LEGAL AND ECONOMIC ASPECTS OF ISLAMIC BANKING

Islam, whose followers include almost one-quarter of the world's population, has made the faith into a guide governing all facets of life. Islamic Law, Shariah, is based on the Holy Quran "The Contemporary Message of Allah," The Most Merciful and the Most Beneficent, Sunnah "The preachings of the Prophet Muhammad", and Jjma or Umma "Consensus, the exercise of one's independent judgment based on scholarly interpretation of questions not covered by the first two sources" (Azzam, p. 82).

Islamic Law governs only those who accept it as the revealed will of Allah; thus Islam tends to be a matter of personal philosophy, rather than geography (Crane). Islamic Law has been praised by Western scholars, such as New York University's Anderson, who wrote that " After thirteen centuries of accomplishment during which the Shariah has governed the lives of myriads of Muslims in successive generations, the great Law is still the object of careful study by scholars and jurists in the East and the West" (Anderson, ix).

According to Crane, there are almost no non-Muslims, especially Western businessmen, "with any knowledge of either the Shariah, i.e., Islamic Law, as it is now developing in the Middle East, or of Islamic economics which, at least in concept, is merely a branch of the Shariah."

Islamic banking, based on the Islamic law of contracts, derives from the Law of Tawheed, i.e., "belief in the oneness of Allah, (and the teaching) that no one should claim for himself what is basically the creation of Allah or the product of another man's efforts and skills." Therefore, Islamic banking is based on- avoidance of fixed-rate interest, and on acceptance of deposits and investment funds on PLS (profit and loss sharing).

Islam condemns riba (fixed interest), which "reinforces the tendency for wealth to accumulate in the hands of a few, and thereby diminishes man's concern for his fellow men," guarantees gain without the risk of loss, and hampers investment and employment ("Islam and Financial Intermediation," pp. 110- 11). In even more explicit terms, riba is said "to impede the productive circulation of wealth, concentrate wealth in a class of economic drones, create an imbalance between production and consumption, increase the cost of production at the expense of consumers, impose rigidity in costs and a bias toward short run planning in investment, encourage unproductive speculation, and trigger credit imbalances and inflation" (Crane, p. 19).
Conversely, Islam teaches that absence of riba ' 'provides a check on the exercise of private proprietorship, and tends to reduce exploitation of the labor force, while still permitting a free cooperative system" (Pomeranz and Haqiqi, p. 155). The need for social justice permeates Islamic teaching. For instance, expanded granting of consumer credit was recommended by Dr .Muhammad Uzair, Director of the International Center for Research in Islamic Economics (Saudi Arabia) at the 1976 Islamic Conference in Mecca; he suggested that interest-free consumer loans, premised on "living within one's means," should be small enough to be handled through an interest-free "residual fund" carried in the bank's current account (Crane, p. 49). In other words, consumer credit may be provided by Islamic banks not only to enable the borrowers to deal with personal or family emergencies and needs, but to assist them in raising their living standard.

The same orientation is reflected in another important concept, Zakah. In a western profit making enterprise, maximization of profit and minimization of loss represent the "bottom line." But Islamic economics is different. As Crane says: "Western economists generally cannot conceive of any measure that extends beyond the material world, whereas Muslims generally cannot conceive of any measure that does not." Zakah, the giving of one's bounty to others, represents one of the pillars of Islam. When he accumulates wealth and earns mole than he needs, the Muslim becomes obligated to pay Zakah to purify himself from the sin of avarice. Zakah, as an instrument of the redistribution of wealth, and of the creation of a society based on mutual assistance, also is being implemented in Islamic banking institutions.

Islamic economic desiderata may be summarized as follows:

Economic growth: An Islamic economy penalizes the accumulation of idle wealth through Zakah, and encourages rapid reinvestment in order to increase production and productivity.

Higher employment: Investment is encouraged in projects which produce wealth, rather than through relatively more passive fixed-income investments. The participative type of project is thought more likely to lead to higher employment, and to fewer negative social and economic effects.

Equal distribution of income and wealth: Zakah is designed to p(Omote more equal distribution of wealth. (Social justice, social cohesion, broth- erhood, and the harmony aspects of Zakah have origins in Tawheed.)

Preserving equilibrium and modesty: Wasteful consumption (lsraf) is discouraged, while abstinence from waste, and saving in the form of direct investment (Iqtisad) are encouraged.

The PLS scheme is thought important to the promotion of social justice and cooperative economic principles. Therefore, all Islamic banks have introduced PLS affecting depositors and borrowers; some banks are still engaged in the process of installing profit and loss sharing in their remaining operations. Several types of PLS arrangements may be found in Islamic banking:

Mudarabah ( trust-financing ): An Islamic bank, as a limited partner, pro- vides cash (capital requirements) to a borrower/entrepreneur who is free to use the funds in pursuit of the partnership's goal. While the share of each party in the profits and losses must be in percentages, and all expenses related to the partnership are deductible before profit distribution, the duration of such a scheme should not be predetermined. The funds must be in cash, and can be invested in trade or industry for an unlimited time- although either party may rescind the contract upon notice to the other.

Murabaha (cost-plus trade financing): In this contracting scheme an Islamic bank as a partner finances the purchase of commodities in return for a share in the profits realized when the goods are sold. However. if losses are incurred, the contracting bank may (or may not) share the loss-depending on the terms and conditions of the agreement. Repayment of such financing can be deferred or made in installments.

Musharaka (participation financing): An Islamic bank provides a part of the equity plus working capital of a project and shares in profits and/or losses.

Ijara (rental financing): This activity, which has provided the bulk of the operating income of Islamic banks, covers both long-term leasing/lease financing and short-term hire-purchase. In financing, the Islamic bank or its leasing company purchases a piece of equipment selected by the entrepreneur and then leases it back to him. In a hire-purchase arrangement the entrepreneur may partially purchase, and partially rent the equipment.

Since the legal basis of an Islamic bank's operations may differ in certain respects from Western commercial banks and interest-paying institutions, statutory reforms are being carried out in various Islamic countries. The major changes affect commercial law (rewritten in Pakistan), corporation law (considered to be rewritten in Pakistan), tax law (Zakah has been incorporated in Saudi Arabia and Pakistan), and the banking law (rewritten in Iran in 1984).