Saturday, June 21, 2014

CHARGING FEES FOR FINANCIAL GUARANTEE: THE BASIC ISSUE

GUARANTEE FEES AND ISLAMIC FINANCE: WHAT IS THE BASIC ISSUE??

Islam prohibits charging of interest for money lending if such is contractually made compulsory on a borrower and as such has made it very clear that payment and receipt of interest made compulsory based on contracts between the two parties is prohibited. However the borrower is allowed out of his own accord without compulsion to pay more than what he had borrowed from the lender as a token of gratitude for the kindness rendered. Money lending must always be treated as a benevolent contract in Islam that its shall carry no interest charges.
Having said that one may ask: will it be possible or allowable to charge fees for provision of a financial guarantee which is itself a form of standby credit/lending to cover for a possible default by a guaranteed borrower/debtor??. It is known that it is a matter of contingency whether the guarantee is ever utilized or not; depending upon whether there is any actual default by the borrower in which case the guarantor will be called or tasked to pay the debt in question. Assuming there is such a default and the guarantor had duly paid the debt to the creditor to discharge the debtor's debt, provided such a guarantee was given as a result of a request by the debtor, then the guarantor who had paid the amount to the creditor will undoubtedly have a right of full recourse against the debtor. It is like the debtor had actually borrowed the amount from the guarantor in order for the debt to be repaid.

Now if fees are collected by the guarantor for providing such a guarantee as explained what it means is that he would receive at the end of the day more than what he had lent to the original debtor (full recourse amount plus guarantee fees) which in itself will constitute riba/interest arising from lending. When Islam prohibit charging of interest for money actually lent as in the case of straight lending with interest, or as in the above case where the guarantee is utilised then is there any doubt about the unlawfulness of charging fees for money not actually lent as is in the case where the guarantee is not utilized. If charging interest for money actually lent is riba, then charging fees for guarantee not utilized can be argued to be more serious than in the first case. This is the operation of a principle known in Islamic law as a form of rule based on qiyas awla (min bab al-awla) meaning a fortiori in English which means a more serious case as compared to the other one (i.e. charging interest for money actually lent.); if charging fees for provision of guarantee as explained is allowed then what is so big about charging interest/fees for money actually lent as charging fees for no borrowing is far more serious than charging interest for money actually lent.

The fact is that the Muslim jurists of the past were very aware of this situation when they decided that charging fees for guarantee is not permissible in Shariah as it leads to riba coming through a back-door (when the guarantee is utilized), and the problem seems to be more serious when the fees are collected while the guarantee is not utilized. In the case of actual lending with riba, even though the borrower receives benefit from the lending/borrowing, still the creditor is not allowed to charge interest. What more to say if there is no actual lending taking place (i.e. guarantee not utilized), can the lender/guarantor be allowed to charge fees?

It is to be pointed out however, as known, conventional banks charge interest for their lending activities as a matter of routine because profit for them come in the form of interest charged; the bigger the amount the better. Since lending is done in a big scale and on a consistent basis the issue of credit risk posed by such activities arise. In order to ensure smooth running and growth of lending and credit activities it is of no surprise that issuance of guarantee with fees is common place as well to support the lending activities as stated. In this context borrowing is encouraged all the times and to the fullest extent as it is the life blood of the banking business, hence guarantee with fees and with it credit guarantee schemes are offered everywhere to support such lending. This is of no surprise in the context of conventional banking/finance as everything revolves around lending with interest. Hence charging fees for financial guarantee has been treated as another form of financial business/product with ease.

But the sad thing is about the practice of charging fees for issuance of guarantee by Islamic financial institutions that has been quite normal a practice for years conducted based on some doubtful justifications. The paradox in this case is that these same institutions are projecting themselves as riba-free financiers who are supposed to to do away with charging interest but when they collect fees for contingency lending activities ( giving financial guarantee) as described above then something must be very alarming, and in fact such fees are to form part of the incomes/profit generated from the so called Islamic financial service business. When riba is of no concern to conventional banking/finance we fully understand; there is nothing much to say about collecting or charging fees for the provision of financial guarantee as it is a form of lending as well although on contingency basis. But when the fees are charged by the so-called Islamic banks which are supposed to avoid riba (coming from money actually lent), then a serious question will arise as to whether riba is truly avoided in their operation as far as charging fees for guarantee is concerned.

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