«Islamic Economics and Finance Rodney Wilson The relevance of religious belief to the material world is often overlooked, even by the devout, but any ...»
Islamic Economics and Finance
The relevance of religious belief to the material world is often overlooked,
even by the devout, but any study of the major religions will show that
there is a considerable body of teaching on how believers should conduct
their working lives, undertake monetary transactions and manage their
financial assets. Economic activity involves human behaviour, and this
introduces a moral dimension, as humans have choices and their actions
can be a force for good or bad. Seeking divine guidance for economic decision making can be helpful in making the right choices, and can ease consciences where decisions affect the lives of others. Economic governance, whether at national or corporate level, can be a lonely and thankless task, but if those exercising responsibility feel they are carrying out their duties on behalf of the Almighty, this can inspire and motivate themselves and others.
Islamic law and economics All three monotheistic religions—Judaism, Christianity and Islam—provide general guidance on everyday living including on economic and financial affairs. For Muslims the authoritative source of guidance is the Holy Quran, the revealed word of Allah, and the Hadith, the sayings and practices of the Prophet Muhammad and his companions, referred to as the Sunnah. Since the time of the Prophet over 1400 years ago there have always been differences of opinion in the interpretation of how this guidance should be interpreted and applied. The Islamic scholars who specialised in this interpretation are referred to as the ulema or fiqhaa, the Rodney Wilson is Director of Postgraduate Studies, School of Government and International Affairs, Durham University and the author, co-author or editor of numerous books and papers on Islamic business, finance and economics.
WORLD ECONOMICS • Vol. 9 • No. 1 • January–March 2008 177 Rodney Wilson latter being derived from fiqh, the study of Islamic law. The study of economic and financial transactions from an Islamic perspective is referred to as fiqh muamalat, that branch of Islamic jurisprudence that is concerned with commerce and other economic activities. The leading Islamic bank in Indonesia, the most populous Muslim country, is Bank Muamalat, an institution that tries to apply fiqh muamalat in all its financial dealings.
Although only a minority of Muslims are Arab, fiqh scholars are normally expected to read Arabic, the language of the Holy Quran and the commentaries on the Hadith. Translations are available, but do not capture the exact meaning of the sacred texts. Arabic terms are used for Islamic economic concepts and shariah compliant financial products as there are no precise equivalents in English with respect to modern economics and contemporary finance. These Arabic terms are used in this article, with a glossary provided at the end to help the reader.
Islamic law is usually referred to as shariah, but this should not be equated with secular national laws enacted by nation states, including commercial law. Shariah provides guiding principles for everyday living, but adherence is a matter of conscience and belief, and not of state enforcement. In most countries, Islamic banking is a matter of choice, and it is only in the Islamic Republic of Iran that all banks must comply with fiqh muamalat under a Usury Free Banking Law enacted in 1983.
To be shariah compliant a financial institution must have a shariah board comprised of specialists in fiqh muamalat who approve all products offered by the institution, including deposit and financing facilities. Such compliance can be provided at national level, as in Iran, or at institutional level, as in most of the Muslim World and the West, including the United Kingdom, where Islamic Bank of Britain, HSBC Amanah and Lloyds TSB have their own shariah scholars. In such cases shariah compliance has effectively being privatised. Compliance can also be outsourced, as in the case of shariah compliant managed funds, where the Dow Jones Islamic Indices, which also has its own shariah board, can supply screening software to determine what equities are acceptable investments from an Islamic perspective.
The rulings of shariah scholars are referred to as fatwa, and these are derived through reasoning and attempting to apply fiqh to contemporary economic and financial transactions. This process is referred to as ijtihad, and in practice involves reading the contractual documentation governing WORLD ECONOMICS • Vol. 9 • No. 1 • January–March 2008 Islamic Economics and Finance economic activity and financial transactions and ensuring that it is consistent with shariah. Where each institution has its own legal documentation for its financial products, devolved shariah compliance becomes necessary.
The lack of consistency of fatwa is sometimes criticised, but this reflects the diversity of financial institutions and the differentiated nature of financial products.
Apart from in the Islamic Republic of Iran where all laws passed by the majilis or parliament are subject to scrutiny by the religious authorities to ensure they comply with shariah, in all other jurisdictions national laws prevail over shariah. Many Muslim countries have shariah courts which operate in parallel with national courts, but it is the latter that are usually involved in commercial disputes, and not the shariah courts whose remit is largely confined to family matters such as divorce and inheritance.
Sometimes shariah courts can be referred to for arbitration, but this is only if the parties to a contract freely agree to such recourse and this is specified in the contract.
Shariah can be upheld by national courts, but this is only where it is consistent with national law, as in most states the shariah courts have no independent powers of enforcement. Islamists who would like to see religion having more political influence favour enhancing the powers and remit of shariah courts, but this is not the policy of most Muslim majority states.
The limited commercial and modern contract law expertise of most shariah judges means they lack the competency to adjudicate in financial disputes, although this deficiency could be addressed through relevant training. In Malaysia the national courts can engage shariah advisors, but their advice is not mandatory.
What is Islamic economics?
Given this fusion of traditional religious ideals with modern compliance methodologies, Islamic economics should not be viewed as a throw back to medieval times and a supposedly unenlightened past, an alien phenomenon or a mere facet of Islamist politics in the Muslim World. Rather there are parallels between the modern ethical finance and socially responsible investment movements and Islamic finance, with investors not only concerned with financial returns, but also with how their money is utilised and its implications for resource allocation.
WORLD ECONOMICS • Vol. 9 • No. 1 • January–March 2008 179 Rodney Wilson It is Islamic banking and finance that has been most in the headlines since the first oil boom of the 1970s and the emergence of the Muslim heartlands as financial superpowers. The principles of Islamic finance are, however, based on Islamic economic theory, and to understand the former, some knowledge of the latter is required. Islamic economics is not a replacement or substitute for mainstream economic theory, but rather of approaching economics from a moral perspective and rejecting the excesses of both capitalistic markets and command economies. A utilitarian approach which sees the motivation of economic behaviour in terms of the maximisation of individual material satisfaction is rejected. For devout Muslims, the aim of man is to serve the Almighty by promoting social good, and the acquisition of material goods is a means, not an end.
What does this mean for economic policy? It would be mistaken to associate Islamic economics with any particular political ideology or social ideal.
The stress is on justice in economic transactions, not on income or wealth equality. Markets are seen as a natural mechanism for allocating resources, but the justice of market outcomes will depend on the behaviour of the participants. Responsibility to Allah comes first, not unrestrained freedom—the stress being on social obligations rather than individual rights.
Private property is recognised, as although all assets ultimately belong to the Almighty, humans have responsibility for how assets are utilised—the Muslim concept of khalifah, accountability to Allah for how resources are managed, being similar to the Christian idea of stewardship.
Taxation and monetary policy In most Muslim countries, fiscal and monetary policy is not influenced by religion, although inflation is of concern because of its distorting effects and its disproportionate impact on the poor. Traditional Islamic taxes mainly applied to land holdings, with kharaj related to land area with adjustments made for its potential rather than production. This encouraged a more productive use of land holding as owners would be liable irrespective of output levels.
Zakat, which can be regarded as a form of alms giving, is often described as a wealth tax. It is one of the five pillars of Islam, with the devout expected to pay an annual amount based of one fortieth of their wealth.
There are differences over what constitutes wealth, with financial assets WORLD ECONOMICS • Vol. 9 • No. 1 • January–March 2008 Islamic Economics and Finance clearly included, but residential and commercial property usually excluded. In Malaysia the administration is formalised, with Muslims who pay zakat permitted to offset these payments against income tax liability.
In the oil rich countries of the Gulf there is no income tax, hence offsetting is not a possibility. Usually states control the zakat collection, often through a special ministry, but revenues are designated for social assistance and cannot be used to finance general government expenditure.
Conventional monetary policy presents difficulty from an Islamic perspective given the prohibition of riba or interest. In practice, as most Muslim countries peg their currencies to the United States dollar, they do not pursue active monetary policies, although there are variable rates at which central banks make funds available to the commercial banking sector which tend to be adjusted in line with Federal Reserve policy. Islamic economists are unhappy about this, but have not advanced persuasive alternatives, other than suggesting variations in reserve requirements and credit rationing as monetary instruments.
In Bahrain, sukuk securities based on salam contracts are used to finance government deficits as an alternative to conventional treasury bills. With these contracts funds from the investors are used to make an up-front payment (salam) to the treasury for the purchase of a state owned asset. After a period of three months the asset is duly transferred, but immediately the treasury purchases it at a higher price. The mark-up represents the return to the investors, usually Islamic banks. As the banks acquire these assets, they have fewer funds to advance to their clients; hence there is a tightening of the money supply. These transactions are regarded as shariah compliant as the mark-ups do not vary with interest and the sukuk securities are asset backed, rather than being pure monetary instruments.
Justice in transactions and reward Although markets are regarded as the normal method of economic interaction, there are shariah concerns that market outcomes can be exploitative, and recognition that regulation may be required to ensure justice to participants. Traditional souk or markets included an institution known as the hisba, which was a trading standards authority that ensured fair weights and measures, and that in the case of foodstuffs that it was fit for human consumption. The verification that meat is halal is a particular concern, WORLD ECONOMICS • Vol. 9 • No. 1 • January–March 2008 181 Rodney Wilson and in recent years the sacrifice of animals for distribution to the poor and needy during pilgrimage or hajj has been formalised. The Jeddah based Islamic Development Bank manages a scheme whereby pilgrims are encouraged to purchase certificates which cover the costs of the animals slaughtered in abattoirs under clean and humane conditions rather than the pious undertaking such sacrifices themselves.
In shariah every reward must be earned through effort, wages and salaries being the reward for legitimate and honourable work which applies to most occupations which are legal. As private ownership is recognised, rent is also viewed as a legitimate reward, but owners must have clear contractual responsibilities, as in the case of operating leases, and cannot pass on all their liabilities to tenants, as is often the case with financial leases. In the case of a building or equipment for example, it is the owner who is responsible for the insurance, not the lessee. Profit is also viewed as a legitimate reward, as it relates to risk taking and entrepreneurial activity. Risk is recognised as unavoidable, and business cycles are seen as inevitable. In this context the participation in risky ventures is seen as beneficial, as with partnership contracts such as mudaraba and musharaka which involve profit and loss sharing. These forms of contracts will be explained more fully later. While sharing in risk reduces the burden for each participant, this is not the case with speculative risk taking, which may involve deliberately increasing market volatility or cornering markets through monopolistic practices to make gains at the expense of others. Such speculative activity is forbidden, as is gambling, muqamarah, or games of chance, maysir, where the returns to those who win are at the expense of the losers.
In the Holy Quran, explicit provision is made for inheritance which governs the estates of those who wish to comply with shariah. The faithful have discretion over one third of their estates, but the other two thirds is subject to a formula which is regarded as fair to all relatives of the deceased. Children have a share of inheritance, and not merely spouses, which can result in children being excluded from the estates of their parents in the event of re-marriage. Male relatives are entitled to twice the share of females, a practice that attracts criticism from some in the West, but in Muslim society males are responsible for the financial upkeep of their families, and income that women inherit or earn can be spent entirely at their own discretion.