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Home arrow Business & Finance arrow The art of RF (riba-free) Islamic banking and finance
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Another issue came up involving barter trading during the time this RF law (the Judeo-Christian-Islamic Shari'aa law) was being developed by the Prophet (pp). The challenge, at the time of the Prophet (pp) as it is today, was how to deal with the challenge of pricing and trading items that could be measured using more than one method — for instance, palm tree dates — as experienced during the time of the Prophet Muhammad (pp). Palm dates can be dry or fresh; they can be measured in size (large, medium, and small) or in numbers of dates, or in terms of weight. Another example, in the case of food items, is that one can exchange rice for rice, but the parties may disagree because one party's rice is inferior in quality to the other party's rice, the length of the grain of one type of rice is longer than another, or the aroma of one type of rice is in more demand than the other type. For dates, it might be that one party had larger dates while the other's dates are smaller and of sweeter quality. In both of these cases, using the Commodity Indexation Discipline required in RF banking and finance, one can only exchange the same weight of rice without increase regardless of size and quality. Another example is the case of dates or grapes.

There are fresh dates or grapes, and there are dried dates and raisins. The question was “Are they the same food items?” The answer was yes, and when they are exchanged they must be in equal amounts: that is 100 small dates for 100 large dates, because the RF Commodity Indexation Discipline rules that dates are dates, regardless. This issue came up when one of Prophet Muhammad's (pp) companions (Bilal, the Ethiopian whose job was to chant the call for the five daily prayers at that time) brought him a gift of large, very high-quality dates. The Prophet (pp) knew that Bilal did not have the means to afford to buy these high-quality large dates. He inquired. Bilal told him that he saved his ration of low-quality small dates for some time and that he went to the market and exchanged them for a smaller number of higher-quality, larger dates. The Prophet Muhammad (pp) told him that this transaction was classified as a riba transaction and that it is divinely prohibited (haram). When Bilal asked what he should have done, the Prophet (pp) said that the small-sized, low-quality dates should have been marked to market by selling them in terms of another reference commodity to satisfy the RF Commodity Indexation Discipline described earlier, such as gold, silver, rice, wheat, or barley, and that he should have used the proceeds to buy the large, higher-quality dates. This way, deception (gharar), misrepresentation, and interference in the free- market forces of supply and demand would be minimized and hopefully eliminated. This process, which we call in this book the RF Marking-to- Market Discipline, helps to fairly define prices and to standardize and stabilize markets, allowing the efficient working of the market forces of supply and demand. This RF discipline has been used by LARIBA since 1988 and is the main reason for its superior portfolio performance over the years.

The Marking-to-Market Discipline is believed to be one of the most important historic developments in the RF finance and banking system and domain. It lays the foundation of fair pricing for products and services, based on real market values within an open and free market operation. The RF Marking-to-Market Discipline is the foundation of the analytical system used by LARIBA[1] to operate in an RF finance mode that is unique.

It is important to stress here that the RF banking brand is not based on renting money at a rental price (interest) but on the actual measured fair market rent of properties, businesses, and services. For example, consider buying a house. The buyer who wants to obtain RF financing and the RF finance institution should mark the house to market. The best way of doing that is to find out how much a similar house in the same neighborhood and with similar specifications would rent/lease for in terms of U.S. dollars per square foot (or euros/square meter). This mutually agreed-upon live market lease rate is used to calculate the rate of return on investment of the proposed purchase and RF Finance transaction, looking at it as an RF investment. If the rate of return on investment makes economic sense (i.e., it is equal to or higher than the expected return by our RF investors), the RF bank proceeds to finance (invest in) the property. In addition, the RF bank does its best to make the monthly payments in the RF mode of financing competitive with those offered by riba-based banks. A very low return implies that this investment would be inferior; the RF banker would advise the customer not to invest.

The RF banking and finance discipline, in an effort to neutralize the effects of the prevailing fiat currency in the local markets, requires that we first apply the Commodity Indexation Discipline to check, in a macroeconomic way, on the existence of a bubble in the business that we are considering to finance. This process is followed by a Mark-to-Market Discipline and approach, evaluating the economic prudence by calculating the real return on investing in this item, using its actual real market rental value. This way, it is affirmed that money is not rented using the prohibited riba — and that the rent is that of the market rent of the facility in the marketplace. For example, in the case of:

■ A car, the value for which this car is leased in the market (dollars per day), as obtained from actual operating leasing companies.

■ A house, the actual market rental or lease rate (dollars per square foot) of a similar house in the same neighborhood. It is important to make sure that this house has essentially the same specifications and is located in the same neighborhood as those researched. These rates can be obtained live preferably from real estate agents or from market data on the Web.

■ A commercial building, the actual market lease rate of the space.

■ A piece of equipment, the market rental value, in dollars per day.

■ A business, the lease rate an owner is willing to lease it for in the market.

This rate is used to calculate the rate of return on investment because RF bankers do not rent money — in fact, they invest with and in the customer. If the rate of return is higher than the target return for the institution (which is the return expected in the market from shareholders and depositors), then it makes sense to finance/invest with the customer. If the return is lower, then it does not make sense to finance/invest, and the customer is advised and the application may be declined. This rejection is applied even if the customer has fulfilled all standard banking requirements from the creditworthiness test, the appraisal test, and the capacity for servicing the financing obligation. We will discuss this process in more detail in Chapters 11 and 14, and examples will be given.

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