Conventional financial system has the capability of providing cash for those who want it, provided they are willing to give back more than they borrow and are able to provide a collateral or guarantee. Islamic financial system as projected in its early theoretical phase does not have this facility.
Since loans cannot carry interest, they are regarded as an act of charity. Charity can hardly form part of a market driven financial system focused on generating profits, so it was left to the voluntary sector comprising zakat/sadaqat and waqf.
But in view of convenience, the need was seen for locating such a provision within the financial system. It was suggested that interest free banks enjoying the privilege of using part of the demand deposits for profitable investments be obliged to provide some loans free of interest.
But the practice of Islamic finance during the last 30 years failed to respond to this need in this way. Instead they were advised by some Sharia scholars to take recourse to a method used earlier to ease out individual difficulties.
One who needs cash first buys an item on credit then sells it for cash. Done independent of one another, the one who bought the item for cash being a different person than the seller on credit; it seems a needy person’s method of last resort and would probably be quite old in practice. But in its current practice in a section of Islamic financial market it has assumed an institutional form.
The client approaches the Islamic financial institution (IFI) with a wish and a collateral and comes back with the desired cash after signing a number of papers. One signature would attest his or her purchase on credit, through the agency of the IFI, a motor vehicle or a certain object or a quantity of a precious metal. A second signature will assign the IFI the task of selling that same vehicle or metal on behalf of the client. The third signature will witness that the sale has been affected and the proceeds handed over to the client.
As we observe in case of a certain type of sukuk, it is money obtained now for more money to be paid later. The real asset involved in the process is no more than a dummy. In actual practice too, the same asset facilitates numerous such transactions with no depreciation suffered. Whatever the legal opinion, the economic role of the transaction can hardly be different from that of lending and borrowing money.
As the credit price on which the client buys the asset is invariably higher than the cash price on which the asset is sold, tawarruq (as the method is called) is functionally identical to interest based lending and borrowing.
Islamic economic analysis has shown that, even in the case of a loan for business purposes, exchange of money now with more money later is unfair because of the uncertainty that accompanies the passage of time. Money needs being converted into goods and services before it can enter the process of production-the source of possible growth/value increase. The results of the process of production have to be reconverted into money before money can be paid back to the one who gave it in the first instance. This amount of money, resulting from conversion of the product into money, may be more than, equal to or less than the original amount of money. A system that arranges for exchange of money with more money will suffer from the inequity that this exchange involves. We have also seen that the matter does not stop here.
A system built around such exchanges will be un-stable. The money the bank practicing tawarruq advances to its clients comes from out of the deposits made with it. Whether it is withdraw-able on demand or is in the nature of a time deposit, it has to be paid back. It can be paid back only when the clients payback to the bank (whom they owe the ‘price’ of the asset on the purchase and sale of which tawarruq was based).The important point is, there is no synchronization between the two payment schedules.
From the macroeconomic point of view, the position of Islamic banks practicing tawarruq is exactly the same as that of the conventional banks giving (interest based) loans to their clients.
They lack the shock absorbing capacity that would have come if their operations were based on profit sharing. Given its inequity and instability, a tawarruq based system will also be inefficient. Like interest based debt financing there is no integration between the real sector of goods and services and the financial sector.
No real asset corresponds to an interest bearing loan .In the same manner, no real asset corresponds to the debt obligation created by the first of the three transactions completing a tawarruq deal. As we have noted above, a single piece of real asset can form the basis of innumerable successive tawarruq deals.
So this practice needs to be reinvented through research to make it effective part of our micro and macro-economic system.