Including Islamic Finance in the Global Economy

Gairuzazmi M Ghani

Muslims can face marginalization in today’s global economy, particularly in the area of finance, where mainstream interest-based transactions conflict with principles of SharÊÑah (Islamic law). To address this problem, alternative institutions of Islamic banking and finance (IBF) have developed which offer instruments that are compliant with SharÊÑah. Yet how far has IBF, as practiced to date, provided greater inclusion and empowerment for Muslims?

The objective behind IBF is to avoid ribÉ’ (interest), to promote Islamic norms of economic behaviour, and ultimately to realise the maqÉsid (objectives) of the SharÊÑah in creating a just economic system. The profit and loss-sharing (PLS) instruments employed by IBF institutions, such as muÌārabah (trust/participation financing), are considered the ideal mode of Islamic finance. In contrast to conventional interest-based finance, PLS instruments counter unequal distributions of income and wealth, leading to an optimal allocation of resources. PLS instruments ensure justice in the relationships between the parties involved, as returns to the bank are dependent on the operational results of entrepreneurs.

The growth of IBF institutions has been phenomenal since their introduction in the 1960s. This expansion has been especially pronounced in the 1970s and since the late 1990s. The upsurge in the 1970s was driven by oil price rises, competition for regional power between Egypt and Saudi Arabia, and a general Islamic resurgence. The second upsurge has involved similar drivers, but with the added benefit of standardized regulation and management, as well as improved overall business decision-making.

The aftermath of 11 September 2001 reinforced the second surge in Islamic finance. The sense that Islam was under siege strengthened the quest for common ground in the operations of IBF institutions. Divergent interpretations of the SharÊÑah had previously divided the industry. After 2001 there were initiatives to enhance standardization, led by the Islamic Development Bank (IDB) in Jeddah, the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) in Manama, andthe Islamic Financial Services Board (IFSB) in Kuala Lumpur.

Today, there are more than 600 IBF institutions across the globe. IBF is estimated to involve total financial assets of US$5 trillion, and total sukuk (Islamic bond) outstanding is US$180 billion. The sector includes many specifically Islamic institutions, such as Al Rajhi Bank Saudi Arabia, Bank Islam Malaysia and Bank Melli Iran. In addition, many large global financial institutions such as Citibank and HSBC have added Islamic banking alongside their conventional operations. It is now often also possible to hold Islamic accounts with these banks in Western countries, where some non-Muslims have become customers as well.

The early IBF institutions of the 1960s, such as Mit Ghamr Savings Bank in Egypt and Tabung Haji in Malaysia, were socially oriented institutions, anchored in the maqÉsid of SharÊÑah and Islamic economic vision. They provided credits and other financial services to peasants, small businesses, and workers, with the goal of overcoming financial exclusion and expanding the ownership base of society.

Subsequently, IBF institutions have tended to respond to prevailing forces of the international financial system by moving closer to the operations of conventional financial institutions. IBF continues to expand the Muslim financial base and reduce financial exclusion, but many institutions have been taken over by pragmatic bankers who shift the core operation away from the original religious and social ideals. Today, most IBF institutions avoid PLS as a central instrument. The use of more risky PLS contracts, such as muÌārabahand mushārakah (joint venture or co-ownership financing), has dramatically declined. Instead, IBF institutions operate largely on debt-based contracts, such as murābaÍah (sale of goods with a disclosed cost and mark-up), ijÉrah (leasing contract), salam (spot payment for deferred delivery), or istisnā (staggered payments for deferred delivery). These relatively safe credits are similar, in some respects, to lending on the basis of fixed interest.

The new generation of financial instruments are at odds with the foundational axioms of Islamic economics. As such, the concept behind IBF has been reduced to the mere removal of ribÉ’ and the conduct of financial activities according to contractual norms derived from the SharÊÑah. IBF institutions are following the letter of the SharÊÑah, but not its spirit, the maqÉsid. The marked-up contracts are only weakly Islamic.

In addition, simplistic ‘pragmatism’ has meant that the globalisation and unprecedented growth of IBF has not permeated through to the lives of many poorer Muslims, who have been disenfranchised by the current economic system. These low-income groups are not interested in sukuk, capital protected funds, Islamic hedge funds, AAOIFI standards or IFSB prudential regulations. They want access to Islamic micro-credits, SME financing, venture capital and other related programmes. ‘Non-bankable’ Muslims want the dignity to provide for their families financially, and IBF could do much more to this end.

Watch video footage of Gairuzazmi Ghani introducing his paper on 'including Islamic Finance in the Global Economy' at our international workshop in Rio de Janeiro.

The workshop brought together academics, activitists and policymakers from around the world and generated lively debates and new understanding on how to understand and overcome exclusion.

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including the exluded | rio workshop |   workshop findings

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