Bilal Randeree
Bilal Randeree

Is Islamic finance a solution?

Even the Christian world is embracing Islamic banking and finance as a response to the international economic crisis. The Vatican has endorsed the values of Islamic finance as a solution to the problems in the world of conventional, interest-based finance. It has stated that Western banks should carefully examine Islamic financial regulations in order to restore confidence among their clients.

“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 conventional banking system is built on a foundation of “Riba”, usually interpreted as usury or interest, which is firmly forbidden in Islam. The collapse of leading Western financial institutions amid the global financial crises has encouraged economists worldwide to consider alternative financial solutions and new approaches to banking and finance.

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

A Financial Times article published early in June 2009 cites evidence that suggests “what happens in the world of conventional finance affects the Islamic financial world with a time lag”. But Daud Vicary Abdullah, expert at consulting firm Deloitte, expects double-digit growth in global Islamic finance over 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.

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, 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 sharia 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 they would be more careful when choosing which deals to 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. 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 why the Islamic finance industry is performing better. Islamic banking benefits from oil revenues (primarily in the Gulf where it is predominately based) 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.

Leading critics of the Islamic finance industry 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 demonstrating thus.

  • Craig

    I’ll bet they’re interested (pardon the pun). Banks given the prospect of not having to pay interest on savings but still allowed to charge interest on loans? Greedy what-nots will be in there like a shot…

  • Siobhan

    The critical point here is the banks sharing in the downturns as well as the upturns of the markets along with their customers.

    IT HAS NEVER MADE SENSE TO LET BANKS GAMBLE WITH INVESTORS’ MONEY THAT IS NOT BACKED BY BANK ASSETS. The current crisis is the direct result of three American Presidents: Reagan, Bush Sr. and Bush Jr. who regulated the banks and the “cowboys” took over.

    The result was the “Enron Scenario”: bonuses and dividends paid out on the PROJECTED FUTURE profits, not on REAL profits!

    Until 1980 people had mortgage that were issued at a fixed interest rate (between5 and 15% from 1945 to 1980 in the US with a 10% down payment from the customer) for the duration of the mortgage, usually 20 years. Every mortgage was insured so that if there were a major recession, the banks would not go under–and neither would the home owners. It was a good system and it worked for 35 years. Then Reagan/Bush de-regulated banks, enforcement agencies, etc. and millions of people lost their homes and savings overnight.

    Fixed-rate mortgages worked because banks limited lending based on actual bank assets–not on imaginary future profits!

    To fix the system we need:
    1) Fixed rate loans and mortgages.
    2) Abolition of bank ‘SERVICE FEES’ . Before 1980 banks made money by paying out less interest than they took in and your REAL deposits were used to make the loans.
    3 )Long-term balanced growth based on real assets.

  • Siobhan

    Sorry: I obviously meant to type DE-REGULATED THE BANKS–aka insanity.

    Service Fees: it used to be that the banks saw their customers as their greatest ‘assets’. The banks needed our money in order to exist. They paid out say 5% on savings accounts but charged 10% to borrow money. The banks made a modest–but guaranteed–profit and covered their costs from those profits. The banks invested in businesses and made more money that way but bank investments had to be backed up by customer deposits.

    Bank de-regulation gave the banks a green light to gouge the public with spurious ‘service fees’ that were NEVER justified. They are even less justified now that banking is done electronically in nano-seconds at a fraction of the cost of human employees.

    ‘Service Fees’ are bank ‘double-dipping': the bank is rated on your deposits which brings the bank more customers but your deposits are depleted by the ‘service fees’.

    In the earliest days of formal ‘banking’ Christians were prohibited from charging interest on loans so they borrowed money from non-Christians whose religions permitted the charging of interest. The Islamic system does not charge interest from its customers but it makes interest (profits) from investing in businesses which pay the banks dividends based on shares held by the bank. There is no reason that this system cannot be a secular system based on sane regulation of banks and financial houses, including stockmarkets. It worked before–why not now?

  • http://letpeoplespeak.amagama.com/ Lyndall Beddy

    Two types of banks/governments were cushioned from the crisis :

    1. Islamic Banks

    2. Banks in countries where Government Fiscal Policy was regulated and permitted real interest rates (of which SA was one)

    Either works. What does NOT work is what started the problem – zero interest which means banks have to speculate to make profits.

    Islamic Banks pay “profits” not “interest” but what was the real thing that saved them was the fact that Islamic Law forbids investing in intangibles (eg derivatives and futures).

    For thousands of years bankers made their profits from the difference between interest paid by borrowers and paid to savers.

    But for most of those thousands of years money was gold and silver not paper.

    As for Christianity and Islam forbidding interest as usury – that is one of the biggist myths of history.

    Both religions merely made the Jews the bankers so they could not be SEEN to be earning interest.

    AND the Jews were the scapegoats when things went wrong (like recessions).

  • http://letpeoplespeak.amagama.com/ Lyndall Beddy

    AND Islamic Law forbids gambling – which was another part of their protection against the meltdown.

  • Jan Swart

    Faith based banking? What next? Banking for the lactose – intolerent? The ugly? What a joke

  • ian

    There aren’t really any ‘big’ sharia compliant banks that are players in the world are there? Compared to the number of conventional banks there numbers are smaller therefore won’t the numbers of failures be smaller?
    Also, how does the west adopt such a scheme when Bai’ Dayn (debt trading) is only allowed with companies that have Shariah compliant business activities? How many of the other 23 Islamic banking concepts are restricted to Shariah compliant business activities (i ask this cause i don’t know) – and does an Islamic scholar have to weigh in with an opinion on what constitutes Shariah compliance? How many Western companies (or Asian) are Shariah compliant?
    So I guess the Muslim scholars are correct when they say if the requirements had been properly implemented there would be no crises – there would also have been no growth or investment in the majority of companies..
    Its ‘big’ (if you call some $250 billion big..) in 4 countries (Malaysia, Indonesia, Pakistan and Singapore), however unlikely to gain favour in many others unless they all opt for Shariah compliance. Which is unlikely, and if you took away the Shariah compliance aspect of Islamic banking, then it is much the same as conventional as others have indicated.

  • Dave Harris

    So whats next? Christian banks, Jewish Banks, Hindu banks, Buddist ….do you see how crazy you sound? I can see Islam as a religion but to shoehorn a boutique banking system like this onto a greater secular community is tantamount to an insult!

    Only this month, Islamic banking even adopted Moody’s Analytics credit scoring methodologies!!! btw. I’d love to see their methodology of calculating the the creditworthiness of non-believers vs believers?

    “in the current crisis no Islamic bank has failed”
    Why is it that you forget to mention the numerous scandaleous failures RIGHT HERE IN SA that have swindled so many innocent Muslim families over the years? You are extremely disingeneous!

    So how do you prevent the financing of terrorism by these banks like Al Rajhi Bank, the LARGEST Islamic bank in Saudi Arabia (“US Tracks Saudi Bank Favored by Extremists,” The Wall Street Journal, July 26, 2007.) Forgot about mentioning this?

    You appear confused as to why US banks collapsed and suggesting replacing a huge modern banking system with an ancient unproven system is like throwing the baby out with the bathwater. The chances of the antiquated, discriminatory, “Islamic banking system” lacking in basic checks and balances to prevent corruption and the financing of terrorism, has a snowball’s chance in hell in replacing the Western banking system. Dream on!

  • Robin Grant

    You miss the obvious – Globally, fractional reserve banking has been imposed upon us. We no longer have money, only a fiat currency. If every debt was repaid today, there would not be one cent in circulation, because the fiat currency in your pocket is actually a debtors note, not money.

    What you are talking about is tantamount to re-introducing the gold standard, and re-empowering people by letting them have actual money again. The individuals and institutions that have actually seized control of the worlds gold stockpiles, and other assets of value (under the guise of collateral) are certainly not going to endorse this plan, and unfortunately today, those with the money, make the rules.

  • Khadeeja

    As a muslim, I have several problems with the concept of Islamic finance.To me, it seems as if it is a marketing gimmick more than anything else. The concept of ISLAMIC FINANCE- in itself is anachronistic, almost oxymoronic in the extreme.

    I think that you need to make valid comparisons, the percentage of money invested via the “shariah-compliant” route- relative to conventional “western” finance is miniscule. Thus, the fact that no Shariah compliant banks have failed is not THAT mean a feat.

    Surely, the islamic principles are merely values for ethical investing. Which, without getting bogged down in nitty gritty technicalities, is in essence in line with the ethos of ‘choosing the middle-road’ morals which define Islam.

    In short- I think Islamic finance is a bit of a farce. The optimal outcome (free-market, capitalist line of thinking) in this scenario will be a reversion to heavier regulation. Which in essence is the POINT of Islamic guidelines- avoiding greed to overpower objectivity, preventing the taking of reckless risks as well as sound fundamentals underlying transactions.

    Which could be what your article was angling at anyway :p

  • Ingalo yo Mthetho

    I think any financial mismanagement boils down to lack of common sense.

    You cannot lend what you do not have (what’s not yours)

    &

    You can not borrow and used funds more than you can earn period

    No faith, belief or religion is needed there

  • Frank Nnete

    Interesting.

  • JohnTheBaptist

    Islamic financial products are not mature enough to completely replace conventional banks. Hence you will fill every single Muslim country has conventional banks. Even Saudia Arabia and Iran (the two most Islamic countries in the world.) It will be quite a bit difficult to conduct business with the world without convetional banking.

    In some distant future, Islamic finance and banking may very well replace the conventional systems. But before that can happen, the majority of the world population have to come to love Islam and Muslim.

    Don’t forget the whole premise behind Islamic finance is “There is no god/God, but Allah. And Muhammad is Allah’s slave and messenger.” To appreciate Islamic finance one must appreciate Islam. Period.

    I would very much like to see Islamic finance succeed because it favour the poor and it favours the risk being shared. We could all use some risk sharing. We don’t need someone earning 2300USD a month to get a 450,000USD mortgage loan. Ok. Thanks. Bye.

    Good luck and Allah bless.

  • peace
  • http://thoughtleader.co.za/grantwalliser Grant Walliser

    The comments above have covered all of the obvious holes. There is no substance either to the article or to the concept of Islamic banking as a progressive concept. The only reason that Islamic banks were not affected by the global crunch was because they were hardly involved in the global boom, preferring to limp along hindered by their archaic, simplistic principles and fooling themselves that they offer interest free finance. Pray tell how do they pay salaries if they do not charge for their financial services. Interest by any other name is…

    As lovely as it would be for those calling for Sharia law (dog help all of us if they get their wish) to believe that the capitalist system has collapsed thus justifying a move back to robes and bartering goods from pack mules, it simply is not true. The capitalist system never budged an inch and remains the defacto standard for progress and growth of a country. The banks played too hard and they got burnt and are now adjusting. Business as usual in a year or two. Sorry to burst the bubble.

  • http://kwerekwere.blogspot.com mundundu

    the problem with confusing “usury” with “interest” — and there is a difference — is that it keeps people out of the housing market.

    i used to do volunteer work with a first-time buyer’s organization in the united states and we sat down the leaders of various islamic councils and explained to them why we felt that permitting muslims to use our program to buy their first home would not be haram.

    we came to an agreement that while they would not write down that it was okay to go through out program, they would give their blessing over the phone or in person to people asking advice.

    at the time, i should add, if you went through the program, it was possible to get a 30-year fixed mortgage at 4% interest. FOUR PERCENT.

    four percent is not usury. hell, bank charges for ordinary transactions often come out to more than that much, in toto, over the year.

    lyndall: yet again, your ‘everybody is out to get the jews’ rhetoric is overly simplistic and needs to be thrown out. *all* literate people who did not have absolute fealty to the state were a threat, not just the jews. eish.

  • http://thoughtleader.co.za/bilalranderee Bilal Randeree

    - Craig
    The FT (Financial Times 8 June 2009) last week quoted the CE of BMB Islamic:
    “There is a perception in the Islamic world that they (Western banks) are in Islamic finance because they are making money. Once they are not, they will wind up their operations”

    – Siobhan
    Interesting points, thanks. The FT (cited above) claims that Islamic banks charge a “sharia premium, expecting Muslims to bank with them simply because (they claim) they are Islamic, and failing to provide competitive services.”

    – Lyndall Beddy
    Good points as well.
    But as mundundu says, your ‘everybody is out to get the jews’ rhetoric is overly simplistic’ idiocy that messes it up.

    – Jan Swart
    The Financial Times, while not featuring on my list of favourite publications, does not make many jokes. There is a joke somewhere in this, but its doubtful you’ll ever get it.

    – Ian
    I agree with your concerns and criticisms – Prof. Rodney Wilson, quoted in my article, states that “the religious teaching underpinning Islamic finance is concerned with justice in financial contracts to ensure that none of the parties is being exploited.”
    It is this justice and anti-exploitation that should be the main focus. The FT (cited above) also claims that “Islamic banks don’t have well defined corporate social regimes. Also, some have seen big rise in profits in recent years but kept the money for themselves.”

  • http://thoughtleader.co.za/bilalranderee Bilal Randeree

    - Dave Harris
    Again. Its not just me – most Western banks have been active in Islamic finance for a while now. That is the FT talking, not me. FT is the Financial Times – I can email you the website if you want…
    But you are completely correct in that there have been numerous scandalous failures right here in SA – unfortunately, thieves come in all colours, shapes and sizes.

    – Robin Grant
    It is for this reason that Muslim thinkers such as Mahathir Mohamad have promoted the use of gold and silver as legal tender in place of ‘representative’ forms of money – gold and silver cannot be created out of nothing. Under the precious metal monetary system, no organisation has the power to create money without cost, and this is one important guarantee of stability in the monetary system – but alas something that, as you correctly point out, is unlikely to happen anytime in the foreseeable future.

    – Khadeeja
    Perhaps I should have been more explicit as few have been able to read through the lines. But another important point to consider as a Muslim, is that regardless whether you believe Islamic finance is a farce or not, we do have an important role to play in the current climate – and by ‘we’ I mean all those that claim to have an ethical foundation in their lives.

    – JohnTheBaptist
    Thank you for your comments and good luck to you too. Ok. Thanks. Bye.

  • http://thoughtleader.co.za/bilalranderee Bilal Randeree

    - Grant Walliser
    The principal behind it is profit sharing – and while it may not implemented by these institutions, it does reduce risk for the investors/partners/banks and means they are less likely to become insolvent. If you look carefully, you will find institutions operating effectively like this – but as I alluded, all Islamic finance institutions are probably not. “Archaic, simplistic principles” may actually be more than what you understand of them.

    – mundundu
    In my opinion, a model that offers 30 year fixed mortgage at 4% is the model that needs to be promoted and supported. Can you establish that organisation to Africa?

  • http://kwerekwere.blogspot.com mundundu

    bilal —

    the organization had a deal with two of the major banks to arrange mortgages at 1% below the prevailing rate. that is, the prevailing rate, at the time, for conventional mortgages, was 5% — to which, btw, many islamic councils also turned a blind eye.

    something important to remember is that conventional mortgages in the united states means the same monthly payment, for or less, for 30 years, with any changes in the payments resulting from municipal taxes [ie the rates bill from the municipality] and not interest rates as dictated from the banks.

    [you know, if you know what your housing bill is giong to be for 30 years, you can plan the rest of your life very easily. i got *really* burned by that when i bought my house here, that's for sure. eish.]

  • HH Higgins

    The author hasn’t read the Bible. Jesus warned against usury. So Vatican isn’t so much backing Islamic principles but following Jesus’ lead. But since Islam recognizes Jesus as the messiah, it doesn’t much matter.

    Whatever religion you are, let’s all try to do better and be more viligant. Citibank was doing dirt w/ loans to China for illegal settlements in Tibet long before the subprime meltdown.

  • Bill

    That is why muslims have more money than you ‘Jan Swart’ and many many many more generations after you. You call it ‘banking for lactose – intolerent’
    We call it being well off………………..