In the modern economy, banks provide short and long term financing to consumers and businesses and charge pre-determined fixed interest in a loan contract. Sometimes, the loan amount is used by the borrower to purchase an asset, pay outstanding liabilities or do investment in business. From the perspective of the bank, it does not make a difference in the contract structure in terms of pricing and in terms of accounting and legal treatment of the contract.
Javed Ahmed Ghamidi in recent times has argued that in corporate financing, banks actually provide commercial financing as a sleeping partner. The relationship between client and bank is that of active and sleeping partner. Javed Ahmed Ghamidi contends that there is no issue if the bank shares in profit, but does not share in loss. He also thinks that since actual calculation of profit can be tedious and become contentious, it is not against any Islamic principle to agree on a pre-determined profit sharing ratio which can be decided either as a ratio of actual profits or as a ratio of principal amount. He calls this structure principal secured financing. According to Javed Ahmed Ghamidi, it is not necessary to share in both profit and loss in investment. Rather, asking the financier as a sleeping partner to share in loss is unfair to him because he is not involved in decision-making. So, the responsibility to share in the loss must not be imposed on him.
In response to this point of view, some submissions are made. From some narrations, the principle of al-Ghanum bil-Ghurm and al-Kharaj bil-Zaman is derived in Islamic jurisprudence.
It is incorrect to think that since even in a loan agreement, the lender does not take responsibility for the loss, then in an investment agreement (such as Mudarabah and Musharakah), the investor can be declared absolved from the responsibility to share in loss as well. It must be noted that in interest-based loans, the lender shares neither in the profit nor in the loss and hence, he is guaranteed to receive the original principal amount back.
It is also incorrect to say that the responsibility for the loss should not be imposed because the investor does not have a choice in decision-making. There can be many reasons for loss which are not within the control of any individual. The systematic risk (i.e. market risk) is unavoidable and it is this risk which the entrepreneur takes. Islamic finance scholars explain that in place of lending for interest, the Islamic alternative is risk-based enterprise. It is this feature which makes a distinction between risk-based trading enterprise and lending for interest. This has been beautifully explained by Maulana Amin Ahsan Islahi. In Tadabbur-e-Quran, Maulana Amin Ahsan Islahi writes:
“A trader invests his capital in a trade which is in demand from the people. He makes his merchandise available to people through hard work and by taking a lot of risk. These people, in the first place, were not in a position to procure this merchandise themselves, and if they were able to, then it was only at a heavy cost. Moreover, a trader spews his capital in the open market for competition and his profit is determined by the low and high trends of the market itself. He may end up losing all his money due to these trends and he may be able to make some profit. So his hands are tied in this enterprise as he cannot earn a single penny of profit in selling his merchandise until his invested capital enters the market after being exposed to the risks and fluctuations of the market forces and after once again providing service to society. So how can the enterprise of a trader, who takes risk and provides service to the society when he invests his capital, be compared to that of an interest devourer whose enterprise is mean, callous, cowardly and hostile to humanity in its very nature. He is a person who is not willing to take the slightest risk with his capital but is very eager to extort profit.”
Furthermore, there is no restriction in Musharakah for the investor to also take part in the decision-making. Corporations are working on the principle of profit and loss sharing and many large and profitable corporations do not even need to borrow money from banks on interest in addition to their shareholders and their accumulated profits from the past. Corporations source equity finance from the equity markets wherein there is no guarantee of profit or capital protection to the investors. Yet, majority of corporations are able to source capital from shareholders with ease. In fact, often times, the issue of shares is oversubscribed. Shareholders do not directly participate in the management of the business. However, they are still not given nor do they expect any guarantee of the investment capital.
Javed Ahmed Ghamidi also thinks that if loss occurs consistently, then the bank and the client can mutually decide the next course of action later. This kind of a casual structuring of relationship is not only impractical, but also susceptible to uncertainty and disputes.
There is a very reasonable principle in Islamic jurisprudence that partners in a business undertaking shall share in both profit and loss. They can decide profit sharing ratio where the ratio is applied to actual profits. The proposal to allow profit sharing ratio as a ratio of investment capital and where the actual distribution of returns is guaranteed and not related to the actual profits is simply interest on capital for all practical purposes. In Islamic jurisprudence, loss is shared only up to the value of one’s investment. Hence, it is erroneous to think of it as injustice to the financier to bear the loss limited to the investment at maximum while also having the opportunity to share in actual profits as per the profit-sharing ratio.
Javed Ahmed Ghamidi thinks that businesses may overstate losses and this will be injustice to the investors. However, if a business continuously shows losses to avoid less profit sharing to the investors, it will close the doors of investment for it in the future. That is why, it is not the case that due to this fear, no company gets capital from the stock market without guaranteeing profit.
As a matter of fact, Javed Ahmed Ghamidi is looking at these financing matters in a personal sphere here. In Musharakah and Mudarabah, profit sharing has been made necessary and that too according to a mutually agreed profit distribution ratio. On the other hand, corporations are not even bound to give profit at all. Still, they get investment and banks generally try to give loans to these corporations instead of giving loans to individuals. In this regard, it is incorrect to infer that since participation in profit and loss is not acceptable to the investor, the principle of participation in loss should be abolished for the investor and a fixed profit-sharing arrangement be introduced in which pre-determined profit rate can be used as a ratio of investment capital.
According to Javed Ahmed Ghamidi, not only there is no need to share in loss as sleeping partner, but also there is no need to calculate the actual level of profit. Rather, money can be invested without taking responsibility for loss on the condition that a fixed pre-agreed profit is received every period which can be a ratio of investment amount. He says that any condition or clause can be placed in the contracts with mutual consent. Therefore, if a fixed profit is agreed upon by mutual consent after making an estimate, there is no harm in it.
It must be noted that mere consent is not enough to insert a condition in a transaction. Nothing invalid or illegal can be done by mutual consent. Profit cannot be fixed for a partner that he will definitely get a fixed rate of profit on his investment, regardless of how much the actual profit is, or even if there is loss.
Javed Ahmed Ghamidi also does not mention the condition that the distribution of the estimated profit should be adjusted later according to the actual profit as per the calculation. From his words, it seems that there is no need for this adjustment because there are chances of differences arising in this again as to how much was the actual level of profit.
So, the gist of his assertion is that a person can demand a fixed profit every period as a ratio of investment capital on the basis of an estimate without taking any responsibility for any loss in investment. Is this not similar to interest where the lender receives fixed amount as interest which is regardless of the level of actual profits and there is guarantee of principal amount.
Javed Ahmed Ghamidi’s suggestion that if the business closes, only the original capital should be demanded is just a proposed method of bankruptcy. This does not remove the similarity of the matter to interest.
It is also not correct to say that the review that a bank carries out for the examination of creditworthiness of the client and his business is the same review that an equity partner carries out while examining a business. The bank examines only to ensure the collection of its money with interest. Generally, all this examination is done once before granting a loan. In the light of this review, the amount, term and interest rate are determined according to the credit score. It is
not right to consider this whole process as like an equity partner analyzing the business as riskbased enterprise. Bank is largely interested in liquidity indicators to ensure that its loan amount is secure. The analysis by the bank adds absolutely no value to the client’s business.
It is surprising to note that this creditworthiness check as a lender is used by Javed Ahmed Ghamidi to justify modern day banking on the premise of Mudarabah. Not even Islamic banks at the moment are using the Mudarabah in financing considering it as riskier as compared to other product structures. Javed Ahmed Ghamidi is advocating to justify modern day interest-based banking by using the analogy of Mudarabah. In Mudarabah, the investment partner bears the entire financial loss. It is incorrect to use the analogy of Mudarabah to justify the modern-day banking interest.
Banks provide money loans at pre-determined interest rates. This is confirmed by all legal, accounting and auditing procedures and documentation. This is what they advertise and offer as a product. Therefore, it is incorrect to put forward an uncalled for advocacy for conventional interest based banking by misunderstanding and incorrect analogy of sleeping partner and Mudarabah.
In support of his view, Javed Ahmed Ghamidi cited Maulana Waheeduddin Khan, who had made a similarly casual and passing remark about banking in his book Fikr-e-Islami. In contrast, there exists a broad consensus among scholars, fiqh academies, dar al-ifta institutions, and Shariah boards at the bank, central bank, and national levels. This consensus is reflected in the Shariah and governance standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the Islamic Financial Services Board (IFSB), and various other regulatory bodies. It is inappropriate to overlook the extensive body of existing literature, institutional developments, and even the basic workings of the banking and financial system when presenting views on such matters.