Islamic Banking and Conscious Capitalism

The nature of money

At the January 2010 World Economic Forum Annual Meeting in Davos, the erudite and prolific Sharia scholar, Muhammad Taqi Usmani, was invited to present a paper with a somewhat radical theme: reforming the world’s post-crisis financial landscape through the lens of religion. The paper generated little interest from the world’s media, which preferred instead to focus on the forum’s lack of reform plans and the predictably defensive stance taken by bankers. Had they read the 37-page document, though, they might have concluded that “caring capitalism” had the potential to be more than a mere romantic notion.

agent bankingUsmani’s paper proved inspirational for introspective Islamic bankers searching for direction. It questioned the very nature of money, inviting a radical philosophical shake-up of their ordered universe. Perhaps few in the audience (if any) were moved that day to tweak their banking practices, but they nonetheless came away with the counsel that social awareness ought to be the underpinning of finance.

When newspapers announce the launch of new Sharia-compliant financial products or institutions, it is often assumed that they are only referring to products that conform with Islam’s ban on interest, as if that were the only relevant criterion and a bank’s only job to make loans. Perhaps as a direct consequence, there are even Muslims who find the modern practice of Islamic banks abhorrent and little different to the practice of conventional banks. Their reasoning is that if Islam prohibits the receipt or payment of interest, then the only business that Islamic banks should be engaging in is interest-free lending, conveniently ignoring the fact that an interest-free loan is construed as an act of charity in Islamic law, and no enterprise driven by the profit motive can be predicated on charity.

Indeed, bank profit is emotive subject for Muslims, particularly when set in the context of a world economy creaking ominously under the weight of capitalism. To what extent is the pursuit of profit acceptable in Islam, if at all? How is one allowed to make profit in a halal (permissible) manner? How are Islamic financial institutions allowed to deploy and invest capital to be profitable in a manner that is compliant with Islamic law? To answer these questions, one must address the nature of money itself.

Sharia And The Role Of Money

As the end of the Prophet Muhammad’s life drew near in 632, he took what he perhaps saw as his last opportunity to raise issues of the utmost importance that he didn’t want his ummah (nation) to let lapse. His final sermon covered women’s rights, the need to perform the daily prayers, to fast during the month of Ramadan, and to give to charity. He also reminded his followers that life and property are a sacred trust; that they should hurt no one by their actions, saying, “Allah has forbidden you to take riba (interest), therefore all interest obligation shall henceforth be waived. Your capital, however, is yours to keep. You will neither inflict nor suffer any inequity.”

A crucial difference between Islamic finance and Western-style banking can be found in the way each system perceives the worth—and role—of money.

In the space of a few minutes, the prophet reminded his followers for the last time that human rights and property rights were paramount—that justice and fairness should be a driving force in their daily lives. And that they now had a complete framework from which to build a new world, irrespective of whatever the curiosity and ingenuity of the human mind would discover or create. Muhammad’s companions, and the men who would come a generation after them, would turn out to be the codifiers of God’s law, particularly in the field of commercial transactions, and their legal analysis would prove to be the lubricant for the advancement of human knowledge, rather than an insurmountable barrier of dogma and intolerance that many today have come to regard as the attributes of religion.

Arab and Persian merchants went on to forge trade links to India and the Far East, becoming indispensable in the chain of trade between East and West. Arab merchants from Baghdad could travel to Cordoba, Spain, taking with them a letter of credit—a suftaja—to be cashed on arrival by an agent, part of a network of money transfer that came to be known as hawala. The hawala would go on to influence the development of the agency concept in common and civil laws throughout Europe. The sakk—a forerunner of our modern-day check—allowed early bankers to become indispensable to every trader as a guarantor of paper money at markets in cities throughout the Islamic world. Muslim traders would share the profits of their ventures with their sponsors through investment partnerships now referred to as musharaka and mudaraba. An exchange economy became the framework for Islamic merchant capitalism.

While Europeans were venturing little further south and east than the islands of Greece, Arab and Persian traders were ranging across continents. By the tenth and eleventh centuries, ultra high net worth merchant families began to dominate commercial activities between the two cultures. In the major cities along the East/West trade route, the funduq (trading exchange) was established and run by leading merchant families within their region. Funduqs developed into commodity exchanges and warehouses, and the great wealth accumulated by the families who controlled these exchanges enabled them to finance state projects and operate an early form of banking institution, taking in deposits and advancing credit to customers. Within a few centuries, Crusaders would encounter Arabian merchants and carry their new-fangled ideas—such as the trust law encapsulated in the Waqf and the agency concept intrinsic to the hawala—back to the Mediterranean. Not only would the techniques of commerce and finance filter through to medieval Europe, but also an entrepreneurial spirit of enterprise that had, to date, been less widespread in Europe.

Ironically, given the negative connotation that capitalism has today—with all its implications of greed and selfishness—it was the Islamic world that institutionalized capitalism and brought it to the West in the form which with we are now familiar. Somewhere along the way, though, the Islamic capitalism that afforded protection to the weak and the needy became diluted. By the time the Ottomans became the pre-eminent Muslim power at the end of the fifteenth century, their approach to financial and monetary institutions dispensed with customs, traditions, and religious guidance. Earlier banking systems such as the hawala method of money transfer were still widely in use, and the 100,000 pilgrims traveling annually to Makkah continued to make use of the suftaja bill of exchange in order to draw money at their journey’s end. Court records of Anatolian cities, however, show that interest-based lending was a frequent and apparently tolerated practice. As European moneylenders ascended in prominence, Ottoman practices eventually fell into line. It would not be until the mid-twentieth century that Islamic finance would reassert its identity.

By Harris Irfan.