[Book summary] Meezan Bank's Guide to Islamic Banking

How I ended up with the book

I sometimes send money to my mom and most of the time I have used Western Union money transfer. Western Union's exchange rates are the worst in the market, but they are ubiquitous and punctual. So I have stuck to them for a long time rather reluctantly. A few months back, one of the good Samaritans who has helped me a lot mentioned about the guys at Barakah money transfer. I cannot ignore his recommendation. So I headed for Barakah for my next money transfer adventure. It turned out that they are an amalgamation of an Islamic bookshop and money transfer operation. As weird a combination it may be, they are really an agent of the Ria money transfer network. Ria claims to be the third largest money transfer operation after Western Union and Moneygram. So Ria is big, quite big, not as bit as Western Union, but still big. Which made me wonder how Ria can support a better exchange rate than Western Union. Anyway, once the money transfer was over, I started browsing the bookshelf and came upon "Meezan Bank's Guide to Islamic Banking" by Dr. Muhammad Imran Ashraf Usmani. I had no idea who this Meezan bank or Dr Usmani were, but that book seem to be the only finance related book available in the shop, so I ended up buying it. Besides, at 4 GBP, it was quite cheap as a hardback. Almost all Muslims know that interest on money is prohibited in the Quran, but apart from that, we know very little as most economies in Muslim majority countries are not run based on Islamic financial rulings. I was always curious to learn more on finance and "Meezan Bank's Guide to Islamic Banking" looked like a good stepping stone. This book is also available online.

The Summary

[In the following text, all direct quotes from the book are wrapped in quotations like this. The rest are based on my understanding.] The opening flap of the book carries the following Quranic verse: O you who believe! Fear Allah and give up what remains of your demand for interest, if you are indeed a believer. If you do not, then you are warned of the declaration of war from Allah and His Messenger; But if you turn back you shall have your principal: Deal not unjustly and you shall not be dealt with unjustly. Okay, so we know what the mood of the author is :-) The opening chapters shed some light on theoretical issues and then quickly moves to more practical waters. The first topic explains the Islamic position relative to Capitalism and Socialism. I will ignore the Socialism bit (it's dead, just as Microsoft is dead :) and mention the difference between Capitalism and the Islamic financial system. It will help if you think about the difference between a personal computer and the iPad. If you are knowledgeable about computers, you can do whatever you want with your personal computer. Not so with the iPad. You might own an iPad, but you still have to live by the restrictions placed by Apple (we are ignoring the practice of jail breaking to keep things simple :) It is as if Apple is the ultimate owner of all iPads. Now replace Apple with Allah (they are only 4 characters apart) and the iPad with your wealth. 'Wealth', no matter what its form, is in principle 'the property of Allah', and it is he who has bestowed upon man the right to exploit it. So Allah has the right to demand that man should subordinate his exploitation of this wealth to the commandments of Allah. Thus, man has the 'right of property' over the things he exploits, but this right is not absolute or arbitrary or boundless, it carries along with it certain limitations and restrictions, which have been imposed by the real owner of the 'wealth'. So both Capitalism and Islam gives you right over property, but Islam places restrictions on how you can exploit it. Next topic is the prohibition of interest on money. If you give someone N USD and then get back N+1 USD, you have received some interest. That is the basic principal. The interest may not even be called interest, but it is still prohibited. This simple rule dictates all types of transactions. When Muslim countries became subjugated to the West in their economic field, some westernized Muslims in the 19th century, on one side, saw the increasing progress of the West in trade and industry and on the other side saw the shattering economic condition of fellow Muslim states. They also became conscious of the fact that banking is inevitable in the field of trade and industry not only on national level but also internationally. This prompted them to say that only usury is haram (illegal) but not commercial interest because rendering commercial interest haram would post irresolvable problems to their way up to industrialization and economic progress. The author terms this a cargo cult attitude. Given the current abysmal state of various Muslim economies (Indonesia, Pakistan, Bangladesh, Egypt, etc. all of who runs interest-based economy), our author seem to have a good point here. The first practical topic that the author touches is "Islamic contract". There are four criterion for judging the validity of an Islamic contract. The most interesting one says A condition that is against the contract and not in the practice of market but it is in favour of one of the contractors or subject matter, this type of condition is void. Hmm ... no escape for the wicked :-) Next up are the rules governing a sale. Here are a few interesting ones:

A sale is makrooh where a third party intervenes to buy something which was under negotiation of sale between other parties. Makrooh means valid but disliked, so it is better if you avoid it.
Both the seller and buyer must be sane :-)
The sale must be instant and absolute. Thus a sale attributed to a future date or a sale contingent on a future event is void.
What is not owned by the seller cannot be sold. This rules out short selling in the share market.
A thing which has not yes come into existence cannot be sold. However, there are exceptions for order of manufacture. It is okay to make a partial payment when placing the order of manufacture. So there is nothing wrong if you go to a printer, place a printing order for 300 business cards and pay half the amount. In fact, forward sale is also possible where the product is not manufactured, but then the advance payment has to be in full and The exact date and place of delivery must be specified in the contract. So you can happily buy some wheat that will be grown next year! Provided that you make a full advance payment right now and the delivery date and place is fixed. I find it a bit weird, but apparently, the Prophet (Peace be on him) allowed it for the benefit of the farming community.
Conditional sales are not allowed. If someone tells you that he will only sell his bike to you if you buy his car, then he is clearly doing it wrong. He really should be offering to sell the bike and the car as individual items. He can, of course, give you a discount when you buy both the bike and the car.
Sale of debt at a discount is completely prohibited. For example, Foo lends 10000 USD to Bar. Foo then sells this debt to Qux for 9500 USD. When Bar eventually pays back 10000 USD sometime in the future, it goes to Qux. This is called Bai-Al-Dain and it is prohibited.

The next part is about Islamic rules of partnership, financing, and investment. This is the most interesting part of the book :-)

The first type of partnership is known as "Shirkah" which has a variant called "Musharakah". Musharakah means a joint enterprise formed for conducting some business in which all partners share the profit according to a specific ratio while the loss is shared according to the ratio of the contribution. So Foo and Bar can each put 20000 USD in a business. They then agree to split the profit at 60:40 ratio. This is fine. But if they make a loss, the liability will be 50:50 as both has invested the same amount. The ratio of profit sharing should be determined at the outset of the business.
There can be both active and sleeping partners in a Musharakah (Sleeping partners do not work, they only invest). The ratio of profit allocated to a sleeping partner should not exceed the ratio of his investment.
A saying by Hazrat Ali provides an excellent summary - Loss is distributed exactly according to the ratio of investment and the profit is divided according to the agreement of the partners.
There is an interesting form of Shirkah called "Shirkat-ul-wujooh". Here the partners have no investment at all. They purchase commodities on deferred price, by getting capital on loan because of their good will and sell them at spot. The profit so earned is distributed between them at an agreed ratio. The book is silent about what happens in the event of a loss :-(

Next topic is "Mudarabah". This is a kind of partnership where one partner gives money to another for investing in a commercial enterprise. The investment comes from the first partner who is called 'Rab-ul-Maal' while the management and work is an exclusive responsibility of the other, who is called 'Mudarib' and the profits generated are shared in a predetermined ratio. All the losses are borm by Rab-ul-Maal (i.e. the investor). This arrangement sounds a lot like a venture capital backed business to me. Here are a few points to note:

The investor should not interfere in the management of the business. But he has the authority to: a) Oversee the Mudarib's activities and b) Work with Mudarib if the Mudarib consents.
The Mudarib shares profit of the Mudarabah as per agreed rate with the investor but his expenses like meals, clothing, conveyance and medical are not borne by Mudarabah. However, if he is traveling on business and is overstaying the night, then the above expenses shall be covered from capital.
The Mudarib cannot claim any periodical salary or fee or remuneration for the work done by him for the Mudarabah.

Another form of Musharakah, developed in the near past, is 'Diminishing Musharakah'. Here is how it works:

Foo wants to buy a flat whose market value is 300,000 USD. The same flat has a monthly rent of 1000 USD. Foo has somehow managed to save 60000 USD. So he approaches Bar who is a wealthy financier. Bar can easily bring out 240,000 USD from his pocket.
Foo and Bar agrees to combine their money and they buy the flat. Now Foo owns 20% of the flat and Bar owns the remaining 80%.
Foo promises to buy 0.5% of the ownership every month from Bar and Bar agrees. This means Foo will pay 1500 USD every month to Bar. In return, Foo's ownership increases by 0.5% every month. After 160 long months, Foo is expected to own the whole property.
Now Foo starts staying at the flat. Since Bar owns 80% of the flat, Foo pays him 80% of the full rent which comes down to 800 USD per month.
So on the first month, Foo pays a total of 800 + 1500 = 2300 USD to Bar.
As Foo's ownership in the property increases, his rent keeps coming down proportionately.
And that is how it goes on until Foo becomes the full owner of the flat.

All of this sounds great to me except #3. #3 involves a "promise" from Foo that he will buy partial ownership from Bar in the future and similarly a promise from Bar that he will sell partial ownership to Foo in the future. But the rulings on sales (see above) clearly prohibits future sales! This has left me seriously confused about "Diminishing Musharakah". It would have been perfectly acceptable to me had Foo been allowed to increase his share of the flat only when he wanted to instead of every month. Apparently, some housing associations are selling flats in the UK in the following way -

You buy 35% of a flat.
You start living in the flat.
You pay 65% of the market rent of that flat to the company.
You have the liberty to buy the rest of the 65% ownership of the flat fully or partially whenever you want.

So it looks to me that this arrangement is more easily Islamic then "Diminishing Musharakah"! Besides, the fact that "Diminishing Musharakah" is a recent innovation makes me a bit nervous about it. Islamic Bank of Britain's house financing plan follows the principles of "Diminishing Musharakah". The summary of the story is, while I am no Islamic scholar, I am not happy about "Diminishing Musharakah", however, the author of the book has no objection about it. Next topic is "Murabahah". This one is severely important as Today in Islamic banks world-over 66% of all investment transactions are through Murabahah. The idea is simple:

Foo airlines from Quxland wants to buy a Boing 747 jumbo jet. But being a new airline, they cannot afford even a 15 year old 747.
So Foo airline approaches Bar-the-wealthy-entity and explains the trouble.
Bar buys the 747 for N million USD and immediately sells it to Foo for N + 1 million USD on deferred price. Deferred price means that Foo does not have to pay immediately.
Before Bar buys the 747, a contract has been signed whereby Foo agrees to pay 1% of the total price every month.

Now what happens in case Foo fails to pay on a certain month? Another issue with Murabahah is that if the client defaults in payment of the price at the due date, the price cannot be changed nor can penalty fees be charged. In order to deal with dishonest clients who default in payment deliberately, they should be made liable to pay compensation to the Islamic Bank for the loss suffered on account of default. Apparently, there are some controversy surrounding Murabahah. An argument that arises in Murabahah is that profit or interest both are the same and Murabahah financing is the same as conventional banking. Islamic scholars however argue that in several respects a Murabahah financing structure is quite different to an overdraft organized along conventional lines and the former offers several benefits to the bank and its customers. So the author considers Murabahah acceptable. But when he writes "Islamic scholars however argue that ..." he does not reference any scholarly work. All this has left me seriously confused once again :-( Next topic is leasing. It is very much allowed. Just note that:

Consumable items (e.g. rice, oil, etc.) cannot be leased out for obvious reasons :-)
The lessor (owner of the leased item) must own an item before (s)he can lease it out.
The rental must be determined at the time of contract for the whole period of lease.
Variable rent rate is allowed. For example, N USD for the first 3 months, N - 1 USD for the next 9 months, and N - 2 USD there of.
If the lessee contravenes any term of the agreement, the lessor has a right to terminate the lease contract unilaterally.
if there is no contraventions on the part of the lessee, the lease cannot be terminated without mutual consent.
The lessor can make a promise that the lessee will have an option to buy the leased item at the end of the lease period at a mutually agreed price.
The lessor is liable for paying any compensation if the leased item is damaged while it is at his/her disposal.
If the lessor permits the lessee for subleasing, he may sub-lease it.
The lessor can sell the leased property to a third party. However, he cannot sell the right to receive the rent only.

Now we will move to a very interesting territory which is securitization which means issuing certificates of ownership against an investment pool or business enterprise. This roughly means issuing shares.

Remember Musharakah (joint investment) ? It can be easily securitized. Every subscriber can be given a Musharakah certificate, which represents his proportionate ownership in the assets of the Musharakah, and after the project is started by acquiring substantial non-liquid assets, these Musharakah certificates can be treated as negotiable instruments and can be bought and sold in the secondary market. However, trading in these certificates is not allowed when all the assets of the Musharakah are still in liquid form (i.e. in the shape of cash or receivables or advances due from others).
whenever there is a combination of liquid and non-liquid assets, it can be sold and purchased for an amount greater than the amount of liquid assets in combination," An example - "Suppose, the Musharakah project contains 40% non-liquid assets i.e. machinery, fixtures etc. and 60% liquid assets, i.e. cash and receivables. Now, each Musharakha certificate having the face value of Rs.100/- represents Rs. 60/- worth of liquid assets, and Rs. 40/- worth of non-liquid assets. This certificate may be sold at any price more than Rs. 60. If it is sold at Rs. 110/- it will mean that Rs. 60 of the price is against Rs. 60/- contained in the certificate and Rs. 50/- is against the proportionate share in the non-liquid assets. But is will never be allowed to sell the certificate for a price of Rs. 60/- or less, because in the case of Rs. 60/- it will not set off the amount of Rs. 60, let alone the other assets.
Lease (or Ijarah) can be securitized as well. Since the lessor in Ijarah owns the leased assets, he can sell the asset, in whole or in part, to a third party who may purchase it and may replace the seller in the rights and obligations of the lessor with regard to the purchased part of the asset." But we must remember that "the Ijarah certificates are designed to represent real ownership of the leased assets, and not only a right to receive rent.

Next up is the rulings on buying shares:

Shares of companies involved in prohibitive activities (e.g. interest based lending, selling porks or wine, etc.) cannot be bought. So forget Barclays or Tesco or Walmart. Google or Apple is fine. Not sure about Amazon.
If the main business of these companies is halal, like automobiles, textile, etc. but they deposit their surplus amounts in an interest-bearing account or borrow money on interest, the share holder must express his disapproval against such dealings, preferably by raising his voice against such activities in the annual general meeting of the company.
If some income from interest-bearing accounts of non-Halal activities is included in the income of the company, the proportion of such income should not exceed 5% of the total income. Such income from the dividend should be given to charity.
total short term and long term investment in non-permissible business should not exceed 30% of the company's total market capitalization. So if the total value of Qux Plc is 9 million and they have 3.5 million stashed in a high interest bearing account with the Natwest bank, then it is not permissible to buy Qux's shares as 3.5 million is more than 30% of its total value.
The shares of a company are negotiable only if the company owns some illiquid assets. It is better if illiquid asset is more than 50% of the value.
Unit trusts (AKA mutual fund) are okay as long as it follows the Islamic rulings on buying shares (e.g. AMANX).
Fund managers can be paid a portion of the profit OR a portion of the total investment BUT not a combination of both.
There is something called the "Ijarah fund" or "Lease fund". It is a simple idea. Share holders combine their money to buy various assets and then rent them out. The rental income is the profit. Share holders can then buy/sell shares of such funds. These type of shares are called "Sukuk".
Another type of fund is "Commodity fund" (these are different from Futures contract). Here again, people pool their money to buy commodities like rice, oil, etc. The profit generated from the sale of the commodity is the income of the fund. Such funds must follow the Islamic rulings on buying/selling stuff.

The very last topic is "Limited liability". This section is written by the author's dad Justice Muhammad Taqi Usmani. Justice Usmani clearly mentions that what he has written here is solely his own view and not a consensus of Islamic scholars. So what is "Limited liability"? Say you have 10000 USD. Out of these you start a business with 4000 USD. Then the business goes down with a total debt of 20000 USD. This is definitely bad news, but if your business is covered by limited liability, the debtor cannot touch your remaining 6000 USD. This is cool. When I first heard of this, I could not believe myself :-) Most companies (AFAIK) are covered by limited liability in the West. Justice Usmani concludes that limited liability should be only granted to publicly listed companies (i.e. companies whose shares trade at the stock exchanges). The concept may also be applied to the sleeping partners of a firm and to the shareholders of a private company who take no active part in the business management. But the liability of the active partners in a partnership and active shareholder of a private company should always be unlimited.

Conclusion

Here is my summary of the summaries:

Interest on money is prohibited. Only way to increase money is to invest it.
Renting out assets (i.e. leasing) seem to be the only low risk way to make money.
Unfair clauses cannot be part of an Islamic contract.
Trading of shares is very much allowed, but there are various restrictions on which shares can be bought and sold.
Various pooled investment funds can also exist as long as they follow the Islamic rulings on investment.

I have to say that I have learned a lot from the book. So my opinion is that if you have any interest in finance and Islam, then this book is worth a read. September 2011

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