What Islamic finance can offer

January 9, 2013

The Islamic approach to finance was once the most advanced in the world. The period of pre-eminence ended six or seven centuries ago, but the religion’s fundamental insights into the field could help form a financial system suitable for the 21st century.

From the beginning, Muslim teaching took a religious view of commercial relations and responsibilities. There are a few injunctions in the Koran and far more in the teachings traditionally attributed to Mohammad. I am not an expert, but the basic ideas seem clear enough: merchants should be fair, risks should be moderate and understood, and God condemns all rapacious financial practices.

During the first centuries of Islam, Muslims became great traders, providing an economic bridge between Asia and Europe. Europeans adopted and then further developed the Islamic techniques of providing credit and of sharing responsibilities, risks and rewards. Christian thinkers continued the Islamic debate over what was fair and just, and church authorities copied the Islamic teachers’ practices, ruling on the legitimacy of transactions, and exhorting merchants and investors to restrain their greed.

Of course, those exhortations often fell on deaf ears. However, until well after the start of the Industrial Revolution few Muslims or Christians would have argued with the notions that trade should be just and finance should serve the common good.

Indeed, much of the Western world’s financial system looked more Islamic than hard-edged capitalist until about 30 years ago. The vast majority of banking assets in Europe and a substantial minority in the United States were held by institutions which did not have profit-seeking shareholders. Rather, these mutuals, thrifts, savings banks, French caisses, co-operative banks, church banks and credit unions aimed first of all to serve their members and their communities. Insurance was also largely a mutual business.
Then came the era of demutualisation, when selfish profit-seeking became the norm. In the new era, the worst possible aspects of a financial system – greed, exploitation of the ignorant and excessive risk-taking – were allowed to run wild. Bankers became ridiculously rich while debts expanded at an unsustainable pace.

The free rein of financial selfishness ended in tears, as any traditional Islamic (or Christian) teacher would have predicted. Unfortunately, contemporary Islamic efforts in finance were too influenced by the free-market model. Jurists and bankers worked together to design instruments, from mortgages to hedge funds, which would be both compliant with the jurists’ interpretation of sharia (Islamic law) and economically identical to conventional financial products.

This finance of “sharia arbitrage”, as Mahmoud A. El-Gamal of Rice University calls it in his book “Islamic Finance”, is largely based on a narrow understanding of two prohibited practices: riba and gharar, usually translated as interest and risk. For example, jurists declare that riba is avoided if a loan can be portrayed as a sale at one price and a gradual repayment at a higher price, even if the gap between the two equates to an interest rate of 100 percent. El-Gamal is highly critical of this sharp practice.

I am not competent to opine on Islamic law, but the current approach to Islamic finance certainly misses what is most valuable for non-Muslims about riba and gharar: the way they fuse ethics with practice.

If El-Gamal is right, riba is best understood as unjust financial advantage, akin to certain legal definitions of usury. Following that definition, there is no riba when lenders and borrowers justly share the wealth created by a loan. Loans, which have fixed interest rates and must be repaid, can be free of riba. Equity investments (common shares) are usually even more just. The forced repayment of principal on loans at maturity can be unjust on the borrower; that possibility is avoided with the permanent capital of equity. Also, while fixed interest payments are sometimes unjustly low or high, shares’ variable dividends can reflect changing circumstances.

Finance always involves commitments in an uncertain world, so risk can never be avoided completely. Gharar, according to El-Gamal, properly refers to unnecessary or inappropriate risks, as exemplified in the classical example of selling the pearl diver’s future catch before the actual dive. Gharar seems to take in all unnecessary speculation. The prohibition is just, because financial gains should come from providing something of economic value, not from luck or from outwitting a trading partner about the risks of a bet.

The excesses and dishonesty which led up to the financial crisis show that the current system has lost its moral compass, but a new one cannot be plucked straight out of some previous era. Traditional banks and insurers would be too small and unsophisticated for today’s global economy.

Still, we can renew the best ideas of the past. Between them, riba or gharar account for most of the objectionable practices of contemporary finance. They should be banned.


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Wow, another great piece. You have a streak going. I’m surprised that you didn’t juxtapose the Chinese approach of less or no religion and far more enforced discipline. I’m not sure their model will hold very long, but I’ll bet it has another century at least. They also seem able to adapt to social changes more efficiently too.

Posted by tmc | Report as abusive

Well, I wouldn’t mind doing business with a Sufi, but don’t forget the doctrine of Taqiyya (broadly translated as dissimulation), which is a matter of dogma in Shia and a matter of practice in Wahabi Islam.

Just think of that Iiam who tells his congregation that the Q/uran orders all women and all girls to wear a hijab (it doesn’t). Is he going to bat an eyelid at telling his congregation that it is entirely moral to rip off Westerners? I think not.

Posted by Ian_Kemmish | Report as abusive

financial infiltration into american culture so they can have a foot in the door to spread their hypocritical religion. I sense a bomb coming!

Posted by covertice | Report as abusive

There are at least five major religious traditions in the world and even when they ruled their respective roosts, their attitudes could fall “on deaf ears” as you say. Economics has had to evolve around or out from under them. Everyone has an instinctive need to deal “fairly” but the “fine print” can change those notions beyond recognition.

I can’t imagine that Islam – even with a billion adherents, is really going to ever be able to do more than provide a “flavor” of banking and financial ethics. In it’s own heydays, I’m sure even the Sultans weren’t beyond bending rules when they felt they could get away with it. It must help to have some house trained clerics around the palace. It’s always nice to have a “Richelieu” so to speak. Removing the heads of critics helps too. In the big picture – they weren’t always actually playing fair at all.

BTW – Notice how Gabrielli has been forgotten in a matter of a few months? Religion isn’t the last word on a blessed or damned thing. Not anymore it isn’t. In 60 years I haven’t seen it yet.

All there ever really seems to be is “thinking about it”.

But you really have a good heart, Mr. Hadas.

Posted by paintcan | Report as abusive

I dislike the tone in which some people speak whenever they word “Islam” is mentioned.

Sad that people get their understanding about Islam from cheap media, without knowing anything of its roots and ideals.

And what is even more sad is that most of the “disgusting flavors of Islam” are or have been backed up by the US. Let’s not forget who created Al-Qaida in the first place and who is pushing hard to arm the heart eating and slaughtering rebells who call themselves freedom fighters in Syria; those people who don’t even shy away from showing the connections to Al-Qaida.

The topic was about Islamic finance people. Why can’t you stick to the topic?

Posted by muhammadalwaeli | Report as abusive