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The Royal Exchange in London - founded in the 16th century as a centre of commerce for the City of London. Image courtesy of Shutterstock.   

Could Islamic finance save capitalism?

By Harris Irfan | February 17, 2015

The Royal Exchange in London - founded in the 16th century as a centre of commerce for the City of London. Image courtesy of Shutterstock.   

In 2010, the World Economic Forum invited a theologian to speak on the subject of an alternative economic system, putting stewardship of our planet at its core.  The unassuming but renowned scholar of Islamic jurisprudence, Mufti Taqi Usmani, would have found the snowy streets of Davos somewhat removed from the dusty chaos of his hometown Karachi, but the paper he presented had global importance: reforming the world’s post-crisis financial landscape through the lens of faith.  And although the media focused largely on the predictably defensive stance being taken by bankers through that turbulent time, perhaps some came away from Davos with the seed of an idea that social awareness ought to be the underpinning of finance.  More recently, comedian Russell Brand has been galvanising public opinion in his inimitable style to protest severe economic imbalances in the UK.  Time will tell which approach will prove more successful in challenging the status quo.

Is there a place for ethics and morality in the global economy?  Should we continue to rely on governments to tweak at the margins of financial regulation, or is there a credible argument that a root and branch reformation is required – a revolution in capitalism?

Mainstream media has at times seemed reluctant to engage in debating conventional economic wisdom and its effects.  When a claimed 10,000 people marched through London last month to protest against cuts to education, the anthropologist David Graeber took to social media to ask the BBC if there was “…any particular reason that you don’t report on [the] student protest in London today?”  The co-founder of the Occupy Wall Street movement believes – along with an increasing number of leading intellectuals – that the world’s reliance on the fractional reserve banking system and fiat currency (money declared by a government to be legal tender) has had a catastrophic impact on society, leading to an increasing divide between rich and poor, an increase in contemporary versions of debt peonage, and perpetuating the idea that credit creation is a mark of human progress.

Other academics support the notion that mainstream economists, bankers and politicians focus on symptoms without questioning the monetary system itself. If banks are given the power to create money and grant credit, then unfettered credit expansion can lead to bad investments, as the last few years have demonstrated.  In addition, fiat money creation by central banks to bail out the financial services industry only encourages those banks to take ever greater risks.  This is the concept of moral hazard: profits are privatised but losses are socialised.

Disturbingly, British politicians seem to have little understanding of money.  On 20 November 2014, the House of Commons witnessed around 30 Members of Parliament debate money creation in the first session of its kind for 170 years.  That so few turned up speaks volumes.  According to a poll conducted prior to the debate, 71% of MPs wrongly believed only the government has the power to create money (whereas in fact 97% of all new money is created by private sector banks).  If those who lead us and determine our legislative framework struggle with the basics, what hope for the rest of us?

Even our measure of human progress seems fundamentally flawed.  Gross domestic product – the universal measure of economic output – does not measure rates of literacy, divorce or suicide.  GDP does not account for our impact on the environment.  In short, it reflects the culture of the modern corporation: a vehicle designed to eliminate all moral imperatives except for profit.  Logically it is impossible to maintain an engine of perpetual motion on a planet with finite resources and yet ever rapacious growth would appear to be the human race’s greatest achievement.

Perhaps it might take a pop culture figure like Russell Brand to spearhead the protest against an apparently clueless elite; whilst some question his technical credibility, his passion and popularity has attracted 9 million Twitter followers.  In contrast, thinkers like anthropologist Graeber, economist Thomas Piketty and theologian Usmani have been quietly postulating solutions to economic imbalance for years.

Usmani, for example, contends that Islamic economic theory may have some answers to the thorny dilemma of balancing the free market with protection of the vulnerable.  Indeed in the Prophet Muhammad’s last sermon before he died, he emphasised human and property rights to his followers, leaving them to codify the ethical principles he had bequeathed through the word of God and the documented precedent of his own life.  This codified law is known as Shari’a and is perhaps more misunderstood today than at any time in its history.

Where once Shari’a was an organic and evolving body of law, emphasising mercy, tolerance and inclusiveness, it is now characterised as an instrument of control by post-colonial Muslim rulers searching for identity.  When Europe’s barbarous principalities once slumbered through their Dark Ages, the Islamic world experienced an age of scientific, literary and philosophical enlightenment, borrowing whatever was good from the cultures around them and building on it.  Islamic scholars in medieval Baghdad and Cordoba developed rules and mechanisms to encourage entrepreneurship, leading to the dissemination of financial innovations along the Silk Route and into Southern Europe.  Contractual structures for investment partnerships, agency and trust laws, the money transfer system, paper money, cheques and letters of credit were just some of the concepts introduced into Europe by merchants from the Islamic world.  These were the roots of modern capitalism, but somehow along the way the protection of the weak became forgotten and the concept of the unfettered free market dominated.

Today, as the Islamic world experiences a crisis of identity, Islamic finance remains a rare bridge between two cultures.  David Cameron announced last year that London would become one of the global capitals of Islamic finance and promptly followed by issuing a UK sovereign Islamic bond in the capital markets.

Conventional commentators describe the industry as “banking without interest” but the fundamental differentiator is the nature of money itself: in Islamic economic theory, money is merely a medium of exchange, not a commodity to be traded.  Thus money may not beget money – it has no intrinsic value.  Financial transactions must have an underlying attachment to the “real economy”.  Real assets must be bought and sold as opposed to the trading of intangible pieces of paper, like the infamous derivatives that led to the downfall of Northern Rock and Lehman Brothers.  And (in theory at least) because money itself should have an asset backing, it cannot be created out of thin air by private sector banks legally able to create fresh credit: a blueprint for a stable global economy and one that might bring long term societal benefits, according even to some non-Muslim academics.

But are the ideals of Islamic finance reflected in the industry?  Not for me, they’re not. An industry dominated by conventional bankers addicted to cheap credit and exotic derivatives has focused on “reverse engineering” of conventional financial products into their Shari’a compliant counterparts.  An emphasis on letter of the law over spirit has left the layman confused: a recent survey of Islamic bank customers in the Gulf by PricewaterhouseCoopers revealed that only 52% believed their bank to be in compliance with their religious beliefs.  With a global Muslim population of 1.6 billion, much of it under-penetrated by financial services, surely the time has come to emphasise broader ethical principles over adherence to arcane contractual mechanisms?  Just as Christian financiers in the Middle Ages created elaborate contractual structures to circumvent the Church’s ban on usury, is Islamic finance not guilty of the very same today?

The industry balances on a turning point.  The next few years will determine whether the history of Islamic finance blindly follows that of medieval European finance, or whether its revolutionary ideals can bring something of benefit to the whole world.

This article was originally published in, on 24 December 2014. An abridged version of this article was also published in the Guardian on 4 December 2014, and was named one of the top 5 stories of 2014 for Guardian Sustainable Finance. 


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Bedi G. Lackmann 5 years ago
Islamic Finance Analyst, Nomura Singapore Ltd.

I do agree that the right ideals and ethics are not sufficiently reflected in the majority of the current IF market. Sometimes practitioners try to comfort themselves saying "we have to do this right now, but once we are big and strong, we will abandon questionable products/structures." The question is, will that day really ever come? And even if, does it justify the current means? Furthermore, does "Islamic finance" at its current state deserve to grow?

Of course there also are a lot of positive developments and trends in the making. Socially responsible investments, social impact bonds, healthcare REITs etc. for example are ideal for Islamic finance. These can be structured in shariah-compliant ways and bear the effects one would hope for from ethical finance. (edited)

Corporate Development Manager, AAOIFI

A new blend and trend is emerging: "Islamic capitalism" in which capitalists (owners of capital or control) engage workers for almost 20 hours a day. In western capitalism, work hours range between 12 and 16 a day. In Islamic capitalism, alas, they extend to 18 or 20 or even more!!! In western capitalism, there is a minimum wage level. In Islamic capitalism, it is up to capitalists to set wages at their own discretion, and irrespective of hefty costs of living. The way forward for Islamic finance is to get back to real objectives of shari'ah (maqasid al-shari'ah) rather than narrowly and merely focus on the interests of those who have. (edited)