THE UNIQUE LEGAL IMPLICATIONS OF THE ISLAMIC FINANCIAL SYSTEM
MICHAEL CLODE
Islamic finance has grown dramatically over the last few years and, although estimates vary, it would appear that the turnover is now at least $50 billion, and probably nearer $100b. These are enormous sums and those involved should be justly proud of their achievements. However, large though these figures are, they still represent only a small fraction of the total financial market even in those countries where Islamic finance is most developed and where, as in for instance Malaysia, there is strong political backing.
One should not under-estimate the difficulties for someone who is not brought up in the Islamic tradition to fully understand and to instinctively react to the culture which surrounds Islamic finance. I particularly wish to stress that it is not my intention in any way to criticise the Islamic system but merely to explain some of the differences of approach which sometimes make it difficult for those of us from outside to have that instinctive understanding which arises from having the system instilled in one from birth.
First, there is the unity of law and religion which is inherent in Islam. In Britain, as in most matters’ constitutional, the position is anomalous in that the Monarch is head, both of the church and of the state. In practice, the influence of religion on the law is limited and there is a long history of ensuring that religion is subordinate to the state and to law. Remember Thomas A Beckett.
In France, the legal system is seminal for the civil law system and thus in most of Europe and its former colonies, there is a constitutional separation of church and state. In the United States, the largest common law jurisdiction in the world, there is again a constitutional separation. These divisions go back a long way and predate the development of multi-cultural societies, which themselves make the separation even more necessary.
The second distinction is that the West is fundamentally a capitalist society and capitalism has developed on the basis of interest, which is not considered (provided it is not usurious) to be in any way improper. Although the early Christian church did have prohibitions on interest, these have not been aired for most of this millennium.
Many economists will argue that the reason for the great success of Britain compared with its continental rivals during the 18th and early 19th century was the establishment of an efficient system of national debt based on the issue by the government of interest-bearing paper. Capitalism was the engine as much as the steam that powered the industrial revolution. Those of us brought up in this system have an initial intellectual hurdle to leap when dealing with a system which considers interest to be not only illegal but immoral.
Finally, Islamic finance relies heavily on the precedence of Form over Substance. Although English law, at least until the recent House of Lords case of Ramsey, was considered to lean in this direction compared with other jurisdictions, it certainly does not go as far as many of the Islamic transactions one sees. Many Islamic financiers are worried by the use of LIBOR as a bench mark for yields, but it seems to be agreed that this is technically acceptable. This approach does require some mental adjustment for a Western lawyer.
I repeat, none of this is intended in any way to be a criticism of the Islamic system, but merely to emphasise that there are distinctions and to ask for understanding if, from time to time, those of us from other cultures seem slow in understanding points which have been made by our Islamic friends.
I mentioned that Islamic finance remains a relatively small proportion of the world total and would now like to consider how it might progress over the next few years into other areas and to expand generally. First, it is my view that the future lies in developing new concepts and instruments peculiar to Islamic finance rather than trying to replicate Western structures in what will inevitably be a more complex form.
Some years ago, in a speech which I gave to the Bankers Association in Bahrain, I said very much the same. At that time, although many of the Bankers expressed enthusiasm, a number indicated that they thought that they should keep to their core business and not to try to run before they could walk. Developments since then have indicated that those who took the more positive approach are continuing to do so and to convert their hopes into specific projects. The number of Islamic funds is slowly growing and we have seen unitisation of rental streams in Pakistan and elsewhere.
There are a number of other exciting new developments, all of which are moving towards the development of new areas.
It is commonly recognised that two of the main problems faced by Islamic banks are liquidity and the availability of long-term funding. Some of the liquidity problems could be addressed if some form of market is established for units in future funds. A number of institutions are thinking along these lines and the IIBI has published articles on the subject in the past.
So far as long-term finance is concerned, it has always struck me that much more thought should be given by the Islamic financial community to insurance and pension schemes. Whilst I appreciate that there are certain Sharia problems with some of these, my understanding is that, provided they are effectively mutual funds, they can be acceptable. They also have two advantages:
First, they meet useful social objectives and second, and more importantly from the point of view of long-term finance, they are by their very nature large and long-term investments. Although the concept of mutual insurance is currently unfashionable in the West, largely because of problems of undercapitalisation, there are still large numbers of them around and of course the bulk of world shipping is insured in the P&I Clubs, which are mutual insurances, and a great deal of professional indemnity insurance is now done on a mutual basis.
This is an area which deserves investigation and development and the Institute of Islamic Banking and Insurance has projects in this area in train.
Some years ago, the Federal Supreme Court in Abu Dhabi ruled that currency future trading was contrary to the Sharia even where the trader concerned was only hedging his exposure rather than speculating. This dampened interest in this market, but since then an article by the Vice President of the Iranian Banking Institute argues in favour of such hedging including hedging against inflation. Perhaps this is an area of activity that should be revisited.
Another area which would assist in the development of Islamic finance would be the securing of consistent Sharia interpretations. I appreciate that, as with all the world’s great religions, Islam is not monolithic and that there are a number of different sects.
Moreover, this is overlaid by the existence of the four juridical schools. In these circumstances, I appreciate that there is no little likelihood of getting world-wide consistency.
There is, however, I believe, merit in trying to obtain consistency at least within each country, and the Malaysian Government is to be commended on the efforts that it has made towards achieving that within Malaysia. I do not underestimate the difficulties of this but I believe that it would be of major benefit to the Islamic finance community as a whole. The IIBI has set up a Sharia Advisory Unit, which is a valuable step in the right direction.
Where is the impetus for these new developments to come from? There have, of course, always been many astute and far-seeing members of the Islamic finance community, but I sense that there is a new breed of young bankers brought up in the Islamic tradition, knowledgeable about the markets concerned, but who have trained in one or more of the major world financial centres. These are the people who will have the vision to develop the new products that are necessary, and the energy and drive to ensure that they are marketed and become successful.
We should not ignore the contribution being made by the Institute of Islamic Banking and Insurance in training this new generation. Not only are there regular courses and lectures, but the Institute has produced a number of most valuable text books, for example the Overview of Islamic Banking. The Executive Development Programme, which was an intensive course run over a period of, I believe, two weeks and targeted at rising executives within the Islamic finance world, was exactly the sort of targeted training which will assist in the developments which I have outlined.
One of the aspects of Islamic finance which strikes someone coming into it for the first time and which is an attractive feature, is the element of social benefit which underlies it. Looking at many of the projects which I have seen financed in the last few years, it is clear that they bring both economic and physical benefit to the communities where those projects are situated.
At a seminar held by the IIBI, the speaker, an Australian academic, questioned whether there could ever be a truly Islamic Stock Exchange because he thought that stock exchanges were inherently anti-social. I beg to differ. I believe that they are one of the power houses which fuel economic development and thereby improve the living standards of all members of the community dragging up those at the bottom of the pile as well as rewarding those at the top who are sufficiently wealthy themselves to be investors. The guidelines laid down a decade ago are still relevant. Similar guidelines have, I understand, been established in Malaysia. We should be welcoming the development of Islamic Stock Exchanges, not trying to find fault with them.
I suggest that a triumvirate of Islamic banking (both retail and investment). Islamic Stock Exchanges and Islamic insurance and pensions can work hand-in-hand to develop their already successful businesses to considerably greater heights and in doing so to benefit the community at large. To sum up. Islamic banking has already made great strides over the last few years. It has the potential to move onward, not just by linear growth but by moving into new areas and by maturing in existing areas. That growth can be exponential.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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