ISLAM AND INTEREST

Why did Islam prohibit interest? What is the logic behind that? What types of interest has Islam prohibited? These are certainly the questions that face a lot of both Muslim and non-Muslim economists. When Islam was introduced 1400 years ago, one of the main issues discussed, was Riba or interest. How interest made people manipulate poor people, and how interest made the rich richer and the poor poorer. It also made people work less because of their guaranteed return.

Muslim economists have always searched and are still searching for flaws in an economy that is driven by interest so that they could justify their theories of a just monetary system. Muslim economists continually refer to the global economic crisis as a result of interest rates from the great depression to the crisis in Southeast Asia. Huge budgetary imbalances, excessive monetary expansion, large balance of payments deficits, insufficient foreign aid, and inadequate international cooperation can all be related to flaws in the theory of interest, which is also the root of the crisis. Muslim economists see the demand for economic growth as parallel to inflated interest rates and global economic crisis. It is healthy to say that most countries, which make the transition to a market economy, had developed some kind of crisis in the early stages. Inflation often occurs as a result of a fast growing economy, hence, contracting the monetary policy is a must to offset inflation. This increase in interest rates would only add to the unemployment level. The Keynesian school had emphasized the problem of high interest as a contributor to unemployment, therefore, stressing the need of reducing interest rates to the lowest possible. But the question is what is the optimal rate of interest? Or should interest exist?

The money and banking system should, like all other aspects of the Islamic way of life, be made to contribute richly to the achievement of the major socio-economic goals of Islam. The system should also continue to perform the usual functions that relate to its own special field and which other banking systems perform, i.e.. :

1. Broad-based economic well-being with full employment and optimum rate of economic growth.
2. Stability in the value of money to enable the medium of exchange to be a reliable unit of account and a stable store of value.
3. A just return is ensured on investment and development projects.
4. Effective rendering of all services normally expected from the banking system.
5. Socio-economic justice and equitable distribution of income and wealth

ISLAMIC FINANCE AND BEYOND

I was reading one article by M, Nejatullah Siddiqui titled Islamic Finance and Beyond (http://www.siddiqi.com/mns/IFandBeyond.html) and he observed the following :

The disturbing features of contemporary finance, which would remain unaffected by the prohibition of interest, restrains on the money market and the demise of the market for debt, are the following:

1. The possibility of massive capital movements into and out of a country, which has destabilizing, effects, especially for small economies.
2. Wide exchange rate fluctuation, to the great disadvantage of small developing countries dependent on foreign trade.
3. Social, cultural and political aspects of financial globalization and multinational corporations (MNCs) dominating the market. This is especially worrisome to developing countries in Africa and Asia that do not share the sociocultural background of the regions where the MNCs are based. These countries also lack sophisticated bureaucracies, mature politicians and efficient media, which could be a guard against the possible undesirable role of MNCs.

He further enhances/strengthens the premises and promises of Islamic economics especially on the quest for justice and morality - justice and morality have to penetrate the behavior of all economic agents, including the decision-makers at the national and international level, so that all can live together in peace and harmony. Has Islamic economics something to offer in making this possible? At the heart of the Islamic economic culture lies care for others as a force tempering man's innate selfishness. In sharp contrast to neoclassical economics, which dominated the scene during the twentieth century, Islamic economics brings the social dimension of living into focus, thus downsizing individualism. It also recognizes morality as a potential motor of action and overseer of self-interest. The former, the social dimension, is compulsory; economic analysis can ignore it only to its peril. The latter, ethical action, is a potentiality in the realization of which civilizations have had different records. But no human society has been devoid of the moral dimension. Thus, ignoring it can never be justified.

LATEST CONTROVERSY - SUKUK

I attended my Islamic Capital Market class recently and my learned Professor shared with us an article in the Wall Street Journal on the first sukuk (Islamic bond) default and no one has a clue how they’re going to shake out - which might actually be a feature rather than a bug.

Bondholders often have a large amount of complacency derived from the fact that an enormous amount of equity needs to be wiped out before they take any hit at all. And that complacency does the system no favours in the long term. If capital structures get muddied a little, and debt takes on more equity-like uncertainty — as seems to be the case in the sukuk market — then maybe investors will be more assiduous about examining underlying risks, rather than relying on capital structures to protect them.

This is not the only controversy in sukuk issue – if we still remember from my earlier posting, a renowned scholar Muhammad Taqi Usmani announced in 2007 that the most popular type of sukuk structures, responsible for up to 85% of issues, were unlawful according to Islam. The main problem with these type of sukuk is that they offered partial or total guarantees of repayments or of annual distributions, which ran counter to the Islamic principle that parties to a financial transaction must share in the risks and rewards attached to it, which also see, the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) formally ruled such structures were not Shariah-compliant in 2008.