LARIBA Banking System
2 Islamic Business Ethics
3 Review of Islamic Economics
4 The Challenge
5 The Federal Reserve System of the United States
6 The Post World War II International Monetary System
7 The European Monetary Union
8 Major Features of the Islamic LARIBA Banking Policies
9 Relationship of the LARIBA Bank with Its Depositors
10 Deposits in LARIBA Banks
11 Investing the LARIBA Bank Deposits
12 The Dream: A World-wide LARIBA Banking System
LARIBA BANKING SYSTEM
THE ISLAMIC BANK
The 1980's witnessed the largest bank
failures in the history of the United States.
of the savings and loans industry along with the banking industry
itself brought about many pressures for the bank and the savings
and loans to compete.
Another parallel event was the emergence
of the money market accounts, by which checking accounts could
earn interest on their deposits.
With the high interest rates
prevailing in the early eighties, many banks and saving and loans
associations resorted to speculative lending hoping to achieve
higher returns and hence pay the money market accounts, the certificate
of deposits and savings accounts those high rates prevailing at
When the economy turned from bad to worse and with
the recessions of 1987, 1989 and 1990's many of the speculative
lending practices were exposed.
Many of the troubled banks and
savings and loans blamed the economy to be the real reason for
It is the author's belief which is based on real
life experience, consulting for and communicating with many friends
and associates in the banking industry, that the real reason for
the failure was the lack of moral responsibility on the part of
both the lender (lending officers) and the borrower.
honest businessman was deprived the opportunity of getting his/her
loan approved only to find the money going to spectaculars with
special connections to the loan officers or the bank management.
The result is well known and the damage done not only to the financial
markets but also to whole economy will take years to fix.
It is the author's belief that if communities
were to flourish again and for the economy to restructure in a
fundamental and lasting way, moral community banks should be tried
History shows that such banks (and building and loan
societies) were the real locomotives of community developments
in the U.S. out of the depression of the 1930's.
That does not
mean that the regional and large money center banks have no place
in the economy.
Indeed they would be the buyers of the community
loan portfolios developed by the community banks.
The step wise approach towards realizing
this goal is to create financial institutions which have the capacity
of circulating the community savings within the community to activate
its economy through financing projects and businesses, and in
the process creating job opportunities for the community members
The bank would be an honest-to-goodness community
development bank which makes money available for non-speculative
and economically productive schemes.
This is essentially the foundation
upon which the concepts of LARIBA (Islamic) banks are built on.
These concepts are much needed in every part of the world.
because the LARIBA system originated in the Islamic doctrine it
becomes the responsibility of the Muslim communities in America
and the West to provide a living example of such a system.
successful, it will present America and the world with an important
contribution towards the happiness and prosperity of all people,
Muslims and non-Muslims.
And the result would be a closer society
which harmonious in its relationships, fair and moral in its dealings,
and most productive because it was done right.
This book addresses the LARIBA (Islamic)
When we describe the Islamic Bank as a LARIBA
Bank, we mean the bank which follows the LARIBA Islamic system.
Many translate RIBA as interest (The word LARIBA consists of two
parts "LA" which means No and "RIBA" which
means to grow, connotating the concept of money growing just because
it is lent out regardless of the purpose of lending it.
system is a development banking system at heart).
We define LARIBA
as a system which involves the creation of money (monetary system),
the creation of credit (banking and financing) and the total economic
system (collection of Zakah, distribution of inheritance, and
most importantly savings).
The contents of the this book are based
on the author's practical experience accumulated through the start
up, organization and development of American Finance House-LARIBA
in Pasadena, California since 1987, in addition to the author's
experience in interacting, consulting and doing business with
many Islamic banks world-wide.
It is our hope that this preliminary
effort will be the beginning of a series of in-depth writings
on each of the concepts discussed in this book.
In conclusion, we ask Almighty God to
accept this effort and to forgive us any unintended errors or
misconceptions of His system, the LARIBA system of banking and
ISLAMIC BUSINESS ETHICS
Islam is the religion of submitting
our will to the will of God.
All Prophets-- Abraham, Moses, Jesus
and Mohammed (S) (ppbu-THEM)-- came to train people to
be better submittors to God's will and custodians/trustees on
God's property; i.e. earth and its resources.
THE ECONOMIC DILEMMA
Human nature, if untamed, is characterized
by selfishness and greed.
Islam focuses on training the individual
spiritually and ethically to suppress selfishness and greed and
to promote goodness.
The government is responsible for justice,
economic justice and justice in all aspects of life.
are some important concepts:
Success lies in both material achievements
and in being virtuous.
Virtue implies a positive attitude towards
life and other beings.
The results are peace of mind, contentment
and a sense of security.
The true image of success is not how
much money one has in the bank or the kind of car one drives.
Success is realizing a track record as a pious person who can
be trusted and is close to God; a person who feels for the neediest
and the poorest in the community.
Success is the progressive realization
of a worthy ideal.
The horizon of time in Islam extends
beyond this life to the life after death; i.e. the hereafter.
Wealth, power, position and affluence do not come with us to our
graves after death.
When one dies he/she leaves behind (as per
Prophet Muhammad's (S) teaching):
A family and descendants who perpetuate the laws of God
A permanent contribution which will benefit the community
A Source of income for the poor and the needy and/or to generate
job opportunities for future generations.
The globe belongs to God and it is
wide open and full of resources and opportunities.
in one location does not justify acceptance.
It is the responsibility
of everyone in particular Muslims to find another location where
freedom and human dignity are prevalent.
In doing so, a Muslim
in his/her pursuit of business, carries with him/her the way of
life of Islam.
ELEMENTS OF THE ISLAMIC ECONOMIC SYSTEM
Islam requires every individual to work
and to produce.
Prophet Muhammad (S) teaches: "Never be lazy
and helpless". There is no good in an individual who does
not want to produce and earn money.
And it is known that the unproductive
hand is an unclean impure hand.
Products should be useful and
not harmful as defined in the Qur'an and the Islamic laws (Sharia).
In its efforts to do away with classes
in the society based on wealth and affluence, and reshaping it
through distribution into an integrated society, Islam makes the
God owns wealth, power and natural resources.
The individual or
the institution is appointed by God as a trustee and custodian
to manage them.
Every being, human or not, has a minimum requirement to be able
to live in dignity.
This should be provided by the government
to anyone who cannot meet his or her own needs.
Islam respects private property and the right of ownership is
The system is paid back and balanced out through the act of Zakah
(Alms giving as an essential part of the system and faith).
this source is not enough, the Islamic government would apply
a temporary tax on the rich and affluent to balance the budget
as a religious duty (Fard Kefaya).
Zakah is spent
by the Islamic Government and distributed to the poor, the needy,
the traveller (wayfarer), administrators and to help the oppressed
indebtors to pay off their debts.
The individuals are trained to feel socially responsible for others
in the community.
He/she can not enjoy life while others cannot.
The government is responsible for the basic needs of every citizen.
These are food, shelter, clothing, education and health care.
The only road to richness and to achievement is hard work and
assumption of risk.
It is not through inheritance.
That is why
Islamic law (by a detailed description in the Holy Qur'an Chapter
4) defines exactly how the estate is distributed after death.
No one can make a will that attempts to alter the predefined distribution
In addition, if one wanted to include in his/her will a
payout to others outside what the law requires, this is limited
to a maximum of 1/3 of the total estate.
This way money is always
distributed and trickled down through the system every time it
is accumulated, not through inheritance taxes to the government
but through direct distribution to those who are entitled to it,
hence reducing government and waste.
Islam preaches moderation and a balanced
pattern of consumption.
Islam is a way of life.
is condemned as the work of satan.
Spending in the wrong way (bribery,
illegal profits and/or reckless spending) and extravagant over-consumption
of lawful matter are not allowed.
Everyone is trained to plan
for the future and to be careful.
The story of prophet Joseph
in the Holy Qur'an Chapter 12, is an important lesson in long
Goals of the Business
Maximize profits and services in a legal way to realize freedom
and independence of the individual and the society using interdependence
and interaction with other nations, communities and businesses.
Islam promotes free markets and free international trade as the
natural mechanism of getting people to know each other in order
to promote peace and prosperity through communications, trading
and mutual benefits.
Develop new and improved ways and means to improve the quality
of life and preserve the individual's most valuable asset, which
Time is life for a Muslim.
Protection of the environment
is a sacred duty of the Muslim.
Focus on a long-term view of investing in the future without speculation,
to provide long term job opportunities for generations to come.
Provide flexibility through strategic planning and training to
prevent business cycles from negatively impacting the community,
as we learn from the story of prophet Joseph in the Holy Qur'an
THE MARKET SYSTEM
Markets should be free and open to everyone provided that other
laws of the system are not violated.
Information about products, goods and services should be made
readily available, complete and known to all parties.
information is considered a part of the contract.
are punishable both in this life and in the hereafter.
is a must.
Monopoly and hoarding are strictly forbidden and prohibited.
Prices are set on the basis of supply/demand using the auction
open market system.
Speculation in commodities is strictly forbidden.
designed to bring a buyer (end user) and a seller (producer) together
to consummate a deal.
No speculation or interference with market
forces of supply and demand is allowed.
A manager is looked upon as a custodian on God's trust given to
him/her to manage.
He/she, on the other hand is considered a shepherd
of his/her employees.
He/she provides guidance, vision and care
for his/her subordinates to maximize their output, and keep the
values of the religion and system intact.
In fact prayers are
part of the system, with the manager leading the prayer or at
least pro-actively participating in it.
A manager is chosen with strict qualifications;
Excellence in professionalism and knowledge
Performance and trust over time and piety
Good interpersonal relations as guided by the ultimate example
of Prophet Mohammed (S) and all other prophets of God.
A manager/owner of the work place is required to provide employees
with maximum job security through continual training, through
optimization and through community interrelationships.
MONEY AND FINANCE
BANKING AND INVESTMENT BANKING
Money is not looked at as a commodity that commands a price, that
is called interest as in the RIBA system.
Money does not reproduce
and give birth to money.
Production and trading produce economic
Money is a means of transacting business and is used
to measure the efficiency of doing business through the use of
"rate of return on investment.".
Monetary policy is based
on actual achievement of economic growth and productivity not
on perceived future rates of growth, since the future is only
known to God.
Banks are required to operate on a 100% reserve basis; i.e. on
an all cash transaction basis.
If money is entrusted with a bank
then it is a trust and should be returned intact as is.
cannot be disposed of in the form of a facility to others without
the consent of the owner.
A service fee can be charged, however.
Investment banks provide the role of bringing the owner of capital
together with the owner of an idea or expertise to invest together
and realize long term economic growth.
The investment bankers'
role is education, evaluation, promotion and follow-up for the
benefit of long term growth not for a commission.
is to realize the Islamic goal of making capital circulate within
the community and to prevent the freezing of assets and capital.
Islam prohibits trading paper instruments, speculation and manipulation.
The objective is long term investing.
Finally, there is one underlying holistic
concept of producing income: "Halal" which means
lawful and "Haram" which means unlawful.
who eat from "Haram" unlawful sources of income
are believed to be as if eating the hell fire in his/her body
in this life and more in the hereafter.
VALUES TO ACHIEVE THE ISLAMIC BUSINESS
Professionalism is the talent of taking
power through God, the source of all powers, to love what we do,
to improve ourselves, to add to our experiences and to do the
best we can at what we promised to do.
Professionalism is making
promises that can be delivered and, if possible, delivering them
better than promised.
Professionalism is Islam at work.
the pride of doing what we know, the strength of being able to
say "we do not know", when we do not, and the determination
to try to learn more.
Concentration is the ability to focus
It speaks to you quietly above the roar of your mind.
Concentration in prayers, in Duaa'(sublication), in remembering
God, and in our work trains us to ignore the extraneous, to dismiss
the distractions, to avoid the pessimists and focusses at will.
Concentration is part of Ibada (worship).
It is clarity.
It is what keeps our emotions from getting the better of us.
keeps pressure from becoming paralysis, and keeps us away from
diluting our efforts by spreading ourselves too thin.
Concentration is what keeps our eyes
on our goals, allows us to turn reaction into action, disadvantage
into opportunity and opportunity into success.
Our goals should be crystal clear.
need to build the foundation of a world-wide LARIBA Islamic financial
system to bring the masses (Alnas) back to the basic values
of trust, humbleness, sincerity and non-wasting through the LARIBA
Consistency is unimpressed with a single
Consistency confers medals only upon those who burn brightly
with the repetition of achievement.
It is more than a promise.
It is performance over time.
Consistency means never resting,
never taking our talents, the gifts of God, for granted.
is the practical proof that we are believers in God.
Commitment is what transforms a promise
We need to promise God to build the financial infrastructure
of our communities world-wide.
Commitment is the word that speaks of
our intentions and the action which speaks louder than words.
Commitment is making the time when there is none.
coming through time after time, year after year for the whole
of our life.
Commitment is what character is made
It is the power to change.
It is the daily triumph of integrity,
of belief in God, and belief in the future over skepticism.
REVIEW OF ISLAMIC ECONOMICS**
Over the last three decades, economics
has received more attention from Muslim scholars and intellectuals
than any other discipline.
Islamic economics has matured as a
discipline and "arrived." .
It has its own journal (Journal
of Research in Islamic Economics), at least two research centers
devoted to the subject and is now being taught in economics departments
of numerous universities both in the Muslim world and in the West.
Prof. Muhammad Nejatullah Siddiqui's
highly praised survey of contemporary literature on the subject
lists some 700 works in English, Arabic and Urdu.
A more recent
work by Muhammad Arram Khan contains over 1500 citations.
banks are mushrooming in almost every Muslim state, form Sudan
to Iran, Pakistan, Bangladesh, Egypt and Malaysia.
cities have one or more Islamic banks.
There is thus good reason
to believe that Islamic economics has not only arrived, it is
here to stay.
DEFINITION OF ISLAMIC ECONOMICS
But what is Islamic economics? How does
it differ from the conventional capitalist and socialist economic
models? What are its axioms and principles? How will Islamic economics
replace the dominant economic orders in Muslim societies? One
of the first points emphasized by author after author is that
Islamic economics is not capitalism minus interest plus zakah
or socialism minus state control plus God.
It is something unique
and different and exclusive to Islam.
How unique and how different
is essentially the key issue.
S. M. Hasanuz Zaman offers the following
definition: "Islamic economics is the knowledge and application
of injunctions and rules of the Sharia (Islamic Jurisprudence)
that prevent injustice in the acquisition and disposal of material
resources in order to provide satisfaction to human beings and
enable them to perform their obligations to Allah (God) and society.
M. Akram Khan considered that "Islamic economics aims at
the study of human falah (Salvation) achieved by organizing
the resources of earth on the basis of cooperation and participation.
The role of the Sharia (Islamic Jurisprudence), the notion
of adl (justice) and falah (salvation), cooperation
and sharing are central to Islamic economic philosophy of the
total system of Islam." Siddiqui(2) sums up this
philosophy as follows:
"The key to economic philosophy
of Islam lies in man's relationship with God, His universe and
His people, i.e. other human beings, and the nature and purpose
of man's life on earth.
Man-God relationship is defined by Tawhid
(Oneness of God).
The essence of Tawhid is a total commitment
to the will of Allah (God), involving both submission and mission
to pattern human life in accordance with His will.
The will of
Allah (God) constitutes the source of value and becomes the end
of human endeavour.
Life on earth is a test, and its purpose should
be to prove successful in the test by doing Allah's (God's) will.
The entire universe with all the natural resources and powers
is made amenable to exploitation by man, though it is owned by
Allah (God) alone.
Life on earth being a test and all the provisions
available to man being in the nature of trust, man is accountable
to Allah (God) and his success in the life hereafter depends on
his performance in this life on earth."
But how is this economic ibadah
There are a host of Islamic concepts
and values which define the extent and nature of economic activity.
There are many positive values such as iqtisad(moderation),
adl(justice), ihsan (kindness par excellence), amanah
(honesty), infaq (spending to meet social obligations),
sabr (patience) and istislah (public interest).
Similarly, there are a number of values which are negative: zulm
(tyranny), bukhl (miserliness), hirs (greed), iktinaz
(hoarding of wealth) and israf (extravagance).
activity within the positive parameters is halal (allowed
and praiseworthy) and haram (prohibited and blameworthy)
which has to be moderated, production which is regulated by the
halal-haram code, and distribution which must adhere to the notion
of adl (justice).
Collectively, these values and concepts,
along with the main injunctions of the Qur'an, provide a framework
for a unique, just and contemporary economic system.
THE CHALLENGE IS IN THE APPLICATION
Islamic concepts are almost always stated
When it comes to the question of "how it is to
be done" and "what exactly needs to be done" problems
emerge and differences arise.
How can Zakah (the ritual
of alms giving) be made the cornerstone of public finance in an
Islamic society? How can brotherhood/sisterhood be promoted; and
what needs to be done to ensure equity? How can wealth be redistributed?
What needs to be done to ensure that wealth does not accumulate
in fewer and fewer hands.
What consumer goods constitute israf
(extravagance)? What types of industry would lead to economic
zulm (tyranny)? What types of technologies negate adl
(justice) and promote Ihtikaar (hoarding) of wealth? How
can Islamic injunctions on the use of land be introduced without
the use of force? What needs to be done to break the feudal structure
in Muslim society?
LARIBA ISLAMIC TERMINOLOGY, RIBA
In the early sixties when Muslim economists
were rediscovering the principles of Islamic economics, their
output was in many respects genuinely original.
The major subject
they have tried to discuss is bank interest.
They have played
around bank interest, and have come sometimes very close to thinking
that if they could avoid dealing with bank interest and introduce
another modern means to provide the same motivation in a different
way that could solve the problem.
It was a huge attempt to cast
Islamic institutions and dictates, like zakah (the ritual
of alms giving) and prohibition of interest, into RIBA economic
The dominant models guide the analysis and shape the inquiry:
everything is compared and contrasted with capitalism and socialism,
highlighting the fact that there is an underlying apologia at
Once the objectives of the LARIBA Islamic
economics have been stated in terms of RIBA paradigm, it is a
short step to accept the major institutions of the RIBA system
and try to mould them into LARIBA Islamic shapes.
The most obvious
example of this is RIBA banking: the institution as it has evolved
into the world since the industrial revolution has been accepted,
without criticism and questions whether banks, as defined and
developed over time are really needed.
While the suggested alternative for
interest, which is profit-sharing, reflects the true ideals of
LARIBA of Islam, it cannot fit in an institution which has grown
up solely on the basis of interest and RIBA.
Professor Siddiqui, describes the function
of a banking system based on "mudaraba" ***
"A large number of depositors enter
into individual 'mudaraba' contracts with a banking company,
organized on the basis of share capital, the contracts stipulating
the sharing of the profits of the 'business of banking'.
undertakes two kinds of business.
Firstly, it offers banking services
for which the bank earns fees and commissions.
Secondly, it assumes
the role of a financier-entrepreneur making judicious selection
of businessmen who seek capital from it, stipulating that they
share with the profits of their productive enterprise.
to loss in a 'mudaraba' contract attaches to the financier
only, the working party i.e. the user of the capital bears no
part of the loss accruing the capital extended by the financier.
It follows that the loss incurred by an individual entrepreneur
will be borne by the bank.
Losses incurred on individual advances
are likely to get absorbed by some of the profits accruing to
the bank from the successful entrepreneurs.
As long as the totality
of profits accruing on banks' advances plus the fees and commissions
earned by the bank remain a positive quantity, the depositors'
capital and return on capital are safe.
But what if the total
earnings of the bank is a negative quantity? This will mean a
loss, to be distributed equally on share capital and 'mudaraba'
The central question is, should the
ordinary act of depositing money become a risk-taking exercise.
How can one plan for the future if one is not sure what will happen
to one's money at the end of the financial year? And some of the
Islamic LARIBA banks as they are normally defined have no guarantee
that they will get a return on their investments.
will happen to a rural agricultural bank in a year of bad harvest
when it has invested all its capital in the labor of the local
farmers! If the financier is risking his/her capital, he/she is
likely to demand a hefty share of the profit; so the poor entrepreneur
ends up working for the bank instead of him/herself.
And if the
bank does not ask for a lion's share of the profit, how can it
ensure that it covers for all those entrepreneurs who have lost
its money? Perhaps both the bank and the entrepreneur are getting
a bad deal.
Perhaps this is why many of the Islamic banks are
losing their investments so rapidly.
The point of this valid and justified
criticism is not that the principles of "mudaraba"
do not work, but that the RIBA institution of banking is the
wrong place to put an Islamic injunction into practice.
RIBA economic institutions do not come on their own: they bring
the entire system with them.
Banking, as Alvin Toffler points
out so powerfully in his book "Third Wave," is the central
institution of the modern money system.
Accept the RIBA banks
and you accept the entire RIBA economic monetary and financial
structure and theoretical framework that comes with it.
are integrated and cannot be decoupled.
The abolition of RIBA and the collection
of Zakah are the corner-stones of the LARIBA economic system.
But the natural emphasis of a system that outlaws RIBA interest
would be to play down the role of money not to raise it as the
arch factor of the economy.
THE ROLE OF MONEY IN RIBA BANKING
Many economists and individuals are
hypnotised by money, and look only at those sectors of production
and consumption that are monetized and involve cash transactions.
The emphasis on the monetized economy has meant that Islamic economics
has equated the monetized sectors of a country with the whole
system of production, consumption and maintenance.
SUGGESTED SOLUTIONS TOWARDS
A LARIBA SYSTEM
A study by Umar Chapra on Islamic banking
and monetary system, suggests a package of reforms which includes
moderation in spending, elimination of hoarding, efficient use
of savings, responsible government spending, increase in equity
financing, reducing the powers of banks, and establishment of
"sane" stock markets.
In addition, the following institutions
Once this institutional set-up has emerged, a step-by-step transition
can be undertaken to an interest-free economy.
- A central bank,
- Commercial banks,
- Specialized credit institutions,
- Deposit insurance corporations and
- Investment audit corporation.
involves the declaration of interest as illegal, substantial increases
in equity/loan ratio of Muslim countries and communities, reform
of the tax system, mobilization of idle funds, and the gradual
conversion of interest RIBA-oriented financial institutions into
Chapra(7) clearly believes that
an important step towards a just society can be produced simply
by modifying the monetary system.
Additional emphasis should be directed
to the relationship between production and consumption, the role
or mode of production in shaping a society, the psychological
impact of the divorce-- in time, space and social distance --between
a producer and a consumer and the illusionary nature of paper
money." What is the role of theory of profit in Islam?"
"What function does macro consumption perform in Islamic
Many Muslim economists have based their
analysis on a number of metaphysical assumptions: first, that
money is to be studied like a physical commodity; second, what
needs to be done is to analyze how the money system of today actually
works; third, that monetary problems can be solved by modifying
the dominant institutions of RIBA; fourth, that the tools of modern
economics, whose cultural impact needs to be appreciated by Muslim
economists, can solve the problem of Islamic LARIBA economics;
fifth, that the economic environment is never depleted; and sixth
that the goals of the Islamic LARIBA economic system can be achieved
without changing the energy base of Muslim countries.
Many Muslim economists need to focus
on working on research directed toward producing policies that
are different from the capitalist and socialist alternatives.
If this is not done, Muslim countries will end up with the same
crisis that confronts industrialized societies.
THE AXIOMATIC ANALYSIS
If Islamic LARIBA economics, just like
Islamic science, has any meaning it is purely in the context of
Islamic society and Muslim civilization.
In this context, Islamic
LARIBA economics has to rely not just on Islamic principles and
injunctions, but must develop its own tools of thought and analysis
and its unique institutions and apply such on Muslim communities.
Islamic LARIBA economic institutions have to be rediscovered,
evolved and invented on the basis of the needs of Muslim societies
and the principles of Islam, not taken or adopted from what already
exists in the market-place.
This means that Islamic LARIBA economics
must construct a living dynamic Islamic economic system, concept
by concept, institution by institution applying Islamic junctions
such as the prohibition of RIBA and introduction of zakah
in a truly authentic manner.
More recently, however, Syed Nawab Haider
Naqvi in his "Ethics and Economics: An Islamic Synthesis"
argues that any set of axioms to be meaningful must satisfy four
criteria: they must be adequate and legitimate representations
of Islam's ethical views; they must form the smallest possible
set; the elements of the set must be internally consistent; and
the axioms must have predictive powers.
Four axioms: unity, equilibrium,
free will and responsibility were recommended.
Unity, or Tawhid,
refers not only to the unity of God, but also the unity of human
life and the healing of the "current schism between ethics
and economics." Social justice is only one component of equilibrium
which is derived from adl (justice).
Free will refers to
human freedom in the realm on worldly affairs; but free will can
also lead to the denial of unity and upset nature's equilibrium
unless man is made responsible for his/her actions.
All four concepts
are interlinked and interrelated, and cannot be isolated from
Naqvi uses his four axioms to develop the basic policy
objectives of the Islamic LARIBA economic system.
social justice, universal education, economic growth and employment
generation as the key policy objectives of Islamic LARIBA economics.
Language and concepts have a profound
impact on our thinking.
(unity), adl (justice),
istislah (public interest) and khilafah (leadership
as a vicegerent of God on earth), are all examples of the rich
reservoir of concepts to be found in the Qur'an and Sunnah (the
traditions and teachings of Prophet Muhammad (S)). It is believed
that they are not there to be ignored.
How does one, for example,
on the basis of linear logic, reconcile the idea that zakah,
which involves subtracting from one's income, can actually lead
to increase of wealth? Growth by subtraction is an idea that RIBA
economics has no understanding of.
The linear logic of RIBA economics is
reflected in the present structure of the world.
and technologically, the globe is structured as though developing
countries, including all Muslim countries, were colonies of the
Colonialism is alive and well, and many
industrialized countries are reaping its benefits.
It is believed that Islamic LARIBA economics
is not going to break this structure if it freely borrows from
On the contrary, it may become part of the structure.
Thus, all those Muslim economists who argue that we should not
hesitate to borrow the "good " and "neutral"
bits of the RIBA economic theory may be asking to be absorbed
into the dominant paradigm.
The fact is that RIBA economics, is
one vast, interlinked, value-laden, self-perpetuating system that
is taking linear logic to its ultimate conclusion.
If Islamic LARIBA economics is to move
toward the ideals, then it must develop not just its own body
of theories and models, but also its own tools and modes of logic,
thought and actual physical operation.
It must assume a civilizational
role and work towards laying the foundations and building the
structures of a muslim civilization of the future.
It has to break
the shell of an atomized discipline and become a multi-disciplinary
mode of inquiry, taking into consideration the social organizations,
the political ideals, the environmental imperatives, and scientific
and technological needs of Muslim underdeveloped societies.
Economics has to draw not just form
Muslim history, and contemporary muslim societies, but also from
a clear vision about the future.
Islamic economics has to develop
a future consciousness for the Muslims and the society at large.
The following are global trends that
spell danger for Muslim countries and the world and should be
taken in consideration:
1. The world is shrinking and becoming
more and more economically interlinked and interdependent.
only winners are the RIBA banking systems.
How to co-exist with
and/or delink from the world's economic and monetary systems must,
therefore, become a major theme of Islamic economics.
2. Electronic banking and funds transfer
systems are giving money an unparalleled and dangerous importance.
Because of the speed of electronic systems, the same amount of
money now supports five times as many transactions as before.
Thus the speeding up of money handling also increases its velocity
At a point not too distant in the future, when
the speed of transaction reaches "real time," money
will acquire a strange new status.
The velocity of the information
about money flows would lose all relationship with thermodynamic
realities of the actual system (subject to natural cycles of crops,
weather, friction, inertia, and human frailties), and the amount
of money and capital available at any point in the banking system
would tend towards infinity.
As information about the money system
become delinked from actual events, all manner of new ventures
and schemes might be initiated by false promissory notes signaling
capital availability with nothing more than an electronic impulse
over a computer terminal.
Moreover, computerization of stock markets
throughout the world has blurred the distinction between investment
The entire system is moving towards becoming
a huge worldwide gambling casino with no pretension to serving
Muslim economists must be aware of the changing
role of money and its implications for Muslim societies.
must work to diversify the basis of Islamic LARIBA economic thought
towards non-monetarist and non-fiscal areas.
3. Information itself is becoming a
Economic power in the future will be determined
by the ability to generate and having access to information.
will play the same role as energy is playing now.
LARIBA economic theory must be developed to cope with non-material
commodities like information.
4. The use of energy and other natural
resources (especially water) of a society is intrinsically tied
The globe's energy and natural resources are depleting
at a rapid rate.
Both inflation and employment are tied to the
rate of depletion of energy and natural resources.
As it becomes
more costly to extract energy and other natural resources, they
become more and more scarce, so the cost of transforming them
into usable commodities increases.
Throughout the world, the price
of basic goods and services is tied to the costs associated with
the exchange and transformation of energy.
Unemployment is the
other side of the equation: the faster conventional sources of
energy run out, more and more people become unemployed and underemployed.
Thus transformation to a renewable energy base is essential for
the future survival of the world.
5. At present, Muslim countries are
essentially consumer states relying exclusively on imported goods.
This situation is likely to get worse and the associated ill-effects
of the ever-increasing social, psychological and intellectual
distance between producers and consumers will multiply at greater
A major task of Islamic economics is to change the patterns
of consumption in Muslim societies as well as to direct production
towards directions which are more suitable to the needs of Muslim
The formidable task is to transform these ethics into
a dynamic economic system that has its individual identity with
its own institutions and methodological tools.
This system will
provide a viable, kinder and gentler alternative to the dominant
systems of RIBA economies.
6. Muslim economists, social scientists
and leaders living outside the Muslim countries in many of the
developed countries of world must carve a role for themselves
to implement the theory of Islamic LARIBA financing in their communities
in the world and try to branch out into the Muslim countries world-wide
in order to facilitate the bringing about of the dream of a world-wide
community based LARIBA financing system.
STARTING A LARIBA BANK IN A RIBA BANKING WORLD
We need to clearly differentiate between
two important approaches to the start up of a "LARIBA"
1.The establishment of a "LARIBA"
bank within a master plan of a perfect Muslim society which is
governed by a government and operating by a full fledged and complete
Islamic LARIBA financial system, and
2.The establishment of a "LARIBA"
bank which follows the Islamic LARIBA laws and which is independent
of the other parts of the society at large, in a society which
does not operate according to the Islamic laws.
assumes that the transformation to a full Islamic society governed
by Islamic laws and ethics will take time.
The first approach will result in applying
the prohibition of RIBA in the banking system in its totality.
Yet, in the second approach, the prohibition of RIBA will be applied
only to the particular LARIBA bank.
We all live in this second option.
fact, regardless of whether a government is in a Muslim land,
or non-Muslim land, most every one, with a very few exceptions,
does not apply Islamic laws in their entirety.
That is why one needs to find a format
that is legally acceptable from the point of view of Islamic law
in our efforts to establish an Islamic LARIBA bank in a world
which is not governed, in most cases, by Islamic laws.
three conditions are thought to be necessary and required to achieve
1.The LARIBA bank should not violate
the rules and laws of Islamic LARIBA banking and financing and
the spirit of Islamic economic principles.
2.The LARIBA bank should operate and
compete in all aspects of the banking business with the other
RIBA banking institutions in the community.
The LARIBA bank should
be designed to have the flexibility, operating creativity and
the financial products "manufacturing" ability to attract
customers (Muslims and non-Muslims) and to keep them.
aspire to make a clear and distinguished difference in the lives
of the citizens of the community at large.
3.The LARIBA bank should be operated
as a profitable business entity.
In particular, the LARIBA bank
should offer superior services and returns as compared to the
In addition, the LARIBA bank should play an important
role which is felt by the community at all levels, especially
at the grass roots level.
The LARIBA bank in its active effort
to serve the community will become the force behind capital accumulation
from the community and in using that capital to finance projects
and services which will make a difference in the economic well-being
of the community.
This is done through job creation for members
of the community and others outside the community.
4.The LARIBA bank should be more sensitive
to risk management than the RIBA banks.
So, in its efforts of
capital accumulation, the LARIBA bank, in its slow and gradual
effort to get established, should target a smaller percentage
of the assets and savings of the community to be used in LARIBA
It should also be made clear to the participating investors,
that because of the start-up nature of the LARIBA bank venture,
there is a risk of loosing all or part of their assets.
the other hand, it should be made clear both operationally and
to the investors that the bank will apply careful due diligence
and portfolio diversification methods and will keep enough reserves
for potential losses in order to minimize the possibility of loosing
money while paying acceptable returns on the investment.
5.The LARIBA bank should start by a
core group of shareholders who believe in the dream of having
a bank and/ or a finance company which operates according to the
They should satisfy the following requirements:
5.1 They should be hand picked to
form a homogeneous group with the same vision, dreams, social
and personal backgrounds as well as the same investment and business
5.2.They should be financially well-to-do
(but not necessarily very rich).
This will make them able to meet
any run on the LARIBA bank in case a rumor or an unexpected event
This way the LARIBA bank will always be able to meet any
requests for withdrawal of investors' deposits
5.3.They should come with a highly
diversified actual "hands-on" experience in the business
fields to be targeted for financing by the LARIBA bank.
the bank will be able to evaluate the projects by owners/experts
who are looked upon as managing their own funds and who are in
actual operational sense the "managing partners" (not
employees) of the LARIBA bank.
5.4.They should be willing to accept
no pay or low pay for their services to reduce the overhead expenses
of the LARIBA bank.
Especially, when the LARIBA bank is in its
infancy and the assets under management are still small.
6. The LARIBA bank should structure
its capital such that the core group of share holders' capital
and/or investments represent at least 50% of the total assets
This way the LARIBA bank can meet any unexpected
run on its deposits.
(As mentioned above under 5.2)
7. Deposited (investors') assets in
the LARIBA bank are looked upon as liabilities of the shareholders.
This way every shareholder/member of the board of directors and
bank management will make sure to carefully evaluate every project
to be financed by the LARIBA bank to minimize their perceived
8. Investments made by the LARIBA bank
should be shorter term in the beginning (3-5 years) to assure
enough cash flow to meet any demands for withdrawals by investors.
This section summarizes the history
of developing the most sophisticated monetary system in the world;
i.e. the American monetary system, and the policies of the U.S.
Federal Reverse Board to manage the economy in the U.S. through
monetary adjustments and interest rates on the U.S. Dollar.
5 reviews the historic development of the system, and the concept
of creation of credit in the banking system.
In an effort to shed some light on the
effect of monetary policy on inflation and the use of monetary
policy to enhance major political goals, a case study on the post
World War II international monetary system is reviewed in chapter
6. Chapter 7 review Europe's efforts to unite as a case study
for all these nations with homogeneous and converging social and
human values and with integrated market and economic potentials
on their way to realize the same dream of unity as that of Europe.
THE FEDERAL RESERVE SYSTEM OF THE UNITED STATES
The U.S. dollar has become the leading
reserve currency of the world.
Any discussion of financial and
monetary system, especially regarding the LARIBA system as compared
to the RIBA system, should be based on a clear understanding of
how the U.S. Dollar monetary policies are handled.
It is a known
fact that most world currencies are either directly pegged to
the U.S. dollar or are dependent on the U.S. dollar.
In an effort to stabilize the U.S. monetary
element of the economy and to systemize the process of money and
credit creation, the U.S. developed one of the most sophisticated
central bank systems in the world.
The system is considered
to be one of the most important pillars upon which the U.S. as
whole is built.
The following is a summary of how the system was
developed, where it derives its power from and how it operates.
MONEY CREATION IN THE U.S.
THE FEDERAL RESERVE SYSTEM
AMERICAN CURRENCY PROBLEMS BEFORE CREATION OF THE FEDERAL RESERVE
The small quantity of paper currency
that circulated in the United States' early years consisted of
the notes issued by the First (1791) and Second (1816) Banks of
the United States--two precursors of the Federal Reserve.
the Second Bank of the United States closed in 1836, the dominant
form of currency became private bank notes issued by state-chartered
commercial banks (normally redeemable on demand for gold or silver).
The U.S. did not have a uniform national
currency, and the system of state-bank issues of notes was confusing
By the 1860s, as many as 8,000 different issues
of state bank notes were circulating in the United Sates.
rarely accepted at face value notes issued by banks unknown to
During the Civil War national bank notes
were issued, and until 1913 these formed the bulk of the nation's
National bank notes were currency the government
gave to nationally chartered commercial banks for them to issue
as their own.
National bank notes grew out of the government's
need to raise money to finance the Union army.
Faced with a depleted
treasury and reluctant to raise taxes on northern industry, President
Lincoln reluctantly agreed to a plan formulated by his Secretary
of Treasury, Salmon Chase.
Under Chase's plan, the federal government
would offer a new type of banking license--a federal, or national,
A bank with a national charter would have the power to
issue a new form of currency; national bank notes.
each note issued, the bank would have to hold a somewhat larger
dollar value of government securities as collateral (a "backing"
The banks could purchase the government securities
directly from the Treasury for gold and silver; a universally
accepted money at that time.
In effect, the government would receive
money assets (gold and silver) in return for its liabilities (government
Chase's plan was embodied in the National Banking
Act of 1863.
To enhance the prospect that national
bank notes would be successful and to eliminate the competition
from notes issued by state banks, Chase also developed a tax that
Congress gradually increased until the state bank practice of
issuing currency ended.
Because national bank notes had to be
fully collateralized government securities, the nation's supply
of paper currency effectively depended on the government's debt.
The supply of currency expanded and contracted in direct response
to changes in the value of government securities in the nation's
bond markets and not in response to the needs of the economy.
When the government began repaying its Civil War debt, redeeming
and retiring securities issued in earlier years, the supply of
collateral available in the banking system
for note issuance shrank.
inelastic (incapable of adjusting to the public's changing needs
and demands), and this led to the money panics (episodes of irrational
public hoarding and runs on banks) that periodically plagued the
economy of U.S.A.
THE PYRAMID OF BANK RESERVES
The National Banking Act of 1863 specified
three tiers of reserve requirements for national banks.
"country" banks could keep some of their reserves in
cash but were required to deposit most of their reserves with
the larger "Reserve City" banks (those in the nation's
Reserve City banks had to deposit most of their
own reserves in still larger "Central Reserve City"
banks (those in the nation's money centers of New York, Chicago,
and St. Louis).
The central reserve city banks had to keep all
their reserves in vault cash.
The banking system's reserves were thus
effectively dispersed throughout the country and could not be
quickly transferred to banks in regions that might be under liquidity
Because the central reserve city banks were the ultimate
depositories of the banking systems' reserves, they were particularly
susceptible to the accumulation of pressures that often led to
A bank panic would generally begin in
the Midwest, when small banks found they did not have enough currency
on hand to pay out to farmers.
These banks would call on their
reserve city correspondents for their reserves.
The reserve city
correspondents, in turn, would call on the central reserve city
banks for their reserves.
Thus, a few central reserve city banks
were often hit by the cumulative shock to liquidity that the needs
of thousands of country banks generated.
A fundamental problem
was lack of for the banking system;
a source of guaranteed liquidity that all banks could tap when
they needed money.
THE FEDERAL RESERVE BOARD OF THE UNITED STATES OF AMERICA
The Federal Reserve power is derived
from the U.S. constitution (Article I, Section 8).
states: "Congress shall have power ... to coin money (and)
regulate the value thereof...." The Federal Reserve Act of
1913 established the Federal Reserve to realize the following
- Furnish an elastic currency which
responds to the economic meeds of the nation.
- Serve as a last resort to defend
against any run on the banking system of the nations
- Establish a more effective and
responsive system to supervise banks
- Improve the efficiency of the national
The 1946 Employment Act established
the following national goals:
These goals were expanded in 1978 when
the congress passed the Full Employment and Balanced Growth Act.
- Full employment.
- Price stability.
- Economic growth.
These are the expanded goals:
- Full employment
- Increased real income.(net of inflation)
- Balanced economic growth.
- Balanced federal budget.
- Growth in productivity.
- Improved balance of trade.
- Price stability.
The Act also required the Federal Reserve
to report to the Congress twice a year on its monetary policies
as they relate to the goals outlined in the 1978 Full Employment
and Balanced Growth Acts.
FUNCTIONS OF THE FEDERAL RESERVE
The three basic functions of the Federal
1. Implementation of Monetary Policy:
This is done through the use of three
primary control devices which are:
1.1.Setting the reserve requirements
of the banks.
1.2.Setting the discount rate at
which the Federal Reserve lends the banks.
1.3. Setting the monetary growth
or contraction through the activities of the Federal Open Market
The monetary expansion or contraction is done
through the purchase or selling of Government securities respectively.
2. Providing Payment Services for the
Like loans, check collections, currency
insurance, wire transfers, and account settlements.
3. Serving As a Bank for the Federal
3.1.Responsible for supervising and
The Federal Reserve was made as an independent
branch of the politics of governing.
3.2.Keeps U.S. Federal Government
3.3.Sells and redeems interest payment
on U.S. Government securities.
3.4.Establishes relations with foreign
central banks and foreign exchange trading world-wide.
The U.S. monetary policy,
which includes adjusting interest rate and money supply, is designed
and implemented without any political interference from the President
or the Congress.
In such a unique set up the monetary policy would
be implemented for the interest of the nation and not to promote
a certain political party, the Congress or the President.
other hand, the President of the United States and the Congress
decide on the fiscal policy of the Government which includes the
federal budget, taxes and government spending.
The Federal Reserve
structure as an independent central bank is unique among the world's
This adds to the power of the Federal Reserve
to influence the U.S. economy and to bring creditability to he
U.S. Dollar world-wide.
Structure of the Federal Reserve
The structure of the Federal Reserve
is unique among the worlds central banks.
It consist of:
The committee is composed
of a 12 member policy making committee of the Federal Reserve.
presidentially appointed Board of Governors with general responsibilities
regional Federal Reserve banks that are private institutions nominally
owned by their stockholders (commercial banks that are members
of the Federal Reserve System), and
Federal Open Market Committee (FOMC).
The 12 members consist of the 7 governors appointed by the President
and 5 regional reserve bank presidents.
The nations monetary policy
is decided at the monthly meetings of the FOMC.
The Federal Reserve banks are directed
by nine member boards of directors.
Congress again stipulated
a unique structure for those boards to insure that the selection
process does not favor bankers and allow them to become a majority
on any given Federal Reserve bank board.
The Congress, in doing
so, wanted to ensure that the views and concerns of all economic
interest groups would be expressed and heard during the development
of monetary policy.
The nine member board of directors of a Federal
Reserve bank is elected as follows:
1.Member commercial banks elect 3 members
from the banking community and 3 members from agricultural, commercial,
industrial, services, labor, and consumer communities.
2.The Federal Reserve Board of Governors
appoints three directors on its own. It also appoints the Reserve
For a detailed description of the operation
of Federal Reserve and the process used to adjust and manage interest
rates please read David H. Fridman, Essential of Banking, American
Banking Associations 1989.
The above discussion clearly indicates
that interest rates especially related to the U.S. dollar are
reflections of the way the Federal Reserve Board manages its monetary
policy in response to many other factors.
Hence; the real intention
of this section.
It is hoped that those who translate LARIBA banking
as interest free banking would understand that LARIBA banking
is much deeper in goal and fundamentally different at heart from
just waiving the word "interest" away.
CREATION OF CREDIT AND
THE MONEY MULTIPLIER OF THE U.S
"T" ACCOUNT TRACKING OF
ONE LOAN MADE BY A BANK AND THE MULTIPLE DEPOSITS IT GENERATES
"T" accounts are abstracts
of a bank's balance sheet that show only the changes in the bank's
assets and liabilities.
For the sake of simplicity, assume, in
this T-account example, that
- All the deposits created by banks stay in the banking system.
- Demand deposits are the only form in which newly created funds
- Banks lend out every available dollar.
These assumptions do not by any means
Some deposits created by banks leak out of the
banking system into non-bank financial institutions and money
Consumers and businesses typically convert
some newly acquired demand deposits into cash.
Banks do not usually
lend (or invest) every available dollar not because they do not
want to, but because the pace with which deposits flow in and
out of banks on any given day is often so rapid and the volume
so large, and the net effect of check collections so uncertain,
that only at the end of the day do banks know just how much net
funds they have to support new loans.
Nonetheless, these assumptions, abstract
as they maybe, do not distort the fundamental process by which
banks create deposits, which takes place in the following sequence
1. Assume that bank A receives a cash
deposit of $10,000 from a customer for credit to the customer's
Under Federal Reserve requirements, the bank
must hold an amount of reserves--vault cash or deposit balances
at a Federal Reserve bank--equal to a fixed percentage of its
deposits; assume 10 percent.
Thus, Bank A must hold $1,000 in
required reserves against its new $10,000 deposit and has $9,000
in excess reserves.
These excess reserves can support a new $9,000
loan and the creation of $9,000 in demand deposits entailed by
such a loan.
Cash Assets $10,000* Demand Deposits
New Loans $9,000 borrowing
* Required reserves $1,000 (10% of deposits)
2. When Bank A makes the loan, both
its assets and its liabilities will temporarily increase to $19,000,
reflecting the addition of the loan to its earning assets portfolio
and the addition of the newly created demand deposit to its total
However, as soon as the borrower uses the newly created
funds, Bank A's assets and liabilities will decline to their pre-loan
level as an inevitable result of the check collection process.
3. Assume that the borrower writes a
check for the loan amount to a manufacturing company that has
an account at Bank B.
When the borrower's $9,000 check clears,
bank A will have to transfer $9,000 of its cash assets in payment
for the check to the presenting bank (Bank B).
Bank A will also
strike the $9,000 demand deposit liability carried for the borrower
from its books.
Thus, after check clearance, Bank A has $10,000
in assets and $10,000 in liabilities.
Note, however, that the
composition of its assets has changed.
Before the loan, it had
$10,000 in cash assets, now it has $1,000 in cash assets and $9,000
in loan assets.
The $1,000 in cash assets meets the assumed 10
percent reserve requirement ratio against transaction account
BANK A BANK B
Cash Demand Cash Demand
Assets $1,000 deposit $10,000 assets $9,000a
a. Required reserves$ 900
Excess reserves $8,100
4. The $9,000 in deposit created by
Bank A is now a demand deposit on the books of bank B, increasing
that bank's liabilities.
However, Bank B also received a transfer
of $9,000 in cash assets when it received payment for the check
deposited by the manufacturing company.
Bank B, subject to the
same 10 percent reserve requirement as Bank A, must keep $900
against the deposit but can use the remaining $8,100 to support
a new loan and the creation of a new $8,100 deposit.
5. When Bank B makes the $8,100 loan
its assets and liabilities will increase initially and then decline
to their pre-loan level in response to the collection of the borrower's
Assume that the borrower writes a check for the loan amount
to pay for a corporate service and that the corporation deposits
the check in its account in Bank C.
Bank B's newly created $8,1000
will now reside as a liability in Bank C, together with the $8,100
in cash assets Bank B had to transfer in payment for the check.
BANK B BANK C
Cash Demand Cash Demand
Assets $ 900 deposit $9,000 assets $8,100a
a. Required reserves$ 810
Excess reserves $7,290
6. Bank C, in turn, will now be able
to create demand deposits equal to 90 percent of its new cash
If it does so it will give still another bank the ability
to create new deposits.
In theory, this process of bank deposit
creation can continue through hundreds of banks, generating, in
this example, a total amount of deposits on all banks' books 10
times grater than the $10,000 in cash deposits that started the
The "multiplier," or expansion coefficient,
is the reciprocal of the reserve requirement ratio.
In this example,
because the reserve requirement ratio is 10 percent, the multiplier
This simple multiplier is valid only in the context of
In the real world of banking there are separate
reserve requirements for different types and amounts of liabilities.
This multiple expansion of bank-created deposits is characteristic
of banking systems but not of individual banks.
No bank can create
deposits in any amount greater than its excess reserves.
did, it would find itself in a reserve deficiency as soon as the
borrower's check cleared.
This act violates the Federal Reserve
rules and the bank will be subject to severel federal stipulations,
controls and penalties.
THE POST WORLD WAR II INTERNATIONAL MONETARY
The Bretton Woods System
After World War II, the Western allies
led by the U.S.A. met in Bretton Woods in 1944 to agree on an
international monetary system.
The International Monetary Fund
(IMF) was established by the Bretton Woods Agreement.
The Agreement foresaw the need for occasional
adjustments in exchange rates among the various currencies of
the Western allies.
At the time, this was thought to be a seldom
used and highly exceptional emergency operation that most nations,
and especially the industrialized nations, would not have to resort
To deal with the expected post World
War II growth in international economic and trade activities,
and to facilitate it, a set of rules was laid down at an international
monetary conference in July 1944.
This is the well known Bretton
Woods Agreement, which led to the creation of the International
Monetary Fund, or IMF.
Among the stated objectives of the IMF
are the following:
1. Expansion and balanced growth of
2. Promotion of exchange rate stability
among international currencies, and
3. Shortening the duration and lessening
the degree of disequilibrium in the international balances of
payments of member countries.
So far, the only one objective that
was met was the growth of international trade.
The Balance of Payment Concept
The U.S. experiences a balance-of-payment
deficit when more U.S. dollars leave the country than enter it.
Dollars leave the country when Americans buy goods and services
abroad (import) or when they invest abroad.
Conversely, dollars enter the country
when foreigners buy U.S. made goods and services, or when foreigners
invest here in the U.S.
These are not the only causes of international
dollar flows, but they are the major ones.
Others are such as
international remittances, military and non-military grants, international
The Bretton Woods Agreement worked reasonably
well in the first few years of its existence, perhaps because
the IMF, being in its infancy, moved with caution.
By 1950, the
first signs of trouble started to appear.
From then on, the United
States persisted in accumulating balance-of-payment deficits,
with only rare and insignificant exceptions.
The question is,
how did the U.S. get away with this persistent deficit accumulation
for so long when no other nation could? The simple answer: By
convincing the creditor nations to hold the U.S. dollar itself
as a means of settling its deficit.
As the U.S. dollar continued to accumulate
in foreign central banks, it was always thought that a simple
reversal of policies could, in due time, reverse the trend.
the meantime, as long as the U.S. government adhered to its policy
of keeping its dollar pegged to gold and convertible into gold,
a run on the U.S. gold stock was not likely.
If a run on gold
were to be made, the U.S. would lose.
But so would most Western
nations, since they would be left holding U.S. monetary units
for which there was no gold backing.
As it became increasingly clear with
time, the Bretton Woods Agreement discriminated in practice in
favor of the U.S.
The U.S. assumed the role of the monopolistic
money-supplier to the world.
The purchase mechanism provided the
U.S. with foreign-made goods and/or services.
The loan mechanism
(compounded by the Euro-and Asia-dollar markets) allowed the U.S.
corporations to make capital investments abroad; i.e. to buy up
foreign companies and productive facilities or to create such
facilities on foreign soil.
In return for this accumulation
of wealth, the U.S. has done no more than run the money printing
presses a little faster.
The only way America could make U.S.
dollars available to the outside world was by incurring balance-of-payments
The greater the deficit, the greater the international
The world got hooked on the spend, spend and spend
policies to meet their ever increasing consumptive behavior and
localized war adventures.
These activities were financed indirectly
through America by using the U.S. dollar as the reserve currency
of the world through the IMF.
The fact that the pre-1971 international
monetary system favored the United States was not the only area
of friction among the leading nations of the West.
Money, at least
the so called M1-concept, is defined as: all checking account
deposits and currency in the hands of the U.S. non-bank public.
This part of the total money aggregate created by the Fed is watched
closely by them to make sure that the economy is under control.
But since the U.S. dollars held outside the U.S. either privately
or by foreign central banks, do not fall in the M1-category, the
Fed did not concern itself with the supply of dollars held abroad.
As an example, suppose the U.S.
supply is $500 billion and that some $50 billion (only 10%) wind
That would leave $450 billion at home here in the U.S.;
not enough to sustain the growth of the economy (Gross National
Product-GNP) at the previous level of $500 billion, since the
reduction in money supply to the public de-stimulates and reduces
the nation's public demand (to buy goods and services).
has what looks like a demand-induced recession on its hands.
keep the economy going in the U.S., the Federal Reserve in this
case, will count and recount the M1-(domestic) money supply, find
it short $50 billion and promptly fill the gap (that was during
the 60's and 70's; now the Fed watches the M2-supply which includes
large CD's and the M3-supply which include Eurodollar term deposits
and large deposits and money market accounts).
would solve the problem and bring back demand.
The GNP would rise,
unemployment is reduced and the problem is solved.
The question is: is it really solved?
The real question is: if America is short $50 billion, where did
the money go? And what is its impact at the new locations overseas?
It went abroad and caused inflationary pressures
In summary, by not filling the money
gap created by transfer of dollars abroad, a recession is generated
in the U.S. and on the other hand, by filling the gap, a U.S.
recession is averted but inflation is created abroad.
be the choice for the fed? The lesser of the two evils: inflate
MR. NIXON ABANDONS THE U.S. DOLLAR/GOLD PARITY
In 1971, many European officials started
realizing what was happening and they screamed foul.
Agnew (the then Vice President of the U.S.), the late Mr. John
Connally (the then U.S. secretary of the Treasury), and Mr. George
Schultz (the then Director of the U.S. office of Management and
Budget, OMB and later Mr. Reagan's secretary of state and former
chairman of Bechtel) all refused to address the problem of balancing
the U.S. balance of payments.
In short, America refused to take
The dollar continued to accumulate abroad, and the inevitable
finally took place.
During the second week of August 1971, another
run on the U.S. gold reserves was stopped by President Nixon.
On August 15, 1971, Mr. Nixon suspended the back bone of the Bretton
He declared the suspension of the convertability
of the U.S. dollar into gold.
There had been previous attacks on the
In 1965, France under President Charles de Gaulle,
converted just under $1 billion into gold.
In 1968, the dollar
was attacked again.
The "two-tier" gold market was then
created as an emergency measure.
The U.S. no longer stood ready
to exchange an ounce of gold for $35 (as per the Bretton Woods
Agreement) to just anyone.
Only foreign governments and /or central
banks were qualified for the trade.
At that time the U.S. cut
itself loose from the private international gold market, just
as it has abandoned and outlawed the private domestic gold market
The trouble was that when that gate was shut, a small
back door was left open.
Under the existing IMF rules at the time,
member governments (except Switzerland) were obliged never to
let their currency money-parity deviate by more than 1% up or
down from the IMF set fixed exchange rate relative to the U.S.
Germany, in particular, was prohibited, by agreement,
to let the price of the U.S. dollar fall.
The only option available
to the Deutsche Bank (Germany's Central Bank, which always stood
as politically independent and with a clear mandate to fight inflation)
was to buy U.S. dollars at the fixed exchange rate to support
the fixed exchange rate agreed upon by the IMF agreement.
The net result was expected.
dollars were in the hands of foreign central banks.
In the days
preceding President Nixon's new economic policy, that meant: That
these foreign central banks had access to Fort Knox's gold through
exchanging that gold for U.S. Dollars as the Bretton Woods agreement
At the time, the foreign central banks of major
European countries (many of them with American troops in some
sort on their soils) were assumed to be reasonable institutions
that would not make a run on the U.S. gold.
In early May 1971, such a private attack
on the U.S. dollar forced four countries; i.e. Germany, Holland,
Belgium and Switzerland, to buy up approximately U.S.
within a few days.
Finally, these and other smaller countries
decided they could not support the dollar any longer.
foreign money exchanges were shutdown for days.
reasoned that a wholesale conversion, in Europe, of U.S. dollars
into European currencies, which were neither wanted or needed,
This was the case of an instant inflation
on a gigantic scale made in the U.S.A. and delivered in Europe.
In addition, the Keynesian economic
policies, which advocates creating monetary liquidity by governments
to support, encourage and sustain economic growth, were advocated
in Western Europe.
This added more fuel to the raging fire of
THE NIXON MONETARY POLICY
On August 15, 1971, President Nixon
suspended the convertability of the U.S. dollar into gold.
immediate result was a joint upward floating of most major world
currencies, in relation to the U.S. dollar.
By December, 1971,
the Bretton Woods Agreement was modified.
The so-called Smithsonian
Agreement (the meeting was held at the Smithsonian Institution)
was reached among the IMF-nations.
The U.S. dollar was devalued
by increasing the price of gold from $35 to $38 an ounce.
"innovation" of the Smithsonian Agreement permitted
the IMF-nations to let their currencies fluctuate 2 1/4 % up or
down from the official price as compared to Bretton Woods' originally
established 1% bracket.
The U.S. dollar promptly fell to the floor
and stayed there.
On February 1973 (just before the October/Ramadan
-1973 war) a second devaluation of the U.S.dollar, this time
a much more pronounced one, took place.
Shortly thereafter, most
major Western nations followed the lead of Canada, Germany, Holland
and others by allowing their currencies to float against the U.S.
The introduction of the "floating exchange rates"
became an accepted fact.
As a result, and claiming that speculations
contribute to stability, the so-called- International Monetary
Exchange Market of the Chicago Mercantile Exchange was introduced.
Finally, in November 1973, the major countries agreed to "demonetize"
The participating IMF major governments agreed to sell gold
on the free market to define a fair market value for gold or indeed
for the U.S.dollar.
Thus governments were no longer required
to hold gold in reserve for the purpose of settling balance-of-payments
The IMF is now an active proponent of
fiscal and monetary controls in many of the developing countries
and the former Eastern European countries as well as the former
The IMF policies are heavily flavored by the
policies of the G-7 club of nations.
These are the U.S., England,
Japan, France, Canada, Italy and Germany.
THE EUROPEAN MONETARY
EUROPE'S ATTEMPT TO REACH
This chapter is a brief review of Europe's
efforts to unite politically.
It serves as an introduction to
a case study of a group of nations on one continent which tries
to integrate their economies, markets and ultimately political
systems into the "United States of Europe.".; It is
felt that these efforts and the experience of Europe in reaching
these goals are important lessons for those who want to see the
developing Muslim countries' economies, markets and political
We hope that this entity will be the major
force behind offering and proving the usefulness of the LARIBA
system as an alternative to the RIBA system in the world.
The European Economic Community-
After WWII, Europe was divided politically
and economically into Western Europe, dominated by the U.S., France
and England, and Eastern Europe, dominated by the (former) Soviet
Germany was split into West and East and France went along
but with subtle resentments to the new and old English speaking
masters of Western Europe (the U.S.and the U.K. ).
As the European economies developed
in the 50's and 60's, many European leaders, mainly in France
under the leadership of Mr. de Gaulle, called for a united Europe.
A 12-nation European Economic Community (EEC) was started with
its own parliament and economic integration boards of governors
including industrial and agricultural policy planning bodies.
The 12- nation EEC focused first on
reducing and/or removing trade tariffs, promoting trade amongst
Western European countries, and attempting to achieve uniform
wage policies in the EEC countries.
The U.K. policy makers never
liked the idea.
They wanted to control Europe through the financial
power house of London and to control international trade through
monetary planning and exchange rate fluctuations, all originating
from the source of world trading in currencies and many commodities;
The Fall of The Soviet Union And
The Unification of Germany
With the collapse of the Soviet Union,
and the unification of Germany into one potential major power
in Europe, the dream of uniting Europe started to gain strength.
German political leaders' vision was to see Germany regaining
its lost bid for Europe, albeit this time peacefully.
was to see Europe disengaged from the U.S.-U.K. political and
France liked the idea, and French political
leaders under the leadership of President Francios Mitterand promoted
a new system called the European Monetary Union (EMU).
The European Monetary Union- An Historic
The idea is to sweep away trade barriers
amongst the E.E.C. countries, and to stimulate economic activity.
This union idea is not new, in fact it was tried back in the year
794; the occasion, the Council of Frankfort; and the man who conceived
of this union was Charlemagne, the man who was responsible for
the stopping of the tide of Islam deep into Europe after taking
control of Spain and Southern Europe.
The military campaigns that
followed his succession in 768 had given him control of an empire
stretching from modern-day Austria to the Atlantic.
and Hitler were to emulate his reach.
Charlemagne was fascinated
by economic policy and the value of his coinage of a standard
currency called the denarius(after the Muslim dinar).
Article 5 of the proceedings of the
Council of Frankfort reads:
"As regards denarii ... you should
be fully aware of a decree that everywhere, in every city and
every trading place, the new denarii are also to be legal tender
and to be accepted by everybody.And if they bear the monogram
of our name and are of pure silver and full weight, should anyone
reject, in any place, in any transaction of purchase or sale,
he is to pay 15 soldi [roughly the price of a cart load of wheat]".
The new coins were introduced after
Charlemagne's crushing defeat of the Avars of Eastern Europe in
For the first time since Roman days, Europe's coins were
minted with uniform design though Charlemagne's bust was not to
be a regular feature until 812.
In contrast to earlier practice,
fewer than 40 mints across the empire were allowed to produce
the new coins; in 812 they were reduced to about ten.
The new money was widely adopted, as
if some European monetary system existed.
King Offa of Mercia
(a small kingdom to Charlemagne's north west) enlarged the size
and weight of his pennies broadly in line with Carolinian reforms.
Before long, others, including Pope Leo, followed suit.
It was not just the coinage that changed.
Before Charlemangne, the economy had centered on gift-giving and
Market place values had largely disappeared
with the Romans.
Charlemagne's reforms, announced at the Frankfort
Council, aimed to tip the balance back towards the market.
Some claim it was made possible by the
influx of treasures from the defeated Avars; others that the reform
coincided with the discovery of new silver mines in western France.
A more elaborate thesis is that Charlemagne obtained the silver
as a tribute from the Beneventan and Danish Kings, who were engaged
in lucrative commerce with the Abbasid Muslim traders connected
to the silver- rich court of Khalifh Harun al-Rashid in Baghdad.
More intriguing, however, than the source
of his wealth are Charlemagne's motives.
Modern French, German
and Italian politicians hark back frequently to the carolinian
All have been nurtured on the thesis of a Belgian
historian, Henri Pirenne, who contends that Charlemagne erected
the scaffolding of a medieval Europe which was quite different
from the totalitarian regimes of antiquity and which has fascinated
generations of historians, philosophers and social scientists.
After Charlemagne's standardization
of the coinage, land, already measured in monetary terms, took
on new values.
The court, the main monasteries and the aristocracy
set out to increase the size of their properties, systematically
clearing land and concluding written, long-term agreements with
tenants to develop agricultural production.
The old tribal ethics of Western Europe was slowly
eclipsed by society in which service was the paramount relationship:
service on the land; service to knights, king, or emperor; above
all services to God.
With monetary reform went a Church-led
cultural renaissance, producing books about paintings and new
styles of wall paintings, metal works and sculpture.
of the coinage, business, and the land went hand-in-hand with
this cultural renaissance.
By contrast, modern Europe's discussion
of monetary reform, with its emphasis on the harmonization of
rules rather than the promotion of cultural and social diversity,
Ironically, Charlemagnes court at Aachen
was less than 35 miles from the new locations for the latest European
Monetary Union; Maastricht.
The central question is, Can the developing
countries of the world learn from history to bring about a Union
of States, clustered in a way that homogenous enough to make a
difference in the life of their citizens?
The European Monetary Union (EMU)
and The European Exchange Rate Mechanism (ERM)
The Europeans, in an effort to establish
a new European block which can stand up to the Japanese and U.S.
economic powers, started promoting the idea of working to achieve
a unified single currency for Europe.
The idea of the "United
Europe" movement gained support and momentum when Mr. Bush,
the former President of the United States, came up with his "new
world order" foreign policy.
This new order saw the world
into larger blocks (or clusters) led by a major country in each
For example, Germany would lead Europe, Japan would lead
Asia and South East Asia, Saudi Arabia would lead the Muslim countries,
and so on.
All of these leader-countries would then be led by
the U.S.A.; the only super power of the world.
This whole vision
was rejected by the policy makers of the U.K.
They saw this as
a direct threat to the very existence and continuation of the
U.K. as the leader of Europe.
The "European Monetary Union"
was created because the European policy makers believed that the
first step towards real political unity was to stabilize exchange
rates through stabilization of monetary policy, then reaching
a unified currency for Europe.
It was towards this effort that
the European Rate Mechanism (ERM) was agreed upon in Maastricht,
Holland to become the treaty that governs the exchange rates
amongst European currencies.
The European Exchange Rate Mechanism-
The ERM was originally designed as a
multilateral system of currencies.
In theory, if one country's
currency hit its floor against another, then both governments
were meant to take remedial action.
In practice, the weak currency
countries have always been forced to raise their interest rates
to keep their exchange rates within its permitted band (2.25%
in most cases and can be up to 10% in some cases and 15% in other
cases) against the Deutsche Mark; i.e. the anchor currency stipulated
by the treaty.
This made the Deutsche Mark, officially, the anchor
currency of Europe (and not the British pound which was the anchor
currency for a long time).
The Deutsche Mark is the world second
most widely held currency after the U.S.dollar.
In 1992, some
75% of European transactions were done in Deutsche Mark.
economy is by far the biggest European economy.
It is 50% bigger
than France and accounts for more than 40% of the total output
of all ERM members.
The U.K. policy makers never liked the
It meant that the U.K. would lose London as the center
of all world financial transactions, an honor which would shift
They balked, but were forced politically to join.
In an effort to try to reestablish itself, the Bank of England
through political and currency speculation and maneuvering got
the British pound to approximately $2 per pound level.
was to justify for the British government and the rest of Europe
to reduce their interest rates to get the economy in England going
and to force the Bundesbank (Germany's Central Bank) to reduce
its interest rates hoping to fuel inflation in Germany.
refused and the British, unilaterally, reduced interest rates.
The British pound sank from $2 to approximately $1.5 per pound
in no time.
The Bank of England was required to increase its interest
rate to keep with the Maastricht agreement.
But they decided to
drop out completely.
Earlier, attacks by currency speculators
drove the Italian Lira out from the system in 1992.
Attacks in the summer of 1993 on other
currencies of the ERM (mainly the French Franc) by currency speculators
were so overwhelming that the system was, for all practical purposes,
European currencies can now float by as much as 15%.
London's nightmare, called ERM and EMU, is now out for sometime
The ERM finally was ratified in October 1993, and Frankfurt
was made the headquarters of the European Monetary Institute,
Europe's Central Bank.
In this last section, the book reviews
the practical aspects of starting up and operating a LARIBA bank.
Chapter 8 reviews the major features of the LARIBA banking policies
The relationship of the LARIBA bank with its depositors
and entrepreneurs and business persons, who would utilize the
LARIBA bank funds to invest it in the economy, is discussed in
Chapter 9. Chapter 10 discusses, in details, the process of attracting
the deposits to the LARIBA bank and the legal (Sharia) relationship
between the bank and the depositors.
It also discusses the types
of deposit services available in the LARIBA banks.
important and most crucial role of the LARIBA banks function;
i.e. its investing of the funds it accumulates, is discussed in
This chapter explains the different financing models
offered by the LARIBA bank and the portfolio management approach
that should be used by the LARIBA bank to reduce risk and realize
Finally Chapter 12 outlines the foundations
of the author's dream of a LARIBA banking system which prevails
world-wide as an alternative banking system to the RIBA system
for the benefit of mankind.
MAJOR FEATURES OF THE
LARIBA BANKING POLICIES
1. Focuses on the human contribution
as a source of income (profits) and limits income from just capital.
The LARIBA Bank emphasizes that it is an institution entrusted
with the management of capital for the purpose of economic growth
through the creation of new job opportunities.
It derives its
income for such a service as a Mudarib, (money manager
for economic growth).
The LARIBA Bank stresses the definition
of a "commission" or a "management credit"
as a remuneration for the work it does.
The LARIBA Bank objective
is to expand its profits through serving the economic growth targets
of the community.
2. Tries to maintain, as much as possible,
the role of the LARIBA Bank as an intermediary, i.e. an honest
match maker (broker) between the owners of capital (depositors/investors)
and the entrepreneur (business person).
The bank's legal status,
from an Islamic point of view, is defined on that basis as a Mudarib.
3. Stands ready to be responsible for
the outcome of this new approach to banking, i.e. The LARIBA Banking
This will present to the community at large a living aspect
of the application of the Islamic LARIBA system.
For that cause
the bank shareholders and its employees (workers and managing
partners) should be willing to accept to forgo some of the short
term higher profits and risk to ensure the success of this new
The financiers in charge of the LARIBA Bank
should approach their responsibility not only as business people
but also as dedicated and believing leaders for the purpose of
realizing a dream.
The dream is to apply and bring to life a working
Islamic LARIBA financial system, at least on a community level,
as one of the pillars of a new world order which operates according
to the Islamic principles.
This task should be looked upon as
a form of Jihad (striving)which requires sacrifices and
The real profits of the LARIBA Bank
will not only be measured in dollars and cents.
But, in addition,
the real profits will be the contributions of the bank to open
job opportunities and new businesses.
The net result would be
more economic activity, growth and affluence of the community.
4. Develops ways and means by which
the LARIBA Bank can perform its unique activities without interest.
Here, the task requires the dedicated contributions of professionals
who are well versed in Islamic knowledge and who are dedicated
Islamically, and who are, at the same time, experts in banking
operations and businesses.
These professional Muslims would act
as the fulfillers of the missing link between Islamic Sharia
(jurisprudence) and the banking business.
Creative financial products
and services development along the lines and rules of LARIBA are
going to be the key to the success of the LARIBA Banking system
in a world governed by RIBA banking system.
Three issues emerge as we attempt to
achieve the goal of developing and building a LARIBA bank.
1. How to structure the LARIBA bank
in such a way that will allow it not to charge interest on money
it pays out to those who need the money (called lending in RIBA
banking and investing in LARIBA banks)? As it is well known, the
interest on loans represents a major source of income for RIBA
2. What should be the relationship
between the LARIBA bank and its depositors and entrepreneurs who
would be in charge of using the depositors' money to invest it
on their behalf (called borrowers in RIBA banking)?
3. How will the LARIBA bank compete
with the banking services offered by RIBA banks? and what are
the alternative services which meet the demands of the community
while at the same time comply with the laws of the Islamic LARIBA
RELATIONSHIP OF THE LARIBA
BANK WITH ITS DEPOSITORS AND THE USERS OF ITS FUNDS FOR INVESTING
The LARIBA bank obtains its funds from
two main sources as compared to the RIBA bank.
Shareholders' Capital; which is
looked upon as long-term risk money by the shareholders.In addition,
the accumulated earnings of the bank, can be reinvested in the
Depositors' funds from those community
individuals and institutions who have a much lower risk tolerance
for their capital.
RIBA banks derive their funds from the
same sources outlined above.
However, a very large source of funds
for RIBA banks is the Central Bank of the country where the bank
For example, in the U.S.if the shareholders' capital
is $100 million, then this RIBA bank can create a lending ability
to lend up to 20 times that much ; i.e. $2 billion (provided that
it abides by other rules and regulations set by the Central Bank;
i.e. the Fed, in the U.S.).
This represents the most important
challenge for the growth and stability of Lariba banks in a world
which operates by Riba concepts.
It is believed that God in
the long run will bless those who commit and have small means
(as reported by the Prophet's"Hadeeth" (saying).
However, prudent planning and management are required to meet
In the RIBA banking system the RIBA
bank focuses on borrowing money at low interest rates (money market
deposits, and/or CD's) or no interest rate (checking account/demand
deposits) and then lending the money at a higher interest rate.
The spread between the interest earned by the bank on its loans
an the interest paid to depositors on their different types of
deposits represents a large portion of the profit of the RIBA
The RIBA bank derives its importance
from its capacity to accumulate capital from those who own money
but are not capable of placing it in productive investments either
because they do not have the experience and ability and/or because
they are not interested in or can afford to assuming the risk
of losing their capital.
The owners of capital are attracted
to the RIBA bank by the level of interest paid to them on their
deposits and the insurance supplied, in the U.S.A. for example,
by the Federal Deposit Insurance Corporation (FDIC) on their deposits
that are less than $100,000.
In this context the RIBA bank's legal
relationships can be broken into the following two entities:-
1. A legal relationship between the
depositors as creditors of the bank and the bank as liable to
2. A legal relationship of the bank
with the business person/entrepreneur who borrows the money to
invest it by putting it to work.
In this case, the bank is the
creditor and the business persons are liable to the bank.
This way, the bank is not legally looked
upon as an intermediary between the owners of capital and the
business person who borrows the money for a business activity.
In fact, the bank in this context has become a real principal
in two different relationships while there exists no relationship
between the owner of capital (depositors) and the real user of
capital (the borrower).
In LARIBA banking, the bank is looked
upon in a different context, this can be conceptualized as follows:-
1. If the deposits are looked upon
as deposits for Amana (trust), then the bank has no right
to dispense the Amana without the prior consent of the
Here comes the question of the effect of inflation
and the impact of it on the deposits which after a certain time
may have less purchasing power.
In fact, if the depositor wants
to keep his/her funds without employing them, as an Amana,
their deposits not only decline due to inflation but also because
they are required to pay the 2.5% Zakah on them if they
are kept unutilized for an economic investment activity of a period
of a year or more; Hawl (period/cycle).
2. If the depositors deposit their
funds with the purpose of allowing the bank to manage their money
on their behalf, then the bank enters into a relationship with
depositors as Mudarib (money manager) for the depositors.
The most important ingredient in the agreement is the level of
risk the depositor is willing to accept.
In this context, the
depositor becomes an investor.
Other ingredients of the Mudaraba
agreement (money management agreement) would be the time duration
of the investment and the distribution of profits between the
bank, Mudarib (money manger) and the owner of capital.
3. If the owner of the capital entrusts
the LARIBA bank with searching for business opportunities to invest
their capital directly (Direct Investments), then the LARIBA bank
takes on the role of an investment banker intermediary who would
work on behalf of the owner of the capital and business person
for a service fee.
Now the relationship is direct between the
owner of the capital and the business person.
The LARIBA bank's
responsibility is mainly the performance of the due diligence
to assess the business parameters of the relationship and maybe
to structure the deal financially and legally and to make sure
that it follows the tenets of Islamic financing of LARIBA.
DEPOSITS IN LARIBA BANKS
The process of depositing the money
with the LARIBA bank; i.e. entrusting the bank with it not as
an Amana (trust or in safe deposit boxes) but as an ivestment
with the LARIBA bank appointed as a Mudarib (money manager).
This deposit is called Mudaraba deposits.
The Mudaraba contract is an agreement
between the owner of the capital and the money manager Mudarib
(in this case the LARIBA bank).
The use of capital is done through
the work of the Mudarib or its designated business person.
The two entities agree on a distribution formula of the profits
of the venture in case the venture is profitable.
If there is
no profit and no loss, then the owner of capital would recover
his/her capital in full.
If there is a loss, then the owner of
capital incurs all the losses without liability to the Mudarib.
The Mudarib loses the value of time and effort put towards
investing the capital.
To encourage businessmen to assume the
risk, the Mudaraba agreement may define a minimum wage
for the Mudarib to encourage him/her to undertake the responsibility.
Of course, the underlying assumption is that the Mudarib
performs with due diligence and according to the defined articles
of the contract.
In summary, the participants of the
Mudaraba deposit transaction are:
- The Depositor: owner of capital
- The Business person: owner of the
idea or business experience; Aamil (worker or employed).
- The LARIBA bank as an intermediary
(money manager) between both sides above and as a representative
of the depositor for dispensing the funds.
DEPOSITING THE FUND IN THE LARIBA BANK
Each deposit is (theoretically) characterized
as a personal deposit owned by the depositor.
The title of the
deposit is not transferred to the bank.
That means that the LARIBA
bank can not lend it without the permission of the owner as in
the case of RIBA banks.
On the other hand, in reality, the deposits
are not kept segregated from one another except by the variation
of the projected duration of the investment and the level of risk
accepted by the owner of the deposit.
The LARIBA bank would pool
these deposits in a number of pools by the permission and consent
of the depositors.
Each depositor would own a certain fraction
of the pool which is proportional to the deposit.
The LARIBA bank would then act as an
investment banker representative (wakeel) to dispense the
funds from the pool for investment purposes.
In order to motivate the depositors
to deposit their money with the RIBA bank, these banks offer the
following motivating factors:
1. Customer deposits are guaranteed
by the bank (as long as the bank is viable), and in the U.S.>A.
deposits are insured by a federal government insurance agency,
the Federal Deposit Insurance Corporation, FDIC up to $100,000.
2. The income earned by the depositor
on his/her deposit is paid in the form of fixed and determined
3. The depositor is able to withdraw
his/her money at the end of the period or at any time.
The challenge faced by the pioneers
of LARIBA banking in a RIBA banking world is to try to come up
with creative ways and means to be able to compete with the RIBA
banks without violating the Sharia (Islamic Jurisprudence).
1. Insuring the Deposits of the LARIBA
The LARIBA bank is allowed by Sharia
point of view to guarantee the principal and promise to return
the deposits of its depositors in its totality.
In case the project
financed is not profitable, the Sharia stipulates that
the worker Aamil (businessman) who is in charge of investing
the funds can not guarantee the principal.
So, as long as the
bank was not participating in the active investing of the funds,
the bank can then guarantee the principal.
So, if the bank acts
as an intermediary between the depositors (pool owner) and the
workers (businessmen) Aamil, the bank is actually a third
party which can volunteer its guarantee to the depositors on their
2. Income on Deposits (Interest in
RIBA banks and Return on Investment in LARIBA banks).
The LARIBA bank would pay a certain
percentage of its profits to the depositors (owners of the funds
in the pool of capital).
Here comes the possibility of project
failure or losses.
This possibility is minimized to a very low
level through diversification by sector (both demography and business
activity) and through dispersion to avoid concentration of investment
risk with a particular entity.
It should be noted here that the return
on deposits should not be less than the interest paid by the RIBA
Otherwise, the depositors will fly away from the LARIBA
banks to the RIBA bank.
In fact, based on the prior operating
experience of the LARIBA bank and the opportunity expected rate
of return as guided by the competition (RIBA banks), the LARIBA
bank should give its customers and depositors an idea about the
expected return on their deposits without guarantees.
There are other risks in addition to
the major risk discussed above regarding the failure of the project.
- the risk of slower than expected economic activity,
- the risk of not investing the deposits immediately after
they have been deposited.
That is why, it may be recommended to
indicate to the depositors that a time lag may occur between the
time their deposits are made and the time these deposits get invested.
This period can be as long as two months.
However, the LARIBA
bank should commit to doing all that it can to redeploy the deposits
in the economy as soon as deposited.
3. Ability of the Time Depositors
to Cash Their Deposits on Demand
The difficulty here is in the ability
of the LARIBA bank to keep enough liquidity to pay the premature
demand of the term depositors while most of the deposits are invested
in medium and long term projects.
This issue is the most important
issue regarding the credibility of any bank.
In fact, if any bank
fails to meet the demands of its depositors, the damage done will
be serious, irreversible and may mean the closure of such bank.
In the RIBA banking system, they developed a lender of last resort;
i.e. the Central Bank.
But because the LARIBA system does not
have a lender of last resort, it is important for the LARIBA bank,
at least for now, to employ a chief financial officer who would
develop a model that is capable of projecting the cash flow of
the LARIBA bank and in the same time project the different maturities
of the different investments authorized by the bank.
should be taken in consideration:
3.1. During the start-up of the bank
(the first 10 years), the LARIBA bank should finance projects
with maturities ranging between 3 months and 3 years in the first
2 years of operation, 3 months and 5 years in the following 3
years and then 3 months and 7 years in the following 5 years.
This way, cash will always be available for unexpected withdrawals
and /or reinvestment.
3.2. The shareholders of the LARIBA
bank, should stand ready to meet any run on the bank deposits.
This in itself will make the shareholders, who are in the same
time the managing directors of the LARIBA bank, careful about
reviewing the assets/liabilities management and cash flow projections
by the chief financial officer.
3.3. The commercial entities and individuals
who seek financing from the LARIBA bank should be required to
keep a balance on deposit as an investment with the LARIBA bank,
with the bank having the right to offset it against the financing
facility (loan in RIBA banks).
This investment deposit can be
built up over time.
3.4. The LARIBA bank executive committee
should keep liquidity reserves to meet expected demands on deposits
as well as additional reserves for unexpected demands.
of such reserves can be obtained from operating experience of
the LARIBA bank.
But the most important factor here is the close
and continual contacts with every depositor, investor and entrepreneur.
If these contacts are developed to reach the level of a big family,
then projections about the demands of the members of the family
can be assessed in advance without any unpleasant surprises.
3.5 As the LARIBA banking system develops
into numerous branches and outlets, they can develop amongst themselves,
a central banking authority and a deposit protection authority
to become the "lender of last resort" ( actually supplier
of liquidity in case a run on a member LARIBA bank is experienced).
TYPES OF DEPOSITS IN THE LARIBA BANK
In order to organize the deposits/investments
(Assets/Liability) management of the LARIBA bank, it may prove
useful, based on our experience, to offer the investors the following
three categories of deposits to meet the competition offered by
1. Demand Deposits-Amana
These are deposits kept with the LARIBA
bank for safekeeping.
The money can be withdrawn on demand.
these deposits are looked upon from a jurisprudence, Sharia,
point of view as an Amana(trust), then the money cannot
A fee can be charged by the LARIBA bank for the service.
The level of the fee is left for the LARIBA bank management to
decide based upon specific condition.
The withdrawal can be conducted
by proper authorization through check writing and/or telephone(wire)
authorization providing that proper written agreements are signed.
In LARIBA banking, all relationships should be formalized in the
form of a written contract, Aqd, as prescribed and required
by the Holy Qur'an.
2. Time Deposits
To compete with the certificate of deposits
(CD's) service offered by RIBA banks, the LARIBA bank can offer
the prospective depositors various portfolios, Mahfaza
of investments with an expected maturity and expected rate of
This way the LARIBA bank financial manager can better
plan and organize his/her total portfolio.
Premature demands for
withdrawals can be met.
However, all administrative and legal
costs involved in the adjustments of the portfolio as well as
the cost of raising of the matching liquidity to meet the demand
should be charged.
In case of RIBA banks, a penalty is charged.
In case of LARIBA banks actual costs should be applied.
outline of the costs should be made clear to the depositors at
the time of making such deposits.
To compete with the Money Market Account
type of deposits offered by the RIBA bank, the LARIBA bank can
offer open ended deposits.
However, it is important to ask the
investor to indicate in writing their expectations for the need
of such deposits; i.e. time horizon of such an investment.
addition, the investment agreement should stipulate that the investor
should give the LARIBA bank enough time to meet their demand on
This can be two weeks to two months depending
on the assets of the LARIBA bank, the maturity and operating experience
of its operations and most importantly the size of the investment.
These accounts can be looked upon in
the same way as investment type deposits.
However, in this case
the objective of the savings account holder should be clearly
For example, if it is opened to save for retirement,
savings for future monthly income, saving for purchase of a home,
saving for children education, saving for pilgrimage Haj,
or saving for spending in the cause of God.
The definition of
the objectives of the savings will give the chief financial officer
of the LARIBA bank an estimate of the cash flow projections of
the bank assets and liabilities.
This will minimize the potential
negative impact of a severe run on the LARIBA bank and will make
it easier on the budgeting process regarding the kinds and investment
duration of the investments financed by the LARIBA bank.
As the picture of the different types
of deposits become better defined, the chief financial officer
of the LARIBA bank would be better equipped to budget and manage
the funds of the bank for the other side of the bank activities
and that is: investing of the bank deposits.
INVESTING THE LARIBA
As the LARIBA bank accumulates deposits,
the most important next step is to employ that capital in a productive
way to generate economic activity which in turn will generate
profit, employment opportunities and more affluence for the community.
The investments department of the LARIBA bank can be looked upon
as a finder of good investments for the purpose of enhancing the
economic well being of the community leading to its financial
The LARIBA bank investment officers (called loan
officers in RIBA banks) can be looked upon as investment bankers
and as development bankers.
In his/her capacity as an investment
banker, he/she is responsible for finding investment opportunities
for the owner of capital.
In this case he/she would match the
risk level acceptable to the owners of capital and their investment
objectives with investment opportunities available in the community.
This activity is rewarded in the form of a finders' credit.
owner of capital would enter into a direct investment agreement
with the owner of the investment idea and/or business person,
Aamil, with the LARIBA bank acting as an intermediary (broker)
and if agreeable as manger of that relationship.
In his/her capacity
as a manager of the relationship the LARIBA bank would follow-up
on the progress of the investment and the adherence of the Aamil
to the conditions of the investment agreement, and can collect
the profits due to the owner of the capital.
These and other services
would be conducted by the LARIBA bank for a service fee agreed
upon by the three parties;i.e. the owner of capital, the Aamil
and the LARIBA bank.
The LARIBA bank can also act as a trustee
on the deposited funds as well as a Mudarib of some of
the deposits (only for depositors who allow Mudaraba using
their deposits) and of the shareholders capital.
In this capacity
the LARIBA bank would realize a service fee as well as participation
in the profits/loss of the investments.
LARIBA FINANCING MODELS
1. Murabaha (Cost Plus)
In a Murabaha contract the client
would approach the LARIBA bank to finance the purchase of a certain
Because the client does not have the funds, the bank would
buy that item in response to the order of the client.
of that item transfers from the seller to the LARIBA bank.
the LARIBA bank would have another sales agreement to sell the
item to the client at a price which includes a profit element.
As a result of this sales step, the title transfers from the LARIBA
bank to the client.
The total sales price (including the LARIBA
bank's profit) would be paid back to the LARIBA bank over a period
It is important to note that the sale price agreed upon
between the LARIBA bank and the client is final.
some questions about special situations which may arise in such
1.1 How Does the LARIBA Bank Define
The LARIBA bank, in its efforts to
return an acceptable profit for its shareholders and investors,
would study the market and the competition.
One important competition
would be the RIBA banks and the products they offer for investors
For example, the interest rates paid by RIBA banks
on certificates of deposit, savings accounts and money market
And because the LARIBA bank's objective is to return
to its investors and shareholders a superior return (by 1.5-2%)
over the interest paid by RIBA banks, this will define the opportunity
rate of return expected by the owners of capital.
On the other
hand, the LARIBA bank, in its effort to enhance its credibility
with its customers, should advise its customers to shop around
for the best available financing in the market.
This way, the
LARIBA bank investment/finance committee would develop a range
for the profit to be negotiated with the customer.
bank should make it clear in its negotiations that this profit
is not of the same nature as that charged, in the form of interest,
by the RIBA banks.
It should also be noted that the LARIBA bank
officer should show the customer in dollars and cents the difference
between the customer's cost of financing using LARIBA and RIBA.
Then comes the question to the customer:
"what is your choice? You (the customer) have a choice between
RIBA and LARIBA- the final decision is yours"
1.2.What If The Customer Wants To
Accelerate His/Her Payments?
In RIBA banking, a time-value of money
Hence, if the customer wants to prepay, the time value
The customer pays less and maybe a prepayment fee.
In this case, the client can save some money.
This concept is
not accepted from a Sharia (jurisprudence) point of view
in LARIBA banking.
However, in case that happens, the LARIBA bank
may include in the sales agreement a renegotiation clause to renegotiate
the price in case of accelerated payments.
In addition, the time
spent by the finance, the accounting and legal officers, in addition
to any out of pocket expenses by the LARIBA bank should be charged.
1.3. What If The Customer Cannot
Make The Payment and Honor the Contract?
This is the very unhappy situation
in any financial institution RIBA or LARIBA.
The reason for the
customer's inability to honor his/her contract may be one of the
The customer over-extended him/herself by expanding his/her activities
and/or consumptive behavior beyond his/her means.
If this is the
case, then it is the error of the LARIBA bank which was supposed
to do an in-depth analysis of the customer's cash flow.
these situations can be specific and they vary from one customer
However, the LARIBA bank should work with the customer
and make a conscious decision as to how to help the customer meet
May be this can be achieved through prolonging
the repayment without charging any additional cost of money as
is done by RIBA banks.
The only additional charges allowed are
out of pocket expenses by the LARIBA bank, and the officers' time
incurred in restructuring the contract.
If a person who has
financed a car, for instance, repeatedly fails to make his/her
payments then the car is re-possessed.
The car is sold in the
market and if there is a credit due to the client, the money is
If there is a deficit, then the loss is LARIBA bank's
The customer is faced with an unexpected calamity like, for example
loosing his/her job.
In this case the customer is treated the
same way as in 1.3.1 above.
The LARIBA bank, out of its good will,
may decide to forgo any additional expenses and costs by donating
the LARIBA bank expenses and officers time as part of its Zakah
(Gharimoon- heavily indebted- category).
1.4 What If the Client was Found
To Have Misrepresented Facts or To Have Given Incorrect Information
This is the time when the LARIBA bank
has the right to withdraw the item financed.
The client is pursued
to the fullest by the LARIBA bank in order to recover as much
of the loss as possible.
Additionally, all out of pocket expenses
should be charged to the client.
2. Leasing (Ajara)
Here, the LARIBA Bank would own title
to the item financed.
At the request of the client, the bank would
purchase the item and lease it back to the client for a predefined
Here one needs to differentiate between
financial leases and capital leases as defined in RIBA financing.
In LARIBA financing, the lease would de defined by a certain period,
usually 3, 5 or 7 years depending on the nature of the project
or item leased.
At the end of the lease, the contract may stipulate
that the client may have the option to buy the item at fair market
value or the item would revert to the LARIBA bank to sell it in
In practical terms, the lease profitability
is defined by asking the client to shop around for competitive
leases in the market.
In most leases the LARIBA bank, because
of its lower overhead and lower loans losses, would be able to
compete and lease the item at a lower rate than what the competition
3. Lease/Purchase - Ajara/Imtilak
In this model the LARIBA bank would
enter into a joint agreement with the client to buy an item.
example the LARIBA bank would own 75% of the item and the client
25% of the item.
The lease rate is defined as the market dictates.
The 25% portion of the lease payment due to the client can be
paid to the LARIBA bank to reduce the banks equity and increase
the client's equity, such that after a certain time the client
owns the whole item.
4. Joint Venture - Musharaka (Direct
In this model the LARIBA bank or its
investment subsidiary enters into direct investment in equity
form with the other parties or clients.
Profit and/or loss would
be assigned to each joint venture according to a well defined
5. Money Management - Mudaraba
Here the LARIBA bank itself can act
as a money manager through its investment banking finance/investment
The bank can also delegate that function (as a
Wakeel) to other money managers.
The Mudaraba contract would stipulate
the responsibility of the bank as a Mudarib (money manager)
or as a Wakeel (representative with discretionary authority)
of the client to find a money manager who will meet the risk level
defined by the client and his/her other investment objectives.
Ultimately, the LARIBA bank, as it matures,
would be involved in Mudaraba business in most of its businesses.
In the Mudaraba agreement the
LARIBA bank can act in one of two capacities.
The first as a representative
on behalf of the client (depositors).
In this case it would charge
a small fee as a remuneration for its servicing the account.
other would be as an active Mudarib (money manager).
the LARIBA bank can invest its own capital along with the capital
of the clients.
Here the bank can participate in the profit/loss
through its capital participation.
However, it can also participate
in the profit realized from the client portion of the investment
according to a predetermined formula.
In case of loss, the LARIBA
bank would incur losses on its capital participation but would
not assume any of the losses due to the client, assuming that
the LARIBA bank has done its due diligence and evaluation of the
The LARIBA bank, however, can charge a service fee to
the client to pay for the cost of servicing the account.
6.Advanced Purchasing of Future Production
- Futures - Baii Salam
In this model the LARIBA bank would
come to an agreement to buy the production of an orchard, a farm
or an item like equipment or automobiles, ahead of its production
at an agreed upon price.
The money is paid in advance to the producer.
The producer, in turn, would use the money as a working capital
to purchase the basic services, pay wages and buy raw materials
necessary for the production.
In this model the bank would help
in the growth of the economy by providing the liquidity necessary
for economic growth.
THE STEP-WISE APPROACH
TO RISK MANAGEMENT FOR A LARIBA BANK
It is important here to stress the importance
of risk management for the LARIBA bank.
It should be stressed
that the credibility and performance of the LARIBA bank are not
only professional duties but also an Islamic requirement.
simple fact is that a LARIBA bank should not be allowed to fail
or loose people's money.
If that happens, then the dream will
die for the next 3 to 4 generations.
We simply cannot and should
not allow this to happen.
Areas of risk management are:
- LARIBA model used in the financing.
- Diversification by client
- Diversification by sector
- Diversification by geographic location
1. Risk Management By Applying The
Proper LARIBA Financing Model
As indicated above, Murabaha
(cost plus) represents the least risky of the LARIBA financing
It is true that the profitability may be limited, and that
the Murabaha model itself is not accepted by some quarters
in the LARIBA financing field, but it offers a lowest risk type
The risk grows as we move from Murabaha and
then to Baii Salam.
It is recommended that the LARIBA bank,
in its infancy (first 5-7 years of operation) uses Murabaha
and Ajara leasing as its primary models of financing with
the intention of slowly moving forward to joint venturing (Musharaka),
and Baii Salam (futures contract).
During these first 5-7
years, the LARIBA bank management should set aside sufficient
reserves to allow it to progress towards the other forms of LARIBA
This way, the risk is minimized.
2. Risk Management Through Diversification
Here, the LARIBA bank management should
do its best to spread its financing activity throughout the community
without concentrating the financing into a small number of already
successful business persons.
This way the LARIBA bank activity
would be dispersed throughout the community which may result in
more clients on the investment side.
On the other hand, the probability
of failure is distributed over a larger number of clients.
3. Risk Management Through Diversification
This is what will create the unique
character of the LARIBA bank.
It is advisable to recruit a viable
board of directors for the LARIBA bank which represents the business
sectors to be financed by the bank.
It is also important that
the LARIBA bank, through its analysis of the economic activity
as well as political, financial and monetary developments, formulates
an investment position on a quarterly basis.
In this analysis
attractive sectors should be identified as well as non-attractive
This way the Credit Policies Committee of the LARIBA
bank would devise an investment "pie" allocating how
much of its funds should be invested in each sector.
would be dynamic and would change as the economic projections
4. Risk Management Through Diversification
By Geographic Location
A close watch should be exercised by
the LARIBA bank on the locations which it is interested in.
example, if one is in the U.S.>, risk factors should be assessed
for different states and major cities to allocate how much of
the capital should be allocated in each location based on that
If the bank is investing world-wide then the allocation
would be by country and on the basis of the risk-reward of investing
in that country.
THE DREAM: A WORLD-WIDE
LARIBA BANKING SYSTEM
Our dream is to establish a world-wide
LARIBA banking system which will be the driving force behind the
economic growth of the community, its political and financial
affluence and most importantly the integration of the markets
Our dream is to establish a small size
($5-20 million) LARIBA bank in each community.
For example, in
the U.S. , it should be in every city.
Then a state LARIBA bank
would be the integrator of all these small community LARIBA banks.
Then a U.S.LARIBA Bank which will include all the LARIBA banks.
The state and country banks would become the "lenders of
last resort" which could rescue any of the smaller community
LARIBA banks in case it experiences a run on its reserves.
many country LARIBA banks would integrate into a world LARIBA
bank which would eventually be the super LARIBA bank of the World.
Such a structure would provide the syndication
power to finance any size project, the networking powers of worldwide
synergism of industrial, agricultural and educational development
It is true that this may be an ambitious
However, we need to plan for the next 100 years.
way of doing this is to start a successful, proven model in our
community which will train the youths in LARIBA banking and create
a new generation of highly qualified international LARIBA bankers
who would be the new "anchor" persons to run the new
LARIBA banks in new communities and countries world-wide.