Islamic finance has much to learn from the west
By Muhammad Saleem
January 18 2007 20:44
The Financial Times
Proponents of Islamic finance maintain that as the Koran prohibits
interest all financing must be done on a profit and loss sharing
basis. In spite of all the lofty rhetoric, in practice no more than 5
per cent of Islamic financing is done this way.
Instead, Islamic banks use a structure called murabaha, or cost plus
pre-determined profit, for the vast majority of their finance deals.
Remarkably, the "profit" for an Islamic bank in a murabaha transaction
and the interest a conventional bank would have charged on the same
transaction happen to be exactly the same. Indeed, Islamic banks in
determining their "profit" even quote the rate as a margin over Libor
or other similar indices.
Murabaha was a crude trading practice designed for transactions
between real sellers and real buyers involving physical goods. By
structuring a financing transaction while disguising it as a trading
transaction - and charging interest concealed in Islamic garb -
Islamic banks turn the entire enterprise into a charade.
Other modes of financing are just as dubious. Take Islamic house
finance, structured as a lease: lease payments are equal to interest
that a conventional bank would charge on a home mortgage loan. Sukuks,
or Islamic bonds, are similar in many respects to murabaha and just as
tainted. Brandishing a fatwa from a scholar of sharia law (who, like
mercenaries, are sometimes for sale at the right price), blessing the
structure does not absolve the bankers from the responsibility of
meeting the spirit of the sharia.
The real problem with the Islamic finance industry is that despite a
30-year history and current assets of about $300bn they have yet to
add any value. Islamic banks have not created any new jobs (employment
at Islamic banks does not count), financed new inventions or
innovations or made the Islamic communities more just and equitable.
The smoke and mirrors Islamic finance industry appears to be all about
creating financial structures to comply with the letter of the law,
not the spirit and intent of the Koran.
Islamic banks need to move away from the deceptive modes of financing
they currently use and step towards the American style of venture
capital. This has two advantages. First, the stated principles of
Islamic banking - favouring profit and loss sharing over interest -
are very similar to the financing techniques used by the venture
capital industry, especially in the US. These private equity groups
are the real Islamic finance, the genuine article. Second, by
providing funds to entrepreneurs with bright ideas, the banks can
assist in promoting innovation, invention and creation of new jobs and
The ironic thing is that although the US is not an "Islamic country",
more authentic and genuine sharia compliant financing is done in the
US than in all the Islamic countries combined. That is because
American venture capital groups annually provide about $25bn in
capital financing to entrepreneurs, scientists and engineers with new
ideas. As a consequence of the availability of this type of financing
the venture capital industry in the US has given birth and nurtured
scores of Silicon Valley companies, including modern day icons such as
HP, Cisco, Intel, Sun Micro Systems, Apple, Netscape, Ebay, and
Google. All were created in the past 30 years or so from ideas
grounded in science and technology. Scientists and engineers came up
with the ideas, innovations and inventions while the venture capital
industry provided the capital on a partnership basis. Millions of new
jobs have been created as a result.
At one time - from AD750 to about AD1100 - it was the Muslim world
that was making advances in science and technology, because of the
availability of risk capital (from rich people or sponsorship from the
rulers) and respect for education, scholarship, discovery and
innovation. But nothing of consequence has been invented in the
Islamic world for hundreds of years.
The west's renaissance partly came as a result of learning from the
Islamic world. Now it is the Islamic world that needs to learn from
the west, especially borrowing those ideas that are both consistent
with its own beliefs and able to contribute to economic and scientific
development. Venture capital is clearly such an idea. By becoming more
like venture capital groups, the Islamic banks can practice real
Islamic finance while helping the Islamic community to rediscover its
tradition of invention and innovation.
The writer is a former international banker and the author of Islamic
Banking: A $300 billion Deception
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