Islamic Finance and Ethical Banking Practices

Forbes reported this year that $500 billion in assets are managed according to Sharia, the laws that govern Muslims’ daily life, and the sector is growing. Trends like ethical banking, global Islamic bonds, and Muslim mortgages are attracting attention everywhere from Britain to Malaysia.

Islamic Finance Law

Sharia’s financial code states that currency cannot be used to make more money. In short, charging interest is forbidden. Investments are limited to those in assets (like property) and legitimate trade. Also, investments can only be made in industries deemed by Muslim practice to be ethical. This rules out pornography, tobacco, alcohol, and illicit drugs. Money is allowed to be traded for goods or services and those services can be sold for profit. All of these regulations and prohibitions are included to promote social justice and prevent exploitation.

According to Business Week, instead of earning interest banks and individuals profit from investments in other ways. Investments are technically considered leases, where the individual will pay back the total sum borrowed in a set amount of time with “rental payments.” Alternatively, the bank turns over the payments to a third party. The third party, Citibank for example, shares the profits with investors in return for service. By charging a “service fee” for doing its part in the transaction, Citibank can earn steady profits from providing a line of credit.

The Global Islamic Bond Market

In “The Enforcers,” Vidya Ram says there are only around 260 Islamic scholars who specialize in finance and are able to decide if business transactions are permissible under Sharia. A boom in global Islamic bonds, or sukuk in Arabic, has created a scarcity of scholars to judge the ethics of new, and increasingly complex, international business practices. It can take 15 years of study to specialize in Islamic finance. Moreover, scholars must have the required business expertise and language skills to work successfully with international institutions.

According to the Forbes article, the scarcity in Islamic finance specialists did not stop the sukuk market from growing, even booming, but it presented a real ethical dilemma. If an Islamic scholar sits on the board for multiple bank deals, which is not uncommon, there’s a chance he will hear information about one business transaction while negotiating another. Since all partners share the risk and profit, Islamic jurisprudence requires that the terms of the deal be transparent for both buyer and seller from the beginning. With financial scholars sitting on 10-15 boards, this might put the judgment of at least a couple of them in question, and could lead to insider trading.

Ethical Banking

Islamic finance in the global market faces several challenges. Perhaps the most important of these is that  the global credit freeze created a break in the exchange system set up by Islamic banking practices. Moreover, concerns have been raised about the legitimacy of partnerships between Muslim financiers and international banks in the Islamic bond markets. Arabian Business released an article saying the best prediction from banks is that the global market for Islamic bonds will not grow again until late 2009.

The international credit freeze has put the global Islamic bond issue on hold since sukuk cannot sustain Islamic loans without outside involvement and services to trade. Without this collateral, the shared risk and profit-sharing requirement laid out by Sharia is not met. The Muslim practices of ethical banking, however, are growing in popularity and have attracted many non-Muslims to use their services and create accounts.

For rich financiers investing in the global bond market, ethical issues may now weigh very heavily in investment decisions. However, as the BBC reports in “Non-Muslims snap up Islamic accounts,” middle-income people with stable salaries are noticeably opting for an Islamic current account. These people share many of the same values in common with Islamic finance. They like that their money is not invested in tobacco, alcohol, or gambling. Also, it’s nice to know that the money is safe in the bank rather than invested an unstable market.

Countries that were on the leading edge of the global bond market, including Britain and Malaysia, have been using Islamic banking techniques to shift with the market demand since the economic downturn. The mortgage crisis, for example, has yielded Sharia-compliant insurance in Britain, and even mortgages in the United States.

Post updated on December 13, 2008:

The Christian Science Monitor reported that Britain is close to becoming the first government to issue Islamic bonds. With the current economic crisis, the publication says Islamic banks are viewed as “bastions of stability” according to the article “London warms to Islamic finance.”

2 thoughts on “Islamic Finance and Ethical Banking Practices

  1. Pingback: Banking - from the Muslim perspective « News Pirates

  2. The story is amazing. The illustration with the help of Sharia’s financial code, helps all the muslims to follow the sharia and also have a financially strong life. The examples of different countries are also opens our eyes to a complete makeover for the financial ideas. Its really sad to learn that only a small no of people are able to understand finance and guide people according to sharia.