By Shawn Woodley, Contributor Islamic finance, an approach to economic activity that incorporates Shariah religious law, is gaining momentum as an alternative to the Western capitalist economic model as the global recession continues. The Western capitalist model is on the defensive as leaders, entrepreneurs, and economists chafe against growing protectionism and erect regulations. Champions of Islamic finance cite its resilience in the current economic climate, but what are the implications of it as a global system?
Islamic economics emerged as a concept and academic discipline in the 1970s. Its founders argued that Islam encompasses all areas of human existence including economics. Islamic finance features divestment in alcohol, gambling, and pork related businesses and zakat, or almsgiving. The most central feature of Islamic finance, and subject of debate within the Muslim world, is the prohibition against riba, which is translated as usury or interest, reflecting two divergent economic approaches and interpretations of the Quran itself.
Moderate practitioners of Islamic finance define riba as usury or an exploitative interest rate. Proponents of this interpretation note the context of the Quran where the pre-Islamic Arabian institution of riba was observed by the prophet Mohammad. During that time, the amount of money a debtor owed would actually double with each default of payment, essentially resulting in economic slavery. This interpretation, which calls for modest or fixed interest, allows the finances to Muslims to be more easily incorporated into, and accommodated by the existing economic system in which interest is a critical component. For example, government bonds, arbitrage, and stock trading are allowable with minor adjustments.
When riba is understood to mean interest of any kind in the strictest possible definition advanced by Islamists, the Islamic economic model is construed as a model which must operate entirely separate of the existing system. It is an asset based system emphasizing profit sharing over interest and applying strict Islamist interpretations to modern financial products. An Islamic business loan, for example, may peg an implicit interest rate to the profit of a venture. If the business makes no money, neither does the bank, and if profits grow, so too may the implied interest. Once the principal on the loan is paid, the profit-sharing arrangement ends. Collateral expectations are generally higher than traditional banks in order to protect the bank from default, and because risk is shared between banks and account holders, banks are expected to scrutinize transactions more closely.
Critics note that the early founders of Islamic economics were Islamists explicitly interested in establishing strict Islamic rule over society and secular governments, supplanting the Western economic model, and priming the world for eventual Islamic hegemony. They further cite institutional weaknesses and suggest that weaker financial reporting standards may result in greater access to financing for terrorist and criminal activities. Patrick Sookhdeo of the Institute for the Study of Islam and Christianity cites that Muslim critics assert that Islamic economics is an “invented tradition” and “neither Islamic nor efficient” and likens the practice to “financial smoke and mirrors” that use legal and financial tricks to merely repackage interest.
Islamist conceptualizations of Islamic economics can be problematic for micro-finance. Micro-lending, which has economically empowered over 100 million of the world's poorest, faces challenges in parts of the Muslim world. For example, in Bangladesh, where tensions between secular and Islamic influences are increasingly pronounce, some villages accept the much needed aid while others turn it down on the grounds that it is incompatible with Shariah law.
Nevertheless, in the Muslim world, the banks are seen by Muslim leaders as more resistant to the current economic downturn than traditional banks. Malaysia is a regional hub of Islamic economic activity, and Prime Minister Abdullah Ahmad Badawi cites a need for an alternative system due to the, “unbridled greed in the financial system.” In neighboring Indonesia, a G20 member and the world's most populous predominantly Muslim nation, President Susilo Bambang Yudhoyono is calling on Islamic bankers to “do some missionary work in the Western world,” pointing out that the West has never been more receptive than it is now.
Calls for the expansion of Islamic banking mirror its growth over the last 40 years. Since the first Islamic banking institutions opened their doors in the 1970s they have expanded, numbering at least 300 in 75 countries with global assets nearing $300 billion according to a 2005 IMF report. In 2006, $1 trillion was handled in an Islamic manner and 50 to 60 percent of the world's 1.2 billion Muslims are expected to have their savings handled by an Islamic financial institution by 2020. Outside of the Muslim world, the availability of Islamic financial products continues to grow, particularly in the UK and the U.S. A 2006 report by the Middle East media Research Institute (MEMRI) attributes the expansion of Islamic banking outside of the Muslim world to the outpouring to wealth from Gulf financial hubs like Dubai.
Muslim wealth will continue to grow and become enmeshed with the global economic system, and so too will Islamic finance. The question within the Muslim world, the UK, and the U.S. is whether or not it is compatible with the traditional financial system. If it is, what are its merits? If it is not, what are the implications of its incompatibility? How Islamic economics is conceptualized by Moderates and Islamists in this financial climate will affect the future of investment and economic engagement in the Muslim world.
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