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Shariah Financing

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What is shariah?

Understanding Shariah law is integral to understanding the dangers of Shariah-compliant finance. Shariah law is Islamic law dating back to the 7th century and is today the law of the land in Saudi Arabia, Iran, Sudan and the law under which the Taliban operates.

Shariah law authorities, some of whom are now being paid handsomely by Barclays, Dow Jones, Standard & Poors, HSBC, Citibank, Merrill Lynch, Deutschebank, Goldman Sachs, Morgan Stanley, UBS, Credit Suisse and others have the power to dictate Shariah compliance as deemed by “scholarly consensus” on matters of finance, family, penal law, apostasy, and war. Examples of authoritarian Shariah law include: requirement of women to obtain permission from husbands for daily freedoms; beating of disobedient woman and girls; execution of homosexuals; engagement of polygamy and forced child marriages; the testimony of four male witnesses to prove rape; honor killings of those, principally women, who have dishonored the family; death to apostate Muslims who chose to leave Islam; inferior status of non-Muslims, and capital punishment for those who “slander Islam.”

Differences and Similarities between Shariah Financing and Conventional Financing

Islamic finance has several characteristics that make it quite different – at least on the surface – from "traditional" Western finance. The most obvious is the prohibition on earning interest. But there are others as well. The Koranic injunction against gambling has been interpreted as a prohibition on contracts where the final terms of the contract (the thing to be delivered, how much is to be paid, etc.) cannot be determined until some future event. This interpretation effectively prohibits most Western commodities and futures contracts and insurance. There is also a third prong to Islamic finance that goes to what you can invest in, rather than the form the investment may take. This, however, is relatively straight-forward and very similar to Western concepts of "ethical investing." For example, following Islamic investing principles, because Shariah prohibits eating pork, drinking alcohol, gambling and watching pornography, investing in Hormel, Seagrams, PartyGaming and Playboy would be no-no's.

Source: http://mydailyfatwa.blogspot.com/2007/01/problem-in-islamic-finance.html

Prohibitions on interest not uniquely islamic or religious

Historic distaste for charging interest was not limited to the religious. Aristotle, in both the Politics and the Ethics argues that charging interest is wrong. In the Politics, Aristotle describes usury as:

  • The most hated sort (of wealth generation) and with the greatest reason, is usury, which makes a gain out of money itself and not from the natural object of it. For money was intended to be used in exchange but not to increase at interest. And this term interest, which means the birth of money from money is applied to the breeding of money because the offspring resembles the parent. Wherefore of all modes of getting wealth, this is the most unnatural.

christian views on interest

Protestant reformer John Calvin came along that the West rejected the view against interest (though even Calvin thought charging interest was wrong if the borrower was poor). (By the way, I'm not a particularly big fan of Calvin, but I am very thankful it was his economic views, and not Martin Luther's, that came to dominate post-Reformation Europe.)

Problem in the media concerning Shariah Financing

Media journalists are not exposing problems with Sharia Financing because it fits into their wealth redistribution desires - Hot Talk 560, Barbara Simpson, 7-23-2011, interview with author on the issue

  • In the Islamic economy, priority should be given to transactions that can benefit the society at large, rather than just the already wealthy corporations, so that wealth can be more widely circulated. 1
  • 99% of Islam is a military political system, with a veneer of religion to it. "Why is the LAPD favoring, because they believe islam is a religion, favoring muslims with an islamic affairs department funded by federal dollars, but no jewish or christian affairs offices?"

Growth of Islamic finance

Since its inception in the 1960s and 70s, the popularity, scope, and diversity of what the field of Islamic finance has to offer has only grown with time.

  • $750B market worldwide for products of "Islamic" banks from countries such as Bahrain, Malaysia, and Pakistan

problem of Shariah advisors

  • Shariah financing and banking requires Shariah Advisory Boards, at both institutional and national levels
    • there are relatively few Shariah scholars available to serve as advisers to financial institutions.
    • several of the most prominent Shariah advisers have either expressed hateful Jihadist views, have direct ties to Jihadists, or were educated in Jihadist-favored incubators.
    • Results:
      • the same scholars sit on the boards of as many as 20-25 financial institutions, many of which are in direct competition with one another.
      • Often these same scholars head, direct or sit on the boards of self-regulating organizations, such as AAOIFI, at the same time that they are being paid by the institutions that are supposedly being regulated.

Problems of shariah financing

first type of problem includes:

  • need for standardization of Shariah rulings, and hence Islamic financial products, across various geographical and sectoral jurisdictions;
  • need to enhance the authenticity and credibility of Shariah Boards that advise banks and other institutions on compliance;
  • need to develop regulatory guidelines and audit mechanisms for these institutions;
  • need to better extend customer rights and protections to Islamic financial transactions;
  • need to develop legal and regulatory frameworks that support dispute resolution in the Islamic financial context, especially in the Western world;
  • need for appropriate disclosure of Shariah-rulings to reduce compartmentalization and allow dissemination, adoption, and cross-examination.
  • risk management is very underdeveloped in Islamic financial theory and practice
    • 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.

It is an open secret in the Islamic financial community that one of the areas of work is to find ways to create financial instruments that could closely replicate the risk and return profiles of those available in modern finance.

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.

Specific examples of shariah financing principles

For example, one of the overriding principles of Islamic transaction law is the impermissibility, under certain conditions, of undertaking two different transactions within the same contract.

  • Problems like these have been addressed by breaking down the overall questionable transaction into two segments - each of which, individually, being Shariah compliant - whose combination ends up recreating the overall effect of the forbidden transaction.
    • did Islam, in prohibiting the combining of two transactions into one, really mean to discourage the act of combining itself or did it mean to discourage the effect that this produced?
  • Does Islamic finance have any inherent intrinsic value other than catering to the needs of certain market segment that continues to demand an aura of Shariah compliance - no matter how flimsy it may be - for their financial needs? How Islamic is Islamic Finance?

Islamic finance requires that financial dealings must be backed by real assets and be in line with the Islamic law, Shariah.

  • requirements that the financial dealings must be free from Riba (interest), gharar (uncertainty), and maysir (gambling) ensure that the elements of exploitation and excessive speculation are avoided.
  • must observe the concept of iwad (equal counter-value, which comprises of work effort, risk assumption, and product liability).

Problems with uncertainty in Islamic Financing

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.

Source Problems and prospects of Islamic Banking and Financing

Much of modern interpretation of the Koran runs directly contrary to modern financial concepts – particularly the concepts of the time value of money and risk. For example, most Shariah scholars argue that interest is impermissible, while profit-sharing is acceptable. The idea is that a guaranteed return on an investment is wrong because the risk is not shared equally between the lender and borrower if misfortune should occur; however, if the risk is shared equally, the "lender" and "borrower" are partners and the arrangement is just. Put simply, equity investments are fine, but bonds are not.

Source: http://mydailyfatwa.blogspot.com/2007/01/problem-in-islamic-finance.html

How islam gets around interest in providing car loans

(called a "murabahah" or "cost plus" transaction)

with a typical "traditional" car loan, the bank lends you money, at a certain interest rate, for you to purchase your car. If you default on the loan, the bank takes your car, sells it, and collects what it is owed and gives you whatever may be left.

With an Islamic "loan," the bank buys the car and then sells it to you at a mark-up, to be paid in installments over time. You end up paying the same amount under both scenarios. However, Shariah scholars believe the Islamic loan is more just because, if you default, the bank simply takes back the car and has no further claim on you. With a traditional loan, the bank may still pursue you for any remaining principal if the repo doesn't provide enough.

How does Shariah and Conventional Finance deal with loan security

As a practical matter, car loans are secured with little more than the car itself, whether the bank is Islamic or "traditional." One corrollary of Merton Miller's and Franco Modigliani's work is that the difference between debt and equity is risk, and in an efficient market, the risk-return ratio of debt and equity are the same. In other words, if the market is efficient (and things like taxes and subsidies of various sorts factored out), the less risk I take as a lender, the less return I can expect. Or, if I'm a borrower, the more risk I expose my lender to, the more I'm going to have to pay to get the lender to part with his or her money. The calculus is as close to an iron-clad law as you can get in economics. Consequently, if I'm an Islamic bank and I'm on the hook if your car ends up being stolen goods, or if the only thing that can secure the "loan" is the car itself, the borrower is going to end up paying more at the end of the day. Whether we call it interest or profit, paying more is paying more.

What if an Islamic bank "sells" you a stolen car

(As an aside, there was a case a few years ago where a woman unknowingly bought a stolen car using an Islamic bank. She lost the car after a fender-bender brought to light that the car was stolen, after which she refused to repay the loan, saying that the bank had sold her a stolen car. Much to the bank's chagrin, the Shariah scholar charged with adjudicating the case sided with the woman. The bank's representatives complained that they specialized in making loans, not buying cars and running title searches. The scholar replied that you are either lending at interest or selling at a mark-up – you can't have it both ways.)

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