Islamic Finance
2001-09-24 10:48 am![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
archershipsVia Robert Hettinga's DBS list:
http://www.en.monde-diplomatique.fr/2001/09/09islamicbanking
September 2001
THE PROPHET AND THE PROFITS
Islamic finance
------------------------------------------------------------------------
Islamic banking and financial institutions grew along with political
Islam: it declined, they did not. In fact, Islamic finance is now a
confident part of the new global world of venture capital, ethical
investment and profit-and-loss sharing. by IBRAHIM WARDE *
------------------------------------------------------------------------
The assets of Islamic financial institutions now top the $230bn
mark. That is more than a 40-fold increase since 1982 (1). Most of the
large Western financial institutions, following the example of
Citibank, have their own Islamic subsidiaries or, at the very least,
Islamic "windows" or products aimed at their Islamic clientele. As
proof of how many companies are compatible with Islamic law - and not
just from within the Muslim world - there is now even a Dow Jones
Islamic market index.
This may seem strange. We often hear it said that Islam is
incompatible with the new world order that emerged with the end of the
cold war (2). How can practices rooted in the Middle Ages thrive in
the age of technology-driven global finance? Or institutions that are
suspicious of interest operate within a global, interest-based
financial system? And how can Islamic finance, often considered a
facet of political Islam, experience its most rapid growth just as
that same political Islam is on the wane (3) ?
Modern Islamic finance began in the early 1970s at the intersection of
two important developments in the Muslim world: the rise of
pan-Islamism and the oil boom. The 1967 Six Day war marked the end of
the secular pan-Arab Nasserite movement and the start of the regional
dominance of Saudi Arabia under a pan-Islamic banner (4). With the
start of the Organisation of the Islamic Countries movement (OIC) in
1970, the idea of updating traditional Islamic banking soon became
part of the agenda. It was something that had preoccupied Islamic
scholars, particularly in Pakistan, for a number of years.
Research institutes focusing on Islamic economics and finance began to
spread throughout the Muslim world. In 1974 the OIC summit in Lahore
voted, after oil prices quadrupled, to create the inter-governmental
Islamic Development Bank (IDB). Based in Jedda, this became the
cornerstone of a new banking system inspired by religious
principles. In 1975 the Dubai Islamic Bank - the first modern,
non-governmental Islamic bank - was opened. In 1979 Pakistan became
the first country to embark on a full Islamisation of its banking
sector; and Sudan and Iran followed suit in 1983.
The first paradigm of modern Islamic banking was established in those
years. Islamic jurisprudents reinterpreted a rich legal but
pre-capitalist tradition to suit the requirements of the modern
era. There was a central problem: although commerce had always been
central to the Islamic tradition (the Prophet Mohammad was himself a
merchant), profits from pure finance were viewed with suspicion. The
Koran says, for example, that despite their superficial resemblance,
profits from commerce are fundamentally different from those generated
by money-lending (sura 2, verse 275). More specifically, Islam
prohibits riba. Though the term literally means "increase", it has
been variously interpreted: sometimes as usury (or excessive
interest), more often as any kind of interest. The majority of Islamic
scholars still equate riba with interest, even though major scholars -
including the current head of Egypt's Al-Azhar, one of Islam's oldest
and most prestigious centres of learning - have condoned the use of
certain forms of interest.
Pricing time
Islamic scholars accepted that time must be priced, but objected to
the fixed, pre-determined aspects of interest-based lending with its
inherent risk of lender exploiting borrower (5). In the early days of
Islam, the dominant form of finance consisted in a partnership between
lender and borrower, based on the fair sharing of both profits and
losses - a logic similar to today's venture capital where financiers
link their fate to the firms in which they invest. For instance, in
medieval Arabia, wealthy merchants financing the caravan trade would
share in the profits of a successful operation, but could also lose
all or part of their investment if the merchandise was stolen, lost or
sold for less than its cost.
A distinctive feature of Islamic banking was to be its focus on
developmental and social goals. Profit-and-loss-sharing (PLS), or
partnership finance, with its focus on cash-poor but promising
entrepreneurs, held more economic potential than conventional,
collateral-based lending, which favours established
businesses. Islamic finance also promised to benefit local communities
and draw into the banking system people who had shunned riba-based
finance. In addition, banks were to contribute to, as well as manage,
zakat funds (6) earmarked for a variety of charitable and social
purposes.
The first Islamic banks were committed to partnership finance -
mudaraba(commenda partnership) and musharaka (joint venture) - though
most of their operations consisted of cost-plus operations such as
murabaha, where the bank would purchase the goods needed by the
borrower, then resell them to the borrower at a profit. Remuneration
of deposits (current, saving or investment accounts) was based on a
profit-and-loss sharing logic: investment accounts were remunerated
based on the performance of specific investments by the bank; and
holders of savings accounts shared in the bank's overall profits.
After a few years Islamic finance began to look like no more than an
exercise in semantics: Islamic banks were really no different from
conventional banks, except in the euphemisms they used to disguise
interest. Forays into profit-and-loss sharing were disappointing, and
often abandoned. The image of Islamic banks was also tainted by the
failure of Islamic Money Management Companies (IMMCs) in Egypt in 1988
and by scandals such as the BCCI (Bank of Credit and Commerce
International) collapse in 1991. People dismissed Islamic finance as a
passing fad associated with the oil boom.
In reality, it was on the cusp of a major boom. Deregulation and
technological change had produced a major readjustment in
international finance. And the Islamic world had been transformed by
new political, economic and demographic circumstances (the impact of
the Iranian revolution, the Gulf war, the collapse of the Soviet
Union, the emergence of new Islamic states, a changing oil market, the
rise of Asian tigers, a growing Islamic presence in the West, the
emergence of new Islamic middle classes).
The traditional world of finance, dominated by commercial,
interest-based banking, could raise potentially troublesome
theological issues. But Islamic finance thrived in the new world, with
its downgrading of interest income, financial innovation and blurring
of distinctions between commercial banking and other areas of
finance. The downgrading of interest (and the concomitant rise of fees
as a major source of revenue for financial institutions) allowed
Islamic bankers to sidestep the controversial riba issue. Deregulation
fostered the creation of tailor-made Islamic products. Until the 1970s
financial institutions could sell only a narrow range of financial
products. With the lifting of constraints on products that could be
devised to suit every need, religious or not, Islamic products could
be created. For example, the process of slicing and splicing makes it
possible to split the interest and principal components of a bond, and
sell them separately.
Moralising finance
At the ideological level, the Islamist critique of statism converged
with the emerging "Washington consensus". The Islamic commitment to
private property, free enterprise and the sanctity of contracts meshed
with the emphasis on privatisation, deregulation and the rule of
law. The reliance on zakat and other religiously-based redistribution
schemes matched increased preference, since the Thatcher-Reagan years,
for the downsizing of the welfare state. In many countries, Islam
became a tool for entrepreneurs seeking to get around restrictive
regulation, and the best excuse to disengage the state from the
economy. Malaysia and Bahrain used Islam as a tool of financial
modernisation - essentially as a way of countering the rentier
inclinations of the private sector and the anti-competitive leanings
of entrenched elites who benefited from the status quo. The Financial
Times noted that Islamic institutions are now often at the forefront
of innovation and dynamism.
Perhaps the main impetus behind the current boom in Islamic finance
lies in the excesses of global finance (7). Just as current business
excesses have spawned a preoccupation with ethics, the amorality of
contemporary finance has generated an interest in "moralising"
finance. And whereas Western or Judeo-Christian finance has become
thoroughly secularised (the religious origin of many financial
institutions has long receded from people's minds), the idea of
Islamic finance was bound, at a time of rising pietism (8), to strike
a chord. Islam has a positive view of economic activities, while
providing for a strict ethical framework; and Islamic finance offers a
fruitful compromise between finance and ethics.
This explains the current tendency to focus on the spirit, or "moral
economy", of Islam. In contrast to the 1970s, when literal, legalistic
and scholastic interpretations dominated, the ijtihad (interpretation)
now underway focuses on making modern financial instruments compatible
with Islamic principles. The modernist slant disavows the view that
whatever did not exist in the early days of Islam is necessarily
un-Islamic. Challenging common perceptions that Islam is rigid and
fossilised, it emphasises those adaptive mechanisms - such as
departures from tradition for reasons of local custom ('urf), public
interest (maslaha) or necessity (darura) - that have allowed the
religion to thrive on every continent for 14 centuries.
Whereas the early years of Islamic finance were dominated by
oil-producing Arab states (primarily Saudi Arabia ), and to a lesser
extent Egypt and Pakistan, the new paradigm reflects the diversity of
the Islamic world. A wide range of Islamic products is now available
in at least 75 countries. Even countries that have Islamised their
entire financial systems have done so under different circumstances
and in vastly different ways. In addition, much innovation and
scholarship now originates within Muslim minorities outside the
Islamic world.
Today the fastest growing segments of the industry are outside
traditional banking products and in areas of finance that were either
initially dismissed as unacceptable to Islam (such as insurance or
takaful) or that barely existed in the 1970s (such as micro-lending
and Islamic mutual funds). Funds invested in stocks acceptable to
Islam (shunning unethical or highly-indebted firms, or engaged in
gambling, alcohol sales and other prohibited activities) are
increasingly popular, just like their "socially-responsible" secular
counterparts. Islamic finance still faces a host of challenges
(strategic, economic, regulatory, political, religious), but the
current boom does not seem likely to abate.
------------------------------------------------------------------------
* Research Associate at Harvard University, author of Islamic Finance
* in the Global Economy (Edinburgh University Press, 2000).
(1) www.islamicbanking-finance.com
(2) Samuel Huntington, The Clash of Civilizations and the Remaking of
World Order, Simon and Schuster Touchstone, New York, 1997, p 211.
(3) See for example Olivier Roy, L'Echec de l'Islam politique, Seuil,
Paris, 1992.
(4) Edward Mortimer, Faith and Power: The Politics of Islam, Faber &
Faber, London, 1982, pp 177-220.
(5) Until recently, the Christian and Judaic traditions had comparable
misgivings about interest. See Rodney Wilson, Economics, Ethics and
Religion: Jewish, Christian and Muslim Economic Thought, New York
University Press, 1997.
(6) Zakat, or almsgiving, is of the five pillars of Islam. The others
are the profession of faith, daily prayers, fasting during Ramadan,
and for those who can afford it, a pilgrimage to Mecca.
(7) Roula Khalaf, "Dynamism is held back by state control: As family
dynasties stifle creativity in most of the industry, the Islamic
sector is showing signs of the greatest vibrancy", Financial Times, 11
April 2000.
(8) Yahya Sadowski "'Just' a Religion: For the Tablighi Jama'at, Islam
is not totalitarian," The Brookings Review, summer 1996, vol 14 no.3,
pp 34-35.
http://www.en.monde-diplomatique.fr/2001/09/09islamicbanking
September 2001
THE PROPHET AND THE PROFITS
Islamic finance
------------------------------------------------------------------------
Islamic banking and financial institutions grew along with political
Islam: it declined, they did not. In fact, Islamic finance is now a
confident part of the new global world of venture capital, ethical
investment and profit-and-loss sharing. by IBRAHIM WARDE *
------------------------------------------------------------------------
The assets of Islamic financial institutions now top the $230bn
mark. That is more than a 40-fold increase since 1982 (1). Most of the
large Western financial institutions, following the example of
Citibank, have their own Islamic subsidiaries or, at the very least,
Islamic "windows" or products aimed at their Islamic clientele. As
proof of how many companies are compatible with Islamic law - and not
just from within the Muslim world - there is now even a Dow Jones
Islamic market index.
This may seem strange. We often hear it said that Islam is
incompatible with the new world order that emerged with the end of the
cold war (2). How can practices rooted in the Middle Ages thrive in
the age of technology-driven global finance? Or institutions that are
suspicious of interest operate within a global, interest-based
financial system? And how can Islamic finance, often considered a
facet of political Islam, experience its most rapid growth just as
that same political Islam is on the wane (3) ?
Modern Islamic finance began in the early 1970s at the intersection of
two important developments in the Muslim world: the rise of
pan-Islamism and the oil boom. The 1967 Six Day war marked the end of
the secular pan-Arab Nasserite movement and the start of the regional
dominance of Saudi Arabia under a pan-Islamic banner (4). With the
start of the Organisation of the Islamic Countries movement (OIC) in
1970, the idea of updating traditional Islamic banking soon became
part of the agenda. It was something that had preoccupied Islamic
scholars, particularly in Pakistan, for a number of years.
Research institutes focusing on Islamic economics and finance began to
spread throughout the Muslim world. In 1974 the OIC summit in Lahore
voted, after oil prices quadrupled, to create the inter-governmental
Islamic Development Bank (IDB). Based in Jedda, this became the
cornerstone of a new banking system inspired by religious
principles. In 1975 the Dubai Islamic Bank - the first modern,
non-governmental Islamic bank - was opened. In 1979 Pakistan became
the first country to embark on a full Islamisation of its banking
sector; and Sudan and Iran followed suit in 1983.
The first paradigm of modern Islamic banking was established in those
years. Islamic jurisprudents reinterpreted a rich legal but
pre-capitalist tradition to suit the requirements of the modern
era. There was a central problem: although commerce had always been
central to the Islamic tradition (the Prophet Mohammad was himself a
merchant), profits from pure finance were viewed with suspicion. The
Koran says, for example, that despite their superficial resemblance,
profits from commerce are fundamentally different from those generated
by money-lending (sura 2, verse 275). More specifically, Islam
prohibits riba. Though the term literally means "increase", it has
been variously interpreted: sometimes as usury (or excessive
interest), more often as any kind of interest. The majority of Islamic
scholars still equate riba with interest, even though major scholars -
including the current head of Egypt's Al-Azhar, one of Islam's oldest
and most prestigious centres of learning - have condoned the use of
certain forms of interest.
Pricing time
Islamic scholars accepted that time must be priced, but objected to
the fixed, pre-determined aspects of interest-based lending with its
inherent risk of lender exploiting borrower (5). In the early days of
Islam, the dominant form of finance consisted in a partnership between
lender and borrower, based on the fair sharing of both profits and
losses - a logic similar to today's venture capital where financiers
link their fate to the firms in which they invest. For instance, in
medieval Arabia, wealthy merchants financing the caravan trade would
share in the profits of a successful operation, but could also lose
all or part of their investment if the merchandise was stolen, lost or
sold for less than its cost.
A distinctive feature of Islamic banking was to be its focus on
developmental and social goals. Profit-and-loss-sharing (PLS), or
partnership finance, with its focus on cash-poor but promising
entrepreneurs, held more economic potential than conventional,
collateral-based lending, which favours established
businesses. Islamic finance also promised to benefit local communities
and draw into the banking system people who had shunned riba-based
finance. In addition, banks were to contribute to, as well as manage,
zakat funds (6) earmarked for a variety of charitable and social
purposes.
The first Islamic banks were committed to partnership finance -
mudaraba(commenda partnership) and musharaka (joint venture) - though
most of their operations consisted of cost-plus operations such as
murabaha, where the bank would purchase the goods needed by the
borrower, then resell them to the borrower at a profit. Remuneration
of deposits (current, saving or investment accounts) was based on a
profit-and-loss sharing logic: investment accounts were remunerated
based on the performance of specific investments by the bank; and
holders of savings accounts shared in the bank's overall profits.
After a few years Islamic finance began to look like no more than an
exercise in semantics: Islamic banks were really no different from
conventional banks, except in the euphemisms they used to disguise
interest. Forays into profit-and-loss sharing were disappointing, and
often abandoned. The image of Islamic banks was also tainted by the
failure of Islamic Money Management Companies (IMMCs) in Egypt in 1988
and by scandals such as the BCCI (Bank of Credit and Commerce
International) collapse in 1991. People dismissed Islamic finance as a
passing fad associated with the oil boom.
In reality, it was on the cusp of a major boom. Deregulation and
technological change had produced a major readjustment in
international finance. And the Islamic world had been transformed by
new political, economic and demographic circumstances (the impact of
the Iranian revolution, the Gulf war, the collapse of the Soviet
Union, the emergence of new Islamic states, a changing oil market, the
rise of Asian tigers, a growing Islamic presence in the West, the
emergence of new Islamic middle classes).
The traditional world of finance, dominated by commercial,
interest-based banking, could raise potentially troublesome
theological issues. But Islamic finance thrived in the new world, with
its downgrading of interest income, financial innovation and blurring
of distinctions between commercial banking and other areas of
finance. The downgrading of interest (and the concomitant rise of fees
as a major source of revenue for financial institutions) allowed
Islamic bankers to sidestep the controversial riba issue. Deregulation
fostered the creation of tailor-made Islamic products. Until the 1970s
financial institutions could sell only a narrow range of financial
products. With the lifting of constraints on products that could be
devised to suit every need, religious or not, Islamic products could
be created. For example, the process of slicing and splicing makes it
possible to split the interest and principal components of a bond, and
sell them separately.
Moralising finance
At the ideological level, the Islamist critique of statism converged
with the emerging "Washington consensus". The Islamic commitment to
private property, free enterprise and the sanctity of contracts meshed
with the emphasis on privatisation, deregulation and the rule of
law. The reliance on zakat and other religiously-based redistribution
schemes matched increased preference, since the Thatcher-Reagan years,
for the downsizing of the welfare state. In many countries, Islam
became a tool for entrepreneurs seeking to get around restrictive
regulation, and the best excuse to disengage the state from the
economy. Malaysia and Bahrain used Islam as a tool of financial
modernisation - essentially as a way of countering the rentier
inclinations of the private sector and the anti-competitive leanings
of entrenched elites who benefited from the status quo. The Financial
Times noted that Islamic institutions are now often at the forefront
of innovation and dynamism.
Perhaps the main impetus behind the current boom in Islamic finance
lies in the excesses of global finance (7). Just as current business
excesses have spawned a preoccupation with ethics, the amorality of
contemporary finance has generated an interest in "moralising"
finance. And whereas Western or Judeo-Christian finance has become
thoroughly secularised (the religious origin of many financial
institutions has long receded from people's minds), the idea of
Islamic finance was bound, at a time of rising pietism (8), to strike
a chord. Islam has a positive view of economic activities, while
providing for a strict ethical framework; and Islamic finance offers a
fruitful compromise between finance and ethics.
This explains the current tendency to focus on the spirit, or "moral
economy", of Islam. In contrast to the 1970s, when literal, legalistic
and scholastic interpretations dominated, the ijtihad (interpretation)
now underway focuses on making modern financial instruments compatible
with Islamic principles. The modernist slant disavows the view that
whatever did not exist in the early days of Islam is necessarily
un-Islamic. Challenging common perceptions that Islam is rigid and
fossilised, it emphasises those adaptive mechanisms - such as
departures from tradition for reasons of local custom ('urf), public
interest (maslaha) or necessity (darura) - that have allowed the
religion to thrive on every continent for 14 centuries.
Whereas the early years of Islamic finance were dominated by
oil-producing Arab states (primarily Saudi Arabia ), and to a lesser
extent Egypt and Pakistan, the new paradigm reflects the diversity of
the Islamic world. A wide range of Islamic products is now available
in at least 75 countries. Even countries that have Islamised their
entire financial systems have done so under different circumstances
and in vastly different ways. In addition, much innovation and
scholarship now originates within Muslim minorities outside the
Islamic world.
Today the fastest growing segments of the industry are outside
traditional banking products and in areas of finance that were either
initially dismissed as unacceptable to Islam (such as insurance or
takaful) or that barely existed in the 1970s (such as micro-lending
and Islamic mutual funds). Funds invested in stocks acceptable to
Islam (shunning unethical or highly-indebted firms, or engaged in
gambling, alcohol sales and other prohibited activities) are
increasingly popular, just like their "socially-responsible" secular
counterparts. Islamic finance still faces a host of challenges
(strategic, economic, regulatory, political, religious), but the
current boom does not seem likely to abate.
------------------------------------------------------------------------
* Research Associate at Harvard University, author of Islamic Finance
* in the Global Economy (Edinburgh University Press, 2000).
(1) www.islamicbanking-finance.com
(2) Samuel Huntington, The Clash of Civilizations and the Remaking of
World Order, Simon and Schuster Touchstone, New York, 1997, p 211.
(3) See for example Olivier Roy, L'Echec de l'Islam politique, Seuil,
Paris, 1992.
(4) Edward Mortimer, Faith and Power: The Politics of Islam, Faber &
Faber, London, 1982, pp 177-220.
(5) Until recently, the Christian and Judaic traditions had comparable
misgivings about interest. See Rodney Wilson, Economics, Ethics and
Religion: Jewish, Christian and Muslim Economic Thought, New York
University Press, 1997.
(6) Zakat, or almsgiving, is of the five pillars of Islam. The others
are the profession of faith, daily prayers, fasting during Ramadan,
and for those who can afford it, a pilgrimage to Mecca.
(7) Roula Khalaf, "Dynamism is held back by state control: As family
dynasties stifle creativity in most of the industry, the Islamic
sector is showing signs of the greatest vibrancy", Financial Times, 11
April 2000.
(8) Yahya Sadowski "'Just' a Religion: For the Tablighi Jama'at, Islam
is not totalitarian," The Brookings Review, summer 1996, vol 14 no.3,
pp 34-35.