Brendan Quirk (IMBA 2009 class) has written this blog on Islamic Finance. I hope you enjoy it as much as I did.
Last week, IE had the pleasure to have Dr. Ibrahim S. Aboulola, from the Islamic Economic Research Center at King Abdul Aziz University in Saudi Arabia. Dr. Aboulola came to speak to the students about Islamic Finance.
Given today’s current banking crisis. Recently, there has been a lot of interest in Islamic Finance these days because it is not only a widely used and proven method of financing but has an ethical component as well, which has been lacking in the current system used in the west.
For that and many other reasons Islamic Finance is being used more and more in the west. According to Ernst & Young in this year’s Islamic Funds and Investment Report, there have been significant increases over the passed few years with the number of 700 funds and now reaching almost US$ 50 billion in fund assets under management.
So what is Islamic Finance? Well what we learned from the Dr. Aboulola’s lecture is that Islamic Finance is a form of financing used in Islamic banking institutions that work in accordance with Islamic Law, or Shari’a. It is understood broadly to be asset based and not currency based because it does not use interest on money lending. This is the idea known, as Riba is that money has no intrinsic value and is only a means of payment. Therefore, Islamic Banking is linked and directed to real activities like buying physical assets like a house on behalf of a borrower. Then the borrower pays the bank payments that are previously agreed to. I know what you’re thinking. Same as western finance, right? Wrong. These payments are fixed and there is no interest on the money. It’s based on ownership and exchange of real assets and not money. Therefore, it avoids potential injustice by unfavorably enriching one party at the expense of another.
Therefore, each bank has a Shari’a board that serves as an oversight committee of Muslim scholars from many different parts of the community to ensure the integrity of the investment as well as its religious sanctity. They serve as a control and review all investments to make sure they are in line with the laws of Islam and issue a fatwa or ruling on each and every investment that the bank is considering to invest in. In that concept at the core is that ethics is considered in the business deal. Yes, I know this is hard to understand from a western point of view. Therefore, gambling, alcohol, and pornography are prohibited. And so is interest on the assets or currency. This is because money has no intrinsic value, and is only a measure of it and therefore believes that one should not charge for its use. Now this makes sense and is a total rethinking of western finance, however it has been around a long time.
Being based on real assets avoids some risks because it shares the risk between the borrower and the lender and does not get out of hand. That means in the event of a default the losses are shared and then it is done. There is no interest that keeps accumulating or overwhelming debt trap that is becoming all too common in western society. Therefore, you could imagine that there is a lot of credit risk assessing before a deal is made in Islamic Finance.
The truth is that putting ethics in finance has been long overdue and it is about time that this is making news. I really tip my hat to the Islamic world for having done so and for their success with it. A true testament to what the Islamic world can teach the west.