Islamic Finance: Principles and Ideals
Within the complex history of the Middle East and the Arab world in the last century, many efforts have been made in this area to define an ‗Islamic way‘ of organising the societies of the umma—globalisation is identified to be consisting exclusively of western values, and a resistance to this comes in the form of the rejection for such values and the promotion of religious and historic narratives. Religious thought and practice is currently experiencing a surge that sociologists weren‘t able to foresee some decades ago; Islam in particular, is the fastest growing religion in terms of population, but a revived lenience to religious sentiments is also notable. Religion has stepped in to fill an identitarian void caused by globalisation, while at the same time feeding off it by taking advantage of faster and easier channels of transport and communication to both reach the muslim diaspora and gain new adepts. In this paper I will be looking at Islamic banking and finance as an interesting paradigm that has gained importance in the last fifty years.
With the achievement of independence of Muslim-majority countries by mid-twentieth century, the effort was put in how to redeem the Muslim world from the grip of colonialism once this had formally ended. The task was to generate a way to manage the new independent countries in accordance to their own values and traditions. On one hand, a more secular nationalism sought to establish strong state structures to foster economic development, while on the other hand Islamic religion was re-explored as the locus of a cultural struggle for liberation. In this context, there was widespread theoretical work, and particularly, theory regarding how to conceive of an economic system that would be compliant with Islamic values and in this way halt the predominance of a western-value-led economy. (Siddiqi, 2001)
In the post 1960s period, the failure of economic development in the Muslim world and the rise in the Islamic political identity motivated certain academics, activists and financiers/bankers to discuss the initial foundational issues of what was later to become Islamic economics or IME. Thus, IME is a response to the failure of economic development in the Muslim world, whether capitalist, socialist or nationalist, with an authentic meaning derived from the ontology of Islam, namely the Qur‘an and the Sunnah or the traditions of the Prophet of Islam. (Asutay, 2012: 94)
Islamic economics constitutes thus a body of theoretical work that is interested in driving economic activity, particularly finance and banking, towards a Shari‘a compliant paradigm. As it was conceived by these scholars in the second half of the twentieth century, it was a highly idealistic model that took up the task of emphasising a ‗human-centered‘ development that successfully integrated the values of Islamic ontology. In order to understand what are the core tenets of such theory, what follows is a brief account of the characteristics of Islamic finance and banking.
The first main characteristic of Islamic finance is the categorical prohibition of interest (riba). Interest is a pillar of conventional finance that rests its logic in considering money as a commodity in itself; money is lent at an interest rate, which is the price of money. Sharia understands money as a tool for exchange that cannot be commodified, hence interest is not a possibility. The prohibition of riba is thus central to Islamic finance. A second central aspect of Islamic finance, derivated from the first one, is found in the requirement that investment is attached to real assests, and that lending incurs in a ‗profit-loss risk sharing‘. The reasoning behind this logic is that investors don‘t incur in speculative activities (Maisir), which are explicitly prohibited by Sharia, but instead only put their money in projects that are somehow a cooperation between the various parts. Contrary to conventional finance, when an Islamic bank or financial entity funds a project or an asset, it does not receive compensation in the fashion of interest (the price of the usufruct of money according to time), but rather is bound to the performance of such asset or project. In this way, if the project incurs in losses, both the financial part and the entrepreneur part suffer such losses, and equally if there are profits, they are enjoyed by both parts. Uncertainity or Gharar is also to be avoided according to Sharia, the terms and obligations of contracts must be clear and certain. Investment must also comply with an ethical dimension established by the Sharia, meaning the refusal of enterprises concerning alcohol, arms, pornography, pork and gambling. The main forms of lending or of Islamic financial products are Murabaha (contract of exchange), Ijarah (contract of usufruct), Mudharabah (participation contract), and Kafalah (supporting contract). Islamic finance thus is bounded with a strong ethical dimension that seeks to shape its activity into a practice that is just and beneficial to society at large, seeking to allocate resources in a way that ensures that ‗the real economy‘ is incentivized. (Shanmugam and Zahari, 2009) Despite the conception of Islamic finance as an instrument that must serve the interest of social justice (Maslauah) and the common good, the reality of Islamic banking and financial institutions at present hardly reflects the enactment of such intention. Further in this paper we will look at this fact and comment on the possibilities that Islamic economics still hold for a substantially different economic model that prioritises equality instead of inequality, and useful distribution instead of unproductive accumulation.
Leaving aside a more extensive account of the technical aspects of Islamic finance, interest must be put on the fact than an effort is being made of pursuing an alternative paradigm to western finance, placing such effort in the current social, historic, and economic context, in which western values are being condemned for eroding the religious, moral and socially responsible aspects of social life. Apart from trying to design a model for a more just economy, the appearance of Islamic economics must be understood as a way of making evident fundamental differences between western and muslim cultures.
Western culture finds one of its most distinctive characteristics in the separation of that which is religious—therefore with that which concerns spirituality and morality—with the economy, which concerns the secular administration of the material and mundane ‗things of men‘—all that concerns the economy responds only to the economy‘s own laws.(D‘Arienzo, 2012) The individual in this paradigm is thus not a conscious actor, who takes into consideration for its actions aspects of spirituality and morality, but rather is a rational actor who merely seeks to increase her well-being, acting with her own self-interest as the only metric. Conversely, this separation does not happen in muslim culture, which is still defined by Islamic faith. No realm of social life falls outside religion, therefore the economy is also upheld by religious values and morality. Since the economy is the field in which resources are allocated, be they natural resources or the product of human labour, it should be commanded at all times by a consciously religious behaviour on the part of the actors interacting through it. Failing this moral duty constitutes a sin for ―The waste, hoarding or destruction of resources constitutes a violation of the duty of respect and guardianship of that which belongs only to God, among being an alteration of the principle of social justice and solidarity‖ (D‘Arienzo, 2012: 3)
Mehmet Asutay (2007) makes an interesting opposition of the ethos of the individual generated by neoclassical economics and that of Islamic economics. The first is homoeconomicus, defined as the individual who, responsible only for himself, acts ‗rationally‘, as to maximise his own interest. The second, what he calls homoislamicus, is more bound with the social body in which she thrives, hence her interest is that of the common good, in at least the same importance as her individual gains. For homoislamicus, ‗rationality‘ entails something substantially different than for homoeconomicus; fort the latter, it means complying at all times with the precepts of
Islamic law or Sharia, thus respecting its mandates in the field of economic activities. However, Asutay argues, the ethos of homoislamicus is hardly observable in the behaviour of contemporary Islamic institutions and their practices at present. In tune with that argument, to make a balance on the other front of it, it could be said as well that the type of behaviour of the neoclassical economics type is also seldom realized fully, as individuals do many times sacrifice strictly economic self-interest in favour of other aspects of that individual‘s life that might be a source of happiness. Many studies have come up in recent years that show that monetary incentives often are less compelling for individuals than other sorts of incentive, such as intellectual challenge or communal wellbeing.
A key differential aspect between the secular-western paradigm and the muslim-religious one is, as has been noted previously, in what regards the conception of money. Money is not considered a commodity in itself, thus using it as such, by generating profit from the trading of money, constitutes usury, hence the prohibition of riba. In western finance, the speculation with money becomes one of the main means to generate profit, which is allowed because money is regarded as a commodity in itself. This resonates with another fundamental difference between the two cultures. Islamic faith prohibits any representation of the prophet Muhammad and the God Allah; the idea is that nothing can be interposed between those divine figures and the spirit of the men and women in this world. It is feared that representation of Allah might be deviate attention from its true essence and constitute a kind of mockery to it. Conversely, in western culture—this time seen in light of its Judaeo-Christian tradition—symbols are not only allowed, but immensely widespread. Jean Baudrillard (1981) has argued that in the immense predominance of the symbols over that they should signify, the core recipient of value is displaced from the true essence to its replicated image—he uses the example of the catholic church, in which representations grew more and more stylised and beautiful along the centuries, making them the object of fascination of the believers. The symbols then, come to occupy a place in the social imaginary that was previously that of God. It could be argued that money, the ultimate symbol—insofar as money is a symbol making reference, in theory, to real economic activity which money only mediates—becomes fetishized precisely in the same way. The fetishisation of the signifier over its abstract signified, allows for the symbol to be commodified. In the same logic, applied reversely, it can be argued that since symbols are not considered a legitimate source of admiration and worship in Islamic culture, money does not become fetichised (as an end commodity in itself). This is perhaps what sustains the possibility of considering that to get rich from the speculation with money constitutes a moral violation, for it transcends the metaphysical conception of money.
It is worth mentioning that Islam however does not explicitly condemn accumulation and richness as anti-ethical displays of greed, but rather it is concerned with ensuring that riches are managed within a code of conduct that seeks to realize the spiritual and moral dimension of the individual and the Islamic community at large. Islamic economics then is charged with the task of ensuring that riches are put to work in the interest of the wellbeing of society without the need of a taxatory state (a 2.5% tax known as zakak on benefits does exist, but it is only conceived as a transfer from most well-off to the very poor). Unfortunately, at present Islamic finance has an observable gap between its utopian conception and the actual practices the institutions engaging in Islamic finance actually engage in. In most cases, the activity of these institutions can be regarded as being ‗just enough‘ compliant with Islamic precepts as to save face. As Hesse, Jobst & Solé have demonstrated (2008), the compliance with sharia precepts of Islamic financial institutions is very much limited to the non-use of riba, while failing to achieve its other tenets of funding the ‗real economy‘.
This is significant, because the failure of the financial and banking system to provide the service of funding entrepreneurship curtails the possibility of a sustained economic growth, which in its turn undermines democracy. Mainstream comparative politics theory argues that an increase in economic development is directly related with an increase in democracy. However, criticism of this assumption holds that economic development cannot be measured in the reductionary metrics of GDP and GDP growth. In order for economic development to be effectively constitutive of a higher level of democracy it has to be generated by a reasonably diffuse and generalised economic production. When instead the economy relies greatly on the exploitation of natural resources, the correlation of a high GDP and democracy is not strong at all. (Herb, 2005) This is observable in the case of the oil-rich countries of the Persian Gulf, which have had a very high income in the last decades thanks to their oil-reserves. The positive monetary balance however has not been put to use to generate an economic circuit within the country that is independent of the oil reserves; instead the dependency on the natural resource is fully exploited. These are most often authoritarian regimes, that while not having to resort to taxation to fund themselves and provide services for the citizens of their countries, they do not depend on their citizens for legitimisation, and are thus free to operate power in virtually full autonomy. This paradigm is known as rentier economy. Islamic finance, if it was applied responding to its true spirit, would be an efficient way to ensure the distribution of the benefits derived from natural resources, not only in the form of social services, as it is now, but also in the creation of a national industry that is more decentralised. The elite classes of these countries have become very rich, and instead of engaging in Mudharabah type of financing, they acquire exotic and luxurious assets such as real estate (sky-scrappers and luxury homes in London, New York and Paris) and assets such as football clubs.
Among the difficulty to find an underlying cause in the Arab world that would justify the sudden spike of protests in early 2011 in what is known as the Arab Spring, one aspect has been pointed as a potential common signifier for the social unrest of this area. This is, that the obscene richness displayed by the elite classes of the oil-rich countries of the Gulf was indignant to the non-oil countries such as Egypt, Yemen, Tunisia and Syria, who would witness how the surplus enjoyed by its fellow umma countries was not being redistributed in the region, missing on a great chance for regional development and integration (Luciani, 2005)
While the precepts of Islamic finance are well-spirited and, were they to be applied fully, hold the potential to be highly beneficial to society, these are very difficult to realize in the framework of global capitalism. The Islamic financial and banking institutions are inscribed in a financial circuit in which the majority of their competitors work solely on the basis of profit maximisation, hence they are in a great deal forced to abide to the same dynamics. Furthermore, in such a system, it would be naïve to believe that actors could be encouraged to follow moral values and norms of conduct detrimental to getting rich—it would take highly pious individuals to subjugate profit maximisation in favour of more illustrious causes. It is not because the neoliberal conception of human nature as avaricious by default is true, but because the hegemonic global model rests on a philosophical conception that does hold this principle as true, and so rewards behaviours of greed, and often overtly anti-social attitudes. The financial world is doubtlessly the sphere in which such behaviours are most encouraged, considering it feeds off ruthless competition, hence the possibility of imposing a moral conscience in favour of religious or simply ethical principles becomes much harder than in any other realm.
The failure of Islamic finance to ensure a more egalitarian distribution of wealth greatly undermines the credibility of these institutions. However, the idea behind Islamic finance should not be dismissed—quite contrarily, it should be further encouraged. It has been argued that the current approach is far from ideal, and many are suggesting interesting solutions. A very contentious aspect comes in the way in which Islamic financial and banking institutions seek to regulate themselves, as to be according, in their activities, with the Islamic law of the Sharia. Each institution has its own board of Sharia consultants, who are paid by the bank to vet its activities. A Sharia board that is employed by the same institution it is supposed to regulate creates an evident moral-hazard; ―unfortunately, discussions of Islamic finance today are dominated by large banks that can afford to pay hefty fees to Shari‘a scholars and lawyers, who jointly develop new Shari‘a arbitrage analogs of bonds, derivative securities, etc.‖ (El-Gamal, 2005: 7) This could be resolved, El-Gamal suggests, by denouncing the interest-driven attitudes of Sharia boards and returning to a mutuality model of finance. Umer Chapra of the Islamic Research and Training Institute considers the need of establishing a Sharia Court for financial matters that could impartially audit so-called Islamic financial institutions and ensure they actually comply with Sharia law. (2008) Such an institution would also need of a very well-trained body of scholars versed in this type of matter, which at present is lacking.
Asutay however argues that it is not that big Islamic finance and banking institutions have ‗gone wrong‘ at some point in their development but rather that their attitude and their tendency are completely normal and it was the expectations were wrong. Instead of trying to reform these infused with more ethical constraints, the solution is to create a set of institutions that fill the void left in terms of social utility and promotion of social well-being and development. Thus, ―[t]he creation of ethical IBF and investment institutions, in the form of Islamic social banking, as part of civil society should be the next stage of financial development in the moral economy of the Muslim world.‖ (Asutay 2010: 185)
Certainly, many of the struggles that the Islamic financial system represents in terms of its lack of ethical behaviour resonate with claims being made in the secular societies of Europe. In fact, the tenets of Islamic banking coincide greatly with many of the suggestions for a more ethical banking made in Europe in the last decades. Most of the measures suggested by El-Gamar in his conference at Harvard to help redirect Islamic finance to its true ethos hold great resemblance with those of Christian Felber in his book The Economy of the Common Good. The book consists of an interesting proposal of policies to make the economy directed towards the realization of the common good: mutuality, lenders of last resort, customer representation in the board of trustees, ‗common good index‘, etc. are all somehow constitutive of a body of law that could be then not so dissimilar to Sharia in its economic respects. IDespite Sharia not being an immutable block of laws, but rather a constant adaptation and reinterpretation (Ijtihad) of the principles expressed in the Qur‘an, it certainly has an immutable foundational reference in the Qur‘an. ‗The common good‘ conversely is more open to new definitions, and in this sense is weaker than Sharia for the task of implementing itself as the maxim that should regulate the economy.
As has been said, the argument is made by many academics reflecting on the failure of Islamic banking and financial institutions in staying true to the moral and socially responsible substance of Islamic Economics theory, that some side institutions could be set-up that truly engaged in lending to the real economy taking a more holistic and less formal approach to their activities. However, in my view, this is something that western finance has already gone through. The creation of satellitar, (somehow parasital to the mainstream) institutions that are set up to palliate the more negative effects of the hegemonic system, or reach to those it marginalises, only reinforces the detachment of those more rich and powerful from their social responsibility, alleviating the urgent need to reform the system into a more just one. What is needed is big, ambitious top-down policy that seeks to make the ethical constraints central to economic activity.
It is likely that in the near future, the demands of civil society for a more responsible and ethical financial system will only increase. In this case, it would be good that the secular idea of the common good and the religious conception of a moral economy joined efforts to think of ways in which this could be done, given that the common interests and fears are many.
References
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Asutay, Mehmet. 2007. ―Conceptualisation Of The Second Best Solution In Overcoming The Social Failure Of Islamic Banking And Finance: Examining The Overpowering Of Homoislamicus By Homoeconomicus‖ IIUM Journal of Economics and Management 15, no. 2: 167-195
Baudrillard, Jean. 1994. Simulacra and simulation Michigan, University of Michigan Press
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D‘Arienzo, Maria. 2012 ―I fondamenti religiosi della finanza islámica‖(quote translated by the author for the present paper)‖ Diritto e Religioni, n. 1/12
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