I have been asked to comment on a recent fatwa (religious edict) issued by the Islamic Research Council of Al Azhar, Cairo, declaring a prefixed rate of return on deposits permissible under Sharia.

Fatwa took the Muslim world by surprise, starting a debate on this major shift by Al Azhar from an established Islamic position on interest since the advent of Islam. In fact, Al Azhar's own previous fatwas have been against the concept of interest.

Background

It all started when somebody recently posed the following question to Sheikh Mohammed Sayed Tantawi, chief of Al Azhar:

"The customers of AIECB (a Cairo bank) offer their money and savings to the bank which utilises and invests them into its legal transactions against a prefixed rate of return for an agreed upon period. Kindly advise Sharia judgment on this type of dealing by the bank."

Sheikh Tantawi referred the question to the Islamic Research Council of Al Azhar for their study and views. The council came up with the following opinion, which was endorsed by Sheikh Tantawi, giving it the 'fatwa' status:

"Those who deal with AIECB, or any other bank for that matter, and offer their savings to the bank so that the bank will act as their agent in investing them on wakala (agency) basis in its legal transactions against a profit given to them which is fixed in advance for periods agreed upon with the customers. This dealing in this form is halal and there is no ambiguity in it.

Because there is no text in the Holy Quran or explanation in the Sunna which prohibits the dealing where the profit or return is fixed in advance, provided that both parties are contented with this type of dealing."

Scrutiny of the fatwa

The fatwa is misleading on various counts. First of all, the questioner had not mentioned that the bank accepts the funds on wakala basis whereas the council members assumed it to be that way.

Second, it did not specify the nature and the modus operandi of AIECB whether it is an Islamic financial institution or a conventional one. Who are its depositors and where does it invest their funds? As such, the council should have sought more information from the questioner before forming an opinion.

Furthermore, whereas the question was restricted to a particular bank, the opinion given by the council covered all banks in general, irrespective of their structure and nature of operation being Islamic or conventional. As per my knowledge and research, no conventional bank in Egypt operates on wakala basis.

Structure of an Islamic bank is radically different than a conventional one. A conventional bank is borrower of funds from its depositors on one hand and the lender to another set of customers on the other. It earns gross profit by charging pre determined interest rates to the borrowers and pays a lower rate to depositors, remainder being its net earnings.

Moreover, while accepting funds, conventional bank is considered a debtor by the depositors, whereas at the time of lending it to entrepreneurs it is recognised as creditor in their books. In other words, a conventional bank owns the funds while it performs lender's role.

To the contrary, an Islamic bank is partner with its depositors as well as with entrepreneurs, sharing profit and loss at both ends. While accepting funds, Islamic bank's capacity is of a mudareb or fund manager for its customers. On the other hand, while parting with funds to the entrepreneurs, bank's role changes to an investor but on behalf of the depositors and not as owner of the funds.

Here, the Islamic bank is liable to pass on the profit made by it from such investment activities to the depositors after retaining certain amount for it to cover administrative and operational costs besides certain incentive for good use of funds. This has been the reason for Islamic banks distributing historically higher profits to the depositors, compared to the rates offered by the conventional banks.

Funds provided by depositors to an Islamic bank are considered an amana or trust and should there be a genuine loss to the bank, the depositors must share it with the bank. However, if the loss is incurred as a result of Islamic bank's negligence, depositors will not be held responsible and will be eligible to get back their full investment amount.

This element of risk is absent in a conventional bank where the depositors are not inclined to share bank's losses and expect a pre-agreed return along with the invested amount, irrespective of the outcome of deployment of their funds by the bank.

Similarly, the bank does not share losses with borrowers and expects to recover full amount lent together with compound interest.

The peculiar role of agent or Wakeel is prerogative of an Islamic bank and therefore assumption by the council that all banks act as agent in itself is inconsistent to the laws and practices of the conventional banking system.

The council's opinion also states that the banks (all banks!) invest depositors' funds in their legal transactions. What are these legal transactions? The only definition of most frequently conducted legal transaction in a conventional banking environment is to lend the money for a specified period at a fixed interest rate.

To the contrary, in an Islamic bank the legal transactions will represent where bank plays active role in buying, selling, owning and leasing of commodities, vehicles, vessels, aircraft, properties and any other goods or assets not disallowed by Sharia.

It is common knowledge that the conventional banks are averse to the idea of dealing with goods and insist on confining themselves in dealing with documents only. As such, unlike Islamic banks, they do not possess necessary skills required to deal with goods and assets.

Another aspect distancing conventional banks from the Islamic banking practices is that Islamic banks levy wakala fee on depositors for handling their funds. Conventional banks do not have any such practice. Islamic banks are also required to maintain complete record of investment transactions for examination by the depositors, a practice non-existent in conventional banks.

Council has also reasoned that such transactions are halal if both parties are satisfied at the arrangement. In Sharia, mere satisfaction by the parties to an arrangement does not make a transaction halal (allowable) or haram (forbidden).

There are recognised principles in Sharia to distinguish whether a transaction is do-able or forbidden. In addition, Sharia requires its followers to avoid a financial transaction where there is slightest doubt that it may be repugnant to Islamic economic principles.

In view of the above, the council's understanding of legal transactions is ambiguous and does not meet with the common practices and understanding of conventional banks.

The author is the head of risk management at Dubai Islamic Bank.