Monetary and Financial Theory and Institutions
In this paper an attempt has been made to present a viable model of interest free commercial banking in a mixed capital market. The study assumes that interest is prohibited in Islam. As an alternative to interest the study suggests that banking operation is possible through ‘trading’ and financial transactions can be linked with accepted Islamic practises of Muzar’ah, Musaqah, Mugharsah, and Qirad/ Mudarabah. The study recognises that interest is a key element in modern banking and its elimination may even distort the generic notion of a modern bank. But it is also true that modern banks are switching their operation towards ‘non-banking’ activities. Factoring and other similar activities related to ‘trading’ provide a clue to alternative activities. The very fact that portfolio structure of commercial banks differs and the proportion of interest in income and outgo varies from bank to bank and also from time to time in the same bank reflects flexibility. It also indicates that bank activities depends upon availability of opportunities as well as upon management discretion. Besides banking legislation in most countries do not insist upon interest transactions. The main purpose of legal stipulations is to ensure the solvency of banks and insist that banks must be able to meet their financial obligations at all times and under all circumstances. This condition, like modern banks, Riba Free banks can effectively meet the pursuing a matching policy. The purpose of matching assets with the nature and terms of liabilities is to: (a) meet the de facto and de jure requirements of cash (b) fulfill the expectations of the depositors and borrowers (c) cover the administrative cost of the banking and non-banking operation (d) yield a surplus to satisfy the depositors and (e) contribute to its reserves for future expansion and growth. Keeping in view the additional constraints involved in interest free banking, several saving schemes have been proposed in this paper. They include Demand Deposits, Joint Venture Plan, Unit Investment Plan and Housing Deposit Schemes. Each of these saving plans have distinctive character and differs from those offered by modern commercial hanks. 39 The Riba Free Banks will stimulate ‘product differenciation’ which is the main character of imperfect competition. Riba Free Banks will be offering distinct services especially tailored for those looking for investment without interest and prefer to share profit or losses. Success in imperfect capital market will depend upon the ability of Riba Free Banks in creating product differenciation and motivating the people to choose an interest free financial transaction.