INTEREST-FREE LOANING
THE NEED, METHOD, AND BENEFITS

Capitalist system, though exploitative, has played a major role in the enormous industrial and agricultural development by providing finance for production and trade freely and widely on the basis of interest which is strictly prohibited in Islam. Quraanic command to believers to give up interest and warning of war from Allah and His Rasool saws against those who do not abide make it absolutely clear that what is required of Muslims is to eliminate interest instantly in one stroke and not in stages. It is a gross misconception that Shariah laws were implemented gradually. Our Prophet Muhammad saws enforced each and every Divine Command immediately upon revelation. Divine laws are all for the good of humanity and are enforceable at all times and in all circumstances. Hence an instrument for advancing interest-free loans freely and widely for production and trade must be available in Islamic financial system which aims at fulfilling the needs of all sectors of society. Zakaat caters for the poor and disabled. Qard hasan (Interest-free loaning) caters for the affluent needing funds on loan for production, trade and consumption. It is utterly wrong notion that Qard hasan is not meant for development financing. Islam encourages widespread use of Qard hasan for need fulfillment as according to a saying of our Prophet Muhammad saws the reward for lending is eighteen times and for charity it is ten times. Only those who do not repay loans are severely reprimanded. Late Shaikh Mahmud Ahmad, the most outstanding Islamic economist and research scholar of Pakistan, devised an Islamic financial instrument for interest-free lending based on Qard hasan and named it Time Multiple Counter Loan – TMCL.

A TMCL transaction between two parties comprises two simultaneously exchanged interest-free loans such that the multiple of the amount and period of one loan equals the multiple of the amount and period of the other loan. It facilitates interest-free loaning of large sums against counter-loans of smaller sums advanced for proportionately longer periods. For example an entrepreneur requiring a loan of $10.0 Million for one year can get interest-free loan of $10.0 Million (against collateral as usual) for one year by advancing an interest-free counter loan of $1.0 Million to the bank for 10 years. Thus TMCL fulfills the client’s need of funds for the required period and also enables the bank to earn profit from long term investment of counter-loan money. Whatever gain or loss the bank earns comes from investment of counter-loan amounts which are actually borrowed sums and in Islam there is no bar on earning profit by investing borrowed sums. In interest-based loaning the lender always gains because he earns interest whereas the borrower may gain or lose from investment of the borrowed sum. Therefore interest-based loaning is inequitable and unjust. In TMCL transaction none of the two parties is a definite gainer and each one of them may gain or lose by investing the loan taken from the other party. Hence TMCL transaction is equitable and just. In TMCL transaction each party does good to the other party and as such TMCL-based loaning conforms with the Quraanic precept Hal jaza-ul-ihsaan illa al-ihsaan and the noble teaching of our Prophet saws that a favour done to any one should be reciprocated.

As TMCL can perform Islamically all legitimate financial intermediation functions which are performed by interest, it can instantly and effectively replace interest without any disruption in the banking system. After switching over to TMCL-based loaning system the banks will continue to function as usual with the basic change that no interest will be paid or charged. All loans will be advanced against counter-loans and all transactions involving credit will be executed on TMCL-basis. Banks will continue to receive deposits and issue cheque books as usual. Account holders will have the option to keep their money in investment or demand deposit accounts. Investment account holders will share profit/loss with the bank on daily product basis. Banks will earn profits by investing counter-loan amounts and surplus deposits in Shariah-compliant modes like stock exchange, real property, musharakah, mudarabah, etc. Outstanding interest-based loans will be converted into TMCL-based transactions. Each borrower will repay only the principal amount of loan on due date or earlier and instead of paying interest the borrower will advance to the bank a counter-loan of the same amount as he took in loan and for the same period for which he availed the loan. Alternatively the bank and the borrower may mutually agree to a different amount of counter-loan for proportionately longer or shorter period on TMCL-basis. Interest-bearing bills and bonds will be encashed at their face value and the holders will receive appropriate counter-loan on TMCL-basis from the issuer.

In the interest-free regime there will be no role of interest-based treasury bills and bonds etc. and all such documents will cease to be issued and no function involving interest will be undertaken by the Central Bank. Other functions not involving interest will be performed as usual. The Central Bank will set up a framework of Central Depository-cum-lender of last resort for mobilizing surplus funds of banks and federal and provincial governments and autonomous bodies and advancing interest-free loans to them in times of need. The Central Depository will receive deposits and advance interest-free loans on TMCL basis. For example, if a bank has a surplus of Rs. 5.0M for 1 month, it may deposit this sum for 1 month with the Central Depository and obtain an interest-free loan of Rs. 0.5M for 10 months. If a bank is short of liquidity and requires Rs. 10.0M for 1 week, it will obtain from the Central Depository an interest-free loan of Rs. 10.0M for 1 week by depositing Rs. 1.0M with the Central Depository for 10 weeks. Central Depository will also earn profits by investing surplus funds in Shariah-compliant businesses.

Banks will deposit 20% of each counter-loan amount with the Central-Depository for 10 years against which Central Depository will allow banks to draw 200% of counter-loan amount for 1 year. This will provide 20% liquidity for the banks. Additional 2% liquidity will be obtained by keeping 20% of counter-loan amount as till money in the bank. Thus total liquidity achieved by the banking sector will be 22%. At present interest rate mechanism is used to control credit availability. In the interest-free regime this function will be performed by raising or lowering the time-multiple ratio in TMCL.

Substitution of interest-based loaning by TMCL-based loaning will disprove the mischievous propaganda that interest cannot be abolished. It will finish the on-going war against Allah and His Rasool saws and will save the Muslim ummah from disastrous consequences thereof, both spiritual and temporal. Many tangible benefits for the Muslim ummah will also emanate from TMCL-based loaning system. The cost of capital in the form of interest charged on loans for production and trade adds to the cost of goods and commodities which results in increase of consumer prices. In TMCL-based loaning system no such cost is incurred and as such it will result in substantial decrease in consumer prices. According to a saying of our Prophet Muhammad saws Allah imposes dearness of necessities upon the society in which interest gets prevalence. Keynes, the most eminent economist of the past century, held that direct relationship between interest rate and prices is one of the most completely established empirical facts within the whole field of quantitative economics. Keynes also argued that lower the rate of interest, higher the level of investment, therefore higher the level of employment therefore higher the level of incomes therefore higher the level of savings. His contention was that highest level of savings can be obtained at the lowest level of interest. Empirical proof supports Keynes’ contentions. According to the World Bank statistics gross domestic savings in Pakistan were 13% in 1965 when interest rate was 9% and savings fell to 5% in 1985 when interest rate had risen to 18%. Clearly highest possible savings must occur at zero rate of interest and in TMCL-based loaning system savings and consequently bank deposits will rise considerably. Higher level of deposits will raise lending capacity of banks and more funds will be available for industry and trade which will provide employment to many of the unemployed millions and hopefully no body willing to work will remain unemployed.

Adoption of TMCL as loaning instrument by Islamic banks will bring the following benefits to Islamic banks and the Muslim ummah as a whole.

1.      It will open for Islamic banks the vast field of loaning to reliable and capable cost conscious entrepreneurs who want to remain independent and in full control of their enterprises and do not accept any sharing of profit or outside interference. Without providing loans to this big class of loan seekers, Islamic banks will not be able to compete with western banks who have started capturing business in Islamic investment field.

2.      It will facilitate inter-bank interest-free loan transactions and Islamic banks will not have to turn to western banks for meeting their short-term needs of liquidity.

3.      It will facilitate setting up of a central depository for mobilizing surplus funds of Islamic banks and governments on TMCL-basis and advancing to them in times of need TMCL-based interest-free loans.

4.      It will facilitate utilization of the financial resources of the Muslim ummah in developing Muslim countries through the Central Depository, instead of being diverted to western financial markets.