Medieval Contracts in Modern Islamic Finance [I]— Claims of Hypocrisy
That is why Islamic financial intermediaries work according to the rules of the game, namely the rules set up by the conventional finance industry. They need to be able to replicate the lending-style practice in which the capital and profit are guaranteed. For Islamic finance to get ‘its way’ in this game, it needs size and influence. Only then can it impose its ideals on the ground.
In the name of Allah (God), the most gracious and the most merciful…
IN THE BEGINNING THERE WAS ONLY THE SHARIAH
If you ask an average student or experts on Islamic finance what contracts Islam approves of, they will list out a series of medieval contracts mentioned in the Quran (God’s revealed book to Prophet Muhammad) and Sunnah (Prophet Muhammad’s tradition). The Quran and Sunnah represent the code of law — Shariah — for Muslims. Ask other seasoned Shariah experts and they’ll give you a different answer of what contracts Islam approves of.
The Shariah is God’s eternal guidance for humanity. It is God’s eternal wisdom. With its principles and objectives, the Shariah is intended to outlive and outwit anyone generation of human beings and their ideologies.
Then, there was fiqh. Fiqh is simply the body of literature of the Muslim religious scholars that they’ve compiled when trying to understand the Quran and Sunnah. Fiqh is not the Quran and Sunnah. The scholars of Islam are unanimous on that a Muslim is only required to follow the Shariah, not the body of fiqh, but to facilitate adherence to the Shariah for a lot of Muslim laymen, fiqh is relied upon for guidance.
THE GIST OF ISLAMIC FINANCE
The Islamic finance industry is composed of commercial, regulatory, supervisory and standard-setting institutions, among others, that are premised on a common set of principles and contracts which can be traced back to the Shariah.
To demonstrate, a sale (bay’) is when I sell you an asset for a payment. A lease (ijarah) is when I lease you an asset for use for a certain period of time for lease payments in return. Bay’ and ijarah are examples of contracts. They are both mentioned in the Quran and emphasized heavily during the medieval Islamic period.
Islam further prohibits usury (like interest on a loan) and extreme uncertainty including gambling, among other things. These are referred to as principles of Islamic finance. Each of the Islamic finance industry’s main three sectors, Islamic banking, Islamic insurance and Islamic capital markets/securities is distinguished by these contracts and principles.
These contracts and principles have formed the theoretical basis of Islamic finance practice. But, is this the ideal theoretical basis that the Quran and Sunnah aspire to?
CLAIMS OF HYPOCRISY
The medieval contracts mentioned earlier are found in the fiqh tradition. The contractual system found in fiqh literature is all based on a set of contracts that are mentioned in either the Quran or the Sunnah. Somehow these contracts have been eternalized as the be-all and end-all of financial transactions sanctioned by the Shariah.
Because of this phenomenon, those who hold firmly to this tradition of ‘fiqh contracts’ label the current Islamic finance practice as hypocritical. Why is that you may ask?
Well, Islamic finance works in an environment where conventional finance reigns supreme. Conventional finance uses lending both for accepting funds (such as deposits in banks) and for giving funds. This system insures the lender gets their capital back, plus interest. This is how conventional financial intermediaries work, they cannot entertain the thought of not getting their principal and interest back — with the exception of the inevitable risk of default.
Islam prohibits this and considers it riba, a form of usury — albeit not the only form.
The proposed ‘Islamic alternative’ is for Islamic financial intermediaries such as Islamic banks to sell or lease assets as demonstrated earlier.
Alternatively, for advancing financing, Islamic banks and Islamic capital markets fundraising practice can use equity capital which is basically where you give money to another party and don’t get a guarantee of repayment, neither of capital or of profits. This is seldom used due to its proven high risk.
All such forms of finance are arguably merchant-style arrangement utilized merchants of the medieval age used to employ. They emphasize real market transactions, but, in their vanilla form, have not suited Islamic finance well.
To make them more practicable, Islamic finance practice had to add a twist. To demonstrate how this is done, consider the lease (ijarah) we spoke about earlier. An Islamic bank would not buy an asset then lease it to the customer for lease payments in return. This is the plain or vanilla ijarah.
Islamic banks instead require an undertaking from the customer to lease out the asset from the Islamic bank, to pay all lease installments, including profit for the bank, and finally to accept the transfer of ownership of the asset from the Islamic bank to the customer — somehow. Although this modus operandi (model) differs from a loan that a conventional bank uses in form, it perfectly replicates it in substance. This is demonstrated in the diagram below.
Take my word for it, this method of amending a plain contract and strapping it with a variety of features, mainly risk mitigating guarantees, is the theme of the industry and a feature of essentially every instrument and product in the Islamic financial system.
It is exactly because of this practice that Islamic finance has been accused of hypocrisy, that is claiming to use plain fiqh contracts but with added twists and appendages that allow it to resemble a conventional loan in its substance.
COUNTERCLAIMING THE CLAIM OF HYPOCRISY
Unfortunately, what such fiqh fanatics tend to overlook is the reality and that Islamic financial institutions are constrained by so many factors that are overlooked by such fiqh fanatics.
The evidence for that is their lack of acquaintance with the intricate workings of modern economics and finance. They also lack acquaintance with the concept of gradual development which is so ethnic to the Shariah.
You see, we live in the age of financial intermediation where massive intermediaries facilitate, perhaps, millions of transactions a day. We have moved far beyond medieval merchant practice.
That is why Islamic financial intermediaries work according to the rules of the game, namely the rules set up by the conventional finance industry. They need to be able to replicate the lending-style practice in which the capital and profits are guaranteed. For Islamic finance to get ‘its way’ in this game, it needs size and influence. Only then can it impose its ideals on the ground.
All of this leads me to believe that claims of hypocrisy are over-accentuated. To be a hypocrite means you have to know the truth, pretend to practice it and hide the falsehood that you genuinely subscribe to. The truth here is presumed to be maintaining the originality of fiqh contracts which is not accurate. Fiqh contracts are not the ideal nor are they the truth. Thus do the claims of hypocrisy crumble.
CLAIMS OF FALLACY
I propose we go back to the beginning, since in the beginning there was only the Shariah. Looking at the Shariah, I claim Islamic finance practice is not hypocritical, but instead I claim it is fallacious.
The justification for that must be deferred to a future article. Furthermore, some questions you may have had come up about the reading, especially about the difference between Islamic and conventional finance, will further be answered in that piece — God willing.
