Bringing morality into finance
19 Jun 2009
At a time when the Global Financial Crisis is tightening its grip around the entire world, the resilience of the Islamic banking and finance industry during the worsening crisis is increasing the quiet confidence of both its advocates and practitioners.
Some experts believe that Islamic banks and financial institutions rely too heavily on property investments and private equity and that the sector could be hit if the turmoil worsens and the value of real assets starts to crumble. There may be some truth to this. However the extent of the damage is not going to be nearly as bad as that already experienced in the conventional sector.
Whereas the world is still trying to understand the reasons behind the most severe financial crisis since the Great Depression, the policy response so far has been bail-outs, stimulus-packages, and liquidity injections. The intent is to slow-down the intensity of the crisis in the short run until things get back on track to something like the "good old days" in the medium to long term.
Muslim economists blame immoral practices for the severity of the problem. They highlight the need for restructuring the world's financial system by fixing some of the immoral dents in it. They believe that the crisis is an opportunity for Islamic banks to promote the principles of Islamic banking and finance for the common good and to expand its appeal beyond Muslim investors.
The Islamic banking and finance industry has expanded in recent years primarily due to a surge in the demand for Sharia'ah, (Islamic law) compliant products and investments. There are, however, fundamental differences in the principles of the Islamic financial system and conventional financial system which are thought provoking and relevant in the current debate.
For example, in a Sharia'ah compliant financial system, every 'nominal' activity should be contractually backed up by a 'real' activity. This, among other things, implies that you cannot earn money on money without linking it to a real project. This is why profit and loss sharing is considered as an alternative to the interest-on-money based system.
The response of Muslim scholars to the global financial crisis so far is that this is what happens when you do not legally 'marry' nominal transaction with real transactions. The legal marriage would require the elimination of riba (usury or interest) from the system, replacing it with an arrangement where profits and losses are shared equitably. This would also require blocking other routes which might potentially threaten the marriage, and, for example,allow people to "sell only what they actually own". One of the many implications is that this prohibits the securitization of mortgages which is one of the major factors blamed for the current financial crisis.
Muslims believe that receiving interest on loans is immoral and unjust as the capitalists want their share irrespective of whether or not their money is earning anything that is real. At the outset, this arrangement might not pose an immediate threat in non-crisis economies; but it certainly shifts the burden to one party when a crisis hits, which adds to severity of the situation. The extent of the negative impact of the crisis would be directly proportional to the gap between the nominal and real economy. Sharia'ah requires the risk to be equitably shared, unlike the interest based system, and therefore has the ability to equitably spread losses during a crisis that might help reduce its severity.
Muslims also believe that this 'nominal-real gap' is one of the reasons behind unhealthy consumerism which tricks people into consuming unaffordable luxuries over affordable comforts. This unhealthy behaviour has the potential to add significantly to the severity of a crisis.
These recommendations of course are for the long run. So what is the position of Muslim scholars on dealing with the crisis in the short run? One doesn't find much in their current writings. An immediate guess would be a non-interventionist "to do nothing and let the nominal-real gap close down". This would be only half right. Most would definitely want to see the nominal-real gap disappear, but not at the cost of harm to the masses.
Any policy that reduces the severity of the losses to the public during the transition and stops the real sector from feeling the heat would be a good thing consistent with their faith.