Islam and the Armies of Mammon
Jeremy Harding returns to the subject of high finance in the Islamic world
The first part of Jeremy Harding’s piece on Sharia finance can be read here.
The rules that govern Islamic banking and finance are non-negotiable, cast in tradition, as good as stone. A finance house that sticks to the plot will not come to grief in a credit crisis; neither will its clients. Yet once large sums are involved – sums beyond the reach of modest customers – Islamic entrepreneurs, corporate and institutional investors take risks with the principles that sharia-compliant finance is meant to embody, by colonising conventional areas where the promise of riches and power looks irresistible but the path is forbidden. The challenge here is technical as much as moral. Faith-accountable fund managers and devout privateers in Malaysia and the Gulf may want a stake in Western wealth creation, but they must try to stick to Islamic principles when they intrude on the money. ‘Leveraging’, ‘derivatives’, ‘shorting’: the ambient glamour of these operations, like the terminology itself, seems dangerous in the new light of day, yet cautious capitalists still find them serviceable and inventive theorists of sharia-compliance are intrigued by them.
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Letters
Vol. 31 No. 10 · 28 May 2009
From David Cobham
Jeremy Harding discusses the requirement for risk to be shared between lender and borrower in Islamic banking, but does not make clear that contracts should take the form of profit and loss sharing (PLS), (LRB, 30 April and 14 May). Thus in principle someone who deposits in an Islamic bank receives not a fixed interest payment but a share in the return which the bank makes on his funds; and someone who borrows from an Islamic bank pays not a fixed interest payment but a share of the profit he makes from the project concerned.
Such PLS arrangements are in principle perfectly viable: borrower and lender agree in advance the split between them, and when the profits are revealed they are divided between them in the ratio previously agreed. The problem with this is that borrowers have an incentive to under-report their profits in order to pay less to the lenders. That means lenders have to expend more resources in ‘monitoring’ the borrowers. In other words, PLS arrangements involve much higher monitoring costs than fixed interest arrangements, where the lender needs to exert himself only if the borrower defaults. These arguments are, in fact, the basis for the formal proof that optimal financial contracts typically involve fixed interest payments, which can be found in the literature on the theory of financial intermediation that was developed in the 1980s.
In practice, Islamic banks appear to have been unwilling to spend significantly more resources on monitoring their borrowers. Instead, as Harding points out, they have sought to replicate conventional banking contracts in ways that their sharia committees have pronounced legal. What data we have on the balance sheets of Islamic banks indicate that for banks which coexist with conventional banks, for example in Egypt, the proportion of PLS lending is typically 5 per cent or less; and even in the Islamicised banking systems of Iran, Pakistan and Sudan it is well below 50 per cent. Instead, Islamic banks focus on short-term lending of the murabaha (working capital loans) or ijara (leasing or hire purchase) type, which Western economists and many Muslims immediately recognise as covert forms of fixed interest transaction. And Islamic banks in the Gulf, in particular, have come more and more to act as conduits for the placing of savings in Western stock markets rather than channels for the financing of investment in their own economies.
It is therefore hard to believe that Islamic banks, as they generally operate at present, are making a significant contribution to the development of economies in Muslim countries, although they do allow a small number of Muslims to get rich at the expense of many others.
David Cobham
Heriot-Watt University, Edinburgh
Vol. 31 No. 11 · 11 June 2009
From Karla Mallette
Jeremy Harding’s discussion of sharia-compliant finance in the West becomes even more fascinating if one reads it with an awareness that our word ‘risk’ derives from the Arabic (LRB, 30 April and 14 May). During the Middle Ages rizk meant (I quote Edward Lane’s definition): ‘A thing (or provision) that comes to one without toil in the seeking thereof: or, as some say, a thing (or provision) that is found without one’s looking or watching for it, and without one’s reckoning upon it, and without one’s earning it, or labouring to earn it.’ Italian merchants picked it up from the Arabs, and it shows up in 14th-century Italian mercantile documents, where it refers first to the unanticipated good that can come of chance or mishap alongside the bad, then to the uncertainties of trade in general.
Karla Mallette
Ann Arbor, Michigan
From Izzud-Din Pal
Jeremy Harding underlines the challenges facing Islamic banking in modern times. During the 1980s and 1990s, the issue was hotly debated in Pakistan as part of the Islamicisation drive launched by General Zia-ul-Haq, and Islamic banking was introduced alongside conventional banking. It has undergone some organisational changes in the last ten years, but its share has remained at about 3 per cent of the total banking sector. Approximately 90 per cent of lending by these banks involves ‘risk averse’ modes of financing such as ijara, murabaha and sukuk.
With the growth of sharia finance, a meaningful comparison in the workings of the two systems has become possible. It seems that Islamic banking elevates form over substance, doing much the same thing as conventional banking, but with the help of subterfuges (hiyal). It will continue to do so, since form matters to some for moral reasons. Over time, Islamic banking will converge with conventional banking, or become irrelevant, unless the Islamic banking system decides to revisit the concept of riba (interest), and focuses on offering differentiated services to customers.
Izzud-Din Pal
Montreal
