Resolution no. 133 (7/14)

Problem of Arrears in Islamic Financial Institutions

The Council of the International Islamic Fiqh Academy of the Organization of the Islamic Conference, holding its 14th session in Doha, State of Qatar,on 7–13 Dhū al-Qi’dah 1423h (11–16 January 2003),

having examined the research papers submitted to the Academy concerning the Problem of Arrears in Islamic Financial Institutions,

having listened to the discussions on the subject,

Resolves

first: The method of dealing with delinquencies in Islamic financial institutions differs from the method used by conventional banks because conventional banks deal with prohibited interest. Hence, it would be suitable to start with emphasizing the prohibition of banking interest on the following grounds:

1. Functions of Conventional Banks

By virtue of the rules that regulate their work, conventional banks are not allowed to pursue investments that involve profit and loss. Banks receive deposits from the public as loans and limit their functions – as lawyers and economists say – to interest-based borrowing and lending, and credit creation through interest-based lending of deposited funds.

1. Relationship between Conventional Banks and Depositors

From the Shariah and the legal viewpoints, the relationship between depositors and banks is lending rather than an agency relationship. This fact is also well-established by the rules and regulations governing banks. This is so because an investment agency is a contract according to which one party delegates the other to invest an amount of money that the principal still owns against a specific lump sum or a given percentage of the return on investment. In such arrangement, Fiqh scholars are, unanimously, of the view that the principal continues being the owner of the invested capital, and therefore he is entitled to its return (Ghunm) and should bear its loss (Ghurm), and the agent is entitled to the wage stipulated in

the agency contract if the deal is a wage-based agency.

Accordingly, conventional banks are not an agent of the depositors in investing their funds because such funds are given to the conventional bank as loans guaranteed by the bank, and therefore the bank owns the right to dispose of them the way it likes committed to their repayment. In Shariah, a loan has to be repaid in the same amount, without any stipulated increment.

1. Conventional Banks’ Interests being a Shariah-Prohibited Usury

Interest on bank deposits is a Shariah prohibited Riba, as per the texts of the Quran and the Sunnah. Several resolutions have well affirmed this fact and Fatāwā (Shariah opinions) since the second Islamic Conference of the Islamic Research Academy, held in Cairo in Muḥarram 1385h (May 1965) and attended by eighty-five most renowned Fiqh scholars and representatives of thirty-five Muslim countries. That conference mentioned in the first item of its resolutions that: Interest on all types of loans is a prohibited Riba. Several other resolutions and recommendations of numerable conferences followed, including:

• The First International Conference on Islamic Economics, held in Makkah al-Mukarramah in 1396h (1976) which was attended by more than three hundred Fiqh scholars and economic and banking experts and which emphasized the prohibition of bank
• The Second Conference of Islamic Banks held in Kuwait in 1403h (1983), which also confirmed the
• The International Islamic Fiqh Academy of the Organization of the Islamic Conference, in its Second Session held in Rabīʿ al-Awwal 1406h (December 1985), stated in its resolution no. 10 (2/10) that “any increase or interest charged on a debt that fell due and the debtor failed to repay it against its rescheduling, and any increment or interest on a loan stipulated at the time of initiating the contract are Shariah- prohibited ”
• The Islamic Fiqh Council of the Muslim World League of Makkah al- Mukarramah in its 9th Session held in the year 1406h (1986) affirmed that any money procured as interest is a prohibited Riba according to
• The Ifta Committee of Al-Azhar University, emphasized the prohibition of returns on investment certificates of type (A) and (B).
• The fatwā (Shariah opinion) of the former Mufti of the Al-Azhar,

Sheikh Mohammad Sayed Tantawi in Rajab 1409h (1989) which stated that “depositing funds with banks as well as lending them or borrowing from them in any form, against predetermined interest is prohibited.”

Added to all that are the fatwas of several Fiqh fora such as Fiqh Councils of Muslim countries, fatwa committees, seminars and conferences, and fatwas of individual Fiqh scholars and experts in the fields of economic and banking activities throughout the Muslim world. These Shariah opinions constitute a clear consensus of contemporary Muslim scholars that banking interest is prohibited; this should not be violated or overlooked.

1. Pre-Specification of the Investment Return as a Lump sum or a Capital Percentage

It is a well-admitted fact that the interest-based loan contract differs from the Shariah-based Muḍārabah contract because, in the former, the bor- rower is entitled to the full return and has to bear the loss. In contrast, in the Muḍārabah, the two parties share return and the fund-owner bears loss when it happens in the application of the Prophet’s ىلص هللا هيلع ملسو saying, “entitlement to return is related to risk-bearing,” (an authentic ḥadīth reported by Imam Ahmad and in the four books of Sunnan) which means that the party who bears the risk of damage, total destruction, or defects deserves the returns, increments and appreciations. From this ḥadīth, Fiqh schol- ars derived the famous Fiqh Maxim that “Gain is related to risk-bearing.” It is also reported that the Prophet ىلص هللا هيلع ملسو “forbade a return of [a thing] whose risk is not assumed.” (Four Books of Sunnan)

For centuries, there has been unanimity among scholars from all Fiqh schools that return on investment in Muḍārabah or any other form of partnership should not be pre-determined as a lump sum or a percentage of the invested funds (the capital), because such an act involves guaran- teeing the principal, contrary to the explicit directives of the Shariah. It also leads to interrupting the principle of profit and loss sharing, which is necessary for partnership and Muḍārabah. This unanimous position is well established and affirmed as there exist no reports that dispute it. In this regard, Ibn Qudamah, in his book al-Mughni (34/3), says:

All knowledgeable Fiqh scholars whose viewpoints have been reported, unanimously annul Qirad (Muḍārabah) if it contains a condition granting either or both parties a pre-determined amount of money as return.

Unanimity of opinion (Ijmāʿ) is a stand-alone evidence as established in Shariah. Therefore, the Academy, while deciding this in unanimity, advis- es Muslims to continuously seek for permissible (ḥalāl) income and avoid prohibited (ḥarām) returns, in obedience to Allāh هناحبس ىلاعتو and His Prophet ىلص هللا هيلع ملسو.

second: outstanding debts

1. Regarding penalty clauses in contracts: the Council re-emphasizes its previous resolutions on the subject as stated in its resolution no. 85 (2/9) on al-Salam, which reads, “Penalty clause for delinquency in delivery of the salam commodity is not permissible because it is an (in-kind) debt, as imposing any increment for delayed debts payment is prohibited,” and its resolution 109 (4/12) on Penalty Clause which states:

…default penalty can be imposed in all financial contracts except those in which the basic commitment is a debt. Increment as a delinquency penalty in debt is a pure ribā. Accordingly, it is prohibited, for instance, to impose a delinquency penalty in the installment sale contract for delay of payment by the debtor of any remaining installments, whether for insolvency or evasion or in an Istiṣnāʿ contract for a manufacturer who delays complete delivery of his obligation.

1. The Academy reconfirms its previous resolution 51 (2/6) on

Installment Sale, which comprises the following points:

third: if the indebted buyer delays payment of due installments, he should not be obligated – with or without a pre-condition – to pay any increment, because that is prohibited Ribā.

fourth: While it is prohibited for a solvent debtor to delay payment of due installments, it is still not permissible in Shariah to claim compensation for his delinquency.

fifth: It is Shariah-permissible for the seller in Installment Sale contracts to include a condition that the buyer should prematurely pay all the remaining installments in case of default in some of them, and the buyer, in this case, is bound by this condition as he had accepted it at the time of contracting.

sixth: the seller has no right to retain the ownership of the sold asset after concluding the sale transaction, but he has the right to demand mortgaging the asset to him so as to ensure payment of his installments.

1. It is important for Islamic banks to give adequate care to studying the reasons behind the problem of debts’ defaulting. They should give attention to Murābaḥah and deferred-contract transactions, observance of technical means of financing (e.g. feasibility studies), and obtaining sufficient guarantees.

Recommendations

1. Islamic banks should commit themselves to the Islamic economic approach and its parameters in their activities. They should also pursue technical and managerial reforms that would enable them to have more progress through promoting direct investments and partnerships in order to achieve social and economic development that is one of the most important objectives of Islamic banks and financial institutions,
2. Efforts should also be exerted for developing new mechanisms for solving the problem of over-dues in Islamic financial In this regard, a study on the subject should be presented to a forthcoming session of the Academy for discussion.

Indeed, Allāh is All-Knowing.