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    Islamic Economics Sen"es - 4

    Issues in IslamicBanking

    Selected Papers

    MUHAMMADNEJATULLAH SIDDIQI

    The Islamic Foundation

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    @ The Islamic Foundation 1983/1403 H. Reprinted 1994/1415 H.

    ISBN(hard case) 0 86037 1182

    ISBN (paperback)0 86037 II74

    All rights reserved. No part of this publication maybe reproduced, stored in aretrieval system,or transmitted in any form or by any means, electronic, mechanical, photocopying, recordingor otherwise, without the prior permission of the copyright owner.

    Contents

    Views expressed by different authors of books and studies published by the IslamicFoundation do not necessarilyrepresentthe views of the Islamic Foundation.

    Acknowledgements ................................................................

    Foreword - Khurshid Ahmad ..........................................Published by

    The Islamic FoundationMarkfield Dawah Centre

    Ratby Lane, MarkfieldLeicester LE67 9RN, UK

    Preface. . .. . .. ..

    . . .. ..................

    1. Islamic Approaches to Money, Banking andMonetaryPolicy ..:..............

    On the Nature ofMoney and its Role inthe Economy.... .. .. .Banking .................................................Short- Term Loans ...............................................................Bills of Exchange ,.............................Credit for the Consumer .....................................................Finance for the Government and the Public Sector ........Monetary Policy ...................................................................International Banking..........................................................

    Conclusion .......................................Postscript Review of Contribut ions During 1977-1981 . .. .Demand for Money.............................................................Discounting Future Values .................................................Indexation ............................................................................Creation of Credit and Seigniorage ...................................100%Reserves ...................................................................Profit-Sharing Ratio as an Instrument of Policy..............Islamic Banking in Operation :...........................

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    Quran House, PO Box 30611,Nairobi, Kenya

    PMB 3193,Kano, Nigeria

    British Library Cataloguing in Publication DataSiddiqi, Muhammad Nejatullah

    Issues in Islamic banking - (Islamic economics series; 4)1.Banks and banking - Islamic countriesI . Tit le l l. Ser ies

    332.1 '097671 HGl573

    ISBN 0-86037-II8-2ISBN 0-86037-II7-4 Pbk

    Printed and bound inGreat Britain byThe Cromwell Press.Melksham. Wiltshire

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    363637414144464748

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    2. Banking in an Islamic Framework 51Consequencesof Interest 54Interest and Bank Credit : 55Profit-SharingBanks 59Short-Term Credit 61Prospects 64

    3. Rationale ofIslamic Banking 67The Critique 69The InvestmentSector:InefficiencyofDebt Finance 69The InvestmentSector : InjusticeofDebt Fimmce 71Consumer Debt 74Public Debt 77InternationalDebt , 78Worsening Distributionof Income and Wealth 81Concentrationof Power , 83Tendency Towards Inflation 84

    The Alternative , 85Allocative Efficiency 85Stability in the Value of Money 86Increase in the Volume oflnvestment 88Justice and Equity in Distribution 89Finance for the Government 90Finance for the Consumer 91International Flow of Funds , 92Curbing Speculation 92Mobilisation ofSavings and Profitability oflnvestments 93Conclusion : 94

    Effects of Changesin the ExpectedRate ofEntrepreneurialProfits, p 105

    Responsivenessto Changes in p in Supplyand Demandof deposits ..... 109

    Effect of Variety in Profit Expectations 110Stabilityof the System ... 111Profit-Sharing in the Shares Market 113Other Avenues of Investment 114Allocation of Resources 115Fluctuations in the Rate of Profit 118Monetary Policy in a Profit-Sharing System 121Conclusion 122

    5. Monetary Theory of Islamic Economics 125

    6. Issues in Islamisation of Banking 133Profit-Sharing as the Chief Alternative to Interest 134Supplementary Methods of Eliminating Interest 137

    Action Plan for the Elimination oflnterest 143Towards the Goals of the Islamic Economy 144

    Index 147

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    I4. Economics of Profit-Sharing 97

    The Rate of Profit 99Profit-Sharing 101The Ratios of Profit-Sharing 102Determinationofthe Banker'sRatioofProfit-Sharing, brp103Determinationof the Depositor's RatioofProfit-Sharing,

    drp 103From Interest to Profit-Sharing 105

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    Foreword

    Acknowledgementis gratefullymade to: Islamic banking is no longer a mere theoretical proposition.In

    excess of twelve national and international banks are nowsuccessfullyoperatingon an interest-freebasis in differentpartsof the world includingthe West This developmentis bound tohavefar-reachingconsequencesfor the futuremodeof bankinginthe entire Muslim world It is, therefore, important thatprofessionaleconomistsshouldengageinmore rigorousexamin-ation of the principles and practices of Islamic banking andparticipatecreativelyinthe processof this historicdevelopment

    Dr. M. N. Siddiqi,Faisal Laureate for 1982/1402 H. isamongst the leading pioneers of Islamic economics. He hasalready authored some twelve books on different aspects ofIslamiceconomicsandhis book Banking WithoutInterest, firstpublishedin 1969,wasthe firstfull and professionallythoroughtreatment of the subject Over the last decade Dr. Siddiqihaswrittenextensivelyoncertainaspectsof Islamicbanking,mainlyin theform of paperscontributedto internationalconferencesandseminarsonIslamiceconomics.He hasdone a valuableservicetothe academic communityin general and the studentsof Islamiceconomicsin particularby compilingthesepapersand lecturesintheformof Issues in Islamic Banking. I havebeen involvedwithmostof the conferencesand seminarsto whichthesepaperswerecontributedand I haveno hesitationin sayingthat Dr. Siddiqi'scontributionin clarifyingmanyissuesin the monetaryandfiscaleconomicsof Islamis originalas wellas sizeable.I am sure the

    present collectionis a significantcontributionto the dialogueonIslamic banking and anyone who goes through this work withopennesswillfindthat he presentsa formidablecase in favourofinterest-freebanking.It shouldalso convinceour friendsandfoesalikethatIshlmiceconomicsisnot anexercisein Muslimtheologyorfiqh but a newand livelyapproachto theeconomicproblemsofman.

    We maybe condemnedas 'utopians' and' romanticists'butwebelievethat the best formof realism lies in challengingall thosesystemswhicharebasedonthe exploitationofmanin oneformor

    The InternationalCentre for Researchin IslamicEconomics,KingAbdulazizUniversity,Jeddah,forthepaperon 'Rationale ofIslamicBanking'originallypublishedbythe Centre in 1981, andfor 'Islamic Approaches to Money, Banking and MonetaryPolicy' presentedat a seminarorganisedby theCentre at Makkain 1977.

    The InternationalCentre for Researchin IslamicEconomics,King Abdulaziz University, Jeddah, and the Planning Com-mission, Governmentof Pakistan, for the twopapers on'Econ-omics of Profit-Sharing'and 'Issues in Islamisationof Banking'

    presented at a seminarjointly organisedby themat Islamabad in1981.The Islamic Council of Europe, London, for 'Bankingin an

    IslamicFramework'presentedat a conferenceinLondonin 1977and includedin the book The Muslim World and the FutureEconomic Order publishedby the Councilin 1979. The paperwas first publishedin the journal Islam and the Modem Age,New Delhi (Vol.VIII, No.4, November, 1977).

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    another and in seekingto establisha just socio-economicorder,whateverthe effortneeded to realiseit Dr. Siddiqidemonstrateswith cogent arguments that an Islamic economy is capable offreeingmodemman from the debt-riddeneconomyin whichhelives and of guidinghim towards a societybased onjustice andequity. He also demonstratesthat such an economywould also

    ensuregrowthandstability.I am sure Issues in Islamic Bankingisgoingtobe a valuablecontributionto thedebateon thefutureofbankingin our owntime.

    Instituteof Policy Studies,IslamabadSept., 1982 KhurshidAhmad

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    Preface

    The idea that Islam is a unique way oflife distinct from all otherisms and ideologies naturally extends to the economic lifeof theUmma. A determination to reshape the economy on distinctiveIslamic lines has been an important dimension of the Islamicresurgence visible allover the world oflslam. The areas ofmoney,banking and investment are regarded as crucial to the process ofIslamisation of the economy. Modem banking, based on interestand biased in favour of the capitalists and the rich and well-to-do,is rejected as un-Islamic because ofthe unequivocal prohibition ofribti by the Qur' an, which the consensus of Muslim jurists hasinterpreted as covering all kinds ofinterest, usurious or otherwise,irrespective of the nature and function of the loan. The Islamicemphasis on cooperation as the key concept in economic lifehasledto reliance on profit-sharing andparticipation as the alternativebases for banking and investment in the Islamic framework.

    Muslim society never legit imised interest : throughout thethirteen centuries of its history prior to domination by imperialistpowers, it man

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