zakat part 2

Economics: Concept and Purpose in Islam: Part 2
In part I of this article, we had examined the prevailing opinions of both religious and secular Muslims, as well as the prevailing system of Zakat in some so-called Muslim countries. We had concluded that the concept and practice of Zakat has been reduced to a lifeless ritual by means of which the rich believe they can gain entry into Heaven in the Hereafter. On the other hand, our Prophet ( pbuh ) acted to establish the Deen of Allah Almighty in Medina by implementing the system of Salaah and Zakat as spelled out in the Quran. In this part we will look closely at this system of Zakat .
If Zakat is one of the pillars of the Deen , it stands to reason that this pillar must stand on a firm foundation. That firm foundation is comprised of each Muslim's unshakable conviction, 100% commitment, utter sincerity, and complete dedication to the belief that the Allah-owned resources on the planet must be made available to all creatures and human beings for their sustenance, nourishment, and growth.
The Arabic word Zakat , with its root Z -K -W means growth and development. A tree is nourished and grows in the presence of Allah-owned resources such as the soil, the rain, the sun, and the air (56:63-72; 80:24-31). Any interference in the flow of any of these resources will retard the growth and development of the tree. Similarly, any individual, group, government, or system which disrupts the natural flow of Allah-owned resources on the planet to all human beings creates an imbalance in society: the rich/poor, the master/slave, the owner/worker. In the West, this awareness is dawning in respect to plants, animal and insect species which are becoming extinct due to this imbalance in nature caused by the actions of human beings.
However, the global economic imbalance continues to grow unchecked because human beings have refused, in their greed, to believe in the basic economic principle of Zakat : unrestricted flow of resources to all human beings (41:10, 50:11, 55:10, 56:73, 79:33, and 80:32).
The capitalist New World Order of the West actively seeks to control the natural resources of weaker nations under the guise of "global economic security." Using the United Nations as a tool, the weak are intimidated into submission either through economic sanctions or military force. Allama Iqbal beautifully captured this mentality of the powerful when he said: "Hai wo sultan ghair ki kheti pe ho jiski nazar." (The master is one who always has an eye on others' lands.) Muslims, too, have abandoned the Quranic Zakat , which is Allah's assured challenge to this naked exploitation of the weak by the strong. Unlike other religions, Islam is a Deen , a system of life, a constitutionally-run, collective life that encompasses the social, economic, political, judicial, and military aspects of a community. The leaders of this community are not priests, or scholars, or the rich, or the strong: they are the most upright who commit to upholding the laws of Allah Almighty in the land, " Amr bil ma'aroof " (enjoining what is right) and " Nahya 'anil munkar " (forbidding what is wrong). They make sure the Quran, the Constitution of Allah, is en acted i.e. put into action.
What then, is the position of the Quran on the Economic World Order that should prevail, in other words, Zakat ? The Quran emphasizes the importance of economics in human life. While describing the life of Heaven, the Quran says there will be no hunger and no misery there.
"There is therein (enough provision) for thee not to go hungry nor to go naked." [Yusuf Ali (20:118)]
Too, the Quran teaches us to work for the good of this life, as well as the hereafter (2:201, 7:156), in contrast to the mindset of those who consider economic prosperity in this life to be an end in itself. According to the Quran, such people live at the animal level:
"Verily Allah Almighty will admit those who believe and do righteous deeds, to Gardens beneath which rivers flow; while those who reject Allah Almighty will enjoy (this world) and eat as cattle eat; and the Fire will be their abode." [Yusuf Ali (47:12)]
Taqwaa (righteous works) includes the use of economic prosperity to achieve a higher and nobler goal (10:63-64, 16:30). Economic prosperity is a means, not an end; it is a source for life, not the end of life; it is a prerequisite for growth and development in life, not the final goal of life. Since economic prosperity is so essential to human growth and development, Allah Almighty has addressed the issue of Zakat in great depth in the Quran.
To begin with, Allah Almighty says He is Rahman and Rahim :
"There is no moving creature on earth but its sustenance dependeth on Allah: He knoweth the time and place of its definite abode and its temporary deposit: All is in a clear Record." [Yusuf Ali (11:6)]
"How many are the creatures that carry not their own sustenance? It is Allah Almighty who feeds (both) them and you: for He hears and knows (all things)." [Yusuf Ali (29:60). Also see verses (6:152) and (17:31)]
Allah, of course, does not personally feed anyone: And when they are told, "Spend ye of (the bounties) with which God has provided you," the Unbelievers say to those who believe: "Shall we then feed those whom, if God had so willed, He would have fed, (Himself)?- Ye are in nothing but manifest error." [Yusuf Ali (36:47)]
Allah Almighty fulfills this promise by creating the resources for the nourishment and growth of all moving creatures. No one, therefore, has the right to own or control the Allah-given natural resources or to restrict their flow to humanity at large (107:7, 17:20). Otherwise, this is tantamount to belying the Deen of Allah Almighty (107:1-6). Any association or partnership with Allah Almighty in this respect is Shirk , an unforgivable sin in the sight of Allah. Allah Almighty says:
"Join not anything as equal with Him; be good to your parents; Kill not your children on a plea of Want- We provide sustenance for you and for them ." [Yusuf Ali 6:151]
Secondly, Allah Almighty is clearly the real owner of the resources He has created. The following verses in the Quran leave no doubt about this:

The earth and all its resources belong to Allah. It is such an obvious fact that no one can deny it (6:12, 10:31, 29:61 &63, 31:25, 34:24, 39:10 &38, 43:9).
• Allah Almighty is the inheritor of the earth (19:40). The earth has been created for the benefit of all (55:10).
It has been created to provide nourishment for all (56:73).
To Him belongs all that is in heavens and the earth, "La hu ma fissamawati fil ardh" (2:116, 2:255, 4:171, 5:40, 14:2, 16:52, 20:6, 22:64).
"Lillahi ma fissamawati fil ardh" (2:284, 3:109, 3:129, 4:131,132, 5:40, 10:55, 10:67, 14:2, 16:52, 20:6, 21:19, 34:1, 42:4, 42:53, 53:21).
"Lillahi miraathus samaawaatti wal ardh" (3:180).
As Owner, then, Allah Almighty has given us these resources as a trust which we are required to disburse according to His Will (the system of Zakat ), which is, to make available to all living creatures according to their needs, without any hindrance or control, the sustenance and provisions of life.
It was the Prophet's ( pbuh ) unshakable conviction, his utter commitment, and total obedience to this system of Zakat that led to the establishment of the basic infrastructure of a universal, welfare-based economic system in Medina, and which reached its pinnacle during Khalifa 'Umar's (R) time when, it is said, hardly anyone was in need of charity. The Prophet ( pbuh ) lived his life true to this principle: he was not an owner of anything, no land, no possessions; he was merely an enforcer of the Will of Allah Almighty - he established the system of Zakat .
Shirk - Associating Other Owners Besides Allah Almighty to the Ownership of the Earth
Since Allah Almighty owns the Earth and its resources, then no one else can be an owner. A simple example illustrates this well: I wish to buy a piece of land. The seller and I sign the papers, and legally, I become the new owner. But if we carry this process back far enough, a point will come where this mutual deal will come to an end. Someone must have acquired that land illegally at first without any mutual agreement. Now, in legal jargon, any illegally acquired property, no matter how many times it is bought and sold thereafter, remains illegal. So, how can I say that "I" am the "legal" owner of that land? In my own defense I may claim that I acquired the land "legally," or that it is not my responsibility to worry about someone else's very first illegal acquisition of that land, or that I bought it from halal earned income, so I "own" it. But it does not change the reality - I am involved in a deal which was Shirk to begin with. And, as long as I believe in "my ownership," I am involved in Shirk .
Brothers and sisters! It is not difficult to understand this kind of Shirk if our hearts and minds are open and sincere. According to the Quran, Muslim believers are required to enter into a contract with Allah Almighty in which they must sell their life and wealth to Him in exchange for Jannah : "Allah Almighty hath purchased of the believers their persons and their goods; for theirs (in return) is the garden (of Paradise)" [Yusuf Ali 9:111]
But, if we cling to the attitude that we own our life and wealth (in violation of the above ayah) then how can we practice and establish Zakat ? First, this Shirk (having two owners, Allah Almighty and us) has to be slowly and gradually eliminated before the tree of Zakat can take firm root in a land rooted in Tauheed (with Allah Almighty only being the owner of everything including our lives) and not in Shirk (in which others are also owners along with Allah). That is where Sadaqaa or charity comes in.
What is Sadaqaa ?
Our Islamic scholars interpret both Zakat and Sadaqaa as charity. And whatever instruction Allah Almighty has given in the Quran in the following verse for Sadaqaat they attribute it to Zakat .
Alms [Sadaqaat] are for the poor and the needy, and those employed to administer the (funds); for those whose hearts have been (recently) reconciled (to Truth); for those in bondage and in debt; in the cause of God; and for the wayfarer: (thus is it) ordained by God, and God is full of knowledge and wisdom. [Yusuf Ali (9:60)]
But, first of all, why would Allah Almighty use two different terms if they mean exactly the same thing? It does not make sense. Secondly, the Arabic language also does not support it. While the root meaning of Zakat comes from Z-K-W , meaning growth and development, the root meaning of Sadaqaa comes from the root S-D-Q , meaning truth and power. Therefore, all the words that are derived from this root will have these two meanings (truth and power) embedded in them. Siddeeq is one who proves his trust and belief by his actions. As-Sadaqatu is anything that is given in the way of Allah Almighty voluntarily to prove one's promise and belief in Him as opposed to Zakat , which is compulsory [Tajul 'Uroos]. Therefore, Sadaqqa has a different purpose in Islam than Zakat and both cannot be equated with each other. How can income tax (a compulsory thing) be equated with charity (a voluntary thing)? .

Zakat part 1

Zakat - Islamic Economy Purpose in Islam
The economics of Zakat and its relevance to modern times is a hotly debated issue among both religious and liberal Muslims. This series of articles will attempt to explain the concept of Zakat in the light of only the Quran and the faithful implementation of this concept by our Prophet Muhammad (pbuh). We will see how a similarly implemented system can solve the current economic problems of not just Muslim Countries, but of the World.

Zakat - First Universal Welfare System
Contrary to the beliefs of both religious and secular Muslims, the Prophet Muhammad achievements were based not on ephemeral but on the permanent values of the Quran. He brought about the greatest revolution, even an economic and political miracle in human history (see Michael Hart, THE 100, pages 3-10). In a very short time after the prophet migrated to Medina and implemented the system of salaat and zakat, the economic condition of the people changed.

* (For a detailed discussion about the system of salaat, see a two part article in MONITOR, pages 6-10, September/October 1998, and pages 7-12, December1998/January 1999)
The Prophet Muhammad (pbuh) is reported to have said; If a single person were to sleep hungry in a town, then God's protection is lifted from that town -[Masnad Imam Ahmad]. This hadith emphasizes that no one (Muslims or non Muslims) under this system should go hungry. Thus this zakat system created the first universal welfare system in human history. It also gradually transformed the existing slave based economy to a universal welfare based economy. By the end of the Prophet's period, the entire Arabian Peninsula enjoyed economic as well as political security. This system reached its pinnacle during Khalifa Umar's time (again, see Michael Hart, THE 100, pages 261-265), a time when, history tells us, hardly anyone was in need of charity.
What has occurred then in the intervening years that the Muslims masses are suffering economic deprivation even though they live in areas with plenty of natural resources?

What Happened Then?
Muslims and non Muslims alike ask the question; If the system implemented by our Prophet Muhammad (pbuh) and Sahabaa (r) was so good, why did it not continue? The answer is simple, we changed or abandoned the system implemented by the Prophet Muhammad. Instead of deciding matters with open consultation, as the Quran requires, the Ummayad and Abbasid dynastic rulers created a dictatorship under the guise of " Shari'iah " and " Ijma'a ". This was a ploy to fool the people. The rulers first acquired illegal political authority, and then delegated religious authority to Imams appointed by themselves.

Thus they hijacked the train of Islam from the track of our Prophet (pbuh) and his Sahabba (r) and put it on a new track called " Shari'ah ." Since then, a minority of the rich and powerful has been riding this train and entertaining their friends while exploiting the vast majority of Muslims along the way. Consequently, common Muslims have continued to live in poverty and to suffer intergenerational economic misery. Islam's system of Zakat has had nothing to do with this sad state of affairs.


Zakat & Our Approach

Today, we are taught that zakat is one of the pillars of Islam. Zakat is generally translated as charity or poor due and it is required to be distributed according to the details given in the Shariah. However, the descendents of the Prophet (pbuh), generally known as "Syeds" in the Indian subcontinent are forbidden to take zakat according to this Shariah. No matter how poor, they are considered superior by birth compared to other Muslims due to their supposed relationship with the Prophet (pbuh). Obviously, this is against our Prophet's Sunnah since he proclaimed justice, fairness, and equality for all, regardless of family or blood relationship.
The dispensation of zakat is regulated by different rates (called shar'h ) for different items called (nisaab) whose details are given in books of hadith and Fiqh. Zakat on money is 2.5% of the savings over a period of one year according to the Shari'ah. There are many conditions attached to the giving and receiving of zakat. There is no uniformity even among the Sunnis in the restrictions, rates and even the items of zakat.
In addition, there are different books of Fiqh and Shari'ah for different Muslim sects or schools of thought! Although Islamic scholars know about these differences in zakah among the Muslim sects, they rarely bring them out into the open, since it is in the interest of these scholars to keep the people ignorant.
The differences in zakat among the four Sunni Imams are not as major as among the Sunni and Shi'ia Imams. For example, in Fiqh Jaffariah , there is no zakat on paper currency. So, for the followers of this Fiqh there is no Zakat on bank accounts. When General Zia-ul-Haq, the Pakistani military ruler instituted compulsory zakat in Pakistan, the Shi'ia 'Ulema revolted against it and refused to abide by the government's zakat ordinance. Ultimately the government excluded Shi'ias from the yearly bank account deductions. This led many Sunnis to declare themselves Shi'ias on their bank forms to avoid paying zakat on their bank accounts.

Zakat - Conclusion
Dear sisters and brothers! We must re-turn to the true spirit of the Quran; we must have the courage to follow the Islam of our Prophet Muhammad (pbuh), which requires real sacrifice and a drastic change in our lifestyles. We must go back to the Quran as the primary source, and not to the rulings of Islamic scholars from the time of the Ummayad and Abbasid rulers.
In Part 2 of this article we will look at the real meaning and significance of zakah - the Arabic word zakah with its root z-k-w , which means growth and development, not charity or poor-due. Keeping this meaning in full view, zakat is supposed to ultimately lead to growth and development of all human beings; it is supposed to remove the need for charity or poor-due in the long term. We will see how zakat not only leads to the economic progress of individuals and all human beings but to their spiritual progress as well. We will also note the difference between Sadaqaa and Zakat.

Islamic Economics what does it mean?

Islamic Economics: What Does It Mean?
by Daniel Pipes
Jerusalem Post
September 26, 2007
While the outside world hardly noticed, a significant and rapidly growing amount of money is now being managed in accord with Islamic law, the Shari'a. According to one study, "by the end of 2005, more than 300 institutions in over 65 jurisdictions were managing assets worth around US$700 billion to US$1 trillion in a Shari'ah-compatible manner."
Islamic economics increasingly has become force to contend with due to burgeoning portfolios of oil exporters and multiplying Islamic financial instruments (such as interest-free mortgages and sukuk bonds). But what does it all amount to? Can Shari'a-compliant instruments challenge the existing international financial order? Would an Islamic economic regime, as an enthusiast claims, really imply an end to injustice because of "the State's provision for the well-being of all people"?

Timur Kuran, professor of economics and political science at Duke University.

To understand this system, the ideal place to start is Islam and Mammon, a brilliant book by Timur Kuran, written when he was (ironically, given heavy Saudi backing for Islamic economics) King Faisal Professor of Islamic Thought and Culture at the University of Southern California.
Now teaching at Duke University, Kuran finds that Islamic economics does not go back to Muhammad but is an "invented tradition" that emerged in the 1940s in India. The notion of an economics discipline "that is distinctly and self-consciously Islamic is very new." Even the most learned Muslims a century ago would have been dumbfounded by the term "Islamic economics."
The idea was primarily the brainchild of an Islamist intellectual, Abul-Ala Mawdudi (1903-79), for whom Islamic economics served as a mechanism to achieve many goals: to minimize relations with non-Muslims, strengthen the collective sense of Muslim identity, extend Islam into a new area of human activity, and modernize without Westernizing.
As an academic discipline, Islamic economics took off during the mid-1960s; it acquired institutional heft during the oil boom of the 1970s, when the Saudis and other Muslim oil exporters, for the first time possessing substantial sums of money, provided the project with "vast assistance."
Proponents of Islamic economics make two basic claims: that the prevailing capitalist order has failed and that Islam offers the remedy. To assess the latter assertion, Kuran devotes intense attention to understand the actual functioning of Islamic economics, focusing on its three main claims: that it has abolished interest on money, achieved economic equality, and established a superior business ethic. On all three counts, he finds it a total failure.
1) "Nowhere has interest been purged from economic transactions, and nowhere does economic Islamization enjoy mass support." Exotic and complex profit-loss sharing techniques such as ijara, mudaraba, murabaha, and musharaka all involve thinly disguised payments of interest. Banks claiming to be Islamic in fact "look more like other modern financial institutions than like anything in Islam's heritage." In brief, there is almost nothing Islamic about Islamic banking – which goes far to explain how Citibank and other Western majors host far larger Islam-compliant deposits than do the specifically Islamic banks.
2) "Nowhere" has the goal of reducing inequality by imposition of the zakat tax succeeded. Indeed, Kuran finds this tax "does not necessarily transfer resources to the poor; it may transfer resources away from them." Worse, in Malaysia, zakat taxation, supposedly intended to help the poor, instead appears to serve as "a convenient pretext for advancing broad Islamic objectives and for lining the pockets of religious officials."
3) "The renewed emphasis on economic morality has had no appreciable effect on economic behavior." That's because, in common with socialism, "certain elements of the Islamic economic agenda conflict with human nature."
Kuran dismisses the whole concept of Islamic economics. "[T]here is no distinctly Islamic way to build a ship, or defend a territory, or cure an epidemic, or forecast the weather," so why money? He concludes that the significance of Islamic economics lies not in the economy but in identity and religion. The scheme "has promoted the spread of antimodern … currents of thought all across the Islamic world. It has also fostered an environment conducive to Islamist militancy."
Indeed, Islamic economics possibly contributes to global economic instability by "hindering institutional social reforms necessary for healthy economic development." In particular, were Muslims truly forbidden not to pay or charge interest, they would be relegated "to the fringes of the international economy."
In short, Islamic economics has trivial economic import but poses a substantial and malign political danger.

the foundation of islamic finance

The Foundations of Islamic Finance

Author: By: Prof. M.N. Siddiqi
________________________________________
During the short span of a quarter century, the Islamic finance spread far and wide reaching Malaysia and Indonesia in the east and the Americas in the west, and a number of Muslim countries adopted the new system at the state level.
It is interesting to ask why it emerged, how it works, what sustains it and what are its potentialities for you and me and the humanity at large. The query is timely as all is not well with our conventional system of money, banking and finance. It has become increasingly unstable, facing recurrent crises. It has failed to help in reducing the increasing gap between the rich and the poor, within nations and between nations. Many think it is partly responsible for increasing inequality.
I will cover the foundations of banking and finance in Islam: its concepts, precepts and laws with some reference to its roots in early Islamic history. I will also take-up the story of its recent emergence and spread. In the third and the last section we will have a closer look at the contemporary scene and the challenges facing Islamic finance today.
The Foundations
Islam looks at wealth as life sustaining, to be used efficiently. God says:
“Give not unto the foolish your wealth which Allah has made a means of support for you”. (Quran, 4:4).
Private ownership is affirmed but viewed as a trust:
“Believe in Allah and His messenger, and spend of that whereof He hath made you trustees.” (Quran, 57:7).
Islam encourages enterprise, efforts to create wealth, which has been characterized as God’s bounty:
“And when prayer is ended, then disperse in the land and seek Allah’s Bounty”. (Quran, 62:10).
Muslims are obligated to fulfill contracts and keep their promises:
“O you who believe fulfill your undertakings”. (Quran, 5:1)
“…And be true to every promise, for, verily, (on judgment day) you will be called to account for every promise you made”. (Quran, 17:34)
All exchange should be with willing consent of the parties concerned:
“O you who believe squander not your wealth among yourself in vanity Except it be a trade by mutual consent”. (Quran, 4:29)
Use of wealth and exercise of freedom of enterprise is constrained by the obligation not to harm others. The Prophet ruled:
“No injury, and no inflicting of injury”. (Ibn Maja, Sunan: chapter on Ahkam)
This has to be seen in the perspective of the positive obligation to care for others and share with them. This is symbolized by the well-known duty of paying Zakat or poor tax. But that is not all, the important thing is the spirit of a cooperative, helpful behavior as mandated by the Islamic view on life being a test:
“Who hath created life and death that He may try you, which of you is best in conduct”. (Quran, 67:2).
These clear texts provide a sound basis for a positive attitude towards wealth creation and economic activity. Clear and secure individual ownership rights, one’s right to the fruits of one’s efforts and contracts enforceable through a social authority, strengthen that attitude and provide a wide arena for it.
Limits of Freedom
Having put production and exchange of wealth on a firm basis, Islam proceeds to define a framework for these activities so that justice and fairness is ensured for all concerned. This comprises do’s as well as don’ts. I focus on the don’ts, as they are more relevant to our discussion. The following are prohibited:
1 Riba,
i.e. interest on loans and exchange of unequal quantities of similar fungibles. Gold or silver or a particular paper currency must be exchanged in equal quantities. When gold or silver or different paper currencies are exchanged with one another, the quantities can be unequal but the exchange must be simultaneous. Prohibition of interest on loans is clearly implied by the text of the Quran:
“And if you repent you have your principal, wrong not and you shall not be wronged”. (Quran, 2:279)
As we shall note later on, this and the prohibition of gambling which is next on the list, target justice in distribution. Islamic law does not distinguish between high rates of interest characterized as usury and lower rates characterized as interest. Any excess over and above the sum lent is disallowed. There have been some modern scholars taking a different view but classical jurists as well as overwhelming majority of modern scholars take the stand reported above. It is this view which is reflected in Islamic banking and finance.
2. Maysir,
i.e. gambling, bets and wager. The essence of gambling is taking a risk deliberately created or invited, which is not necessary in economic activity, to gain thereby. This is unlike the risks taken by other economic agents, entrepreneurs, speculators, insurers, which are there as an inalienable aspect of reality.
3. Ghabn,
i.e. fraud and deception.
4. Ikrah,
i.e. coercion, e.g. imposing a contract, or a condition therein, on an unwilling party.
5. Bay’ al -mudtarr,
i.e. exploitation of need, e.g. by charging an exorbitantly high price.
6. Ihtikar,
i.e. withholding supplies of essential goods and services with a view to raising prices.
7. Najsh,
i.e. raising prices by manipulating false bids.
8. Gharar,
i.e. hazard or uncertainty surrounding a commodity, its price, time of payment, time of delivery, quantity,.. etc. makes the deal invalid. But some little gharar can be ignored as it may be humanly impossible to eliminate it.
9. Jahl mufdi ila al-niza’,
i.e. such lack of information about a commodity, its quantity, price, etc. as may lead to dispute.
This list is by no means all inclusive, rather it serves the purpose of highlighting what the Shariah (Islamic Law) cares about in order to guide men and women towards an efficient and just economy.
I would also underline the fact that other than prohibition of interest, regulators all over the world, especially in the United States of America, have been doing their best to rid the markets from the bad practices noted above. In other words most of the concerns of Shariah and modern commercial law are common.
As I noted earlier, these do-nots are to be seen in the perspective of the numerous do’s Islam has mandated, those that enshrine the spirit of caring for other human beings and, as need be, sharing with them one’s hard earned income and wealth. Economic agents, be they individuals, groups or institutions, are also under the obligation of regarding public interest and social purpose in their decisions. However, a detailed discussion of this point is not warranted in this lecture.
Early Islamic History
True to its view on life, Islamic society witnessed vigorous economic activity since the day the Prophet came to Madinah. To the agrarian community of the city state was added a group of experienced traders from Makkah, a great center of inter- regional trade. The first four to six centuries recorded continued expansion and increasing prosperity. Monetization came early, and the ban on unequal exchange of similar fungibles seems to have expedited the process. Muslims started with gold dinars from the Byzantine and silver dirhams from Persia, but very soon they took to minting their own coins. The state had the monopoly of coinage and any tampering with their weight or purity was severely punished.
It is not surprising that trade and commerce over the vast expanse of the world of Islam, including northern parts of Africa, Spain in Europe and a large part of Asia, soon produced certain elementary financial instruments.
Chief among these was suftaja (bill of exchange) and sakk (check).
Muslims used customary contracts known in the Arabian peninsula and other parts of the land of Islam. But some were found violating one or more of the limits noted above and, therefore, rejected. Some were modified to meet the standards of fairness. Thus the Prophet forbade traders from selling what they did not yet own. He also forbade selling pieces of cloth spread on the ground by inviting the customer to throw pebbles in their direction, getting the piece actually hit. Muawiya, the first Umayyid khalifa (661-680) banned trade in securities based on grain entitlements of recipients.
It is time now to focus on those contracts, other than simple sale and purchase, which have a closer relationship with investment, finance and business organization. It is these which were recently adapted to modern conditions to form the basis of Islamic banking.
Profile of Early Islamic Financial Contracts
Mudaraba,
i.e. profit-sharing. Supplier of money capital contracts with a working partner on the basis of sharing the resulting profits. Losses, if any, are considered loss of capital and borne by the owner of capital. The working partner, in that case, goes unrewarded for its efforts. This is the ‘loss’ borne by the working partner, a feature of mudaraba which has made some to characterize it as profit and loss sharing or PLS.
The sharing contract when applied to farming, is called muzara’ah or share-cropping.
Shirka, also called musharaka
i.e. partnership. In partnership two or more parties supply capital as well as work/effort. They share the resulting profits according to agreed proportions, but losses are to be borne in proportion to respective capitals.
Wakala,
i.e. agency. Business is managed by an agent appointed by the principal-owner. Agent’s compensation may take different forms.
Ju’ala,
i.e. reward which is given on successful completion of a specified job. There is no compensation in case of failure.
Ijara,
i.e. leasing.
Salam,
i.e. payment now for agricultural products to be delivered at a specified time in furure, with the price being agreed now.
Istisna’,
i.e. salam applied to manufactured goods, with the possibility of payment in installments as the goods are delivered.
Urboon,
i.e. depositing a small fraction of price in a deal to be concluded in future. It binds the seller to wait but allows the buyer to back out of the deal, with the seller keeping the deposit.
Murabaha,
i.e. a sale agreement under which the seller purchases goods desired by a buyer and sells it to him/her at an agreed marked up price, payment being deferred. It is also referred to as bay’ mu’ajjal or bay’ bi thaman aajil. It is a modern adaptation of an earlier contract in which deferment was not necessarily involved. The higher price paid would leave a margin for the seller in order to reward him/her for expertise in bargaining, better knowledge of market conditions, etc.
It may be noted that Islamic law allows a seller to sell on credit at a price higher than he/she was charging for payment on the spot. In fact it is regarded to be an aspect of freedom of enterprise, the seller’s freedom to ask for a price he/she thinks fit to cover his/her costs and leave a decent profit. It is not like asking for an excess over cash lent in view of time, the time that passes between borrowing and repayment. No price is involved in a lending transaction. The object of the transaction in murabaha is a commodity with its perceived utility to the buyer, whereas the object of transaction in a loan is money which gives its services through being converted into commodities. Unlike commodities whose services are known and not necessarily time related, the services of money involve time and are surrounded with uncertainty.
Trade credit has always played a major role, and it was no different in early Islamic history.
This list should also include qard, i.e. loan’ which has to be interest free. Since lending does not bring any material benefit to the lender it is classified with charity and called ‘qard hasan’—good loan or beneficial loan. It played a significant role in financing consumption of the poor and needy but its role in business enterprise has been marginal, except in the form of trade credit, which changes its nature.
As noted above, for centuries Muslims were able to carry on international trade as well as domestic economic activities---agriculture, industry and trade--on the basis of the above mentioned practices without resorting to interest based contracts on any large scale. As Professor S.D. Goitein has recorded in his monumental work, A Mediterranean Society, partnership and profit-sharing and not interest based borrowing and lending formed the basis of commerce and industry in twelfth and thirteenth centuries (sixth and seventh in Islamic calendar) in the Mediterranean region.
(S D Goitein, A Mediterranean Society, vol. 2, Berkley and Los Angeles, University of California Press, 1971)
A Realistic Approach.
Prohibition of interest on the one hand and permission to charge a higher than spot price in credit sales on the other hand makes the Islamic model of finance unique. In order to realize its significance one should consider the many financial needs, which are not easily amenable to profit sharing. These are the cases in which there is nothing to share as the project involved is not a for profit activity. Also relevant are cases of business enterprise, which are difficult to monitor. The inclusion of trade based modes of financing like murabaha, salam and leasing along with sharing based modes makes the package of Islamic contracts capable of accommodating all kinds of financing needs. What is important to note at this stage is that both kinds of contracts are rooted in early Islamic practice.
Recent History Of Islamic Banking And Finance
During the eighteenth, nineteenth and the first half of the twentieth centuries almost all of the world of Islam was colonized by the European countries. They managed the economies and finances of these countries in their own interests and in their own ways. Other than the native elites who had to get involved, the Muslim masses stayed away from interest-based financial institutions. As the national consciousness grew and freedom movements promised to bear fruits during the second half of the last century, the urge to manage their affairs in accordance with their own values and traditions also emerged in these countries. Indonesia gained independence in 1945 and Algeria in 1963. In between these two dates, all Muslim majority countries became independent. The discussion on the management of their respective economies in order to promote their own interests had, as an offshoot, brought the Islamic financial movement into being. While nationalism made them focus on rapid economic development, religion, the other motivating force in freedom struggle, made many turn to Islam for guidance.
Theoretical Literature
Early theoretical work on the subject appeared during 1940s through 1960s, in Urdu, Arabic and English. The focus was not banking and finance in the narrow sense but the economic system as a whole. The writer would, generally speaking, criticize capitalism and socialism and proceed to outline a system based on Islamic injunctions relating to moderation in consumption, helping the poor, encouragement of economic enterprise, avoidance of waste, justice and fairness, etc. The poor tax, zakat, and prohibition of interest would be emphasized in this context. It would be argued that Muslims should not adopt the conventional system of money, banking and finance blindly. They must purge it of prohibited interest and modify it to suit the just and poor-friendly economic system of Islam. Some of these writers went beyond generalities and suggested that the early Islamic contracts provided sound bases for restructuring banking so that it was free of interest and served the goals of Islam. The youngest of Islamic countries, Pakistan, made the commitment to abolish Riba a part of its constitution.
Professional Muslim economists as well as Shariah scholars made significant contributions to the subject so that by the end of 1960s some kind of a blueprint of Islamic banking was available. Bankers and businessmen had also joined the task of evolving a workable model since efforts were on in several Muslim countries to put the idea into practice. The political conditions in Arab countries were not favorable for any initiative at the state level. But private practical initiatives had a greater chance of mobilizing the monies needed for such a venture in these countries, as we shall see when tracing the history of the practice of Islamic banking.
The earliest theoretical model was based on two-tier mudaraba, profit sharing replacing interest in bank-depositor as well as bank-borrower relationship. Islamic banks would be financial intermediaries, like conventional commercial banks, only they would purge interest from all their operations, relying on partnership and profit-sharing instead. They could operate demand deposits like their conventional counterparts and offer other services against fees, like other banks. Banks directly doing business and entering the real estate market in order to make profits for their depositors and shareholders (partners) was not a part of this model.
But practitioners in the Arab world did not see much scope in this model. Accepting deposits into investment accounts on profit-sharing basis was all right, but their profitable employment needed direct involvement in business. Merchant banking was also nearer to the milieu with which Shariah scholars were familiar. They felt more at home with a model in which savings were mobilized on profit sharing basis but their profitable use was based on familiar Islamic contracts of sale and purchase and leasing, etc.
Murabaha,
i.e, cost plus or mark up financing entered into the model of Islamic banking in the second half of the nineteen-seventies. By this time practice had revealed the difficulties of applying the mudaraba (profit-sharing) contract in dealing with businessmen in a legal environment that failed to provide any protection to the financier in this case, unlike the protection it provided to interest based finance. Adverse selection in an environment dominated by interest-based institutions was another serious problem. Other Islamic contracts like salam, istisna’ and wakala were also being explored. Shariah scholars, many of them formally advising Islamic financial institutions, made significant contributions in developing the model.
One of the specific needs to meet was financing house purchase on terms acceptable Islamically. Three models of interest free finance were developed. The first, which formed the basis of the House Building Finance Corporation of Pakistan (1980), was based on joint ownership and rent sharing, eventually leading to the home dweller possessing it in full as he/she purchased the government owned part bit by bit. The second was a cooperative in which members pooled resources and got funded in turn, the pooled resources being profitably invested while waiting. The third method is based on murabaha, the customer paying the higher deferred price in installments.
In practice small variation were introduced to ensure Shariah compatibility as well as financial viability.
During 1980s the subject of Islamic banking and finance received broad based academic and professional attention. A number of Muslim countries began considering implementation of the idea officially and appointed expert bodies to work out the details. Several universities started teaching the subject and encouraged research resulting into hundreds of PhD dissertations, some of them in the universities in Europe and America. Numerous seminars and conferences drew attention to the subject in places as wide apart as Kuala Lumpur, Dhaka, Islamabad, Bahrain, Jeddah, Cairo, Khartoum, Sokoto (Nigeria), Tunis, Geneva, London and New York. A number of research centers made Islamic economics their field, paying special attention to money and banking. Some of these launched academic journals providing forums for exchange of views and dissemination of information on a world-wide scale.
During the 1990s the model was further developed and refined. The liabilities side saw frameworks put in place for handling trust funds, venture capitals, and financial papers based on ijara (leasing) salam (forwards) and murabaha (mark up). The special techniques for launching Shariah compatible mutual funds were also developed in this period. This involved selecting companies whose shares could be traded as they did not violate any Shariah norms. This selection was made by screening out the undesirables. The first norm was that the products in which the company dealt should not be prohibited ones like alcohol or pork. The other was that its finances should be free of interest bearing loans and its revenue free of interest income. Since the condition about debt finance would eliminate almost all shares traded on the stock exchange, some scholars allowed a leverage of 30% or less. There could be other criteria also but these two are the main, common to all existing Islamic funds. Once the filtering process was complete, managing a portfolio became a professional job. This is why the phenomenon of Islamic mutual funds, even though endorsed by a group of Shariah scholars, owes itself to the initiative of professional players in the field.
As the launching of the Dow Jones Islamic Indexes evidenced, Islamic finance too needed the modern tools designed to handle the complex web of financial transactions. The Indexes track Shariah compliant stocks from around the world.
Advantages of Islamic Banking and Finance
Before we turn to Islamic banking in practice, let us note some of its features emphasized in the literature.
Justice and fairness to all concerned was the main feature of a model of financial intermediation whose core was profit sharing. Interest was essentially unfair because our environment does not guarantee positive returns to business enterprise financed with borrowed money capital. Current practice penalizes entrepreneurship by obliging it to return the principal even when part of it is lost due to circumstances beyond the entrepreneur’s control. Justice requires that money capital seeking profit share the risk attached to profit making. A just system of financial intermediation would contribute to a more equitable distribution of income and wealth.
Islamic finance will foster greater stability as it synchronizes payment obligations of the entrepreneur with his or her revenues. This is possible only when the obligation to pay back the funds acquired from the financier and pay a profit is related to realization of profits in the project in which the funds are invested, as it is in the profit-sharing model. Contrary to this, in the debt-financing model the payment obligations of the entrepreneur are dated as well as fixed in amount. The same is the case with the financial intermediaries, their commitment to the depositors in time and saving accounts is to pay back the sum deposited with interest added. When a project fails and businessman defaults, the financial intermediary must also default with ripple effects destabilizing the whole system. The debt based financial system of capitalism is inherently prone to recurrent crises. This malaise of the capitalist financial system is well discussed by Hyman P. Minskey in his book, Stabilizing an Unstable Economy (New Haven and London, Yale University Press, 1986.)
The linking of depositors’ entitlements to the actual profitability of the projects in which their monies are invested through the services of the financial intermediary, the bank, would almost eliminate the risk of runs on the bank insofar as the investment accounts are concerned. A report or rumor that the bank investments are not doing well will not prompt a rush of withdrawals from investment accounts as depositors could get only what is actually salvageable. Waiting till the situation improves would be a more rational option.
Islamic finance is more efficient as it allocates investable fund on the basis of expected value productivity of projects rather than on the criterion of creditworthiness of those who own the projects, as is the case in debt based finance. There is no guaranty that the most promising projects seeking finance will come from the most wealthy. As Schumpeter has shown the most innovative may be empty handed. But debt finance would not serve these. It would prefer those who, on the basis of other assets owned by them, would be able to pay back the sum borrowed, interest added, even when the project being financed failed to create additional wealth.
Last but not the least, Islamic finance will be less prone to inflation and less vulnerable to gambling-like speculation, both of these being currently fueled by the presence of huge quantities of debt instruments in the market. Debt instruments function as money substitutes while equity-based financial instruments do not. And speculators find it much easier to manipulate debt instruments than those based on profit-sharing.
It is true that these advantages belong to a system whose core is profit- sharing. But even murabaha (cost plus or mark up) financing keeps the system far less vulnerable to inflation and gambling-like speculation than the conventional debt based arrangements. Murabaha is firmly linked with exchange of real goods and services. It is a price, to be paid later. It is essentially different from money given as a loan which may or may not be linked to production or exchange of real goods and services. An Islamic system of finance in which profit-sharing and mark up financing both exist side by side would still retain the advantages noted above.
Islamic Banking Practice: Early Initiatives
A number of interest free saving and loan societies are reported to have been established in the Indian subcontinent during 1940s. But efforts to arrange finance for business enterprises seem to have started later. One pioneering but short lived experiment was that in Mit Ghamr in the Nile valley in Egypt in 1963. Same year saw the establishment of Tabung Haji in Malaysia. Money being saved for meeting the cost of the pilgrimage to Makkah is profitably invested by this organization which is still working.
The Phillipine Amanah Bank was also established during the same period to enable Muslims to meet some of their financial needs without involving interest. An interest free bank in Karachi, Pakistan was established by some individuals around the same time but it did not survive for long.
Islamic Banking Practice In The Private Corporate Sector
The Dubai Islamic Bank was established in 1975 under a special law allowing it to engage in business enterprise while accepting deposits into checking accounts, which were guaranteed, as well as into investment accounts which were to receive a share in the profit accruing due to their use in business by the bank. Within the next ten years, i.e. by 1985, 27 more banks were established in the same manner in the Gulf countries, Egypt, Sudan, etc. Many more were to follow all over the Muslim world. Also by 1985, over 50 conventional banks, some of them located at money centers like London, were offering Islamic financial products. This was followed by up by some of the major conventional banks establishing Islamic branches dealing exclusively in Islamic products. Citi-Islamic in Bahrain and Grindlays in Karachi were followed by the National Commercial Bank in Saudi Arabia establishing over 50 Islamic branches by 1990s.
Islamic investment companies and Islamic insurance companies also appeared in the late 1970s and grew in number. Later, in 1990s, a number of Islamic mutual funds appeared, many of them being managed by reputed western firms.
By the year 2000, there were 200 Islamic financial institutions with over US$ 8 billions in capital, over $100 billions in deposits, managing assets worth more than $ 160 billions. About 40% of these are in the Persian Gulf and the Middle East, another 40% in south and Southeast Asia, the remaining equally divided between Africa on the one hand and Europe and the Americas on the other hand. Two thirds of these institutions are very small, with assets less than 100 million US dollars.
Two Islamic banks operated in Europe for some years. Islamic Bank of Denmark was converted into an investment company and Al Barakah London had to stop deposit taking. As the Bank of England explained, a deposit taking institution had to guarantee its repayment in full in order to qualify for a banking license. As of now, western societies are served either by Islamic mutual funds or by grass roots initiatives at the community level financing the purchase of houses and other consumer durables.
Islamic Banking at the State Level
Pakistan ‘Islamized’ banking between 1979 and 1985 through a series of Ordinances issued by the Federal government and a number of circulars issued by the State Bank of Pakistan, the country’s central bank. Even though profit sharing replaced interest as the basis of time deposits and saving accounts, the actual rates paid are not market determined as all major banks were nationalized during the previous regime. On the assets side mark up became the main basis of bank finance for business. Some financial products based on profit-sharing were launched but their role in the market is minimal. Government finances remain conventional, burdened with huge interest based foreign and domestic debts.
Private initiative played little role in the Islamization process and the market hardly got a chance to throw up Shariah compatible financial instruments. The whole process was conducted with some speed by the bureaucracy under orders from the top. Even the recommendation of the Islamic Ideology Council to make a start from the assets side was not heeded.
Iran passed its usury free banking laws in 1983. All banks are nationalized. In accordance with the school of Islamic law followed in Iran, depositors may get ‘rewards’ on their savings provided they are not committed in advance. Financing of domestic and external trade is done on mark up basis. But sharing modes do play a significant role in financing agriculture and industry. Interest free loans are available for the poor to meet such needs as housing, their source being the state.
Sudan launched Islamic banking in 1984 whose coverage was later extended to the entire financial sector in 1989. Sharing based modes of finance are used in agriculture and industry and the government is considering sharing based investment certificates to be sold to public, the funds so mobilized to be used in developmental projects. The poor state of the economy stands in the way of the market playing any significant role in the process. But the recent phenomenon of oil as an increasing source of public revenue is likely to make a difference.
Malaysia had its first officially sponsored Islamic bank in 1983. All other banks also offer Islamic financial products. Overall supervision vests in the country’s central bank, Bank Negara Malaysia, which has a board of Shariah scholars to advise it. Malaysian Islamic financial system allows sale of debt instruments based on receivables from sale of real goods and services and those based on leasing. The government issues bonds (Malaysian Government Investment Certificates, MGICs) to be redeemed at par but carrying coupons conferring financial benefits that vary. Malaysia has an active Islamic money market trading in assets based securities.
Indonesia’s Bank Muamalat, established 1994 under state patronage, has about 400 branches all over the country. Its financial operations follow the Malaysian model. There are other smaller Islamic banks too, e.g. the Shariah Bank.
Turkey does not practice Islamic banking at the state level, but several Islamic banks were launched under special licenses in late eighties-early nineties. They are still functioning, along with other non-bank Islamic financial institutions.
The Islamic Development Bank
The Organization of Islamic Conference (OIC) took several steps culminating in the establishment of a bank of Islamic countries which would serve the entire Muslim ummah (community of the faithful). Share capital, initially fixed at US dollars two billion was supplied by member countries the largest coming from Saudi Arabia, Kuwait, Libya, United Arab Emirates and Iran. It started operations in 1975 with head quarters at Jeddah, Saudi Arabia. Clause one of its charter states that it was “to foster economic development and social progress of member countries and Muslim communities individually as well as jointly in accordance with the principles of shariah.” In compliance, the IDB does not deal with interest.
By the year 2000 the Islamic Development Bank (IDB) had financed inter-Islamic trade to the tune of over 8 billion US dollars mostly using the mark up technique. It also gives loans, taking only service charges according to actual administrative expenditures. But it does try to promote sharing based modes of financing. It is also managing an investment portfolio in which individual Islamic banks place their surplus liquidity. Even though it cannot, and does not aspire to, serve as a lender of last resort for all Islamic banks, it is trying to help them solve their liquidity problems. It fosters technical cooperation between member countries and has established or sponsored a number of institutions for this purpose. The Islamic Chamber of Commerce and the Islamic Foundation for Science, Technology and Development are two of these. It is also distributing scholarships for higher learning and technical education to Muslim students in countries in which Muslims are in a minority.
In order to fulfill its mission, the IDB has established the Islamic Research and Training Institute (IRTI). It conducts in house research, sponsors external research, publishes a research journal, conducts training courses, organizes seminars and conferences and maintains a database on Islamic countries’ economies, etc.
The Islamic Development Bank interacts with all regional and international financial institutions like the International Monetary Fund (IMF), the World Bank, the Asian Development Bank, etc.
Islamic Banking and Finance as Part of the International Community
The IMF issued its first study on Islamic banking in 1987. Since then more than a dozen research papers have come from that forum on important aspects of Islamic finance. IMF has reported no problems in dealing with member countries committed to Islamic banking. On the other hand Islamic financial institutions too never faced any problems dealing with regional and international financial institutions. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is in contact with the standards committee of the Bank of International Settlements based at Basel, Switzerland.
All Islamic financial institutions operate within the system supervised by their respective central banks and other relevant authorities. They are neither working in isolation nor engaged in creating a separate space of their own. They are inspired by a vision of financial arrangements more conducive to justice and development for all, especially the poor and the weak. This is a goal hopefully cherished by all.
Problems and Prospects of Islamic Banking and Finance
During the last few decades of the twentieth century, the period in which Islamic banking and financial institutions were evolving, great changes were taking place in the financial environment. In this lecture I will examine the problems and prospects of Islamic banking in the perspective of these changes. Two changes are most significant, decline in intermediation and resort to more active, rather aggressive management of investment, and world-wide integration of financial markets in the wake of globalization.
The first trend, symbolized by the repeal of Glass-Steagal in the United States, should be advantageous to Islamic finance insofar as financial intermediation was based on interest. Greater involvement of banks/financial institutions in investment management afforded wider scope for using the Islamic financial techniques of profit-sharing, mark up financing, etc.
The problem is, investment management in modern conditions boils down to risk management which is very underdeveloped in Islamic financial theory and practice. Add to this the fact that, in Islamic perception, this is one of the areas of conventional finance in need of drastic reforms. This need was recently underlined by the story of Long Term Capital Management (LTCM ), (told by Roger Lowenstein in his book, When Genius Failed, Random House, 2000 ). So we face a double challenge, to develop Islamic techniques of risk management and to see that these new techniques are free from the ills with which conventional methods are suffering. This is different from the challenge faced in the middle of twentieth century, to develop a method of financial intermediation free of interest.
Risk Management in an Islamic Framework
The task is stupendous. Mastery of risk may be regarded as the unique feature distinguishing the modern times. Some one has rightly remarked that elimination of risk has stolen the center stage from the elimination of scarcity as a major preoccupation.
Risk was always there, especially in business. But industrialization brought risks unknown in trade and agriculture. Industrial production often involves long periods of time .The longer the period of production the more the uncertainty. The scope of the market has expanded to cover the whole world, introducing new kinds of risk. More than a thousand years ago, when Islamic laws were being written, the nature and scope of risk and uncertainty was different. However, something can still be learnt which, in combination with the modern experience, should enable us to realize the Shariah objectives of justice, fairness and efficiency.
The Prophet is reported to have prohibited the sale of an unborn calf, i.e. one still in its mother’s womb. He is also reported to have prohibited sale of fish still in the pond. In both cases the reason is the uncertainty surrounding the quality and/or the quantity of the commodity being sold. Also, note that it was possible to remove the uncertainty involved to ensure fair dealing without killing the deal itself or causing unbearable inconvenience.
The Prophet is reported to have permitted the sale of fruits still on the trees and yet to ripe, despite the uncertainty as to quantity and/or quality present. It was not possible to wait till the fruits were fully ripe and were plucked and weighed or counted. That would leave no time for marketing.
The Prophet is reported to have prohibited the sale of a non- existent commodity. But he did allow salam, sale of an agricultural produce months ahead of the crop, provided the price was paid in advance at the time of contract. This was found to be advantageous to the farmer as well as the grain trader, hence the uncertainty present was tolerated for a purpose.
The message seems to be clear. Transactions need be based on complete information, as far as possible, in order to ensure neither party is under any illusion. But, given mutual consent, some uncertainty can be tolerated in order to secure larger advantages.
As to be expected, the juristic discussion of gharar (hazard, uncertainty) or transactions in absence of complete information is full of controversies. Some would care more for fairness and, hence, try to discourage transactions in situations of incomplete information. Others would give more importance to allow people enter deals they perceive to be mutually advantageous. I do not propose to enter into the details in the limited time available. I would rather draw attention to what exactly is involved in terms of human needs and interests in situations in which contracts must cover the future in order for life to go on efficiently.
Risk, Speculation and Gambling
It is important, at this stage, to distinguish gambling, which must be avoided, and other kinds of risk taking. In the words of Irving Fisher, a gambler seeks and makes risk which it is not necessary to assume. All games of chance are of this nature. But life is full of risky situations which cannot be avoided. Business specially involves risk because production of wealth as well as some other transactions involve the future, and it is not possible to have full and certain information regarding the future. People arrive at ways to face these uncertainties that are mutually advantageous. We try to understand this through some examples.
A farmer sells future contracts of grain in order to protect himself from a fall in price, whereas a food processor buys future grain contracts in order to protect himself from a rise in prices. Both benefit. Even though each one is taking some risk, total risk is now less and both can go ahead with their production plans on the basis of agreed prices. Another example is oil futures sold by oil companies and purchased by airlines. Without these contracts possible fluctuations in oil prices would make future planning in both industries almost impossible.
Since direct deals between farmers and food processors or oil companies and airlines would be cumbersome and costly, it is efficient to have middlemen/intermediaries. Some sort of clearing arrangements soon follow. In short we have a new market for commodity futures. There is a role in this market for speculators. They do not, like gamblers, create or invite the risks they are dealing with. These are business risks which had to fall some where. Speculators take these risks, pool them, repackage them into parcels more acceptable to some in terms of quantity, quality, time involved, etc. Speculators take risks in order to make a profit thereby. They specialize in transferring risks to those willing to take them. They also allocate risk over time. Future markets have decisive impact on spot markets, making them more stable.
Current research in these matters, and on the subject of risk management in Islamic framework in general, is inconclusive. The position is the same when we consider the currency markets. Contractors need different currencies at different points of time in order to fulfill production plans extending far into future and involving inputs from several currency areas. To make a commitment to do a job like delivering an aircraft or a shopping complex or an airport at a price denominated in a single currency at the time of the contract, the firm doing the project has to ensure that requisite amounts of other currencies are available at the proper time to buy the inputs needed. This involves buying foreign currencies in advance, something not permitted in Islamic law as interpreted at the present. Some scholars do, however, find a way through binding promises doing the job of actual contracts.
Current methods of dealing with uncertainties in the financial markets involve dealing in derivatives. These are innovations with little by way of precedents in the past. Some Islamic scholars find the old practice of urboon, i.e. depositing a small fraction of price in a deal to be concluded in the future, capable of justifying some kind of options which are the simplest kind of derivatives. This could be the first step towards a broad range of derivatives, some of them based on futures.
Financial Markets
It is time to wind up this discussion of financial markets in Islamic framework with a synoptic view of the situation. If we classify financial transactions into:
Money for money
Money for equity
Money for debt
Debt for equity
Debt for debt
Equity for equity
Prohibition of interest seems to affect all the three markets into which debt figures, insofar as debt can be traded only at par. Money for equity poses no problems. Nor does the swapping of equity for equity. I have already noted the problem relating to the currency market. The overall conclusion is that financial markets under Islam will be smaller as compared to their size in an interest based regime, all other things remaining the same.
Islamic economists think it will be good for society. The ballooning of the financial sector out of all proportions with the real economy has undesirable consequences for the distribution of income and wealth. It also makes it amenable to gambling like speculation.
But a too restrictive approach on part of Islamic scholars in the name of minimizing gharar (hazard, uncertainty) and blocking the road to riba (sadd zariah) runs the greater risk of stifling genuine economic activity by reducing the amount of liquidity available on the one hand and increasing the total amount of risk on the other hand. The overall result could be Muslim societies run in accordance with these restrictive interpretations of Shariah lagging behind in economic progress and losing out to others, eventually, politically and culturally also. Instead of being the heralders of a more just, more stable and more efficient financial regime they would then serve only as a warning against a religious and moral approach to money, banking and finance. That would be a disaster that needs not be. It is hoped the new generation of Islamic economists will rise to the challenge posed by this situation.
Globalization of Financial Markets
This is the second change I mentioned in the beginning. Financial markets the world over are integrated as never before. Money moves across national boundaries without cost and instantaneously. The few remaining exceptions are on the way out. In principle this change should be favorable to Islam which never cared much for national boundaries. In practice however it does pose problems for Islamic financial movement, for two different reasons. Firstly the home base of this new trend is the Middle East and South and South East Asia where the economies are small and financial system less sophisticated than in the developed countries. Secondly, Islamic financial institutions themselves suffer from smallness in size and very few of them operate in more than one country as the major players in the field do. The situation has changed with the entry of some major conventional financial institutions into the field. But that has made it harder for the older Islamic financial institutions, obliging them to consider mergers and consolidation.
Globalization has increased the volatility of almost every financial variable, especially the exchange rates. It has also reduced the efficacy of national economic macro-management. The redress can only come through international agreements curbing speculation and regulating the financial markets. The insights of the Islamic financial movement relating to sharing modes of finance, commodity-linked financing like murabaha, and reducing the role of debt have great potential in this regard.
Prospects at the State Level
There is a lull in the state sponsored Islamic finance. Pakistan, which took the lead, is in a flux. With the economy skidding and burdened with huge domestic and foreign debt, it is faltering in its resolve to forge ahead with an innovative approach to money, banking and finance. Sudan, possibly emerging out of a period of being ostracized by western countries, sends no signals of being in a better situation. Malaysia was expected to do better after its emergence from the crisis that visited South East Asia in 1997-98, but the world wide recession looming on the horizon at this moment (November 2001) makes the prospects uncertain. Little is known about Iran, but at least there is no setback and no weakening of the political will. In short, no new initiatives are expected in state sponsored Islamic banking and finance in view of the difficult economic situations and political uncertainties in the countries pioneering the experiment.
Prospects in the Private Corporate Sector
Meanwhile progress has been made in the regulation of Islamic financial institutions by their respective national authorities in view of the increasing market share of these institutions. There is better understanding of Islamic finance by the monetary authorities and closer cooperation between them and these institutions, sometimes with the involvement of the Islamic Development Bank.
Efforts to standardize Islamic financial products continue. The standards developed by the Accounting and Auditing Organization of Islamic Financial Institutions are being adopted. The need to standardize such basic elements of Islamic finance as mudaraba, murabaha and ijara is widely felt as the present lack of uniformity is baffling. There are moves to coordinate the activities of the various Shariah advisory boards of Islamic financial institutions as the way they function remains a source of confusion.
There is a big information deficit in the Islamic financial industry hampering its further growth and development. The absence of rating agencies, specially agencies that would rate products as well as institutions on the ground of their Shariah compliance, is the biggest example of this deficit.
Despite odds, the industry continues to grow, especially in the Gulf countries. It has also reached the newly independent Central Asian Islamic Republics and the Balkans. But the weak economic conditions in those countries are naturally reflected in the state of their nascent Islamic financial institutions.
Prospects at the Grass Roots and the Community Level
The youngest Islamic financial institutions are found outside Muslim majority areas, in the Americas, Europe and India. Many of them have successfully completed their first decade of operations. All of them are growing in size. They serve their respective communities in interest free house finance and installment purchase of consumer durables, as well as in investing their savings on the basis of profit sharing. The possibilities of expansion are great.
Research and Development
All innovations need a base in research and development, which in turn draw on fundamental research in universities and laboratories. Islamic finance became a subject of research in universities in 1980s. The subject is discussed every year at high profile conferences in Bahrain, Harvard, and other places. Yet the resources devoted and the facilities available hardly match the challenges facing the industry.
As the Bank of International Settlements has noted, innovations in three directions are crucial: liquidity enhancement, risk transfer and revenue generation. In its early days Islamic finance had to focus on revenue generation as it had to compete with conventional finance and show comparable returns. Times have changed. The need to enhance liquidity, and hence to move towards greater securitization of assets, is already recognized as evidenced by the developments in Malaysia. The bottleneck at the present seems to be risk management.
Another important area awaiting innovative initiatives is a vision that encompasses Zakat (obligatory charity) Waqf (charitable endowments) and Islamic financial management. Securitazation can help mobilize the huge wealth locked into awqaf properties which in their turn can be developed by investment of zakat funds awaiting distribution. At the present only a small fraction of the liquidity generated by zakat passes through Islamic financial institutions, a situation reflecting the distance between the poor, non-banking population and these institutions.
The goal of progress with justice and equity inspires the entire humanity and there is no reason the potential of Islamic financial institutions contributing towards the realization of this goal remain unexploited. In the age of globalization no system that serves only the interests of a particular country or group of countries can evoke universal acceptability. Protection of small countries from speculators chasing instantaneous profits, reduction of the role of debt in international finance and financing projects helpful in reducing poverty and inequality deserve every ones attention.
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Seeking Halal Earning By Khalid Baig

According to Abdullah ibn Masud, Radi-Allahu unhu, The Prophet Muhammad, Sall-Allahu alayhi wa sallam, said: 'Seeking halal earning is a duty after the duty.' In other words working to earn a halal living is itself a religious obligation second in importance after the primary religious obligations like prayers, fasting and hajj.

This brief hadith contains three very important messages. First, it points to the Islamic way out of the apparent dichotomy between the material and the spiritual worlds. We often see them working in opposite directions. Indulgence in the material world does lead one away from the spiritual world. Spiritual uplifting seems to accompany a tendency to distance oneself from the material pleasures. There is a conflict, but is there a contradiction also? Is it possible to resolve the conflict in a way that one can take care of both? Or are they mutually exclusive? This has been a central question for all religions and many in the past suggested the second answer, making hermits as the ideal for the humanity. Unfortunately not much humanity is left when one moves too far in this direction. One can read today the horror stories of Christian and Hindu monks, among others, who tried to seek spiritual purification this way.

As a reaction, others took the other course, making material pleasures the goal of this life. The western civilization today is the prime example of that. Its toll on human spirit and morality is well known and is a constant reminder that something is wrong here as well.

In between the two extremes Islam points out the Straight Path. Man is both a material and a spiritual being. The solution does not lie in denying the material needs and desires but in denying their claim to primacy. They are part of being but not the reason or goal of being. As long as they are kept in place, they are an important part of our life. The problem is not money but the love of it. Wealth itself is not bad. In fact Qur'an refers to it as ' ... your wealth which Allah has made for you a means of support.' [Al-Nisa, 4:5]. And another hadith praises the merits of 'the halal wealth of a pious person.' The effort to earn a living is not only not against spirituality, it is a religious obligation!

But this earning must be through halal means. This is the second message of this hadith. Our obligation is not just to make money but to make halal money. This is a broad statement that is the basis for Islamization of a society's economic life. Not every business idea or possible business enterprise is good for the society. And the decision regarding right and wrong here cannot be left to the so-called market forces. Right and wrong in the economic life, as in all life, must be determined by a higher source. Shariah guides us as to the halal and haram business enterprises and practices, and at both individual and collective levels we must follow that guidance.

At times that guidance may conflict with the prevailing practices. For example riba (interest), gambling, pornography, and liquor are haram, and no matter how attractive the financial rewards of engaging in those enterprises may seem to be, a Muslim must refrain from them. This is the economic struggle of a believer, and it is obvious why it should be carried out as a religious obligation. At the individual level the obligation is to engage is halal professions and businesses. At the collective level the obligation is to establish a system that facilitates such individual efforts and discourages their opposite.

Sometimes we lose the balance between obligations at the two levels. Obviously our ultimate responsibility is at the individual level; in the hereafter we will be asked about what we did in our personal lives. At the same time, in the era of multi-national companies, CNN, IMF, World bank, and GATT, it is obvious that individual efforts alone cannot steer the economic life of a society in the direction of halal. Why avoiding interest has become so difficult today? Not because of its inherent merits as a healthy financial instrument but because it is entrenched in the system. Can we build an Islamic life style when the CNN is advertising a western life style in the most enticing ways 24 hours a day in our homes? Can we resolve the issues of halal and haram in taxation in Muslim countries when the national budgets and tax decisions are dictated to these countries by the IMF and the World Bank? (Jurists say that taxes may be permissible if they are necessary, reasonable, fair, within the ability of the payers, and if the means of collection are not harsh. Otherwise they are unjust and haram). Obviously the struggle to avoid haram individually must, of necessity, include the struggle to change the system that forces haram.

Third, all this effort for halal earning should not eclipse our primary religious obligations. Indulgence even in a purely halal enterprise should not make us miss our Salat, or hajj, for example.

This point is more important than we may realize at first. In this century, some Islamic movements made the error of suggesting that the primary acts of worship. like Salat were not meant for their own sake, but were there to prepare us for the real challenge of establishing an Islamic state. It was stated to persuade the audiences to join such movements but the speakers had gone carried away and in effect it would result in an inversion of the relationship between the two. The result is that those drawn to collective struggles, in political or economic arenas, sometimes may ignore their primary religious responsibilities, in favor of the 'bigger' struggle. This hadith may help us set our priorities right: The economic endeavor is a duty after the primary duties. And let us remember: In economics, as well as in religion, getting the priorities right is part of being right.

Principles Of Islamic Banking

For millions of Muslims, banks are institutions to be avoided. Islam is a religion which keeps Believers from the teller's window. Their Islamic beliefs prevent them from dealings that involve usury or interest (Riba). Yet Muslims need banking services as much as anyone and for many purposes: to finance new business ventures, to buy a house, to buy a car, to facilitate capital investment, to undertake trading activities, and to offer a safe place for savings. For Muslims are not averse to legitimate profit as Islam encourages people to use money in Islamically legitimate ventures, not just to keep their funds idle.

However, in this fast moving world, more than 1400 years after the Prophet (s.a.w.), can Muslims find room for the principles of their religion? The answer comes with the fact that a global network of Islamic banks, investment houses and other financial institutions has started to take shape based on the principles of Islamic finance laid down in the Qur'an and the Prophet's traditions 14 centuries ago. Islamic banking, based on the Qur'anic prohibition of charging interest, has moved from a theoretical concept to embrace more than 100 banks operating in 40 countries with multi-billion dollar deposits world-wide. Islamic banking is widely regarded as the fastest growing sector in the Middle Eastern financial services market. Exploding onto the financial scene barely thirty years ago, an estimated $US 70 billion worth of funds are now managed according to Shari'ah. Deposit assets held by Islamic banks were approximately $US5 billion in 1985 but grew over $60 billion in 1994.

The best known feature of Islamic banking is the prohibition on interest. The Qur'an forbids the charging of Riba on money lent. It is important to understand certain principles of Islam that underpin Islamic finance. The Shari'ah consists of the Qur'anic commands as laid down in the Holy Qur'an and the words and deeds of the Prophet Muhammad (s.a.w.). The Shari'ah disallows Riba and there is now a general consensus among Muslim economists that Riba is not restricted to usury but encompasses interest as well. The Qur'an is clear about the prohibition of Riba, which is sometimes defined as excessive interest. "O You who believe! Fear Allah and give up that remains of your demand for usury, if you are indeed believers." Muslim scholars have accepted the word Riba to mean any fixed or guaranteed interest payment on cash advances or on deposits. Several Qur'anic passages expressly admonish the faithful to shun interest.

The rules regarding Islamic finance are quite simple and can be summed up as follows:
a) Any predetermined payment over and above the actual amount of principal is prohibited

Islam allows only one kind of loan and that is qard-el-hassan (literally good loan) whereby the lender does not charge any interest or additional amount over the money lent. Traditional Muslim jurists have construed this principle so strictly that, according to one commentator "this prohibition applies to any advantage or benefits that the lender might secure out of the qard (loan) such as riding the borrower's mule, eating at his table, or even taking advantage of the shade of his wall." The principle derived from the quotation emphasises that associated or indirect benefits are prohibited.
b) The lender must share in the profits or losses arising out of the enterprise for which the money was lent

Islam encourages Muslims to invest their money and to become partners in order to share profits and risks in the business instead of becoming creditors. As defined in the Shari'ah, or Islamic law, Islamic finance is based on the belief that the provider of capital and the user of capital should equally share the risk of business ventures, whether those are industries, farms, service companies or simple trade deals. Translated into banking terms, the depositor, the bank and the borrower should all share the risks and the rewards of financing business ventures. This is unlike the interest-based commercial banking system, where all the pressure is on the borrower: he must pay back his loan, with the agreed interest, regardless of the success or failure of his venture.

The principle which thereby emerges is that Islam encourages investments in order that the community may benefit. However, it is not willing to allow a loophole to exist for those who do not wish to invest and take risks but rather content with hoarding money or depositing money in a bank in return for receiving an increase on these funds for no risk (other than the bank becoming insolvent). Accordingly, under Islam, either people invest with risk or suffer loss through devaluation by inflation by keeping their money idle. Islam encourages the notion of higher risks and higher returns and promotes it by leaving no other avenue available to investors. The objective is that high risk investments provide a stimulus to the economy and encourage entrepreneurs to maximise their efforts.
c) Making money from money is not Islamically acceptable

Money is only a medium of exchange, a way of defining the value of a thing; it has no value in itself, and therefore should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or lent to someone else. The human effort, initiative, and risk involved in a productive venture are more important than the money used to finance it. Muslim jurists consider money as potential capital rather than capital, meaning that money becomes capital only when it is invested in business. Accordingly, money advanced to a business as a loan is regarded as a debt of the business and not capital and, as such, it is not entitled to any return (i.e. interest). Muslims are encouraged to purchase and are discouraged from keeping money idle so that, for instance, hoarding money is regarded as being unacceptable. In Islam, money represents purchasing power which is considered to be the only proper use of money. This purchasing power (money) cannot be used to make more purchasing power (money) without undergoing the intermediate step of it being used for the purchase of goods and services.
d) Gharar (Uncertainty, Risk or Speculation) is also prohibited

Under this prohibition any transaction entered into should be free from uncertainty, risk and speculation. Contracting parties should have perfect knowledge of the counter values intended to be exchanged as a result of their transactions. Also, parties cannot predetermine a guaranteed profit. This is based on the principle of 'uncertain gains' which, on a strict interpretation, does not even allow an undertaking from the customer to repay the borrowed principal plus an amount to take into account inflation. The rationale behind the prohibition is the wish to protect the weak from exploitation. Therefore, options and futures are considered as un-Islamic and so are forward foreign exchange transactions because rates are determined by interest differentials.

A number of Islamic scholars disapprove the indexation of indebtedness to inflation and explain this prohibition within the framework of qard-el-hassan. According to those scholars, the creditor advances the loan to win the blessings of Allah and expects to obtain the reward from Allah alone. A number of transactions are treated as exceptions to the principle of gharar : sales with advanced payment (bai' bithaman ajil); contract to manufacture (Istisna); and hire contract (Ijara). However, there are legal requirements for the conclusion of these contracts to be organised in a way which minimises risk.
e) Investments should only support practices or products that are not forbidden

-or even discouraged- by Islam. Trade in alcohol, for example would not be financed by an Islamic bank; a real-estate loan could not be made for the construction of a casino; and the bank could not lend money to other banks at interest.

Dealing With the Financial Crisis

“By Muzammil H. Siddiqi
President of Fiqh Council — North America
Almighty Allah says in the Glorious Qur’an,
(O children of Adam, look to your adornment at every place of worship and eat and drink but do not be extravagant; surely He does not love the extravagant.) (Al-A`raf 7:31)
(But seek the abode of the hereafter in that which Allah has given you and neglect not your portion of the world, and do good (to others) as Allah has done good to you, and seek not corruption in the earth; surely Allah does not love the corrupters.) (Al-Qasas 28:77).
Today, America is in the grip of a terrible financial crisis. Chicago-based psychologist Nancy Molitor said, “It is not a Wall Street crisis — it is affecting the entire consumer economy and almost every individual that I see …. I have never seen something that has affected such a wide range of people. The number of people seeking mental help because of finance-related stress has skyrocketed over the last month.”
She further said,
There is a sense of total helplessness, which if it goes on long enough, it becomes depression.
A survey conducted by the American Psychological Association found that eight in ten Americans say the economy is a major source of stress in their lives. Nearly half say they are worried about providing for their families’ basic needs.

Causes of the Crisis

Multiple factors have brought about this crisis: greed, corruption, mismanagement, extravagance, injustice, war, exploitation, riba (usury), etc. Fixing this crisis and bringing the situation back to normal may take years. Meanwhile, it is our turn to learn how to deal with this situation for our own sake and for the sake of our children. When people are in a financial crunch, they normally try to find scapegoats.
In political or financial crises, minorities (whether racial or religious) often suffer more, and we, Muslims, are already under great stress due to negative propaganda. For us, Muslims in America, it is even more important to understand this financial challenge and to face it with wisdom.
According to the Qur’an, money is both a blessing and a trial. It is sometimes called khayr (a blessing) as in Verses 180 and 215 of Surat Al-Baqarah. It is called qiyam (a mean of support) as in Verse 5 of Surat An-Nisaa’. It is also called fadl (a bounty) as in Verse 198 of Surat Al-Baqarah, Verse 10 of Surat Al-Jumu`ah, and Verse 20 of Surat Al-Muzzammil.
However, it is also called mata` (a temporary thing) as in Verse 60 of Surat Al-Qasas. It is called fitnah (a trial) as in Verse 28 of Surat Al-Anfal.
In the Qur’an and the Sunnah of Prophet Muhammad (peace and blessings be upon him), we are reminded again and again to earn in the ways that are honest and halal (permitted by Allah). We are reminded to avoid deceiving, defrauding, cheating, stealing, and being greedy. We are also told that we should use our wealth carefully, without waste or extravagance.
As for the current crisis, I suggest that every one of us deals with it as follows:
1. First and foremost, observe taqwa (piety and fear of Allah) and tawakkul (trust in Allah). Allah has promised in the Qur’an,
(And [for] whosoever keeps his duty to Allah, He will appoint a way out for him and give him sustenance from whence he thinks not, and [for] whosoever trusts in Allah, He is sufficient for him; surely Allah attains His purpose; Allah has indeed appointed a measure for everything.) (At-Talaq 65:2–3)
In this situation, observing taqwa and tawakkul would mean that — first of all — we should not panic; we should remain steadfast and content. It would also mean working hard without doing anything that is haram (prohibited by Allah) or illegal (opposed to the law of the land).
2. Second, remember that Islam teaches us to live debt-free. Avoid taking loans as much as possible. However, if you take any loan, pay it off as soon as possible.
Loan with interest is a great wrong that should be completely avoided. The worst loans are those of the credit cards. They can easily be obtained, and they have the highest interest. They already ruined the lives of many middle-income people. Wise people should treat their credit cards just like cash. They should not get into what is called “buying what you do not need with the money that you do not have.”
3. Third, be careful with your resources. Wastefulness, extravagance, show-off, and unnecessary expenditure are signs of ungratefulness toward Allah. Those who waste their resources and indulge in extravagance are called devils’ brothers. Almighty Allah says,
(Surely the squanderers are brothers of the devils, and the devil is ever ungrateful to his Lord.) (Al-Israa’ 17:27).
4. Fourth, learn how to save money for yourself and for your children. The Prophet said,
“Take advantage of five before five: your youth before your old age, your health before your sickness, your wealth before your poverty, your free time before your becoming [too] busy, your life before your death.” (Al-Hakim in Al-Mustadrak)
5. Fifth, be smart with your money. Invest it very carefully and always in halal ways. Also, do not be fooled by telemarketers or people who will try to take away your money by giving you many incredible “lucrative” ideas. Some of them may even come to the mosque (also with a very pious look) and then deprive you of your precious earnings or savings. Check out every proposal very carefully and consult with others.
6. Sixth, take care of your health. Health costs drain the savings of many people. Find a good health plan and keep it up.
7. Seventh, pay your zakah (obligatory alms) in due course and give sadaqah (optional charity) regularly. This is the best way to receive Allah’s blessings and to avoid stumbling in difficulties. Help the poor and the needy. Help those who are out of job and are in difficulties. Those who help others will be helped by Allah. The Prophet said,
“The most beloved to Allah among the people are those who are most beneficial to others. The most beloved deeds in the sight of Allah are bringing happiness to a Muslim, removing his or her difficulty, paying off his or her debt, and removing his or her hunger. Going out with my Muslim brother [or sister] to take care of his [or her] need is more beloved to me than spending a month of i`tikaf[spiritual retreat in the mosque]. For those who control their anger, Allah will cover their shortcomings. For those who subdue their revenge that they can carry on, Allah will fill their hearts with happiness on the Day of Judgment. For those who walk with their brothers [or sisters] to take care of their needs, Allah will establish their feet on the Day when the feel will stumble. Bad temper spoils the deed as vinegar spoils honey.” (Reported by At-Tabarani in the Kabir and by Ibn Abi Dunya. Al-Albani said it is a good hadith)
I pray to Allah so that He would keep us all on the right path and save us from all difficulties in this world and the hereafter. Amen.”
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Tags: Causes of the Crisis, Financial Crisis

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4 Responses to “Dealing With the Financial Crisis”

1. Muhammad Says:
October 20th, 2008 at 9:52 am

It is clear that oppression will not stay for ever. moreover, those who opressed will be judged at the day of judgement