I repeat, for a purpose, the last paragraph of the previous article published on the 13th June 2018. Please take note of the underlined wording:
“The contract entered into between the Islamic bank and the customer is termed as Mudarabah (fund management contract), the customer is called ‘Rab Al Maal’, ie the owner of the funds whereas the Islamic bank is called the Mudarib or manager of the fund”.
The explanation to the underlined wording shall be clearer if we first understand a conventional bank’s treatment of a customer’s deposit. When a conventional bank’s customer completes a term deposit transaction, the customer actually sells his or her money to the bank and the bank purchases the same on a deferred contract basis.
For example, if a customer decides to place a term deposit of US$200,000 for a year at the currently prevalent 2% interest rate in a conventional bank in the UAE, he shall be selling his money worth US$200,000 to the bank at a deferred price of US$204,000 payable upon completion of the deferred sale period of one year. This is because both parties consider money as a commodity which could be bought or sold on a deferred basis at a price higher than its current value.
We know that every sale and purchase contract legally transfers the ownership and possession of the subject matter of the contract from the seller to the buyer irrespective of the payment terms. As such, the ownership of the money and its possession in the said example is transferred from the customer to the conventional bank upon completion of the placement of deposit by the customer with the bank.
Having shifted the title and possession of money to the conventional bank, the customer stands relieved from the equity risk, ie the risk of ownership of money. However, the customer will now be exposed to the credit risk of US$204,000 resulting from entering into a deferred payment contract (term deposit contract) with the bank. Having acquired the title and possession of money from the customer, the conventional bank becomes the owner of the money, giving it the right to sell the money to another person or entity, ie the bank’s borrowing customer, at a price higher than the price the bank bought at from the depositor. The borrower does not in turn lend the money to anyone but utilizes it to fulfill his or her needs. Hence, there is always a Chinese wall between the money and its application at the levels of the depositor to the bank and then the bank to the borrower. As such, the ultimate application or consumption of the depositor’s money takes place at the borrower’s level.
Assume the borrower used the funds to commence a retail garment shop which started doing well due to good quality products, courteous service and the borrower’s hard work. The positive cash flow enabled the borrower to meet the periodic installment and interest payments to the conventional bank on time. Unfortunately, after a year, a large branded boutique opened up nearby which was never in sight when the borrower planned his business. This new development adversely impacted the borrower’s cash flow, making him vulnerable to keeping up with the periodic installment and interest payments to the bank besides meeting the operating expenses of the shop.
Do you think the lender bank would give any consideration to the genuine unfavorable situation the borrower is faced with despite his innocence? No, the conventional bank would actually want the borrower to continue paying the loan installments on time irrespective of what has gone wrong with the business. In the case of a delay, the bank would apply the third layer of interest, ie the penalty interest, in addition to normal and compound interest charged in the normal course. Further delays would warrant the bank’s staff to adversely classify the loan account, start taking the accrued and unpaid interest in the suspense account instead of the profit and initiate legal action against the hapless borrower to recover the loan amount. I am quite familiar with such procedures having observed them myself while part of the conventional banking system.
Why would the conventional bank adopt such tough measures? The answer is simple. It is because the conventional bank has ‘sold’ the money to the borrower and would want him to pay the ‘sale proceeds’ irrespective of how and where the borrower applied the money and whether the borrower’s situation is genuine or not. It is also because the conventional bank is indebted to its depositors, having bought the money from them, and unless it recovers the interest and principal amount of money from the borrowers in the normal course, it will be difficult for the bank to pay the depositors. Another primary reason is that conventional banks remain solely focused on enhancing the shareholders’ value through increased interest income.
There is a possibility that conventional banks may appreciate the borrowers’ situations and agree to reschedule the loan amount; however, it is normally carried out at an exorbitant interest rate and with tougher conditions. In a nutshell, the business model of conventional banks is built around the principle of confining itself to recovering each and every penny lent along with the layers of interest to enhance shareholders’ value without giving consideration to the borrower’s genuine difficulties.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next week: We shall examine how an Islamic bank treats customers’ deposits and how it ought to react in a similar situation.