Islamic Finance

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By Loretta Napoleoni

Islamic finance has become the fastest-growing, most dynamic sector of global finance. Every Western-style financial product has its sharia, i.e. Islamic law, compliant instrument: microfinance, mortgages, oil and gas exploration, bridge building, even sponsorship of sporting events. Islamic finance is innovative, flexible, and potentially very profitable. “Operating in 70 countries with about $500bn in assets, it is poised to expand geometrically.” With more than one billion Muslims eager to support it, analysts project that this system will soon manage approximately 4 percent of the world economy, equivalent to $1 trillion in assets. Such figures explain the eagerness of Western banks to tap into sharia financial services. Citigroup, along with many other Western banking retailers, have opened Islamic branches in Muslim countries.

At the end of 2004, the Islamic Bank of Britain, the first bank catering to a European Muslim client base, floated its shares on the London Stock Exchange. Ironically, Western capitalism’s three major global economic crises - the 1970s oil shocks, the late 1990s Asian crisis, and 9/11 - paved the way to the ascent of Islamic finance. Unlike market economics, Islamic finance centers on the religious tenets of Islam and operates in a way to keep Muslims compliant with sharia, the religious law that comes directly from the Koran. Islamic activists, intellectuals, writers, and religious leaders have always upheld the prohibition of riba, the interest charged by moneylenders, and denounced gharar, which refers to any type of speculation. Under this belief, money must not become a commodity in itself to create more money. Islamic finance thus shuns hedge funds and private equities, because they simply multiply cash by stripping assets. Money serves as a means or instrument of productivity as originally envisioned by Adam Smith and David Ricardo. This principle is embodied in the sukuks, Islamic bonds. Sukuks always link to real investments - for example, to pay for the construction of a toll highway - and never for speculative purposes. This principle springs from the sharia’s ban on gambling as well as on the prohibition of any forms of debt and activities that trade risk.

At the end of the nineteenth century, supporters and promoters of Islamic finance repeatedly expressed discontent with the Western-style banks that had penetrated Muslim countries.
Several fatwas, or religious decrees, were issued to reiterate the tenet that the interest-based activities of the colonizers’ banks proved incompatible with the sharia. Yet, because Western financial institutions were the only banks active in the Muslim world, the faithful had to use them even if they performed poisonous practices based on prohibited activities.

From the mid-1950s to the mid-1970s, economists, financiers, sharia scholars, and intellectuals studied the possibility of scrapping interest rates and of creating financial institutions centered on a sharia-compatible alternative to the riba. In their mind the Islamic economic system would incorporate the zakat - obligatory almsgiving to help the poor - and other fundamental elements of the Muslim religion, such as the funding of the haj, i.e. the pilgrimage to Mecca. The first projects of applied Islamic economics came into existence concurrently in the 1950s in the countryside of Lower Egypt and in Kuala Lumpur, Malaysia. The Egyptian project, located in Meet Ghamr, Egypt, supported a housing plan for the less wealthy. The Malaysian government-sponsored experiment was promoted by the Pilgrims’ Administration and Fund of Malaysia. It supervised financial institutions that collected savings and invested them in accordance with the sharia. It aimed to finance the haj, which, together with the zakat, is one of the five pillars of Islam.

Until the early 1970s, Islamic economics was essentially embryonic and regarded with deep skepticism. “Back then, no one really thought Islamic banking would ever become big,” recalls Sheik Hussein Hamid Hassan, an Egyptian scholar involved in the creation of one of the first Islamic banks. “People thought it was a strange idea - as strange as talking about Islamic whiskey!” Western skepticism compounded daily because of the Muslim countries’ chronic lack of capital. They had no money to start an alternative banking system, many thought they never would, therefore people dismissed the idea of Islamic finance as merely utopian. This scenario changed with the 1973–1974 oil shock, which generated a massive capital inflow into Arab oil-producing countries from Western importers. The quadrupled price of oil generated the capital needed to put into practice what had remained only an idea debated for decades. That idea materialized with the establishment of an international developmental bank for the Islamic region. Such a bank would enhance the Organization of the Islamic Conference, considered a potential power base for some of the newly enriched countries, especially Saudi Arabia and Algeria. At the same time, the bank would serve as the instrument for distributing financial help from oil-rich Muslim countries to their brethren in Africa and Asia. The first call for the establishment of the Islamic Development Bank (IDB) came from the heads of state of Saudi Arabia, Algeria, and Somalia. In 1974, when the articles of agreement of the IDB were drafted, it formally stated that the bank’s activities had to be conducted in accordance with the sharia.

At the core of sharia-compliant economics there is an exceptional joint venture. Indeed, this alliance emerged in the 1970s when richMuslims and sharia scholars began working together. This unusual partnership is a phenomenon unique in modern economics, but one that cemented the foundation of a new economic system. A few visionary personalities, like PrinceMohammad al Faisal (son of the late Saudi King Faisal bin Abdul-Aziz), Saleh Kamel of Saudi Arabia, Ahmed al Yaseen of Kuwait, and Sami Hamoud of Jordan, channeled some of the new wealth produced by the first oil shock into the formation of a new breed of Islamic banks. Sharia scholars and clerics drew up the monetary structure of the new banks.

Partnership between leaders and clerics, therefore, serves as the root of Islamic finance. This concept springs from the essence of the Umma, the body or community of believers, central to the spirit of Islam. For Muslims, the Umma represents a single and unified entity; it breathes, thinks, and prays in unison. It exudes the soul of Islam. Individualism within
Islam does not make sense because Islam, based on tribal culture, does not recognize it. Traditional tribal values, such as the strong sense of belonging, the obligation to help friends in need, and the acceptance of religious leaders’ authority are the pillars of Muslim culture. Sharia scholars transplanted these values into Islamic economics; these same principles allowed Arab Bedouins to withstand the harshness of the desert for centuries. Cooperation was essential in such a hostile environment and is still a must in modern times.

Partnership is the heartbeat of Islamic economics. “Underlying the system is the philosophy of risk sharing: the lender must share the borrower’s risk, making the two in effect partners, injecting a strong social component into the financial system. This concept separates Islamic Finance from Western Finance, which seeks to maximize profits and minimize loss through diversification and risk transfer.” Also, money must be put to work. Because Islamic finance prohibits interest, it seeks revenues from rents, royalties, business profits, or commodity trading; a mortgage, for example, represents a “rent to buy” arrangement. Thus, conceptually, Islamic economics is the opposite of Western finance, which revolves around the individual’s self-interest.

Above all, Islamic finance represents the sole global economic force that conceptually challenges rogue economics. It does not allow investment in pornography, prostitution, narcotics, tobacco, or gambling. As discussed above, since the fall of the Berlin Wall, all these areas have blossomed thanks to globalization outlaws under the indifferent eyes of the market-state.