SOAS University of London

Centre of Islamic and Middle Eastern Law

Islamic Law and Finance: Introduction

Islamic Law And Financial Transactions In Contemporary Perspective by William Ballantyne

In this introduction I want expressly to highlight some of the matters which I believe merit special consideration and continuing discussion. Nobody who has read or heard anything which I have uttered over the past few years will be in any doubt of my strong views as to the practical importance of an understanding of the Shari'a law at the present time in the context of the undoubted reassertion of Islam, and thus the Shari'a, which we are witnessing. I do not believe that anybody who knows the Muslim world will doubt this: I do not have space here to go into the justifications for this belief. I have dealt with the subject at some length in the Coulson Memorial Lecture, which I delivered at the School of Oriental and African Studies in March 1988.

The first paper in this book is on 'Financial Transactions and the Islamic Theory of Obligations and Contracts' by Nabil Saleh. Now, of course, the importance of the reassertion of Islam and the Shari'a goes a long way, far beyond the subject of this book, although it is in the context of banking that the difficulties inherent in the Shari'a have achieved most prominence in the world today. Commercial law overall is really basically a matter of contract, and an understanding of the legal background is of increasing and vital importance. Thus this paper of Nabil Saleli is itself of great importance. In particular, perhaps, Nabil will forgive me for quoting a phrase which appears in the course of his paper: 'inevitable clash or mutual tolerance'. He links this with a warning to those who may tend to view the possible collapse of Islamic banking with eagerness: as I say, I hope I may be forgiven for anticipating this, because it is a subject so close to my own heart. I would like directly to identify myself with the sentiments which he expresses. An earnest plea must be made for an attempt to co-ordinate the two systems of Islam and the West. Once again, time simply does not permit me to analyze how this might be done but it does seem to me that the least that is required is:-

  1. An international Arab Code of the Shari'a – a new Majalla? – to remove the uncertainty surrounding the true, immutable precepts of the Shari'a in basic texts, nusus, so that at least we can all know where we are; and so that above all we can ascertain where there exists in the Shari'a sufficient flexibility to make it adaptable to modem economic circumstances; and at the same time:
  2. Flexibility on the part of the occidental systems of law and finance in considering how far the Islamic concepts really do constitute anathema, in so far as their interests are concerned. I shall return to this subject later.

It is not surprising that, given the title of this book, the main preoccupation should be with Islamic banking, although the title could take the matter further than that. Thus Munir Morad's paper on taxation, with its learned analyses, is very welcome.

It is, of course, easy for a lawyer who like myself has spent the whole of his professional life practising in and with the Arab world to become obsessed solely with the Arab jurisdictions, but in assessing the importance of our subject today, we must not forget that there are between 700 and 1,000 million Muslims, encompassing a vast area of the world. This is in part evidenced in the book by the fact that Jane Connors writes on the system in Malaysia, Abbas Mirakhor on Iran and Pakistan, and David Baldwin and Rodney Wilson make special reference to Turkey. Finally, Volker Nienhaus in dealing with the comparative performance of Islamic banks, makes specific reference to several jurisdictions, and – I found this extremely interesting and significant – emphasizes the importance of the agricultural sector and the tendency to neglect the rural areas.

That brings me to Chibli Mallat's paper on riba – the great debate on riba. This points out, as always in studying this eternal subject, that the key element is doubt. There is still not even unanimity on what riba really means, or a proper definition, on the extent of its application. It is while such doubts remain that there can be no certainty in financial negotiations where there is any question of the Shari'a law being applicable. This doubt, of course, extends beyond riba to the concept of gharar, into the third difficulty highlighted by AI-Sanhuri, the ban on multiplicity of transactions, etc. It is for these considerations that in my opinion a unified codification of Shar'ia principles is of the utmost urgency, wherein those precepts of the Shari'a which are by common consent deemed to be immutable, that is to say as stemming from the Qur'an or the Sunna, from the Qur'an itself or from the traditions of the Prophet – wherein such precepts can be defined by common consent between the Islamic jurisdictions – an international convention to that effect. The Learned Academy of Islamic Jurisprudence is presumably engaged in some such exercise, but since its formation little has emerged. On the other side, as I have said, Western lawyers and economists should be urgently considering the extent to which flexibility exists in the Western system, whereby the two systems, Western and Islamic, may be brought closer together. May I briefly try to point out the importance and practical application of these difficulties by stating three propositions:-

  1. That in a jurisdiction where the Shari'a applies, contracts not in accordance with its precepts are quite simply illegal: in our present context, banking transactions based upon the conventional Western system of interest;
  2. That in Muslim eyes, not only is a system of economics which is not based on Shari'a principles anti-religious, illegal, and sinful, but that in the world today, the Islamic system is better;
  3. That, as I have said, the alternative to some co-operation is a clash, a confrontation.

Let us consider these three in turn.

I. The Basic Illegality

Let me take a topical example – I always consider practical examples better than theory – a syndicated loan agreement. You are all familiar with these. Let us suppose several liability in a syndicate of banks for a period loan to an Arab State, probably with guarantees via ECGD, COFAS, EXIM, as the case may be. Interest is defined by a rate above an inter-bank rate, and in case of default there is interest upon interest. Let us suppose that in our example, it is a sterling loan, with payments to be made in London, and that there is a proper law clause which defines English law as the proper law of the agreement; and there is a jurisdiction clause giving non-exclusive jurisdiction to the English courts, but vesting jurisdiction also in the courts of the borrowing State and indeed any other courts which may properly have jurisdiction according to their own laws. There is usually also, in the case of the State, express waiver of sovereign immunity.

Now, as you all know, such agreements invariably contain a number of conditions precedent, not the least of them being the necessity for the opinion of a lawyer qualified in the law of the borrowing State to the effect that the agreement is legal according to the law of that State. Why is this necessary in view of the choice of law clause and the jurisdiction clause? There are, of course, a number or reasons, but not the least are that it may be necessary to sue upon the contract in the courts of the borrowing State, either directly or by way of enforcing a foreign judgment obtained on the contract: it is also not inconceivable that an English court or other appropriate foreign forum may, despite the choice of law clause in the contract, take cognizance of public policy provisions in the law of the borrowing State. Thus an expert or .'clearing'opinion is sought. The lawyer giving such opinion must of course be fully cognizant of the laws of the borrowing State, and where it is an Islamic State, the first question he must ask himself is, does the Shari'a have any application? In dealing with the Arab States, as I am accustomed to do, the answer to this depends upon the jurisdiction: to take examples at one end of the scale, in Kuwait and Bahrain (since its new Commercial Code of 1987), and as Mr Edge points out in his chapter, in Egypt, the answer would be 'no', but with a caveat that interest rates are pegged by the Central Banks. At the other end of the scale, in Saudi Arabia, the answer would be 'yes', the Shari'a is most certainly relevant, and the whole contract is illegal. In various other jurisdictions, there are varying shades. Whether such contract would in any case be denied as being illegal in present circumstances is another matter; what the lawyer has to advise on is the position of that contract at law. Almost invariably, he has to add to his opinion a proviso to the effect that if the Shari'a were to be applied, the transaction would be void, or voidable. If, despite such caveats as may have to be entered, the bankers take, nonetheless, a commercial risk (and this has happened in many cases), that is entirely another matter; but this is hardly satisfactory! It is one thing where a State is obliged from a position of weakness to reschedule or renegotiate its loans; it is entirely another where that State has a valid legal or constitutional argument on which to base its renegotiation (vide infra).

In the simplest terms, the Shari'a forbids interest on monies lent. Western economies are structured upon it. With the onset of oil wealth, the Arab world has entered the Western system, and in the majority of cases the conflict has simply not been allowed to arise. However, for a lawyer this is hardly satisfactory when he has to advise his clients on the possible legal risks involved in such a transaction as we have been considering.

As to the generality of the prohibition of interest qua riba, we may refer to that great Hanbali jurist, lbn AI-Qayyim, who, following Shafi'i's view, writes in I'lam al-Muwaqqiin,

Dirhams and dinars are the units of valuation of articles sold, and constitute the standard by which the evaluation of property is recognized. It must therefore be fixed and regulated so that it does not go up or down, since were the price (of currency) to go up or down like commodities we would not have a standard with which to value the articles sold. Indeed, everything is commodity, and the people's need for a price by which to value articles sold is a general and compelling one. Such valuing is not possible, save on the basis of a rate by which to know, value. This requires a standard on the basis of which things are assessed, which continues upon one state of affairs, and which is not itself assessed by reference to anything else. If it becomes a commodity which goes up and down, then the transactions of people will be impaired....

II. Is the Islamic System Preferable ?

The second, and no doubt controversial, issue to which I direct your attention for discussion, is the extent not only to which the Muslims may now be largely committed to a system of Islamic financing, but the extent to which they may be justified in regarding this system as better than the conventional Western system. May I quote from what I said at the 1988 Coulson Memorial Lecture:

Do the Arab States really wish, would they even be advised, to tamper with the existing concepts of riba at the present time? When they look at the world banking system, which is based essentially upon interest, and which may seem to them at times to be tottering on its base; when they see the most powerful nations in debt rather than in credit – may this not provide, apart from basic beliefs which exist anyway, a powerful argument that what the Prophet uttered so long ago was entirely right, and that the principle of profit-sharing and partnership is better not only from the religious point of view but in practice? Is Islamic banking not true merchant banking? Why then, they may say, erode the principles of riba as they exist, when it may be contended that they provide the only solution to impending chaos? I am not saying that I subscribe to such an extreme view – I am simply not sufficient of an economist – but it is a solemn thought.

In order to give further background for a consideration of this subject, I would like to refer very briefly to the main incidents in the economic history of the Gulf States, since they provide, after all, the prime example of the sudden onset of vast wealth, and the necessity for its absorption into the world economic scene.

When I first went to the Gulf in 1948, it was common form for the oil concessions of the time to provide for a fixed royalty on the oil produced by the oil companies of 3 rupees 8 annas per ton! The rupee was then valued at Is. 6d., and a ton of oil is seven barrels. Even these munificent terms were of largely academic interest over much of the area because virtually no oil was being produced: it did not suit the international oil cartel to fit it into the existing international marketing pattern. When I advised on the first 50/50 sharing agreement in Bahrain in 1952, the 50 per cent tax payable to the Ruler of Bahrain was calculated upon an inter-company price of $1.40 per barrel (tlie posted price at that time of comparable crude was, as far as I recall, $1.75). The average annual rent for a concession was 100,000 rupees, or £7,500. These undoubted exploitations of the early years were, of course, gradually redressed by the increasing power of OPEC and the demands of that organization, together with the increasing demands for energy, until in the later 1970s the spot price for a barrel of oil in the Gulf reached $41 - $42, of which the OPEC countries were taking the major share. This led, of course, to astronomical increases in income. The current scene reveals an average price of $15 per barrel, and it has been lower. As we know, in all the producing countries there have been drastic cut-backs, and recently Saudi Arabia went to the length of restoring personal income tax, not to control inflation or for any other like economic reason, but because the income was needed. This measure was almost immediately withdrawn, but it tells its own story.

Against this background, the Arabs, looking at the contemporary scene, and having subscribed to the Western economic system in large measure, may perhaps he forgiven for wondering where on earth they have got to!

The Observer Business Section on 3rd April 1988, said, under a heading 'The U.S. Bank Bust':

Some 184 American banks failed last year, the largest number in a single year since the Great Depression. In the first three months of this year, another 44 have gone under. In 1987, America's 200 largest banks suffered a combined deficit of $21 billion, while the top 25 lost more than $7.2 billion. The major cause related to the necessity to raise provisions against Third World debt.
If I may give another quote, this time from The World Debt Crisis and Its Resolution, a publication by the United States Department of Agriculture (1987):
Debt rescheduling has become increasingly common since 1982. Such a move, however, only superficially improves the immediate payment structure. The long term effect of rescheduling will probably be to make the total cost of the debt even more expensive, and to make overconzing the debt problem even more difficult. Developed countries and their lending institutions mayfind that the benefits of forgiving some portion of the debts outweigh the costs that will result. Forgiving some of the indebtedness of the developing countries may stimulate the world marketplace, leading to mutually beneficial trade among nations.

The report to which I have just referred indicates the commencement of the debt crisis as beginning ostensibly with the international debt repayment problems of Poland in 1981, followed by those of Mexico, Brazil and Argentina in 1982. The report accentuates the circular effect of the various forces which go to make up the problem into which we do not have time to go here: briefly, for our present purposes, we might sum up the progression as follows:-

  1. Rapid growth in development in the 1960s and early 70s, when credit was readily available and inexpensive.
  2. Excessive demand for resources, notably petroleum, resulting in a virtual monopoly position for OPEC.
  3. Fourfold increase in petroleum prices initiated by OPEC in 1973-74.
  4. A resulting vast liquidity in the OPEC countries recycled by international bankers in the form of 'petrodollar' deposits by a massive lending program to developing countries.

To quote again from the report, "these bankers anticipated high returns on investments, and assumed that a country guarantee was adequate provision against repayment defaults. The bankers did not ask if the funds were being invested in such a way that a stream of foreign exchange earnings would be forthcoming to repay the loan."

Pausing there for a moment, might not an Arab Islamic banker say that the attitude of the international banks would have been far different if Islamic principles had been adhered to, and if the banks themselves had had equity interests in the projects in which these vast amounts of money were to be invested? Would such a contention be a valid one? Let us bear in mind that the IMF itself has recently recommended the replacement of much of the burden of debt by equity investment. Then, let us recall that this is really what the Shari'a dictates by way of mudaraba and musharaka !

Well, as we all know, the 1973-74 oil price rise set the stage for the large debt accumulation, and then there came the second oil shock of 1979-80. This was too much, and the major industrial countries restricted available credit.

It must be salutary surely to reflect that the guarantee of a sovereign State to pay a debt, regarded historically as sacrosanct, rapidly loses its value in circumstances where the State simply cannot repay. It would appear that of the 25 countries rescheduling between 1981 and 1985, only two, Morocco and Sudan, were Arab States, and of these only one, the Sudan, may be regarded as having essentially an Islamic regime. It is, however, sobering to consider that in many Islamic jurisdictions, should difficulties arise, there might be a legal, even constitutional, argument at the Shari'a with which to bolster up renegotiation or rescheduling – the basic illegality of the original transaction.

III. Mutual Adjustment, or Confrontation ?

My third proposition is in effect – can anything be done by cooperation between the two ideologies to regularize all this ? Because I believe that with the undoubted reassertion of Islam and the Shari'a which is upon us, the alternative is a clash I gave my views on this situation at the 1988 Coulson lecture, and as those views have not changed since then, perhaps I may restate them here.

What, if anything, can be done by the Western lawyer, other than to sit back and wait for an inevitable crash application of the Shari'a ? First of all, realize the existance of the problem, and problem it is. Secondly, Western lawyers must show a great sympathy and understanding for this powerful religious and cultural background, and we have to devise where necessary (not as yet in all jurisdictions) our bridges – if indeed these can be built. There are many ifs. The Shari'a is a sacred subject, and apart from understanding on the Western side, any dialogue must require the cooperation of the Muslim side in what in many quarters is regarded as a forbidden subject. Certainly, let us never underestimate the importance of this subject at this time – a classical and rigid application of the Shari'a to modern economic agreements could be catastrophic, and it is sobering to reflect that this could occur in most of the Arab jurisdictions with no need for.prior legislation. Let it not be thought either that such application is relevant only within a Muslim jurisdiction – what of the situation in a Western court directed by its conflict rules to apply to a contract the Sharia law, proved by expert evidence to be the law applicable as the proper law of contract? Also, what of the enforcement of foreign judgments in the Muslim jurisdictions? These are grave matters.

Perhaps what is required in today's climate is not just a restructuring of the Shari'a to fit Western economic concepts, but some restructuring of those concepts in order to meet the Shari'a: a study of just how far Western and Shari'a concepts are incompatible in the light of a new ijtihad. In so far as dialogue is possible, let us pursue it. The need for it is the reason that I insisted upon 'Tbe Shari'a in Transnational Transactions' as the leading subject of the first conference of the International Bar Association to be held in an Arab country --Cairo, February 1987. The Arab Regional Committee of the IBA formed as a result of the outstanding success of the conference (of which I have the honour to be the first chairman) will, I hope, provide an opportunity for such dialogue. There will be a second major conference of that Committee in Bahrain in March 1989. Another hopeful initiative witli which I am concerted is that of the Euro-Arab Chambers of Commerce in the field of arbitration.

We must take the opportunity for discussion while wise and moderate men are available to participate in it. Really, this can only be done by lawyers, and, in the final analysis Muslim lawyers at that – such is the difficulty where the law is identified with religion. The political implications are, of course, obvious; but for the issue to become an international political issue, or to be overtly treated as such, is, I hope, unthinkable – to say that that would be counterproductive is to understate the obvious. We are too apt to write learned memoranda based upon the material pros and cons of a situation. Our Arab friends can be supreme materialists; but also supreme romantic idealists, and, of course, religionists. Despite the obvious difficulties, I am optimistic enough to believe that something may be achieved.

It should not be impossible. We read in Mr Edge's paper, for example, of the international effort which subsumed the draft Law of Commercial Companies in Egypt in 1980. It is my sincere hope that the material presented here will provide at least a small stepping stone towards the realization of further achievement. There must be many more international fora for the discussion and analysis of these issues.