Religion and money: Islamic finance

ByAsma Hanif
Islamic finance is on the rise in what in many parts of the world can be called an anti-Sharia age, and it has been proven compatible with Western financial systems and legislation. But challenges have still to be faced.

Although implementation of Sharia law often sparks deep controversy in today's world, it seems that finance is a subject where the "Islamization process" spreads at great speed, but with least objection.

Islamic finance is estimated to manage nearly $500 billion. A recent report by Moody's, a New York-based company carrying out financial research, suggests that the amount has annually risen by 15% over the past three years and predicts an excellent prospective for the coming years.

"It seems that Islamic finance evolves in a completely independent way from Islam," says Imane Karich, a Belgian economist of Muslim descent, who promotes the implementation of Islamic banking in Belgium. "Money has neither a smell nor a religion. Once an alternative is proven profitable, people get interested. Even in France, where the climate is very secular, doors are opening for Islamic finance."

Lord Edward George, former governor of the Bank of England, was a key figure who helped implement Islamic banking in the United Kingdom. His involvement started when he met an "absolutely charming young Muslim couple" who had just bought their first house in the United Kingdom. "They were very excited," Lord George says.

But after talking to them for a while, he discovered the less pleasing side of their story. "We have a terrible guilt complex," he quotes them as saying, "because we had to pay for the house with a Western mortgage, which is incompatible with Sharia law."

Lord George could not see why Muslims should not be able to abide by their faith and the British financial and legal systems alike. "I could not understand why, in the United Kingdom, where we have a very sophisticated financial system, we couldn't actually find a way in which mortgages to buy houses could be made compatible with Sharia law and with British regulations and legislation as well," he says.

Islamic finance is based on the sharing of profits and losses, and prohibits any source of unjustified enrichment, one such method being generating money from money. This justifies the ban on the collection and payment of interest, Riba.

Mufti Taqi Usmani, an eminent Islamic scholar from Pakistan and pioneer in Islamic banking, draws the line between the Islamic and the conventional financial systems: "The conceptual difference actually lies in the distinction between money and commodity," says the Hanafi scholar. "The conventional system does not differentiate between them. Money is as tradable as any commodity. Therefore, in the conventional system, you can buy money for money.

"Islam, on the other hand, treats money differently from commodity. Money is not a commodity; it has no intrinsic utility. If you have money, you cannot eat it, nor drink it, nor wear it. It has been created by Allah as a medium of exchange."

Furthermore, the Islamic Sharia law prohibits investment in non-ethical industries such as alcohol and tobacco, which are considered taboo in Islam, and prohibits taking unnecessary risks, such as gambling and speculation.

"But this in no way means that Islam proscribes taking a risk by investing," says Mrs Karich. "Investment is encouraged provided the person has studied the environment around this investment before becoming engaged in it."

The main challenge has been to develop Islamic alternatives to conventional financial products. In the case of home financing, for instance, the Islamic alternative is the cost-plus transaction, called Murabaha. It consists of a contract between the bank and the client for the sale of a commodity at a price that includes an agreed profit margin. The bank purchases the good as requested by the client, and then sells it to the client with a mark-up, which is paid within a fixed period of time. The bank remains owner of the commodity until the loan is repaid in full.

Critics have suggested that what is categorized as "Islamic banking" is not always halal, accusing banks of finding "clever ways to meet religious strictures." But Mrs Karich does not agree.

"When Muslim economists search for Islamic alternatives," she says, "they look for products that already existed at the time when the Sharia was implemented, i.e. during the lifetime of the Prophet Muhammad, such as Murabaha, for instance. Although in the end the client pays a price that includes a profit margin, this is business. Islam differentiates between the means and the goals."

Historical overview

Islamic finance started being promoted by Malaysian and Indian Muslim scholars at the beginning of the last century, at the same time as the colonized countries' struggle for independence. "While, under colonization, Islam was adapted to economics," Mrs Karich says, "but Muslim economists wanted economics to be adapted to Islam."

The first Islamic bank was founded in Egypt in 1963. Although its activities were free of interest, it was an undercover project that made no reference to Islam, as the regime in power at the time was hostile to any form of Islamization.

The real blossoming started in the 1970s, as a consequence of both the oil industry boom in the Gulf States, which sparked the appearing of liquidity, and the revitalization of a religious consciousness in the Muslim world.

"The Dubai Islamic Bank, founded in 1975, was a private initiative," Mrs Karich insists. "It was founded by Arab businessmen who were deeply religious. Initially, governments did not welcome these moves, because Islamic finance contradicts their investment in the World Bank, where they collect high interest rates."

In the 1980s, the first Islamic banks united to form the Islamic Development Bank (IDB), seen as the "world bank" of the Muslim world. Covering 56 Muslim countries, the IDB invests in infrastructure and development projects in the Muslim world, and contributes to developing Muslim economic thought.

Islam's political weakness was also a factor that enhanced the system. The 9/11 attacks resulted in rich Arabs withdrawing their money from US accounts for fear of having their accounts frozen in the war on terror.

"This created a need for alternatives either in the Middle East or in Europe," explains Mrs Karich. "While the system was already functioning in the Middle East at that time, its development was boosted in Europe in order to meet Muslim investors' requirements."

And today's record oil prices are another factor widening the scope for the Islamic banking industry.

Implementation of Islamic finance in the West

On the European scale, the United Kingdom is the leading centre for Islamic banking, which was successfully integrated into the country's legislation after a long debate both within the Muslim community itself, and between Muslims and the UK authorities.

"The foundation of the Islamic Bank of Britain in 2004 was a turning point for Islamic finance in the West," says Imane Karich, who covered the event for the French national daily Le Monde. "It made the West aware of the opportunities Islamic banking can offer."

It was Lord George's experience with the young Muslim couple that mobilized him to act. Having discovered that the Sharia product enabling people to buy houses had first to be standardized, he encouraged Muslims to "produce a more standardized definition of a Sharia mortgage, which could then be made compatible with UK legislation and regulation."

Then he promoted the setting up of a committee under the leadership of Andrew Buxton, former chairman of Barclays Bank, and including both Sharia scholars and British experts, to produce a report identifying the obstacles facing Sharia finance in the United Kingdom.

"In the case of housing finance," Lord George explains, "one of the problems was that the stamp duty on the purchase of a house was paid twice: first by the financier who purchases the house; then when the ultimate buyer had acquired 100% of the equity, it was payable again. Given this report, the then chancellor of the exchequer, Gordon Brown, agreed to accommodate the legislation, and so stamp duty would only be paid once."

But standardizing the Islamic finance system still remains a challenge to Muslims. "Islamic banks need to harmonize their accounting systems," Mrs Karich says. "We need to create a platform on which the banks can communicate with each other."

Such an initiative has already been undertaken by the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institution, which creates accounting standards that are accepted by international institutions and which Islamic banks have started to adopt.

In the United Kingdom, Lord George says, from the UK perspective, the move meant "holding a hand out to the Islamic community and saying, if you can help us by standardizing, to a great extent, the Sharia products, then we will be able to accommodate Islamic products within our legal and regulatory system."

And Islamic finance is not limited to Muslims. "It is in the interests of the community as a whole, not just the Islamic community," Lord George says, "because some of these products are attractive to non-Muslims as well."

From the Muslims' side, when the opportunity is there, they prefer to comply with Sharia law, so that they have no guilty conscience, as the young couple had when Lord George first met them.