Islamic Banking: Is It Really Kosher?
By Aaron MacLean
Friday, March 16, 2007
Muslim scholars say the Qur'an prohibits collecting interest on
loans. But many banks, both global and local, have found clever ways
to meet religious strictures. It's a system that may be
hypocritical, but also profitable.
The coverage can be a little bit breathless: "La finance Islamique
en plein boom," Le Figaro reported in September. Yes, Islamic
banking, structured along the lines that religion decrees, is in
full boom. But is it really banking? And is it really kosher?
Islam prohibits the payment of interest on loans, so observant
Muslims require specialized alternative arrangements from their
banks. Many of the largest global financial companies, including
Deutsche Bank and JPMorgan Chase, have established thriving
subsidiaries that strive to meet these requirements. As a result,
optimists speculate that the common pursuit of lucredivinely
sanctioned, filthy, or otherwisewill bring bickering civilizations
together. They may be right.
The Islamic aversion to interest collection comes from the Qur'an.
Not that the term "interest" is ever used: the Arabic injunction
forbids something called riba. The Qur'an offers no exact definition
of what riba meant in seventh-century Arabia, the time and place of
the Prophet Mohammedlet alone what the term should mean today. In
particular, the passages are ambiguous on the question of whether
riba refers to all kinds of interest collection, or only usurious
interestthat is, lending practices that are, according to some ill-
defined standard, unfair and exploitative. What is clear in the
divine financial critique is that, whatever riba may be, Jews are
doing it. At one point God warns that they will face a "painful day
of doom" if they keep it up.
This ambiguity was a practical problem for the early Muslim jurists,
who formalized religious rules in a code called sharia. They were
divided on the subject, but as time went on, the weight of consensus
came to rest on the side of prohibiting all interest collection.
The financial instruments that 20th-century Islamic theorists
championed were updated versions of medieval commercial instruments,
still known in the Islamic financial sector by their Arabic names:
in addition to bonds, known as sukuk, there are profit-and-loss
sharing instruments known as musharaka or mudaraba, Islamic leases
known as ijara, and a commercial trade instrument called murabaha,
the flexibility of which has made it extremely popular among Islamic
financial firms.
Banking, as an institution, evolved at the same time as the
unprecedented economic growth in Europe over the past 500 years.
That growth was made possible in part by the codification, in the
12th century, of a distinction between usury and interest in the
Christian tradition.
The Islamic world witnessed the development of corporate contract
law and the European banking system from afar. A mixture of
traditional arrangements and, later, imported Western practices
prevailed in Muslim countries. But it wasn't until the 1960s that
anyone tried to combine the two, governing a modern bank according
to Islamic law.
You don't have to be Islamic to bank in accordance with sharia. All
you need is a board of religious scholars to approve your operation.
Islamic financial institutions, the argument went, would boost the
economic development of Muslim societies. The fraternal style of
Islamic bankingwith its emphasis on equity financing rather than
lendingwould enhance social responsibility. In practice, however,
Islamic finance has had to bend to the same pressures as any other
kind of finance. Social, religiously oriented investment in the
development of the Islamic world is something people are more
interested in publicly championing than personally doing. Khalid
Ikram, who represented the World Bank in Egypt, says of Islamic
banking, "it hasn't had a lot to do with development."
Pinning down the growth of Islamic banking is a challenge. Whether a
banking system truly counts as halalthat is, compliant with the
laws of sharia, or, in another religious context, kosheris a
religious question, hard for accountants to answer. Take Iran:
should the country's whole banking system, which is nominally
Islamic, be counted as part of the sector even though many experts
raise questions about its legitimacy?
The numbers I found were anecdotal. Rodney Wilson, professor of
economics at Durham University in Britain and editor of the essay
collection The Politics of Islamic Finance, estimates total assets
within halal banking systems at just under $500 billion. That's
roughly the size of Wells Fargo Bank, America's fourth-largest.
Hussein A. Hassan of Deutsche Bank predicts that Islamic finance
will be the world's fastest-growing banking sector for years, based
on what he calls a modest estimate of 20 percent annual increases in
deposits.
So it's big business, getting bigger, and those who hesitate to
enter it now risk suffering an expertise deficit later. The number
of professionals trained to structure sharia-compliant products, and
of religious scholars qualified to certify them, is small enough to
be already causing problems. Governments are getting in the game,
too: Japan is planning to become the first non-Muslim country to
issue sharia-compliant bonds; the UK, Gordon Brown announced last
summer, is revising its laws to make London the "gateway" for
Islamic finance in Europe; and Malaysia has proposed substantial tax
incentives in its 2007 budget for its Islamic financial sector.
Deutsche Bank, Chase, and HSBC, the giant London-based financial
institution with an extensive presence in Asia, have all entered the
sector within the last ten years. Their moves coincide with rising
oil prices, echoing a phenomenon three decades ago. When the 1970s
oil boom gave Muslims and their governments wealth that seemed
barely countable, Islamic financial institutions bloomed: the
Islamic Development Bank (1975), the Kuwait Finance house (1977),
the Faisal Islamic Bank of Egypt (1977), the Jordan Islamic Bank
(1978), and others. In 1979, Bank Misr, a conventional financial
house in Egypt, became the first mainstream bank to build a halal
subsidiary, which in the late 1990s began to attract more capital
than its chief domestic competitor, the Faisal Islamic Bank.
Oil prices and religious fervor are both on the rise again. This
time, Western financial firms have noticed that you don't have to be
Islamic to bank in accordance with sharia. All you need is a board
of religious scholars to approve your operation. Muslim is as Muslim
does.
The Islamic world witnessed the development of corporate contract
law and the European banking system from afar.
Hussein Hassan of Deutsche Bank is an example of the sort of expert
required. He structures specialized Islamic bonds, or sukuk. For a
bond to qualify as sharia-compliant, there must be an underlying
asset backing it. One cannot simply issue bonds to raise money, the
way it's been done elsewhere for centuries, in return for a promise
of a fixed rate of return. To be Islamic in nature, the securities
that look like bonds must represent fractions of an equity asset,
rather than fractions of a loan.
According to sharia scholars signing off on the prospectuses, the
practices of the multinationals are fully Islamic. That is good news
for corporations that want to raise money from Muslims, and for the
observant clients themselves. But the potential clientele is by no
means captive. As Hassan put it to me, "money always looks for the
best deal." if Islamic finance couldn't provide results close to
those of secular institutions, it wouldn't exist.
Khalid Ikram, who headed the World Bank's operations in Egypt in the
late 1990s, looked into the performance of Faisal Islamic Bank of
Egypt (FIBE) back during the early boom days. It turned out that,
despite the bank's citing "religious fervor" to him as the reason
for its growth, Coptic Christians made up about 10 percent of the
bank's clients, just as they do of the country's population. When
returns dropped, so did investment and market share. Egyptians with
foreign capital generally preferred to keep their cash overseas,
even though the returns there were less than the roughly 20 percent
returns FIBE was promising on current accounts. The greater security
of foreign deposits made up for their lower rate of return. The
rational profit motive never lost its place as the key factor in
investor behavior.
Timur Kuran, professor of economics and law at the University of
Southern California and author of Islam and Mammon: The Economic
Predicaments of Islamism, points out that investing in sharia-
compliant fashion doesn't just buy you decent returnsit can also
buy political legitimacy. "Islamic finance didn't come into its own
until the 1970s. Why during the oil boom? Huge amount of assets,
petrodollars, were accumulating in the sheikdoms and with the
Saudis. These regimes were considered quite illegitimate, and there
were a lot of opposition movements, so they wanted to legitimize
their regimes and invest the money at the same time
. They could
claim that they were promoting Islam and avoiding interest."
Since the inception of Islamic economics as a distinct discipline in
the 20th century, it has always been held up as a champion of
ethical development. Islamist writers such as Sayyid Qutb and Sayyid
Abul-A'la Maududi envisioned Islamic finance as the economic arm of
a new, sharia-guided political order. Free of the scourge of
interest, the instrument by which fat-cat colonial and imperial
capitalists make money from money, Islamic financial institutions
would effectively become private equity or venture capital firms,
providing sorely needed investment and support for the region's
economy. By investing in Islamic finance, you weren't just being
piousyou were aiding development and helping the poor as well.
But the post-capitalist utopia that reliance on these instruments
was meant to inaugurate was dead on arrival. Those involved in the
first wave of Islamic banks realized that equity financing does not
make for a stable banking sector, and, after a series of shocks and
bad investments, they became very conservative. It was a race to the
loopholesa search for means of sharia compliance less risky than
straight-out equity investing.
It's big business, getting bigger, and those who hesitate to enter
it now risk suffering an expertise deficit later.
The chief loophole was murabaha. Let's say that you, a small
businessman, wish to go into business selling cars. A conventional
bank would examine your credit history and, if all was acceptable,
grant you a cash loan. You would incur an obligation to return the
funds on a specific maturity date, paying interest each month along
the way. When you signed the note and made the promise, you would
use the proceeds to buy the carsand meet your other expenses
yourself. But in a murabaha transaction, instead of just cutting you
the check, the bank itself would buy the cars. You promise to buy
them from the bank at a higher price on a future datelike a futures
contract in the commodities market. The markup is justified by the
fact that, for a period, the bank owns the property, thus assuming
liability. At no point in the transaction is money treated as a
commodity, as it is in a normal loan.
But here's the catch: most Muslim scholars agree that there is no
minimum time interval for the bank to own the property before
selling it to you at the markup. According to Timur Kuran, the
typical interval is "under a millisecond." The bank transfers
ownership of the asset to its client right away. The client still
pays a fixed markup at a later date, a payment that is usually
secured by some sort of collateral or by other forms of contractual
coercion. Thus, in practice, murabaha is a normal loan.
Since murabaha must be asset-based, however, it can't help a small
businessman who needs a working-capital loan, for example, to
provide cash on hand to meet payroll or other expenses. To get such
capital from an Islamic financial institution, an entrepreneur would
have to sell the bank an equity interest in his business. This is
far riskier for the bank and thus much harder to obtain.
The experts tell me that every Islamic bank has at least three-
quarters of its investments structured as murabaha. Even the inaptly
named Islamic Development Bank was, as of the mid-1980s, doing four-
fifths of its business through murabaha, and only 1 percent through
equity transactions.
What the "Islamic" label might mean is left to the beholder. The
sharia scholars make it their business to pronounce only upon the
letter of the law. Like legal practitioners everywhere, they focus
on the technicalities. The spirit, being intangible, tends not to
cloud their rulings. The leading critics of this inconsistency are
political Islamists themselves. Majed Jarrar, a personable young man
who studies electrical engineering, wears a long beard, and is keen
to discuss his faith, recently opened an account with FIBE here in
Cairo, only to let it sit empty. He's been investigating
whether "it's actually Islamic or not," and he doesn't like what
he's finding.
When I asked him about the sort of innovation that, for example,
Hussein Hassan at Deutsche Bank is involved in, Majed scoffed.
Recalling a similar campaign by a Gulf-based Islamic financial house
("creative Islamic Solutions" was the slogan), Majed argued that
sharia law is less about innovation than it is about a return to the
ways of seventh-century Arabia.
Despite the zeal of purists like Jarrar, an entire banking sector
without debt would be far too unstable. Such a system has never had
to existmedieval Islam had extensive regulations governing trade
relations and individual contract law, but there was no banking, so
there were no banking rules.
While no one I interviewed argued that sharia-compliant financing
directly retards economic and social development, there was
agreement that it does much less than the original rhetoric claimed.
Not only are working-capital loans, critical to many small
businesses, rare, but also sharia-compliant transactions tend to be
short-term.
Still, there's something reassuring about the way that the rational
profit motive trumps strict ideology. The willingness to put profit
first is, it turns out, the real shared value that links Islamic and
Western civilizations.
Aaron MacLean lives in Cairo. From 2003 to 2006 he was a Marshall
Scholar at Oxford University, where he researched medieval Arabic
thought.
Image credit: "Halal Banking" by Flickr user Nicobobinus
