What is condemned is the greed of wealth that is unable to see beyond one’s selfish desires…
Justice Mufti Muhammad Taqi Usmani
In January 2010, at the World Economic Forum Annual Meeting in Davos, the erudite and prolific Sharia scholar, Justice Mufti Muhammad Taqi Usmani, was invited to present a paper with a somewhat radical theme: reforming the world’s post-crisis financial landscape through the lens of religion.1 The paper generated little interest from the world’s media, who preferred instead to focus on the lack of plans for reform or ‘real achievement’, and the predictably defensive stance taken by bankers.2 Had they taken the time to read the thirty-seven-page document, they might have concluded that ‘caring capitalism’ had the potential to be perhaps more than a mere romantic notion.
Yet Mufti Taqi Usmani’s paper proved inspirational for introspective Islamic bankers searching for direction, in that it questioned the very nature of money, thus inviting a radical philosophical shake-up of their ordered universe. Perhaps few in the audience (if any) were moved that day to tweak their banking practices as a result of the paper’s suggestions for reformation of the world’s financial system, but they nonetheless came away with the counsel that social awareness ought to be the underpinning of finance.
When you read in the newspapers about the launch of another new Sharia-compliant product, or the establishment of a financial institution that conforms to the principles of Sharia, it is often the case that journalists refer to Islamic products as ones that ‘conform with the religion’s ban on interest’, as if that were the only relevant criterion. It is as if every time we read about the conventional banking industry we are reminded parenthetically that the business of banks is to make loans with interest, ignoring the diversity of activity that retail bankers, private bankers, investment bankers and fund managers engage in. Accordingly, in the minds of the public, Islamic finance seems to stand for one thing – no interest.
Perhaps as a direct consequence, there are Muslims who find the modern practice of Islamic banks abhorrent, and little different to the practice of conventional banks. Their reasoning is that if Islam prohibits the receipt or payment of interest, then the only business that Islamic banks should be engaging in is interest-free lending, conveniently ignoring the fact that an interest-free loan is construed as an act of charity in Islamic law, and no enterprise driven by the profit motive can be predicated on charity.
The profit motive is an emotive subject for Muslims, particularly when set in the context of a world economy creaking ominously under the weight of capitalism as we know it. To what extent is the pursuit of profit acceptable in Islam, if at all? How is one allowed to make profit in a halal, or permissible, manner? How are Islamic financial institutions allowed to deploy and invest capital to be profitable in a manner that is compliant with Islamic law?
In order to begin to answer these questions, let’s consider the value system inherent in Islam. To understand how and why Muslims behave as they do – or perhaps, more accurately, how they are instructed to behave – we note that Islamic thinking revolves around the fundamental belief that there is one God, Allah, and that the universe is created and controlled by Him.
A brief examination of the word ‘Islam’ will provide us with a clue to understanding why Islam governs every aspect of a Muslim’s life, even those aspects that a non-Muslim would deem to be outside the domain of religion. Islam literally means submission – submission to the will of Allah. In a world dominated today by Western cultural practice, freedom has come to signify that most precious attribute of a civilized society: freedom to think what we want, say what we want and do what we want, within the bounds of the (man-made) law. And yet the very word Islam implies that we are dependent upon, and submissive to, God, the ultimate arbiter. And so freedom is contained within the bounds of sacred law.
The ‘Muslim’ is one who has submitted, and the ethical value system that governs his or her everyday thoughts and actions are derived from two sources. First, from the word of Allah (documented in the Quran), as revealed through His final messenger, Muhammad. Second, from the Sunnah, the actions and sayings of Muhammad as recorded in the Hadith, the books that document the Sunnah through a chain of scholarly authority.
These two sources lead the Muslim to believe that every thought, intention and action is an act of submission to the sovereignty of Allah. The way of life espoused through the Quran and Sunnah is intended to promote a healthy and balanced society, in equilibrium with itself. How Muslims conduct their daily business dealings is one aspect of ensuring this harmonious balance, and hence why a system of commerce that adheres to Islamic law has become such an essential consideration for Muslims today. So when we talk about Islamic finance, what we really mean is a framework for commercial and financial transactions in accordance with the principles of Sharia, as derived from the Quran and Sunnah.
In order to establish what are the guiding principles – the principles that will lead to a just distribution of wealth, to accommodate the economic needs of all segments of society on a fair basis – we need to begin just after the beginning.
In the year 632, or the tenth year after the Prophet Muhammad had fled persecution in his home town and migrated with his followers to the agricultural oasis of Yathrib, he led his people on the first Muslim pilgrimage – the Hajj – back to his birthplace, the holy city of Makkah. From the pulpit of a dusty valley near the bleakness of Mount Arafat, the 63-year-old Prophet delivered what would become his final sermon. For three months later he would fall ill with fever and die with his head resting in the lap of his wife, Aisha.
During that final sermon, God revealed a verse to the Prophet that would turn out to be suitably timely: ‘This day have I perfected your religion, and completed My favours upon you and approved Islam as a religion for you.’3 And in those words God would be putting His seal of approval on a lifetime of the Prophet’s actions. The Prophet had been the messenger whose mission it was to leave behind the word of God, setting out the principles to govern people’s daily lives. His actions – the Sunnah – had been duly recorded and orally transmitted by his many companions, as an example to his followers, and his final sermon was the culmination of that lifetime’s work.
The final sermon was succinct and yet at the same time widely encompassing. In it, the Prophet began by reminding his followers that life and property are a sacred trust, that they should hurt no one by their actions, and that they would one day meet their Lord who would reckon their deeds. He continued: ‘Allah has forbidden you to take riba [interest], therefore all interest obligation shall henceforth be waived. Your capital, however, is yours to keep. You will neither inflict nor suffer any inequity.’4
Muhammad realized he was entering his final days and perhaps took what he saw as his last opportunity to raise once again issues of the utmost importance, issues that he didn’t want his ummah – his nation – to let lapse. His final sermon covered women’s rights, the need to perform the daily prayers, to fast during the month of Ramadan, and to give to charity. He emphasized that no Arab had superiority over a non-Arab, no white over black nor vice versa, except by piety and good action. And he ended by reminding his followers that he was the last of the messengers of God, and that no other would follow him, and therefore that the Quran and Sunnah would be the definitive legal precedents for all time.5
It was a farewell remarkable for its timeliness and impact, one that would be felt for centuries to come. To the Prophet’s followers, the finality of this last speech at the Mount was palpable: ‘I know not whether after this year, I shall ever be amongst you again. Therefore listen to what I am saying to you very carefully and take these words to those who could not be present here today’,6 he told them. In the space of a few minutes, the Prophet had reminded his followers for the last time that human rights and property rights were paramount. That justice and fairness should be a driving force in their daily lives. And that they now had a complete framework from which to build a new world, irrespective of whatever the curiosity and ingenuity of the human mind would discover or create.
With the death of the Prophet, the link with divine revelation was abruptly severed and the Prophet’s nation would be forced to think for itself. For some, the death of the beloved Prophet was inconceivable. One of the Prophet’s closest companions, Umar ibn al-Khattab, almost fainted at the news but regained his composure to stand before the gathered crowd. He swore fiercely that the Prophet would return just as Moses had communed with his Lord in secret for forty days and forty nights, and condemned those who said he was dead as hypocrites. Few would risk the considerable wrath of Umar except the Prophet’s closest companion, Abu Bakr as-Siddiq.
‘Umar, be seated,’ he told him calmly and Umar refused. Abu Bakr continued. ‘Whoever worshipped Muhammad, prayers and peace be upon him, let them know Muhammad is dead now. But whoever worshipped Allah, let them know He is Ever Living and He never dies.’ As Abu Bakr recited a verse of the Quran reminding the people that Messengers were mortal but the message was eternal, Umar fell to his knees and grieved. Where would divine law come from now?
In the frighteningly infinite possibilities to come, the nation of Islam would discover new ideas, push the frontiers of knowledge, and grapple with the critical question of whether such new concepts were permissible according to God’s law. Astronomy, mathematics, chemistry, medicine, architecture, commerce – all of these disciplines and more would be subject to the scrutiny of the clerics. The Prophet’s companions, and the men who would come a generation after them, would turn out to be the codifiers of God’s law, particularly in the field of commercial transactions, and their legal analysis would prove to be the lubricant for the advancement of human knowledge, rather than an insurmountable barrier of dogma and intolerance that many today have come to regard as the attributes of religion.
Though the Prophet had advocated charity to the poor and needy – and had himself lived an austere life – he had certainly not decreed haram, or impermissible, the accumulation of wealth. The Prophet himself had been a competent mudarib – that is, a trader or manager of other people’s capital – and there was no indication that a man may not be both rich and pious at the same time. Nor had he discouraged a market economy, though he had consistently advocated an equitable distribution of wealth within that economy.
Though an outwardly inflexible and strict man, Umar ibn al-Khattab – the grief-stricken companion who threatened to kill anyone who said the Prophet had died – was driven by the idea of the protection of the weak, and it was he who carried forward the idea of a compassionate society on the Prophet’s death. As the second caliph of the new Islamic era, Umar instituted the Bayt al-Maal, the ‘House of Wealth’, a state-run financial institution responsible for the administration of taxes, including the distribution of zakat, the charitable wealth tax. He established the Central Treasury in the city of Madinah, and introduced welfare programmes to ensure equality and a basic standard of living was extended to all citizens. In Umar’s quest to ensure systematic provision for widows, orphans, invalids, the unemployed and the elderly, limitations were placed even on governors and officials, with the most manifest example of this being Umar himself whose personal wealth was meagre despite his status as the leader of what quickly became an empire.
He introduced the concept of public trusteeship and public ownership through the charitable trust system, the Waqf, a legal form of social collective ownership that allowed public property to generate an income stream for the benefit of the needy and contributed to the building and maintenance of schools and hospitals – and that has survived and evolved to this very day in, for example, the English trust law.
The basic principles of social advancement through charity and commerce were thus in place at the time of the Prophet’s death and through the subsequent institutional creations of his closest companions. By acting as conduits for the redistribution of wealth, rather than by using their positions to accumulate wealth (as pre-Islamic rulers had done), they were building an egalitarian society rather than an aristocratic one. But the Islamic world still needed the right person to turn these principles and social institutions into practical commercial tools, tools that might lead to a type of caring, or just, capitalism. With a little insight, the principles could be codified to place constraints on greed, speculation and opaqueness. They reprioritized the very nature of money itself.
One man in particular would come to be regarded as one of the greatest scholars of Sharia that the world would ever see. Born at the turn of the eighth century in the town of Kufa in what is now Iraq, sixty-seven years after the death of the Prophet, Al-Numan bin Thabit at first demonstrated little inclination to a scholarly life, though his was certainly a pious one. His family lineage has been lost in the mists of history, but some suspect his grandfather was a former slave of a conquering Arab tribe, and likely to have been of Persian descent.7 As a merchant in the garrison town, Al-Numan’s textile business flourished and he established a reputation for scrupulous honesty and fairness. In time he would come to be known as Abu Hanifa, a nickname meaning ‘the Father of Orthodoxy’, and the parallels between the Prophet’s reputation as a merchant – who himself had earned the nickname Al-Amin, meaning the Trustworthy One – as well as the Prophet’s closest companion, Abu Bakr as-Siddiq – who had been a textile merchant – did not go unnoticed.
Subsequent generations would relate many stories about Abu Hanifa, but perhaps one of the most famous – and most indicative of the man himself – was the purchase of a silk garment from a woman who came to his store. The lady offered to sell the garment to Abu Hanifa for 100 dirhams but Abu Hanifa would not buy it. ‘It is worth more than a hundred’, he told the surprised woman. ‘How much?’ he asked her again. She offered to sell it for 200 dirhams and he turned her down. Then she asked for 300, then 400, at which point the exasperated woman scolded him. ‘You are mocking me’, she declared, and prepared to walk away from the deal to try her luck elsewhere. So they summoned another merchant and he solemnly valued the garment at 500 dirhams. Rather than profit from the woman’s ignorance, Abu Hanifa had opted to settle for a fair trade, a principle he would abide by all his life – that the greedy should be regulated from taking advantage of the vulnerable.
It was not until a providential encounter with one of Kufa’s leading jurists that the young Abu Hanifa finally embarked upon his calling. Whilst walking to the market one day, the merchant was spotted by a locally famous scholar named Ash-Shabi. The scholar called out to the young man and scolded him for passing by while wrapped up in his temporal thoughts of making money and without an apparent care for the spiritual. ‘Do not be heedless’, he said. ‘You must look into knowledge and sit with the scholars. I discern alertness and energy in you.’8 And indeed Ash-Shabi had been right. There was something about Abu Hanifa, an indefinable presence, a greatness even. Or perhaps, more prosaically, it had just been the older scholar’s way of making small talk with a passerby. Whatever the case, Abu Hanifa decided not to go to market that day, and instead sat with Ash-Shabi’s students.
It was immediately clear that Abu Hanifa had a preternatural scholastic aptitude. Before long, he had immersed himself in and mastered theology, literature, grammar and poetry. He systematically analysed and codified the application of Islamic law. His predisposition towards fairness in dealings with one’s fellow man inspired him to develop a legislative framework for commercial and social interactions based on the life and actions of the Prophet. He and his students and followers, the Hanafites, would develop his ideas, enshrining the works of ancient Greek philosophers, themselves the subject of much research in Persia. The foundation stones of Islamic economics would be laid on a bedrock of a systematic development of Sharia.
To Abu Hanifa, God was supremely rational. Instead of shunning alternative philosophies and schools of thought, and providing they did not conflict with fundamental principles encapsulated in the Quran and Sunnah, Abu Hanifa embraced them. Here on the banks of the Euphrates River, the town of Kufa was part of the cradle of Western civilization, a nodal hub of knowledge and an ideal birthplace for a man who was liberally inclined and inquisitive, as he himself observed.
‘I was situated in a lode of knowledge and jurisprudence, so I learned the jurisprudence of Umar, of Ali, of Abdulla ibn Masud, and of Ibn Abbas,’ he said, referring to the scholarly companions of the Prophet who had preceded him. ‘The most knowledgeable of people is the one with the most knowledge of people’s differences.’9 He proposed that Muslims should seek to determine from the Quran and Sunnah the purpose underpinning God’s laws. Logic and analogy were the key tools to codifying the law and soon the Hanafites would clarify the Quran’s prohibitions on commercial speculation and unjust transactions. They critically analysed each and every recorded action of the Prophet to determine its authenticity and authority. Where they found no direct Quranic or prophetic guidance on a matter, or where the actions of the Prophet’s close companions unearthed little new information, they exercised their minds to derive additional rules. First, by logical deduction, then by analogous deduction, then finally by relying on the social customs of the time. These were the roots of jurisprudence and the evolution of the Sharia itself.
Abu Hanifa’s work – and those of others like him – on the fundamentals of jurisprudence, followed by the codifying of commercial law, would eventually lead to the development of a widespread money economy, with gold and silver giving way to paper notes. At first, traders relied on prophetic injunctions against usury or uncertainty in transactions or manifest examples of immoral behaviour (avoiding selling goods suspected as being stolen, for example). As scholars like Abu Hanifa built upon prophetic traditions, cheques and letters of credit followed naturally, and before long a market-oriented capitalistic economy – underpinned by an ethical code – was thriving in the Islamic world. Arab and Persian merchants forged trade links to India and the Far East, becoming indispensable in the chain of trade between East and West. An Arab merchant from Baghdad might travel to Cordoba in Spain, taking with him a letter of credit – a suftaja – to be encashed on arrival by an agent, part of a network of money transfer that came to be known as hawala. Indeed the hawala would go on to influence the development of the agency concept in common and civil laws throughout Europe. The sakk – the forerunner of our modern-day cheque, and the singular of the word sukuk – allowed the early banker to become indispensable to every trader as a guarantor of paper money at markets in cities throughout the Islamic world.
Sugar cane, cotton, rice and silk were not the only commodities that the merchants brought with them. Like early management consultants, they disseminated knowledge along their trade routes, advancing fundamental human development on the way: the production of silk and paper from China, the use of the compass and numerals from India, the development of financial tools to oil the wheels of trade from the Arabian peninsula. An agricultural revolution was taking place, with Muslim traders introducing crops and plants along their trade route and spreading advanced farming and industrial techniques, such as water turbines and gears in mills. In boosting agricultural yields through the mechanization of production, Muslim traders – and the later Crusaders who carried ideas back home with them – laid the foundations for Europe’s Industrial Revolution some centuries later.
These Muslim traders would share the profits of their ventures with their sponsors in a pre-defined manner that would come to be the hallmark of Islamic economic activity, an investment partnership that modern Islamic banks now refer to as musharaka and mudaraba. An exchange economy became the framework for Islamic merchant capitalism.
The main cities of the Islamic world became the centres of Islamic capitalism. Islamic commerce shifted from Baghdad to Cairo, strengthening trade links into the Mediterranean. Whilst Europeans were venturing little further south and east than the islands of Greece, Arab and Persian traders were ranging across continents. By the tenth and eleventh centuries, ultra high net worth merchant families – the Rockefellers and Rothschilds of their day – began to dominate commercial activities between the two cultures. In the major cities along the East/West trade route, the funduq was born: a trading exchange, like a large shopping mall, often the centre of trading activity for a leading merchant family in the region. The funduqs developed into commodity exchanges and warehouses, and the great wealth accumulated by the families who controlled these exchanges enabled them to finance state projects and operate an early form of banking institution, taking in deposits and advancing credit to customers.
Within a few centuries the Crusaders would encounter Arabian merchants and carry their new-fangled ideas – such as the trust law encapsulated in the Waqf and the agency concept intrinsic to the hawala – back to the Mediterranean. Not only would the techniques of commerce and finance filter through to medieval Europe, but also an entrepreneurial spirit of enterprise that had, to date, been less widespread in Europe. Ironically, given the negative connotation that ‘capitalism’ has today – with all its implications of greed and selfishness – it was the Islamic world that institutionalized capitalism and brought it to the West in the form that we might be familiar with today. Somewhere along the way, ‘Islamic’ capitalism – of the type that Abu Hanifa legislated in favour of, and that afforded protection to the weak and the needy – became diluted.
At a time when Islamic ideas of commerce were starting to filter through to Europe, the Islamic world began to lose many of the essential characteristics of ‘Islamic’ finance. Inheriting the mantle of defenders of the faith from their Arabian brethren, the Ottomans rose to become the pre-eminent Muslim power by the end of the fifteenth century, and their approach to financial and monetary institutions was pragmatic and flexible. Dispensing with customs, traditions and religious guidance became a characteristic of the early Ottoman Empire, aided no doubt by the heterogeneity of a region populated by both Christians and Muslims speaking in Greek and Turkish.10
Although earlier banking systems such as the hawala method of money transfer were still widely in use, and the 100,000 pilgrims travelling annually to Makkah continued to make use of the suftaja bill of exchange in order to draw money at their journey’s end, court records of Anatolian cities show that interest-based lending was a frequent and apparently tolerated practice. Most disputes were in relation to small-scale transactions from person to person, with interest rates ranging from 10 to 20 per cent.11 There appeared to be no attempt to conceal the interest-bearing nature of the transaction, and indeed the local pious endowments became important providers of credit in major urban centres. Though some clerics denounced the practice of charging interest as incompatible with Sharia, the majority adopted the pragmatic view that disallowing the practice might harm the community.
Ottoman merchants continued to make use of the business partnership models developed by the earlier classical scholars, models such as the mudaraba, or investment partnership, which typically financed long-distance trading ventures without resorting to a fixed interest charge. These risk-and-reward sharing models had certainly not been killed off by the reversion to conventional banking practices, nor was the need lessened for earlier innovations such as the letter of credit. However, little development of an Islamic system of economics and finance took place during the 600 years of Ottoman power. As European moneylenders gained in prominence, eventually Ottoman practices fell into line, and it would not be until the middle of the twentieth century that Islamic finance would reassert its identity.
And so today, several decades into the modern post-colonial era and shortly after the Mit Ghamr experiment, we meet one of the men who has taken up the legacy of the classical scholars such as Abu Hanifa. Mufti Taqi Usmani – our incongruous speaker among the pinstriped suits at Davos in 2010 – is no stranger to controversy. A retired judge on the Sharia Appellate Bench of the Supreme Court of Pakistan, he has established himself as one of the world’s leading contemporary scholars of Islamic jurisprudence, and is a recognized authority on Islamic finance, economics and the books of Hadith.
Wearing a long straggly beard often traditionally dyed with henna, his moustache trimmed in accordance with prophetic tradition, and uncorrected dentures hinting at his humble origins, he speaks with a heavy subcontinental accent. At first, the urbane Western sophisticate will struggle to identify with and be captivated by the words of this outwardly unremarkable and slightly built man. Born in the city of Deoband in northern India in 1943, he studied at the Grand Mufti of Deoband school in Pakistan, and went on to further study at Darul Uloom in Karachi. Armed with degrees in law and Arabic literature, he taught Hadith whilst authoring books in Arabic, English and Urdu on subjects ranging from Hadith and jurisprudence to comparative religion and Islamic finance.
He was a key driver in the creation of Pakistan’s Meezan Bank and now chairs the Sharia board of the quasi-regulatory body, the Bahrain-based Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI). AAOIFI’s stated aim is to prepare accounting, auditing, governance, ethics and Sharia standards for Islamic financial institutions and the industry. Although an independent international organization supported by 200 institutional members, it is widely viewed as an authoritative body whose pronouncements on the acceptability or otherwise of contractual structures in relation to Islamic financial instruments are to be viewed in the same vein as regulatory edicts.
In November 2007, Mufti Taqi Usmani courted controversy through his remarks made to a Reuters journalist at the annual AAOIFI conference in Bahrain, an event attracting the heavyweights of the industry, including the eighteen Sharia scholars who sit on its Sharia board, and who provide guidance to the Islamic finance industry on matters of Sharia compliance. At that conference, I completed my own presentation and stepped off the stage to make my way to the heaving buffet tables with my fellow Samadiite bankers and lawyers. Mufti Taqi had been part of the same panel, politely observing the slick executives alongside him making thinly disguised pitches for their products. Their brash presentations were filled with structure diagrams so complex that they looked like electrical wiring circuits, peppered with the impressive argot of their industry. By contrast, the modest scholar had no PowerPoint slides and quietly reiterated a mantra familiar to those who knew him: if the Islamic finance industry was about bringing the spirit of the Sharia to our daily business interactions, then the industry needed to focus on profit-and-loss-sharing principles that contrasted with the rapacious debt culture of the conventional banking industry. He was approached by a young Reuters journalist looking for a scoop. There was nothing unusual in this post-conference interview ritual, but on this occasion perhaps the eminent scholar was caught a little off guard. The journalist was intrigued to learn more about the contractual structure of sukuk, the tradeable debt instruments issued by borrowers looking to raise Islamic funds from investors. These Islamic bonds evidently seemed to be guaranteeing repayment of the bond, somewhat at odds with the Islamic concept of sharing in risk when funding a business venture. The journalist wanted to know where the risk was if the borrower undertakes to repay the bond in full, and how this distinguished the sukuk from a conventional interest-bearing bond.
‘For current sukuk,’ responded Mufti Taqi, ‘risk is not shared and reward is not shared according to the actual venture proceeds. About 85 per cent of sukuk are structured this way.’ The man from Reuters thought for a moment, pondering Mufti Taqi’s words, which suggested that sukuk have the same structure and risk as conventional bonds and that most sukuk in the markets today are not in compliance with Sharia.
The comments were published the next day under the headline ‘Most sukuk not Islamic’12 and a cold sweat broke out across the Islamic finance industry. Investors began to ask themselves whether the Islamic financial instruments that they held in their portfolios were truly Islamic. Suddenly the proprietary trading desks of Islamic institutions – those who manage an institution’s own investments – as well as Sharia-compliant fund managers and high net worth individuals were faced with the very real prospect of being forced to dump their assets. If the investment parameters of a given fund stipulated Sharia compliance of its holdings, then it would have no option but to divest. Had the vast majority of buyers of sukuk been only conventional institutions, this would be no issue, but given the substantial investment by Sharia-compliant investors and institutions, the nightmare scenario had come to pass.
Fortunately, the anticipated crash in sukuk valuations never took place, at least not as a result of this pronouncement. For two or three months, investors held on, seeking clarity from their own Sharia boards, and clarity came in the form of a directive drafted by the Mufti himself, and issued by AAOIFI in February 2008. Crisis averted, the industry mopped its brow and went back to work.
Rather than taking at face value the notion that the world’s leading Islamic finance scholar believes the Islamic finance industry is substantially a fake, it is necessary to consider this in more detail. I have already hinted that social awareness is the underpinning of Islamic finance, that human beings should do good to one another, that whatever contractual and social relationships they have with each other should be just and equitable, and to their long-term mutual benefit. But there is something almost as fundamental to consider, a concept that endows Sharia-compliant finance with its sturdy endoskeleton. It is the question of money: is money a commodity to be traded?
According to the Sharia, money is merely a means to achieve an objective and not the objective itself. In itself, money has no intrinsic utility or usufruct. It cannot be processed to build a house or be woven into clothes. It cannot be eaten and it does not provide heat or shelter. It cannot be created out of itself. It cannot be created from thin air. It is merely a store of value.
At a stroke, we immediately come into conflict with the modern notion of money as a commodity. Today, central banks are printing money in a process that economists term quantitative easing. They create money. Financial institutions enter into phantasmagoric trades with one another, with corporations and with individuals, to lend money and receive more in return; to enter into ‘contracts for differences’, or swaps, where one party swaps one cash flow for another (for example, in interest rate swaps or forward currency transactions); to sell highly complex intangible instruments whose values are derived from other assets and to which they may not themselves have legal title; to take speculative positions on the outcome of events over which the buyer of the instrument may not have an intrinsic interest.
In all of these transactions, value has apparently been created even where a real economy transaction has not taken place. Recall the Mit Ghamr experiment: an institution whose primary role was to enter into trades in the real economy, to invest and develop businesses so that investors’ money was put to work in a tangible way. And when those investments came to fruition, investors would share in the spoils alongside the manager of their money, the ‘bank’. This was an institution where money was a store of value, a medium of exchange, a means to achieve an objective, and not a commodity to be traded between borrower and lender, the objective itself.
If individuals cannot earn money from money by depositing it into an interest-bearing bank account, they will be forced to put it to work. Hoarding money would defeat its purpose.
So now we come to what conventional observers understand to be the definition of Sharia-compliant banking: banking without interest. Interest on money becomes an injustice because money is required to exist for another purpose, a purpose that the modern financial system appears to have bypassed, injecting into it anabolic steroids and juicing it up on 12,000 volts.
The celebrated twelfth-century Islamic theologian and thinker Abu Hamid Muhammad ibn Muhammad Ghazali, more commonly known as Ghazali, analysed the nature of money, stating that 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’. He concluded that ‘whoever effects the transactions of money is, in fact, discarding the blessings of Allah, and is committing injustice, because money is created for some other things, not for itself. So the one who has started trading in money itself has made it an objective, contrary to the original wisdom behind its creation, because it is an injustice to use money other than what it was created for.’13
Ghazali had not reached this view in isolation. Indeed Aristotle had argued over a millennium earlier that gold and silver had no intrinsic value, an argument that Ghazali would uphold and build upon many centuries later.
If we are prohibited from trading money, then we cannot create money out of money, and we cannot lend at interest. And this religious injunction was not unique to Islam alone. Some anthropologists argue that before money, there was debt.14 Five thousand years ago, elaborate systems arose to enable early agrarian societies to buy and sell goods and services on credit, since coinage had not been invented. So a farmer buying clothes from a merchant might pay with an IOU. If the merchant then decides he needs to fix the door on his house, he gives the IOU to a carpenter. The carpenter accepts, on the basis that the farmer’s standing in the community is good and he’ll make good his debts. Eventually, after a series of transactions within the community, the farmer buys goods or services from a party who holds his IOU and pays it back with some crop from his harvest. The IOU doesn’t even need to come full circle. It can stay in circulation for ever, acting in the same manner as modern money. Money originates as debt.
When the community becomes large and powerful it gains the ability, as anthropologist David Graeber argues, to conquer and enslave neighbouring peoples. Now human beings are reduced to mere inventory, material commodities to be traded.
Early civilizations held surplus commodities in temples – essentially large commercial and industrial concerns – and these commodities were lent out to merchants to transport for trade. Auditing the profits and losses made by merchants would have been impossible for the temples, so instead of taking a stake in the merchants’ trading activities, the temples would have demanded a fixed rate of return. In other words, interest. In turn, merchants would also lend to others at interest. As these loan contracts became more prevalent, they became more elaborate: now merchants demanded collateral against the debt. Typically collateral started with grain, livestock and household goods, but if the debtor was still unable to pay, and the collateral was insufficient to redeem the outstanding principal, then there would be one option remaining: offer up oneself or one’s children or wife as a debt peon15 – as bonded labour, until the debt was repaid. Owning a human being became debt’s most egregious manifestation. Slaves were no longer just war booty. Now they could be anyone. The debt could be passed from generation to generation and violent coercion became the primary enforcement mechanism. In years of bad harvests in Mesopotamia, the poor became increasingly indebted to rich neighbours and would start losing title to their fields, becoming at first tenants, then sending their children to become bonded servants to creditors’ households, then finally enslaved and sold abroad.
In several early civilizations, those slaves who escaped their bonds would join nomadic pastoralist tribes. Once these tribes had grown large and powerful enough, they might return to overrun the cities and conquer their existing rulers, and the cycle would repeat itself: the wealthy lend to the poor, the poor are enslaved, some poor break free, become powerful and enslave their former masters. It is not hard to see why, for example, Nehemiah, the governor of Judaea in the fifth century BC, issued a Babylonian-style clean slate, the Law of Jubilee, ruling that all debts would be automatically cancelled in the Sabbath year (in other words, every seventh year), and debt peons would be returned to their families.16 Nehemiah’s Mesopotamian ancestors had done just the same to preserve economic order and avoid being overrun by the desperate poor.
In fact, this practice still exists in some form today: in January 2013, a parliamentary committee in Kuwait took a step closer to avoiding an Arab Spring-style unrest by proposing to pay off interest on loans incurred by citizens over a six-year period. Two years earlier, the ruler had granted 1,000 dinars (around US$3,500) to each citizen and free food rations for thirteen months.
Throughout the ages, intellectual movements questioned the morality of materialism, and the necessity of violence and conquest to uphold the economic system. Religion came to play an important role in galvanizing opinion against materialism, debt and usury. Jesus visited Herod’s Temple in Jerusalem at the time of the Passover, when hundreds of thousands of pilgrims would have been in the city. He would thus have had quite a crowd witness him furiously expelling money changers from the Temple: ‘And making a whip of cords, he drove them all out of the Temple, with the sheep and oxen. And he poured out the coins of the money changers and overturned their tables, and the seats of them that sold doves. And he told those that sold the pigeons, “Take these things away, and do not make my Father’s house a house of trade.”’17 ‘My house shall be called a house of prayer, but you make it a den of robbers.’18
Throughout the Bible, numerous injunctions can be found against usury, and early Christian universities debated as to why it was sinful: it was theft of material possessions, or a theft of time, or an embodiment of the sin of Sloth. Yet in time the Church found itself looking the other way as moneylenders found they might exploit semantic differences between ‘interest’ and ‘usury’, the latter being considered a severe and oppressive form of mere interest.19 Islamic law, meanwhile, remained unwavering on the issue of usury, treating money as a means to an end, not the end itself.
Medieval Christian financiers had a neat solution to the problem of usury. In a passionate treatise advocating the reform of the modern economic system, The Problem With Interest, the former derivatives dealer turned Islamic finance consultant, Tarek El Diwany, describes an elaborate medieval ruse known as contractum trinius. This legal device allowed moneylenders to circumvent the Church’s ban on usury and some analogies may be drawn between this and some practices evident in modern Islamic finance: ‘The investor would simultaneously enter into three contracts with an entrepreneur: to invest money as a sleeping partner; to insure himself against any loss; and to sell any profits over and above a given level back to the entrepreneur in return for a fixed amount of money per year.’20
In isolation, each of the three contracts remained compliant with the Church’s injunction against usury, though in combination a loan with interest had quite evidently been created. Contractum trinius allowed financiers to meet the letter of the law but not the spirit. In time, even this combination of smoke and mirrors would disappear, as the substance of the transaction became acceptable and the form was dispensed with in favour of simple bilateral agreements. Centuries later, those moneylenders would find even more abstract methods to conjure trade from a unit of value.
El Diwany goes on to note that the acceptability of interest-based finance throughout the world makes the objections of today’s Muslims appear conspicuously old-fashioned:
‘Nowadays, injunctions against usury from religious quarters are frequently seen as little more than an embarrassing appendage of backwardness, motivated perhaps by simple-minded distaste for the money-lenders of old. Often, the religious arguments seem unscientific and weak when placed before the articulate economists of the pro-interest camp.’21
And indeed within modern investment banks, Sharia-compliant financing techniques are wearily viewed as a necessary additional service for a demographic of unsophisticated and anachronistic clients. The cadre of young and ambitious structurers and sales staff touting these products may have little empathy with the philosophical framework within which their clients live. To many of these bankers, Islamic finance is merely the provision of modern sophisticated instruments, whether interest bearing or not, within an alternative legal jurisdiction. The key is to find the appropriate legal devices to circumvent the restrictions under which Islamic finance may operate. It is a common complaint of the lay observer that much of Islamic finance has merely mimicked its conventional counterpart, and added little in the way of ethical or moral guidance, or a participation in the real economy.
As Ghazali had presciently noted about the financier, ‘it becomes easy for him to earn more money on the basis of interest without bothering himself to take pains in real economic activities. This leads to hampering the real interests of humanity, because the interests of humanity cannot be safeguarded without real trade skills, industry and construction.’22
Was Ghazali predicting the rise of the modern financial services industry? Had he, eight centuries ago, foreseen the rise of the modern banker, predisposed to seeking ‘value creation’ in increasingly arcane manipulations of global cash flows? The same generation of bankers who have presided over the creation of a derivatives market worth more than ten times the world’s total gross domestic product? Or had he perhaps failed to conceptualize a future in which the world has been miniaturized, where commodities and cash could be beamed from continent to continent in the click of a button, and where corporations and governments would look to hedge their exposures to macroeconomic risks on a global scale through complex instruments that we call derivatives?
Let us briefly consider what Ghazali might have meant by real trade. Typically, a trade involves the transfer of ownership from one party to another for a consideration. It is generally understood that the seller has ownership of the subject of the trade, and indeed this is a precondition of a trade in Islamic jurisprudence: that the seller must not sell what he does not own.23 In addition, the seller must also have the goods in his possession,24 which is closely related to the injunction that the seller may not earn profit from a commodity the risk of which he does not assume.25
These are the rules of engagement for trade in the real economy – they are simple rules and designed to ensure apportionment of risk in appropriate measures, and transparency in risk assessment. So far, so good. What does this mean for modern commercial and financial transactions? So much of modern commerce involves profiting from movements in markets in which one does not have tangible involvement. ‘Short’ selling, that is selling what one does not own, is a common trading technique often used by hedge funds – typically funds that invest in a manner that generates an ‘absolute return’, in other words a return that is uncorrelated with the wider market, and able to extract profit perhaps even when markets may generally be in decline. They are so called because they tend to hedge their positions to movements in markets, for example by ‘going long’ (or buying) certain stocks, whilst simultaneously ‘going short’ (or selling) others. This natural balancing act means that they may find positive returns in markets whether those markets are bullish or bearish.
Modern economists and observers of financial markets tend to have a strong fundamental belief that the ability to short a market ensures free and efficient markets. In contrast, scholars such as Mufti Taqi Usmani believe that short selling is a characteristic of speculative markets, and that actual delivery of sold goods is often not a characteristic. To Mufti Taqi, the end result of a series of such ghost transactions is the payment or receipt of a difference in prices, such a system resembling gambling rather than commercial business.
The requirement for certainty and transparency in any commercial transaction leads us to another characteristic of Sharia-compliant transactions: that one may not sell a debt or cash flow. Without full control on the goods being sold, the seller is entering into a trade that creates uncertainty for both parties. If a seller owns debts that are payable to him from his obligors, it is not a certainty that those debts will in fact be repaid. By selling such debts to another party, the risk of default is also being transferred to that buyer. The buyer will lose a portion of the money paid to the original seller should one or more obligors fail to repay their obligations. In Islamic jurisprudence this uncertainty is considered a fundamentally unjust transaction.
But what if both parties have mutually agreed the terms of that sale of debt? What does it matter? After all, both have accepted the uncertainty inherent in the transaction and take their own (presumably calculated) risks. Not so, says the branch of Islamic jurisprudence concerned with commercial transactions. Mutual consent does not necessarily justify a transaction. The sale of narcotics may be by mutual consent but that does not make it permissible. Bribery may be by mutual consent, but does not benefit the interests of society at large. If a transaction either fails to meet the interests of both parties, or has harmful social implications, that is, it is unethical in the secular vernacular, it may not be consummated. And in Islamic law, interest is considered harmful to society, whether we choose to label it interest or usury to denote an ‘excessive’ rate of interest, as the Church eventually did.26
To Ghazali and his present-day successors, capital must be deployed in other ways to generate a permissible profit. According to the scholars, the equitable way of utilizing the savings of depositors is to deliver to them a proportionate share in the profits – and losses – in investments undertaken on their behalf. Can today’s depositors, accustomed as they are to unexciting and secure returns on their deposits, be persuaded to share their profits with the bank, or indeed to contemplate the possibility of losses on their principal? Are businesses seeking to raise capital from financial institutions prepared to relinquish some of their profits to the bank? Or perhaps will only the more risky ventures find this profit-and-loss-sharing model an attractive proposition on the basis that the bank is prepared to share the downside with them as well?
In the context of the modern banking system, depositors might need to make a giant leap of faith in order to consider placing their principal in an institution whose business model seems primarily equity based rather than debt based. But that is just the point. That an economic system should be based on the concept of risk sharing, of equity. And with sufficient diversification and tranching of deposits so that depositors can specify the level of risk they are prepared to accept, according to explicit investment parameters, perhaps the Islamic banking model need not be at an economic disadvantage to the conventional model, provided that a critical mass of depositors and business enterprises participate. This is exactly what the Egyptian, Pakistani and Malaysian experiments of the last few decades have tried to achieve with varying degrees of success. Their challenge was to deliver lasting success within the framework of the fractional reserve banking system.
We’re nearing the end of this examination of the nature of money, and yet I’ve only just mentioned the elephant in the room. If we fail to address the suitability of fractional reserve banking as an appropriate modern economic system, then we cannot have a discussion on Islamic banking and economics. The world economy functions according to this model.
Briefly, it is the practice of all modern commercial banks, who keep a fraction of a bank’s deposits as reserves for withdrawal by depositors. These reserves are cash and other highly liquid assets. Money deposited by depositors at the bank is partially retained as reserves, with the majority being loaned out to borrowers or spent on securities. Any money loaned out or spent is deposited with other banks, thus increasing the reserves of those other banks. In turn, they are able to keep a fraction of the new deposit, and lend or spend the remainder. New deposits are continually created as cash travels through the system from bank to bank. The total amount of money available in an economy at any given point in time, known as the money supply (calculated as the currency in circulation plus demand deposits), is expanded by this practice to a large multiple of the cash reserves held by banks.
We can trace the root of this modern commercial banking practice to sixteenth-century Europe. Four centuries ago, state money was denominated in gold, and the goldsmith was the banker, his vault being the bank account. Savers would deposit their gold coins and other precious metals with the goldsmith, in return receiving a ‘running cash note’ as it was then known, what we would call a certificate of deposit, or a bearer receipt. Anyone bearing this receipt in future and presenting it to the goldsmith would claim back the sum deposited, hence why we still see ‘I promise to pay the bearer on demand the sum of five pounds’ on a British five-pound note, meaning that the Bank of England’s cashier would hand over a 5 lb weight of gold coins on demand (in the days when the notes from the Bank of England still had a link with gold).
In time, depositors came to realize that the receipts from goldsmith bankers could be accepted elsewhere as payment for goods and services. Indeed, why bother returning to the goldsmith to redeem one’s running cash note, when one could simply present it to a merchant in exchange for goods? The merchant could simply redeem the note at the goldsmith’s or, better still, reuse the note to purchase goods and services for himself. Bank money had been born, and the bearer receipts circulated in the economy.
At this point, the goldsmith realizes that he has a hefty cache of gold locked up in his vaults, sitting idle, whilst the bearer notes they are linked to are gainfully employed and changing hands. It would seem perfectly good business sense for the goldsmith to lend gold to reliable and prudent borrowers, ensuring of course that he did not lend too much in case other depositors demanded their gold back. The fraction of gold held for depositor redemptions is the reserve ratio, and would have been a suitably small enough number (since only a limited number of depositors would redeem at any given time) now that the goldsmith is running a bank in the modern sense of the word, rather than a storage facility for precious metals. The goldsmith has become a banker.
Clearly, the smaller the reserve ratio, the greater the potential for profits from loans, but the greater the risk of being forced to close the bank doors in the event of a ‘run on the bank’ (depositors simultaneously demanding their deposits back). And why indeed should the bankers lend physical gold to borrowers? After all, if the wider economy found bearer notes to be an acceptable currency, then why not simply lend out their own receipts instead of gold coins? In the event of heavy withdrawals, the bank would simply enter into arrangements with other banks to borrow additional gold.
Bankers made their profits from the interest on lending, on money that they had themselves created. However, the interest had to be repaid with money that had not yet been created. If the total money supply was £10, of which £1 was the total amount of money created by the state, and the other £9 was lent by banks, and the interest outstanding on the total amount of bank loans was a further £2, where will this additional £2 come from? It needs to be created, and there are only two methods to do so: either the state increases the supply of money or the banks lend even more. If neither takes place, borrowers would be forced to default.
And that is fractional reserve banking in a nutshell. A business idea without compare in any industry – a licence to print money – but with significant implications for society.
The world practises it; it is supported by almost all of the world’s economists and no practical alternatives are actively considered by any government in the developed world. Capitalist democracies are generally considered the most free and successful societies in the world, and their economic model is therefore held up as an ideal. Those who criticized the model were once viewed as lunatics on the fringe of economics, dismissed as long-haired ranting anti-globalization protestors. But in the light of recent economic turmoil, fractional reserve banking has increasingly become a topic for discussion among established economists and scholars. Tarek El Diwany echoes the views of a small group of Western academics and politicians, Muslim thinkers and scholars, and is convinced that fractional reserve banking is the main economic issue of our time. Although those like him might be dismissed by the establishment as misguided and raging lone voices, he believes that the ‘mainstream’ in Islamic banking and finance has ‘studiously ignored [it] for over three decades with fundamental implications for the structure and product range of the industry’.27
Are the young bankers and lawyers in Masjid Al-Samad part of the system, ignoring the implications of the methods they use to replicate conventional financial instruments with Sharia-compliant contracts, operating as they do within the mainstream banking system? Are they going through the motions to pay the rent and the kids’ school fees? Or are they actively working to create a new economic paradigm, one that they believe could and should change the world for the better? Is their active involvement in the mainstream a work in progress, a means to an end, the only way for Islamic banking and finance to survive, break through and succeed?
If fractional reserve banking was an invention born out of the cunning of the goldsmith banker, and his desire to grow and accumulate wealth, then perhaps the concept of growth itself – that indicator of success in the capitalist system – is at fault. The modern world’s emphasis on corporate and GDP growth rates has been known to come at the expense of both the tangible and the intangible: the environment, societal values, marriage, family life, health, safety, mortality. In an Islamic framework, these factors are a fundamental consideration in every business transaction that one undertakes. One is not only to refrain from what is wrong, but to enjoin what is right and good.
I leave you with the story of the American tourist and the Mexican fisherman. Although originally a short story by the German writer Heinrich Böll,28 this anecdote often gets retold with different protagonists in different settings. Here’s the version that I know:
An American businessman stood at the pier of a picturesque coastal Mexican village when a small boat docked. The lone fisherman stepped out with his catch for the day, several large yellowfin tuna. The American complimented the Mexican fisherman on the quality of his fish.
‘How long did it take you to catch them?’ asked the American tourist.
‘Only a short while’, replied the fisherman.
‘Why not stay out and catch more?’ asked the American.
‘I have enough to support my family’s needs’, said the fisherman.
‘But what will you do with the rest of your time?’
‘I sleep late, fish a little, play with my children, take a siesta with my wife. In the evening, I stroll into the village, sip wine and sing songs with my friends.’
The American scoffed. ‘I have a Harvard MBA and work as a management consultant for McKinsey. I can help you.’
‘How, señor?’ said the fisherman, taken aback.
‘Spend more time fishing. With the proceeds, you can buy a bigger boat, and with the catch from the bigger boat, you could buy several boats. Eventually you would have a fleet. Instead of selling your catch to a middleman, you would have the power to sell directly to the customer, eventually opening your own canning factory. You would control the product, the processing and the distribution. You could leave this small coastal village, and move to Mexico City. After that, Los Angeles and then eventually New York where you would run your expanding enterprise.’
‘How long would that take?’ asked the fisherman.
‘Oh, fifteen, maybe twenty years.’
‘And after that?’
‘Ah, now this is where it gets really interesting’, replied the management consultant with the MBA from Harvard. ‘When the time is right, you announce an initial public offering, and sell the company’s shares to the public. You would be rich, make millions.’
‘Millions, señor? Then what?’
‘You retire! You can move to a beautiful coastal village where you would sleep late, catch a little fish, play with your children, take a siesta, then in the evening you could stroll into the village and enjoy drinks and songs with your friends.’