to implement this directive, the State Bank of Pakistan allowed 12 modes of financing, all free of interest, for the banks and financial institutions. The government has also brought amendments to a large number of financial laws to eliminate interest from the economy. After all these steps are taken, interest is no more applicable in the banking transactions of the country. All the banks today are working under 12 modes of financing announced by the State Bank of Pakistan.

The history given by Haafiz S.A. Rahman is essentially true and it is correct that the State Bank of Pakistan had suggested 12 modes of financing instead of interest, but the practical situation on the ground is that out of all these 12 modes only 2 or 3 modes are normally being used by the banks and financial institutions, the foremost among them being mark-up. But the way the mark-up is used by the banks today is nothing but a change of nomenclature of the transaction. Practically what is being done is to replace the name of interest by the name of mark-up. The concept of mark-up was originally presented by the Council of
Islamic Ideology in its report on the Elimination of Riba submitted to the government of Pakistan in 1980. The Council has in fact suggested that the true alternative to the interest is profit and loss sharing (PLS) based on Musharakah and Mudarabah. However, there were some areas in which financing on the basis of Musharakah and Mudarabah were not practicable. For these areas the Council has suggested a technique usually known in the Islamic banks as Murabahah. According to this technique the financier bank, instead of advancing a loan in the form of money, purchases the commodity required by the customers from the market and then sells it to the customer on deferred payment basis retaining a margin of mark-up (profit) added to its cost. It was not a financing in its strict sense. It was rather a sale of a commodity in favor of the client. The very concept of this transaction implies the following points:

a) This type of transaction may be undertaken only where the client of a bank wants to purchase a commodity. This type of transaction cannot be effected in cases where the client wants to get funds for some purpose other than purchasing a commodity, like overhead expenses, payment of salaries, settlement of bills or other liabilities.
b) To make it a valid transaction it was necessary that the commodity is really purchased by the bank and it comes into the ownership and possession (physical or constructive) of the bank so that it may assume the risk of the commodity so far as it remains under its ownership and possession.
c) After acquiring the ownership and possession of the commodity it should be sold to the customer through a valid sale.
d) The Council has also suggested that this device should be used to the minimum extent only in cases where Musharakah or Mudarabah are not practicable for one reason or another.

While implementing this technique by the banks and the financial institutions, all the above points were totally ignored. The result is that no meaningful change has ever been brought about to the system of interest of the banks.

Qarz and Qiraz

Dr. M. Aslam Khaki expressed his opinion that if the financing transaction stipulates a fixed return to the financier regardless of whether the financed party has gained a profit or suffered a loss, it should be regarded as riba. But if the financing transaction contemplates that in the case of a loss, the loss will be shared by both the parties in proportion to their respective investments, this much is enough to validate the transaction after which the parties can agree on a condition that if the business gains a profit a certain rate of profit attributable to the original investment of the financier will be deserved by him. It will become a transaction of Qiraz which is not impermissible in Shar'iah.

The appellant’s view is neither supported by the Holy Qur'an and Sunnah, nor by any jurist throughout the fourteen centuries. Qiraz is a term used in the literature of the Islamic Fiqh as a synonym to Mudarabah and all the schools of Islamic Fiqh are unanimous on the point that in an agreement of Mudarabah no rate of profit attributable to the investment can be allocated for the financier. Any such arrangement has been held by the jurists as impermissible.

Riba and Doctrine of Necessity

Mr. Siddiq AlFarooq, the Managing Director of House Building Finance Corporation (HBFC) argued that the Holy Qur'an has allowed even to eat pork in the case of extreme hunger to save one's life. The interest-based system has now become a universal necessity and no country can live without it. Interest is no doubt prohibited by the Holy Qur'an but to implement this prohibition on countrywide level may be a suicidal act which may shatter the whole economy, therefore, it should not be declared as repugnant to the injunctions of Islam.

The doctrine of necessity is one of the doctrines enshrined by the Holy Qur'an and Sunnah and expounded by the Muslim jurists. There are certain criteria expounded by the Muslim jurists in the light of the Holy Qur'an and Sunnah to determine the magnitude of necessity and the extent to which a Qur'anic command can be relaxed on the basis of an emergent situation. When we analyze the case of interest we find there is a great deal of exaggeration in the apprehension that the elimination of interest will lead the economy to collapse.

In the domestic transactions the apprehension against the elimination of interest is often based on some misconceptions. There are many people who think that abolishing interest means to turn the banks into charitable institutions and that the banks, in an Islamic system, will advance money with no return and the depositors will get nothing on their money held in the banks. What is meant by Islamizing the banks and financial institutions is that the banks will finance on the basis of profit and loss sharing, and other Islamic modes of financing, none of which is devoid of return.

Some other people are of the view that the alternative banking system based on Islamic principles has not yet been designed nor practiced, and therefore, by implementing it abruptly we will enter into a dark and obscure area and subject ourselves to unseen dangers that may bring total disaster to our economy.
Muslim jurists and economists have been working on various aspects of Islamic banking from different dimensions for the last 50 years, and it is from the 1970s that the concept of Islamic banks has been translated into real institutions working on the Islamic lines. The number of Islamic banks and financial institutions throughout the world has been growing during the last 3 decades. As stated by Mr. Iqbal Ahmad Khan, the head of the Islamic banking division of HSBC London who appeared in this case as a juris -consult, the number of Islamic banks and financial institutions has now reached more than 200 across 65 countries of the world with US $90 billion capital at a growth rate of 15% p.a. Besides, since the experience of Islamic banking is passing through its initial phase, the industry is facing numerous issues. These issues have given birth to a number of research institutes, study circles, training programs and specialized groups. There is a large number of seminars, workshops and conferences, held every year in different parts of the world where the Muslim jurists, economists, bankers and practitioners sort out the practical problems and find out their solutions.
This shows that Islamic Banking Industry is not a utopia idea.

Let us now examine the main features of the proposed system of Islamic banking.

Profit and Loss Sharing

The basic and foremost characteristic of Islamic financing is that, instead of a fixed rate of interest, it is based on profit and loss sharing. We have already discussed the horrible results produced by the debt-based economy. Realizing the evils brought by this system, many economists, even of the Western world are now advocating in favor of an equity-based financial arrangement. For instance, John Tomlinson, an Oxford based Canadian economist has strongly recommended the conversion of debt into equity in his book “Honest Money". He has clarified the merits of this conversion to the banking community, the marketplace, and individuals. Thus, the injustice, instability and business shocks created by the present debt-based financial system have themselves compelled them to think about an equity-based system that has more potential to bring about distributive justice and stability. In equity-based banking the depositors are expected to gain much more than they are receiving today in the form of interest which often becomes negative in real terms by the inflation caused mainly by the expansion of the debt-based money. It will divert the flow of wealth towards the common people and in turn will encourage savings and bring a gradual and balanced prosperity.

Some Objections on Musharakah Financing

It is argued that the arrangement of Musharakah is more likely to pass on losses of the business to the financier bank or institution. This loss will be passed on to depositors also. The depositors, being constantly exposed to the risk of loss, will not like to deposit their money in the banks and financial institutions and thus their savings will either remain idle or will be used in transactions outside the banking channels, which will not contribute to the economic development at national level.

This argument is, however, misconceived. Banks and financial institutions do deep studies and take the required precautions before Musharakah. In addition, no bank or financial institution can restrict itself to a single Musharakah. There will always be a diversified portfolio of Musharakah. If a bank has financed 100 of its clients on the basis of Musharakah, after studying the feasibility of the proposal of each one of them, it is hardly conceivable that all of these Musharakahs, or the majority of them will result in a loss. After taking proper measures and due care, what can happen at the most is that some of them make a loss. But on the other hand, the profitable Musharakahs are expected to give more return than the interest-based loans, because the actual profit is supposed to be distributed between the client and the bank. Moreover, the case of the bank and financial institutions is much stronger than joint stock companies whose business are restricted to a limited number of commercial activities, because their Musharakah activities will be so diversified that any possible loss in one Musharakah is expected to be more than compensated by the profits earned in other Musherakahs.

Dishonesty

Another apprehension against Musharakah financing is that the dishonest clients may exploit the instrument of Musharakah by not paying any return to the financiers. They can always show that the business did not earn any profit.

The solution of this problem is not as difficult as is generally believed. If all the banks in a country are run on Islamic pattern with a support from the Central Bank and the government, the problem of dishonesty is not hard to overcome. First of all, the system of credit rating will have to be implemented with full force. Every company or corporate body should be compelled by law to subject itself to an independent credit rating. Secondly, a well-designed system of auditing should be implemented whereby the accounts of all the clients are fully maintained and properly controlled. It is true that even after taking such precautions, there will remain a possibility of some cases of dishonesty, but the punitive steps and the general atmosphere of the business will gradually reduce the number of such cases.

Murabahah Transaction

Islamic banking is not restricted to profit and loss sharing. There is a variety of instruments that may be used on the assets side of the bank, like Murabahah, leasing, salam, istisna, etc. Some of these models are less risky and may be adopted where Musharakah has abnormal risks or is not applicable to a particular transaction. Some of the appellants have complained that the Federal Shariat Court, in its impugned judgment, has declared the mark-up system, too, as against the injunctions of Islam. It means that Murabahah cannot be used by an Islamic bank as a permissible mode of financing.

This complaint is misconceived. The Federal Shariat Court has not held the Murabahah transaction as invalid in principle. It has rather suggested Murabahah for financing exports in para 367 of its judgment. However, the Court has held the "mark-up system as in vogue" to be against the Islamic injunctions and has expressed its apprehension that this mode will be subject to misuse and, applied without fulfilling the necessary conditions on a large scale basis, it will bring little difference to the present system. We have already observed that the "mark-up system as in vogue in Pakistan" is not a Murabahah transaction in the least. It is merely a change of name.

Murabahah is a sale and not a financing in its origin. It must, therefore, conform to all the basic standards of a sale. It may be used only where the client of the bank really wants to purchase a commodity. The bank must purchase it from the original supplier and after taking into its ownership and (physical or constructive) possession sells it to the client. This is the basic feature of the Murabahah which makes it distinct from an interest-based financing and once it is ignored, the whole transaction steps into the prohibited field of interest-based financing.

When money is exchanged for money, no excess is allowed in cash transaction or in credit, but where a commodity is sold for money, the price agreed upon by the parties may be higher than the market price, both in cash and credit transactions. Time of payment may act as an ancillary factor to determine the price of a commodity, but it cannot act as an exclusive basis for and the whole consideration of an excess claimed in exchange of money for money. This position is accepted unanimously by all the four schools of Islamic law and the majority of the Muslim jurists. This is the correct legal position of Murabahah transaction according to Shar'iah. However, it should be used only where the Musharakah and Mudarabah are not applicable since it is susceptible to misuse and it is not an ideal way of Islamic financing.

Therefore, the Doctrine of Necessity cannot be applied to protect the present interest based system for ever or for an indefinite period. However, this doctrine can be availed of for allowing a reasonable time to the government necessarily required for the switch-over to an interest-free Islamic financial system.

The Loans of the Government

The process of elimination of Interest from borrowings of the Government represents a major difficulty. At present the government of Pakistan is heavily indebted to domestic and foreign lenders.
The substance of the alternative suggestions is that all the borrowings of the government from domestic sources should be designed on the basis of project-related financing. This will, in addition to being compatible with Shar'iah, help curbing the corruption and misappropriation of borrowed funds. We are of the view that in this sector too, the interest cannot be taken as a necessity to continue for an indefinite period. However, this area may justify some more time for transformation than the private banking transactions will require.

Foreign Loans

It is argued that conversion of this type of borrowing to an interest-free basis is almost impossible. In the beginning we started borrowing funds from international sources for our development projects. Later the scope of foreign borrowing was extended even to the non-development expenses. Thereafter huge amounts were borrowed for debt servicing and now these borrowings are meant to pay interest to the international lenders.
The notion that the foreign borrowings help the developing countries in their development projects and assist in attaining prosperity is now proved to be false in the case of a large number of the "third world" countries. This fact is increasingly realized by the independent economists.

A Canadian scholar Jaques B. Gelinas , in his book "Freedom From Debt", figured out who actually has benefited from this system. He said:

"The foreign-aid-based development model has proved itself powerless to bring a single country out of economic and financial dependence. However, it has turned out to be a source of fabulous wealth for certain Third World elites, giving birth to a new form of power and a socio-political class that can rightly be called the 'aidocracy.'"

Even in this intervening period, we must try our best to renegotiate with our lenders to convert the existing loans into Islamic modes of financing. Thanks to the atmosphere created by the Islamic banking, these modes of financing are no longer totally unfamiliar to the West. Even the International financial institutions have undertaken studies to understand them. IFC, the private financing branch of the World Bank has already expressed its willingness to use some Islamic modes of financing. The assets-related loans can easily be converted into Leasing arrangement. Project related loans can be reshaped on the basis of Istisna. Therefore, it should not be much difficult to renegotiate the existing loans on Islamic lines. For new finances even wider variety of modes is available that can be designed on the basis of Islamic principles. However, it will be possible only if the government itself has a firm commitment to its Islamic obligations and a true will to implement what Islam requires.

On November 17, 1990, the Prime Minister of Pakistan had appointed a committee of experts to analyze the growing dependence of our country on foreign assistance and to chalk out a plan to reduce this dependence and evolve a self-reliance development strategy. The report of the Committee was submitted to the government in April 1991. This Committee, after deliberations, came to the conclusion that, even on pure economic grounds, the goal of self-reliance can be achieved only by elimination of interest. The recommendations of this committee can be availed of while tackling with the issue of foreign loans.

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