Call it the consequences of irresponsible American invasions, call it the irrational exuberance of short sellers, call it the catastrophe of subprime lending, call it the mismanagement of leveraged products, blame it as you may, American markets are facing unprecedented meltdown and doomsayers see little promise in the federal bailout package. Ironically,Wall Street has noticed that Shariah-compliant investments–which avoid speculative risk and debt-ridden greed–have fared much better in these troubled markets. In the past few years, Shariah-compliant investments in Western markets have grown to more than half a trillion dollars.
Islamic financing is attracting huge academic curiosity. Many experts participating in the 8th Harvard University Forum on Islamic Finance held this past April wondered if Islamic financing could have prevented the meltdown that American markets are facing primarily due to mortgage debt and mortgage-backed securities—now known as "toxic investments." This legal commentary highlights the two fundamental principles of Islamic financing that I presented at the Forum.
High Risk Investments
The Quran prohibits al-Maysir or speculative risk, warning the faithful to avoid games of chance in which the probability of loss in is much higher than the probability of gain (2:219). Shariah-compliant investments, therefore, avoid speculative risk, including interest rate options, naked equity options, futures, derivative and numerous leveraged products purportedly designed to hedge investments. Many of these financial products attract speculators in hopes of making quick money. When trusted fund managers, under institutional pressures to show profit, resort to speculative risk, hedge investments turn into suicidal strategies for financial destruction.
In pursuit of greed and thrill, straightforward investments in companies engaged in socially useful activity has become unattractive, even boring, because of their presumably lower rate of return—frequently a self-fulfilling prophecy. Billions of dollars are dumped into companies that promise huge profits but produce nothing. While Islam would allow risking investments in socially beneficial research projects, it prohibits investments in companies peddling alcohol, tobacco, pornography, debt, and weapons—products that undermine our health and safety.
Some investment strategies rampant in the markets are not only morally corrupt but socially harmful. Short sellers, for example, make money when companies collapse and close. Turning the conventional logic of investment on its head, short sellers wish companies to crash rather than prosper for they make most money when companies go bankrupt, workers and employees lose jobs, and pension funds evaporate through declining company stock. Such cynical investments, touted as useful forces that balance the market, are contrary to Islamic law.
Interest-Bearing Debt
In addition to prohibiting high risk investments, the Quran also prohibits no risk investments. The prohibition against riba, interest on loans, is strictly forbidden. Islam does not prohibit passive investments. Nor does it prohibit giving interest-free loans. Debt is not contrary to Islamic law. Charging interest is. Although some experts argue that usury, and not interest, is prohibited under Islamic law. Most Muslim scholars agree, however, that interest on loans is contrary to the Shariah.
Refuting arguments that money has time value or that interest is analogous to profit, the Quran offers a categorical principle that “trade is permitted but interest is not.” (2:275). The prohibition against interest was revealed not only to save the poor from unscrupulous lenders but also to deter investors who demand a set return on their investments and decline to take the risk of engaging in useful trade.
Contrary to Islamic principles, lending in general and subprime lending in particular was predestined to harm American financial markets for two distinct reasons. First, debt braced with high interest was being extended to persons who simply could not afford to pay back loans. This was usury. Second, the real estate mortgage was no longer a prudent investment decision, since numerous investors were trading in real estate with inflated prices. Investment bankers and other geniuses on Wall Street were securitizing mortgage debts, turning them into interest-bearing securities. These fancy securities began to fail when their underlying assets were foreclosed or deflated. The debt turned deadly and its holders bankrupt.
Shared Destruction
Between the prohibited limits of maysir (speculative risk) and riba (no risk), however, Islamic Law permits creativity in financial markets where investors mobilize surplus monies for the production and distribution of halal (Kosher) goods and services. These permissible markets are neither risk-free nor prone to irresponsible risk. Though innovative and authentic, the markets are infused with the values of fairness, transparency, and reasonable profits. They are free of predatory practices that corrupt transactions with greed and inflict hardship on the poor, the elderly, and the novice.
The federal bailout package that the Bush Administration is selling as a quick cure of all problems will only aggravate the underlying cancer of interest-bearing debt. It is unlikely that the infusion of more money will reform institutions and companies built on layers of interest-bearing debt. When the best and the brightest are engrossed in finding ways to make money with money, and no more, the system may look creative and intelligent but it is geared toward shared destruction.
Ali Khan is Professor of Law at Washburn University in Topeka, Kansas.
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Islamic Banks Unaffected by Global Financial Crisis
Oct 2 2008
http://gifc.blogspot.com/2008/10/islamic-banks-unaffected-by-global.html
By Mohammed Al-Hamzani
Riyadh, Asharq Al-Awsat- A number of experts and officials of Islamic banks and financial institutions have confirmed that Islamic banks have not been affected by the global financial crisis, and that any effects would be limited due to the nature of Islamic banking.
Experts told Asharq Al-Awsat that Islamic banks are untouched by the current crisis due to the nature of Islamic banking especially that it does not deal in debt trading and distances itself from market speculation that takes place in European and American banks.
CEO of the Bahraini-based Albaraka Banking Group Adnan Ahmed Yousif stated that Islamic banks do not rely on bonds or stocks, and are not involved in the buying and selling of debt unlike most conventional European and US banks. He noted that Islamic banking is distinguished by the fact that it is prohibited from buying debts under Islamic Sharia law; therefore, Islamic banks are safe from the effects of the global financial crisis.
Adnan Yousif, who also chairs the Union of Arab Banks, reiterated that Islamic banks are largely sheltered from this crisis; however, it is inevitable that they will be affected to a certain degree as they are part of the wider global financial system and consequently will be affected by all global financial dealings, even if only in an indirect manner.
Yousif predicted that this global crisis will continue for two years or more. He argued that Islamic banks have become a safe haven for secured liquidity and are in a good position. The success of Islamic banking will lead to serious consideration of Islamic economics, which continues to realize numerous achievements, as a viable alternative to the current global economic system which continues to be hit by these crises.
Adnan Yousif further explained that the expected losses to be incurred by a number of banks in the Gulf region and Arab countries will not be declared, as major banks and investment funds, and sovereign wealth funds in particular, have investments in Europe and America.
General Manager and board member of the Arab Finance House Dr. Fouad Nadim Matraji explained that Islamic banks have not been affected by the mortgage crisis that afflicted the international financial markets and that they are largely immune against such crisis thanks to inherent factors within Islamic banking. The most important of these factors is the prohibition of debt trading, taking precautions against money laundering, as well as the official and professional restraints upon which banks are based such as caution against embarking upon projects that entail financial difficulties and risks.
Dr. Matraji explained that Islamic banks have several alternatives [to conventional banking products] such as Ijarah Bitamlik [a renting contract that ends in ownership], Murabaha etc. which demonstrate that Islamic banking is a sound and systematic alternative banking system that others should take as an example. Islamic finance is expected to increase on the international level and its number of customers is also expected to rise as they search for an alternative [banking system].
Matraji added that Islamic banking is distinguished by a commitment to uphold integrity and its distancing from risky projects. He pointed out that this crisis has caused significant global inflation in world banks because they buy debts and enlarge accounts without tangible transactions taking place or without brokers being aware of them, highlighting that Islamic banks do not engage in such ventures.
Matraji added that only the profits of Islamic banks could be affected by the international financial crisis, but not the capital, which is protected by Islamic banking unlike conventional banks.
Dr. Tawfiq Bin Abdul Aziz al Swailem, Chairman of the Gulf Bureau for Research and Economic Consultation, said that Islamic banking is a part of the global economy and can be affected either negatively or positively by it but Islamic banks are not major investors in conventional western banks so as to be affected by such crises.
Dr. al Swailem added that the impact [that the crisis has had] on some markets in the Gulf and the surrounding areas, is psychological and is caused by media coverage over the past few days.
Relying on over 25 years of experience in the Saudi financial sector, Dr. al Swailem expects Islamic banks to end the year successfully with the forthcoming announcements of their budgets because of the clarity of contracts and Islamic banking projects that are spread throughout the countries of the Islamic world.
The international financial crisis began over a year ago, and has intensified over the past few months. The International Monetary Fund warned that this credit crisis will result in losses of over one trillion dollars and that it may worsen especially that the 150-year-old US financial giant Lehman Brothers declared bankruptcy not to mention the sale of financial services firm Merrill Lynch to the Bank of America. These two news items heralded the worst of this financial crisis so far, and speculation continues as to whether this crisis has reached its peak or if worse is yet to come.