21 March 2009

Islamic Finance as a solution?

“They are experiencing divine punishment. We are happy over that. The more they become unhappy, the happier we get,” proclaimed Ahmad Jannati, senior Shia cleric and secretary of the Guardian Council, to a crowd at the Tehran University in Iran. His Sunni counterpart Yusuf
al-Qaradawi was less dramatic: “The collapse of the capitalist system, which is based on usury and securities rather than commodities in markets, shows us that it is undergoing a crisis and that our integrated Islamic philosophy – if properly understood and applied – can replace the Western capitalism.”

The Western (conventional) banking system is built on a foundation of ‘Riba’, usually interpreted as usury or interest, which is firmly forbidden in the Quran. The collapse of leading Western financial institutions amid the current global financial crises and imminent global economic recession has encouraged economists world-wide to consider alternative financial solutions and new approaches to banking and finance.

According to Joseph DiVanna, finance expert for The Banker publication, Shariah compliant banks were performing better than conventional banks. He said that more Islamic banks and financial products have been launched worldwide since late 2008, despite the banking crisis that restricted conventional banks from doing so.

Daud Vicary Abdullah, of International financial consulting firm Deloitte, expects double digit growth in global Islamic finance in the next few years. “Countries like Japan, South Korea and Singapore are showing more interest in the Islamic finance because of the value of the products offered and also the transparency of the transaction.”

Another finance expert, Professor Rodney Wilson of Durham University, claims that in the current crisis no Islamic bank has failed, and in contrast to conventional banks, none have needed government funds to save them from collapsing.

Some claim that Islamic banking provides a viable alternative to conventional banking. The spread of Islamic finance into western markets shows that it is being treated seriously by government and finance authorities.While the Islamic financial system is being increasingly sold as the best alternative, it is widely recognised that the Islamic system itself has been largely modelled on its interest-based western counterpart. Both share the same material goals
and adopt the same institutional structures, with the result that the products promoted by the Islamic finance industry are sometimes indistinguishable from those of interest-based institutions. These similarities have led some to claim that the Islamic banking and finance industry has failed to properly implement Islamic ideals.

In the Islamic finance industry, despite the prohibition on Riba, loopholes may exist. For example, a Muslim may earn a profit by selling an item for more than he paid for it, provided the two transactions are kept separate. A current Islamic finance mortgage may involve a bank buying the property on behalf of the customer, who then pays off the principal loan along with “rent” or a “fee” for using the property until it finally transfers into his name when the loan amount is fully settled.

In some Islamic mortgages, the home-owner is in debt to the finance company just as he would be in an interest-based mortgage. Should he fail to make payments when due, the home-owner faces the same threat of repossession and loss that clients conventional banks face.

The religious teaching underpinning Islamic finance is concerned with justice in financial contracts to ensure that none of the parties is being exploited. Riba is one source of exploitation, where high rates are charged to lower earners. Such discriminatory charging by conventional banks is justified as being a reflection of the risks involved.

The soundness of Islamic banks is perhaps accounted for by the fact that they use a classical banking model, with financing derived from customer deposits. Islamic banks are less susceptible to economic downturns, as instead of paying interest to depositors, those with investment (mudaraba) accounts share in the bank’s profits. This profit sharing reduces risk for the banks and means they are less likely to become insolvent.

Muslims scholars are claiming that had the requirements of Shariah been properly implemented, a financial crisis of the present kind would not have occurred. For example, if commercial banks were required to share the risks as well as the profits and losses of their clients, whether on business investments or home purchases, they would be more careful when choosing which deals to finance. This is because their financial returns would depend on the performance of the projects that they finance.

However, the fact that Islamic finance has copied the Western template of finance raises serious questions around its ability to point to a viable alternative at this time of crisis. Besides the fact that Islamic investment funds tend to invest in better performing companies by avoiding investing in companies that are heavily indebted with interest based loans, a closer look at the industry might explain the reasons why the Islamic finance industry is performing better. Islamic banking, primarily in the Gulf where it’s predominately based, benefits from the flush of cash inflows from recent high oil prices, and is relatively smaller than its’ interest-based counterpart. These characteristics allow the industry to deal with problems quicker and without huge public bailout packages.

Tarek el-Diwany and Haitham al-Haddad, leading critics of the Islamic finance industry, thus argue that the Islamic banking and finance industry is partially just a soft version of the secular system. According to them, if the Islamic finance industry continues to develop in the manner that is has, it will suffer from the same systemic problems as the conventional system. They call for a total reconsideration of the objectives, frameworks and methodologies of the modern Islamic banking and finance industry before it is presented as a viable alternative. Muslims firmly believe that Islam has the solutions to the world’s problems, and now is the ideal time to start truly demonstrating thus.

This article was originally written for and published in the Al-Huda Magazine. Contact [ alhuda at live dot co.za ]to get a copy.


Saaleha said...

mabrook on teh article. Am selling the mag at the bakery, which you must visit soon.

Ali la Loca said...

Very interesting! I'm so glad - I can see your blog again. Not sure what happened, but I was unable to see several blogs (got a 404 error message) for some time now.

Okay - we're back!!