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Monday, 15 February 2016



“When the dinar and the dirham were first minted in the form of metal coins, Iblis the accursed held them happily. He then placed them over his eyes and said to them, ‘You are the fruit of my heart and the delight of my eyes; through you, I will drive people to become tyrants. I will cause them to become disbelievers and lead them to Hell. . .”
-         Ibn Abbas

In my interactions involving economic systems, I have consistently been asked to throw light on an enigma that is Islamic Finance. People often tend to condemn the discipline (along with Hawala) as sinister.

Islamic finance, at its roots, is about making finance Sharia compliant. The fundamental difference between the discipline and conventional western capitalism lies in the philosophical understanding of the nature of money. Today, money itself is perceived as a commodity; financial institutions enter into specious deals that have no rooting in the real economy or involve assets over which they have no ownership or claim. Traders are free to take speculative positions and earn emolument. Complex instruments birthed through financial engineering like derivatives or swaps; or the latest contrivance by central banks, dubbed Quantitative Easing or QE involves creating money out of nothing.
Sharia sees money, merely, as a store of value with no inherent, intrinsic worth. A twelfth-century thinker, Abu Hamid Muhammad ibn Muhammad Ghazali, in an nalysis of money said, ‘[Allah had created Dirhams and Dinars] so that they may be circulated between hands and act as a fair judge between different commodities and work as a medium to acquire other things’, and that, ‘whoever effects the transactions of monay is, in fact, discarding the blessings of Allah, and is committing injustice, because money is created for some other things, not for itself.’. It is a means to an end, a medium of exchange, and not an end in itself. It cannot be created from thin air, and is devised to facilitate real economy transactions; and in that spirit Sharia outlaws transactions aimed at earning a profit out of purely financial transactions, or usury. This brings us to what is widely thought to be the definition of Islamic finance: Banking without interest or riba. A wanting definition.
Islam was not alone in its admonition of interest. The Church had also placed an injunction (before it was lifted) against usury. Though many look at Islam’s ban on riba as an appurtenance of backwardness, I think it holds some rationale: If investing money in interest bearing instruments in prohibited, investors will be forced to turn their capital to real-economy projects as hoarding is considered as a waste of resources (assuming the owners of capital are rational.). Once again, Ghazali chips in with all too prescient words on investors: ‘it becomes easy for him to earn money on the basis of interest without bothering himself to take pains in real economic activities. This leads to the hampering the real interests of humanity, because interests of humanity cannot be safeguarded without real trade skills, industry and construction.’
But, what may be considered as a real economy transaction? It is a transfer of ownership from one person (the seller) to another (the buyer). As per Islamic jurisprudence, ownership is desideratum for a trade to take place. One cannot sell what one does not own. A principle addendum is that the seller must be in possession of the commodity involved in the trade; that the seller cannot sell and profit from something the risk of which she does not assume. This is a vital proviso to ensure accountability and prudence in any trade. By assuming commensurate risk, participants may be weaned off harum-scarum actions.
Islamic scholars have enshrined a manner in which capital may be deployed to earn ‘permissible profits’. At the core of all such methods lies the establishment of a risk sharing mechanism by which an investor partakes in the profits earned and the losses incurred by the project which was the principal of the investment.
One large scale project that comes to mind is that of the social banking experiments by Islamic states starting in the 1950s—especially in Egypt and then Pakistan. The most notable of these experiments was conducted by Dr. Ahmed Elnaggar in the Egyptian town of Mit Ghamr. Mit Ghamr was a small and sparsely populated town on the banks of the Nile. The Mit Ghamr Savings Bank transfigured the conventional ‘creditor-debtor’ relationship to a more Sharia prudent ‘risk-sharing’ relationship. No interest was paid on deposits nor any collected on loans made; the depositors were investors who were partakers in the profits earned by their investments, and the bank only engaged in what would now be called ‘Real-Economy’ transactions. The Mit Ghamr Savings Bank functioned more as a vehicle for savings and investments and less as a commercial. The Savings Bank was later incorporated into the Nasser Social Bank—which was also ‘interest-free’. (This is one of many instances of Islamic finance in action in the 20th and the 21st centuries. There exist many other instruments, most notable of which is the revolutionary Sharia compliant bond or sukuk. But, I must reserve a discussion on this front for another time.)
Financial markets today offer a motley array of instruments that, according to Islamic scholars, amount to gambling. A lot of transactions involve speculating on the movement of various markets. By entering into such trades and employing the various strategies available to the modern trader, investors are able to earn a positive return even from a market in decline. Such trades have no grounding in real economy transactions. As the financial crisis of 2008 has sufficiently clarified, various financial products—like Collateralized Debt Obligations and the notorious Credit Default Swap—not only brazenly courted uncertainty, but also marred transparency that is vital to the success of any transaction.
Islamic finance is steeped in, and arises out of the concept of equality and justice because Sharia seeks to extend it to every aspect of human interaction—even economics and finance. It is a fast growing industry and may well prove to be a beacon of virtuosity in a world mired by crony capitalism.

The opening quotes and the words of Ghazali have been borrowed by me directly from a published work—Heaven’s Bankers by Harris Irfan—that introduced me to the world of Islamic finance, and has played an indispensable and vital role in assisting me develop the ideas that I have presented in this article.


About the Author: 

Abhishek Anirudhan is a student of Economics at Fergusson College, Pune. His areas of interest include Money, Finance and International Relations


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