Sunday, July 21, 2013

Can we continue to ignore equity Islamic finance?

 Assalamu 'Alaikum,

Can we continue to ignore equity Islamic finance?

An economic system is where economic units interact to produce the optimal amount of goods and services needed by the economy. A key factor introduced into  economics by Shariah is the legal maxim, AlGhunm bi AlGhurm meaning rewards comes with risk.

In Islamic muamalat one is not entitled to reward unless one is willing to expose oneself to risk. This provides a fair formula for the economic units. and the economy runs on equity instead of debt.

The problem with today’s economy is that we have allowed an unnatural formula to persist in economic transactions. This is the formula of debt. Instead of an equity transaction where both parties are exposed to risk and reward we have accepted a situation where a particular economic unit is given a special dispensation on risk or where one is spared of all risks.

One enters into the economic transaction where the price of one’s capital is guaranteed profits and guaranteed return of capital. This is an abominable formula to fair business transactions but we have accepted this unquestioningly.

Apart from it being a riba transaction we have also conducted the sin of maysir or gambling because we gamble that our business will be profitable. In an equity transaction we are spared the penalty of loss but in the debt transaction we are penalised for loss.

The result of our acquisience to this unfair business formula also resulted in the misallocation of wealth in society. We have just ensured that those with money by the mere possession of money are forever wealthy because of that unnatural formula of debt. To make matters worse we have legislated laws to perpetuate this unnatural practise and courts upholds this injustice in business practise.

We have also accepted a practise called risk management which is a tool to perpetuate the wealth of the money lenders. We should have confined ourselves to  business risk management but we have allowed money lending risk management to be the definition of risk management.

The greatest risk to a money lender is the risk of his borrower not repaying his loan. As he is ungoverned by any Shariah rules he is free to set risk management rules that stacks against the borrower.

Since society has accepted money lending as a business, money lending risk management is not questioned as an abominable practise. In the name of risk management we perpetuate unfair conditions on the borrower. Shariah does not accept money lending as a valid business therefore Shariah abhors money lending risk management as much as it abhors money lending itself.

The problem with Islamic finance today is that it does not address itself to the requirement of the above-said Maxim of rewards only with risk. Therefore on technical Fiqh positions Islamic finance validates the extension of debt to its customers via the various well known Islamic financing principles .

The issue here is that whilst complying with Fiqh the end result is the same to the receiver of finance if he were to take the conventional loan. His Islamic financier does not care whether his business is profitable or not. He has to return the capital extended to him at the agreed date and on agreed intervals pay ‘profits’ whether or not he has made profit.

Questioned on this the Islamic financier will quote the acceptability of buying and selling or trade by Shariah. Quite apart from the dubious nature of current Islamic finance transactions whether they can all be classified as trades we need to discuss  the issue of whether or not their compliance with Fiqh results in their achievement of Maqasid Shariah or the objectives of Shariah?

It is perfectly possible in certain situations to comply with Fiqh, yet unable to achieve the objectives of Shariah. Islamic banking is in the field of Iqtisad or economy and deals with maal or property.

Within the broader context of achieving Maslahah or benefit for mankind Shariah is meant to protect five values of man. These are his religion of Islam, life, lineage, intellect and property.

Within the specific context of property Shariah demands amongst others no transgression of property rights, an equitable distribution of wealth, and a wide distribution of wealth in society.

An Islamic financing industry that confines itself to debt financing will extend financing only to customers with collateral and with high amount of capital. As these are characteristics of wealthy customers we find Islamic debt financing guilty of making the rich richer and the poor poorer.
If this is the case, Islamic financiers  have failed to uphold the objective of Shariah in relation to wide distribution of wealth in society, and ensuring an equitable distribution of wealth for society.

The Islamic financier also does not find it objectionable to operate in a fractional reserve banking money creation system. Under this system money are created multifold by banks when an initial deposit of money by a customer is lent many times by the banking system.

In a debt based system where collateral and high capital are prerequisites sought by banks these new monies tend to be given by banks to rich corporates. When these rich corporates used the new money to buy real assets they create inflation in society because the increase in money supply is not matched by a correspondent increase in goods and services.

Thus the rich corporates have transgressed unfairly on the property rights of society by forcing a loss on society’s purchasing power through the inflation. Again Islamic debt finance have failed to uphold the objective of Shariah of no transgression on the property rights of others.

If it is said these situations are forced on the Islamic financiers by their operating in a dual system it needs to be addressed whether it is really crucial to maintain this duality.

With the debt based international financial system heading towards its own Armageddon, Islamic finance can hardly be said to be an alternative if it is unwilling to shed debt in favour of equity.

Muhammad Zahid Abdul Aziz of Muamalah Financial Consulting is an international trainer and consultant in Islamic Finance with 23 years experience in the industry.

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