Disconnect Between Riba Theory & Practice, Concerns About Separation of Church & State in US | IRR Part XVI

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

THE DISCONNECT BETWEEN RIBA IN THEORY UNDER THE SHA’ARIAH AND IN PRACTICE

As Dr. Mahmoud A. El-Gamal[1] pointed out in his most insightful article “Incoherence of Contract-Based Islamic Financial Jurisprudence in the Age of Financial Engineering”[2] (May 2007), there is a disconnect between the goals of Islam and the methodology chosen to avoid the strictures against Riba.

I would suggest, as noted above, there is also a disconnect between the artificial contract forms and structures used and how they might be interpreted under US law as compared to what they were intended to accomplish.

Furthermore, Dr. El Gamal notes that even when the capital markets have dealt with Sha’ariah compliant financial products (embodying equity like legal structures, so different from the loan products they are intended to mimic), they cost more than the equivalent loan product.  It is submitted that if these religious oriented financial products were actually fully tested in the US courts and the courts properly interpreted the text of these legal documents, it is likely that there would even be a greater pricing disparity.  Indeed, for good reason; because the legal structures are based on re-characterizing a loan as equity, with all of the attendant risks, including, intervening creditors, claims of lack of priority and difficulty of enforcement associated with such products.  These deficiencies usually result in pricing disparities.  Moreover, it is unclear whether there even is a summary enforcement remedy of foreclosure, which is also fundamental to the pricing of a loan product.  Frankly, it is likely that the very nature of the documents is open to question.  After all, it is not supposed to be a loan; or is it?

The response of the English courts is cogent.  They found that it’s not their business.  They chose instead to deal with the note itself and not the overlay of Sha’ariah compliant legal structures and the documents; and, as noted herein, well they should.  This is because the enforcement of these structures is fraught with all manner of legal difficulty for all the reasons noted herein and likely others as well.

This kind of analysis echoes the views of Rabbi Epstein in his work the Tosefot Bracha[3] noted above.  He noted the success of the banking function in promoting commerce and prosperity and yet it appeared to be prohibited Biblically.  There was a disconnect.  How could something so good, be so wrong?  His answer was cogent.  He found that the new world of commerce and finance was to be embraced and that this was indeed what the Talmud was suggesting, thousands of years before.  Whether it is the original Iska (part loan and part investment trust) structure or its further development in the Heter Iska, the Halacha  is not fixed; it is vibrant.  It developed mechanisms to meet the needs of the real world and market place.  Similarly the Sha’ariah and the mechanisms described above that are Sha’ariah compliant.

Nevertheless, to be fair, it requires some further practical changes, because nefarious debtors have sought to misuse the US courts to defeat their obligations.  However, if properly employed in the religious setting, only, as intended, then it serves a vital function.

In the case of a Heter Iska, ordinary loan documents can be signed and, as noted below, a separate instrument (whether on the wall and unsigned or signed only by witnesses and not the parties), resolves any religious concerns about Ribit.  This while not upsetting the requirements of the capital markets and US law.  Hence, religious matters are dealt with in a way amenable to religious authorities and the wonderful benefits offered by the capital markets are embraced.  As noted below, this kind of approach, in practice, may provide a useful solution as to how to deal with similar Sha’ariah law concerns.

Dr. El-Gamal also notes that the higher cost of the Sh’ariah compliant version of a financing, as compared to an ordinary loan, is also of concern.[4] Ideally, this should be a focus of Islamic jurists and mitigate against a wholesale rejection of the benefits of the capital markets approach under US law.  Why not find a way to accept these lower cost formats on some expedient basis? Thus, Dr. El-Gamal points out the focus on “contract forms” as a means of purporting to provide financial products and services in accordance with Islamic law or Sha’ariah may in fact be misguided.  In essence, instead of extending a mortgage loan on most favorable terms and rates, the Sha’ariah banks are purporting to buy the property first and then re-sell it to the customer in a credit priced transaction where the borrower still pays on the basis of a benchmarked implicit rate of return on capital comparable to (but higher than) prevailing mortgage rates.  He points out that this, therefore, should be viewed as fundamentally adverse to the interests of the Sha’ariah in protecting borrowers.  Why engage in this kind of exercise if the result is to hurt and not benefit borrowers? As noted above, the structures become very complicated and with each level of complication there are added concerns about enforceability and additional costs and pricing.  Moreover, ultimately, the whole structure appears to be a ruse.  There are other structures not discussed in this article that add even more additional layers of structure but the common theme is that ultimately it is all just a mechanism.  At its heart, it is just an analogue; a means by which a loan with interest is derived.  The form takes precedence over the substance.  Is this what religion has come to stand for? Do it one way, as a matter of form, and it’s OK and, yet do the very same thing in substance, using another form and it’s not.

The incoherence that Dr. El-Gamal speaks of has many different layers of application.  Frankly, as noted at the beginning of this article, the objects of each system may be the same, to facilitate the movement of capital from those with a surplus to those in need.  The methodology chosen may not always perform as intended, especially when the structure is subjected to the laws of another system.  Hence, there is further incoherence, as it were.

The solution may lie in the concepts expressed below.  Instead of forcing one religion’s internal solutions on another conflicting legal system, it may be more effective to minimize the intrusion.  Why not adopt the best each system has to offer and do so in a manner that limits interference or entanglement.  Set forth below is a possible solution.

 

BLOWBACK BECAUSE OF REAL LIFE CONCERNS ABOUT SEPARATION BETWEEN CHURCH AND STATE IN THE US

There are reportedly initiatives underway in at least 7 States and reportedly as many as 22,[5] to ban the use of Sha’ariah in their State courts.

Bill Mears of CNN in discussing the matter,[6] reports that this is in reaction to a most disturbing case in New Jersey.  It would appear that  a lower court judge refused to grant a restraining order against a Muslim husband who was accused by his wife of forcing her to have sex with him.  The husband defended himself against the charge of rape by asserting he was just exercising his right as a husband under Islamic law to have marital relations when he so desired.  Thus, he was acting in accordance with his religious beliefs, albeit wholly inconsistent with US law that viewed his actions as nothing more than rape.  Fortunately, the New Jersey Appeals Court[7] intervened and overturned the lower court’s decision to deny the wife the protection of a restraining order.  The New Jersey Appeals Court found that the case “presents a conflict between the criminal law and religious precepts.”[8]  The Appeals Court went on to say “In resolving this conflict, the judge determined to exempt (the husband) from the operation of the State’s statutes as the result of his religious beliefs.  In doing so, the judge was mistaken.”[9]

Earlier this year, a Florida Senate panel approved an anti-Sha’ariah bill.  Scott Keys[10] reported that the panel deliberated for 3 minutes.  The bill had already been passed by the Senate Judiciary Committee.  A concurrent bill was also to be voted on in the Florida House.  The proposed legislation would ban the use of foreign laws like the Sha’ariah in Florida courts.

A similar ban was on the ballot in Oklahoma to amend the State Constitution.  The initiative was preliminarily enjoined by the Federal Court of Appeals in the 10^th Circuit.[11] Under the Oklahoma version, the State Constitution was to have been amended to mandate its State courts to apply only US law and not International law like the Sha’ariah.[12]  Legislators in Louisiana, South Carolina, Utah, Tennessee, Texas and many other States are undertaking similar legislative initiatives.

There are in fact conflicts between Western law and traditions and other systems of law like the Sha’ariah.  They cannot be readily integrated.  The differences are striking and irreconcilable.  My own view is there is no reason to meld these conflicting systems of law and ethics.  Rather, they can and should continue to exist side by side, as discussed in this article.

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[1] A noted Islamic scholar who is the Chair of the Islamic Economics, Finance and Management and Professor of Economics at Rice University.

[2] Supra footnote 176. See also supra footnote 179.

[3] Supra footnote 42

[4] See also Handbook of Islamic Banking, page 94, which notes that Islamic banks in England are more expensive more than conventional banks for the same types of credits. The Handbook is edited by M. Kabir Hassan and Mervyn K. Lewis.  It is published by Edward Elgar Publishing, Inc. of the UK and Northampton, Mass. in the US. It may be referenced on the Internet as well.  See also “Interest and the Paradox of contemporary Islamic Law and Finance” by Mahmoud A. El-Gamal of Rice University; Losing Interest:  Financial Alchemy in Islamic, Talmudic and Western Law by Michael H. Lubetsky; Islamic and Jewish Perspectives on Interest by Joel S. Newman (89 Tax Notes 1311-12/4/2000); Contemporary Practices of Islamic Financing Techniques by Dr. Ansaf Ahmad (1993); and Issues in Islamic Banking by Mahammad Ne Jatillah Siddiquim; The Islamic Foundation, Leicester, London UK (1983/140314 at page 152).

[5] See Report by Scott Keys in ThinkProgress.org on February 29, 2012; Report by Donna Leinwand of USA Today on 12/9/2010; and Report by Bill Mears of CNN on 11/29/2010.

[6] Ibid

[7] S.D. v. M.J.R., 415 N.J. Super 417, 2 A.3d 412 (2010).

[8] Ibid

[9] Ibid

[10] Supra footnote 190

[11] Awad v. Ziriax  (Federal Court of Appeals-10^th Circuit Index # 10-6273-Jan. 10, 2012).

[12] See Op Ed by Michael A. Helfand “A Law We Don’t Need” – LA Times (November 10, 2010).

Analysis of Prohibition Against Riba in Practice & Rules | IRR Part XI

Interest, Ribit and Riba: Must These Disparate Legal Concepts Be Integrated or Is a More Nuanced Approach Appropriate for the Global Financial Community?

By: Leonard Grunstein

 

AN ANALYSIS OF THE NATURE OF THE PROHIBITION AGAINST RIBA AND ITS APPLICATION IN PRACTICE, INCLUDING WHETHER ENTITIES ARE SUBJECT TO THE SAME RULES AS INDIVIDUALS

It is respectfully suggested that not all interest is prohibited Riba and not all Riba is interest[1].

Consider for example the 16^th century Ottoman Cash Waqfs[2]. They were permitted to charge interest. A Waqf[3] was viewed as a separate legal entity (as distinguished from the individuals who invested or operated the same). There is also a Fatwa[4] issued by Ebusud Effendi, the 16^th century Mufti of Istambul that expressly determined that a Waqf and Charitable Trust could charge borrowers interest and pay interest to the providers of capital to the entities. Many a 16^th century effendi made profit this way. The use of an entity as an intermediary shielded both the debtor paying interest to the entity and those providing capital to the entity and thereby earning interest from the prohibition against Riba. The interest had to be fair in theory. Indeed Cash Waqfs were said to be formed to help borrowers, who were otherwise paying excessive rates of interest.

Yahia Abdul-Raman[5], relying on the Fatwa of Baraka[6]reports that the term interest can be used in documents to satisfy local legal requirements, so long as Riba was not practiced in the transaction. The Fatwa itself states that there is no objection to using the term interest as an alternative to profit or rate of return. Hence it is possible to have a parallel set of documents with the term interest being used as appropriate to satisfy capital markets requirements, so long as Riba is not practiced. However, just what is or is not Riba was not defined.

Al Baraka Bank in London devised a structure for interest bearing loan documents to be imbedded in the transactional documents that are otherwise Sha’ariah compliant. This was done in an attempt to thereby achieve satisfaction of the requirements of the capital markets, without falling astray of the Sha’ariah. Thus, it employs a Mushraka[7] framework, where under the Bank and borrower initially buy the home to be financed as a joint venture; but the Bank retains title to the property, as described below. The Bank then sells its interest to the borrower at a mark up that reflects the interest factor it charges. Ownership of the property however remains with the Bank until the purchase price is paid in full (i.e.: the principal and interest factor that comprises the mark up). However, consistent with UK law, the Bank also takes a mortgage lien against the property. The borrower enters into a lease with the Bank of the property, where under the borrower rents the property from the Bank at a rental rate equivalent to the monthly interest and amortization payments that would ordinarily be charged (albeit at a higher rate of interest that the prevailing rates for a traditional mortgage loan). In essence it is viewed as an installment sales contract under the Sha’ariah and a mortgage loan that is interest bearing under UK law.

The concept of having a separate set of traditional interest bearing loan documents could be very useful, if properly structured. A good example of how this can be successfully accomplished is noted above in the discussion of the use of a Heter Iska. Just embedding a set of traditional loan documents in a Shariah complaint structure may not be the appropriate solution. On the other hand, if properly structured, then conceptually it can be adapted to meet the requirements of the capital markets, as well as, US legal requirements. Indeed, courts in the UK dealing with a Murabaha[8] structured product with parallel interest bearing note and mortgage held that under English law the interest earning note prevailed[9].

However, as more fully discussed below, just embedding a set of more traditional loan documents in a structure that is inconsistent with capital markets and likely Sha’ariah requirements may not be advisable, for the reasons set forth below. Consider the inconsistent expectations. The bank hopes the documents will be interpreted in favor of the traditional loan documents embedded in the structure so as to have an ordinary interest bearing loan obligation that is secured by a priority first mortgage on the property. On the other hand, the borrower desires that the transaction be Sha’ariah compliant and not be viewed as an interest bearing obligation that is likely prohibited Riba according to many Sha’ariah scholars and others. The courts or other juridical authorities in the US and in the Islamic world may have conflicting views as to how to interpret and enforce the various documents encompassing the transaction between the bank and borrower. There is a need for clarity and predictability and yet it is conspicuously absent, as described in this article. As noted below in the discussion of modern Sukuk structures, these issues have been put into focus with unintended and less than desirable results.

Sukuk bond structures are very interesting. Instead of being asset based (i.e.: with a security interest in the assets or mortgage on real estate) they are said to be asset backed (i.e.: the lender actually owns the assets). However, as discussed below this is not always so clear. Typically, an Ijara[10] rental structure is then employed, if the underlying collateral is real estate. It provides for a rental arrangement with the borrower under a lease of the property, with the rental being tied to the yield agreed to with the lender. As noted below there is no thought given to providing for a genuine market rent, it is just a derivative interest based financial arrangement.

However, as more fully discussed below, many such Sukuk structures also provide for a set of loan documents to be embedded in the transactional structure. These are not exactly typical mortgage loan documents that are compliant with capital markets requirements. They may in fact be a vain effort to mimic those kind of loan documents; but, as noted below, the path taken is anything but traditional from a capital markets’ prospective. For example, instead of providing for a first priority mortgage securing an interest bearing note, it provides for a putative mortgage lien securing a buy-sell arrangement between the borrower and lender. This is more like a preferred equity structures that mimics equity. Indeed, depending on the vagaries of the forum dealing with the matter, it might be interpreted as an equitable loan between the lender and borrower or it might be viewed as just plain equity. The buy-sell arrangement is another way of saying the preferred equity must be repaid. It purports to convert what looks like equity into a loan. However, even if that is the case, it is on a subordinated basis; rather than on a priority basis of the sort represented by a first mortgage against the property. There are real risks associated with this kind of arrangement, both structural and from a bankruptcy point of view, as discussed below[11].

Abu Hanifa[12] was one of the greatest known Imams in history.  He issued a Fatwa[13] (commonly known as the Hanifa Fatwa) ruling that there was no prohibition against charging Riba in a foreign land (i.e.: a country not under Islamic sovereignty and control and where Islamic law is not the law of the land). The Fatwa of Sha Abdul Aziz of India goes even further and just flat out permits Muslims to lend non-Muslims on interest[14].

It would appear that some Sha’ariah scholars have adopted the position that whether a Waqf, government treasury or bank, a legal person (i.e.: entity, as opposed to an individual) is not subject to the prohibition against Riba (when it pays or charges interest). This includes the scholarly work done by the Mufti of and various Sha’ariah legal authorities at the Al-Azhar University in Egypt. For example, Dr. Muhammad Shanqri al-Fanjar of Al-Azhar asserts that bank interest is not Riba. He views the blanket equation of Riba and interest as something to be avoided.[15]

Similarly, as noted above, Sheikh Dr. Muhammad Sayyid Tantawi, the Grand Mufti of Egypt and a leader of Al-Azhar, held that government bond interest is not Riba[16]. Dr. Tantawi viewed government bond interest as, in essence, a sharing arrangement in the government’s profits.

Dr. Tantawi also issued a Fatwa on December 2, 2002, in which he held, in effect, that bank interest is permitted, as more fully discussed below. In his Fatwa, Dr. Tantawi noted that it is well known banks fix the pre-specified return to depositors (i.e.: interest rate on deposits) after a detailed study of the international and domestic market conditions and the economic circumstances in society. This, as well as, the special conditions and nature of each transaction and the average profitability thereof are also considered by the bank in setting the pre-specified return (i.e.: interest rates) payable to depositors. He summarizes his position in the Fatwa as follows:

“In summary, pre-specification of profits for those who invest their funds through an investment agency with banks or other institutions is legally permissible, and above legal suspicion (la shubhat fiha). This transaction belongs to the domain of benefits that were neither explicitly permitted nor explicitly forbidden (min qabil al-masalih al-mursalah), and does not belong to the domain of creeds or formal acts of worship, wherein change and alteration is not allowed.

Based on what has been stated [we rule that] investing funds with banks that pre-specify profits or returns is legally permissible and there is no harm therein, and Allah [only] knows best.”

Shaykh Mahmud Shaltut Grand Imam of Al-Azhar ruled that post office savings interest and state bond interest was not prohibited Riba[17]. He reasoned that a pre-fixed share of the profits (which is equivalent to an interest rate) is not prohibited Riba, if offered by the State or an affiliate thereof. He goes on to say that there is no exploitation of either party in this kind of arrangement[18]. This concept is a dramatic breakthrough in thinking by Sha’ariah scholars. It laid the groundwork for the  even more dramatic Fatwa by Dr. Tantawi[19] noted above.

These eminent Sha’ariah authorities ruled that banks can, in effect, pay interest to depositors, in the form of pre-specifying the profits or return as a percentage of the amount deposited by the customer (i.e. interest in common parlance). It is not a percentage of the actual profits of the bank, In essence, just don’t use the term interest expressly and it’s permitted. Whether it’s a prefixed share of profits as a percentage of the principal amount invested or some other analogous formulation for interest, form appears to govern over substance.  Thus, the concept of “interest based” products being permitted as opposed to “interest bearing” products. Dr. Tantawi goes on to explain that the pre-fixing of profits benefits the depositor in this age of corruption, dishonesty and greed. He goes on to say that just as profits may be shared by two parties, so too can the parties agree that one would receive a pre-specified share of profits.[20] Tantawi rules that this concept does not contradict the Koran or the Sunnah. It benefits both parties and forbidding it would result in harm[21].

Others have found that the use of the term interest does not in and of itself violate the prohibition against Riba. Thus, Sheikh Dr. Yusuf Al-Quaradawi and others issued a Fatwa in October 1990, ruling that it is possible to use the term interest, instead of the term profit or rate of return, in order to benefit from the financial advantages granted by the relevant authorities in the West with regard to deposits and financings. This would include using the term interest in tax declarations or the documents used by the bank in various financings. It is respectfully suggested that this Fatwa recognizes the need for a parallel set of loan documents so as to better access the capital markets. At the same time, there would also be a Sha’ariah compliant structure and set of documents, so as not to fall astray of the requirements of the Sha’ariah. This concept is more fully discussed below. It is also helps support the proposed solution set forth in Section XVIII below.

Notwithstanding these well reasoned, expedient and useful Fatwas and scholarly approaches described above, that are sensitive to the realities of the marketplace and the human condition and provide a nuanced and practical approach to dealing with the issues, there are conflicting views. Some have scholarly pretensions but many are pronouncements made by the more nationalistic side of Islam. They do not seek to live side by side with non-Moslems or integrate. Rather, it would appear they want to conquer and impose their own brand of Islam on others. One such harsh critic of Islamic banking (including the Sha’ariah compliant forms they have adopted) was Osama Bin Laden. He was the notorious head of the terrorist organization Al-Qaeda until his demise. Among other dastardly acts, he was responsible for the 9/11 bombing of the World Trade Center and the thousands of deaths of innocent souls in New York City. In a rambling so called Fatwa he published[22], declaring war against the US, he included a statement to the effect that the banks in Saudi Arabia violated the prohibition against Riba. There was no discussion of the Sha’ariah or analysis of just how this was so, in theory or in practice.  It was just one of many baseless pronouncements he made in his so called Fatwa. Interestingly, notwithstanding his pronouncements, even Osama bin Laden reportedly had a bank account.

However, even as these extremist views are being forcefully expressed, interest or its equivalent is being charged and paid by Moslems in Islamic and non-Islamic jurisdictions. Described below are some of the so-called Sha’ariah compliant structures.

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[1] See An Economic Explication of the Prohibition of Riba in Classical Islamic Jurisprudence by Dr. Mahmoud A. El-Gamal (2001) in the Proceedings of the Third Harvard University Forum of Islamic Finance.

[2] Supra footnote 183 at page 6. Of Article by Dr. Farooq, noted therein. See also An Analytical Review of Different Concepts of Riba (Interest) in the Sub-Continent by Farooz Azizi, Muhammed Mahmud and Emad u Karin in Kasbit Business Journal 1 (1): 36-43  (Fall 2008)., that asserts that Riba is compound interest (i.e.: usury) and that it is extreme exploitation that is restricted by the Koran. It goes on to state that borrowing for trading purposes on interest and Bank interest is not prohibited Riba.

[3] a religious or other foundation.

[4] Supra Footnote 183, at page 10 of Article by Dr. Farooq, which cites the Fatwa of Ebusud Efendi, a 16^th century Mufti of Istambul, permitting a Waqf to charge interest. See also discussion by Timur Kuran,  supra footnote 162, at pages 7-8. See further discussion by Dr. El-Gamal,, supra footnote 176, at page 109. Finally, see The Concept of Artificial Legal Entity and Limited Liability Company by Mahmoud M. Sanusi in Critical Issues on Islamic Banking and Finance and Takaaful, beginning at page 192, et seq.

[5] A founder of the American Finance House-LARIBA.  Parenthetically, the term LARIBA can be loosely defined as no Riba.

[6] Reported in The Art of Islamic Banking and Finance at Page 213.

[7] See discussion below regarding this type of Sha’ariah compliant financing structure.

[8] As defined below.

[9] See, for example, the Beximco  UK case described in Section XII below.

[10] As defined below.

[11] See The Logic of Financial Westernization in the Middle East by Timur Kuran in the Journal of Economic Behavior and Organization, Vol, 56 (2005) beginning at page 553.

[12] A 7^th century Islamic religious legal authority and Imam.

[13] See Masri and Keller (1997)- Reliance of the Traveler: The Classic Manual of Islamic Sacred Law Umdat Al- Salik at page 944. See also Dr. Salah al Sawi, A Polite Reconsideration of the Fatwa Permitting Interest-Based Mortgages for Buying Homes in Western Society-2001 (www. Islamic-Finance.com), which argues that the Hanafi Fatwa should be limited to circumstances of necessity, only, where there is no other possible alternative.

[14] Supra Footnote 187, at page 38.

[15]Supra footnote 183, at page 25 of Dr. Farooq’s article.

[16] Ibid at page 17 of Dr. Farooq’s article.

[17] Ibid at page 16 of Dr, Farooq’s article.

[18] Ibid

[19] Chibli Mallat, Tantawi on Banking Operations in Egypt in Islamic Legal Interpretation: Mufti and their Fatwas at page 286 (1996). See also Fatwa of Ibn Baz ( Abdul Aziz ibn Abdullah ibn Baz),Grand Mufti of Saudi Arabia,  Ruling 137 in Volume 19 beginning at page 240, in opposition to Tantawi’s  view.

[20] Ibid at page 118.

[21] Ibid at page 119.

[22]  Dated August 23, 1996 and reproduced by PBS Newshour Online (at www.pbs.org/newshour terrorism/bin laden fatwa 1996…html).