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The mass anti-globalisation protests which have paralysed gatherings of G7/G8 leaders have highlighted a serious unease with the operations of unfettered markets. For many, the present arrangement leads to perpetuation of gross global inequity, and rampant globalisation is seen as making things worse. Similar sentiments underlie the protest against policies of the International Monetary Fund and the World Bank. These are seen to be pushing what has come to be called the “Washington Consensus” of policy prescriptions designed to institutionalise unfettered markets across the developing world. Unregulated markets are now seen as the primary mechanism generating inequity on a global scale.
At another level, the saga of Huntingdon Life Sciences (HLS) in the UK has become a landmark issue. The company, a leading user of live animals for experiments, fell foul of the Animal Rights lobby. Mounting a sustained campaign of mass protests, this powerful lobby was able to cut off all sources of bank finance to the company. HLS had to move its operational headquarters from the UK to the USA and rely on funding from non-banking sources. This was a dramatic illustration of banks bowing to pressure from the provider of their funds – the depositors. Not long a go the Bank of Scotland was also forced to withdraw from a deal with the US televangelist Pat Robertson because of the latter’s controversial views. The embarrassing about turn was forced on the bank by its shareholders and depositors.
In the UK unease is mounting about the Private Finance Initiatives (PFI) which seem to have delivered a pitiful level of public service at enormous cost to taxpayers. Again unfettered market principles are seen as not suitable for all purposes.
These developments provide an illustration of a major shift in public perceptions about how economies and businesses operate. At one level unregulated markets are seen as perpetuating inequity. An urgent need is seen to challenge the prevailing dogma about free markets and introduce regulatory regimes to safeguard the public interest. On another front, the freedom of financial intermediaries to provide funding for operations without taking into account the wishes of the providers of the funds is being seriously questioned.
These developments provide an interesting parallel with the ideals of Islamic economics and finance. The quest for equity and justice has been central to the thinking of Muslim economists. Indeed, most protest movements in Muslim societies have their anchor in the spirit of social equity and justice. At the same time Muslims are deeply concerned about the ways of financing businesses to ensure that ethical considerations are paramount.
In this spirit, Muslim economists have argued for tempering the market mechanism with regulations designed to embody the public interest. According to them, in designing all policy, the primary consideration should be justice and equity rather than laissez faire market operations.
Muslim jurists have argued the case for limits on land ownership and strict application of inheritance laws to avoid concentration of wealth. Some radical Muslim jurists have also argued that land is a communal resource and ownership is confined to period of active use rather than perpetual. Again, mineral and other natural resources are regarded as communal property.
In Muslim societies, the injunction of Zakat provides a vital mechanism for addressing social welfare issues. All Muslims are required to give away at least two and a half percent of their income to the poor and the needy as Zakat. As the principle is well established in Muslim societies, Muslim economists have argued for its institutionalisation with even higher levels of giving. A social welfare state is thus not alien to Muslim thinking at all.
As for national borrowing, Muslims are expected to have risk-sharing contracts rather than fixed rate loans. Translated into practice this would imply that lenders to Muslim countries would need to be convinced of the viability of the projects financed as their return would depend on the success of these ventures. This would have a mitigating effect on spurious debt build ups and repayment crisis as has become common.
Thus in theory Muslim societies should have a much more equitable ethos than they do at present. This discrepancy is there for a variety of reasons, but developments in banking and finance show that a slow evolution reflecting this basic ethos is taking place.
In the area of banking and finance, Muslims share common concerns, about the use of funds by financial intermediaries, with the growing body of ethical investors.
The best way to appreciate this is to look at the growth of Ethical funds and investments. Basically, these try to incorporate the desire of the providers of the funds to have a say in the use of their monies. Thus, some funds do not invest in companies which deal in tobacco, alcohol, or military hardware. Others, only invest in corporations which incorporate environmental sustainability criteria in their operations.
This is in sharp contrast to the traditional banking model whereby the providers of funds were expected to limit their concerns to the security of their investment rather than the use of the funds. It was little wonder that ethical investment notions were met with cynicism and ridicule when they were mooted in the early seventies. However, they did reflect a public desire and slowly but surely the movement has grown.
Islamic finance has a similar rationale. Indeed in some respects it goes further, being concerned not just with what kind of activities are being financed but also with the way in which they are funded. Thus Muslims are encouraged to invest in “permissible” (Halal) activities, via “permissible” means.
That means that while Islamic financial institutions will not invest in corporations dealing with forbidden items like alcohol and gambling, neither will they deal with organisations involved in riba, or usury, transactions. Indeed, the lending of money for a predetermined return (riba) is expressly prohibited in the Qur’an. Many Muslim jurists consider any form of interest as riba (usury) and thus do not allow dealing with or investing in banks per se.
In practice this is less dramatic than it sounds. Muslims still make everyday transactions like investing their surplus funds, house-buying, and taking out loans and working capital for their businesses etc. For investment purposes Islamic financial institutions employ criteria similar to those used by the ethical investment funds. The big difference comes in the way they structure lending transactions, both for personal finance and business purposes. In simple terms, lenders enter into risk-sharing contracts with borrowers; return is based on the outcome of the venture or investment, rather than a predetermined rate.
The principle of risk-sharing can have far reaching implications. For risks to be shared, borrowers have to be willing to provide much more information about their situation than normal banks would seek for lending against collateral or guarantees. It will include confirmation that the funds are to be deployed in permissible activities, as well as transparency in reporting financial information about the progress of the business or project for which the money has been borrowed.
Several modes of financing have been developed. The primary tenet of Islamic financial intermediation is that there should be a sharing of risk between the lender and the borrower. Thus the two prominent instruments are Mudharaba and Musharaka. The Musharaka is very similar to a partnership sharing profits and losses. Under a Mudharaba, however, the provider of capital and labour share the rewards, but losses are borne by the provider of capital only as the provider of labour is already deemed to have contributed his share. There are also two additional instruments utilised by Islamic bankers. These are Murabaha and Ijara. The Murabaha is a simple cost plus transaction and is not accepted as a genuine Islamic banking instrument by many Muslim jurists. Ijara transactions work in a similar way to leasing.
Present day Islamic financial institutions also invariably have a Shari’a (Islamic Law) Supervisory Board of Advisors. This is usually a body of qualified Muslim jurists well versed in commercial transactions. All new transactions and structuring of deals are vetted by these Boards for compliance with Islamic Law.
Over the last three decades Islamic banking and finance has grown manifold in Muslim communities and countries. In Malaysia, about five percent of all banking transactions are conducted by Islamic Financial Institutions. This is set to rise to ten percent by 2005. Pakistan’s Finance Minister has also announced plans for a similar phasing in of Islamic financial intermediation. Similar moves are afoot in most Muslim countries. Malaysian and Middle Eastern corporations have also begun to raise long and medium term finance by issuing Shari’a compliant bonds. There are plans for launching of primary and secondary debt and equity markets in Shar’ia compliant financial instruments.
In other parts of the Muslim world Islamic equity investment funds have also mushroomed. Very much like ethical funds, these restrict their portfolios to approved corporations, based on criteria devised by their Shar’ia Supervisory Boards. An increasing number of Muslim investors are channelling their savings through these funds. There is also a Dow Jones Islamic Index which acts as a benchmark for the performance of some of these funds.
In the UK and USA Muslim communities have started to experiment with saving and housing finance products which meet the stipulations of the Shari’a (Islamic Law). In the USA, the Islamic housing finance company Lariba, has had its funding augmented by Freddy Mac, the leading mainstream provider of housing funds. In the UK I-Hilal and Parsoli have started to market Shari’a compliant ISA (Individual Savings Account) products. Indeed, a recent survey by business information company, Datamonitor, concludes “the market for Islamic (Shari’a-compliant) finance in the UK is set to grow hugely. A huge gap exists for Shari’a compliant equity and mortgage products. Muslims have historically been underserved by UK financial institutions, but this is set to change.”
The closest situation to a possible scenario in the UK is the Malaysian example. There, a full range of banking products are available to customers from Bank Islam Malaysia Bhd or the “Islamic Banking” counters of all the major banks. The set up is fully regulated by the Central Bank of Malaysia and Islamic finance instruments seem to co-exist with traditional banking products without any problems. If such products are launched in the UK, then the Malaysian model would be ideal as it provides a precedent for a small Islamic banking sector harmoniously co-existing with a much larger traditional banking sector. In fact, two years ago, in a seminar hosted by the Islamic Foundation in Leicester, Eddy Gorge the Governor of the Bank of England and Ahmed Mohammed Don the former Governor of the Bank Negara Malaysia (Central Bank of Malaysia) had and exchange of views on this very subject.
The growth and public appreciation of Islamic financial institutions, just as with the ethical investment movement in developed economies, will in time help ‘persuade’ the big financial players to pay far more heed to their customers’ views in deciding where and how they invest their depositors’ money. In the process it will become easier for social and ethical criteria, like equity considerations, to be incorporated into financial intermediation.
The incremental growth of Islamic financial institutions also shows how Muslim societies will begin to incorporate the spirit justice and equity. Emerging from the colonial interlude, Muslim societies have begun to reflect on the basic precepts of their economic organisation. Understandably, there are a host of external and internal realities which impinge upon the way these societies are organised. However, as the move towards more representative societies gathers pace, the underlying thrust of the Islamic quest for equity and justice is likely to manifest itself in developments in Muslim societies over time.
In these endeavours Muslims will be in good company. Together with the growing protest against the growth of global inequity, the quest for ethical financial intermediation, will provide platforms for like minded players from across faith and ideological boundaries to come together.