Islamic Finance: Religious and Ethical - Essay Example

Islamic Finance: Religious as well as Ethical Islamic finance is the strongest and the most stable system of finance among all in the present age. “Islamic or sharia-compliant finance refers to financial products that are in compliance with the Koran and other sources of Islamic sharia law” (qsociety.org.au, n.d.). There has occurred a lot of growth and expansion in the Islamic finance in the recent years. Last year, Germany declared its plans of establishing its first Islamic bank following the European neighbors in the same footsteps. It seems a bit ironic if this is considered in the context of Germany’s history. Similarly, Ireland that is arguably a country where a vast majority of the citizens are staunch Catholics, is also advancing toward becoming a global hub for the Islamic finance (Lai, 2013). The growth of Islamic banking on the global scale in the recent years can, to a considerably extent, be attributed to the need of a more ethical financial system. Islamic finance is not simply an ethical spin over the traditional western banking, but also provides tangible solutions both for the Muslims and the communities beyond them. Islamic finance, as the name implies, is conventionally thought of as a financial system that is strictly religious whereas an in-depth analysis of the fundamentals and principles of the Islamic financial system suggests that it is also the most ethical finance system. The former diplomat and politician of Pakistan, Zafrullah Khan said, “the object of the Islamic economic system is to secure the widest and most beneficent distribution of wealth through institutions set up by it and through moral exhortation. Wealth must remain in constant circulation among all sections of the community and should not become the monopoly of the right” (Khan cited in Ahmad, 2013). Use of funds for some specific purposes is prohibited in Islamic finance. It is very much like ethical investment in the standard sector of finance. For instance, Islamic banking prohibits investment of money in activities that are condemned in Islam. Such activities include but are not limited to pornography, alcohol, and gambling. “the charging of interest is prohibited in Sharia law because it is deemed to be against social justice…Gambling, arms companies, pork and alcohol companies are some of the investments they would avoid, for example. However, Islamic finance is gaining a lot of credit, not only in the Middle East and Arab world but elsewhere in the world” (Kamla cited in scotland.org, 2010). The code of ethics in the Islamic finance derives its basis from the religious texts and is not quite as arbitrary as the secular ethical investment. Interpretation of the religious texts may lead to debate. Nevertheless, it can be said without doubt that the religious texts are permanent anchors that dictate the best behavioral practices unlike the standard ethical investment. Islamic finance is far more deep-rooted as compared to the standard ethical investment. Islamic finance not only prohibits releasing the funds for or dealing in activities that are unethical, but it also condemns such transactions in which the risks and uncertainties are shared by people in a disproportionate way. It is the main reason why Islamic banks prohibit the use of interest. In the traditional western banking style, when an individual borrows some money to operate a business from a standard bank, the borrower guarantees the bank a return in the form of interest whereas the borrower assumes all the risk of losing or making money by operating the business. Such arrangements are prohibited by the Islamic finance. Islamic finance cultivates a system of shared losses and profits rather than a banking system based on interest. Islamic banks lend money as a return of the loss or profit made from a business that is shared by the bank and the borrower rather than lending money for the payment of interest. The standard banking system allows the speculative activities. They do this in order to maintain the efficiency of the market. The effects of speculative activity can be unwelcoming as well like the creation and burst of financial bubbles. One fundamental difference between Islamic banking and standard financial system is that unlike the latter, the former prohibits financial transactions which include speculation. Islamic texts oblige the existence of a clear link between the financial transactions and the real activity. An individual can thus purchase the financial assets and sell them if he/she is genuinely interested in the underlying value of the financial assets rather than being interested in gambling over the changes in value. Since the early 1900s, the gap between the real economy and financial sector has widened. The real economy is economy’s that part that is concerned with the production of services and goods contrary to the less tangible financial sector. Islamic finance makes the investment more than just ethical in that it challenges this increasing gap. By doing so, Islamic banking leads the system back to the time when the financial sector assumed the role of serving as the real economy. Islamic finance adopts a number of measures to emphasize upon the development of link between the financial transactions and a real activity. These measures include but are not limited to establishing limits on the volume of debt, creating lesser speculation opportunities, and therefore, reducing the likelihood of instability of the financial system. Products that played a major role in the growth of instability in the financial system of the US in the year 2007 would have all been prohibited by the Islamic finance. As the Islamic banking system prohibits dealing in interest and at the same time, encourages conducting business with shared system of loss and profit, this approach transfers part of the risks traditionally carried by the consumers over to the financial institutions. This way, Islamic finance provides a more equitable as well as safer approach for finance’s organization as compared to the approach adopted by the standard financial system. “human behavior informed by Islamic values and geared towards the objectives of Shari’ah may bring about a totally different intra- and international system characterized with considerably less disparity in growth, wealth and income, less damage to the environment and more genuine human happiness” (Heydarova, 2013). While the religious teachings of Islam lay the basis of an extremely rational and ethical financial system, the Islamic banks practically have not been perfectly following the teachings of Islam with respect to the structuring of financial system. Although Islam prohibits interest and encourages the banks to share losses and profits with the borrower while lending money, one can observe an intentional structuring of the Islamic banks in such a way that the outcomes achieved are very much like the products based on interest; the outcomes of the Islamic banks operating in the industry are more certain than they can be if they exactly followed the teachings of Islam. They do not exactly bear the sharing of loss and profit by being that certain. These choices of the Islamic financial institutions have been made to make the practices competitive with those of the standard financial sector. However, such practices have made the Islamic financial institutions deviate from the ethical standards of their origin i.e. Islam. In the perspective of Islam, “one cannot be ethical before being legal in the first place. For instance, Shari’a considers as morally worthless a charitable contribution to good causes from money earned by illegitimate means” (Al-Jarhi, n.d.). There are fair chances of the abolishment of these practices with better establishment of the Islamic finance. Islamic financial institutions assume the risk of betraying their roots if they continue mimicking the practices of the standard financial sector. In addition to that, such an approach undermines the assertion of the Islamic financial institutions to offer a system that is substantially different as well as important. In spite of these criticisms, the Islamic financial institutions still have the tendency to reframe the debate regarding the financial sector’s role in the contemporary modern society. The point to ponder is; whether finance should be used for the sake of speculation or it should be exclusively used for funding activities that are real. The approach adopted by the Islamic financial institutions provides us with a way to consider reforming the financial sector in order to serve the needs of the society in a better way considering the debate regarding reformation of the financial sectors and the global financial crisis. The financial system plays a crucial role in the allocation as well as distribution of the resources and to make the economy stable and stronger, because of which the financial system’s restructuring aligned with the socioeconomic Islamic goals is considered very important to conduct the socioeconomic reforms meaningfully. Therefore, Muslims felt the need to establish the Islamic Financial Services Industry (IFSI) that implied that the goals, values, and principles of Islam imparted the need to establish a system different from the traditional system in a variety of ways. Establishment and substantial progress of the IFSI in the last thirty years have spurred critique as well as interest among the academics, religious scholars, and the practitioners. The main concern for the Islamic financial institutions is to have such financial practices that are compliant with the law of the Shariah. “Having a shariah advisor or committee of respected fiqh scholars who can endorse the bank’s activities is seen as crucial to ensure the institution’s reputation” (Wilson, n.d., p. 1). The principal economic obligation in the Islamic law is the payment of zakat that is the capital levy imposed upon the rich and the affording for the assistance of the poor. The law of zakat in Islamic finance applies upon the business wealth as well as of the individual. Three parties share the wealth thus produced; the working man, the community that represents the mankind, and the provider of the capital. Zakat is the share of community in the produced wealth. After setting that aside for the community’s benefit, the rest of the money is purified, so it can be divided among the rest of the parties that have share in it. Although the percentage of zakat on the actual assets is small, yet the teachings of Islam encourage wealth’s injection into the communities with minimal or inexistent support. Islam encourages its followers to keep the wealth in constant circulation whether it is in the local communities or in the business. This is required to consistently attend to the sick and the poor. Communities and equity holders share the wealth of social enterprise and the Islamic wealth. These two businesses have common community interests and face similar issues. One main common interest is the reduced assets because of the constant circulation of money either to support the community or to expand the business. Over the passage of time, consumer trends have moved toward investing in such services and products that are linked with a social benefit. This has made the shared successes of social enterprises profound. Muslims and the owners of social enterprise that do businesses following such models accept challenges as they tend to make a difference socially. The value of this is greater as compared to the accumulated wealth. A social enterprise is such an agency that places its focus upon the economic, environmental, and social well-being with the business model of profit-making. The major objective of a commercial business is maximization of the wealth of the shareholders while a social enterprise’s primary aim is maximization of the social value. It serves as a bridge between the commercial businessman and the non-profit organizations. There are numerous examples of social entrepreneurs in the Muslim world that have values rooted in the teachings of Islam. Grameen Foundation is one such organization that provides life-changing information, financial services, and unique opportunities of generating income in order to improve the standard of living of the poor. Over the last decade and a half, the Grameen Foundation and its partners have improved the living standard of up to 9.4 million poor people in the world (Ahmad, 2013). The Islamic finance was established within a capitalist or global system of finance. The capitalist financial system pursues its own objectives and has thus played a role in the development of such tools, mechanisms, and means that help it achieve its own objectives. The establishment of Islamic finance, is in a way, a desperate search by the Muslims to find ways of preserving their constructed and alleged authenticity in such an environment in which others set the rules (Roy, 2004). It is only because of the exceptional strength and advantages of the Islamic financial system that it is being implemented even in the countries where Muslims form a minority. Scotland is a potential example of such countries. Muslims form the second largest community by faith in Scotland after Christianity. The number of Muslims in Scotland during the 2001 Census was 42,557 (scotland.org, 2010). After Scotland provided the first Islamic mortgages consistent with the law of Scotland and Sharia, a gap that was obvious and had prevailed for a long time in the market was filled. Having found the advantages of adopting the principles of the Islamic financial system, Scots firms are devising more of such products that are compliant with Sharia like insurances along with removing the obstacles that have deterred the Islamic people from becoming part of the traditional western banking system. Concluding, the Islamic financial system is not only a religious system but is also a very robust ethical system. Islamic financial institutions that exactly follow the teachings of Islam do not lend money to the borrowers on interest. Instead, money is lent in the form of investment and the financial institution and the borrower mutually share the profits and losses thus made. Islamic financial system encourages constant circulation of the money so that it does not get blocked in one particular community. This, in effect, reduces the gap of wealth between the rich and the poor so that a balance is created in the society. Islamic financial systems impose zakat according to a well-defined percentage on the money. Zakat is taken from the people who can afford to help others and is used for the benefit and well-being of the poor. Since wasteful practices that are condemned by Islam are reflected by the present consumption patterns and production, the Islamic financial system has to finance the economy’s real needs and thus, has to be aligned with moderate patterns of production and consumption. This way, financial practices existing today would not create dearth of resources for the future generations. Although the Islamic financial system is very strong and ethical, yet it is not being implemented in the true Islamic way. There is no doubt in the fact that the Islamic financial system supersedes the standard financial system by many levels, yet rather than criticizing, challenging, or questioning the traditional economic assumptions, providing suitable alternatives to the flaws of the conventional system and thus transforming it, the Islamic financial institutions have to a considerable extent adapted to the standard financial system and have thus rendered legitimacy to the standard financial system. References: Ahmad, S 2013, How Islamic finance and a more ethical capitalism go hand-in-hand, The Guardian [Online] Available at http://socialenterprise.guardian.co.uk/social-enterprise-network/2013/jan/24/islamic-finance-ethical-capitalism-social-enterprise [accessed: 16 March 2013]. Al-Jarhi, MA n.d., Regarding the ethical standards of Islamic finance, International Association for Islamic Economics. Heydarova, A 2013, Islamic Finance: Ethical Analysis of Status Quo, On Islam, [Online] Available at http://www.onislam.net/english/reading-islam/research-studies/politics-and-economics/460670-islamic-finance-ethical-analysis-of-status-quo.html?Economics= [accessed: 16 March 2013]. Lai, J 2013, Can Islamic finance provide salvation for the banking sector? The Conservation, [Online] Available at http://theconversation.edu.au/can-islamic-finance-provide-salvation-for-the-banking-sector-9506 [accessed: 16 March 2013]. qsociety.org.au n.d., Q on: Understanding Islamic Finance or Sharia-Compliant Finance, Society on Australia Inc. [Online] Available at http://www.qsociety.org.au/qonshariafinance.pdf [accessed: 17 March 2013]. Roy, O 2004, Globalized Islam: the Search for a New Ummah, NY: Columbia University Press. scotland.org 2010, Scotland champions Islamic finance, [Online] Available at http://www.scotland.org/features/scotland-champions-islamic-finance [accessed: 16 March 2013]. Wilson, R n.d., Parallels between Islamic and ethical banking, University of Durham, [Online] Available at http://www.kantakji.com/fiqh/Files/Banks/b082.pdf [accessed: 17 March 2013]. Read More