Sunday, October 24, 2010

Questions about "Islamic" Financing

I recently wrote a 2-page article with some questions I have on "Islamic" financing. Next month I have a meeting with a senior cleric at an Islamic institution and perhaps he can give me some answers. I am reproducing the article here so that if you are attending any course etc. on "Islamic" financing, please see if your instructor can answer these points. I recently found out my alma mater Rotman is going to offer a course in "Islamic" financing (via Muslim Girl on Twitter).

1. It seems like a Recent Addition

Islam has been revealed over 1400 years ago, yet interest-free banking seems to be of recent origin. The earliest references to the reorganization of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952), followed by a more elaborate exposition by Mawdudi (1950). Much work followed later from the works of these pioneers. The first private Islamic bank was Dubai Islamic Bank in 1975.

My question is: what was the Muslim world doing before 1940? We had a huge empire, in particular the Ottoman Empire; one would assume there would be a need for large financial transactions over the 1400 years of Islam’s history. Yet, all the so-called organized Islamic financing mechanisms such as Mudaraba, Mufawada, Suqooq, Ijarah etc. all seemed to be recent developments. What did a Muslim man who wanted to borrow a huge amount of money, much more than his current capital leverage would allow, do before 1940?

2. Compatibility with local law

Islamic financing in many instances seem to ignore local laws. For example’s sake, let’s take a simple lease-to-own mortgage mechanism used by entities such as ISNA.

How it works (my understanding of it)

The homebuyer wants to buy a house for some amount, say $250,000, and can afford a down payment of $50,000. He borrows $200,000 from the Islamic bank, for 30 years. Every month, he pays a certain amount of money to the bank, and at the end of 30 years, the bank gets their $200,000 back. So, how does the bank make a profit without charging interest?

Answer: they charge the homebuyer “rent” because as they say, they put up $200,000 out of the $250,000 so they own 80% of the house. The homebuyer will pay rent on 80% of the house as “determined by market” – this is their profit. Every year the rent should theoretically go down because less and less is owned by the bank.

My Questions:

1. So who owns the house? Bank, homebuyer or both? If the bank owns a part then should they not share in the cost of utilities, insurance, property taxes etc.? Yet these costs are all borne out by the homebuyer. So why is the homebuyer paying “rent”? According to law these should be borne out by owners only in proportion to their ownership.

2. If every year, more of the title goes to the homebuyer, then should not the Islamic bank pay the City of Toronto a Land Transfer Tax every year because every year the title is changing in composition?

3. If a fire destroys the house after first year who collects the insurance money? (Again goes back to the first question: who is the owner).

4. So what transaction is this? Is it a lease, a loan, a purchase? I thought uncertainties were NOT allowed in an Islamic transaction?

5. Why does the Islamic bank re-evaluate the market price of the house every year to determine the rent? According to Ontario Law, rent can only grow by a fixed percentage every year. Yet suspiciously most Islamic financier’s reevaluation of the market price of the house to determine the “rent” is surprisingly close to Bank of Canada’s financing rates or the international LIBOR rate.

3. General Questions

Student Loans and other non-profit loans

Many so-called Islamic financing schemes require profit sharing which theoretically also implies loss sharing. Yet what about necessities where there is no profit – such as student loans?

I wanted to do an MBA which would cost $60,000. Who would lend me $60,000 interest free for 10 years? It would mean the lender would lose the use of $60,000 for the duration of 10 years, with no profit at the end of term (in fact actually a loss due to inflation and future time value of money) and with the risk of default. Why would ANY one lend me that amount of money interest free?

Similarly, in any country, the government accounts for a major component of the demand for credit – both short-term and long-term. Unlike business loans these borrowings are not always for investment purposes, nor for investment in productive enterprises. Even when invested in productive enterprises they are generally of a longer-term type and of low yield. General profit-loss-sharing ideas do not apply for loans to government for many such projects and therefore Islamic banking becomes impractical.

Accounting / Knowledge of Economics

Those who argue the word “riba” in the Quran means all interest and not just usury (which is excessive interest) also do not study accounting / finance / economics because doing so (and perhaps working as an accountant / banker / economist) would imply they will have to calculate interest as part of their day-to-day jobs. For them, even calculating interest is haram. Thus, if everyone adopted their approach the whole Muslim world would be bereft of accountants, economists etc. Clearly this is not practical. Even the Islamic Foundation of Toronto has an accountant.

30 comments:

Organica said...

All I have to say is that MBA is totally worth it.

You need to blog more about these kind of topics. WE NEED MORE EDUCATED folks to write about these matters!

mezba said...

@Organica, I meant to link to your post on Mindless Muslims but forgot before published.

Basically many muslims are too lazy to think. You label something as "Islamic" and suddenly you have a whole group of new customers.

Yawar said...

OK, if I may: let's call a spade a spade. All these complicated Islamic financing schemes basically boil down to interest. There's no way you can get around the time value of money.

On a related note: I wonder how the Central Banks of Saudi Arabia and other prominently Islamic countries enact monetary policy without interest?

Anonymous said...

http://www.suhaibwebb.com/islam-studies/the-case-against-interest-part-i/

http://www.suhaibwebb.com/islam-studies/the-case-against-interest/

try contacting andrew busco who wrote the above articles...

Anonymous said...

It's true, am just too *suspicious* about all this *halaal* banking. Someone somewhere is earning the interest while the *naive muslim* is being taken for a ride. Some people are so gullible that anything that has Islamic attached to it is like a magnet. I really would like to read more on this as Organica mentioned above. And yes, I did read somewhere that courses would be offered in one of the Universities. sf

mezba said...

@Yawar, the time value of money is actually partly BASED on interest - so if you eliminate interest you don't have time value of money ... EXCEPT for inflation!

I can get a buy/sell mechanism where the bank buys the property/car and sells it to you at a profit, with deferred payment and zero percent interest on the deferred amount. But a) that is not what most banks do and b) that doesn't answer any of the other problems like needs where there is no profit to be shared.

@Anon, thanks for the link but the articles does NOTHING to answer the practical questions of commerce raised in this post. In case you did not understand the points raised in this post please say so and I will condense it.

Even some parts from the second part

First: The taking of interest implies appropriating another person’s property without giving him anything in exchange, because one who lends one dirham for two dirhams gets the extra dirham for nothing.

This is complete fallacy and erroneous. The extra dirham compensates for the loss of the one dirham during the time period of the loan and inflation.

@Sf, in Bangladesh there was this Islamic bank that stated it would not pay any interest on deposits so people would not have to deal with it. Many muslims deposited with them. What the bank did, it took all this money and deposited it in a conventional bank, and pocketed the interest!

Abu Pokemon said...

This is one of the best exposition on the subject that I have read.

The problem is that it requires us to think about these things in a deep and hard manner in order to get an educated answer. Unfortunately we as a people are bereft of this quality. :(

Lat said...

Personally I don't understand much on Islamic financing.It was surprising to read this latest post after reading the mornining papers on 'Dispelling myths about syariah-compliant financial products' :) So are you in contact with a Lorna Tan,a senior correspondent?:) You post is intereting and an eye-opener esp on the lacking of financial history in aearlier era.

In the article by Lorna Tan,4 myths are debunked.They are
1.outdeated
2.only for muslims
3.not rewarding
4.expensive

What I understand is that Islamic banks in essence forbid interest but under the safe custody principle of wadiah(gift) in the form of dividends may be distributed to customers as a token of appreciation.The ban on predetermined interest stems from the Islamic belief that wealth should not be hoarded but rather should be put to productive use so that others can share in its benefits.That's why Islamic banks buy an asset using the customers' deposits and thus making an investment.With the sale of the asset,the bank uses the proceeds as working capital just like a conventional bank.

There's more info like the car loan and reit.

Muslim Girl said...

This is exactly why I am attending this (http://twitpic.com/2wgenl) I have so many questions and uncertainties about "Islamic" financing, some of which you mention (ex. loan on buying a house, paying tuition, etc) and basically want to know how it works and how it claims to avoid interest.

Love this post and if I may, would like to borrow the points to ask the Shaykh!

mezba said...

@Abu Pokemon, thanks.

Yes deep thinking is too tough to do!

we would rather play with lego lol :)

@Lat, can you link that article here?

@Muslim Girl, please feel free to use this post as questions.

PS that seminar, it's on Oct 14... which is past isn't it? Or it's some on going thing?

Muslim Girl said...

No it's actually a series of 5 classes. Oct 14 was the first, the next one is Nov 9 I believe. It'll be updated on their FB page (http://www.facebook.com/group.php?gid=143603809004832&v=info) if you were interested.

mezba said...

@Muslim Girl, oh I see.

Well I can't attend due to work and some other commitments, but if you are attending, please DO point out this post and the questions, and share with us the answers given.

I will be attending a meeting with a senior cleric at the Islamic Foundation inshAllah next month and I will update after that discussion.

mezba said...

@Muslim Girl, I was perusing the notes someone put up of the first class on the fb link. This one caught my eye.

growth of wealth & being social is a religious goal

This is funny because MuslimMatters had an article (blog post) with a writer who was adamant that rich people would find it harder to go to heaven and therefore muslims shouldn't try to be rich. Which I thought was wrong but the writer was quite rude in his replies as well (must be something to do with that site - it seems the more 'pious' you are on that site the more rude you are).

I think the idea that poor people are better religiously comes heavily from Christian influence.

You can ask your instructor this as well.

Anonymous said...

Interesting post.

There is another way of looking at the situation. Why do we not drink or eat pork? It's possible to come up with 100 legitimate reason on why not to do so. Ultimately, Allah (SWT) forbad it. Is that not a good enough reason?

Some other points:

1. Just because you do not agree with the current terms of a loan that is labeled to be "Islamic" doesn't mean paying interest is halaal. Like many things, its a failure of Muslims.

2. Most reference to lending goes hand in hand with the concept of usury. Usury itself is considered unseemly by Jews and Christians as well. Its just a guess, but the writers your cite and considers "reformers" of Islam; At least they saw themselves that way. Given when their critiques were published, its possible that they were reacting to changes in Western finance. You should ask the scholar this point.

3. Your points on Central Banking is legitimate. It is true that monetary policy is executed by change interest rates. And when that is zero-bound, buying debt/or printing money. Muslims should lead in research on how to accomplish this without interest. Central Banking is essentially about money supply; adjusting interest is a means to do so.

In the end, what you are doing is risking heaven with the concerns of this world. Allah (SWT) knows best.

mezba said...

@Anon, Salaams.

Thanks for the comment.

I am familiar with the arguments for/against banning interest. I accept that if it is banned (and this is a big 'if' depending on the meaning of the word 'riba') then other means have to be found.

What I am saying is that the other "means" that is established today - the so-called "Islamic" financing - is not only a scam and a play to get the money of Muslims but wrong from an Islamic AND legal point of view as well.

When Allah banned pork, He also gave us beef, chicken etc.

So if interest is banned, there must be a way around it. What we see today, the so-called "Islamic" financing, doesn't seem to be that way.

Farah said...

What you forgot to mention is that most Islamic financing banks today are actually owned by non-Muslims!!!

mezba said...

@Farah, thanks for the comment. It's an interesting fact! So these banks are taking the money of Muslims and using it in non-Shariah compliant activities! lol

Anonymous said...

@Mezba, Wsalaam

Thanks for the response.

"and this is a big 'if' depending on the meaning of the word 'riba'"

It's quite a big risk when the etymology of a word determines whether something is halaal or haram. It's a fairly important point, since this is suppose to be universally Haram. Again, a risky personal choice.

"What I am saying is that the other "means" that is established today - the so-called "Islamic" financing - is not only a scam and a play to get the money of Muslims but wrong from an Islamic AND legal point of view as well."

I agree with you on this whole-heartedly. The intention of the loan will manifest itself in the terms. If someone is being responsible and Allah fearing when design such contracts then the interest-free component should be apparent.

"When Allah banned pork, He also gave us beef, chicken etc."

I don't see the point. Alcohol is haram and the alternative is you simply don't consume it.

"So if interest is banned, there must be a way around it. What we see today, the so-called "Islamic" financing, doesn't seem to be that way."

The short-term solution to this problem is try not to take out loans. For example, you can simply rent. Go to a cheaper university. You might suffer in the world, but in the ultimate long term. iA, may Allah (SWT) have mercy and reward you.

Lets take the concept of Mortgages and think about the long term. If people do not take out loans and buy durable goods or homes with savings then IN large numbers then your avoiding asset inflation.

If you think about how people think about "affording" a home. They don't look at the total price, how much it cost a month. So as interest rates goes up asset prices goes down and vice versa. I need to actually collect the data myself. But intuitively, if homes are bought as cash, then based on the viability of supply (cash/income) you simply cannot go that high.

This is easily verifiable, look at what happens when asset prices hit a ceiling of affordability even AFTER interest-rates are near zero. Look at the NYC, DC and SF bay area real estate market.

Thanks!

-Anon

Muslim Girl said...

"rich people would find it harder to go to heaven and therefore muslims shouldn't try to be rich."

That argument is seriously flawed. Why not look at it in the way that more wealth = more opportunities to give to charity? Poor people can be ungrateful, too, it doesn't have anything to do with how much $ is in your pocket.

I really liked the first lecture. The shaykh stressed the importance of attaining financial freedom/independence (esp. for women), which is something I think EVERYONE should try to do!

I think I'm going to post my notes from it on my blog, or at least write a review of the course in relation to this post of yours and whether it addresses the points you made.

Zerin said...

1. Shaykh Mohammed Taqi Usmani: one of the world’s leading Shariah-finance scholars; talks about sukuks or the islamic bond market issues

http://www.propheticguidance.co.uk/pdf/Are_You_Sick_of_Sukuks_Yet.pdf

2. Can find an islamic finance text book at this site. Sheikh Abu Eesa has written extensively about it, and also attends Davos forums

http://www.1stethical.com/2010/08/islamic-banking-and-finance-textbook-2/

'liya said...

Wow great post Mezba! I'm looking forward to reading more, update us soon on the answers you get.

TManiac said...

so there are sceptics who really believe that working in finance is haraam because they'll be dealing with interest?

Lat said...

I think I've got the right link to the article I mentioned.Hope it helps.

http://www.singaporelawwatch.sg/remweb/legal/ln2/rss/legalnews/69444.html?utm_source=rss+subscription&utm_medium=rss

mezba said...

@Anon,

I just put the alternative opinion of 'riba' just to let other readers know there is that opinion out there. As for myself, I don't know what to think at the moment - I am trying to educate myself on this. I try and avoid interest whenever possible - but it's not always possible.

The short-term solution to this problem is try not to take out loans. For example, you can simply rent. Go to a cheaper university. You might suffer in the world, but in the ultimate long term. iA, may Allah (SWT) have mercy and reward you.

As you said, this is only a short term solution - and I don't know if it's any good. For example, there is this hadith.

The Prophet Muhammad (peace be upon him) said: “The good deeds of any person will not make him enter Paradise (i.e., no one enters paradise only through his good deeds).” The Prophet’s companions asked: “Not even you?” The Prophet replied: “Not even myself, unless God bestows His favor and mercy on me. So be moderate in your religious deeds and do what is within your ability. None of you should wish for death, for if he is a doer of good, he may increase his good deeds, and if he is an evil doer, he may repent to God.” – Sahih al-Bukhari, Volume 7, Hadith 577

So I am trying to explore interest/Islamic finance within this context.

Thank you for your very interesting comment!

@Muslim Girl, I look forward to reading those notes! Please do put them up.

@Zerin, thank you for those links. The "Islamic" bond market (now there's an oxymoron!) was seriously shaken after Sheikh Taqi's comments.

@Liya, will do iA.

@Taha, yes. And so they avoid ANY thing to do with interest, including studying economics/accounting. In a way I don't blame them - if they plan to take a job in accounting they are going to have to deal with interest so in this way they are safe guarding themselves.

@Lat, thanks!

Zerin said...

This is a little dated - but it might open other avenues in terms of your exploration into the field

Check out the November 29th, 2007 post:

http://alternativeentertainment.wordpress.com/2007/11/

Mufti Hassan Kaleem – he has been appointed as a Shari’ah advisor for Deloitte.

The Big Four groups – Deloitte, PwC, KPMG and Ernst & Young – all have Islamic teams. But, apart from Deloitte, none has a scholar, who is required to sign off that products are fully Shariah-compliant.

Tauqeer said...

In simple terms, Islam teaches us to remain humble, not to involve ourselves in materialistic things that we do not get enough time to pray and perform our religious duties.

The whole idea of Islamic financing, as per my understanding is that it encourages people to use their money, instead of keeping it safe.

If I have lot of money in hand, with good interest rates and all, why would I want to invest? I would rather keep it safe in bank, use the interest for living and do NOTHING.
The whole idea is to keep the economy rolling, money exchanging hands, so few can't get extra rich and rest remain poor for generations.
I am not expert in current Islamic financing system, but what I have also being told that Islam teaches us to remain within our means. If one cannot afford to buy a house , then he shouldn't opt for buying, rather stay at rented place? If you can afford to go for an expensive MBA, you should! but if you can't, then is it really required to go for loans?
Loans are only to be taken for 'constructive' use, such as building a factory, venturing a new business, where you can actually share the risk with lender, eventually sharing your profit/loss.

It is not an ideal situation we all live in, because we live in a system which is built on basis of 'interest'. As a Muslim I appreciate people who are trying to come up with Islamic financial products, but I still believe that at some point we would need an independent financial system to support it.

mezba said...

@Zerin, thanks for the link.

I know that most "Islamic" financing is actually owned by non-Muslims and they do have scholars who rubber stamp their decisions (they know where the paycheck is coming from!).

I hope this scholar isn't one of those - but I am pessimistic. The whole sukook (Islamic bonds - hah!) is evidence that "Islamic" finance is crooked. How can you have an Islamic bond? No matter how they slice and dice it - it's still a bond paying interest.

mezba said...

@Tauqeer, thanks for your comments. I disagree with some of them.

If one cannot afford to buy a house , then he shouldn't opt for buying, rather stay at rented place? If you can afford to go for an expensive MBA, you should! but if you can't, then is it really required to go for loans?

I find this idea wrong because this goes against what you just stated - that the rich will remain rich and poor will remain poor and Islam trys to change that! If everyone followed your suggestion then only those who can afford to invest will invest (and so the rich get richer) while the poor will never own a house and forever rent and be subjected to the whims of the house owners.

Loans are only to be taken for 'constructive' use, such as building a factory, venturing a new business, where you can actually share the risk with lender, eventually sharing your profit/loss.

Is this supported anywhere in the Quran or hadith or is this your opinion? In practical terms, people have to take loans (credits) for all sort of ventures.

As a Muslim I appreciate people who are trying to come up with Islamic financial products, but I still believe that at some point we would need an independent financial system to support it.

Exactly. What "Islamic" finance has tried to do is ape the interest-based system, and therefore blown up.

Tauqeer said...

Subject to whims of owner? I am not if that's the topic here.

One can live decently in a rented accommodation, and if ever he can manage enough funds from savings/pension he can buy a house of his own?

As for the loans, I have studied islamic courses at university in Pakistan from Prof. Dr Malik Ghulam Murtaza ( who was sadly shot dead later on), this was the concept I was given. I will try to search for the reference.

and as for your first point in the post, this all seems to be very recent, and what was going on before 1940 is a very reasonable and valid question. Perhaps all these efforts are to adjust Islamic mode of financing in today's interest based economy. Anyhow research is definitely needed, we may have some answers in our history.

Anonymous said...

Here is a link to a comprehensive discussion on The Riba-Interest Equivalence: Is there an Ijma (consensus)?

http://www.globalwebpost.com/farooqm/writings/islamic/r-i-consensus.html

Then if you click on the link below you will find a table of names. Look for the late Fazlur Rahman and click on his article titled 'Riba and Interest'.

http://www.globalwebpost.com/farooqm/study_res/default.html

I hope this helps.