Munich Personal RePEc Archive
An Ideal Islamic Economic System: A Gone Case
Shaikh, Salman
1 November 2010
Online at https://mpra.ub.uni-muenchen.de/26701/
MPRA Paper No. 26701, posted 17 Nov 2010 06:28 UTC
An I de a l I sla m ic Econ om ic Syst e m : A Gon e Ca se ? Sa lm a n Ah m e d Sh a ik h
1isla m ice con om icspr oj e ct @gm a il.com w w w .isla m ice con om ics.vivit i.com
Abst r a ct
I slam ic finance indust ry m ost ly uses LI BOR linked financial cont ract s w hich are akin t o debt financing t han t he m ore preferable part icipat ory m odes of Mudarabah and Musharakah. As per t he current ort hodox underst anding and pract ice of I slam ic finance, t he oft en cit ed preferable m odes like Mudarabah and Musharakah ar e incapable even in a sim ple m odel econom y w it h t hem as t he only m ode of financing. Hence, t hey are rarely used. The prevalent I slam ic product s which are linked wit h LI BOR are and will predom inant ly be used and pract iced I slam ic finance m ay rem ain incapable of providing egalit arian benefit s it once prom ised. I ronically, I slam ic values like j ust ice, equalit y, t rut h, t rust , kindness, honest y and responsibilit y are oft en discussed in lit erat ure and sem inars on I slam ic Econom ics; whereas, in realit y, t he lack of t hese values in pract ice is t he m aj or reason w hy preferable part icipat ory m odes rem ain unusable! As discussed, t he current ort hodox underst anding of I slam ic fiscal redist ribut ion m echanism s like Zakat and I nherit ance also m ake t hem incapable of cont ribut ing t ow ards t he est ablishm ent of an egalit arian econom ic fram ework. This paper proposes an alt ernat e approach t o pract iced I slam ic finance and ort hodox underst anding of Zakat and inherit ance law s and shows t hat t he alt ernat e approach could st ill be sufficient t o cont ribut e t ow ards egalit arian obj ect ives effect ively.
Ke yw or ds I slam ic Finance, I slam ic Econom ics, Welfare Econom ics, Experim ent al Econom ics, Het erodox Econom ics, Zakat , Fiscal Redist ribut ion
1 . A Look a t Pr a ct ice d I sla m ic Fin a n ce
I slam ic Finance is a growing indust ry which is const ant ly evolving and has been com pet it ive t o reach and sust ain it s growt h m om ent um am id even t he Great Recession and beyond. Asset s of t he global I slam ic finance indust ry are est im at ed t o grow t o around $1.6 t rillion by 2012 ( Source: Reut ers) . Lat ely, t he Vat ican said t hat banks should look at t he rules of I slam ic finance
1 Salman Ahmed Shaikh is a researcher in Islamic Economics. He is author of “Proposal for a New Economic Framework Based on Islamic Principles”. He has also written 14 papers on Islamic Economics. He is a faculty member at Szabist, Pakistan. He can be contacted at salmanahmed_hyd@hotmail.com
t o rest ore confidence am ongst t heir client s at a t im e of global econom ic crisis. ( Source: Osservat ore, March 04, 2009) . Som e report s suggest t hat asset s held by I slam ic financial inst it ut ions m ay rise five- fold t o m ore t han
$5 t rillion ( Source: Moody’s I nvest or Service) .
But , I slam ic finance indust ry m ost ly uses LI BOR linked financial cont ract s which are akin t o debt financing t han t he m ore preferable part icipat ory m odes of Mudarabah and Musharakah.
1 .1 . Tim e V a lu e of M on e y & I sla m ic Fin a n ce
I n invest m ent for t rade ( which I slam allows) , t he invest m ent goes t hrough t he ent ire process of a com m ercial act ivit y t hat involves risk t aking at each st age and any com pensat ion on invest m ent is st rict ly dependent upon t he out com e of t he com m ercial act ivit y. The profit for t he businessm an st rict ly depends upon t he act ual profit realized aft er t aking m arket risk including price risk. I t does not depend upon t im e.
Tim e value of m oney is t he basis of int erest . Tim e value of m oney is t he problem for t he invest or t o avoid keeping his m oney idle and t o avoid forgoing t he use of m oney t hat m ay bring posit ive value t o his invest m ent . However, it does not m ean t hat t he invest or can dem and an arbit rary increase ( or is given as t he case m ay be) as t he cost of using m oney wit hout t aking t he m arket and price risk.
Assigning weight age t o invest m ent based on t enor of invest m ent t hrough which horizont al dist ribut ion of profit t akes place in I slam ic banking creat es t he sam e yield curve as in t he case of t erm deposit s of convent ional banks.
The sit uat ion where losses are incurred would have been very int erest ing, but t he m oney is invest ed in cont ract s in which t he chance of loss is rem ot e.
Also, t he arrangem ent is such t hat t he bank m akes sure t hat it get s com parable ret urns t aking LI BOR as t he benchm ark rat e. Now a discussion on t hose inst rum ent s ( asset s of t he bank) will inquire t hat how t hese inst rum ent s enable t he bank t o provide com pensat ion based on t enor.
1 .2 . An a lysis of D im in ish in g M u sh a r a k a h
I n ‘Dim inishing Musharakah’, t wo cont ract s i.e. t enancy and sale are included as t wo separat e com ponent s of a Dim inishing Musharakah cont ract . Bot h t hese cont ract s are separat ed by way of a unilat eral undert aking in place of t he act ual sim ult aneous sale/ purchase of unit s of t he asset / propert y. The rent is calculat ed and charged on t he basis of LI BOR.
The rent increases when t he LI BOR increases.
Upon close inquiry, one can not ice t hat undert aking or prom ise m akes t he cont ract condit ional. This argum ent is furt her subst ant iat ed by t he fact t hat if t he client refuses t o undert ake or prom ise t o buy t he asset ( in unit s) , t he bank will not m ake cont ract wit h him . Furt herm ore, t he prom ise gives t he legal cover t o t he bank and is accept able in a court of law.
Following t able com pares t he convent ional m ort gage and ‘Dim inishing Musharakah'. I t can be seen from t he t able above t hat t here is hardly any difference bet ween t he t wo m odes of financing wit h respect t o t he flow of funds.
Fe a t u r e s Conv e n t ion a l M or t ga ge D im in ish ing M u sha r a k a h
Benchm ark Rat e KI BOR KI BOR
Basis of Rent KI BOR KI BOR
Nat ure of I nst allm ent I nt erest + Principal Repaym ent Rent + Sale of Unit s
Prepaym ent Penalt y Yes Sale of Unit s at Higher Price Rent + Sale cont ract Dependent Separat ed by unilat eral prom ise I n subsequent years I nt erest decreases Rent paym ent decreases
I n subsequent years Principal repaym ent increases More Unit s are purchased
Changes in Rent Based on KI BOR Based on KI BOR
Price and Market Risk No No
Price of Asset Locked at init iat ion Locked at I nit iat ion Cost t o t he borrower Sam e in bot h cases Sam e in bot h cases Profit t o t he bank Sam e in bot h cases Sam e in bot h cases
1 .3 . An a lysis of Risk Ta k in g by Ba n k
There are several t ypes of risks. The m ost relevant risk is t he m arket risk including price risk i.e. t he risk t hat t he goods will not be sold or will be sold at lower prices t hat m ay or m ay not cover cost s. I n ‘Murabaha’ and
‘Dim inishing Musharakah’, price and m arket risk is not t aken by t he bank.
I nsurance, im port dut y, levies, and all ot her expenses are indirect ly charged from t he cust om er t hrough t ransfer pricing.
Had t he t enancy and sale cont ract were m ade separat ely, t he bank would have had t o bear t he m arket risk which t he bank avoids by t aking a unilat eral undert aking from t he cust om er t o lease or purchase an asset in I j ara/ Dim inishing Musharakah and Murabaha respect ively.
El- Gam al ( 2008) crit icized current I slam ic banking by st at ing t hat t he prim ary em phasis in I slam ic fi nance is not on efficiency and fair pricing.
Rat her, t he em phasis is on cont ract m echanics and cert ifi cat ion of I slam icit y by “ Shariah Supervisory Boards” .
1 .4 . An a lysis of M u r a ba h a
I t is referred t o as “ cost + profit ” t ransact ion. I n t his t ransact ion, if a person needs a m achine wort h Rs.100,000. The bank appoint s t he person as an agent t o buy it and before it pays t he am ount ( Rs. 100,000) t o t he supplier, t he bank m akes sure t hat t he cust om er signs an undert aking t o buy t he asset . This undert aking by t he cust om er is lat er used t o sell t he asset t o t he cust om er at a profit . The bank m akes sure t hat it get s t he required profit by locking t he price at t he out set and avoids t aking any m arket relat ed risk.
Undert aking t o purchase t he asset once t he asset is bought by t he client as an agent of t he bank m akes t he cont ract condit ional. This undert aking is t aken from t he client before t he bank releases funds. This argum ent is furt her subst ant iat ed by t he fact t hat if t he client refuses t o undert ake or prom ise t o buy t he asset , t he bank will not m ake cont ract wit h him . Furt herm ore, t he prom ise gives legal rem edy t o t he bank and is accept able in a court of law.
Usm ani ( 2003) describing t he less ideal nat ure of Murabaha wit h respect t o cont ribut ing t o t he goals of socio- econom ic redist ribut ion in econom y wrot e:
“ The inst rum ent s of leasing and Murabaha are som et im es crit icized on t he ground t hat t heir net result is oft en t he sam e as t he net result of an int erest - based borrowing. This crit icism is j ust ified t o som e ext ent , and t hat is why, t he Shariah supervisory Boards are unanim ous on t he point t hat t hey are not ideal m odes of financing and t hey should be used only in cases of need wit h full observat ion of t he condit ions prescribed by Shariah.” ( p. 13) Com m odit y Murabaha used by t he I slam ic bank’s t reasury for asset liabilit y m anagem ent ( basing t heir act ions on t he opinion of scholars t hat ‘Murabaha is allowed, even if not ideal’) t ook t he allowance t o t he ext rem e whereby in Com m odit y Murabaha t ransact ions, t he subj ect m at t er is not genuinely required by bot h financial inst it ut ions, but each of t hem t akes ownership lit erally for som e m inut es and execut e a com plex sale result ing in a profit for one and fulfillm ent of liquidit y requirem ent for t he ot her.
Sim ilarly, use of sale and lease back t ransact ion in house const ruct ion finance and in com m ercial finance is also a t ransact ion in which I slam ic bank purchases t he asset wit hout any need of it s own from t he sam e cust om er t o whom t he asset is leased subsequent ly. The lapse of at least one year period bet ween sale and lease recom m ended by Shariah scholars is also not a sufficient j ust ificat ion as t he I slam ic bank t akes undert aking from t he client beforehand t o lease it aft er one year.
Wit h Murabaha as an alt ernat ive, profit able com panies will not opt for Mudarabah/ Musharakah because t hey will not like t o share profit s and else
would go for cheaper way of sourcing funds i.e. debt financing. Less profit able com panies will want t o go for Mudarabah/ Musharakah, but bank as conservat ive financial inst it ut ion will not t ake risk wit h t hese com panies.
The argum ent t hat Mudarabah/ Musharakah financing is not possible due t o lack of aut hent ic docum ent at ion and t rust level is also very weak. I slam ic banks operat ing in developed m arket s ( it is t o be not ed t hat t he developed count ries are t he hub of I slam ic banking) where such problem s are not found have also not gone for Mudarabah/ Musharakah financing. As a m at t er of fact , I slam ic banks do not want t o t ake m arket and price risk. Default , credit , polit ical, exchange and ot her risks are also t aken by convent ional banks. I f Mudarabah and Musharakah are deem ed ideal alt ernat ives by I slam ic banking expert s and scholars favoring it ; t hen, t hey would have been bet t er off ent ering int o invest m ent banking before t hey ent ered int o com m ercial banking.
1 .5 . An a lysis of Sa la m
Salam is an alt ernat ive for short selling. I t s allowance is confirm ed from an aut hent ic Hadit h. I t is a sale in which paym ent ( in full) is at spot but delivery is deferred. But , it is t o be not ed t hat t he t ransact ion approved by Prophet Muham m ad ( pbuh) did not involve a financial int erm ediary. I deally, we have t o elim inat e t he need of excessive financial int erm ediat ion and look for t he alt ernat ive m et hods, som e of which have been suggest ed lat er in t he paper and also in m y book ‘Proposal for a New Econom ic Fram ew ork Based on I slam ic Principles’ and m ore research is required in t his regard. I n parallel Salam , t he sam e problem of cont ingency in cont ract s persist s.
1 .6 . An a lysis of M u da r a ba h
One of t he m aj or im pedim ent s in t he use of Mudarabah on t he asset side of a bank i.e. for financing is t hat only Rabb- ul- Maal is considered t o bear all t he financial losses. Therefore, if an I slam ic bank ent ers int o t he Mudarabah cont ract as a Rabb- ul- Maal, only t he I slam ic bank would have t o bear all t he losses. Mudarib ( Fund m anager) bears no loss while he has t he com plet e aut horit y in running t he affairs of t he business. The Rabb- ul- m aal ( invest or) is not allowed t o int erfere in t he affairs of t he business. When a loss occurs, t he Mudarib act s like an em ployee of t he business and when t he profit occurs, he shares in t he profit as if he was t he only reason behind t he profit s. This j urist ic viewpoint didn’t creat e m uch problem during early I slam ic era when m ost ly t he Mudarib was a poor and resource- less person in financial need wit h lim it ed incent ive and aut horit y t o ent er in corrupt ion and no capacit y t o part icipat e in loss sharing if t he loss was caused by any reason ot her t han negligence on his part .
The principle t hat loss sharing should be based upon and lim it ed t o t he am ount of capit al invest ed is not a condit ion m ent ioned in Quran or Hadit h.
Fuqaha recom m ended it , but it does not m ean t hat it can not be m odified, especially if doing so is necessary and will m ake t he preferable I slam ic m odes of financing m ore applicable. When we m ake t erm s and condit ions for em ploym ent cont ract s, for appoint m ent of Shariah Advisors et c, any condit ion not in violat ion wit h I slam ic principles is allowed and is used.
Sim ilarly, lim it ing loss sharing up t o t he am ount of capit al invest ed is not t he only way loss sharing could t ake place.
Furt herm ore, in Musharakah, loss part icipat ion by all part ners across t he board is j ust ifiable because all part ners are also allowed t o work. But , due t o t he condit ion in Mudarabah t hat working part ner is t he sole aut horit y t o m ake decisions on business, m aking Rabb- ul- Maal com plet ely responsible for sharing all losses is unj ust ified in t he first place.
I t is considered t hat in case of loss, Mudarib loses t he com pensat ion t o his effort s. But , Mudarib was not an em ployee. He was a j oint part ner, m ore precisely, a working part ner. Taking t he posit ion t hat he lost t he com pensat ion t o his work is invit ing opport unit y cost which I slam ic econom ics does not acknowledge apparent ly.
I n Mudarabah, t he prevalent concept of loss sharing m akes it different from a General part nership ( all part ners have unlim it ed liabilit y) and even wit h lim it ed part nership ( som e or all have lim it ed liabilit y) . I n Mudarabah, Rabb- ul Maal not only has unlim it ed liabilit y, but no aut horit y t o part icipat e in t he business. Consider an I slam ic econom y wit h Mudarabah on asset and liabilit y side and t here is no ot her inst rum ent used, Mudarib ( usually blue chip com panies) wit h no liabilit y t o share loss can obt ain financing from banks who would be Rabb- ul- Maal in asset side use of Mudarabah. On liabilit y side, bank will be Mudarib and t he sm all savers and invest ors will be Rabb- ul- Maal. So, any loss incurred by blue chip com panies is ult im at ely paid by sm all savers and invest ors who have all t he liabilit y t o share losses wit hout having a say in t he affairs of t he business!
Rest rict ed Mudarabah and clause of willful negligence is insufficient t o prot ect t hem from losses st rict ly due t o business cycle fluct uat ions. This exam ple shows t hat wit h current st ruct ure, even Mudarabah used alone in an econom y is insufficient t o bring about any egalit arian change let alone prove t o be m ore dest ruct ive t han int erest based syst em .
Let us analyze t rust deficit and docum ent at ion problem s which are cit ed as reasons why Mudarabah is not being used widely. Relax t hese assum pt ions and now consider t here is no t rust deficit and docum ent at ion problem in t he
econom y. I f a loss occurs due t o business cycle fluct uat ions, no part of t he loss is borne by t he business t hat had all t he aut horit y t o run t he business.
The loss is borne not by t he bank as well because bank is Mudarib on liabilit y side. All loss is borne by t he sm all savers and invest ors. Now consider t he governm ent prohibit s int erest based lending and borrowing t oo. Will t he people want t o be Rabb- ul- Maal in Mudarabah wit h bank or t he shareholder in a blue chip com pany which can t ake all t he m oney, invest it , earn from it and if loss occurs, pass it ont o t he sm all savers! Mudarabah ( wit h current st ruct ure) even w hen assum pt ions of t rust deficit and docum ent at ion problem are relaxed and even when t here is no com pet ing convent ional banking syst em is ineffect ive t o say t he least .
I f we look at Mudarabah as it is current ly underst ood, Mudarib is basically an em ployee who would get Uj rat - e- Misl in case of loss and his com pensat ion will feat ure som e share in profit also. He is not liable t o bear any loss. Rabb- ul- Maal is basically t he ent repreneur ( who has t he ult im at e responsibilit y t o share losses) . How is it a part icipat ory m ode t hen? This should not be cit ed as a part icipat ory m ode wit h current st ruct ure. Secondly, it is also different from a principal agent relat ionship in corporat e form of organizat ion. I n t hat , t he principal hires t he agent only because of his inabilit y/ incapacit y, but t he rules do not rest rict him not t o influence agent ’s decisions. I m port ant decisions t aken by t he agent ( s) have t o be vet t ed in AGM. Mudarabah rules even do not allow t hat m uch part icipat ion. So, in m y hum ble opinion, we first need t o j ust ify t hat how Mudarabah is a “ j ust ” m ode of financing, let alone a part icipat ory one and a m ost preferable one.
Wit h im port ant covenant s in place, equit y financing can be used and is used widely. I t is int erest ing t o st udy t he size of debt and equit y m arket in developing count ries. For inst ance, in Pakist an, corporat e bond m arket hardly exist s, whereas equit y financing is m ore prevalent and widely used.
Equit y financing t hrough shares will forever deny t he claim s of bankers in general and I slam ic bankers in part icular who hide behind t rust deficit and docum ent at ion problem s. Why people invest in shares of com panies wit hout any guarant ee over par value let alone dividend? This is an im port ant quest ion t o answer even if som e financial t ycoons help prom ot e t he pract iced I slam ic Finance t he way it is pract iced for com m ercial reasons.
1 .7 . Se cu r it iz a t ion , Gr e a t Re ce ssion & I sla m ic Fin a n ce
The proponent s of I slam ic finance argue t hat t he dem ise of financial inst it ut ions in developed m arket s was due t o excessive securit izat ion and t his crisis has exposed t he weaknesses in t he int erest based financial syst em .
Shaikh, Salm an ( 2010) analyzing t he t endency of proponent s of I slam ic finance who argue t hat t he dem ise of financial inst it ut ions in developed m arket s was due t o excessive securit izat ion wrot e:
“ But , securit izat ion in I slam ic finance is also possible and is used frequent ly in recent t im es. The argum ent t hat Asset backed nat ure of financing would ensure effect ive risk m anagem ent is also weak as CMOs, MBS, ABS et c were inst rum ent s wit h m ort gage loans as t heir underlying asset s. The problem was wit h excessive leveraging and lax regulat ion and not wit h securit izat ion per se. Securit izat ion in I slam ic finance as in Sukuk also suffered a set back in Dubai Crisis in 2009/ 10. Asset backed financing also lacks t he pot ent ial t o provide need based loans for educat ion, m arriage, financing t o pay short t erm debt , salaries, ot her accrued expenses t o 3r d part ies et c.” ( p. 152)
The cont roversy regarding Sukuk got heat ed up when Maulana Taqi Usm ani crit ically com m ent ed on unscrupulous Sukuk issuance. Maulana Taqi Usm ani is report ed t o have said t hat 85% of t he Sukuk issued worldwide are unislam ic. ( Source: BBC News, Decem ber 11, 2009) .
Aldrin ( 2010) caut ioned t hat due t o t he absence of appropriat e Sukuk pricing m odel, indust ry current ly uses sam e pricing benchm ark for bot h convent ional and Sukuk I slam ic bond i.e. LI BOR. Hence, high correlat ion bet ween t he t wo inst rum ent s is no surprise; rat her it m ust be a signal for indust ry t o m ake a dist inct ive benchm ark for it self.
Andreas & et al. ( 2008) crit ically analyzing indust ry pract ices in Sukuk argued t hat com pared t o t he replicat ion effort s m ade, less research and effort s were m ade on how t o innovat e and develop purely Shariah based product s.
1 .8 . Con clu din g Re m a r k s
The proponent s of I slam ic banking repeat edly t ry t o give som e logical answers t o support t he case of I slam ic banking. These logical argum ent s are analyzed briefly.
I t is said t hat a McDonald burger in west and east m ay t ast e sam e, but one m ay be perm issible i.e. halal and one m ay be prohibit ed i.e. Haram if it is prepared from t he m eat of t he chicken which was not slaught ered in t he prescribed m anner. I t is a very weak argum ent . The prohibit ed burger is not prohibit ed due t o t he t ast e. I t is prohibit ed because t he prescribed m anner of slaught ering is not followed t o obt ain t he m eet for t he burger. The reason of prohibit ion is not biological ( t ast e) , it is psychological i.e. Allah has perm it t ed t o t ake t he life of an anim al, but hum ans m ust rem em ber t hat it is
Allah who has perm it t ed t hem t o t ake t he life of an anim al for food and m ust ut t er words which signify t his underst anding.
I t is said t hat pre- m arit al and post - m arit al sex m ay give sam e ut ilit y, but one is perm issible and t he ot her is not . Here again, t he reason for prohibit ion of pre- m arit al sex is not biological or wit h regards t o difference in ut ilit y, but it is social i.e. I slam t reasures fam ily syst em and want s t o prot ect it s sanct it y at all cost . The very st ruct ure of t he fam ily syst em rest s on lim it ing free sex and confining it only t o m arit al relat ions else from a social point of view, hum ans would be no different t han anim als.
Proponent s of current I slam ic banking argue against t he viewpoint t hat int erest is prohibit ed solely because of it s econom ic evils ( Usm ani, 2007) . Explaining t he verse ( Al- Baqarah: 275) , t hey argue t hat t he verse was revealed t o clarify t he difference bet ween credit sale ( of t he t ype which is used t oday in I slam ic banking) and Riba. There is a huge difference bet ween int erest based econom ic act ivit y and t rade. I f t here had been a lit t le difference, Allah would have given t he reason for it s prohibit ion in place of t he verse in which Allah has declared t he advocat e of int erest as t he one who has becom e m ad by t he t ouch of t he evil ( Al- Baqarah: 275) . Rat her t han being derisive here, argum ent s against int erest should have been given. But , it was not needed because t he people underst ood what int erest was and what t rade was.
Respect ed m ainst ream scholars like Muft i Taqi Usm ani while explaining verse 275 of Al- Baqarah st at ed t hat if t his and sim ilar inj unct ions do not becom e clear t o t he hum an m ind, it should not becom e a reason for argum ent and disbelief. However, if one reads t he verse 275 of Al- Baqarah, it seem s t hat Allah is crit icizing using t he very argum ent t hat no sane person can equat e t rade wit h Riba. I f one does, t hen, he is like som eone who has becom e m ad by t he t ouch of t he devil. Following is t he t ranslat ion of t he verse under discussion.
“ Those who benefit from int erest shall be raised like t hose who have been driven t o m adness by t he t ouch of t he Devil; t his is because t hey say:
" Trade is like int erest " while Allah has perm it t ed t rade and forbidden int erest .” [ Al- Baqarah: 275]
I f argum ent of int erest not prohibit ed due t o any explicit , logical and rat ional reason is t aken; t hen, we ought t o believe t hat Allah has declared an act ivit y t o be like waging War wit h Allah and Prophet and 70 t im es m ore heinous t han com m it t ing adult ery wit h one’s m ot her wit hout m aking it clear why int erest is prohibit ed!
Alt ernat ively, if t he explanat ion of t he proponent s of I slam ic banking for verse 275 of Al- Baqarah is t aken, t hen, it seem s very st range t hat if no apparent difference exist s in t he econom ic effect s of t he t wo t ransact ions i.e.
credit sale which resem bles Riba and Riba it self, why would som eone indulge in Riba if t he sam e level of profit can be achieved t hrough a credit sale which only resem bles Riba. Secondly, how st range it would be t o assum e t hat Allah would punish t aker of Riba so severely, while from t he econom ic st andpoint , t he one who undert akes a credit sale t ransact ion which resem bles Riba would have earned t he sam e level of profit .
Count ry risk, polit ical risk, currency risk, default risk, credit risk, int erest rat e risk et c are t aken by convent ional banks as well. The relevant risk is t he price risk i.e. sale price m ay not cover cost s and t he m arket risk i.e.
goods/ services m ay rem ain unsold.
Though, proponent s of I slam ic Banking have prom ised and shown com m it m ent t hat in t he long run, t hey are working t owards t he obj ect ive of m aking a syst em conducive t o achieve equit able dist ribut ion of incom e. But , if in next decade or t wo, t he pract iced I slam ic Banking fails t o give a result different from convent ional banking in a capit alist econom y; t hen, t he proponent s of I slam ic Banking will have lit t le aut horit y rem aining t o crit icize Capit alism .
I slam ic bankers and scholars m ust rem em ber t he behavior of 'I hl- e- Sabbat h' and Allah's verdict on t hat behavior. People of Aylah were prohibit ed from fishing on Sat urdays. The fish used t o com e only on Sat urdays since Allah was t est ing t heir obedience. But , t hey m ade a t rick t o cat ch t he fish on t he Sabbat h. They fixed t heir fishing net s and ropes on Friday so t hat fish get int o t he net s on Friday and t hey could cat ch t hem on Sunday. They were considered disobedient by Allah on t his behavior and t hey were doom ed.
2 . A Look a t I sla m ic Fisca l Policy
Supposedly, Zakat is one of t he m aj or m echanism s for redist ribut ion of incom e in an I slam ic econom y. But , t here are following com plicat ions in Zakat rules and int erpret at ion which leads t o very low Zakat collect ion.
1. Only agricult ural product ion is Zakat able.
2. Gold and Silver are Zakat able, but diam onds and ot her precious st ones are not .
3. Dual Nisab wit h com plet ely different values and hence dual exem pt ion am ount .
4. Wealt h in cash is subj ect t o Zakat , but not if it is convert ed int o a m ult ist oried resident ial bungalow or when som eone purchases diam onds and precious st ones wit h it .
5. The condit ion of Tam leek in Zakat i.e. t he condit ion t o m ake som e living person t he owner of Zakat . Therefore, Zakah cannot be spent for general welfare of t he poor. For inst ance, one cannot build hospit als for t he free t reat m ent of t he poor, cannot est ablish schools for children and cannot provide t heir dwellings wit h fresh wat er.
Due t o t hese and ot her num erous anom alies in t he current ort hodox underst anding of Zakat , m ost Muslim scholars have allowed im posit ion of t axes.
This is despit e t he fact t hat neit her t he Prophet Muham m ad ( pbuh) nor t he pious Caliphat es ( rt a) levied any t ax ot her t han Zakat even when t hey were aware of t he t axes im posed by neighboring non- Muslim count ries on t heir cit izens. Saleem ( 1992) gave an account of t he narrat ions of t he Prophet in t his regard which are m ent ioned below:
a) There is no [ legal] share [ for t he societ y] in t he wealt h [ of people] except Zakat .” ( I bni Maaj ah: Kit ab- uz- Zakat ) .
b) “ Aft er you have paid t he Zakat of your wealt h, you have paid [ all] t hat was [ legally] required of you.” ( I bni Maaj ah: Kit ab- uz- Zakat ) .
c) “ No t ax- im poser shall ent er paradise.” ( Abu- Daud: Kit ab- ul- Khiraj ) .
Hence, I slam ic fiscal inst rum ent s as t hey are underst ood in ort hodox lit erat ure also seem incapable of offering any help.
Next , we look at inherit ance law of I slam which is also an im port ant vehicle in redist ribut ion of incom e at t he m icro level. As per t he ort hodox underst anding of inherit ance law of I slam , in som e cases, t he sum of t he shares m ent ioned for beneficiaries exceeds one and hence inherit ance can in no way be dist ribut ed. The problem is solved by ort hodox scholars by proport ionat ely decreasing all t he shares. I n I slam ic j urisprudence, t his is called " aul" i.e. doct rine of increase and lam ent ably, t hey regard it as one of t he finest accom plishm ent s of hum an int ellect !
3 . Con clu sion
As per t he current ort hodox underst anding and pract ice of I slam ic finance, t he oft en cit ed preferable m odes like Mudarabah and Musharakah are incapable even in a sim ple m odel econom y wit h t hem as t he only m ode of financing. Hence, t hey are not used and will not be used due t o t he reasons discussed above. The prevalent I slam ic product s which are linked wit h LI BOR are and will predom inant ly be used and pract iced I slam ic finance m ay rem ain incapable of providing egalit arian benefit s it once prom ised.
I ronically, I slam ic values like j ust ice, equalit y, t rut h, t rust , kindness, honest y and responsibilit y are oft en discussed in lit erat ure and sem inars on I slam ic Econom ics; whereas, in realit y, t he lack of t hese values in pract ice is t he m aj or reason why preferable part icipat ory m odes rem ain unusable! As discussed, t he current ort hodox underst anding of I slam ic fiscal redist ribut ion m echanism s like Zakat and I nherit ance also m ake t hem incapable of cont ribut ing t owards t he est ablishm ent of an egalit arian econom ic fram ework.
4 . I sla m ic Econ om ic Syst e m : Th e W a y Ah e a d
I n developing I slam ic Econom ics, we first need t o present t he t hesis of I slam answering all valid argum ent s against it and it s t eachings. Then, we can present t he econom ic t eachings of I slam which will act as broad guidelines for appropriat e conduct in econom ic pursuit s. Then, given t he lim it s and const raint s at t he out set , ut ilizing bot h t he lit erat ure and pract ice of Classical Econom ics and I slam ic Econom ics, we can develop and present t he foundat ions, inst it ut ions, inst rum ent s, m echanism and delineat e role of each in t he new Econom ic fram ework.
I n m y work on I slam ic Econom ics, I have explained it as a blend of nat ural feat ures present in Capit alism i.e. right t o privat e propert y, privat e pursuit of econom ic int erest , use of m arket forces et c used along wit h som e dist inct feat ures derived t hrough I slam ic econom ic t eachings i.e. int erest free econom y, m oral check on unbridled self- pursuit and provision of socio- econom ic j ust ice t o achieve t he goals of Socialism as far as is nat urally possible wit hout denying individual freedom and profit m ot ive.
I n I slam ic fiscal econom ics, I have explained wit h reasons t hat Zakat is t he only com pulsory paym ent t o t he governm ent on one’s incom e and wealt h in an I slam ic econom y. Zakat able asset s should include all asset s above t he value of nisab except t he asset s in personal use and m eans of product ion.
Minim um Nisab Am ount is t he m arket value of 612 gram s of silver only.
( See Mu’at t a I m am Malik, No: 578) .
Product ion is not lim it ed t o agricult ure nowadays, but t he m aj or part of it is com ing from indust ries as well as services sect or. Therefore, indust rial
product ion could also be t axed j ust like agricult ure. Services incom e could also be t axed on t he sam e principle.
I nvest m ent in st ocks should be int erpret ed as any ot her invest m ent wit h som e m eans of earning incom e. St ock is a m eans of earning dividend or capit al gains. Just like m eans of product ion/ incom e are exem pt from Zakat , invest m ent in st ocks should be exem pt ed from Wealt h Zakat as invest m ent in st ocks m eans t hat t he m oney is not kept idle. Therefore, any incom e arising from invest m ent in st ocks i.e. capit al gains or dividend m ust be subj ect t o Ushr. Sim ilarly, t his argum ent could be ext ended t o int roduce Ushr on incom e from m ut ual funds, invest m ent in ot her financial inst rum ent s et c. Likewise, if land/ building/ house is leased, t he land/ building/ house becom es t he m eans of earning rent . Hence, Ushr could also be int roduced on rent al incom e on houses, asset s, buildings et c. Through an em pirical st udy, I concluded t hat Zakat in t his way can relieve t he governm ent of Pakist an from deficit s.
I n I slam ic corporat e finance, I suggest ed an alt ernat e approach t o corporat e finance in an int erest free econom y by looking beyond pract iced I slam ic finance and suggest ed alt ernat ives for corporat e finance in sourcing funds i.e. i) I j ara wit h em bedded opt ions, ii) lim it ed liabilit y part nership, iii) equit y m odes like Musharakah and Mudarabah iv) incom e bonds and v) convert ible incom e bonds. Then, I suggest ed alt ernat ives for corporat e finance in using funds ( invest m ent s) i.e. i) I slam ic incom e funds, ii) I slam ic REI Ts, iii) GDP growt h rat e linked sovereign bonds, iv) incom e bonds v) convert ible incom e bonds, vi) foreign currency reserves, vii) m aking st rat egic expansion, and viii) equit y invest m ent s in ot her com panies. I j ara wit h em bedded opt ion can solve t he paradox of unilat eral undert aking and convert t he sale of put opt ion from t he perspect ive of client int o a call opt ion. I n Mudarabah, following t wo covenant s can be int roduced.
a) Mudarib can be asked t o cont ribut e som e capit al. The cont ract will st ill rem ain different from Musharakah as only t he Mudarib is t he working part ner.
b) Mudarib can be asked t o share in loss t o som e ext ent .
These t wo covenant s will m inim ize t he problem of adverse select ion, m oral hazard and agency problem .
I n m et hods of valuat ion in I slam ic Financial Managem ent , I suggest ed an alt ernat e m eans of pricing capit al in int erest free econom y and use of appropriat e discount rat e i.e. Nom inal GDP growt h rat e in public finance and
corporat e finance in CAPM, dividend discount m odel, proj ect valuat ion, calculat ing NPV, valuing incom e bonds and st ocks.
I also discussed in m y book ‘Proposal for a New Econom ic Fram ework Based on I slam ic Principles’ t hat how savings would feat ure despit e discont inuat ion of int erest , how inflat ion will be checked wit h cent ral banks not having at t heir disposal t he convent ional OMO, how liquidit y will be m anaged in banking sect or when a cent ral bank want s t o inj ect liquidit y or m op up funds. How and t o what ext ent t he inst it ut ion of Zakat would enable t he governm ent t o m eet it s fiscal t arget s and does not crowd out privat e sect or wit h public borrowing and how t he balance of paym ent s and exchange rat e st abilit y can be m anaged in an int erest free econom y.
Fin a l Re m a r k s
Therefore, all is not lost . But , t here is a need t o realize weaknesses, only t hen can we look for solut ions and in search for solut ions, we need t o be crit ical, obj ect ive, im personal, unbiased and open t o hear and receive all possible solut ions and t hen accept ing and rej ect ing any of t hem on t he basis of aut hent ic I slam ic sources i.e. Quran, way of Prophet Muham m ad ( pbuh) and Sahih Ahadit h rat her t han on t he basis of fact ional affiliat ions. Only t hen, can we hope t o progress t owards t he goal of an ideal I slam ic Econom ic syst em .
Re fe r e n ce s
El-Gamal, Mahmoud A. Islamic Finance: Law, Economics & Practice. Cambridge: United Kingdom.
Foster, John (2009). “How Shariah Compliant is Islamic Banking?”. BBC News. December 11, 2009.
Herwany, Aldrin, A Value at Risk Analysis on the Performance of Sukuk and Conventional Bonds: The Case of ASEAN Markets (August 16, 2010). Available at SSRN:
http://ssrn.com/abstract=1659799
Jobst, Andreas A., Kunzel, Peter, Mills, Paul S. and Sy, Amadou N. R., Islamic Bond Issuance - What Sovereign Debt Managers Need to Know (July 1, 2008). International Journal of Islamic and Middle Eastern Finance and Management, Vol. 1, No. 4, pp. 330-344, 2008;
Islamic Law and Law of the Muslim World Paper No. 09-63.
Osservatore. Vatican. (March 04, 2009). “Islamic Banking May Help Overcome Crisis”. Press Release.
Saleem, Shehzad (1992). “Islamic Concept of Taxation”. Renaissance. Vol 02, Issue 10.
Shaikh, Salman (2010). “Proposal for a New Economic Framework Based on Islamic Principles”. Karachi: Islamic Economics Project.
Usmani, Dr. Imran A. (2007). “Ghair Soodi Bainkari” [Interest Free Banking]. Karachi: Maktaba Ma’ariful Quran.
Usmani, Muhammad Taqi (2003). “Islam Aur Jadid Maeeshat-o-Tijaraht” [Islam and Contemporary Economy and Trade] . Karachi: Maktaba ma’ariful Quran.
