Contemporary Islamic Finance

Innovations, Applications, and Best Practices

Karen Hunt-Ahmed

• Publisher: Wiley
• Year: 2013
• ISBN:
  9781118240335
• Edition: 1
• Topic: Business
• Subtopic: Islamic Banking & Finance
• Index: Business

A comprehensive look at the innovations, applications, and best practices of Islamic finance

Islamic-compliant finance is transacted in every major world financial center, and the need for information on the topic in light of its global reach has grown exponentially. As an expert in this field, author Karen Hunt-Ahmed understands the intricacies of this area of the capital markets. Now, along with the help of a number of experienced contributors, she skillfully addresses Islamic finance from the perspective of practitioners, examining issues in wealth management, contract law, private equity, asset management, and much more.

Engaging and accessible, Contemporary Islamic Finance skillfully explains the practices and innovations of Islamic finance in everything from banking and real estate to private equity, asset management, and many other areas. It is intended to be the go-to resource for both Muslims as well as non-Muslims with an interest in the subject. Divided into three comprehensive parts, it will put you in a better position to understand, and excel at, this important endeavor.

• Introduces you to the history, legal structures, and basic financial contracts in the industry
• Highlights the various issues facing contemporary Islamic finance practitioners, and details their significance in the contemporary financial and cultural environment
• Includes case studies of United States-based transactions and related challenges and successes

Filled with in-depth insights and expert advice, this detailed analysis of Contemporary Islamic Finance will help you gain a firm understanding of how effective this proven approach can be.

CHAPTER 1

Introduction

Islamic Finance in the World Economy

KAREN HUNT-AHMED

President, Chicago Islamic Microfinance Project Lecturer, DePaul University

The religion of Islam has existed for 1,400 years but Islamic economic theory and its financial institutions as an industry emerged only in the 1970s. Islamic banks are late twentieth-century institutions designed, against the backdrop of a global economy dominated by capitalist business practices, to help Muslims conduct business internationally while simultaneously upholding traditional Islamic values related to trade finance and currency movement. The basis for their existence is the Islamic moral prohibition on charging interest—interest is a central component of capitalist banking—yet Islamic banks conduct billions of dollars of business annually in the world economy and the de facto Islamic banking transaction is—in most cases—virtually identical to a capitalist banking transaction. The industry of Islamic Banking and Finance (IBF)1 is the manifestation of attempts to apply Islamic law and Islamic economic theory to financial dealings.

An Islamic Financial Institution (IFI) refers to any financial institution that performs Islamic transactions derived from either Islamic law or Islamic economic theory. An Islamic Bank is an institution that performs conventional banking services2 (or their Islamic equivalent) such as checking accounts, savings accounts, loans, and so forth. An IFI may or may not be a bank but an Islamic bank is always an IFI. Islamic financial institutions include venture capital firms and insurance companies, and may be distinguished from conventional banks by three primary elements (Bahrain Monetary Agency 2002):

1. Prohibition of prohibited financing arrangements and business practices. The most important prohibition in Islamic finance is the prohibition of riba (interest or usury). This means not only that financing transactions are structured differently than in conventional finance, but also that the asset structure of the institution is based entirely upon tangible assets and partnership arrangements instead of on interest-based financial assets. Gharar (speculation) and maysir (gambling) are prohibited, as well as trading in haram (forbidden) goods such as alcohol, pork, and owning equity in riba-based institutions (Lewis and Algaoud 2001).

2. Integration of religious practices into daily life by governing business under Islamic law.

3. Existence of a Shari'a Standards Board (SSB) composed of Islamic scholars. The SSB's purpose is to insure that Islamic law is being followed accurately in the business practices and financial arrangements of the IFI. A member of the SSB (called a Shari'a Scholar) has been trained formally in Islamic law, but has not necessarily been trained in finance. A separate financial standards board evaluates the efficacy of financial transactions, just as it does in a conventional institution, and the two boards often work together.

Ideally, an IFI should combine the elements of Islamic financial practices with some effort to uphold Islamic daily life practices (Lewis and Algaoud 2001).

The industry of Islamic banking and finance is growing daily. There are hundreds of Islamic financial institutions worldwide and the world's potential market for Islamic finance consists of more than one billion Muslims, in addition to non-Muslims, who are welcome and encouraged to participate in Islamic finance. When I began my fieldwork in 2002, Islamic assets were estimated to be around USD 200–300 billion. By 2011, estimated industry assets under management topped USD 1 trillion and is growing at a rate of at least 10 percent per year.3 The Financial Times reports that at least one bank, Dubai-based Saadiq (the Islamic banking arm of Standard Chartered Bank), saw revenue growth of 65 percent in 2011 over 2010.4

This book speaks to an audience that is dynamically involved in—or thinking of being involved in—the Islamic finance industry. As the industry grows rapidly, finance professionals, investors, attorneys, educators, and students demand more detailed and sophisticated knowledge. Innovations abound as practitioners find ways to reconcile existing practices and regulations with Shari'a requirements. This volume will provide a useful and timely guide to Islamic finance for anyone interested in learning about basic concepts, current issues, and best practices predominant in the industry today.

GLOBALIZATION AND MUSLIM SUBJECTIVITY

World conditions due to globalization have contributed to the formation of the industry of Islamic finance. (Please see Chapter 4 of this volume.) Geographic mobility and technological advances made possible (and desirable) by globalization have profoundly changed definitions of personal, community, and religious identities of humankind. Islamic law does not allow for individuals or institutions that lend money to charge interest on that money. Muslims who orient themselves according to Islamic practices would be acting against their moral constitutions to participate in transactions that involve the charging of interest. Yet in the early twenty-first century global economy, trade finance and other crucial banking transactions are clearly dominated by capitalist financial institutions whose return on investment is based upon charging interest. Heretofore, a Muslim wishing to participate in the global economy has had to invest in capitalist institutions and act in opposition to his or her religious and moral belief system. As financial resources in the Islamic world have grown over the past three decades, Muslims have increasingly sought alternatives to capitalist investment that are more in keeping with Islamic practice. Islamic banks provide a framework for Muslims to invest their money “morally,” in accordance with Islamic law, while at the same time they do not miss out on profit opportunities provided by the global form of capitalist exchange. Islamic banking must locate itself as a Muslim institution in the world economy, yet it is also an industry that explicitly engages with the capitalist institution of banking and as such must be studied in the context of globalization and its relation to capitalism.

Throughout history, Jewish and Christian religious doctrines have objected to what they defined as unsavory business practices, including the practice of usurious loans. De Roover (1974) emphasizes that usury at that time in history referred to any increase over principle and that usury was prohibited; consequently, any increase was considered excessive. Christianity and Judaism resolved this moral problem in a way that advances capitalist enterprise—by declaring loans at interest as acceptable transactions as long as they are not usurious, whereas Islam seems to be engaging with capitalism in a way that critiques capitalism while at the same time advances it. The industry and its resultant institutional structure act as a culture broker (cf. Mazzarella 2004), providing a bridge between capitalist business practices and a competing Muslim sensitivity for its practitioners, who are comfortable in both cultural systems. Furthermore, IBF acts as a bridge between competing subjectivities—or practices of Islam—within Islam itself.

HISTORY OF ISLAMIC FINANCE

Islamic finance is a subcategory of the discipline of Islamic economics, which is in turn informed by Islamic legal thought. Chapters 2 and 3 of this volume (Farooq's “Contemporary Islamic Economic Thought” and Shawamreh's “The Legal Framework of Islamic Finance,” respectively) introduce those two concepts. In this section, I take you through a brief history of the industry's evolution. This account is informed by Kuran (2004), Warde (2010), and Askari et al. (2010), and draws upon the history of economic thought as its basis. This chapter is meant to be a brief introduction to the formation of the industry from a psychological perspective; the specifics of Islamic economic thought, and a critique of that thought, are discussed elsewhere in this volume (Chapter 2 and Chapter 5).

Whereas textual and traditional sources of Islamic law date to the time of the Prophet Mohammed and the ensuing three hundred years or so, Islamic economic theory is a contemporary theory. It has its roots in postcolonial India and its tenets have been widely debated since the middle of the twentieth century. Islamic economics is always written about with reference to classical economic theories that form the basis of capitalism. Early writings about Islamic economics were often presented as critiques of one or more economic theories prevalent in the world, such as communism, socialism, or capitalism (cf. Chapra 1976; Zarqa 1981; Siddiqui 1981). Since the fall of the Soviet Union and the apparent victory of capitalist economics over other forms of economic structures, critiques of communism and socialism are no longer at issue, so most of the contemporary critiques are direct reactions to capitalist economic values. Timur Kuran, in his book Islam and Mammon, recognizes the emphasis of values in the theory of Islamic economics: “at least initially, the economics of ‘Islamic economics’ was merely incidental to its Islamic character” (italics in original; Kuran 2004, p. 82).

The framework of Islamic economic theory was developed in India in the early twentieth century by Islamic scholar Mawlana Mawdudi (1903–1979) and expounded upon by one of his students, economist Khurshid Ahmad. Indian Muslims as a group were relatively disadvantaged economically compared with the majority population of Hindus. The British Raj had provided some economic protections to Muslims, farmers in particular, but it was unclear how or if a Hindu-led government would provide the same protection (Kuran 2004). Mawdudi believed that economic activity and technology were crucial to the success in the modern world, and he was dedicated to providing Muslims in India with economic opportunities that allowed them both to function in the modern world and to retain their Muslim identity. Many Muslims did not participate in conventional banking activities because of the prohibition against riba. Mawdudi himself adhered to this belief, as we learn from reading the notes to his own translation of the Qur'an. In particular, Mawdudi stresses different ways in which loaning at interest can erode communal bonds between men (1988). Nonetheless, Mawdudi believed it was detrimental to the Muslim community in India to abstain from banking activities. He and Ahmad believed that it was possible and desirable for Indian Muslims to embrace systems and institutions of Western modernity while at the same time adhering to the teachings and practices of Islam (Mawdudi 1980). One goal of Mawdudi was to redefine Islamic practices to conform to economic changes. He felt that Muslims in India could use practices to retain their Muslim identity in the face of the postcolonial Indian modernization project. In one of his last books, a short history of the founding of Islam, Mawdudi wrote (1974, p. 11):

The Islamic way of life can be revived and reconstructed again and again with the help of the Qur'an and the traditions if ever, God forbid, the freshness of its true spirit wanes. The world no longer requires any new Prophet to revive Islam to its pristine glory. It is enough to have among us the learned people who know the Qur'an and the traditions of the Prophet and who are able to apply their teachings to their own lives and stimulate others to adopt and apply them in their lives as well. This is how the stream of Islam will continue to flow, refreshing the eternal thirst of mankind.

Khurshid Ahmad argued that economic systems are value-based systems; even the capitalist economic system was founded on certain cultural values, which are reflected in that system. This belief is not unlike Max Weber's (1930) assertion that Calvinist religious practices served to advance capitalism. Therefore, if Muslims are to be economically empowered, a theory of Islamic economics is necessary. Other theorists took up that line of thought, such as Umer Chapra, who states: “Virtue lies . . . not in shunning the bounties of God, but in enjoying them within the framework of the values for ‘righteous living’ through which Islam seeks to promote human welfare” (Chapra 1976, p. 173). In Islam, all fields of life are interrelated. Goals and values of each segment of life should be aligned, so the economic system's values are aligned with those of society.

Kuran (2004) asserts that the emergence of the industry grew out of the debate on whether or not Muslims in India should have a separate homeland or remain part of a greater India after the Partition of 1947. Mawdudi favored the latter proposition—cultural reassertion—and contended that a separate homeland was unnecessary because if Muslims practiced their religious duties faithfully, the matter of a national homeland would be irrelevant. In this view, group solidarity depends more on shared beliefs and practices than on shared geographical territory. This principle foreshadows many of the basic principles of globalization, namely the belief that group solidarity or identity can be based on something other than geographical place.

Mawdudi favored thinking of Islam as a way of life, rather than as a system of faith. In a treatise of his interpretation of the Qur'an published immediately after his death (1980), Mawdudi asserts that the kalimah5 affirms that there is one God, Allah, and Mohammed is his Prophet. Mawdudi considers this to be the primary doctrine of Islam: The real difference between believers and unbelievers “lies in the acceptance of this doctrine and complete adherence to it in practical life.” (Mawdudi 1980, p. 62) An emphasis of the connection between belief and practice is the foundation for Mawdudi's entire project of strengthening Islam worldwide. A Muslim must not only believe in the doctrine of Islam, but internalize and incorporate its practices in everyday life. It is only in this way that Islam (and Muslims) will survive in a world that is increasingly influenced by modern inventions and systems. We can see this idea at work in the thinking of contemporary scholars of Islam. It had particular relevance in the anxious times of postcolonial India, and has gained relevance in a globalized and post-9/11 world in which Islam has frequently come under attack from the prevailing world order.

In contrast to politicians who wanted a territorial solution for Muslim independence (Pakistan), Mawdudi sought to keep Islam salient in the minds of its practitioners without necessitating a territorial division. He fully recognized the prudence of tying economic behavior to religious beliefs. According to Kuran (2004), a technologically advanced world requires complicated economic decisions. In the dominant world economic order, those decisions are thought of as secular decisions. If Muslim traders and customers were making daily economic choices based on religious thought instead of on secular ...

Table of contents

• Cover
• Series Page
• Title Page
• Copyright Page
• Dedication
• Acknowledgments
• Chapter 1: Introduction
• Part I: The Contemporary Islamic Finance Landscape
• Part II: Case Studies
• About the Editor
• Index