Islamic Finance
By Saulat Pervez
Muslims often try to explain that Islam is more than a religion. They contend that Islam is actually a ‘way of life,’ with the Quran and the life traditions of the Prophet Muhammad (pbuh) providing a blueprint for daily life. From marriage and family life to lawful food and drink, from modesty in dress and excellence in social manners to ethics in trade and finance, Islam encompasses all aspects of our existence. One of these, Islamic finance, is gathering more and more interest from Muslims and non-Muslims lately.
A recent article on CNN.com highlights the importance of Islamic finance in today’s economic-crunch world. It reports that according to ratings agency Moody’s, the global Islamic finance sector is worth $700 billion and has the potential to be worth $4 trillion.
Professor Habib Ahmed, Sharjah chair in the school of government and international affairs at Durham University, England, told CNN, “Islamic finance has been growing by 15 to 20 percent per year for some time and there is a lot of interest at the moment. People are looking for alternatives after the economic crisis.” In fact, Durham University will be offering a Masters degree in Islamic Finance from October of this year, in line with a number of other European institutions.
A fundamental difference between conventional banking and Islamic banking is that the latter does not charge interest. The Quran expressly forbids trading in interest in several places.
At one point, God says, “And God has permitted trading and prohibited interest. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is up to God (to judge). And the ones who revert back, those are the people of Fire. There they remain (for ever).” [2:275]
Interestingly, Judaism and Christianity also prohibit usury. For instance, the Bible states, “Do not charge your brother interest, whether on money or food or anything else that may earn interest.” (Deut. 23:19) Yet, Islam is the only faith which maintains this prohibition originally observed by Christians and Jews.
“People think the Islamic [financial] system is based on faith, but it’s based on justice. The system is based on justice for the two parties and how you get to the justice is extracted from Islamic faith,” Aly Khorshid, an Islamic finance scholar who writes for Islamic Banking and Finance magazine, told CNN.
Comparison of Islamic and Conventional Finance
Islamic Finance Conventional Finance
Interest-free
Interest-based
Equity partnership (profit and loss sharing)
Profit is the chief motivation
Inherently micro-financing-friendly
Not inherently micro-financing-friendly
Checks and balances to maintain ethics and justice
Not enough checks and balances which can lead to excess, causing economic meltdowns
Indeed, while Islam prohibits dealing in interest, this does not mean that the system is not based on profit. In his book, An Introduction to Islamic Finance, Muhammad Taqi Usmani explains that commercial banking under Islam is based on the concept of profit and loss sharing. It is an equity partnership in which both parties not only benefit from the profit, but also share in the losses. Other features have been added to Islamic banking in view of contemporary needs, such as leasing, cost plus financing, delayed payment sale, etc. Yet, these are not substitutes for interest. “They have their own set of principles, philosophy and conditions without which it is not allowed in Islamic law to use them as modes of financing,” adds Usmani.
“Islam does not deny the market forces and the market economy. Even the profit motive is acceptable to a reasonable extent. Private ownership is not totally negated,” writes Usmani. “Yet, the basic difference between capitalist and Islamic economy is that in secular capitalism, the profit motive or private ownership are given unbridled power to make economic decisions. Their liberty is not controlled by any divine injunctions. … This attitude has allowed a number of practices which cause imbalances in the society.”
In fact, today’s severe economic downturn was triggered by banks excessively dealing in mortgage-backed securities and credit-default swaps, two of the practices which Islamic banks on principle do not transact.
“The global financial crisis and the credit crunch were inter alia the result of greed and avarice – since financial institutions advanced loans to people who did not have repayment capacity. If the aforesaid financial institutions were practicing Islamic finance, the problem might probably not have arisen,” stated Aftab Ahmad, an economic writer from Islamabad, Pakistan.
“The present interest-based system is of an exploitative nature as capital earns profit under this system without taking any responsibility and running any risk,” he commented. “Besides, smaller sectors of the economy such as the small enterprises and small farmers can not often avail themselves of credit facilities under this system because they are unable to pay interest at the higher rate.”
However, under a profit and loss sharing system, not only is micro-financing easier, the finance system forces the financiers to ensure that their businesses remain profitable. In this way, there would be more “employment generation and national income would increase manifold. Thus, the society, at large, would be the gainer in this system,” Ahmad observed.
At the same time, he believes that current Islamic banking in Pakistan is not entirely based on the profit and loss sharing system. “While the traditional banks pay interest on deposits and charge interest on loans advanced by them, the Islamic banks pay profit to the depositors and collect service charges on credit facilities provided by them. The profit disbursed to the depositors and service charges collected from the borrowers by an Islamic bank have been certified by Islamic scholars as perfectly Islamic in character,” he said.
Ahmad recommends that Islamic banks adopt innovative products to capture a greater market. “The traditional banks, in spite of their gigantic size, are profit-oriented rather than welfare-oriented. By bringing welfare-based products in the market, the Islamic banks may acquire an edge over the traditional banks,” he opined.
With justice and ethics as its chief means, Islamic finance has the potential to not only streamline today’s erratic banking trends but also to eradicate poverty across the globe. As a matter of fact, it is these characteristics which are drawing the attention of traditional financial institutions which are eager to learn their lessons after the recent banking meltdown. Let’s hope that the world at large will adopt this honest and moral system of banking in the near future, affirming divine foresight and wisdom!
The Prophet (p) was asked which was the best form of income. He replied: “That for which a man works with his hands. And honest trading.” The Prophet himself was a trader and was well-known for his integrity. In fact, he was popularly known as “al-amin,” which means “the trustworthy.”
At a time when prices became high, people asked him to fix prices and he replied, “God is the One who fixes prices, who withholds, who gives lavishly, and who provides, and I hope that when I meet Him, none of you will have a claim against me for any injustice with regard to blood or property.” This points to the importance of fair trade and freedom of individuals to sell and buy without interference, allowing the market to fluctuate according to supply and demand. Price controls can result in a number of negative effects such as quality deterioration of good or services like a landlord reducing his maintenance of a rent-controlled apartment, a black market where goods are sold illegally, rationing being imposed to deal with shortages produced by the controls, and so on.
However, when there is manipulation of prices by businesses or merchants in attempts to undermine market efficiency and fairness, then public interest takes precedence over individual freedom and “price controls do become permissible in order to meet the needs of the society and to protect it from exploitation and injustice” (An Islamic Perspective on Fair Trade, Ajaz Ahmed Khan and Laura Thaut).
The importance of integrity and honor in business dealings is pointed to by the Prophet’s (pbuh) statement, “A truthful and trustworthy merchant will be in the company of the Prophets, the upright, and the martyrs.” So what happens when corruption permeates the market and economies of nations and the global community are controlled by those who care little about fairness and social justice? What happens is that poverty and suffering afflict untold numbers of men, women, and children: more than 3 billion people in the world who live on less than 2 dollars a day; the people of Africa who own only one percent of the total wealth of the world; the six heirs of the Wal-Mart fortune having as much wealth as the bottom one-third of all Americans combined (roughly 100 million people); the top 0.01% of Americans making an average of $27,000,000 while the bottom 90% make an average of $31,000.
A World System of Financial Control
In Tragedy and Hope: A History of The World in Our Time, Professor Carroll Quigley of Georgetown University, (a teacher and mentor of Bill Clinton) wrote,
The powers of financial capitalism had another far reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements, arrived at in frequent private meetings and conferences. The apex of the system was the Bank for International Settlements in Basle, Switzerland, a private bank owned and controlled by the worlds’ central banks which were themselves private corporations. The growth of financial capitalism made possible a centralization of world economic control and use of this power for the direct benefit of financiers and the indirect injury of all other economic groups.
So the central banks are at the core of this “world system of financial control,” a system “controlled in feudalist fashion” by central banks. What is this new feudalism? It’s giving every economic advantage, tax preference, and government subsidy to the “job creators,” the wealthy elites of industry and the corporate world, and attaching to that preferential treatment the mock notion that prosperity will trickle down to the general population. But in this system, everyday working men and women are like the vassals waiting outside the castle or estate wall hoping for some paltry generosity from the lord of the manor.
A perception that the financial industry, as it is structured, is primed for unscrupulous outcomes is not without warrant. Mayer Amschel Bauer Rothschild, the 18th century banker who has been called the “founding father of international finance” is quoted as saying, “The few who understand the system, will either be so interested from its profits or so dependent on its favors, that there will be no opposition from that class” and “Let me issue and control a nation’s money and I care not who writes the laws.” Napoleon Bonaparte said, “…financiers are without patriotism and without decency; their sole object is gain.” In 1933 Franklin Roosevelt said, “The real truth of the matter is, as you and I know, that a financial element in the large centers has owned the government of the U.S. since the days of Andrew Jackson.”
Thomas Jefferson said, “If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks…will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered…. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.” David Rockefeller wrote in his 2002 memoirs “Some even believe we are part of a secret cabal working against the best interests of the United States, characterizing my family and me as ‘internationalists’ and of conspiring with others around the world to build a more integrated global political and economic structure — one world, if you will. If that’s the charge, I stand guilty, and I am proud of it.”
A Business Model Whose Sole Object is Gain
Exploitation, fraud, and manipulation is the business model in international finance today, as the “sole object is gain.” Goldman Sachs made huge profits betting against investments they sold to their own clients. The big banks colluded to rig the public bids on municipal bonds, cheating cities and town of billions of dollars. Bear Stearns sold the same mortgage to multiple buyers as part of complex investments linked to mortgages. JP Morgan is being investigated for illegal manipulation of electricity markets, have been fined for violating embargo laws, and are cited in a Senate report on their $2 billion loss on derivatives about which they lied to investors and to Congress.
This is the tip of the iceberg. Even the World Bank stands accused of fraud. Karen Hudes, who studied law at Yale Law School and economics at the University of Amsterdam, worked in the Legal Department of the World Bank from 1986 through 2007, eventually as senior counsel. She is now a whistleblower who has tried to expose questionable loan procedures involving hundreds of millions of dollars. She says, “I saw corruption. I saw that poor people weren’t getting what was coming to them. They were starving and the reason they were starving is because people made sure that the money that was intended for the poor was lining someone else’s pockets. ..The people in management wanted to make sure that the money continued to flow in the wrong direction.” She asserts that everyone in the world suffers because of the corruption at the World Bank, as it is an “international cooperative that’s owned by 187 countries including the U.S. which has a 20% share. And when there’s a breakdown in the rules of the World Bank what this basically means is that the entire financial system is broken.”
She sounds the alarms, noting, “What I ultimately documented was something very serious which is called state-capture.“ In the literature of business and economics, state-capture is defined as “… efforts of firms to shape the laws, policies, and regulations of the state to their own advantages by providing illicit private gains to public officials” (Hellman and Kaufman, 2001). Citing a landmark Swiss study published in the PLOS ONE journal on the “network of global corporate control,” Hudes notes that a small number of entities — mostly financial institutions and especially central banks — dominate the international economy. “What is really going on is that the world’s resources are being dominated by this group.” Included in the core network of control, as noted in the study, are familiar names including Morgan Stanley, Citigroup, Merrill Lynch, Bank of America, JP Morgan Chase, Goldman Sachs, Bear Stearns, Lehman Brothers, and others. According to the study, 147 financial institutions and central banks, in particular the Federal Reserve, stand at the very core of this super-entity that, through its complex network, controls the international financial system. “This is a story about how the international financial system was secretly gamed, mostly by central banks — they’re the ones we are talking about.”
Those Who are Ruled by Avarice
There are many wealthy people in the world whose fortunes are acquired legally, through hard work, who live decent, moral lives, and who care about the poor and disadvantaged. But there is a percentage of the super wealthy who care nothing about fairness and social justice and seek to reign over the world’s population. They have the upper hand, poised as a ruling class, enjoying power and privileges that they do not want to relinquish or see diminished in any way. They typify those who are ruled by their avarice: “If the son of Adam were given a valley full of gold, he would love to have a second one; and if he were given the second one, he would love to have a third…” (Bukhari).
Those who engage, as described by FDR, in “business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, [or] war profiteering” are willing to exploit ordinary people in order to ensure that surplus value produced by those who labor for a living is channeled exclusively towards the top, to the owners of capital. Workers are paid as little a wage as possible that allows, just barely, the survival of themselves and their families so that the elites may further hoard their wealth. This is contrary to the divine injunction to make sure that the distribution of wealth does not unfairly advantage some to the abject detriment of others. Abu Saeed Khudhri reports that the Prophet (p) said; “Anyone who possesses goods more than his needs, should give the surplus goods to the weak (and poor); and whosoever possesses food more than his needs should give the surplus food to the needy and the destitute” (Al-Muhalla by Ibn Hazm).
Neo-Liberalism: Endorsing the Structural Imbalance
A structural imbalance between capital and labor is embedded in the system to ensure the ascendancy of the elite class. This is the division of humanity into two groups: the great masses of humanity who toil in order to survive, and through their productivity create surplus wealth in which they do not share except in meager ways. Instead that wealth is directed to the ruling elite, a very small group who claim for themselves all the fruits of humanity’s labor including property, privilege, and leisure.
Liberal social philosophy recognizes the need for the government to ensure that wealth and power are distributed in ways that create a more equitable and decent society. In opposition to liberalism as a social philosophy is the program of the ruling class, which is called, ironically, neo-liberalism. Liberalism as a social philosophy is often confused with economic liberalism or neo-liberalism. In our current political discourse, we continually hear sound bites about the free market, deregulation, cutting of social services, privatizing of state-owned assets, and the primacy of individualism over and against the collective needs of society. In fact, these are the interlocking characteristics of neo-liberalism:
The market rules – the idea is that a “free” market, unimpeded by state imposed controls or interventions, would unleash the creative and innovative entrepreneurial spirit that fuels economic growth and prosperity for the entrepreneurial class which then “trickles” down to the middle class and the poor.
Deregulation is the standard of the “free” market – unhindered by regulation, profits are maximized. This includes weakening or eliminating of unions and collective bargaining, reduction of wages or at least minimalizing and keeping them static. Labor laws including those regarding minimum wage, the eight-hour workday, health and safety, and anti-discrimination are to be weakened or dismantled.
Cutting of social services – this is promoted under the guise of reducing the size and role of government. While subsidies to businesses and tax breaks and benefits for the wealthy are to continue, the safety-net for the poor and middle class is to be reduced. Cuts are to be made to education, health care, and maintenance of infrastructure including roads, bridges, and water supply systems.
Privatization – infrastructure crumbles from lack of care as any semblance of a robust, activist government and its necessity spending is demonized; then the clarion call about government incompetence and inefficiency is made. The selling of state-owned enterprises to private investors is advocated, including toll roads, water systems, hospitals, prisons, education, etc.
Elimination of regard for public good, of shared community and fellowship – the primacy of the individual is trumpeted, over and against any claims of the social collective and the common good. Emphasis is on individual responsibility to the extent that those who are poor or disabled or needy are left to their own resources and when unable to procure basic or adequate services in education, healthcare, etc., they are called lazy or irresponsible.
Neo-liberalism, as a ruling class program, considers that the only legitimate purpose of the state is to safeguard individual and commercial liberty and property rights. It opposes any policy that would intervene in the elite-favoring distribution of wealth and power. In this paradigm, instances of inequality and social injustice are deemed morally acceptable as they are considered the result of freely made choices and decisions by individuals in a free market. Many capitalists who argue for a laissez-faire economic system cite what is known as “social Darwinism” which applies Charles Darwin’s principles of natural selection to human society. Fierce competition is thus considered natural in the fight for survival, and “survival of the fittest” means that the rich and successful individuals are the “fittest” and the poor and needy, the deprived, the disadvantaged, all are rightfully doomed to failure and misery.
Rapacious Capitalism
That cynical and selfish perspective results in what we have today — rapacious capitalism. William Deresiewicz in a piece in the New York Times in 2012, titled Capitalists and Other Psychopaths, wrote, “… Enron, BP, Goldman, Philip Morris, G.E., Merck, etc., etc. Accounting fraud, tax evasion, toxic dumping, product safety violations, bid rigging, overbilling, perjury. The Wal-Mart bribery scandal, the News Corp. hacking scandal — just open up the business section on an average day. Shafting your workers, hurting your customers, destroying the land. Leaving the public to pick up the tab. These aren’t anomalies; this is how the system works: you get away with what you can and try to weasel out when you get caught.”
That is truly a description of capitalism gone wild in rapacious and dissolute abandon: using every sort of predatory and amoral tactic to plunder people and the environment for the satisfaction of greed. In tandem with this is the pushing of unbridled consumerism on the people of the world; this is central to the policy of perpetual economic growth. Yet, the idea of a perpetually growing economy is a flawed one. We live upon a finite planet with exhaustible resources and a finely-tuned and balanced ecology that can be tipped to an out-of-kilter state that cannot recover. Out-of-control growth is cancer. A healthy organism is in a state of homeostasis. As such, the earth has self-regulating mechanisms and feedback cycles that maintain stability, balance, and proportion. According to the U.S. Environmental Protection Agency , “Sustainability creates and maintains the conditions under which humans and nature can exist in productive harmony, that permit fulfilling the social, economic and other requirements of present and future generations.” There must be a proper interplay of the “three pillars” of sustainability: environment, social equity, and economic demands.
Co-op Capitalism
In contrast to greed capitalism is a concept called “co-op capitalism,” promoted by Noreena Hertz, a Cambridge University economist. Co-op capitalism unites businesses, governments, NGOs, and the general public in a collaborative task of creating business models and financial structures that encompass profits but also the social good. She mentions the Emilia-Romagna region in Italy which is “the seventh-most-successful economic region in Europe.” She stresses that they must be doing something right in using a cooperative model where workers own shares in the companies they work for. The co-ops are profit oriented but they take a long-term focus and success is a collective, collaborative success. On SolidarityEconomy.net, Frances Moore Lappe writes about the Emilia-Romagna region, “whose hub city is Bologna, is home to 8,000 co-ops, producing everything from ceramics to fashion to specialty cheese. Their industriousness is woven into networks based on what cooperative leaders like to call ‘reciprocity.’ All co-ops return 3 percent of profits to a national fund for cooperative development, and the movement supports centers providing help in finance, marketing, research and technical expertise. The presumption is that by aiding each other, all gain. And they have. Per person income is 50 percent higher in Emilia Romagna than the national average.”
Islam Espouses an Ethical Economic System
Islam is clear and straightforward in espousing the ideals of cooperation and solidarity. The Prophet (p) said, “Truly The faithful are to one another like a building—the different parts support the others” (Bukhari and Muslim). Islamic teachings stress the importance of social equity and justice. The Qur’an says, “God loves those who are fair and just” (Qur’an 49:9). Also advocated is protection of the weak from economic exploitation by the strong. Allah SWT says, “Give just measure and weight, and do not withhold from the people the things that are their due” (Qur’an 7:85). The importance of properly paying wages is referred to in the hadith: “Give the worker his wages before his sweat dries”(Tirmidhi and Ibn Majah). With reard to business transactions, the Prophet said, “…if both parties spoke the truth and described the defects and qualities (of the goods), then they would be blessed in their transaction, and if they told lies or hid something, then the blessings of their transaction would be lost” (Bukhari).
As to those who engage in fraudulent activities and enterprises, the Qur’an says, “Woe to those who deal in fraud, those who, when they have to receive by measure from men, exact full measure, but when they have to give by measure or weight to men give less than due. Do they not think that they will be called to account on a Mighty Day, a day when mankind will stand before the Lord of the Worlds? (Qur’an 83:1-6). And in another verse, “And, O my people, give full measure and weight justly, and withhold not from people the things that are their due, and act not corruptly in the land making mischief” (Qur’an 11:85).
Regarding protection of the environment, humans are appointed the stewards of the earth and this is a trust to be fulfilled with great responsibility and devotion. The Qur’an says, “It is He that has made you custodians, inheritors of the earth” (Qur’an 6:165). And Prophet Muhammad (p) said, “The world is green and beautiful, and Allah has appointed you His guardian over it” (Muslim). With regard to the impulse to greed and hoarding of wealth, the Qur’an says, “And let those who hoard gold and silver and do not spend them in the way of Allah know that a severe and painful punishment is awaiting them” (Qur’an 9:34). And in another verse, “By no means shall you attain piety unless you spend of that which you love; and whatever of good you spend, Allah knows it well” (Qur’an 3: 92). In contrast to the neo-liberal policy of disregarding the social good and shirking any responsibility for the poor and needy, the Qur’an says, “They ask you what they should spend. Say: whatever you spend of good must be for parents and kindred and orphans and the poor and the wayfarer; and whatever you do of good deeds, truly, Allah knows it well” (Qur’an 2: 215).
Requisite Goals for a Fair and Economically Sustainable World
Social justice and economic equitableness, respect for nature and protection of the environment, human and civil rights, peacemaking —these are requisite goals for a fair and economically sustainable world. In such a world, the markets would serve the interests of people and corporations would be socially responsible. GDP alone would not define success; quality of life and protection of the environment would be primary factors for consideration. Business schools would teach ethics and long-term thinking in their core curricula. Economics would not be reduced to mathematical formulae but elevated to take into account the social, ethical, and spiritual needs of humanity. Rather than the excesses, inequities, and biases of the current model, all things would be balanced fairly in the aim for social justice and harmony.
What will it take to alleviate the suffering in the world caused by greed?
“Men whom neither trade nor selling diverts from remembrance of God, nor from performing the prayer or giving in charity — they fear a day when hearts and eyes will be transformed ; that God may reward them according to the best of what they did and increase them from His bounty…”
(Quran, 24:37-38)
At a time when economic observers are worried about the threat of a new global financial crisis and global credit rating agencies have brought down credit ratings of giant financial institutions such as the Bank of America, J.P. Morgan Chase and Morgan Stanley etc, it may be amazing to see that Islamic banks, with their meager resources, are sailing smoothly in troubled waters.
Economic observers had expressed their fears about the possibility of another global financial crisis mainly because of the European debt crisis that has plagued a number of euro-zone economies. European banks that have not yet fully recovered from the global financial crisis of 2008-09 may be required to play an important part in bailing out the debt-ridden economies. It may turn out to be the last straw on the camel’s back, as far as the European financial institutions are concerned. Since the U.S. financial institutions are closely linked with their counterparts in Europe, they may also be in trouble if something happens to the European banks.
Sub-Prime Mortgage: A Disaster
Economists and analysts have been of the view that sub-prime mortgage was the main culprit behind the global financial crisis. What is sub-prime mortgage? In the United States – having a population of nearly 300 million people – nearly every one desires to own a house. A large number of such people can not fulfill their desire without a loan. All such people have a low income and a poor repayment capacity. The conventional banks, in order to boost their business, advanced loans to such persons on higher interest – due to higher risk involved in these loans. The aforesaid loans, according to reports, ran into trillions of dollars. Since the amount was beyond the capacity of the US banks (loans advanced by a bank can not be more than five or six times of its capital), the conventional banks in the US sold a percentage of these loans to the conventional banks in Europe (who willingly purchased papers of such loans because of higher interest attached with the loans).
At the time when these loans were advanced, the interest rate was on the lower side. But, when the time of repayment approached the interest rate had gone up. The situation led to massive loan defaults, which created a panic and eventually paved the way for the GFC. Many reputed banks and financial institutions failed in the United States and Europe, because of loan default on such a massive scale.
Sub-prime mortgage or advancing loans to people with poor repayment capacity was professionally undesirable. It brought disaster to the borrowers, depositors and the banks themselves. The Islamic banks remained unaffected as they had neither advanced such loans nor had purchased any related product from the conventional banks.
Hence, Islamic banks, which are new, relatively less experienced and have limited resources as compared to the traditional banks, have come out largely unscathed from the global financial crisis and Great Recession of 2008-09, which is a matter of surprise for the financial circles in the industrialized world. Honesty and moderation have been the hallmark of Islamic banks. Honesty demands that loans should be advanced after fully judging the repayment capacity of the borrower, in order to safeguard the interest of the borrower, depositors and the bank itself. Islamic banks consider it unethical to lend to someone not having repayment capacity at exorbitant interest rates.
Islamic Finance: Responsible Banking
As laid down in the book entitled ‘The Art of Islamic Banking and Finance’ by Yahya Abdur Rahman, Islamic finance is not a money-lending operation as is the case with the conventional banks. Islamic banks are built on assets (and services) based financing. Islamic Banks finance economically viable projects. If the project is not considered viable for the customer, it will not be financed by the Islamic bank. An agreement between the Islamic bank and the customer involves the exchange of assets/properties/businesses or the leasing of these.
Islamic banks do not look at money as something that can be rented for a price (the interest rate). Besides, an Islamic bank does not invest in alcohol-related businesses, gambling and related businesses or in businesses that are not environmentally and socially responsible. It also does not invest in businesses that are unfair to its labor or customers. Islamic banks do not finance speculative activities that are focused on making money out of money or based on speculations in the financial, commodities and real estate markets. For the afore-mentioned reasons, risks facing the Islamic finance are considerably less, as compared to the conventional banks.
Islamic banks extend financial assistance for specific purposes such as to locally buy or import a car, purchase or construct a house, etc. The object for which financial assistance is being sought has to be clearly defined and fully identified. This gives an opportunity to the Islamic banks to judge the viability of the project as well as the repayment capability of the borrower. After the bank is fully satisfied about the viability of the project, it enters into an agreement with the borrower. The aforesaid agreement includes all the details about the timing, profit to be charged and mode of payment, etc. The agreement is strictly followed until the project is finalized. Since there is no uncertainty in the business, chances of a default are minimized, thus safeguarding the interest of the borrower, depositors and the bank itself.
Following the global financial crisis and Great Recession, which had resulted in the failure of well-renowned banks and financial institutions in the West, economic observers were surprised to find that Islamic banks were doing business as usual. Financial analysts are still trying to identify the factors behind the strength and resilience of the Islamic banks. The aforesaid scenario has given a new confidence to the Islamic banks and they are trying to expand their business in a cautious and calculated manner.
There is no doubt that conventional banks – considered to be the backbone of the global economy – have been engaged in performing a much more difficult task. They have to meet the financial needs of the various sectors of the national and global economy, in order to ensure economic prosperity. The sphere of activities of the conventional banks is almost unlimited and, therefore, the perils and hazards facing these banks are also innumerable. However, by strictly following the rules and acting with caution and responsibility such risks can be minimized. The conventional banks and all financial institutions should listen to the regulators and refuse to cross the red line. It may be hoped that the lessons learnt from the GFC and global recession would enable all stakeholders to take precautionary steps, so as to avoid the recurrence of such crises in future.
Aftab Ahmad, a retired research economist, writes articles on economic issues regularly.
Islamic finance is flourishing even in a time of economic turmoil in the world. And, more and more people are taking notice. Recently, many articles have been written by mainstream publications highlighting the success of Islamic banking and the need for the world to learn from this financial model.
For Muslims across the globe, Islamic banking is not simply a financially attractive alternative. Rather, it is a conscious choice based on the commandments laid down by God in the Quran, the holy book of Islam. A fundamental difference between conventional banking and Islamic banking is that the latter does not charge interest. The Quran expressly forbids transacting in interest in several places.
At one point, God says, “God has allowed trade and forbidden usury. Whoever, on receiving God’s warning, stops taking usury may keep his past gains–– God will be his judge–– but whoever goes back to usury will be an inhabitant of the Fire, there to remain.” [2:276]
Interestingly, Judaism and Christianity also prohibit usury. For instance, the Bible states, “Do not charge your brother interest, whether on money or food or anything else that may earn interest.” (Deut. 23:19) Yet, Islam is the only faith which maintains this prohibition originally observed by Christians and Jews.
“People think the Islamic [financial] system is based on faith, but it’s based on justice. The system is based on justice for the two parties and how you get to justice is extracted from the Islamic faith,” says Aly Khorshid, an Islamic finance scholar who writes for Islamic Banking and Finance magazine.
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