Is Islamic banking \\\'fraud\\\'?

Finance Minister Abul Maal Abdul Muhith recently dubbed Islamic banking as "fraud".  He, however, did not explain what he meant by "fraud" and why he thought so. Well, Islamic banking is not "fraud."
Let's first acknowledge that the Qur'an has explicitly and categorically prohibited 'riba'. That the Qur'an has declared riba 'haram' and that interest in all its form is riba have been the basis for what has emerged as Islamic banking and finance. With respect to Islamic banking there is a spectrum of viewpoints.
First, those who consider Islamic banking as Islamic are the vanguards and patrons of this niche industry. They do uphold the riba-interest equation and believe that they have succeeded in coming up with products and services that essentially avoid the major prohibitions (riba - interest; gharar - excessive uncertainty; maisir - gambling, etc.)
Second, there is a group among the religious establishments that believes that Islamic banking is un-Islamic. This group does agree with the first group that interest is 'haram', but believes that contemporary Islamic banking is merely a concoction or legalistic exercise to replicate the interest-based, conventional banking, and fails to avoid riba in substance.
Third, there is a smaller group that considers Islamic banking un-Islamic, because the very concept of banking is un-Islamic and in their view there cannot be an 'Islamic' banking. This group agrees with the first and second group in terms of the riba-interest equation, but believes that banking concept is incompatible with Islam and furthermore, the banking system based on fiat money renders Islamic banking unacceptable.
Fourth, there are those who believe that while riba is categorically 'haram', interest should not be blanketly equated with riba. In their view, the modern banking interest is not the riba prohibited in the Qur'an and Sunnah. One of the most prominent Islamic establishments that holds this view is the Al-Azhar of Egypt.
However, there are some serious issues regarding credibility of Islamic banking and its Islamicness as well as about the issue of riba-interest equation:
First, most common people do not understand and are not able to differentiate between conventional and Islamic banks. They basically see that interest rate is being replaced with 'profit' rate, but nonetheless, it is similar fixed rate, quasi-fixed rate or rates that are equivalent of or benchmarked to conventional, 'haram' interest rate. They have known that loans can only be 'qard hasan' (a benevolent loan without any return accruing to the lender), but now Islamic banks offer loans (from which they earn return or profit). There is rationalisation of these aspects from the advocates of Islamic finance, but the majority of Muslims either do not care about these aspects or they are simply not convinced about the Islamicness of contemporary Islamic banking.
Second, the contemporary Islamic banking is inseparable from the interest-based global economy and system. It should be common knowledge that Islamic finance does not have any separate mechanism or basis for valuation or pricing. That's why Islamic banking products and services are benchmarked to 'haram' interest rates, such as London Interbank Offering Rate (LIBOR). The Shariah experts have given 'fatwa' that such interest-based benchmarking is okay. They do have rationalisation. However, one can raise the question: Can Islamic finance industry do pricing or valuation without referring or benchmarking to LIBOR, which has to be considered 'haram'   itself by the very same riba-interest equation that the advocates of Islamic finance uphold? The answer clearly, until today, is negative. This means that if the conventional world suddenly abolishes LIBOR or similar 'haram' benchmark rates, Islamic finance would become inoperable. Critics do observe and point out that Islamic finance, which is based on considering interest as 'haram', is dependent on the existence and service of the same 'haram'. Some might go beyond characterising this as misleading, and rather view this as hypocrisy. Even a commoner would have difficulty understanding how Islamic banking can be benchmarked to and dependent on something that is regarded as 'haram'.
Third, many Muslims find Islamic banking to be far removed from their lives. In some countries, including in Bangladesh, Islamic banks, led by Islami Bank Bangladesh Limited, has set good example of serving the society and with transparency. However, globally speaking, there is no strong link of Islamic financial institutions to broader development.
Is the industry helping the respective society and country to help increase employment opportunities, to raise income and standard of living, or to reduce poverty, inequality and concentration of wealth? The answer is unclear at best. The reason behind this disconnect is partly and importantly because Islamic banking is simply a micro-juristic exercise at the contract or transaction level. Financial institutions are part of a financial system. Islamic financial institutions do not exist and operate as part of an Islamic financial system. A financial system is part of an economic system. Islamic financial institutions lack the environment of an Islamic economic system. In some ways, without having an economic and financial system that is based on Islamic norms and parameters, Islamic banking has emerged like cart before the horse.
Fourth, if Islamic banking and finance has some unique Shariah aspects, how do interest-based, conventional banks are among the vanguards and patrons of this niche? Commonly it is mentioned that the engagement of the conventional banks serves as the validation of Islamic banking as a viable and genuine alternative to conventional banking. However, conventional banks definitely do not view Islamic banking as something useful or valuable enough to offer the products in their respective home countries or conventional clients. They do not believe that this is something better than or different to what they offer. That's why they merely operate in the Muslim-majority countries, enthusiastically making legalistic accommodations at the contract level.
Fifth, some of the 'fatwas' have added to the confusion among the common Muslims. In regard to interest (read: riba), it is argued that interest is 'haram' whether the rate is lower or higher, whether interest-based return is small or large. However, in screening for Islamic securities, Shariah experts have issued the 'fatwa' that companies that have interest-income no more than one-third of its total income are shariah-compliant for inclusion in an Islamic portfolio. There is rationalisation, but if interest is 'haram', small or large, how can one-third threshold be 'halalised'?
Sixth, many key Islamic finance products and the institutional mechanisms are contrived. The essence of Islamic finance is avoidance of interest-based products and services. To accomplish this, except traditional loans as part of conventional financial intermediation, Islamic banks resort to contracts that are sale- or lease-based. Currently, murabaha (mark-up pricing) is the disproportionately large component of the portfolios of Islamic financial institutions.
One of the precepts of Islamic finance is that transactions must be asset-backed. That's why when someone needs a loan, it cannot be similar to the conventional bank. To synthesise such loan, the bank will engage in an artificial, redundant sales transaction involving an item (that the borrower does not want or need). This is 'hiyal' or legal ruse. Indeed, banks generally are not merchants. To act like a merchant, while it actually is not, adds inefficiency, complexity and costs than its conventional counterpart. But this is needed, because bank interest is blanketly equated with 'riba', so a loan cannot be made commercially without engaging in such artificial sales transactions.
Conventional banks with Islamic operations do not mind engaging in such legal ruses, because they are in a premium market based on shariah-arbitrage. The fact of the matter is that the classical Islamic scholars did not treat or view 'murabaha' as a contract with financing component, and during the time of the Prophet or the companions, we are not aware of any such transactions based on ruses, where loans were given through contrived sales transactions to earn "profit". If the Finance Minister had this kind of ruses in mind, even then it can't be considered "fraud", because, as interest has been equated with 'riba', such contracts and transactions are a sort of creative solutions to avoid the prohibition of 'riba', and also that these matters are fully and adequately disclosed. Anyone who does not consider Islamic banking services to be shariah-compliant does not need to deal with it.
However, the legally contrived transactions and contracts of Islamic banks can be considered misleading or misrepresentation of the imperatives of Islam, because ultimately if we are synthesising "loans", then doing it through an artificial, redundant sales transaction does not make the loan something else, which even the conventional banks with Islamic operations understand quite well and are reaping premium profits from it.
These and many other reasons contribute to the scepticism and criticism about Islamic banking and finance. But to refer to Islamic banking and finance as 'fraud' is simply unwarranted, as it is rooted in a sincere traditional position about 'riba'-interest equation. So, the crux of the issue is whether interest is 'riba'. If it is, then all discussions about the subject are futile and irrelevant. That's the way the proponents of the Islamic banking and finance as well as those who hold the orthodox position of 'riba'-interest equation feel. However, if the view is that not all interest is 'riba', then the matter is different.
So, is interest 'riba' or not? Unfortunately, the answer is not so simple. If the traditional definition of 'riba' as "stipulated excess without any counter-value" is correct, then the traditional position is right and we are stuck with a situation that the conventional counterpart does not find or view anything substantively different from their own, while we must have the 'haram' interest-based benchmark to depend on to run our operations and come up with products and services that are mostly contrived. If interest is not always 'riba' (that's the non-equivalence view about 'riba' and interest), then the scope of discussion becomes more relevant. There is position of a leading group of ulama that interest is not always 'riba'. Unfortunately, that position is often summarily dismissed.
Contemporary Islamic banking and finance has emerged as a creative enterprise to come up with products and services that are shariah-compliant (read: avoidance of major prohibitions) as legalistic alternatives to conventional, 'haram' interest-based products and services. (The article has been abridged.)
Dr. Mohammad Omar Farooq is an associate professor of economics
and finance in Bahrain and former head of the Centre for Islamic Finance, Bahrain Institute of
Banking and Finance.
 farooqm59@yahoo.com