Challenging the IBF model - I

During an online search on relevant topics while writing this article, the author coincidentally lands on a page where a Professor from Scandinavia, apparently disturbed by the recurring collapses of the prevalent global economic and financial system (as designed by the West), is curious to know the major technical differences between non-credit and non-interest-based Islamic banking and finance and, the conventional banking and finance. The likely answers to the thought-provoking, fundamental questions he raises with regard to monetary system and money creation, fractional reserve banking, inflation, business cycles, and asset bubbles indicate that there actually is not much difference between the conventional banking and finance model, and the Islamic banking and finance (IBF now) model as is being practiced around the Muslim world today, as well as in parts of the non-Muslim world. This is because, the current IBF model is itself based on debt, as well as interest, in one form or the other. Although there are some differences in theory, in practice both the conventional banking and finance and the IBF are not only very similar in their form and mechanism, but the two also produce almost the same effect on the economy of a country and its common population.
According to the Oxfam report released in January 2017, which coincides with the annual meeting of the World Economic Forum in Davos, just eight men own the same wealth as the poorest half of the world. The report calls for building a 'human' economy that benefits everyone, not just a select few, already rich and powerful individuals. While the whole world is in search of an alternate economic and financial system that is more stable, just and equitable, and caters to the needs of the masses especially the downtrodden, the current IBF model, as practiced, does not seem promising enough to live up to Islam's potential of offering such an alternative to the world.
Being very similar to the conventional debt-based economic and financial order, the current IBF model conveniently ignores the economic and social benefits that only a truly Islamic economic and financial system based on equity/profit and loss-sharing structure of the economy can bestow upon humanity. Thus, by presenting the current IBF model as the only feasible one, its Muslim proponents are not only avoiding the hard work of devising and implementing real Islamic modes of finance that are equity- based, they are also failing to present to the world the real Islamic economic and financial system that has the potential to benefit the whole of humanity and not just the Muslims.
The main difference between conventional banking and finance, and real Islamic finance is the use of equity-based or profit and loss sharing financial structures, and not the debt-based financial structures as promoted by the current IBF model. The main modes of finance as permitted and encouraged by numerous Islamic scholars are the Musharakah and the Mudarabah that are both equity-based structures with profit and loss-sharing implications. Contrary to this emphasis on equity-based financial modes, the current IBF model promotes debt-based financial modes like Murabaha, Ijarah and Sukuk.
The current IBF model turns out to be very much a replica of the conventional, riba-based banking and finance model as originated in the West. In fact, there is a strong disagreement between the Muslim scholars themselves as to how truly "Islamic" the current IBF model is. More so, ironically, the proponents of the current IBF model, ulemas and practitioners alike, openly admit themselves that their model is less Islamic and hence less desirable than the Musharakah and Mudarabah that are the completely riba-free, real Islamic modes of financing based on equity/ profit and loss sharing.
Despite this skepticism about how truly Shariah-compliant the current IBF model is in its practical application, the IBF industry today, although still miniscule as compared with conventional banking and finance industry, has a rapidly growing market share, particularly on the deposit side. The IBF industry constitutes not just the Islamic banks and other Islamic financial institutions, but also includes the Islamic windows offered by the conventional, riba-based finance and banking institutions. These institutions offering IBF products and services are operating in all parts of the globe including both the Muslim and non-Muslim countries, and interestingly, have both Muslim as well as non-Muslim customers.
In Pakistan, considerable focus, energy and speed is evident in developing the support apparatus for the IBF industry in the form of newly established centers of excellence in IBF research, education and training at leading Pakistani universities, to produce IBF related research, create IBF-related awareness in the masses to win more, especially religious minded customers, and produce a steady stream of suitably qualified workforce to run the IBF industry. The State Bank of Pakistan's Islamic banking department gives further institutional legitimacy to the debt-based modes of financing offered by the IBF industry, while ignoring the real Islamic modes of equity financing.
The question that comes to a curious mind is, why are the ulemas and professionals associated with the IBF industry promoting the less Islamically desirable debt-based modes of financing like Sukuk, Murabaha and Ijarah over the truly Islamic modes of financing, the Musharakah and the Mudarabah, that are equity-based? Why are efforts not being employed in making the equity sharing modes of finance possible, practicable and feasible to implement?
As an answer to this commonly raised question, the proponents of the current IBF model present the moral hazard argument, which they claim is the main impediment to adopting the truly Islamic, equity-based modes of finance. They state that it is very difficult in practical terms to implement profit and loss sharing or equity-based Islamic finance modes in society because by their very nature, these modes require a society high on morals and ethics to be successfully implemented and operated. It is claimed that due to a lack of ethics and morals, organisations operating in Muslim societies of today will either falsely declare losses and thus fraudulently devour investors' money, or, at best, understate profit so that they can deceptively keep a part of the profit to themselves rather than distribute it honestly amongst the investors under the truly Islamic profit-loss sharing model.
Since Muslim countries generally have a high incidence of corruption (as indeed reflected in the subsequent annual rankings of Transparency International including its rankings for the year 2015), one cannot hope, at least in the present, to implement equity finance in Muslim countries, claim the IBF policymakers and practitioners. Hence, the moral hazard inherent in equity-based/profit-loss sharing modes is the main excuse presented for the current IBF model to be debt-based and not equity-based.
This excuse by IBF proponents is indeed plausible, and when coupled with the effort being expended in the propagation and implementation of the current IBF model, it successfully persuades common religious-minded Muslims to helplessly accept keeping their savings in "Islamic deposits" and seek "Islamic loans" for their businesses as offered by the IBF industry, in the absence of the truly Islamic, equity-based alternatives.
This article challenges this notion of impracticality of the truly Islamic, equity-based finance on the pretext of moral hazard, and argues that little effort has been put in by Muslim experts in the field to make equity finance practicable and feasible to implement. Also, it aims to present a few ideas to make equity-finance, as prescribed by Islamic teachings, the norm in a Muslim country, and thus facilitate the designing and implementation of a truly Islamic economic and financial system that could also serve as an exemplar of a stable, equitable and just system for the world.
First, to challenge the central pretext of moral hazard in failing to implement equity finance, the author wants to ask the ulemas and professionals associated with the IBF industry if they do not see the possibility of moral hazard in their own IBF model, which being very similar to the conventional finance and banking model in its form and substance, is prone to similar ethical failures that have caused the widely destructive global debt crisis, and consequently, the global economic collapse.
The expected answer to the above question would be that actually, the IBF policymakers and practitioners are very cognisant of the moral hazard in their own IBF model. To tackle this moral hazard and to reduce the skepticism of a rapidly growing clientele, they have instituted multiple layers of intelligent checks and balances that include monitoring of Islamic Banks by the State Bank of Pakistan, supervision of Shariah compliance by Shariah advisory boards of the respective Islamic banks and their regular internal audits. If that is the case, then one might ask why such an effort cannot be employed in tackling the moral hazard inherent in the truly Islamic, equity modes of finance.
Sadly, the Ulemas and professionals backing the current IBF model are declaring defeat without even trying to tackle the moral hazard issue in equity finance. They are demonstrating an inability to provide persuasive guidance for the creation of an ethical business environment in Muslim countries just at a time in history when, in the wake of one financial and corporate scandal after another, Western academia and practitioners are putting spotlight on various facets of the hitherto relatively ignored concept of morality in business.
Currently, there is a lot of academic and practical work being done in the West on topics like business ethics and morality, spiritual intelligence and spirituality at the workplace, social responsibility of business, corporate governance, accountability and transparency in business etc that are all, ironically, the domain of a truly Islamic business setup. Weren't these ulema supposed to be the torch-bearers in upholding and ensuring Islamic ethics, transparency and accountability in business organisations in Muslim societies, instead of pronouncing their helplessness in tackling the moral hazard in equity finance?
In effect, when the ulemas backing the current IBF model pronounce equity finance as being unrealistic due to the moral hazard under prevailing circumstances, they appear to be waiting for a utopian society to "arrive" before the Islamic modes of finance as permitted and encouraged by the Quran and Hadith could be implemented. Since, in reality, it is virtually impossible to develop a utopian society where no one lies, cheats or commits corruption, hence, the design and implementation of a truly riba-free Islamic economic and financial system will likely be delayed for eternity! The moral hazard argument against implementing equity finance is thus futile reasoning.
As this article would argue, all hope is not lost. One wants to inquire how the Muslim businesses and economies functioned before the advent of modern banking and finance, and, modern stock exchanges, all of which are rather recent developments as organised forms of financing designed by the non-Muslims. Were the Muslim societies during the golden period of Islamic history (traditionally dated from the 8th century to the 13th century) morally utopian societies? Or, was it the brilliant economic management and financial administration in those thriving economies that compelled businesses to be ethical, transparent, and accountable so as to build the trust of investors and attract financing from them, following the real spirit of Islam. Now, this was much before the advent and widespread use of information technology and its tools that are being intelligently employed today to enhance transparency and accountability in different types of human endeavour including the business enterprise, in all progressive societies of the world.
Contemporary Muslim thinkers unabashedly ape the West in almost all intellectual pursuits. Why then are they not doing so when it comes to learning from the West in tackling the moral hazard issue, particularly when today, we also have information technology tools at our disposal to facilitate transparency and accountability in business organisations? Thus, whatever needs to be done to make the equity-based or profit-loss sharing financial structures practicable today, has to be done for this imperfect world only, keeping in view the bitter realities of human nature that is prone to lie, deceive and be corrupt when given an opportunity.
(To be continued)
(The writer is a former Commonwealth Scholar for UK, and Fulbright Scholar for USA, in the field of Management with special interest in corporate governance, business ethics and sustainable business. The views expressed in this article are not necessarily those of the newspaper)