Islamic economics has increasingly become a force to be reckoned with, with portfolios of oil exporters and multiplying Islamic financial instruments, such as interest-free mortgages and Sukuk. By the end of the last decade, more than 350 institutions in over 65 jurisdictions were managing assets worth over US$1.5 trillion in a Shariah-compatible manner.
Can Shariah-compliant instruments challenge the existing international financial order? Would an Islamic economic regime really imply an end to injustice because of “the State’s provision for the well-being of all people?”
Is Islamic economics an “invented tradition”?
Teaching economics, political science and Islamic studies at the US’ Duke University, Prof Timur Kuran, discovered that Islamic economics did not go all the way back to Prophet Muhammad’s time, but it is actually an “invented tradition”, which emerged in the 1940s in India from the work of an Islamist intellectual, Abul-AlaMawdudi.
According to Prof Kuran, proponents of Islamic economics make two basic claims – that the prevailing capitalist
order has failed, and that Islam offers the remedy. To understand the actual functioning of Islamic economics, he
devoted intense attention, focusing on its three main claims:
1. The abolishment of interest on money,
2. The strive for economic equality, and
3. The establishment of a superior business ethic.
Prof Kuran concluded that on all three accounts, it is a total failure. Is there any substance in what Prof Kuran has concluded?
He said, “Nowhere has interest been purged from economic transactions, and nowhere does economic Islamization enjoy mass support”. Prof Kuran asserted that Islamic finance is exotic and complex – with profit-loss sharing techniques, such as ijarah, mudharabah, murabahah and musharakah, all involve thinly disguised payments of interest. He further criticized that banks claiming to be Islamic, in fact, “look more like other modern financial institutions than like anything in Islam’s heritage”. He concluded that, there is almost nothing Islamic about Islamic banking – which goes far to explain how Citibank and other Western majors host far larger Islam-compliant deposits than do the specifically Islamic banks. On the goal of reducing inequality, Islam imposes Zakat tax. Prof Kuran’s findings is that this tax “does not necessarily transfer resources to the poor; it may transfer resources away from them”. He went to the extent of accusing Zakat taxation, which is supposedly meant to help the poor, instead appears to serve as “a convenient pretext for advancing broad Islamic objectives and for lining the pockets of religious officials”. Prof Kuran also concluded that the renewed emphasis on economic morality has had no appreciable effect on economic behaviour, simply because, in common with socialism, “certain elements of the Islamic economic agenda conflict with human nature”. Rather than rejecting all of Prof Kuran’s accusations as nonsense and baseless, we should positively take them as “bitter pills” that may be useful as “wake up calls” to Muslims, and especially, the professional and academicians who are always working to practice the teaching of Al-Quran in our daily life.
To retaliate against the accusations by attacking back may not be very productive as we can just be labelled the emotional lots. Instead, let us explore how we could overcome all the weaknesses and drawbacks of the current Islamic economics practices, if any.
The Pathway towards a full-fledge Islamic Economic Model
The greatest influence I had on the Islamic economic model came from Dr Muhammad Umer Chapra, a senior researcher at the Islamic Research and Training Institute (IRTI) of the Islamic Development Bank (IDB) in Jeddah, Saudi Arabia. The idea of Qardhul Hassan Institution that I will be projecting later on came after I stumbled into a footnote in Dr Umer’s keynote address on Islamic finance, more than two decades ago.
His perspective of Islamic economic model has really formed a lasting impression in my mind. The discussion that follows was based largely on Dr Umer’s thoughts and works on the Islamic economic Model. Various solutions have been tried to meet the economic needs of a man, but very little has been seen that come near to achieving a welfare society, free from periodic recessions and depressions, based on equal opportunity, balance between classes and spirit of cooperation, rather than unbridled competition and greed. Normally in economics, technological advancement as measured by gross national product (GNP), became the hallmark of a man’s progress. To overcome the economic ills of the West from spilling over into the political and social realms, another alternative economic model is needed, especially in the wake of the failure of the socialist model.
Proposing the practice of Islamic Economic Model within Conventional Economics paradigm The best approach to apply the Islamic Economic Model is to practice the micro perspectives of it, but in a complete model. A complete model of the Islamic economy can be introduced in the form of financial mechanism. Islamic financial model can conveniently be applied in a conventional economic environment. This has been the approach taken by scholars like AbulAlaMawdudi in India, and this was how Islamic banks started to develop, five decades ago in the 1960s, in Egypt, India, Pakistan, Malaysia and the Middle East
The challenge in implementing a true Islamic Financial model
Though we have successfully implemented an Islamic financial model side by side with the conventional one in the conventional economic system, and made some great impact, in terms of support and responses from the public, we are still facing some basic hurdles that limit our success rate. The reality is that the Islamic financial sector has a lot of constraints. Unfortunately, although Islamic banks and financial institutions are supposed to be an interest-free sector, they have never promised to be a profit-free sector. This is because Islamic financial sectors have been initiated as a private banking and financial sector in the economy. All the banks are owned by a set of shareholders who expect to make some return from their investment in the form of dividend. The depositors who saved their money in the Islamic banks also expect some return in the form of profit from their investment and deposit. Hence, the management team in the Islamic banks and financial institutions, acting as the fund managers, are on a constant pressure to perform well in managing the shareholders fund and the depositors’. To perform well means they must make the maximum return in the form of profit to be shared with the depositors and the shareholders.
Now, where would Islamic bank derive their profits from? The only opportunity available is from investing the depositors’ funds. Depositors’ fund could be invested either in the form of joint-venture investment (mudharabah and musharakah) with their clients; or by lending the depositors fund (murabahah) to their clients, who become borrowers. It is through this profit-sharing and the borrowing fees collected from their clients that they could expect their return. That means, the bank had to impose a maximum possible financing charge and profit-sharing rate in order to perform well. Hence, it is just unfair to expect the Islamic banks and financial institutions to provide concession to the borrowers and joint-venture partners – the small and medium enterprises and micro businesses. When measured in terms of the true Islamic economic model, the financial system implemented in the Islamic financial model still lack the spiritual perspectives that has always been seen as the essence of the Islamic system.
As a result, Islamic banks and financial institutions worldwide have not seen to be distinctly different from the conventional banks’operation. This was the primary source of Prof Kuran’s assertions. A very important criteria of an Islamic economic model as projected by Dr Umer is that
“Islamic economic system ‘exists’ in the sense of having its own ethical values, a set of economic objectives, as well as policy instruments. It must be seen as an “optimum regime” – which optimally combines the concerns of social justice with those of economic growth.
Hence, the problem is to maximize social welfare subject to well-defined constraints and “initial conditions”. The true Islamic banking approach is, however, rather different from the conventional financial institution’s approach, in that in Islamic practice, there is no separation between financial institutions and other business institutions. Hence, the term Islamic bank is actually a misnomer. An actual Islamic bank is supposed to be a conglomerate involved in many types of businesses and holding many types of trading assets, such as properties, motor vehicles, plants and machineries. At the same time, the conglomerate also offers some financial services to accommodate the trading activities with their clients and suppliers. Two types of financing which Islamic banks can offer are debt and equity financing. Though debt financing, such as installment sales and deferred payment schemes, are allowed in Islamic banking, Muslims are more encouraged to use equity financing in their funding mechanism.
The purest form of equity financing will be the venture capital and common shares subscriptions in the businesses. However, the concept of temporary investment using the concept of Declining Balanced Investment, or the Arabic term Musyarakah Mutanakisah, is gaining popularity in the Islamic banking practices. In its basic forms, the financial institutions will finance a particular project, or business, as an equity investor. It, however, allows the entrepreneur’s partners to buy back the equity held by the financial institutions at any time within a specified period. The entrepreneur’s projected return on the business will be used as the basis of gauging the return on the equity investment. It will still be measured in terms of percentage of the total equity in the business. It creates a true partnership arrangement between the entrepreneurs and the financial institutions in running the business.