Contemporary Islamic Finance: Innovations, Applications, and Best Practices
CONTEMPORARY ISLAMIC FINANCE – Book Sample
Introduction – Islamic Finance in the World Economy
The religion of Islam has existed for 1,400 years but Islamic economic theory and its ﬁnancial institutions as an industry emerged only in the 1970s. Islamic banks are late twentieth-century institutions designed, against the backdrop of a global economy dominated by capitalist business practices, to help Muslims conduct business internationally while simultaneously upholding traditional Islamic values related to trade ﬁnance and currency movement.
The basis for their existence is the Islamic moral prohibition on charging interest— interest is a central component of capitalist banking—yet Islamic banks conduct billions of dollars of business annually in the world economy and the de facto Islamic banking transaction is—in most cases—virtually identical to a capitalist banking transaction. The industry of Islamic Banking and Finance (IBF)1 is the manifestation of attempts to apply Islamic law and Islamic economic theory to ﬁnancial dealings.
An Islamic Financial Institution (IFI) refers to any ﬁnancial institution that per- forms Islamic transactions derived from either Islamic law or Islamic economic theory. An Islamic Bank is an institution that performs conventional banking services2 (or their Islamic equivalent) such as checking accounts, savings accounts, loans, and so forth.
An IFI may or may not be a bank but an Islamic bank is always an IFI. Islamic ﬁnancial institutions include venture capital ﬁrms and insurance companies, and may be distinguished from conventional banks by three primary elements (Bahrain Monetary Agency 2002):
1. Prohibition of prohibited ﬁnancing arrangements and business practices. The most important prohibition in Islamic ﬁnance is the prohibition of riba (interest or usury). This means not only that ﬁnancing transactions are structured differently than in conventional ﬁnance, but also that the asset structure of the institution is based entirely upon tangible assets and partnership arrangements instead of on interest-based ﬁnancial assets. Gharar (speculation) and maysir (gambling) are prohibited, as well as trading in haram (forbidden) goods such as alcohol, pork, and owning equity in riba-based institutions (Lewis and Algaoud 2001).
Integration of religious practices into daily life by governing business under Islamic law.
Existence of a Shari’a Standards Board (SSB) composed of Islamic scholars. The SSB’s purpose is to insure that Islamic law is being followed accurately in the business practices and ﬁnancial arrangements of the IFI. A member of the SSB (called a Shari’a Scholar) has been trained formally in Islamic law, but has not necessarily been trained in ﬁnance. A separate ﬁnancial standards board evaluates the efﬁcacy of ﬁnancial transactions, just as it does in a conventional institution, and the two boards often work together.
Ideally, an IFI should combine the elements of Islamic ﬁnancial practices with some effort to uphold Islamic daily life practices (Lewis and Algaoud 2001).
The industry of Islamic banking and ﬁnance is growing daily. There are hun- dreds of Islamic ﬁnancial institutions worldwide and the world’s potential market for Islamic ﬁnance consists of more than one billion Muslims, in addition to non- Muslims, who are welcome and encouraged to participate in Islamic ﬁnance. When I began my ﬁeldwork in 2002, Islamic assets were estimated to be around USD 200– 300 billion. By 2011, estimated industry assets under management topped USD 1 trillion and is growing at a rate of at least 10 percent per year.3
The Financial Times reports that at least one bank, Dubai-based Saadiq (the Islamic banking arm of Standard Chartered Bank), saw revenue growth of 65 percent in 2011 over 2010.4 This book speaks to an audience that is dynamically involved in—or thinking
of being involved in—the Islamic ﬁnance industry. As the industry grows rapidly, ﬁnance professionals, investors, attorneys, educators, and students demand more detailed and sophisticated knowledge. Innovations abound as practitioners ﬁnd ways to reconcile existing practices and regulations with Shari’a requirements. This volume will provide a useful and timely guide to Islamic ﬁnance for any- one interested in learning about basic concepts, current issues, and best practices predominant in the industry today.
GLOBALIZATION AND MUSLIM SUBJECTIVITY
World conditions due to globalization have contributed to the formation of the industry of Islamic ﬁnance. (Please see Chapter 4 of this volume.) Geo- graphic mobility and technological advances made possible (and desirable) by globalization have profoundly changed deﬁnitions of personal, community, and religious identities of humankind. Islamic law does not allow for individuals or institutions that lend money to charge interest on that money.
Muslims who orient themselves according to Islamic practices would be acting against their moral constitutions to participate in transactions that involve the charging of interest. Yet in the early twenty-ﬁrst century global economy, trade ﬁnance and other crucial banking transactions are clearly dominated by capitalist ﬁnancial institutions whose return on investment is based upon charging interest.
Heretofore, a Muslim wishing to participate in the global economy has had to invest in capitalist insti- tutions and act in opposition to his or her religious and moral belief system. As ﬁnancial resources in the Islamic world have grown over the past three decades, Muslims have increasingly sought alternatives to capitalist investment that are more in keeping with Islamic practice.
Islamic banks provide a framework for Muslims to invest their money “morally,” in accordance with Islamic law, while at the same time they do not miss out on proﬁt opportunities provided by the global form of capitalist exchange. Islamic banking must locate itself as a Muslim institution in the world economy, yet it is also an industry that explicitly engages with the capitalist institution of banking and as such must be studied in the context of globalization and its relation to capitalism.
Throughout history, Jewish and Christian religious doctrines have objected to what they deﬁned as unsavory business practices, including the practice of usurious loans. De Roover (1974) emphasizes that usury at that time in history referred to any increase over principle and that usury was prohibited; consequently, any increase was considered excessive.
Christianity and Judaism resolved this moral problem in a way that advances capitalist enterprise—by declaring loans at interest as acceptable transactions as long as they are not usurious, whereas Islam seems to be engaging with capitalism in a way that critiques capitalism while at the same time advances it. The industry and its resultant institutional structure act as a culture broker (cf. Mazzarella 2004), providing a bridge between capitalist business practices and a competing Muslim sensitivity for its practitioners, who are comfortable in both cultural systems. Furthermore, IBF acts as a bridge between competing subjectivities—or practices of Islam—within Islam itself.
HISTORY OF ISLAMIC FINANCE
Islamic ﬁnance is a subcategory of the discipline of Islamic economics, which is in turn informed by Islamic legal thought. Chapters 2 and 3 of this volume (Farooq’s “Contemporary Islamic Economic Thought” and Shawamreh’s “The Legal Frame- work of Islamic Finance,” respectively) introduce those two concepts. In this sec- tion, I take you through a brief history of the industry’s evolution. This account is informed by Kuran (2004), Warde (2010), and Askari et al. (2010), and draws upon the history of economic thought as its basis. This chapter is meant to be a brief introduction to the formation of the industry from a psychological perspective; the speciﬁcs of Islamic economic thought, and a critique of that thought, are discussed elsewhere in this volume (Chapter 2 and Chapter 5).
Whereas textual and traditional sources of Islamic law date to the time of the Prophet Mohammed and the ensuing three hundred years or so, Islamic eco- nomic theory is a contemporary theory. It has its roots in postcolonial India and its tenets have been widely debated since the middle of the twentieth century. Islamic economics is always written about with reference to classical economic theories that form the basis of capitalism.
Early writings about Islamic economics were often presented as critiques of one or more economic theories prevalent in the world, such as communism, socialism, or capitalism (cf. Chapra 1976; Zarqa 1981; Siddiqui 1981). Since the fall of the Soviet Union and the apparent victory of capi- talist economics over other forms of economic structures, critiques of communism and socialism are no longer at issue, so most of the contemporary critiques are direct reactions to capitalist economic values. Timur Kuran, in his book Islam and Mammon, recognizes the emphasis of values in the theory of Islamic economics: “at least initially, the economics of ‘Islamic economics’ was merely incidental to its Islamic character” (italics in original; Kuran 2004, p. 82).
The framework of Islamic economic theory was developed in India in the early twentieth century by Islamic scholar Mawlana Mawdudi (1903–1979) and expounded upon by one of his students, economist Khurshid Ahmad. Indian Muslims as a group were relatively disadvantaged economically compared with the majority population of Hindus. The British Raj had provided some eco- nomic protections to Muslims, farmers in particular, but it was unclear how or if a Hindu-led government would provide the same protection (Kuran 2004).
Mawdudi believed that economic activity and technology were crucial to the suc- cess in the modern world, and he was dedicated to providing Muslims in India with economic opportunities that allowed them both to function in the modern world and to retain their Muslim identity. Many Muslims did not participate in conven- tional banking activities because of the prohibition against riba. Mawdudi himself adhered to this belief, as we learn from reading the notes to his own translation of the Qur’an. In particular, Mawdudi stresses different ways in which loaning at interest can erode communal bonds between men (1988).
Nonetheless, Mawdudi believed it was detrimental to the Muslim community in India to abstain from banking activities. He and Ahmad believed that it was possible and desirable for Indian Muslims to embrace systems and institutions of Western modernity while at the same time adhering to the teachings and practices of Islam (Mawdudi 1980). One goal of Mawdudi was to redeﬁne Islamic practices to conform to economic changes. He felt that Muslims in India could use practices to retain their Muslim identity in the face of the postcolonial Indian modernization project. In one of his last books, a short history of the founding of Islam, Mawdudi wrote (1974, p. 11):
The Islamic way of life can be revived and reconstructed again and again with the help of the Qur’an and the traditions if ever, God forbid, the freshness of its true spirit wanes. The world no longer requires any new Prophet to revive Islam to its pristine glory. It is enough to have among us the learned people who know the Qur’an and the traditions of the Prophet and who are able to apply their teachings to their own lives and stimulate others to adopt and apply them in their lives as well. This is how the stream of Islam will continue to ﬂow, refreshing the eternal thirst of mankind.
Khurshid Ahmad argued that economic systems are value-based systems; even the capitalist economic system was founded on certain cultural values, which are reﬂected in that system. This belief is not unlike Max Weber’s (1930) assertion that Calvinist religious practices served to advance capitalism. Therefore, if Muslims are to be economically empowered, a theory of Islamic economics is necessary. Other theorists took up that line of thought, such as Umer Chapra, who states: “Virtue lies . . . not in shunning the bounties of God, but in enjoying them within the frame- work of the values for ‘righteous living’ through which Islam seeks to promote human welfare” (Chapra 1976, p. 173). In Islam, all ﬁelds of life are interrelated. Goals and values of each segment of life should be aligned, so the economic sys- tem’s values are aligned with those of society.
Kuran (2004) asserts that the emergence of the industry grew out of the debate on whether or not Muslims in India should have a separate homeland or remain part of a greater India after the Partition of 1947. Mawdudi favored the latter proposition—cultural reassertion—and contended that a separate homeland was unnecessary because if Muslims practiced their religious duties faithfully, the mat- ter of a national homeland would be irrelevant.
In this view, group solidarity depends more on shared beliefs and practices than on shared geographical ter- ritory. This principle foreshadows many of the basic principles of globalization, namely the belief that group solidarity or identity can be based on something other than geographical place.
Mawdudi favored thinking of Islam as a way of life, rather than as a system of faith. In a treatise of his interpretation of the Qur’an published immediately after his death (1980), Mawdudi asserts that the kalimah5 afﬁrms that there is one God, Allah, and Mohammed is his Prophet. Mawdudi considers this to be the primary doctrine of Islam: The real difference between believers and unbelievers “lies in the acceptance of this doctrine and complete adherence to it in practical life.” (Maw- dudi 1980, p. 62) An emphasis of the connection between belief and practice is the foundation for Mawdudi’s entire project of strengthening Islam worldwide.
A Muslim must not only believe in the doctrine of Islam, but internalize and incor- porate its practices in everyday life. It is only in this way that Islam (and Muslims) will survive in a world that is increasingly inﬂuenced by modern inventions and systems. We can see this idea at work in the thinking of contemporary scholars of Islam. It had particular relevance in the anxious times of postcolonial India, and has gained relevance in a globalized and post-9/11 world in which Islam has frequently come under attack from the prevailing world order.
In contrast to politicians who wanted a territorial solution for Muslim independence (Pakistan), Mawdudi sought to keep Islam salient in the minds of its practitioners without necessitating a territorial division. He fully recognized the prudence of tying economic behavior to religious beliefs. According to Kuran (2004), a technologically advanced world requires complicated economic deci- sions. In the dominant world economic order, those decisions are thought of as secular decisions. If Muslim traders and customers were making daily economic choices based on religious thought instead of on secular economic principles, the average person could think of business activities as religious activities.
Therefore, religion would always be prominent in their minds (Kuran 2004). In this way, Muslims would remain politically visible despite their minority status. In this sense, Mawdudi advocated the creation of an Islamic economic actor in order to allow citizens to pursue economic activities in a morally acceptable way.
According to a comprehensive survey of Islamic economic literature, Professor Muhammad Siddiqui has outlined some of the key philosophical underpinnings of Islamic economic theories. The practitioner is meant to use these philosophical points as a guideline for developing practices in an (theoretical) Islamic economic system. Of course, no purely Islamic economic system exists in the world today, but it is held up as a goal to which Muslims should strive. Some of the major Islamic economic values are (Siddiqui 1981):
- A person should be a “God-conscious” human being. He or she should practice tawhid, or unity, at all times. This means that all earthly actions must be pleasing to the will of Allah.
- Economic enterprise is encouraged, as long as moderation is practiced and
special attention is paid to social justice.
- Ownership has both an individual and communal component. Private prop- erty ownership is encouraged but it is a human responsibility to make sure that all humans have their basic needs met.
- Humans are encouraged to cooperate with each other in production rela-
tions, rather than to compete (i.e., as in capitalism).
- Economic development is a necessary human condition and must be under-
taken in the spirit of social justice.
Throughout this volume, we will see much evidence that Islamic ﬁnance practi- tioners pay particular attention to these principles of Islamic economics in discourse and in practice.
ISLAMIC BANKING: ORIGINS IN PRACTICE
Whereas the theory of Islamic economics was never actually enacted systematically in Mawdudi’s India, it was put into practice in the Arabian Gulf. The ﬁrst success- ful Islamic bank—Dubai Islamic Bank—opened in Dubai, United Arab Emirates, in 1975.6
Until this time, Muslims had been carrying on their business activities in one of two ways: Either they used conventional banks or they just used other, private methods of ﬁnancing outside of the capitalist banking system. Islamic ﬁnancing was originally part of interpersonal business dealings and not meant to be an institutional function (Udovitch 1970). But by the late twentieth century, if Muslims wanted to participate in the world economy, they would have to engage in some way with the capitalist banking system.
In particular, the Arabian Gulf of the 1970s was undergoing tremendous and rapid changes as signiﬁcant cash poured into the region from recently discovered oil (Ali 2002). Businessmen sought to use their newly acquired oil wealth to put into practice an idea that was theoreti- cally conceived to solidify Muslim identity. The formation of Islamic banking was introduced as a practical solution to this problem.
There were several political developments in the Arab world around the same time that contributed to heightened sense of urgency about asserting pan-Islamism. In an article written on September 9, 2001 in the online version of Le Monde, Ibrahim Warde, a researcher of Islamic ﬁnance and adjunct professor at Tufts’ Fletcher School of Business, reminds us that in 1967 Arab losses in the Six Day War had given birth to Nasser’s secular pan-Arabism as well as to Saudi Arabia’s Islamist domination in the Arabian Gulf region.7
These political developments in addition to the inﬂow of cash into the Gulf provided the impetus for the establishment of the Organization of Islamic States (OIS) in 1970. Banking reform quickly made its way onto the OIS agenda (Warde 2010).
Dubai Islamic Bank (DIB) was the ﬁrst Islamic bank in the context of the contemporary Islamic banking industry formation (Henry and Wilson 2004). There has always been considerable trade between Dubai and the Indian subcontinent, especially in the late twentieth century, when large numbers of Indians/Pakistanis migrated to the Gulf as guest workers. It is highly likely that ideas such as the theory of Islamic economics accompanied the people and goods that have always been traded between these places. In addition, Gulf Arabs also go to India or Pakistan for an education and must have been exposed to theories such as Mawdudi’s during their stay. I consider it a natural extension of the theoretical origins of Islamic banking that its practice was taken up in the Gulf: Material prosperity enabled the theory to be enacted. This origin story seems to be important to bankers in Dubai, at least, and at any rate DIB is one of the most active of the purely Islamic banks.
A CONTEMPORARY INDUSTRY
Trade and ﬁnance have always been part of Islam’s history. The Prophet Mohammed, the founder of Islam, was a business owner in the seventh century of the Christian era, as was his wife Khadijah. Nonetheless, there was no such thing as an Islamic bank until the late twentieth century. Classical Islamic jurisprudence has always been concerned with regulating trade and ﬁnancial transactions between individuals and has produced a large body of rules on the subject; however, those rules did not give rise to an Islamic ﬁnancial system until the 1970s. Udovitch (1970) points out that trade ﬁnance was always prevalent in Muslim societies, but that merchants would provide ﬁnancing instead of ﬁnancial institutions.
This arrangement is similar to the function of merchant lending in Europe at the same time (Udovitch 1970). For example, bancherius, or merchant institutions in Venice that accepted deposits and made loans, were not specialized and were usually part of larger business operations, like cloth merchants. In the mid-twentieth cen- tury, a few individual Islamic banks were started in Egypt and Turkey, but they either failed on ﬁnancial terms or were folded into the national banking system and converted to conventional banks (Kuran 2004, 2001). A corporation founded in Malaysia in 1963 eventually evolved into the Bank Islam Malaysia, incorporated in 1983.
Contemporary Islamic banks were formed in the 1970s when considerable oil wealth became available in the Arabian Gulf States. Muslim populations in other parts of the world—notably Indonesia, Pakistan, and Malaysia—have since generated sufﬁcient steady income growth to develop a network of Islamic ﬁnancial institutions that strive to integrate themselves into the global ﬁnancial system. Growing Muslim populations in the United States and Great Britain have very recently begun to contribute to the Islamic ﬁnancial network both institutionally
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