Islamic finance is from that select group of topics – moon-sighting and HFA-approved meat being two other examples – that every Muslim has an opinion on, opposing sides oppose vehemently, and few really know enough about the topic to be able to fully grasp the intricacies of the debate, writes Ibrahim Khan.
In this article I will try and sort out the conflicting arguments made regarding Islamic finance, give them some semblance of a structure, reply to them, and contend that Islamic Finance is a necessity for Muslims in the 21st century.
Let me start by unpacking the tangle of views by presenting two common arguments against Islamic finance.
Murad the liberal Muslim goes to his local Islamic bank and gets told that he can get Islamic finance to buy a house – however he will ultimately end up paying a bit more for it than the conventional interest-based bank. Murad is incensed and complains to everyone he meets that “Islamic finance is charging even more than normal banks! What kind of Islamic bank is this?”
On the other hand, you have Karim the conservative Muslim who also goes to his local Islamic bank and asks for Islamic finance. The Islamic bank – having learned their lesson from Murad and his friends – now charge exactly the same rate as the high-street interest-based bank – even if it means cutting their profit margins.
Unfortunately Karim is now incensed. He rails to his local community that “they call themselves Islamic but all they’ve done is replaced the word “interest” with “profit” and made the same amount. They peg their rate of return to the LIBOR rate just like a conventional bank and they’re using the term “Islamic” to pull the wool over our eyes and make money off us Muslims.”
Common complaints
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We have all met both these types of characters, and what is interesting about their views is that the bank is in a lose-lose situation with the Muslim consumer. Either it differentiates itself from the conventional banks, incurs greater costs, and charges more as a result, or it reduces these differences to the bare minimum but then gets accused of being basically an interest-based bank.
My reply to the Murads of this world is simple: Islamic banking is a new industry which is tiny compared to its conventional rivals. One would not expect a start-up corner shop to immediately compete with Tesco on pricing and we should not expect it in this case either.
Islamic banks charge the prices they do for a number of reasons. Firstly, the volumes they handle will naturally be much less than the conventional bank. Secondly, the initial costs incurred developing the idea are high – as the idea is new and no templates can be followed.
Thirdly, heavy costs are incurred meeting legal and regulatory requirements. This is because regulators treat Islamic banks differently to conventional banks as Islamic banks, as part of their financing, actually buy the (illiquid) asset – which shows on their accounts – unlike conventional banks whose accounts only show the debt owed – which is easily securitised and sold on.
This means that Islamic banks need to maintain higher reserves, which means they can use less of their money, which means they must charge higher prices. The irony of all this is that the non-Muslim regulator recognises that there is a fundamental difference between the equity financing of the Islamic bank and the debt-financing of the conventional bank, while people like Murad fail to appreciate this.
My reply to the Karims of this world is slightly more complicated. This is because the Karims of this world actually have a point. There is a central tension that runs through much of Islamic finance today: does the industry “Islamise” the conventional models in line with the letter of the Islamic law, or does it present something truly Islamic in line with the spirit of the law?
At the moment there is an inclination towards the former and that has led to some (not all) Islamic finance products having rather dubious Islamic credentials.
Having said that, the Karims of this world now face a choice. Either they walk away from banking altogether – and by that I mean they withdraw all their cash, stop using debit cards, credit cards, cheques, and stop dealing with companies and other individuals who do use banks – or they recognise that banking is a necessity and if Muslims are unhappy with its ethics then something needs to be done about it.
Only viable alternative
Like it or not, Islamic finance is the only viable alternative to conventional banking for those who want an Islamic alternative and it needs to be supported both by using it but also by studying it and thinking of it as a career-path.
Only when the Karims of this world actually enter the industry, replace the non-Muslims currently staffing it, and get their hands dirty trying to make a change will Islamic finance start upholding the spirit of the Islamic law; only when they have tried and failed will their censure carry any weight.
As it is, I can think of nothing more hypocritical than someone who shuns Islamic finance as “just like the other banks” for having the same prices, and then materially assists the conventional banking system by staying with HSBC, Lloyds, Barclays, Santander etc in their day-to-day transactions.
Let me conclude this article by saying that I recognise that Islamic finance has some way to go both technically and ethically and, by my strong support for the industry above, I in no way want to gloss over this fact.
However my central thesis is independent of this: theoretically, Islamic finance is the only Islamic-ethical alternative to conventional banking, and practically it often does work in providing this alternative. But in order for it to increase its success-rate in providing this alternative it needs the Muslim community to support it a) by using it, and b) by staffing it.
In a world full of interest, the best guys to stick with are those who are doing something about it.
Ibrahim Khan is currently reading for an MA in Islamic Banking & Finance and previously read Philosophy, Politics, and Economics at the University of Oxford.
