By Tengku Razaleigh Hamzah, former chairman of the World Bank and IMF, former chairman of Asian Development Bank, former chairman of Islamic Development Bank and the Founding Chairman and Chief Executive of Petronas
In this article I will be touching on certain issues that I consider pertinent and relevant to our efforts to further the global cause and development of Islamic finance and banking. Islamic economics, and thus Islamic finance, is based on the philosophy of justice, equity and morality. This is reflected by the overarching and core Shari’ah principles governing or underlying its features and operations, the most important of which are as follows:
- prohibition of riba (usury), which includes interest on debt in any form,
- prohibition or avoidance of gharar (uncertainty or ambiguity in contracts),
- adherence to risk-sharing and reward-sharing, i.e. profit- and loss-sharing (PLS),
- ban on immoral business activities and investments (such as production and sale of liquour, gambling, hoarding, pornography),
- sanctity of contracts,
- protection of ownership rights,
- prohibition on dishonesty and deceptive practices,
- discouragement of concentration of wealth in a few hands,
- redistribution of wealth by way of zakat (alms tax).
The overall mission of Islamic finance is the socio-economic and moral well-being of the whole community. This means that its orientation and ethos differ, or should differ, from those of conventional banks. While the performance of commercial banks is solely measured on financial criteria, the most important of which is the profit criterion, the performance of Islamic banks ought to be based on a combination of social and financial criteria. The focus should never be solely on profitability but also on social benefits to the community. Adherence to this philosophy dictates that Islamic banks should not surrender themselves to the pressures of following the profit-maximization practices of conventional banking, such as getting rid of unprofitable but socially beneficial lines of business or downsizing the workforce to cut costs and thus contributing to unemployment, or shying away from microfinance for the empowerment of the underclass.
Proponents and practitioners of Islamic finance must always be mindful that the raison d’etre of Islamic economics is justice, equity and the socio-economic well-being of the whole community. They must not sacrifice this very important principle just for the sake of increasing their market share or for easing the entry or expansion of their operations into the global financial system, which still very much functions and operates according to the rules, practices and ethos of conventional banking. In the long-term, the survival and growth of Islamic finance depends on its integrity and reputation.
Islamic banking and finance currently constitutes only a small portion of the global economy, although statistical data indicates that it is growing. An estimate has put the total assets held by Islamic banks and finance institutions globally at around $1 trillion in 2010 then increasing to $1.6 trillion currently, representing between 1 to 2 percent of the entire assets in the global economy and growing at between 15 to 20 percent annually. Some analysts take the view that Islamic banks and financial institutions are more resilient than their conventional counterparts, better able to minimize or mitigate the effects of the most recent financial crisis of 2007-2008 and the global economic downturn that followed. Of course, this resilience is attributable to the inherent features and characteristics of Islamic finance itself, in view of its adherence to the Shari’ah principles, which I briefly mentioned. However, we should not fall prey to over-optimism and entertain the illusion that Islamic banking and finance is immune from the effects of a global recession, or, indeed, of any great shift or turn in the forces and currents that shape the world— culturally, politically, socially or economically.
For this reason, we must continuously make the effort to monitor and understand the happenings in the world as well as the apparent and hidden forces giving rise to them. These include first, the civilizational crisis today with the possibility of collapse and general chaos, as a result of the interplay of various seemingly intractable phenomena—climate change, global environmental crisis, depletion of natural resources, loss of biodiversity and extinction of species, economic instability, wars and serious humanitarian crises, proliferation of nuclear weapons, hunger and famine, widespread social unrest, and many more—all of which are largely attributable to human follies and misdeeds (ghafla and fasad in the language of Islam). Many factors have been advanced to identify the root cause of this civilizational malaise.
The second is globalization: in the last few decades, the world has become increasingly integrated in all spheres of life. This globalization is not an accident of history. It is underpinned by a combination of sub-processes and policies—particularly liberalization, privatization and deregulation—that are consciously propagated and pursued to promote free trade and level playing fields for all economic agents. High technology, particularly the Internet, and modern means of transportation enhance the speed and efficiency of the globalizing process. The opening of national markets to foreign competition, through a liberalized and deregulated environment, diminishes the ability and power of governments and market regulators. In this sense, the market is playing the supervisory role in reverse. Governments everywhere are under the constant surveillance and radar of international rating agencies and market analysts. Thus globalization is both a boon and a curse. Whether it works for us or against us depends to a large degree on our own wisdom, on the policies and strategies we put in place.
The third reality is the shift from the real economy to the financial economy; some observers refer to this phenomenon as “financialization”, whereby investors no longer look for dividends but behave more like gamblers speculating and betting on price movements, and by extension even on the collapse of national economies. This development magnifies the dangers and risks of speculation that many economists fear and is abhorrent to the Islamic financial system.
Finally, the rise of the global Occupy movement and the Arab Spring uprisings in the wake of the financial crisis of 2007–2008. They signify a new wave of consciousness and desire for change in the existing political, social and economic order and arrangements that benefit a few at the expense of many. The acceptance of capitalism as the economic system by the former socialist states does not negate the amorality of the system in which consumers are open to exploitation. It was the natural choice since capitalism was the order of the day, and it would have been odd for them to have done otherwise. Thus it is not surprising that the annual report put out by the World Economic Forum in Davos in each of the last three years identifies income inequality as the number one global risk.
It is worth reiterating that the Islamic economic system is neither capitalistic nor socialistic in nature. It is a system that has been provided by the Quran and the Sunnah of the Holy Prophet Muhammad SAW. It is the ethical system that operates on the basis of shared risk and profit to the lender and the borrower. Similarly, Islam differentiates between the production of goods and services, the science of economics as it were, and the manner in which they are distributed, or the economic system. The science of economics is universal and can be absolute, irrespective of creed and beliefs. The economic system, on the other hand, elaborates on the manner in which wealth is to be acquired, distributed and disposed of. It is, therefore, the ideal system that is not encumbered by the drawbacks of capitalism and socialism. This is the subject at hand and the crux of the matter; and the Islamic economic system has laid down the rules based on the Shari’ah.
The fundamental of the Islamic economic system lies in the belief that man is the representative or trustee of Allah SWT, who is the real owner of the heavens and the earth and everything in the universe. It is man’s right to apply resources for his existence, but it is not limitless. And divine wisdom dictates that man should not hoard his wealth as if it belongs to him absolutely, while denying the use of such wealth by others. It is for this reason that sadaqah and zakat were instituted, and these serve as the platform for the equitable distribution of wealth. It is also timely to note the contrasting differences between interest or usury or riba of the capitalist system and sadaqah and zakat. They are complete opposites of each other. While sadaqah and zakat channel wealth from the rich to the poor, interest channels wealth away from the poor to the rich. It denounces miserliness, greed, extravagance and unnecessary wastage. It is in this context that we must situate Islamic banking and finance.
There are good reasons for believing in a bright future for Islamic finance. As noted by Dr. Mahmoud Moheildin, the managing director at the World Bank, there is a growing interest in financial instruments that emphasize risk-sharing in the aftermath of the recent financial crisis. Islamic finance’s “underlying tenets of an ethical and just financial system that strengthens real economy sectors has tremendous global relevance. A large client base exists that is sensitive to doing business with socially responsible institutions” (“State of the Global Islamic Economy”, a 2013 report produced by Thomson Reuters). According to a survey conducted by Thomson Reuters, the demand for sukuk is expected to reach $421 billion by 2016 from $200 billion in 2012. In his inaugural address at the World Islamic Economic Forum (WIEF) in London in October 2013, the British prime minister, David Cameron, said he wants London to stand alongside Dubai and Kuala Lumpur as one of the leading hubs for Islamic finance. He also announced the plan of the London Stock Exchange to launch an Islamic Market Index. This is some of the good news that point to the wide open road for Islamic finance in the years to come.
The success of Islamic finance requires the commitment and support of many quarters, especially the government, which possesses the wherewithal to put in place the requisite regulatory framework and the policies to create a conducive environment and to allocate seed funds and resources. The experience of Malaysia is a good case in point. With a modest beginning in 1963 with the launching of Tabung Haji (Pilgrimage Fund), the brainchild of a pre-eminent Malaysian economist, Royal Professor Ungku A. Aziz—currently with assets of $10.4 billion and 8.2 million depositors—Islamic banking and finance in Malaysia has grown by leaps and bounds and is now internationally acknowledged as a leading success story. Value-wise, total Malaysian Islamic banking assets currently stand at about $168.4 billion, representing more than 10 percent of the global total, while our sukuk issuance accounts for more than 60 percent of the global Islamic bond market. Regulatory-wise, Malaysia is one of the 30 countries today to have standalone legislation and regulation governing Islamic banking and finance. Institution-wise, Malaysia has 21 full-fledged Islamic banks, the highest number worldwide, and 16 takaful/re-takaful operators, the third highest in the world behind Saudi Arabia, with 23 operators, and Indonesia, with 22 operators. In terms of supporting infrastructure, it has a full-functioning national Shariah Advisory Council, established in 1997 by Bank Negara Malaysia, the Malaysian central bank; the International Centre for Education in Islamic Finance (INCEIF), a university established by Bank Negara in 2005 to provide education in Islamic finance up to the doctorate level; and, of course, the Islamic Financial Services Board (IFSB), another initiative of Bank Negara inaugurated in 2002 as a standard-setting body of regulatory and supervisory agencies dedicated to ensuring the soundness and stability of the Islamic banking and finance industry.
However, for Islamic finance to realize its full potential and respond to the increasing demand for ethical, equitable, stable and risk-resistant financial products and services, serious efforts must be undertaken to address the challenges, weaknesses and constraints existing and their potential at all levels and in all aspects of implementation, operation and practice. Many proponents and thinkers in Islamic finance—including Dr. Umer Chapra, Dr. Mahmoud Mohieldin, Dr. Abbas Mirakhor, Professor Hossein Askari, Dr. Iraj Toutounchian and Mr. Daud Vicary Abdullah, just to name a few—have produced insightful analyses and have come up with substantive and useful suggestions relating to this very important issue; these include improving and strengthening regulatory framework and supervisory oversight, promoting standardization both domestic and across jurisdictions, rebalancing tax treatment, ensuring adequate liquidity, establishing sound best-management practices, establishing cooperative mechanisms to respond to crises occurring at institution and industry levels, ensuring adequate supply of trained personnel, and raising the level of understanding of Islamic banking and finance among judges, arbitrators and industry-connected professionals (lawyers, accountants, etc).
The efforts and measures undertaken in enhancing Islamic banking and finance should not focus merely on the quantitative aspect but must also encompass the qualitative as well. Firstly and most importantly is the need to strictly adhere to the core Shari’ah principles underpinning Islamic finance and resist the temptation to circumvent them, for example, by resorting to so-called creative financial engineering or using ambiguous or deceptive words or turn of phrases. Doing so would not only be wrong in the sight of the Shari’ah but also would compromise the integrity of Islamic finance itself, and this would ultimately reduce public confidence in the industry and damage its reputation. Secondly, we should give special priority to the socio-economic mission embedded within the philosophy of Islamic finance to realize distributive justice by extending the reach of services to the disadvantaged sectors of the community through micro-finance, qard al-hasan (good loan or loan without interest), zakat, sadaqat and waqf and so on.
In the early development of Islamic finance and banking, there was a tendency to not design Islamic finance products to the strictest of Islamic principles and standards. It was inevitable then as the understanding and measurement of the economic and finance systems were based on the conventional system. This being the case and given the lingering tendency, although somewhat infrequent now, to continue measuring the mechanics of Islamic finance using conventional indicators, I think a relook at the system with a view to refining it is timely and opportune. In this regard, it does not hurt the system if we were to revisit what constitutes halal and haram in Islamic banking and finance. This, I submit, is part of the continuous quality-assurance exercise that we have to go through to keep our practice true to the dictates of the Shari’ah.
In the mission to empower the global ummah economically, it is now quite obvious that the system of choice is the Islamic economic system. To undertake this game-changing transformation of the global ummah requires the financial wherewithal to provide the substantial funding. In this regard, the success of Tabung Haji (Pilgrim’s Fund) in Malaysia, the international waqaf movement and the growth of Islamic cooperatives could be replicated throughout the Muslim world to help in developing that financial muscle and strength. All that is required is the political will to make that replication a reality. With the right type of cooperation, and with the participation of such bodies as the Islamic Development Bank and the Organisation of the Islamic Conference, which have the necessary technical expertise, the empowerment of the global ummah would be a reality. I strongly believe that such a development as this could provide the platform and the basis for the universal application of the Islamic economic system together with the complementary political and legal systems.