Hey monkeys, I recently came across the topic of Islamic finance in one of my business classes and I found it intriguing to say the least. For those of you already versed with this topic, continue to the end where I have a few questions for discussion and for the rest of us, I'll outline a few basic tenets and rules of this system.
First and foremost, it's extremely important to understand that almost all the rules of Islamic finance stem from the guiding principles of Islam. So, as a quick reminder, the five pillars of Islam are:
- Declaration of Faith
- Prayer
- Charity
- Fasting
- The Pilgrimage to Mecca
There are tons of little details within each pillar but for the sake of simplicity and brevity, I'll move on to the topic on hand. Islamic finance draws from those five pillars and the Quran's teachings. More specifically, it relies on the ever-expanding Shari'ah law and lays down these 4 rules:
- There will be no collection of Interest as it is considered to be a form of manipulation
- There will be no speculation
- Gambling is disallowed since it could lead to addiction and poverty
- There will be no commercial transactions or investments that include pork or alcohol
As a prospective monkey in the conventional finance world, I was intrigued by some of the implications of these rules particularly the rule on interest. I'm still a little skeptical about the utility of this system going forward but based on the guest speaker who explained these guidelines to us, it seems to be working in the region and according to him, more institutions are looking into this given its regional success.
In fact, there are billions of dollars under management using these rules in the world mostly in places such as Turkey, Qatar, UAE and Saudi Arabia. The market for such finance is also said to be growing at a much faster rate and there is an increasing number of funds cropping up to match the needs of the people who wish to follow Islamic finance in the region.
Nonetheless, I wanted to hear some questions and comments from the community. There are certain partnership structures that one can use in Islamic finance to get around the first rule and I can elaborate on those in another blog post if a significant number of people are interested. I, personally, think that the guidelines are a little restrictive but maybe that's a good thing in some cases. So what do you guys think? I'd be interested in hearing some opinions, criticisms and even, questions.
Great post. It is very interesting, and some of these Islamic countries have sovereign wealth funds which you can work at too. There are also what people consider "Islamic stocks" in Malaysian companies who follow these religious guidelines.
Yup. Sovereign Wealth Funds are huge in these countries. It's really important because a lot of these countries have realized the utility of diversification and are trying to move away from solely relying on oil and minerals for their revenue streams. So, they're pumping money into these funds that invest all over the world and give them exposure to other asset classes and other types of revenue streams. I was going to highlight this in the next post if more people were interested
Thanks for sharing and highlighting this topic, I had no idea this was the case. My initial thoughts are along the lines of; If it works for the nations participating in this sort of finance, then let them continue, not every society needs to be a capitalistic society.
I tend to agree with you. It's working on multiple levels for these firms and nations. Interestingly, some of the bigger banks are taking notice of this potential market and trying to enter it. The guest speaker said he expects this market to grow anywhere between 15 to 20% a year for the next 3 to 5 years as more institutions are exposed to this
Sukuk (or otherwise known as Islamic bonds) follows the Islamic principles and stipulates that any form of financing need to be backed by tangible assets.
In Malaysia and Indonesia especially, recent trend suggests huge growth in Sukuk issuance especially by large palm oil producers (about $ 1.8 billion in 2013) since agricultural lands fit well as underlying Sukuk asset.
I would say there is definitely a market for Islamic finance.
Perfect! I was going to mention that in my next post. We talked about it extensively in class among other things. How did you know about it?
Haha, I am from the region itself and came across some hard figures in a market update report a couple of weeks back.
To be fair Malaysia and Indonesia are the largest palm oil producers (>85% of world's output), so they tend to drive the growth of Sukuk issuance in the region. But it would be interesting to see how the Islamic capital markets will be developed to woo the Middle Eastern money.
From my knowledge however Islamic sovereign funds are more heavily weighted on real estate investments, simply given the securitization of hard assets and relative good yield especially when you have the billions to look at top quality properties.
How do loans work if no interest can be collected?
I can perhaps speak for Sukuk investments.
In replacement of the conventional interest payments, investors are guaranteed a share of profits generated from the underlying assets, since technically they own a piece of the asset.
This also implies two things: - investors have to bear the losses when the cost of capital exceeds the return of the asset; and - investors are exposed to capital appreciation/depreciation and therefore corresponding adjustments to the principal when it is due to be fully repaid by the issuing firm.
So if a company had no profit in a given period, it wouldn't pay its creditors even if it had plenty of cash to do so?
As the OP mentioned there are many vehicles to work around the "no interest" stipulation. Just as a a quick and dirty on how it works let's start off using the example of how a car loan in Bahrain works: 1. You go to a dealership and pick out a $25k car. 2.You then go to the bank and say I want said car 3. They say sick Dood, I'll buy it for you and then sell it to you for $30k on a super convenient 5 year monthly installment basis 4. You sign the dotted line and drive off There you just bought a new car with no interest involved(wink wink the interest is just baked into the principal). Now that might be overly simplified as there are other things in play (for example a fair amount of the time the banks actually own the dealerships and just sells from the inflated amount from the get go).
Commercial loans are more complex. Let's say for example you own a company that needs a credit line for $10m. 1. You go to bank expressing need for $10m and you agree to payback $12m in one years time in turn for the money now 2. Bank gives you $10m worth some sort of raw material(steel, gold, alumn....you name it) 3. You sell it to an predetermined intermediary for $10m (usually already sitting in the intermediary's warehouse; it actually never leaves) 4. In a year you pay the bank $12m for the raw materials Once again overly simplified but I hope I got the point across. If anyone spots any inaccuracies in this explanation please let me know and I'll correct.
cheers
I think "Islamic finance" is a complete joke and an insult to the intelligence of the Islamic God (if He exists). One of our clients is working on a major real estate development project and this client is a wealth fund from the UAE. I saw the write-up on the loan that we issued them with the chart that demonstrated how the Islamic financing would work. Basically, God forbids the charging of interest, so you'll create a ridiculously complicated system that allows the lender to realize basically the same return, but it's not called interest. As if God isn't aware that the spirit of His commands have just be circumvented by people who don't want to live under the command.
In a nutshell, the Islamic God forbids the charging of interest because He considers it exploitative. In response, Muslim capitalists circumvent the command against exploitation (which is what it really is--not simply a command against charging interest) by "exploiting" the "borrower" by charging him rent or something else. It's a complete insult to the intelligence of the Supreme Being.
It's like if God said don't cheat on your wife by having extramarital sexual relations, so you have oral sex with a mistress instead of vaginal sex so that when you stand before God at the end of your life you can say, "Aha! See, God! I didn't violate your commands! You've got nothing on me! Now give me my rewards!"
I'm actually a practicing Muslim and I completely agree. It's essentially the equivalent of a chef using pork meat and packaging it into your food in such a way that it's nature as pork is imperceptible...it's still the same thing lol.
Honestly I think that the real need is for a serious reexamination of what is meant by "Riba" in Islam...as it can mean a lot of different things (and there's a lot of scholarship on the subject actually, many of it highly contested)... those proponents of "Islamic finance" choose to oversimplify the category as well as negate the seriousness of the issue...
But that would require serious introspection and a conversation about the nature of these Islamic categories and law, capitalism, and modernity, blah blah blah. Much easier (and more profitable) to set up a multi-billion dollar farce.
The idea of eliminating interest has been around since at least Aquinas, and the period in which this policy was actually implemented is typically referred to as the dark ages. Economic literature during the latter part of the 18th century, which extending into the early part of the 20th century, explained that interest is (a) not trivial and (b) it can't truly be eliminated. It's an integral part of value and exists in any transaction that occurs throughout a specific time frame. Not accounting for this variable or, even worse, preventing individuals from incorporating it into their calculations, leads to major distortions and ultimately to disaster. In other words, it cannot be implemented on any large scale for any extended period of time.
If it's working in the region it's because there are intermediaries from other regions that aren't bound by the same arbitrary rules facilitating commerce. The region in question might be doing well but would do even better if they eliminated this out-dated and thoroughly refuted concept. Also, "speculation" is a fuzzy term that lacks concrete meaning. Who or what gets to determine whether an action is or isn't speculative?
My two cents.
I worked for a while in Malaysia in the reinsurance market (Takaful broker) and it was pretty interesting, but there are so many ways to work around the different rules that it all seemed a bit pointless to me as a non-muslim, I'm sure however it was incredibly important that we followed the Takaful Act for our Muslim clients!
I was aware of the no interest thing but the below requirement confuses me:
"There will be no commercial transactions"
What is meant by commercial transaction and how do they get around that?
Also what is meant by "speculating", a focus on capital appreciation rather than capital return plus inter.....eh extra principal?
Seems very contrived to me.
Wrote a short essay on this in undergrad:
@peyo212, good essay. Very interesting.
As a Christian, my understanding is that the Bible's position on "usury" is that it is 1) charging excessive interest (i.e. 50% annual interest), and 2) charging interest on loans given to family/friends/neighbors when they are in need. I think the Christian prohibition of interest was par for the course at the time--the masses couldn't read or write so they accepted the Church orthodoxy on the topics. Once reading and writing and the Bible became available to the masses it became painfully obvious that there was no Biblical prohibition against charging interest in the normal course of business. At best, it was a mistaken reading of what the Bible says, and at worst it was a cynical attempt to manipulate people. I think America today reflects the general spirit of the Bible's usury rules--it's illegal to charge excessive interest and most Christians will lend money to people in need and not charge any interest, and in many cases forgive loan principal (that at least has been my experience).
thanks for bringing this up, interesting.
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