Islamic Banking: Is It Really Kosher?

March/April 2007

Muslim scholars say the Qur’an prohibits collecting interest on loans. But many banks, both global and local, have found clever ways to meet religious strictures. It’s a system that may be hypocritical, but also profitable.

By Aaron MacLean
The American

The coverage can be a little bit breathless: “La finance Islamique en plein boom,” Le Figaro reported in September. Yes, Islamic banking, structured along the lines that religion decrees, is in full boom. But is it really banking? And is it really kosher?

Islam prohibits the payment of interest on loans, so observant Muslims require specialized alternative arrangements from their banks. Many of the largest global financial companies, including Deutsche Bank and JPMorgan Chase, have established thriving subsidiaries that strive to meet these requirements. As a result, optimists speculate that the common pursuit of lucre—divinely sanctioned, filthy, or otherwise—will bring bickering civilizations together. They may be right.

The Islamic aversion to interest collection comes from the Qur’an. Not that the term “interest” is ever used: the Arabic injunction forbids something called riba. The Qur’an offers no exact definition of what riba meant in seventh-century Arabia, the time and place of the Prophet Mohammed—let alone what the term should mean today. In particular, the passages are ambiguous on the question of whether riba refers to all kinds of interest collection, or only usurious interest—that is, lending practices that are, according to some ill-defined standard, unfair and exploitative. What is clear in the divine financial critique is that, whatever riba may be, Jews are doing it. At one point God warns that they will face a “painful day of doom” if they keep it up.

This ambiguity was a practical problem for the early Muslim jurists, who formalized religious rules in a code called sharia. They were divided on the subject, but as time went on, the weight of consensus came to rest on the side of prohibiting all interest collection.

The financial instruments that 20th-century Islamic theorists championed were updated versions of medieval commercial instruments, still known in the Islamic financial sector by their Arabic names: in addition to bonds, known as sukuk, there are profit-and-loss sharing instruments known as musharaka or mudaraba, Islamic leases known as ijara, and a commercial trade instrument called murabaha, the flexibility of which has made it extremely popular among Islamic financial firms.

Banking, as an institution, evolved at the same time as the unprecedented economic growth in Europe over the past 500 years. That growth was made possible in part by the codification, in the 12th century, of a distinction between usury and interest in the Christian tradition.

The Islamic world witnessed the development of corporate contract law and the European banking system from afar. A mixture of traditional arrangements and, later, imported Western practices prevailed in Muslim countries. But it wasn’t until the 1960s that anyone tried to combine the two, governing a modern bank according to Islamic law.

You don't have to be Islamic to bank in accordance with sharia. All you need is a board of religious scholars to approve your operation.Islamic financial institutions, the argument went, would boost the economic development of Muslim societies. The fraternal style of Islamic banking—with its emphasis on equity financing rather than lending—would enhance social responsibility. In practice, however, Islamic finance has had to bend to the same pressures as any other kind of finance.

Social, religiously oriented investment in the development of the Islamic world is something people are more interested in publicly championing than personally doing. Khalid Ikram, who represented the World Bank in Egypt, says of Islamic banking, “it hasn’t had a lot to do with development.”

Pinning down the growth of Islamic banking is a challenge. Whether a banking system truly counts as halal—that is, compliant with the laws of sharia, or, in another religious context, kosher—is a religious question, hard for accountants to answer. Take Iran: should the country’s whole banking system, which is nominally Islamic, be counted as part of the sector even though many experts raise questions about its legitimacy?

The numbers I found were anecdotal. Rodney Wilson, professor of economics at Durham University in Britain and editor of the essay collection The Politics of Islamic Finance, estimates total assets within halal banking systems at just under $500 billion. That’s roughly the size of Wells Fargo Bank, America’s fourth-largest. Hussein A. Hassan of Deutsche Bank predicts that Islamic finance will be the world’s fastest-growing banking sector for years, based on what he calls a modest estimate of 20 percent annual increases in deposits.

So it’s big business, getting bigger, and those who hesitate to enter it now risk suffering an expertise deficit later. The number of professionals trained to structure sharia-compliant products, and of religious scholars qualified to certify them, is small enough to be already causing problems. Governments are getting in the game, too: Japan is planning to become the first non-Muslim country to issue sharia-compliant bonds; the UK, Gordon Brown announced last summer, is revising its laws to make London the “gateway” for Islamic finance in Europe; and Malaysia has proposed substantial tax incentives in its 2007 budget for its Islamic financial sector.

Deutsche Bank, Chase, and HSBC, the giant London-based financial institution with an extensive presence in Asia, have all entered the sector within the last ten years. Their moves coincide with rising oil prices, echoing a phenomenon three decades ago. When the 1970s oil boom gave Muslims and their governments wealth that seemed barely countable, Islamic financial institutions bloomed: the Islamic Development Bank (1975), the Kuwait Finance house (1977), the Faisal Islamic Bank of Egypt (1977), the Jordan Islamic Bank (1978), and others. In 1979, Bank Misr, a conventional financial house in Egypt, became the first mainstream bank to build a halal subsidiary, which in the late 1990s began to attract more capital than its chief domestic competitor, the Faisal Islamic Bank.

Oil prices and religious fervor are both on the rise again. This time, Western financial firms have noticed that you don’t have to be Islamic to bank in accordance with sharia. All you need is a board of religious scholars to approve your operation. Muslim is as Muslim does.

The Islamic world witnessed the development of corporate contract law and the European banking system from afar.Hussein Hassan of Deutsche Bank is an example of the sort of expert required. He structures specialized Islamic bonds, or sukuk. For a bond to qualify as sharia-compliant, there must be an underlying asset backing it. One cannot simply issue bonds to raise money, the way it’s been done elsewhere for centuries, in return for a promise of a fixed rate of return. To be Islamic in nature, the securities that look like bonds must represent fractions of an equity asset, rather than fractions of a loan.

According to sharia scholars signing off on the prospectuses, the practices of the multinationals are fully Islamic. That is good news for corporations that want to raise money from Muslims, and for the observant clients themselves. But the potential clientele is by no means captive. As Hassan put it to me, “money always looks for the best deal.” if Islamic finance couldn’t provide results close to those of secular institutions, it wouldn’t exist.

Khalid Ikram, who headed the World Bank’s operations in Egypt in the late 1990s, looked into the performance of Faisal Islamic Bank of Egypt (FIBE) back during the early boom days. It turned out that, despite the bank’s citing “religious fervor” to him as the reason for its growth, Coptic Christians made up about 10 percent of the bank’s clients, just as they do of the country’s population. When returns dropped, so did investment and market share. Egyptians with foreign capital generally preferred to keep their cash overseas, even though the returns there were less than the roughly 20 percent returns FIBE was promising on current accounts. The greater security of foreign deposits made up for their lower rate of return. The rational profit motive never lost its place as the key factor in investor behavior.

Timur Kuran, professor of economics and law at the University of Southern California and author of Islam and Mammon: The Economic Predicaments of Islamism, points out that investing in sharia-compliant fashion doesn’t just buy you decent returns—it can also buy political legitimacy. “Islamic finance didn’t come into its own until the 1970s. Why during the oil boom? Huge amount of assets, petrodollars, were accumulating in the sheikdoms and with the Saudis. These regimes were considered quite illegitimate, and there were a lot of opposition movements, so they wanted to legitimize their regimes and invest the money at the same time…. They could claim that they were promoting Islam and avoiding interest.”

Since the inception of Islamic economics as a distinct discipline in the 20th century, it has always been held up as a champion of ethical development. Islamist writers such as Sayyid Qutb and Sayyid Abul-A’la Maududi envisioned Islamic finance as the economic arm of a new, sharia-guided political order. Free of the scourge of interest, the instrument by which fat-cat colonial and imperial capitalists make money from money, Islamic financial institutions would effectively become private equity or venture capital firms, providing sorely needed investment and support for the region’s economy. By investing in Islamic finance, you weren’t just being pious—you were aiding development and helping the poor as well.

But the post-capitalist utopia that reliance on these instruments was meant to inaugurate was dead on arrival. Those involved in the first wave of Islamic banks realized that equity financing does not make for a stable banking sector, and, after a series of shocks and bad investments, they became very conservative. It was a race to the loopholes—a search for means of sharia compliance less risky than straight-out equity investing.

It's big business, getting bigger, and those who hesitate to enter it now risk suffering an expertise deficit later.The chief loophole was murabaha. Let’s say that you, a small businessman, wish to go into business selling cars. A conventional bank would examine your credit history and, if all was acceptable, grant you a cash loan. You would incur an obligation to return the funds on a specific maturity date, paying interest each month along the way. When you signed the note and made the promise, you would use the proceeds to buy the cars—and meet your other expenses—yourself.

But in a murabaha transaction, instead of just cutting you the check, the bank itself would buy the cars. You promise to buy them from the bank at a higher price on a future date—like a futures contract in the commodities market. The markup is justified by the fact that, for a period, the bank owns the property, thus assuming liability. At no point in the transaction is money treated as a commodity, as it is in a normal loan.

But here’s the catch: most Muslim scholars agree that there is no minimum time interval for the bank to own the property before selling it to you at the markup. According to Timur Kuran, the typical interval is “under a millisecond.” The bank transfers ownership of the asset to its client right away. The client still pays a fixed markup at a later date, a payment that is usually secured by some sort of collateral or by other forms of contractual coercion. Thus, in practice, murabaha is a normal loan.

Since murabaha must be asset-based, however, it can’t help a small businessman who needs a working-capital loan, for example, to provide cash on hand to meet payroll or other expenses. To get such capital from an Islamic financial institution, an entrepreneur would have to sell the bank an equity interest in his business. This is far riskier for the bank and thus much harder to obtain.

The experts tell me that every Islamic bank has at least three-quarters of its investments structured as murabaha. Even the inaptly named Islamic Development Bank was, as of the mid-1980s, doing four-fifths of its business through murabaha, and only 1 percent through equity transactions.

What the “Islamic” label might mean is left to the beholder. The sharia scholars make it their business to pronounce only upon the letter of the law. Like legal practitioners everywhere, they focus on the technicalities. The spirit, being intangible, tends not to cloud their rulings. The leading critics of this inconsistency are political Islamists themselves. Majed Jarrar, a personable young man who studies electrical engineering, wears a long beard, and is keen to discuss his faith, recently opened an account with FIBE here in Cairo, only to let it sit empty. He’s been investigating whether “it’s actually Islamic or not,” and he doesn’t like what he’s finding.

When I asked him about the sort of innovation that, for example, Hussein Hassan at Deutsche Bank is involved in, Majed scoffed. Recalling a similar campaign by a Gulf-based Islamic financial house (“creative Islamic Solutions” was the slogan), Majed argued that sharia law is less about innovation than it is about a return to the ways of seventh-century Arabia.

Despite the zeal of purists like Jarrar, an entire banking sector without debt would be far too unstable. Such a system has never had to exist—medieval Islam had extensive regulations governing trade relations and individual contract law, but there was no banking, so there were no banking rules.

While no one I interviewed argued that sharia-compliant financing directly retards economic and social development, there was agreement that it does much less than the original rhetoric claimed. Not only are working-capital loans, critical to many small businesses, rare, but also sharia-compliant transactions tend to be short-term.

Still, there’s something reassuring about the way that the rational profit motive trumps strict ideology. The willingness to put profit first is, it turns out, the real shared value that links Islamic and Western civilizations.

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Aaron MacLean lives in Cairo. From 2003 to 2006 he was a Marshall Scholar at Oxford University, where he researched medieval Arabic thought.

Canada's Banks working with Islamists to cash into Muslim fears

January 25, 2008

Banks are helping sharia make a back-door entrance

TAREK FATAH
The Globe and Mail

It seems only yesterday that Premier Dalton McGuinty declared: "There will be no sharia law in Ontario." Many of us, who witnessed the medieval nature of manmade sharia laws in our countries of birth, heaved a sigh of relief back in September of 2005. We thought this was the end of the attempt by Islamists to sneak sharia into a Western jurisdiction. We were wrong.

The campaign to introduce sharia is back. Last time, the campaign took a populist approach, invoking multiculturalism. This time, the pro-sharia lobby is dangling the carrot of new niche markets and has the backing of Canada's major banks. Such icons of the corporate world as Citibank NA, HSBC Holdings PLC, and Barclays PLC have endorsed sharia banking and have started offering Islamic financing products to a vulnerable Muslim population.

In May, 2007, The Globe reported that "Several Canadian financial institutions are preparing sharia-compliant mortgages, insurance, taxi licensing and investment funds to help serve the country's fastest-growing part of the population." Recently, the Toronto Star's business section reported that an unnamed bank may offer sharia loans as early as this summer; Le Journal de Montreal disclosed that Canada Mortgage and Housing Corporation(CMHC) was also getting in on the act. Stephanie Rubec, spokesperson for the CMHC, said the Crown corporation had launched a tender worth $100,000 to study Islamic mortgages for Muslim Canadians. Could she be oblivious to the fact that almost all Muslim Canadians currently have home mortgages through banks and don't feel they are living in sin? In fact, CMHC has gone a step further: It has quietly entered into a partnership with a Saudi company, AaYaan Holdings, to develop sharia-compliant mortgage-lending systems.

The origin of Islamic banking has its roots in the 1920s, but did not start until the late 1970s and owes much of its foundation to the Islamist doctrine of two people — Abul Ala Maudoodi of the Jamaat-e-Islami in Pakistan and Hassan al-Banna of the Muslim Brotherhood in Egypt. The theory was put into practice by Pakistani dictator General Zia-ul-Haq who established sharia banking law in Pakistan.

Proponents of sharia banking rest their case on many verses of the Holy Koran that outlaw usury, not interest.

Verses that address the question of loans and debts include:

* Al Baqarah (2:275): God hath permitted trade and forbidden usury;
* Al Baqarah (2:276): Allah does not bless usury, and He causes charitable deeds to prosper, and Allah does not love any ungrateful sinner.

Every English-language translation of the Koran has translated the Arabic word riba as usury, not interest. Yet, Islamists have deliberately portrayed bank interest as usury and labelled the current banking system as un-Islamic. Instead, these Islamists have created exotic products with names that are foreign to much of the world's Muslim population. This is where they mask interest under the niqab of Mudraba, Musharaka, Murabaha, and Ijara.

Two authors, both senior Muslim bankers, have written scathing critiques of sharia banking, one labelling the practice as nothing more than "deception," with the other suggesting the entire exercise was "a convenient pretext for advancing broad Islamic objectives and for lining the pockets of religious officials." Why Canadian banks would contribute to this masquerade is a question for ordinary Canadians to ask.

Muhammad Saleem is a former president and CEO of Park Avenue Bank in New York. Prior to that, he was a senior banker with Bankers Trust where, among other responsibilities, he headed the Middle East division and served as adviser to a prominent Islamic bank based in Bahrain. In his book, Islamic Banking — A $300 Billion Deception, Mr. Saleem not only dismisses the founding premise of sharia and Islamic banking, he says, "Islamic banks do not practise what they preach: they all charge interest, but disguised in Islamic garb. Thus they engage in deceptive and dishonest banking practises."

Another expert, Timur Kuran, who taught Islamic Thought at the University of Southern California, mocks the very idea. In his book, Islam and Mammon: The Economic Predicaments of Islamism, Prof. Kuran writes that the effort to introduce sharia banking "has promoted the spread of anti-modern currents of thought all across the Islamic world. It has also fostered an environment conducive to Islamist militancy."

Dozens of Islamic scholars and imams now serve on sharia boards of the banking industry. Moreover, a new industry of Islamic banking conferences and forums has emerged, permitting hundreds of sharia scholars to mix and mingle with bankers and economists at financial centres around the globe. In the words of Mr. Saleem, who attended many such meetings, they gather "to hear each other praise each other for all the innovations they are making." He gives examples of how sharia scholars only care for the money they get from banks, willing to rubberstamp any deal where interest is masked.

No sooner had CMHC announced its plans to study sharia-compliant mortgages, than an imam from Montreal's Noor Al Islam mosque offered his services to Canada's banks, claiming Muslims are averse to conventional mortgages because "it goes against their beliefs," a claim that would not withstand the slightest scrutiny.

Other academics who have studied the phenomenon have reached similar conclusions. Two New Zealand business professors, Beng Soon Chong and Ming-Hua Liu of Auckland University, in an October, 2007, study on the growth of Islamic banking in Malaysia, wrote: "Only a negligible portion of Islamic bank financing is strictly 'profit-and-loss sharing' based. … Our study, however, provides new evidence, which shows that, in practice, Islamic deposits are not interest-free." They concluded that the rapid growth in Islamic banking was "largely driven by the Islamic resurgence worldwide."

In the name of Islam, deception and dishonesty is being practised while ordinary Muslims are being made to feel that their interaction with mainstream banks is un-Islamic and sinful. As Mr. Saleem asks, "If Islamic banks label their hamburger a Mecca Burger, as long as it still has the same ingredients as a McDonald's burger, is it really any different in substance?"
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Tarek Fatah is the author of Chasing a Mirage: The Tragic Illusion of an Islamic State, to be published in March.

Sharia Banking:"There's big business in fooling God"

October 15, 2007

God and financial loopholes -- what of it?
For some religions, there's big business in fooling God

ANDREW POTTER
Macleans Magazine
http://www.macleans.ca/article.jsp?content=20071015_110166_110166&source=srch

Wally: Do you mean you knew what was happening to us all the time?Supreme Being: Well, of course. I am the Supreme Being, I'm not entirely dim ...
-- Terry Gilliam's 1981 film Time Bandits

When I was in graduate school, I spent some time as a teaching assistant for the department's big Introduction to Philosophy course, which served first-year students a tasting menu of questions in logic, metaphysics, and ethics. The most fun to teach were the various proofs for the existence of God. One year, a student submitted a paper where, on the title page, "God" was written as "G-d." When the professor asked for an explanation, the student said he was Jewish, and Jews were not permitted to write out the full name of God. The professor pursed his lips for a moment, looked at the student, and said: "You know, you're not fooling God."

For those of us most familiar with the Christian approach to religion, writing "G-d" to get around a prohibition against writing God's name amounts to little more than impious cheating. Ours is an omniscient God, after all: he knows what is in our hearts and in our minds, and he can't be fooled by legalistic hairsplitting.

Turns out that for some religions, fooling God is not only considered fair play, it is also big business. Consider the controversial bit of religious sea-lawyering known as "Islamic finance" or "Islamic economics": a basket of financial instruments designed to get around the Quranic rule that forbids Muslims from charging or paying interest. Given that interest is the cornerstone of our financial markets, it is pretty much impossible to turn your nose up at interest and participate in the modern economy.

That is why the past few years have seen tremendous growth in sharia-compliant financial instruments, such as interest-free mortgages and savings accounts where the bank rewards the depositor with occasional "gifts of appreciation" for the use of his money.Let's be honest. Islamic finance isn't fooling anyone, least of all God.

Everyone involved understands that the various gifts and deferred payments are just bearded forms of interest, but the proper question is not whether God is fooled, but whether anyone should care.Someone who cares a great deal is the Scourge of Islam, Daniel Pipes, better known as the director of the pro-Israel think tank the Middle East Forum. In a recent article in the National Post about the rise of Islamic finance, Pipes warns that there is nothing "Islamic" about the barely disguised interest payments, and that behind its economic triviality lurks a great political danger.

Drawing on the book Islam and Mammon, by the Muslim scholar Timur Kuran, Pipes argues that Islamic finance was created for political motives, designed to strengthen the Muslim identity by minimizing their interactions with non-Muslims.He concludes that by enabling the economic activities of Muslims and allowing them to "modernize without Westernizing," Islamic economics serves as a source of global instability.

Pipes suggests that it would be much better if Muslims were really forbidden from paying interest or any of its facsimiles, because they would then be relegated "to the fringes of the international economy."This is insane, not to mention a bit obtuse. For starters, not every religion places so much value on correct belief or thought. Observing the faith is in some cases more about following a strict set of rules or codes, cleaving as close as possible to their letter and worrying less about their spirit. Among the big three monotheisms arising from the Mideast, Judaism and Islam are more concerned with rules than Christianity is.

That is why, to Christian eyes, Jews and Muslims seem to expend a great deal of effort trying to fool God.One example is the Orthodox Jewish practice of installing eruvin around neighbourhoods -- symbolic fences made of rope or string slung from lampposts and street signs. It is a way of getting around the rule against carrying things from one domain to another on the Sabbath.

The presence of the eruv around a neighbourhood allows residents to treat the whole area as a single dwelling, which lets them carry stuff outside on the Sabbath without breaking Torah law. Is God fooled? To ask the question is to miss the point.If anything, we should be celebrating the rise of Islamic economics, since if its goal was to keep Muslims isolated from the corrupting influences of the West it has been a huge failure. As a major survey in the Financial Times last spring pointed out, Islamic finance is now a trillion-dollar business, and most large Western banks -- including HSBC, Barclays, and Citibank -- are racing to re-craft all of their products along Islamic lines.

To see this as a source of instability and political danger is sheer paranoia. Far from ghettoizing Muslims, sharia-compliant finance is drawing them deeper into the network of global institutions, helping them to integrate into the modern world without having to assimilate to Western values. Sure, Islamic finance appears to many -- me included -- as little more than an exercise in trying to fool God. But if helping Muslims fool their God is part of the price we have to pay for global economic and political stability, it's the bargain of the century.