Understanding Islamic Finance - Doha Academy of Tertiary Studies

94 Understanding Islamic Financeit may not be harmful for the financial and payment systems. Abolition of interest will, to alarge extent, curtail the harmful features of the creation of credit by banks. They argue thatthe crucial question with regard to causation of trade cycles is related to the role of interestin such a credit system and not credit creation as such. Under an interest-based system, theentrepreneur has to aim at a rate of profit which may be three times as high as the rateof interest or even higher. This high pitching of profits forces him to either raise the priceof the product or lower the wages of labour. Whatever proportion is assigned to either ofthe alternatives, effective demand is slashed. The remedy suggested by these economistsrecommends reshaping the credit structure so that loans cease to command any interest andprofits get reduced to the level where they pay only for the labour of the enterprise.Under a Shirkah-based, interest-free system, it should not be difficult to conclude thatpossibilities for overexpansion will be sufficiently limited, especially as the liability to losseswill attach to the banking system – the creator of credit. The relationship of an Islamic bankwith its clients is that of a partner, investor or trader, and not of a creditor or debtor, as in aconventional bank. Islam lays stress on equitable sharing of profit and loss between capitaland enterprise that should be by mutual consent. Working along these lines, the Islamiccommercial banks will be creating credit as their counterparts do in the present system.Creation of credit by the banks depends on the public habit of keeping their income andsavings in the form of bank deposits and making the most of their payments through cheques.This enables the bank to meet public demand for cash by keeping a fractional reserve againsttheir deposits. The overall volume of credit fluctuates as banks’ cash reserves change dueto changes in the public demand for cash or the central bank’s policies. 194.7.4 Currency Rate Fluctuation and Settlement of DebtsIFIs create debts/receivables by way of trade and leasing-based modes. What impact inflationhas on their receivables is an area of important discussion. Before deliberating upon theSharī´ah position of linking the debts with any money or a commodity, it is pertinent toobserve that, even in conventional finance, indexation is not normally used to make upthe loss occurring due to inflation. Conventional institutions rather make a provision for afloating rate in the agreements, keeping in mind the future inflationary pressures. As such,any new rate is applied on the remaining period, while it does not affect the liability alreadyaccrued.Islamic banks are not allowed as a rule to link any debt or receivable for the purposeof indexation. In certain modes/products, however, they are allowed to stipulate a floatingor variable rate. But this does not affect any debt liability already created. For example,in Ijarah, Islamic banks can charge rental at a higher rate, if already provided for in theagreement, for any remaining period of the lease; but the rentals for a particular period onceaccrued cannot be indexed.The issue of indexation will be deliberated upon in detail in Chapter 7. Here, we shallgive only a brief overview of the Sharī´ah position on indexation. The clear injunctions ofthe Holy Qur’ān and Sunnah reveal that if the financial contribution takes the form of a loanor a debt, it is to be paid back exactly in the same kind and quantity, irrespective of anychange in the value of the concerned currency or price of the commodity lent or borrowed,19 For further details on various aspects of money see Chapra, 1985, pp. 195–208; Al Jarhi, 1983; Choudhury, 1997, pp. 71–103,286–291.