THE PREACHER AND THE
BANKER---Reappraising the Progress of Islamic Finance Industry
Mohammad
Nejatullah Siddiqi
(January
2011)*
By all counts Islamic finance
has done well during and after the financial crisis triggered by subprime
lending in US and engulfing the world during 2007-09(?). I mean what counts
conventionally. Is there something else that counts? That is a different story.
Economics is about incentives.
Man is moved by many kinds of incentives: material, spiritual; mundane,
other-worldly; individual, social, etc. Material incentives may relate to
wealth, fame, power and privilege, etc. Economics specializes in dealing with
material incentives, particularly those related to wealth. It is also best
equipped to deal with individual/personal incentives (something it owes to its
history over the last two centuries). It
works best where measurable sums of money are involved. It never claimed to
deal with other kinds of incentives, especially spiritual ones. It is of little
use here to lament these limitations or wish for a more ‘holistic’ approach.
Better to use it where it serves and find other ways to deal with what is
beyond (conventional) Economics.
Islam too deals with
incentives. Though it concerns itself with all kinds of incentives, it gives
special importance to spiritual and social incentives. Life’s multifarious
needs cannot be all met by encouraging only individual-material-money- focused
motivation. In fact this kind of short-sighted approach has been the bane of
capitalism. Many a critique of the recent crisis has pointed out this
affliction’s role in what happened. A search is on for forces that could limit,
if not altogether eliminate the role of this deficiency. In fact the problem is
not confined to crises, as capitalism has suffered from this disease from day
one. Humanity has been led to believe(I think wrongly) that this affliction is
the price we must pay for ‘progress’ at a rate without any precedent in human
history, of creation of wealth at a monumental rate. That requires we ignore
the fact that more than a billion people still suffer from abject poverty, let
inequalities increase overtime bringing in its wake increasing crime and soring
anxieties, and leave untreated the threat to world peace posed by existing and
forthcoming hegemonies.
That is
not going to be. The current paradigm can no longer sustain itself. It is at
this point that we recall there is more to good life than
individualistic-materialistic incentives can bring forth. Admittedly the cures
are not simple. We need a methodology that ensures progress with equitable distribution of the fruits of progress. It is
foolish to tolerate abject poverty and deprivation in an age of plenty. World peace
is too valuable to be sacrificed for the sake of aggrandizement of any one
people. The new approach cannot be effective unless its incentive structure
accommodated the social nature of life on earth. In view of the fact that
overwhelming majority of human beings believe and have always believed in life
beyond death, spiritual dimension of motivation also deserves recognition.
Islam,
and all world religions for that matter, wisely relied on spiritual and social
incentives to meet the requirements of dimensions of life not amenable to
individualistic material incentives. These incentives appeal to the individual,
in the first instance. But these incentives also persuade the individuals to
cooperate with one another for bettering their conditions (in this life and the
life yet to come). This cooperation extended to finance too. As exemplified in
early Islamic practice, such cooperation involved, besides individual economic
agents, the state as well as voluntary organizations. Cooperation in finance
was institutionalized in different kinds of partnerships, credit sales, lending
(free of interest), and trade credit, etc. It is not always possible to
replicate old institutions in new circumstances. What is important is to keep
the spirit of cooperation alive and active, with an approach to wealth creation
that sees wealth as means to good life, not as an end in itself. The
translation of the cooperative approach into appropriate institutions can be
different in different circumstances.
That is
where all religions, Islam included, differ from capitalism. Once again the
financial crisis of 2007-09(?) has demonstrated that capitalism is incapable of
ensuring good life that would inclusive of entire humanity and cover the social
and spiritual dimensions of life. The reason lies in capitalism’s incentive
structure, which is one sided. Some think clever regulations can manipulate
individualistic incentives to serve social objectives. It is good as far as it
serves, but the record thus far has not been very encouraging. There is no
escaping the conclusion that
social-moral orientation of man’s approach to wealth better start from
the individual at the early stages of education. That is what religions have
done since the dawn of civilization. Religions, Islam included, give us values
(like justice, equity, social equality, compassion) which values have to be
translated into institutions suitable for the time-space contexts in which
these values are sought to be realized. The real challenge, intellectual as
well as organizational, lies in devising suitable governance and regulatory
structures that could complete the task begun in educational institutions of
inculcating humane incentives in economic agents (consumers, savers, investors,
entrepreneurs).
Religions
rely on preaching rather than coercion. The intention is to preserve human
freedoms. Islam wisely accommodated some coercion necessary to keep order. In
finance it has laws like prohibition of interest and gambling to meet some minimum
requirements of justice and fairness. But the realization of the larger
objectives of Islam in finance requires broadening the incentives-structure.
Islamic finance cannot succeed in its vocation on the basis of capitalistic
incentives-structure. The realization of Islamic values of justice, equity,
social equality, compassion,in contemporary society requires an imaginative
exercise in social innovation that Islamic finance votaries have yet to
attempt.
When
the Islamic finance project was launched in the third-fourth quarter of the
twentieth century it had the ambition to do exactly that. Instead of being a
mere replica of capitalist finance, that accepted the sovereignty of profit
motive, the guiding light of monetary advantage and the focus on the
individual, Islamic finance aimed at serving the Islamic objectives of money
and finance by eliminating interest and gambling like speculation, removing
ambiguity from contracts and
facilitating cooperation and sharing among people. Islamic finance implied
a culture of risk sharing by the wealth owners: the depositors into Islamic
banks’ investment accounts and those seeking profits through Islamic mutual
funds, sukuk, etc. The capitalist culture of seeking profits while refusing to
share risks fits ill with the Islamic spirit and does not belong to Islam’s
incentive structure. Is it possible to retain the capitalist culture and record
progress in Islamic finance? Does Islamic finance involve sacrificing the
vitality and forward surge of capitalist enterprise? Can we survive in the
fiercely competitive environment of modern industrial society with a
non-capitalistic incentive structure and less than capitalistic rates of
growth? These are difficult questions indeed, but they have to be raised and
dealt with.
A
reappraisal of the Islamic finance industry along conventional/capitalist lines
misses the distinctively Islamic features of the industry. Reappraising the
progress of Islamic finance industry on the basis of Islam’s
incentive-structure is beyond the scope of this brief note and too big an order
for the limited capacities of this writer. It is a challenging task. It has
some complex dimensions. Understanding the
information deficit and its role in contractual relations, especially agency
relations, is one of these dimensions. Another one is to recognize herd
mentality, irrational exuberance and other psychological aspects of human
behavior in investment and stock-trading. Then there is the issue of
misalignment of incentives between share-holders, managers and rating agencies,
for example. Financial relations like risk sharing or lending ,at arm’s length
take a different color as compared to financial relations established directly,
on a person to person basis. Most of the Islamic precedents we draw upon for
guidance belong to the latter category. How to institutionalize the spirit of
human relations in a local community in the global village of impersonal
dealings? These challenges to human ingenuity call for creative solutions. Most
writers on finance are worried by the
growing distance between the financial sector and the real sector of the
economy. With the rise of ‘shadow banking’—financial institutions functioning
like banks but not regulated like banks—and dominance of ‘fictitious capital’
having no counterpart in the real economy, the resulting misallocation of
resources and the concomitant worsening of income and wealth distribution have
assumed crisis proportions. What remedy is possible?
Last
but not the least: What do you do if the banker does not listen to the
preacher? The easy way over the ages has been for the preacher to threaten with
eternal damnation (hell on earth, hell thereafter). But that is not of much
help for us, the ordinary folk who fear the preacher but need the banker. There
must be a way out! The initial spurt of Islamic financial institutions as
exemplified by Tabung Haji, the Mit Ghamr experiment and other community level
institutions established in the nineteen sixties, bore the promise of becoming
something distinctive. May be they could not meet the needs of impersonal
financial relations at a global scale. Some other initiatives, preferably at
state level, would have had better chances of success. But the trillion dollar Islamic finance
industry being reappraised by this forum is more of a dish in the standard menu,
albeit with an ethnic flavor. Where did we slip?
A
detailed answer must await special focus by competent scholars, but some
observations are in order. For too long the industry has been focusing on
product development, Shariah- compliant products in current parlance, to the
neglect of building the institutional infra- structure needed by the new kind
of finance. Islamic financial industry worth the name calls for institutions
rooted in Islamic values and Islamic (dual) incentives, incentives that are not
forgetful of spiritual-social objectives while they focus on
material-individualist interests. Man’s environment does not force one to
choose between the two: material/spiritual, individual/social. Good living
implies a judicious mixture of the two. Balancing the two is what sustains the
world despite our aberrations. With modern capitalism the balance has been
lost. Islamic finance was conceived to regain balance. We can still do it by
paying due attention to our values and objectives, inviting each and all to
participate in the task of building appropriate institutions to support a
humane society the treats wealth as a means to good life for all and sees
finance as a necessary ingredient in this enterprise.
*Inputs
from Professors Valeed Ansari (AMU) and Habib Ahmad (Durham) are gratefully
acknowledged.