A PARADOX OF OUR TIMES
MAHMOOD FARUQUI
Islamic banking, as a growing facet of Islamic economics, is not a metaphor, it is a reality. It is a paradox of our times, in the context of Francis Fukuyama’s End of History & The Last Man. He concluded that the crumbling of the Berlin Wall and the disintegration of the Soviet Union was the inexorable consequence of the dialectical conflict. The triumph of Western liberal democracy was not merely inevitable, but had the finality of the end.
The argument was further advanced by Huntington’s article [Foreign Affairs: Summer 1993] prophesying a clash of Islamic and Western civilisations, as the next dialectical battle – not academic debate, but modern warfare – in which the West’s victory would culminate in the ascent of man to full rationality and self-conscious awareness. The implication is that Christian values, instead of faith, would become the faith.
In my opinion, if the essential elements of Islamic economies – of which Islamic banking is albeit a small and imperfect part – are examined not as a ‘crusade’ but without theological bias, then the Armageddon clash of civilisations appears unnecessary.
The opportunity of Islamic banking, at the higher conceptual level, is to act as a catalyst in inducing a rapprochement between Western and Islamic ideologues. Islamic and Western bankers interact and do business with one another in the international market place. They have the means and the credibility to act as honest brokers between the two confrontational belligerents.
Methodology
To make such a dialogue meaningful, I endeavour to delineate areas of common agreement, by illustrating that the criticism, by western thinkers, of modern free-market capitalism, would be equally valid from an Islamic perspective. It will be demonstrated that the axioms of Islamic governance are not an anathema to at least some western economists; that the Islamic way is elucidated by specifying three rules; and that some operational challenges in Islamic banking are indicated.
Criticism of Free Market Capitalism
The post-seventies reductionism of economic liberalism to the beautiful simplicity of the ‘Market’ (as a panacea) in Reganomics and Thatcherism is now seriously questioned. The gravamen of the charge is that it did not grasp the link – indeed the precondition – between a flourishing market economy and a cohesive and harmonious community.
The neo-liberals are wrong, so the critique continues, in advancing the individual as an economic agent, without any understanding of the institutions, values and ties which bind and bond individuals in the society. These bonds are not just good in themselves but are essential for any free market to thrive. The values, legal and cultural ethos of a society are not derived from the economic calculations of an efficient free market but from institutions such as family, school, hospitals, church and community sharing cultural events.
This is the secret bonding glue that has been dissolved by the rampage of the free market. Raphael Samuel, in his Theatres of Memory, shows with sensitivity the scars and destruction of the working-class common man’s cultural values by the powerful capitalist market. Will Hutton, a governor of the LSE, in The State We’re In, eloquently enumerates the marketisation of everyday life situations and intermediate institutions of the society which provide the community bonds: health, education, housing, transport. It recalls the refrain of Karl Marx that capitalism ‘commodifies’ not only transactions but even relationships.
Margaret Thatcher said, “There is no such thing as society. There are individual men and women and there are families”. In the context of her philosophy, it was fair to interpret it as the dogma of supremacy of naked self-interest over familial ties; society came last, if at all. Samuel Britain, arguing in Capitalism with a Human Face (1995 Edward Elgar) that economics has a moral content, takes issue with the patronising attitude of the Thatcherite free marketers.
He is not alone. There is further reflective evidence that the unfettered market philosophy savaged the patterns of life of the very social groupings that supported the market. It intensified their sense of insecurity by engendering idle consumerism, urban violence, stress illnesses, while denying access to health care and education, ignoring environmental pollution and reducing opportunities. Here again, the social and ethical criteria of Islamic economics would join ranks with the above criticism.
David Selbourne, in his recent book Principle of Duty, shifts the debate from ‘individual rights’ to individuals’ civic duties. In contrast to the Thatcherites, he asserts that society does not owe individuals any inherent civic rights. He argues that civic rights are a consequence of the compliance by individuals with the societal norms of family and community. He formulates the equation that the extent of welfare and benefits provided by the society is equal to the extent of the individuals’ compliance with societal traditions and norms. A disruption of this equation results in fragmentation of civic rights and causes social insecurity and unrest.
John Gray, in Beyond the New Right, the Undoing of Conservatism, reaches the same conclusion of disenchantment with free capitalism. The social democracy of Sweden, so eulogised as a socio-political model in the seventies, is now derided as a cold, mechanistic view of life.
Professor Sherwin of the University of Chicago shows the irony of Swedish family structure by discovering that a large number of women work in the public sector, to take care of the children of other women, who also work in the public sector, taking care of the parents of the women who look after their children! These criticisms, by Brittan, Selbourne, Hutton, Gray and their supporters, are equally valid, as the following axioms of Islamic governance will bear out.
Islamic Axiology of First Principles
The Islamic view of life is holistic: the principles of sociology, politics, economics and law are not like a set of gothic columns, but rather like bricks in a dome, each discipline interdependently supporting the other and the whole underpinned by an organic system of ethics. The essential constitutional elements of Islamic society are: Tawheed, Khalifah and Al-Adal. References are from the Holy Qur’an quoting chapter and verse – i.e., 2:30 means chapter 2, verse 30.
Tawheed (unity) is the first principle. God is not only one (Al-Wahid) but unique (Al-Ahad), the Creator who created the universe, of which man is but a part, for a purpose. Islam is man’s commitment to the Creator to fulfil this purpose. This has at least four implications:
Firstly, sovereignty resides in God. This, along with the next concept of Khalifah, differs from, for example, the British concept of the sovereignty of the king (in parliament). The political sovereignty of the monarch sanctifies the commercial sovereignty of the free market and the theory of the absolute rights of individuals. This absolute right is the motive and the sanction for advancing self-interest.
Secondly, it makes him not an alien individual in isolation, but a harmonious part of the whole; and, therefore, it negates the motive of self-interest.
Thirdly, bondage to a Merciful and Compassionate God frees him from the strings of worldly bondage.
And, fourthly, because he is a part of the whole, there is a commitment to his immediate environment, namely society.
God has “subjected whatsoever is in the heavens and whatsoever is in the earth to be made use of by you (human beings); they all are from Him; herein verily are portents for those who exercise imagination and rational analysis.” (45:13). This meditative imagination and pursuit of innovation and exploration transforms man’s love of self to concern for others.
Adam Smith echoes this in his ‘Impartial Spectator’ doctrine expounded in The Theory of Moral Sentiments. He concluded that although individuals act on self-interest, an individual should love himself no more than he loves his neighbour. This is a familiar reiteration of Christ’s urgings of ‘Do unto others what you would others do unto you’. This has obvious policy implications for state intervention and removal of special privileges to vested interest groups; a common platform for both Islamic and modern economists.
Khalifah (vicegerency) is the empowerment of human beings by God enabling them to follow His Way. God has made human beings his Khalifah (2:30). To the Creator belongs everything in the heavens and in the Earth (20:6). Whatever man has, belongs to God (6:162). Man is a trustee, but if the way of God is followed, the role of trustee merges with the position of beneficiary.
The principle of trusteeship involves prudence and honesty in commercial dealings between man and man; and the fiduciary duties of neither ‘insider’ transactions nor discriminatory practices in relations between the governors and the governed. Th e obligation of the people to follow their temporal or spiritual leaders is only when the leader follows the Qur’an and the Sunnah (practice of the holy prophet (4:59).
Islam allows, and encourages, private ownership, but with the duty to explore and develop all the resources of the universe (45:13) and use them not for self or the few, but for the benefit of the public good. Thus, unlike socialism, it does not nationalise economic activities; and unlike social democracy, Islam does not collectivise the income of individuals.
For instance, in Sweden, a majority of voters obtain their income from the state. This universality of all embodies the principle of equality and brotherhood. The Holy Prophet is reported to have said “all human beings are dependants of God and the most pious before Him are those who do their utmost for the benefit of their fellow-beings”.
By sharing resources with the less privileged, the powerful establishment are only performing a duty (30:38). Therefore, the act of receiving by the less privileged (51:19) does not compromise their freedom to the powerful givers. This spirit of freedom and brotherhood has the familiar reiteration in Rousseu’s “liberty, and equality”, the clarion call of the French Revolution, which heralded the modern Republican democratic tradition.
Al-‘Adl (equity) is not restricted to the Western jurisprudence doctrine of ‘Rule of Law’. It embodies the concept of comprehensive justice: social, economic and legal. The steadfastness to Adal means a positive policy implementation for elimination of the concentration of legislative, executive and judicial powers and the factors of production.
The concentration of power is inequitable because it creates and perpetuates inequalities and exploitation. Islam places equity and justice in juxtaposition with piety (5:8). Chapra, in Islam and the Economic Challenge, quotes Ibn Taymiyyah that: “God upholds the just state even if it is unbelieving, but does not uphold the unjust state even if it is believing…the world can survive with justice and unbelief but not with injustice and Islam.”
The mandatory obligation to prevent injustice is a positive duty, and not a passive restraint, on society. The objective of the Sharia is to provide for the welfare of the human beings in the society (Masalahat-al-ibad). According to Imam Ghazali, welfare equates with safeguarding faith, life, intellect, wealth and posterity. Ibn al-Qayyim lays emphasis on justice, mercy, well-being and wisdom as the qualitative constituents of the public good. Whatever safeguards these serves the public interest. These declarations find sympathetic recurrence in modern republican democratic manifestos.
The difference is that in an Islamic context, there is certainty and voluntary compliance. This means more efficient and less expensive regulatory and policing systems for society. In an ethically neutral system, it will work, but society will have to observe it so long as it believes it to be in its own interest.
Once the tidal wave of freedom and choice disrupts this, the delicate balance between various community institutions is not easily regained without an ethical catharsis of the society. As Wittgenstein said: “trying to repair a broken tradition is like a man trying to mend a broken spider’s web with his bare hands.”
The above axioms, may be elucidated by referring to three rules to illustrate the framework for the socio-economic organisation of society.
1. Prohibition of Riba (Interest)
The prohibition of Riba in Islam (2:275-276, 3:130) is consistent with the prohibition in the old and the New Testament (Psalm 15, Luke 6:35). Thomas Aquinas also opposed interest: “…. money was invented for exchange; (it is unlawful) to make payment for the use of money lent”. Interest may be defined as the additional money paid by the debtor to the creditor, related to the time period, irrespective of the result (profit or loss) of the venture to which the lent money was put; and capable of recovery according the laws of the land.
The rationale for the banning of interest in Islam is that it breaches the axiom of adal. In Islam, savings can be used only for investment, as savings per se would violate the injunction against hoarding: it is specifically prohibited to “bury gold and silver” and a specific injunction to invest in the way of God (social well-being) (9:34). Thus, there is no reward, indeed there is penalty in Islam, for the mere abstention from consumption of money (which is put forward as one justification for payment of interest in Western economics).
In Islam, money is potential capital. It becomes capital only when it is put to productive use. The provider of capital becomes entitled to a share of the profits of the productive venture. In a legalistic context: if money represents property rights, then its employment in a project will either result in the creation of additional property rights (profit) or the dilution of originally invested property rights (loss).
If the share of the provider of funds in the outcome is fixed ex ante and is irrespective of the outcome, then it is inequitable, either to the financier or the entrepreneur or both. This iniquitous arrangement is at the heart of the prohibition against interest. It is resolved by substituting the relationship of creditor/debtor with the relationship of a co-risk bearers’ partnership in the result of the venture.
2. Trade Not Interest
By one stroke, Islam eradicates interest and also provides the alternative – trade (2:275). As a necessary adjunct to the use of surplus savings in trade, Islam emphasises social welfare. Charity is not so much a duty to the less privileged as an act of piety (2:276). Private ownership is allowed, the accumulation of wealth is not prohibited, but the spending of disposable income is to be within a just balance; neither extravagant, nor niggardly (25:67). This again is an attribute of adal, equitable balance.
3. Focused Distinction Between Good and Evil
Moral philosophers have used the word ‘good’ or ‘right’ to denote virtue, and ‘bad’ or ‘wrong’ to denote evil. The Qur’an, in order to focus on what is to be done (good) and what is to be eschewed (bad), uses the opposites in the same set: salihat & sayyiat (45:21); khair & kharr (99:7-8); birr & ithm (5:3); halal & haraam (10:59 etc); ma’ruf & munkar (3:104 etc.); and tayyeb & khabith (2:267 etc.).
Operational Challenges in Islamic Banking
The following is an overview of the challenges which must be satisfactorily resolved, on shortand long-term bases, by those concerned with the healthy development of Islamic banking. The solutions are neither arcane nor elusive, but their implementation requires honesty of purpose and a strong political will:
i) Sharia: The systems and operations of the bank must conform to the Sharia. This may be resolved by the Sharia Board of the holding company or a cross- border banking institution, whose edict runs across national territories. Yet, it is not easy to resolve a harmonised system of directives applicable to all jurisdictions, as the relatively homogeneous group of European Community members are only too painfully aware. The differentiation in the approaches of Malaysian bankers and Middle Eastern bankers on the progressive or conservative postures in interpretation are becoming visible.
ii) No Deposit Protection. Due to the capital-uncertain nature of his ‘deposit’, an Islamic banker in any regulation-conscious Central Banking jurisdiction has to be like Caesar’s wife – above all suspicion.
iii) Prudent Banking. This is necessitated not so much by regulatory concerns, as warranted by their trading risk bearer status.
iv) Accounting Standards. Accounting is the recording, measurement and reporting of financial assets and risks. The treatment of a particular asset or liability can be honestly and heatedly debated by different accountants.
This is compounded by different views of the Central Banks within whose jurisdiction the bank may operate. Subsidiaries of a bank in two different countries may well carry out the same transactions differently. The consolidation of accounts and the consolidated supervision as required by the Basle Committee is yet another conundrum.
v) Regulatory Considerations. The increased accountability to which Central Banks have been exposed in the media has naturally made them more sensitive to keeping their watchful eyes looking even more hawkish. This particularly affects Islamic banking, which is still in its teething period.
vi) Higher Costs. Because the creditor/debtor relationship is substituted by the sharer in trading-risk, financing proposals, risk analysis and on-going monitoring is different in character, not merely level, requiring greater expertise, time and therefore higher costs.
vii) Higher Returns. These are necessary not only to offset higher costs, but also to meet the competition. Although, theoretically, the ‘depositors’ share in profit and loss, and there should not be any ‘cost of funds’, market competitive pressures force the Islamic banker to give to the depositors a return comparable with traditional banks; since traditional banks are older and considered safer.
viii)Lack of Secondary Markets. This leads to liquidity pressures and consequently lower returns on total funds compared to traditional banks, who can securitise long-term debts; and their treasury management can yield good profits.
Here, as in the establishment of an inter-bank market and adopting modern innovative instruments, Malaysian Islamic bankers and banking authorities have shown greater initiative than their Middle Eastern brethren.
ix) Lack of an Inter-Bank Market. This again places Islamic banks at a relative disadvantage to traditional banks, placing extra constraints on their asset-liability management.
x) Innovation. In the real world of market competition, banking is as much about marketing as providing a financial service. In the last few years, merchant bankers have spawned an incredible number of products.
In Islamic banking, the drive to innovate is beyond the market-share battle. It is needed for accommodating various conceptual issues of economics, jurisprudence, public and business interests. It is not so much about developing a bespoke product for a particular customer at a particular time, as deriving workable solutions from the abstract principles of Islamic thought.
A Tale of Two Systems
I began with Fukuyama’s reference to The End of History, first expounded in 1989. His post-communism, post-war-carnage, central European thinking (See his interview in New Perspectives Quarterly. Winter 1995) seems to be that in actual working, the ideal would be neither the archetypal free-market model, nor the social republican democratic state, but the area between them.
He refers to the lost art of familial life. He stresses that the West has adopted Adam Smith’s view of the world. But as for the malaise of society: “…our problem is the unravelling moral cohesion of societies that were once bound by the habits of religion, community or family.” Perhaps the modern economists did no service to their own profession, or to their society, by neglecting Adam Smith’s Theory of Moral Sentiments.
Now they may do worse than the common links between Abrahamic traditions of how societies should be organised. The challenge and opportunity of discovering the beneficial principles of Islamic banking is as much theirs as that of any other group of people.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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