Islamic Finance and the Dubai Crisis

islamBankingA year ago we wrote a post about the seemingly unstoppable growth of Islamic finance while Western bankers and investors were entangled in the worst financial mess since the Great Depression. But the recent debt crisis in Dubai has caused many people to wonder whether the phenomenal growth in Islamic finance is a “mirage in the desert” after all. For me, the trouble in Dubai is another example of challenges faced by any socially responsible investment, Islamic or not.

An active investor for 10 years, I’m very attracted to the idea of socially responsible investing. It makes both the investor and the citizen in me happy because money invested in a mutual fund can generate financial return for me while supporting corporations who do good things for society. I’m also curious about the value of ethics for business: can a company do well by doing good? So out of principle and curiosity, I invested a good chunk of my retirement money in a “social awareness” mutual fund whose focus is on companies that are sensitive to the impacts of their products, services, and ways of doing business on the society and the environment.

I kept the fund in my portfolio for many years, but its performance was always below average. Although its poor financial return is compensated by a psychological satisfaction from knowing that my money was spent for a good cause, this experience makes me realize that socially responsible investing may never yield high financial return because part of the total return is intangible and goes to the society rather than the investor. A truly socially responsible investor must care about the social impact of investment so much that he or she is willing to sacrifice some personal gain.

Islamic finance is meant to be a form of socially responsible investing. The Sharia law with which it has to comply requires that (1) investments be based on tangible assets and (2) lenders and borrowers share profits and losses. By reducing the possibility of exploitation and gambling in financial transactions, these requirements are designed to make money exchange more of an instrument for cooperation and community building. They also shield Islamic finance from the impact of a global financial crisis.

Unfortunately, the recent rapid growth of Islamic finance has also attracted many greedy investors who care little about the social impact of investment. They have found ways to dress up conventional profit-driven investments to look like Islamic finance. As a New York Times reporter described a British banker’s ideas, “the investments looked like bonds, walked like bonds and talked like bonds — but he never called them that.” Those Sharia-dressed bonds remind me of zebra donkeys that a Gaza zoo created using hair dye to get around Israeli restrictions on the importation of animals. Zebra donkeys delight children and benefit their families. Sharia-dressed bonds delight only profit chasers and threaten the health and reputation of the Islamic financial market. The trouble in Dubai is a wake-up call that too many Sharia-dressed investments have entered into the Islamic financial market and severely decreased its immunity to global financial crisis.

What’s your take on the debt crisis in Dubai? How should Islamic financial industry and countries respond? We welcome your comments.

2 thoughts on “Islamic Finance and the Dubai Crisis

  1. First concerning returns of socially responsible funds. Generally, most long term studies show that they perform as well as ‘conventional’ funds. For a run down of these studies see, http://investingforthesoul.com/Main%20Pages/ethical-investing-CSR-research-studies.htm

    Concerning Islamic finance. As you know, in theory, it resembles socially responsible investing (SRI). However, the way in which it is often practiced lacks transparency. And the rights and obligations of Islamic investments are, as far as I’m aware, often subject to feudal legal systems which are abhorent to westerners.

    There is no doubt that Islamic finance will take a big hit here, but I do expect it to recover–and in a more ‘modern’ form–in the years ahead.

    Incidentally, I run one of the most popular global SRI/ethical investing sites which uniquely covers the latest related world news and research as well. It’s at http://investingforthesoul.com/

    Best wishes, Ron Robins

  2. The spectrum of Islamic Finance and for that matter Islamic Banking rest on the substructum of Central Banking or Treasury Issued fiat money.

    And fiat money is anathema to the well-grounded muamalat and qirad that have been practised for ages by merchants and traders.

    The whole edifice of Modern Liberal Capitalism in which Islamic Banking & Finance subsist is grown out of DEBTs and the creation of more DEBTs.

    Modern businessmen and entrepreneurs are looking to Bankers and Financiers who live on making DEBTS for themselves and others rather than creating wealth.

    Out of nothing ie. some numbers on paper or books, fiat money has been created and NOT from natural wealth.

    Debt payment is enforceable by the compulsion of Central Bank or Treasury edits that “promise to pay to the bearer” the sum US$ or what whatever currency it is.