ISLAMIC LENDING INSTRUMENT FOR MEETING SHORT-TERM NEEDS OF LIQUIDITY - TMCL

Following assertions in authentic publications on Islamic Finance highlight the need for a lending instrument to meet the short-term needs of liquidity of Government, banks and very large number of sole proprietorship enterprises forming vast source of productive manpower employment. These short-term needs of liquidity cannot be fulfilled by the traditional Islamic financing modes currently in use by Islamic banks. Hence the necessity of an Islamic lending Instrument in Interest-free regime. TMCL (Time Multiple Counter Loan) is such an instrument as it facilitates Interest-free loans of large amounts for short periods against counter-loans of smaller sums for proportionately longer periods. It is institutionalization of the Islamic concept of Qard-Hasan and conforms with the Quraanic precept Hal Jaza-ul-Ihsan illa Al-ihsan and the noble teaching of our Prophet saws that a favour done to any one should be reciprocated. For fulfilling the financial needs of all types for all sectors of the economy it is absolutely necessary that TMCL is included in the list of Financial Instruments for use by Islamic banks in Interest-free regime. A document on the shortcomings of Islamic banks resulting from the lack of a lending instrument brought the following response from Islamic Development Bank Jeddah:

"REFERRING TO THE DOCUMENTS SUBMITTED TO H.E. THE PRESIDENT OF ISLAMIC DEVELOPMENT BANK (IDB) ABOUT YOUR OBSERVATION ON THE ISLAMIC BANKING MOVEMENT, WE APPRECIATE VERY MUCH YOUR GOOD EFFORTS AND INSIGHTS. THE ISLAMIC BANKS' OFFICE OF IDB WILL TRY TO DO ITS BEST TO COMMUNICATE TO THE ISLAMIC BANKS THE SHORTCOMINGS THAT YOU HAD MENTIONED IN YOUR DOCUMENT".

Research Paper No. 29 published by Islamic Research and Training Institute – Islamic Development Bank Jeddah:-

“…in order to effectively replace Interest, the Islamic Economy needs a comprehensive financing mechanism. In the absence of such a mechanism, even if the capital structure of an enterprise is cleansed from Interest, overtime, the maintenance of such an Interest-free capital structure may not be possible. On the other hand, if a comprehensive Islamic financing mechanism can be devised, not only Interest can be prevented from entering in the capital of enterprises but also existing enterprises may be able to replace their Interest-based debts at a larger scale. ….a comprehensive financing mechanism may be defined as a mechanism which provides monetary financial accommodation to enterprises but remains neutral with respect to their longer-run ownership structure. Although, hiring, installment purchase and spot sale of owned assets and Mudharabah etc, serve the purpose of financing but, neither of these can function as a comprehensive financing mechanism. ….For some reasons, if the company needs cash, installment purchase or hiring does not directly meet such requirements. Mudharabah and Musharakah arrangements directly meet the company’s cash requirements. But both of these essentially lead to a change in the ownership structure of the enterprise. Thus enterprises which need cash, but, for the time being, not wanting or being able to change their ownership structure would find hard to compromise. An interest-free comprehensive financing mechanism is thus needed by an Islamic Economy.….if funds are needed for expansion and business sections cannot be identified for new Mudharabas and Musharakahs the enterprise has to admit new Mudharibs/Mushariks (Partners) by issuing profit sharing financial instruments. Besides the cost of such arrangements, this option is suitable only for those enterprises which are willing to change their ownership structure. Capital structure of sole Proprietorships: - these enterprises are effective source of productive engagement of manpower, particularly, in the capital-scarce developing countries. As sole proprietorships do not like to associate others with their enterprises, they cannot utilize Musharakah or Mudharabah finance. The capital structure of these enterprises may contain debt as a natural result of shortage of internal resources to finance either the establishment of the enterprise or its expansion. But, since these are solely owned by a single person, by definition, the capital structure of such firms shall never contain external funds such as Mudharabah, Musharakah, or common stock. In other words, due to their typical ownership structure, these enterprises could not benefit from the traditional Islamic participatory modes of financing or from the equity finance. It may not be just to ask the enterprises to sacrifice their ownership characteristics if they need financial accommodation. Nor, such an administrative arrangement sounds efficient or even logical economy-wise. The right approach, in our opinion, is therefore, to evolve a scheme of permissible financial accommodation which could also be consistent with the universal preference of these enterprises for the form of capital structure. The problem is one of meeting the cash needs of a sole proprietorship for establishment or growth, but at the same time, without changing the structure of the enterprise. Thus conceptual efforts as well as institutional arrangements are required to provide such a financing mechanism in conformity with the ban on interest.….the actual problem of the elimination of Interest also requires an alternative mechanism which can be used by common people and millions of sole proprietorships. …there must be hundreds of thousands of enterprises in the Muslim World which may not have interest-based funds in their capital structure. Many of these enterprises must be looking for funds in conformity with the shariah requirements but due to their preference for strong internal ownership these enterprises may be in difficulty to compromise with the ownership structure underlying Mudharabah and Musharakah arrangements…….the problem of capital participation in enterprises is in fact a problem of devising a comprehensive Islamic Financing Mechanism – a mechanism which can provide financial accommodation in the form of money, but simultaneously remain neutral to the longer-run ownership structure of the enterprise. ….once a comprehensive Islamic Financing Mechanism is provided, the infant enterprises are expected to have a proper environment to avoid interest while financing their growth.”

Research Paper No. 41 published by Islamic Research and Training Institute-Islamic Development Bank Jeddah:-

“The issue of a short-term excess liquidity is one of the problems facing IBs (Islamic banks). However, this problem is exacerbated by the fact that there is neither a money market in the countries where most IBs operate, nor adequate and efficient financial instruments that can be used to manage these surplus funds in order to recycle them among IBs themselves or among other financial institutions. The seriousness of this problem is increased since some IBs hold temporarily idle balances whereas other IBs need these balances, and both groups are unable to benefit from these funds due to the lack of short-term financial instruments which are not in contradiction of shariah laws.

Seminar Proceedings No. 39 published by Islamic Research and Training Institute – Islamic Development Bank Jeddah:-

“When an Islamic Government (or any economic agent) needs money to acquire goods, they can buy them through Murabaha. If they need funds to build a road, they can use Istisna or Musharakah. But what if the government needs cash (to pay salaries or buy services) and needs it now. The options available, so far, is borrowing from the public or the banking sector at interest. It is no accident that while great advances had been taking place in the Islamization of the private financial transactions in many Muslim countries, very little has been done in the public sector. Almost all Islamic governments borrow on interest.”

Occasional Paper No. 2 published by Islamic Research and Training Institute – Islamic Development Bank Jeddah:-

“While Islamic banks use Mudarabah on the resource mobilization side, they use a number of Shariah-compliant financial instruments on the asset side. It is generally observed that the modes of finance used by Islamic banks are dominated by fixed-return modes especially Murabahah ... .The profit-sharing modes account for less than 14 percent financing. In case of financing by sectors trading gets the biggest proportion i.e. 42 percent. The second largest sector is real estate which accounts for 13%. Agriculture claims only 2 percent and industry 12 percent of the financing. This calls for rethinking the role of Islamic banks in economic development against the hopes which had been raised in the past regarding their ability to finance agriculture and industry. While Islamic banks and investment funds have so far mobilized huge financial resources, a large part of these resources have found its way into Western financial markets. Likewise, the same thing happened with resources mobilized by conventional banks. There is no Islamic (or for that matter, conventional indigenous) financial institution which has been able to channel savings from Western countries into Muslim countries in spite of the great demand for such resources in the latter countries. This is another challenge for Islamic banks with very important implications for Muslim countries. Islamic banks have succeeded in mobilizing large amounts of funds. However, it will require much more strenuous efforts to maintain a reasonable rate of growth in future. There are several reasons for that. Firstly, it must be realized that much of the deposits now with the Islamic banks came not due to the attraction of higher returns or better services but because of religious commitment of the clients. Most of this money has already found its way into the coffers of Islamic banks. Therefore this source has been almost dried up. Secondly, so far Islamic banks had a fairly large degree of ‘monopoly’ over the financial resources of Islamically motivated public. This situation is changing fast. Islamic banks are now facing ever-increasing competition.”

Introduction to Islamic Finance by Hon. Justice Muhammad Taqi Usmani:-

“The case of Islamic banking cannot be advanced unless a strong system of inter-bank transactions based on Islamic principles is developed. The lack of such a system forces the Islamic banks to turn to the conventional banks for their short-term needs of liquidity which the conventional banks do not provide without either an open or camouflaged Interest”.

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.

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