Salman Ahmed Shaikh

As per views of some scholars, it is not prohibited for a borrower to obtain interest bearing loan and to pay interest on it. They argue that the Hadith which appears in Sahih Muslim is misunderstood. The Hadith says: “The Prophet has severely condemned the devourer of interest and the one who pays interest and those who write an agreement [for such lending] and the two who are the witnesses to this document and has said: ‘All of them are equal’” (Sahih Muslim: 1598). They opine that even though, the word ‘Mokil’ can be used for the borrower who pays interest, it seems more congruent with other Qur’anic verses that the word is referring to the agents of the lender who facilitate him in his interest based lending operations. Secondly, they contend that the borrower needing money is unjustly forced to pay interest. He suffers and succumbs to the condition which was neither stipulated by him nor would he have agreed to it if he had choice. An example is given that if the buyer receives counterfeit or defected goods, it is not his fault. Seller certainly has done wrong and his profiteering would be considered impermissible. But, buyer in such case is innocent.   

In response to this view, few observations are humbly stated. First, it is not appropriate to look at a person who gives interest as like the buyer who suffers by receiving adulterated goods from the seller. Over there, there is no contract to receive adulterated goods. There is just plain deceit and fraud. Likewise, a person suffering from robbery is not entering in a contract to be robbed. Better analogy is that if consumption of liquor is prohibited, can one sell it if not consuming himself? Can we buy pirated goods? Knowing that for the seller, it is not right to sell pirated goods and earn profit on it, should a person still buy pirated goods? Knowing that a good is smuggled and is considered illegal for trade, should a person still buy it? How contemporary law treats it? If a person buys non custom duty paid car, the law puts burden on buyer and his car can be confiscated.

Secondly, it is a voluntary and independent act to enter into a loan based contract in which there is stipulated interest. In modern day banking, most of the borrowers are corporate entities. In Pakistan alone, around three-fourths of the total financing provided by banks goes to corporations. These corporations are setup up with equity first. These corporations have other options to finance their expansion. Financing products offered by full-fledged Islamic banks and the Islamic banking branches of conventional banks provide interest-free short term finance solutions. Besides that, financial markets are also accessible to the large scale corporations where equity financing and Sukuk can be used to meet the long-term financing requirements.

Thirdly, the equity based modes of financing are not widely used in Pakistan because the after-tax cost of debt is usually cheaper for high-performing corporations with higher returns on equity. Cost of debt is also tax deductible which reduces the after-tax cost of debt. Thus, borrower is not necessarily worse-off or is handicapped by having to pay interest. However, this results in concentration of wealth since debt financing is provided by banks mainly to the large scale businesses. Equity financing achieves inclusiveness and fosters equitable resource distribution. One important reason why there is predominant use of interest based debt finance by corporate clients of banks is that they find it cheaper. On the other hand, those individual and corporate clients who would be burdened with the debt servicing commitments are not served by banks in the first place anyways.

Fourthly, Islamic banking in Pakistan has been operational since 2002. Its branch network has exceeded 3,500 in number and its market share has steadily risen to 17% in short time by 2020. House finance through Islamic banks even in Pakistan has now more than 50% market share. Thus, in the scenario where interest based banking is considered unlawful and when there is also wide access to Islamic banking products and services, it is not advisable to give unqualified freedom to borrowing on interest.   

Lastly, it is difficult to conceive that in tribal Arab, there would have been big and organized financial institutions hiring scores of people to pursue interest based lending operations as is the case today. It seems that the Hadith may well have been referring to the borrowers who pay interest and we know that by and large, these borrowers were taking mostly commercial loans and equity based modes of financing like Mudarabah and Musharakah were also prevalent as alternate options for them. In the contemporary world, pawnshops and single-branch financial lenders in developed world almost operate with no human resource as agents. But, commercial contract of interest based lending would always include lender and borrower from the primitive to the most contemporary times of Fintech rich peer-to-peer lending.

As a matter of fact, conventional banks deal in debts. They mobilize deposits on debt basis and they also provide funds to the borrowers as debts. They do not provide funds on equity financing basis. When banks provide debt based financing, they expect to receive repayment of principal amount of debt with stipulated interest. Banks loan out money on expectation of getting their principal amount of loan paid along with stipulated interest. It does not matter whether the loan is provided for personal use or commercial use and whether it is provided for the purchase of assets, property or to retire other payment obligations. As per Islamic principles, if the nature of finance provided by banks creates debt, then they cannot demand a stipulated increase over and above the principal amount of debt. However, banks demand a stipulated predetermined increase over the principal amount of debt.

Let us illustrate this point with a simple example. A borrower receives a loan of Rs 1,000,000 for three years at a rate of 15% and earns return of Rs 200,000 in the first two years, and incurs a loss of Rs 50,000 in the third year. Then the amount payable to the bank in the form of interest is Rs 150,000 in each of the three years. The proposal to not charge interest in the period when there is loss does not alter the nature of contract, which is based on debt. There is no justification for the stipulated Rs 150,000 demanded by the lender from the borrower irrespective of what is the outcome of productive enterprise. The profit to the lender in conventional banking remains Rs 150,000 in all three years no matter whether the borrower earns profit or loss.

In addition to that, it is suggested by some that taking any form of asset based finance lease is allowable in Islam. It is contended that asset finance from finance lease does not involve any injustice. In fact, it is a benevolent act on the part of the financier to facilitate asset ownership whose prices rise overtime. Whatever that is paid by the client can be considered rent for the use of asset or payment towards the purchase of the asset.

In response to this view, it is humbly stated that conventional banks only provide loans no matter whether the loan amount is used for purchasing assets or not. As far as repayment of debt is considered, the interest is due from the very first date of sanctioning of loan to the very last day of loan term. If the asset remains unusable during the conventional finance lease, the installments including interest and principal repayment will continue without any break.

Islamic banks also provide lease as a way of financing the purchase of asset for the client. However, they ensure that during the lease period, ownership rests with the bank as lessor. They also pay asset related costs directly. For the commercial sustainability and competitiveness of their financing product, Islamic banks charge rents keeping in view their costs incurred and an expected level of profit which will allow them to provide competitive returns to the depositors.

One may make an economic criticism on Islamic way of leasing as being similar in the eventual effects and outcomes. Nonetheless, it is inconsistent to criticize Islamic banking on the understanding that they merely use legal stratagems, while giving blanket admissibility to all modes of finance lease and mortgages. It is humbly stated that conventional banks do not justify their charge of interest or mark-up as a form of rent. The installments in finance lease and mortgages are computed by using present value annuity formula. Conventional banks have no regard and concern with the value of the asset or property. Bank as a financial broker looks to get returns on its debt receivable with interest.

In Islamic Ijarah and Diminishing Musharakah based contracts, Islamic bank charges rent for the use of asset which is in its ownership and risk. Islamic bank charges these rents after the asset has been provided to the client in usable condition and only till the asset remains in usable condition during the lease period. These differences also ensure strong links with the real economy and productive sector and limit credit creation for the purpose of genuine value creating economic activities in the real economy.