A Modern Perspective of Islamic Economics and Finance 1789731402, 9781789731408

Table of contents :
Contents
List of Figures AND TABLES
Figures
Table
PREFACE
LIZARD HOLE
Part I: The Ship of Fools
MAQASID AL-SHARI’AH
1.1. Maqasid Al-Shar’iah: The Purpose of Divine Rules
1.2. The Role of Islamic Finance in Maqasid
1.3 Moral Hazard
Part II: The Milkmaid and Her Pail
ISLAMIC MONEY
2.1. The More Probable Origin of the Monetary System
2.2. Inflicting Pain on Youth
2.3. The Scruples of Islamic Money Creation45
Part III: Caravan
IMPORTANCE OF TRADEIN ISLAM
3.1. Infant Industry
3.2. A Tale of Two Cities: Singapore and Hong Kong
3.3. Random Walk Versus Islamic Reasoning
Part IV: Eleven Rounds
FINANCING IN ISLAM
4.1. Financing Working Capital
4.2. Regulation and Supervision
4.3. Liquidity Management
Part V: Conquistador
A Parade from Greenfield to Capital Markets
5.1. Introduction to the Untold Story of Sukuk
5.2. How Expandable is Sukuk for Liquidity Management?
5.3. Resolution of Dissolution for Islamic Capital Markets
Part VI: The Miser
Wealth Distribution through Zakat and Poverty Alleviation
6.1. Poverty Alleviation
6.2. Complementary Currency as an Anti-Venom
6.3. An Islamic Monetary System Based on Fair Trade
Part VII: Except by Taqwa
“Conclusion”
Bibliography
Appendix: To-Do List and Not-to-Do List
Index

Citation preview

A MODERN PERSPECTIVE OF ISLAMIC ECONOMICS AND FINANCE

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A MODERN PERSPECTIVE OF ISLAMIC ECONOMICS AND FINANCE

BY

AHMET SUAYB GUNDOGDU Istanbul Zaim University, Turkey

United Kingdom – North America – Japan – India Malaysia – China

Emerald Publishing Limited Howard House, Wagon Lane, Bingley BD16 1WA, UK First edition 2019 Copyright © 2019 Emerald Publishing Limited Reprints and permissions service Contact: [email protected] No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Center. Any opinions expressed in the chapters are those of the authors. Whilst Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise, as to the chapters’ suitability and application and disclaims any warranties, express or implied, to their use. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-78973-140-8 (Print) ISBN: 978-1-78973-137-8 (Online) ISBN: 978-1-78973-139-2 (Epub)

“My Lord, increase me in knowledge” – 20:114 –

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CONTENTS List of Figures and Tables

xi

Preface: Lizard Hole

xiii

Part I The Ship of Fools

1

1.1 Maqasid Al-Shar’iah: The Purpose of Divine Rules

5

1.2 The Role of Islamic Finance in Maqasid

10

1.3

14

Moral Hazard

Part II The Milkmaid and Her Pail

25

2.1 The More Probable Origin of the Monetary System

26

2.2

34

Inflicting Pain on Youth

2.3 The Scruples of Islamic Money Creation38

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Contents

viii

Part III Caravan55 3.1

Infant Industry

3.2 A Tale of Two Cities: Singapore and Hong Kong 

60

62

3.3 Random Walk Versus Islamic Reasoning65 Part IV Eleven Rounds73 4.1

Financing Working Capital

75

4.2

Regulation and Supervision

84

4.3

Liquidity Management

89

Part V Conquistador97 5.1 Introduction to the Untold Story of Sukuk

98

5.2 How Expandable Is Sukuk for Liquidity Management?

106

5.3 Resolution of Dissolution for Islamic Capital Markets

109

Contents

ix

Part VI The Miser119 6.1

Poverty Alleviation

123

6.2 Complementary Currency as an Anti-venom

129

6.3 An Islamic Monetary System Based on Fair Trade

133

Part VII  Except by Taqwa139

Bibliography141 Appendix: To-Do List and Not-To-Do List149 Index155

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LIST OF FIGURES AND TABLES Figures  Fig. 1. Pillars of Islamic Finance Product Development.18  Fig. 2. T-bills, Money Creation, and the Public Finance Problem.

33

 Fig. 3. Commodities Map of the Roman Empire.39  Fig. 4. Islamic Microfinance as Practiced by Some Microfinance Institutions.

47

 Fig. 5. Islamic Working Capital Finance Contracts.75 Fig. 6. Transaction Flow for Islamic Export Financing.80  Fig. 7.  Two-step Murabaha.

83

 Fig. 8.  Sukuk and Oil Prices.

101

Fig. 9.  Islamic Electronic Trading Platform.

110

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List of Figures and Tables

Fig. 10. Licensed Warehousing and Electronic Warehouse Receipt. 126 Fig. 11. Creating Complementary Currency in Microfinance

131

Fig. 12. Electronic Trading Platform for Microfinance.134

Table Table 1.  Return on Infrastructure Sukuk.

132

PREFACE LIZARD HOLE Contemporary works on the theory of Islamic economics and finance emerged out of a sense of urgency in order to address the significant changes in the Muslim world after the independence of nations from Southeast Asia to West Africa in the twentieth century. Educated Muslims realized that simply obtaining independence had not been provided the expected freedom or solved the protracted problems of Muslim communities. They referred to the glorious days of Islam and hastily praised the ideas of classical Muslim thinkers such as Ibni Khaldun and Ghazali. However, this approach to establish an identity based on the asabiyyah concept of Ibni Khaldun or the use of standardized religion as an instrument to consolidate society, as proposed by Ghazali, had an opposite effect and caused Muslim societies to crumble further. Indeed, reference to the ideas of the classical thinkers was not the solution to the Muslim world’s contemporary problems but was perhaps the deep-rooted reason for the Muslim world’s decline. The Messenger of Allah said, as narrated in Abu Dawud: He is not one of us who calls for Asabiyyah, or who fights for Asabiyyah or who dies for Asabiyyah. Once, I received an email forwarded from an educated man because he was happy to see a citation of Ibni Khaldun

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by a New York Times columnist. It is strange to observe such veneration regardless of the clear messages in the hadith and Qur’an against asabiyyah. Asabiyyah is the concept of group unity in pursuit of success in a competitive environment where, as Charles Darwin claimed, the “survival of the fittest” is detrimental. Asabiyyah can appear in ethnic, sectarian, religious, or geographic forms. Islam as a religion is a set of principles advised by the Almighty as a means for the salvation of humanity. The divine knowledge we received through the messengers of Allah indicates a life for the unity of humanity and harmony with nature. In order to achieve this unity and harmony, Islam prescribes strict “to-do” and “not-to-do” lists, unlike asabiyyah, which tolerates any act for the wellbeing of the group. Unfortunately, contemporary Muslim leaders and intellectuals chose the asabiyyah concept of Ibni Khaldun over the divine message delivered by Muhammad (PBUH). The result has been the growth of Islamic groups or Islamic political movements that have ultimately become either violent or have subverted Islam. The same mental fixation was reflected in economics and finance. Contemporary economic and financial systems in the Muslim world appear to replicate those in Western countries, except that they “wear a turban.” Muslims inadvisably try to grapple with the Western world through asabiyyah-based courses; moreover, while doing so, they converge on the Western world because they use the same instruments for so-called defense and the internalization of wrongdoing. It is unsurprising to observe such trends whereby Muslims, bit-by-bit, internalize the Western world’s philosophy, and economic and financial system, while defying the West. The messenger of Allah said: “You will certainly follow the ways of those who came before you hand span by hand span, cubit

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by cubit, to the extent that if they entered the hole of a lizard, you will enter it too.” We said: “O Messenger of Allah, (do you mean) the Jews and the Christians?” He said: “Who else?” Humans, whether Muslim or non-Muslim, do not deserve to enter a lizard hole. We live in a world where all countries implement the same economic and financial system and try to blame the problems caused by this flawed system to other groups inside or outside their countries. Islam recognizes traditional world religions, yet claims to be a higher version of the latest divine religion of the Almighty. Among other issues, it provides a blueprint for a healthy economic and financial system that is greatly needed to sustain unity and harmony among humans. The Almighty creates humans and wishes us to be happy and in love, with no hatred and no envy of others. Unfortunately, no matter how spiritual a person is, this approach to life is lost in the wrong economic and financial environment. Moreover, such an environment is exactly what is present today in the world. It is the mandate of Islamic economics and finance as a discipline to explore a novel system in the context of the contemporary world. However, the bulk of intellectual work on Islamic economics and finance adopts Western theories and inserts “Islamic” in front. Can we claim that the capital asset pricing model (CAPM) makes sense? If it does not make sense, why should Islamic CAPM do so? This approach also fundamentally contradicts the philosophy of Islam. Islam does not propose any kind of theory; instead, it has to-do and not-to-do lists. From these lists, we can design a blueprint of a sustainable economic and financial system because it is the wish of the Almighty to see humans employing their intellects to solve problems. Thus, this book’s purpose is to search for a blueprint and provide the to-do and not-to-do lists in the context of contemporary world issues.

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Part I: The Ship of Fools “MAQASID AL-SHARI’AH”

If there are any who scorn writing, Or any who could not read it, They will clearly see their own nature in the images And in these will see who he is, Whomsoever he might be, will see what he lacks. I call this the fool’s mirror, In which every fool can see himself; Who each is will be made known to he Who looks in the fool’s mirror. Whoever reflects properly will soon learn That he should not consider himself wise, Should not believe of himself what is not the case, For there is no-one alive who is not deficient, Nor who may claim at all That he is wise and no fool. Sebastian Brant (1494).

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The Ship of Fools is a series of fifteenth century Western European satirical allegories by Sebastian Brant (1494) that depicts the common foolish attributes of Western Christians at that time. Why should such a work appear at the beginning of a book on Islamic economics and finance? Unfortunately, there are many similarities in the satires of the Ship of Fools with the contemporary Muslim World. Why should this be so? As Muhammad (peace be upon him [PBUH]) prophesized, Muslim Ummah (community) will follow the people of the book hand span by hand span and cubit by cubit; thus, the Muslim world is expected to present the characteristics of the fifteenth century Christian world because Islam appeared six centuries after Christianity. Those days of Western Christianity were characterized by bigotry, comprador religious clergy, economic chaos, social inequality, and significant internal and external armed conflicts. Soon after the Reformation, ideas and sectarian wars began in Europe with the intention of saving Christianity from some Christians. Western Christianity since then has covered a lot of ground; yet, serious human misery in the form of economic upheavals and violence in the form of wars have not disappeared. The failure of the financial and economic system in the early twenty-first century showed that humanity could still not find a sustainable system. Moreover, the flawed contemporary economic and financial system is reflected in violence and unhappy people. It is surprising to observe such failure, which has occurred regardless of scientific advancement. However, it has a cause: The governance structure of human society does not allow a major change in economic and financial advancement combined with an understanding of the Almighty’s message about such advancement. Socrates pointed out this problem in the fifth century bc:

Part I: The Ship of Fools

To answer that question, Socrates said, I must give you an illustration: Suppose the following to be the state of affairs on board a ship or ships. The captain is larger and stronger than any of the crew, but a bit deaf and shortsighted, and similarly limited in seamanship. The crew are all quarreling about how to navigate the ship, each thinking he ought to be at the helm; they have never learned the art of navigation and cannot say that anyone ever taught it them, or that they spend any time studying it; indeed they say it can’t be taught and are ready to murder anyone who says it can. They spend all their time milling round the captain and doing all they can to get him to give them the helm. If one faction is more successful than another, their rivals may kill them and throw them overboard, lay out the honest captain with drugs or drink or in some other way, take control of the ship, help themselves to what’s on board, and turn the voyage into the sort of drunken pleasure cruise you would expect. Finally, they reserve their admiration for the man who knows how to lend a hand in controlling the captain by force or fraud; they praise his seamanship and navigation and knowledge of the sea and condemn everyone else as useless. They have no idea that the true navigator must study the seasons of the year, the sky, the stars, the winds, and all the other subjects appropriate to his profession if he is to be really fit to control a ship; and they think that it’s quite impossible to acquire the professional skill needed for such control (whether or not they want it exercised) and that there’s no such thing as

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an art of navigation. With all this going on aboard aren’t the sailors on any such ship bound to regard the true navigator as a word-spinner and a stargazer, of no use to them at all?1 Socrates was found guilty of corrupting the youth of ­Athens and was sentenced to death; however, his teachings on governance are still valid. The ship depicted by Socrates would sink in the first strong storm; indeed, this is what has happened throughout history. Whether a country is a demo­ cracy or a monarchy does not change the result as long as humans fail to learn and achieve a greater degree of understanding about good governance. Such understanding is one of the propositions of Islam as a religion. Islam does not propose or oppose a democratic or monarchical system; instead, it provides to-do and not-to-do lists. The Almighty gives an example of a recruitment process checklist for Moses (PBUH) in the Qur’an: One of the daughters said: Father, hire this man. The best that one can hire is a man who is strong and trustworthy. – 28:26 – The Almighty also indicates the golden rule for leadership selection and/or appointment in Islam as: (1) Trustworthiness (2) Merit. With regard to Moses (PBUH), his particular merit for shepherding was his strength. With regard to technical professions in the contemporary world, the particular merits would involve undertaking suitable education in the appropriate subjects and adequate training. Here, we obtain the first rule

Part I: The Ship of Fools

5

in the table of the to-do as opposed to not-to-do lists: respectively, merit and trustworthiness as opposed to asabiyyah in the category of governance.

1.1. MAQASID AL-SHAR’IAH: THE PURPOSE OF DIVINE RULES It was Ghazali, and the contemporary work of Umar Chapra on the work of Ghazali, which depicts a chart for maqasid al-shari’ah: the protection of the human self (nafs), wealth (mal), faith (din), posterity (nasl), and intellect (aql).2 There is no need to follow this chart; however, because it was supposedly taken from the Qur’an, there is also no harm in using it while elaborating on the purpose of divine rules. Even so, it is important to note that this interpretation of maqasid seems to stipulate, to some extent, the means to achieve maqasid and yet can conflict with maqasid. The Day when nothing will avail, neither wealth nor offspring, but only he that brings to Allah a sound heart will (attain to success). – 26:89 – According to the Qur’an, the ultimate purpose of maqasid is to have humans with “sound hearts” or qalb-i selim ( ). What is a sound heart? It is a heart that is directly connected to Allah; moreover, such a connection is only possible if there is no hatred, envy, and oppression of others. There should also be love but not fanaticism. Eric Hoffer, in his book The True Believer published in 1951, argues that mass movements are interchangeable regardless of their stipulated goals and differing values.3 The followers of a mass movement can change their adherence to another because radical or revolutionary movements,

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being nationalist, religious, and social, present similar behavioral patterns and use identical rhetorical tools and the same tactics. Social psychology proposes two facts about social movements if there is no “sound heart.” (1) People will move from one fanaticism to another: from communism to religious extremism or from drugs to the Islamic state. (2) Even if they claim they are Islamic, people will act against the strict rules of Islam in the name of Islam based on their poor judgment. Such radical or reactionary movements imitate the opportunistic nature of other wicked movements. The people in these types of movements are on board the ship of fools for their final destination: the fools’ paradise, Narragonia. The Almighty does not want humans to sail to Narragonia but encourages us to use our intellects to solve our problems and progress. Humanity keeps repeating the same blunders, with minor changes, in the name of communism, capitalism, and religious ideologies for two reasons. (1) The asabiyyah-based understanding of human society. Islam strongly condemns asabiyyah and provides a code of conduct. Islam is a principle-based religion; asabiyyah is not. If we develop Islamic understanding based on identity and not principles, the result will be similar to another communist or capitalist experience, or wicked empire of oppressors. (2) An unsustainable economic and financial system. Humanity has not been able to develop a sustainable economic and financial system that is not the cause of upheavals and the reason for the collapse of states.

Part I: The Ship of Fools

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There is a vicious circle: revolution, the establishment of new structures, the failure of existing structures, and new revolutions or war. The fundamental problem is the first reason. If we have a sound understanding of asabiyyah, or an identity-based understanding as opposed to a principle-based understanding of religion, we can extract a useful blueprint from the five classical pillars of maqasid al-shari’ah to address the ­asabiyyah by developing a sustainable economic and financial system. Islam does not propose either communism or capitalism. Instead, it encourages a fair distribution of resources and the empowerment of people so that no tyranny in the form of a communist dictatorship, capitalist despotism, or any other form of autocratic establishment can flourish. For example, the protection of nafs translates into contemporary human rights and includes the rights of property ownership and inheritance, freedom of entrepreneurship, fair trade, and, most importantly, the certainty of the legal system to assure these rights to protect individuals (nafs). Disastrously, in the history of Islam, maslaha opened up the doors to irrevoc­ able decomposition. For instance, the right of inheritance is clearly acknowledged in the Qur’an; yet, the rule of Allah was rescinded under the pretext of maslaha with the purpose of preventing alternative power centers in society to emerge with capital accumulation. Unfortunately, the confiscation of inheritance by the state started at the early stages of Islam and was implemented arbitrarily without legal certainty. The system was then institutionalized by the Ottomans in the name of musadara. The result was a lack of capital accumulation and investment in the Muslim world that substantially ­contributed to its decline.

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Without going into the details of Islamic jurisprudence or attempting to defend any criticism, it should be noted that what matters in a legal system is certainty. All large states in the history of humanity, starting from Babylon to Greece, Greece to Rome, and from Rome to Muslim states and the British Empire, had one thing in common: They established legal systems that were omnipresent and had legal certainty (in other words, the same result for the same case was assured whoever was involved). The decline of such states began with the deterioration in their legal systems. A grisly Wolf carried off a sheep from the fold into a retired nook in the forest not from hospitality, one may well suppose. The glutton tore the skin off the poor sheep, and began devouring it so greedily that the bones cracked under its teeth. But, in spite of its rapacity, it could not eat it all up; so it set aside what remained over for supper, and then, lying down close by it, cuddled itself together at its ease, after the succulent repast. But, see, the smell of the banquet has attracted its near neighbor, a young Mouse. Between the mossy tufts and hillocks it has crept, has seized a morsel of meat, and has run off quickly to its home in a hollow tree. Perceiving the theft, our Wolf begins to howl through the forest, crying, “Police! Robbery! Stop thief! I ‘in ruined! I have been robbed of everything I possessed!” Just such an occurrence did I witness in the town. A thief stole a watch from Clement, the judge, and the judge shouted after the thief, “Police, police!” I. A. Krylov4

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In the Muslim world, not only corruption but also ­maslaha have undermined legal certainty. Maslaha is the concept first articulated by Ghazali: the prohibition or permission  of things, according to circumstances, to serve the interest of Muslim ummah.5 Resonating opportunism, the concept of maslaha contradicts basic principles of Islam. (1) Islam as a religion is for the whole of humanity not only for Muslim ummah; moreover, there is no room for asabiyyah. (2) The judgment about determining interest is not left to followers of Islam. It is only Allah who knows the ultimate good for humans. For this reason, the Almighty provided strict rules in the form of to-do and not-to-do lists. Moreover, people should not put themselves in the shoes of Allah to make such judgments; rather, these judgments can and shall serve the interests of rich and powerful small groups at the expense of the masses, whether Muslim or non-Muslim. In the end, what is good for the rich and powerful would be good for the poor and weak. Thus, you should be persuaded of this approach either through the media in developed countries or with a stick in emerging countries. Private ownership and the right of inheritance do not come in Islam without counterbalancing measures. Al-Rumi evoked nafs in terms of a ship that needs water (an analogy with wealth) in order to float and navigate; however, precaution is needed to prevent water from entering the ship to assure that the ship does not sink. Similarly, Islam does not forbid financing; rather, it encourages certain types of financing. However, restrictions on the financial system exist to ­protect the economy from being held hostage.

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A Modern Perspective of Islamic Economics and Finance

1.2. THE ROLE OF ISLAMIC FINANCE IN MAQASID Several accounts have claimed that many conventional transactions can be converted into Islamic finance by simple changes in conventional finance contracts.6 This point may be particularly accurate when it comes to areas where Islamic finance and conventional finance converge: trade finance and leasing operations. As long as conventional finance emerges as a need to facilitate economic activity, such similarity with Islamic finance is anticipated. Islam prescribes the role of financing as a facilitator for bona fide economic activities. As long as value adding bona fide activities are financed, Islam encourages such endeavors. However, having bona fide transactions alone is not enough. The activity should be consistent with maqasid al-shari’ah and the to-do and not-to-do lists in order to protect the rights of all parties involved as well as overall society. In contemporary Islamic finance jurisprudence, much attention is given to riba (interest); however, it is only 5.5 ­percent of the overall issue. Indeed, 19.5 p ­ ercent relates to maysir (speculation) and gharar (uncertainty). Most, 75 ­percent, is associated with policy issues. The first 25 percent of these issues relate to shari’ah compliance and the remaining 75 p ­ ercent relate to maqasid al-shari’ah.7 A product fulfilling riba, maysir, and gharar would not qualify as acceptable while it is not consistent with maqasid ­al-shari’ah. However, riba prohibition should by no means be u ­ nderestimated because Allah declares war on those committing this sin.8 With its expanding business reach, the Islamic finance industry embarked on product development to address requests coming from the market and to cope with conventional financial institutions. In many instances, newly developed products lack shari’ah compliance; moreover, even if such products are compliant with shari’ah, criticism is un­avoidable because newly developed products have similar side effects to those

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of conventional products. As it stands, the Islamic finance industry is not in the service of society to enable sustainable and healthy economic growth; rather, it merely complies with shari’ah rules for the sake of boosting the industry. The asset-based modern murabaha is a good example: it can both serve maqasid and work against it. If used for household consumption finance, murabaha leads to where conventional finance takes society: squandering, inflation created by a temporary bubble demand through loan growth, and a vicious circle of wealth inequality; hence, fasad. For example, murabaha credit cards lead to household bankruptcy in a similar way to interest-based cards.9 Ironically, though deemed to be an alternative to organized tawarruq or bai alinah, this type of card can also be used for cash borrowing. Customers desperately in need of money may use the cards to buy gold and sell it immediately for cash. Although the names are Arabic, organized tawarruq and bai al-inah are not shari’ah compliant because they represent cash lending. In brief, organized taqarruq represents buying and then selling back with a discount, while bai al-inah represents a sell and lease-back structure. Unlike murabaha, both are not shari’ah compliant. However, if some aspects are not observed, even murabaha would not qualify as acceptable so long as it works against maqasid ­ al-shari’ah. Contradictions with maqasid and shari’ah compliance are revealed in the systematic risk and risk management related to the product. Murabaha credit cards are examples of improper Islamic finance because they fuel systematic risk in the same way as conventional credit cards. The result is rapidly ­rising default rates due to risk management deficiency, which indeed results from ignoring maqasid al-shari’ah.10 Financial institutions calculate the price of credit cards by adding statistical default rates on top of their capital costs and expected real returns. For instance, if the cost of capital is five percent, the targeted real return is

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A Modern Perspective of Islamic Economics and Finance

three percent, and the observed default rate is three percent, they determine the lending rate at eleven percent. Statistical errors also occur, which is a significant problem because a three percent default rate is very often associated with deteriorating social parameters. In the long term, an infectious effect of debt on wealth distribution together with unsustainable demand increase default rates; thus, the financial system falters. Several academic studies have analyzed the trade-off between official liquidity provision by central banks and the issue of moral hazard in international financial crises.11 Regrettably, central banks, as the lenders of last resort, stepping in to save so-called required financial system, create even bigger bubbles for the next cycle. The bill must be paid by the public in the end because financial institutions’ problems, unlike those of other corporations, fall not only on shareholders but also on the public in the form of increased taxes, inflation, and/or asset bubbles through central banks’ interventions, which involve quantitative easing (QE) and the printing of money, and deposit insurance provided by governments. The experience of murabaha indicates flaws in maqasid ­al-shari’ah, thereby leading to issues of shari’ah compliance and risk management. In the course of their development from their early days to the contemporary age, Islamic banks started to make so-called “profit deprivation charges” in cases of late payment.12 However, unlike the name, these charges are not profit deprivation but default interest. This situation arose by charging for delays up to the inflation rate or pegging a debt’s amount to foreign currency. However, when f­oreign currency prices went down instead of up, Islamic banks asked shari’ah boards to pave the way for profit deprivation. The issue of charging up to the inflation rate may also be unsound because this practice would require Islamic banks to pay defaulted debtors if the inflation rate becomes negative.13

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Should Islamic banks provide finance for required household items such as home appliances? The key here is the presence of a wealth redistribution mechanism: zakat. The importance of a wealth redistribution mechanism in the form of zakat is critical in order to compensate for the side effect of debt created by Islamic financial products. The Islamic view assumes, unlike classical economic views, that “there are enough resources to fulfill necessary needs of any human being on earth.”14 For this reason, Islam makes a distinction between necessary needs for contentment as opposed to dissipation. As long as no wealth distribution mechanism exists in a society, any debt-creating instrument, Islamic or conventional, may lead to similar deduced consequences. However, in some cases, murabaha should be appreciated from the maqasid perspective. An example is two-step murabaha product development case, where the line of financing in international trade is replaced by two-step murabaha for operational efficiency in terms of the finalization of requested transactions in a much-needed short period.15 Whether line of financing or two-step murabaha is used, such financing makes the acquisition of intermediary goods for industrial production easier and fulfills the requirements of maqasid al-shari’ah. Nevertheless, the introduction of two-step murabaha ensures the payment to suppliers in a couple of days as opposed to the months needed when line of financing is employed. This case suggests that shari’ah compliance and fulfillment of maqasid al-shari’ah requirements are inadequate for product development. The product should be efficient enough to be implemented smoothly and timeously to satisfy, in the long term, customers and executors. A shari’ah-compliant product can be acceptable or unacceptable from the maqasid perspective depending on the implementation details and the implementation results. ­Perhaps one of the reasons for shari’ah-compliant product

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A Modern Perspective of Islamic Economics and Finance

failing to fulfill maqasid is the impediment represented by rules and regulation. Islamic finance requires the acquisition of goods somewhere in the process. Any restriction created by local rules and regulation that does not enable Islamic banks to operate properly prompts the banks to offer the products of conventional financial institutions. Unfortunately, in twenty-first century, we still have a financial system that registers a profit for itself during the good days. If the system fails, a public problem arises because central banks act as lenders of last resort in order to avoid a financial crisis. The present financial system is a real burden on the general public. If the system makes a profit, it flourishes; if the system fails, the public pays. A serious moral hazard issue exists here. Today, Islamic banks are on their way to becoming conventional banks and contributing to the same created systematic risk. This situation mainly exists because there is a significant focus on riba; however, there is a slightly greater focus on maysir and gharar, and almost no focus on maqasid al-shari’ah, in the context of products offered to public, resource mobilization, and lending strategies.

1.3 MORAL HAZARD With regard to moral hazard and its reflection on maqasid al-shari’ah, can we finance services such as student loans and hospital bills in an Islamic finance system? This question should be heeded because Islamic banks propose to meet so-called needs with faulty organized tawarruq. Such implementation of organized tawarruq is opening doors for the introduction of controversial treasury department products and loan restructuring with default interest.16 Islamic financial institutions have traditionally been very active in merchandise financing. The main reason is the

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c­ ompatibility of such financing with the basic principles of Islamic finance and the prevalence of murabaha (profit sale) contracts that constitute the bulk of overall Islamic finance transactions.17 However, although Islamic financial institutions have been very active in trade financing, particularly import financing, relatively little progress has been made in the area of export financing and the trade in services. The main problem with export financing has been executing murabaha transactions. With import financing, Islamic financial institutions establish contractual obligations on importers, which are buyers as well as debtors, bearing in mind that the banks and the importers are in the same country. With regard to export financing, buyers and Islamic financial institutions are in different countries. This situation makes it difficult to establish contractual obligations. Thus, for export financing, Islamic financial institutions introduced Islamic discounting schemes to serve their clients. However, in terms of implementation, this scheme was not deemed to differ from the factoring transactions, bay al-dayn, of conventional finance; hence, it was criticized.18 Nevertheless, there have been recent developments that have facilitated export financing with the help of takaful to mitigate the risk of receivables in another country. Takaful can support the expansion of exports and economic growth; hence, it is a good fit with maqasid. With regard to trade in services, the use of murabaha instead of faulty organized tawarruq was seen as a shari’ahcompliant alternative. At first glance, this approach may appear acceptable; however, the proposal is not evaluated from the maqasid al-shari’ah perspective. Financial innovation in the services sector can be rather vain if not maleficent. The novelty of student loans and insurance coverage for medical care can be put forward as two precedents. Student loans, arguably, ignited soaring college tuition fees and caused desolation among youth. In the same fashion, the existence of

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medical insurance may be the reason for flourishing medical businesses with increased treatment fees that have damaged public finance in many countries. These intangible aspects of services appear to lead to unjustified price bubbles, which may be discerned in inflation data.19 Widespread financing of trade in services and the availability of access to financing appear to inflate the prices of services, which in turn impoverish people directly or indirectly through the financial burden of loans received and increased prices of commoditized services. This circumstance has strong potential to create a vicious circle. Is this also the case for financing tangible assets? Perhaps to some extent, particularly for house financing, which may be related to uncomplicated collateralization for banks through mortgages and households’ need for shelter. The issue should be the subject of a wider question of maqasid al-shari’ah: Is it permissible to commoditize certain basic human needs such as education, health care, and shelter to enable financial institutions, whether Islamic or non-Islamic, to prey on vulnerable people? If trade in services is financed by murabaha, a similar deficiency relating to maqasid al-shari’ah may be observed. Hence, the aforementioned problem with murabaha financing for trade in services is expected to manifest itself subtly in terms of shari’ah compliance. Put bluntly, financing trade in services with murabaha is not shari’ah compliant because of gharar, unlike tangible assets financed in the example of two-step murabaha for trade financing. The possibility of ­ assuming ownership is unclear in the case of trade in services. A bank may claim contractual ownership of goods traded; however, this may not apply for services. Can a bank claim to buy a bespoke hospital treatment plan and sell it to its customers? This situation is akin to selling fish in the sea and violates the principle of “Sell not what is not with you.”20

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What happens if companies in financial stress issue fictitious invoices for purported services, which is much easier to do than for goods, in order to access financing? In Islamic finance product development methodology, ignoring maqasid al-shari’ah is expected to cause subtle issues in shari’ah compliance, which in turn can lead to risk management defects. These defects then conflict with maqasid al-shari’ah in a vicious circle through linked economic mechanisms, thereby leading to systematic risk in the long term. First and foremost, it is vital to start Islamic finance product development with reference to maqasid ­al-shari’ah. The case of trade in services evinces the soundness of such an approach. Though it appears to be appealing to replace organized tawarruq with murabaha to finance trade in services, both contracts give rise to similar dissonance with maqasid al-shari’ah. Basically, Islamic financial institutions should not be in a position to cater for all requests from the market nor do they need to replicate all the products of conventional banks. Can a Muslim community accept the selling of non-permissible items in their grocery shops for the sake of competing with other grocery shops? If the answer is no, the same principle applies to Islamic banks, which are no different to grocery shops because they are all commercial enterprises. There needs to be to-do and not-to-do lists that relate to the ontology of Islamic finance in terms of such finance being a reliable and economically sustainable alternative to serve necessary, but not boundless, human needs. In this regard, Islamic banks should follow a methodology for product development. Product development should be formalized for long-range results to serve society with sustainable and healthy economic growth rather than to meet the whims of mere compliance with shari’ah rules for the sake of boosting the Islamic finance industry.

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A Modern Perspective of Islamic Economics and Finance

Further, this approach should be undertaken for the sake of maqasid al-shari’ah. Starting product development from the perspective of maqasid al-shari’ah should ensure sound shari’ah compliance and, in many instances, better risk management. As the framework in Fig. 1 indicates, in addition to shari’ah compliance and risk management, operational efficiency and compliance with local rules and regulation are needed to form a purposive table standing on four pillars. The four pillars should be attached to the table to support maqasid al-shari’ah. Perhaps the insurance business can tell us a great deal about moral hazard and shari’ah acceptability of products from the maqasid perspective? Lloyd’s Coffee House in London was a remarkable place for international maritime trade in the seventeenth century. Indeed, Lloyd’s had access to maritime trade information more quickly and accurately than the British Navy; thus, it rendered its information and intelligence services to the Navy in exchange for maritime protection. All information gathered in the coffee shop soon opened the doors for a new business, maritime cargo insurance, which today has expanded to the extent of insuring the soccer players’ legs. The patrons of the coffee house started to underwrite maritime cargo insurance for shipowners on

Fig. 1.  Pillars of Islamic Finance Product Development. Source: Author.

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the desks they occupied in the shop. Some of the underwriters lost fortunes and some flourished. The presence of Lloyd’s insurance, however, was one of the major reasons behind the expansion of international trade and the rise of the British Empire because an increasing number of people started to venture into risky but profitable maritime trading. The acceptability of insurance has been the subject of Islamic thought. The matter has been discussed from the perspectives of the organizational structure of takaful (insurance) companies, the collection of capital, and the compensation mechanism for claims. Indeed, in terms of these perspectives, takaful companies can be organized as traditional Western cooperative insurance companies. The cooperative insurance business model started in Europe in the form of solidarity funds to compensate the losses of trade union members. The business model is perfectly fine and matches that of I­slamic takaful. Instead, the question pertaining to the insurance business from the Islamic point of view is related to deals: what can be insured and what must not be insured? As long as the presence of insurance supports the expansion of inter­ national trade, stimulates capital expenditure (CAPEX) investment, and protects nafs (human self) and mal (wealth), there is room for shari’ah-compliant alternatives, given that there is no moral hazard and gharar in insurance policies. ­Historically, Ibni Abidin (1784–1836) gave a fatwa (ruling) to Muslim shipowners to purchase maritime cargo insurance from conventional insurance companies in the West.21 The main argument for such permission was the continuity of business from one generation to another. When there is no insurance and risk is present, very often not only capital but also the know­ledge of a generation is not transmitted to the next generation; hence, the economy stagnates. Ibni Abidin issued the fatwa with such arguments and some conditions.22 Insurance practices leading to moral hazard and gharar

20

A Modern Perspective of Islamic Economics and Finance

­ istort an economy and give rise to the inefficient allocation d of resources. For this reason, the widespread implementation of insurance that has unpleasant consequences is against maqasid al-shari’ah. Case Box 1 presents an excerpt from an early nineteenth century book on a maritime court case. The eighteenth century Mills Frigate case is still a reference point for many court decisions related to moral hazard. The ship was unsuitable to finish a sea voyage; yet, a high-risk voyage started with the presence of insurance as a risk mitigant for the shipowners. Underwriters refused to accept a damages claim made on the grounds that the ship was unseaworthy. The foregoing excerpt suggests two important aspects of the British business environment in those days. First, there is a

Case Box 1.  Mills Frigate That these principles, subsequent to the case of the Mills Frigate, were deemed to be unshaken, is manifest from this, that within two years after the case of the Mills Frigate was decided (judgement having been given in that cause in January 1769) Lord Mansfield, in the case of the Earl of March v. Pigot, which came before the Court of Kind’s Bench in the year 1771, the case of the Mills Frigate having been mentioned at the bar, said, – “The insured about to know whether his ship was sea-worthy or not when she set out upon the voyage insured; but how should he know the condition she might be in, after she had been out a twelve months?” Source: Park (1817).

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legal certainty: Court decisions were aligned to a prior court decision. Second, the presence of moral hazard with insurance could be detrimental for some parties. Perhaps, in the past, moral hazard cases were still straightforward compared to those of the contemporary world. Although the presence of insurance expanded trade and contributed to the economic progress of the West, the way in which the insurance business expanded into the financial sector in the form of credit default insurance and derivatives led to systematic risk, as ­evidenced during the 2008 financial crisis. There is another question that needs to be answered regarding the history of people and ships: Why did the people of those days in Western Europe risk death by ­venturing out on dangerous trips across the oceans? The answer is the attraction of a yellow shiny metal called gold. People put their lives in danger and, even worse, killed other people for gold because it was, in those days, a medium of exchange and the most efficient way of exchanging goods anywhere in the world, with a value obtained from trade.

NOTES 1.  Excerpt from Plato and B. Jowett, The Republic, Book 6, lines 487d–488e (1946). 2.  Al-Maqasid Al-Shari’ah: Human Development and well-being is to be realized by ensuring the enrichment of nafs (human self), mal (wealth), nasl (posterity), aql (intellect), and din (faith). 3. Hoffer, The True Believer: Thoughts on the Nature of Mass Movements. 4.  I.A. Krylov, Krylov and His Fables, 1768–1844 (London: Cassell & Company, 1883); Ralston, William Ralston Shedden, 1828–1889.

22

A Modern Perspective of Islamic Economics and Finance

5.  Abdul Rahman, “Ma’lahah”. 6.  Beck, Demirguc-Kunt and Merrouche, “Islamic vs. conventional banking: business model, efficiency and stability”. 7.  Calculated from the to-do and not-to-do lists in the Annex. Of 36 items, only two relate to riba while seven relate to gharar and Maysir. 8.  Surat al Bakara: verses 278 and 279. 9.  Dariyoushi and Nazimah, “Forecasting patronage factors of Islamic credit card as a new e-commerce banking service: An integration of TAM with perceived religiosity and trust”. 10.  Refers to the authors work experience and proceedings of 2nd International Congress on Islamic Commercial Law, October 15–18, 2015, Konya, Turkey. 11.  Corsetti, Guimaraes and Roubini, “International lending of last resort and moral hazard: a model of IMF’s catalytic finance”. 12.  Late payment charges are acceptable in Islamic finance as long as any funds received from late payments are not entered on a bank’s balance sheet. This separation should include the use of these funds for public relations or marketing campaigns in the name of so-called charity. 13.  This refers to the author’s work experience and the proceedings of the 2nd International Congress on Islamic Commercial Law, 15–18 October 2015, Konya, Turkey. 14.  Surat Al-Isra, Verse 30: “Verily thy Lord doth provide sustenance in abundance for whom He pleaseth, and He provideth in a just measure. For He doth know and regard all His servants.” 15.  Gundogdu, “2-Step murabaha as an alternative resource mobilization tool for Islamic banks in the context of international trade.” 16.  Gundogdu, “Two-step murabaha in stock exchange as an alternative to commodity murabaha for liquidity management”.

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17.  Yousef, “The Murabaha syndrome in Islamic finance: laws, institutions and politics”. 18.  Gundogdu, “Exploring novel Islamic finance methods in support of OIC exports”. 19.  The US Bureau of Labor Statistics has kept detailed data on tuition fees since 1977. The data are available at https://www.bls. gov/. 20.  Hadith No. 2187 from Ibni Majah. 21.  Burling and Lazarus, Research Handbook on International Insurance Law and Regulation. 22.  Ibn Abidin had strange views and ways of thinking. He stated that a non-Arab was lower than an Arab. Ibni Abidan has been a highly venerated scholar regardless of his views, which apparently contradict the Qur’an and the hadith of Muhammad (SAW). In a different account, Ibni Khaldun predicted that Europeans would never develop because the cold climate in which they live freezes their brains.

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Part II: The Milkmaid and Her Pail “ISLAMIC MONEY”

A Milkmaid was going to market carrying her milk in a pail on her head. As she went along she began calculating what she would do with the money she would get for the milk. “I’ll buy some fowls from the Farmer,” said she, “and they will lay eggs each morning, which I will sell to the neighbors. With the money that I get from the sale of these eggs I’ll buy myself a new frock; and when I go to market, won’t all the young men come up and speak to me! Other girls will be that jealous; but I don’t care. I shall just look at them and toss my head like this. As she spoke she tossed her head back, the Pail fell off it, and all the milk was spilt. So she had to go home and tell her mother what had occurred. “Ah, my child,” said the mother, “Do not hatch chicks to make others jealous.” Fables of Aesop23 In the story, the milkmaid dreams about the supply chain that generates money to buy a new frock. She has to have money to transform her milk into clothes. In a situation 25

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A Modern Perspective of Islamic Economics and Finance

where she can barter her milk for a frock, would she need to create a demand for money? Indeed, in an economy, supply and demand is equal. If an efficient trading platform exists, then in a chain barter, all exchanges can be matched without monetary intermediation. The probability of the milkmaid exchanging milk for clothes in a bilateral barter is low; however, in a chain of exchanges, the probability increases. For example, assume that the egg provider is ready to buy milk, gives eggs to a cloth seller in exchange for cloth, and hands the cloth to the milkmaid in exchange for milk. Such a supply and demand matching mechanism does not exist; today, we still need money.

2.1. THE MORE PROBABLE ORIGIN OF THE MONETARY SYSTEM The concept of money emerged out of a need to facilitate the exchange of goods and services among humans. Although unrealized in the contemporary world, invention and the use of money has always been about trade. The contemporary monetary system has naturally developed out of commerce. Trade is the exchange of goods and services, and commerce is an auxiliary structure that supports and facilitates trade. For instance, the insurance business emerged out of insuring overseas maritime trading and financial products such as working capital loans developed to support the trade of goods and services. Organized exchanges around the globe today were once seasonal trade fairs where the trade receivable financing business instigated banking. The first public stock offering, or initial public offering (IPO), was undertaken by the Dutch East India Company with the intention of supporting an expansion of international trade in the early seventeenth century.23 The introduction of a financial system to support

Part II: The Milkmaid and Her Pail

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international trade substantially contributed to the economic progress of Western Europe. However, soon after, the connection between bona fide transactions and supporting financial systems was lost. The first problem was the verdict of the School of Salamanca about the acceptance of the contractum trinius. This was a set of contracts to circumvent the prohibition of usury by the Christian faith.24 The insurance that emerged to support international trade was immorally used in the contractum trinius, whereby a borrower arranges insurance to insure a lender against default. Since then, the monetary system has strayed from its grass roots and evolved to become the weed it is today. Flawed and riba-based, the vicious monetary system developed alongside population growth in Western Europe. It brought agony and violence to Western Europeans, who expanded their problems to the rest of the world later on. However, this is not the full story. With a proper monetary system, and by following the divine rule on usury, the results would have been better, although they would have been far from ideal because precious metals were used as mediums of exchange. Money has several functions. It is a unit of account, a means of payment, and a store of value; thus, we define money as a medium of exchange.25 Currently, after the obsolescence of the Bretton Woods system, we have been using fiat currency that emerged out of a monetary system based on precious metal. Unlike Fukuyama’s claim in 1992, it does not seem that we have reached the end of history; at least it is clear that humanity has not yet developed a sustainable ­economic and financial system. Neither the monetary and economic system nor contemporary finance are ideal. There is no reason to declare a dogmatic end that inhibits progress. In particular, the 2008 great recession cast s­ ubstantial doubt on such over-confident declarations. Bernstein (1991)

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A Modern Perspective of Islamic Economics and Finance

applauded modern financial theory and its founders, from Bachelier to Markowitz and onwards. He thought that it was their theories that had opened the doors for 30-year ­tenure mortgages available to the average household. B ­ ernstein would doubtless be a little shy about such veneration after the 2008 great recession because he never questioned the fundamentals of conventional finance: riba, maysir, and gharar. The 2008 great recession sparked a debate about contemporary money and monetary systems. Some people searched for alternatives in the form of old-fashioned precious metals; others adopted cryptocurrencies in search of a better monetary system to ­sustain the healthy exchange of goods and services. Our ancestors, during their journey on Earth, started with a bilateral barter system to exchange goods and services for their sustenance.26 Unfortunately, there was a major problem with bilateral barter because it does not work when there are no coinciding wants and needs. Moreover, there are more ­disadvantages than advantages.27 (1) Lack of stored value and time. Bilateral barter transactions take a long time and the parties involved do not have the option to postpone their purchases. For example, a wheat producer has no option to wait until cold days to purchase clothes. People cannot store the value of their past works’ efforts in a barter system. (2) Lack of the double coincidence of wants. Exchange through a bilateral barter is only possible when there is an exactly coinciding match of supply and demand. (3) Indivisibility of certain goods. Not all goods are fungible. A wheat harvest can be divided into bushels for barter but a cow cannot be divided to exchange for clothes.

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(4) Lack of a common measure of value. Since there is no common measure for goods bartered, reference prices cannot be determined. There are substantial accounts from the Islamic perspective about bilateral barter. Allah’s Messenger (PBUH) deputed a person to collect revenue from Khaibar. He brought fine quality dates, whereupon Allah’s Messenger (PBUH) said: Are all the dates of Khaibar like this? He said: No. We got one sa’ (of fine dates) for two sa’s (of inferior dates), and (similarly) two sa’s for three sa’s. Thereupon Allah’s Messenger (PBUH) said: Don’t do that rather sell the inferior quality of dates for dirhams (money), and then buy the superior quality with the help of dirhams.28 In some other accounts, it was narrated that Muhammad (PBUH) advised the use of worth and not weight to make exchanges. The major issue with the khaibar date exchange case is the presence of gharar in the exchange, which may unjustly benefit one party at the expense of the other. Whatever the case, the Islamic perspective on traditional bilateral barter is apparently not very favorable unless the issue of gharar is resolved. A system of money based on precious metal was adopted because of the drawbacks of bilateral barter. The introduction of precious metals as money resolved many problems because parties could make exchanges anywhere and anytime.29 However, regardless of such a major improvement, the use of precious metals as money is not the end of financial history and must change. Although many contemporary Muslims zealously support a return to gold as money, the merits of gold and silver are questionable from the maqasid al-shari’ah ­perspective, unlike claims to the contrary.30

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Homer and Sylla (2005), in the book A History of ­Interest Rates, presented historical interest rates throughout the ­history. According to their study, there is an interest rate rise during the turbulence after changing from the gold-based standard to fiat currency, starting from the 1970s. Apart from the extraordinary times of the 1970s, during which the monetary system changed, interest rates under fiat currency are much lower than the long-term historical averages of monetary systems based on precious metals, particularly after the 2000s. Negative interest rates can also happen with fiat currency; however, we cannot present this as an achievement because it is the presence of riba in a contract, and not the amount charged in the market, that matters in Islam. Indeed, very low interest rates, or negative real interest rates, mark the end of a business cycle for fiat currency because the collapse of asset prices and a financial crisis are expected in due course. From the maqasid al-shari’ah perspective, perhaps the major issue with money based on precious metal is money supply. The money created in accordance with gold and s­ ilver standards is not related to production or work effort for sustenance. With gold and silver standards, money creation requires the availability of precious metals, even if there is a significant increase in production and work effort. Under such circumstances, unlike barter, which does not generate a demand for cash, a commoditized medium of exchange is heavily traded; hence, demand for riba accelerates. Even worse, the instrumentality of possessing gold and silver incentivizes oppression for hegemony because money can be accessed by plunder, the invasion of another country, and a lethal struggle for controlling the mines. Perhaps the most remarkable of such occurrences was the invasion and conquest of the New World by Spaniards. In such days, a common scenario was as follows: attack the villages, plunder the gold, and obtain slaves. Hernan Cortes said of the conquest

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of Mexico that “I and my companions suffer from a disease of the heart which can be cured only with gold.”31 Unlike the claims made by scholars regarding e­merging markets, brutality has not only been used by Western ­Europeans. In this instance, the Spaniards’ victims, the Aztecs, oppressed, killed, and plundered their neighbors. The use of gold and silver as money may explain bloody human history more precisely than anything else. Such history represented fasad, whereby people attacked each other everywhere on earth regardless of ethnicity or religion. And when your Lord said to the angels: “Verily, I am going to place generations after generations on earth.” They said: “Will You place therein those who will make mischief therein and shed blood – while we glorify You with praises and thanks and sanctify You.” Allah said: “I know that which you do not know.” – 2:30 – What is the issue that angels did not know about humans? Perhaps it is the future in which humanity one day will break the vicious circle of corruption and bloodshed on Earth and fulfill the purpose of its creation with consciousness and intellect to solve its problems and progress. Considering the repercussions of money based on precious metal because of limited money supply, contemporary fiat currency is superior and more favorable for maqasid alshari’ah. With fiat currency, central banks can increase the money supply if economies keep expanding. However, the systematic risk created by the financial sector in the fiat currency system, which does not observe maqasid al-shari’ah or at least shari’ah compliance, may lead to unjustified monetary expansion in the form of QE. This is a mysterious name given to disguise the following fact from the public eye: The central banks are printing money to save financial institutions.

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Humanity moved from barter to fiat currency alongside governmental involvement in the economy because governmental credibility supports the monetary system. In fiat curr­ ency, money is created by debt and a fractional reserve banking system. Money creation starts with the issuance of Riba-based Treasury bills (T-bills). Since money creation is relatively easy for governments, more money is soon printed for unproductive governmental spending, which leads to the loss of governmental credibility.32 There is also another side to the coin: Since T-bills include the principal plus riba, whatever the method of tax collection, the system will always fall short of the riba part of the printed T-bills. This situation occurs because the riba amount, unlike the principal, was not printed as money; further, this amount is payable at maturity in addition to the principal for which money was printed. Hence, another riba-based T-bill issuance is assured at the maturity of a T-bill, thus guaranteeing spiraling public debt. In other words, ever-increasing governmental spending is accompanied by rising money supply and price growth. In the fiat currency system, money is created based on debt; moreover, the system is soon disconnected from the economy at the end of the business cycle.33 Governments resort to issuing more debt to obtain money from central banks to spend inefficiently. Since governments spend inefficiently because of the instrumentality of easily printed money and the riba part of T-bill issuance is never created as money, there is always a budget problem in a fiat currency system no matter how disciplined governments may be with budgeting. Because of ever-expanding governmental debt, public finance can only be managed, after a critical point, by zero interest rates or negative real interest rates. Emerging markets, in their desire to converge toward leading economies, also implement the same economic system and use the same monetary system.34 Hence, they should end up, with a time lag, where the developed countries ended up in 2008.

Part II: The Milkmaid and Her Pail

Central Bank

1. Issue Riba based contract: T-bills and sell it to Central Bank 2. Issue Money and lend to Treasury with Riba

33

State 3. Government Spending

4. Not enough Tax

R.I.P

Fig. 2.  T-bills, Money Creation, and the Public Finance Problem. Source: Author. The issues with fiat currency have been widely discussed in the economics literature. (1) After initially beneficial years, fiat currency gives rise to economic, social, environmental, and political failures. The default cases for governments, people, and companies are inevitable since the system is always short of funds. Money is created by debt bills with interest. Debt is mainly created by printing money, while the interest, payable at maturity, is not created as money.35 (2) Money creation based on debt causes asset price bubbles and inflation in the fiat currency system.36 (3) The fiat currency system favors an extraordinarily privileged few who are close to money creation. Wealth and property is accumulated in their hands at the expense of society.37 Such unfair wealth accumulation is not related to work effort but subtle deceit. (4) The fiat currency system fuels inequality, which leads to increased criminality in society. Some studies have shown that a correlation exists between fiat currency and criminal cases.38

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In sum, the money in the contemporary world’s fiat c­ urrency system is created by issuing debt instruments for which the principals plus riba must be paid in the future. The riba element, unlike the principal amount, is not created as money at the time of issuance; riba can only be paid by issuing additional debt at maturity, assuming that the government has collected enough tax to pay the principal.39 The ever-expanding debt burden is the problem of the next generation and is in addition to the burden of the contemporary financial system on a country’s youth.

2.2. INFLICTING PAIN ON YOUTH The repercussions of the contemporary monetary system and contemporary economic policy cause severe and protracted problems in the form of youth unemployment and consequently give rise to demographic movements. Some scholars have argued that contemporary society enjoys the benefits of the fiat monetary system; however, they do not properly elaborate the reasons for economic failure in the contemporary world.40 There is a need for a philosophical discussion starting from the grass roots of the problem because debate on the issue is seemingly far removed from reality. Unfortunately, many scholars have proposed that technological development is a key to tackling contemporary economic issues, particularly youth unemployment.41 However, regardless of the significant technological developments in the twentieth and twenty-first centuries, youth unemployment statistics have not improved. Indeed, youth employment is not peculiar to the Muslim world but is a global issue that includes developed countries. This point alone hints at the instigator: The same economic system is implemented worldwide. Like a matryoshka, the causes of the problem are elusive in a subtle but unfairly integrated economic and financial system.

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In addition to other causes, economic growth may develop from population growth and/or productivity increases; at least the Islamic perspective certainly states this.42 The major contributor of economic growth in the Muslim world has been population growth, while in the rest of the world the major contributor has been productivity increases. Perhaps this is one of the reasons why the repercussions of youth unemployment are more violent in the Muslim world. Assuming that population growth to instigate productivity growth by itself without human capital investment has proved to be unjustified optimism in the Muslim world. Even so, population growth has recently started to stall in the Muslim world as it once did in developed countries.43 Today, young people do not tend to marry; indeed, when they do marry, it is usua­ lly when they are older. In addition, the age at which someone has a first child has increased, and the number of children per family keeps decreasing. In this regard, you could compare today’s observations with the situation in the prior generation. What was the age at which the prior generation married? At what age did they have their first child? How many children did they have? Perhaps any change has something to do with the economic and financial system that has been similarly implemented in the Muslim and non-Muslim worlds. Youth are cornered by a subtle inter-generational income transfer and the unfair transfer of wealth to the financial system. In one way or another, every country tries to have a social security system supported by health care for senior c­ itizens in addition to regular pension payments. With increased life expectancy and expensive medical intervention, the bill keeps increasing. Assume that a pensioner retired at the age of 60. He receives an expensive medical operation at the age of 70 that extends his life for a further 10 years. At the age of 80, he has another expensive operation that extends his life to the age of 90. Every extension to his life means a c­ ontinued

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monthly pension payment, which instead of 10 years is now 30 years. Such payments are in addition to the cost of medical care. Of course, such an approach appears reasonable: It is un-Islamic and inhuman to propose any other way. However, the Islamic perspective challenges such views: These bills result in increased tax rates, an increased public finance burden to be paid by the next generation, and youth unemployment. Instead of allocating resources to youth who can reproduce, the system provides resources to extend the ailing lives of senior citizens. Reviewing holy scripture does not reveal such a distorted social security system but rather obliges youth to take care of their parents. However, most youth in the contemporary world do not have the economic capacity to sustain their spouses and children let alone provide additional support to their parents. One related issue is low productivity, which can be improved by redirecting funds from social security to human capital investment; another is unfair wealth transfer from households to the financial system. Financial products that address human deprivation can lead to significant unrealized wealth transfer. Healthcare costs, education costs, and housing prices have been unstoppable since the collapse of the Bretton Woods system.44 Even if the prices of many other commodities fluctuate, inflation in these commoditized human needs is spiraling upward. Enabling more housing loans in the name of helping youth to own their homes is a subtle deceit. The availability of loans to people increases the bids for real estate stock; hence, the prices of homes rise. If there was not such demand, youth may need to save for 10 years to purchase a home for which at the moment, they need to buy with a 30-year mortgage. Increased housing prices benefit landowners and, to some extent, real estate developers. However, those that benefit the most are banks. The higher the prices of homes, the larger the loans. The larger the loans, the less there is left from

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i­nterest payments for youth to invest in their futures: marrying, having children, and saving for personal development. The same holds true for unjustified education costs. There is no indication of increased costs for educating people. Education institutions do not pay more to their teachers; however, tuition fees keep increasing. Student loans and cash loans to households for education are the villains. The price of commoditized human needs is not defined by cost plus profit but by affordability, even if it is through a 30-year loan. Moreover, medical fees keep increasing because they are backed by insurance schemes. Hospitals are happy with the increased fees for medical expenses; further, insurance companies, unlike many people believe, support such price rises so that they can ask for higher premiums from households. Youth pay such increased costs directly or indirectly through governmental social security systems. Thus, wealth is transferred from households to the financial sector. Indeed, all these issues are more pronounced in developed countries. Having a family under these circumstances involves a simple calculation: Waiting for 30 years to own a home and accepting ever-increasing education and medical costs represent significant liabilities for youth. They may prefer to escape from such unfulfillable and unfair liabilities through either hedonic lifestyles or radicalism, both of which undermine the Muslim world and Islamic values. Indeed, the possibility of hedonic lifestyles, drug taking, and radicalism among youth should be the concern of the world. The Islamic economic proposition is not confined to riba alone but goes beyond it with regard to maqasid al-shari’ah. In addition, the aforementioned unfair economic and financial policies violate maqasid al-shari’ah and are no less prohibited than riba. Unlike riba, though, the effects of these subtle deceits are difficult to discern since they can be extended for decades by financial engineering. However, such practices

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in the end lead to demographic movements because of a fall in reproduction rates, which translate into weak household consumption demand. This circumstance is the major reason for the sluggish world economy: Weak sustainable demand leads to declining gross domestic product (GDP) growth. A sponge has water-absorbing capacity; however, we far exceed this capacity by artificial and unsustainable demand created by loans. The world economy is now like a company that cannot generate enough profit to pay its daily compound interest fees. It is a hostage of the financial system. Weak sustainable household demand and the existence of riba compounding in good days and bad days is about to prove that the current monetary system has fatal flaws, not imperfections. Such a situation was the case for the communist economic system, which unlike the Islamic approach disregards private ownership and entrepreneurship. It seems that an invisible hand has already placed triggers into the stress points of the system to bring about an inevitable end. This invisible hand is not, apparently, that of Adam Smith and we are ready to suspect any person of being defective in selfishness.

2.3. THE SCRUPLES OF ISLAMIC MONEY CREATION 45 What would have happened if the Romans used scruples as a complementary currency to their metal coins for the exchange of commodities? Further, once the scruple price of each commodity was determined, would they have debased the scruple in terms of the metal coins? In this instance, history would probably have changed because for every commodity entered in the market, the state would have been able to create money with scruples instead of precious metals. There is a reason for referring to ancient states in a book on Islamic economics and finance. The names of money, the dirham and dinar,

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entered the Muslim vocabulary from the Greek language. Dinar is derived from denarius, a Roman silver coin. Dirham is derived from drachma, a Byzantine coin.46 If the Romans used proper money instead of metal coins, the major reason for their invasions to plunder gold and silver would have been eliminated; however, their expansion for the control of commodities would have continued. Fig. 3 presents map that reflects this. Like any vast empire in human history, Roman expansion was not arbitrary. The Romans expanded to control commodities and build infrastructures, such as roads and ports, to bring the commodities to the markets. Further, Romans developed their legal code, with a high degree of legal certainty, to assure that markets functioned well and created prosperity. Other empires have taken the same course. It is unsurprising to see the British Empire establishing a railroad infrastructure in the Indian subcontinent. The main motivation was probably not to contribute to the development of local people but to make the commodities in their colonies accessible to the markets. The British even invested in railroads in other countries to have

Fig. 3.  Commodities Map of the Roman Empire. Source: Creative Commons.47

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access to strategic commodities. In  1856, the British Empire established the Ottoman Empire’s first railroad track from Izmir to Aydin in order to transport cotton cultivated in the region to a seaport for onward shipment to the textile industry in Britain. The Arabian Peninsula was very quiet until a new commodity called oil began to be exploited in the twentieth century.48 Humans are very similar across the globe; indeed, it was not only westerners who invaded other countries to access strategic commodities in case it was not possible to gain entry through infrastructure investment and trade deals. The imperial Japan’s strategy of ­Hokushin-ron to control Northeast Asia and access commodities to feed expanding Japanese industries transformed into exploring the possibility of using the Zaribuno port of Russia to reach the mines of Mongolia in the twenty-first century. Indeed, this approach reflects the Islamic proposition to have exchange and access through fair-trade and investment, and not oppression, invasion, and unfair trade. In the twenty-first century, the People’s Republic of China’s heavy investment in sub-Saharan Africa is not perhaps only intended to help these countries to be free from Western exploiters.49 Indeed, the Chinese have been very smart throughout the history and they were the first who invented paper money. Because they did not fix the money supply to commodities that entered the market, their experience led to a significant excess of paper money.50 Hopefully, we are now aware of the negative correlation between the value of the world reserve of money and ­commodity ­prices. At least a weaker dollar causes higher commodity prices.51 Similar to prior monetary systems, the contemporary ­system and the way money is created causes economic d ­ estitution for many people and fuels social unrest. Assuming there is major dissatisfaction with the contemporary monetary ­system and fiat currency, should we go back to precious metal money or barter? In Islamic shari’ah, anything can be ­transformed to

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serve as money as long as the money is consistent with the to-do and not-to-do lists concerning riba, gharar, and m ­ aysir. Any fungible item such as gold, silver, ­barley, wheat, etc., can be used as a medium of exchange; the riba restriction applies to the trading of the medium of exchange. However, if these items are traded as commodities, m ­ urabaha sales are allowed.52 The key issue in Islamic money is the mechanism in which money is created out of fungible items. Humanity reached today’s paper money system through an evolutionary process that began from barter. Each replacement of the prior system was a search to address the defects of the old system; thus, the contemporary monetary system is not “the end.” A perfect monetary system is yet to emerge out of the urgency to address the protracted problems of the contemporary system. History has repeated itself because humans keep making the same mistakes. Islamic economics and finance shall and should have a strong say regarding this issue. The decisive implementation of the to-do and not-to-do lists of Islamic shari’ah is thought to ring-fence people from the jaws of the contemporary monetary system; however, while the fundamental issue of the way money is created is ignored, the situation is akin to that of the story of the purple dragon. Scarcely had the King spoken when some of his soldiers came running with news that they had seen the Purple Dragon eating plum-pudding in the royal garden. “What did you do about it?” asked the monarch. “We did nothing,” they answered; “for, had we interfered with its repast, the Dragon would probably have eaten us for dessert.” “That is true,” remarked the King. “Yet something must be done to protect us from this monster.

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For many years it has annoyed us by eating our choicest crops, and nothing we can do seems of any avail to save us from its ravages.” “If we were able to destroy the Dragon,” said Prince Thinkabit, “we should be doing our country the greatest possible service.” “We have often tried to destroy it,” replied the King, “but the beast always manages to get the best of the fight, having wonderful strength and great cunning. However, let us hold a council of war, and see what is suggested.” So a council of war was called. The Wise Man, all the Princes and Noblemen, the Dog and the Wise Donkey being assembled to talk the matter over. “I advise that you build a high wall around the Dragon,” said the Wise Man. “Then it will be unable to get out, and will starve to death.” “It is strong enough to break down the wall,” said the King. “I suggest you dig a great hole in the ground,” remarked the Donkey. “Then the Dragon will fall into it and perish.” “It is too clever to fall into the hole,” said the King. “The best thing to do,” declared Timtom, “is to cut off its legs; for then it could not walk into our gardens.” “The scales on its legs are too hard and thick,” said the King. “We have tried that, and failed.” “We might take a red-hot iron, and put the Dragon’s eyes out,” ventured Prince Jollikin.

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“Its eyes are glass,” replied the King with a sigh, “and the iron would have no effect on them.” “Suppose we tie a tin can to its tail,” suggested the Dog. “The rattling of the can would so frighten the Dragon that it would run out of the country.” “Its tail is so long,” answered the King, gloomily, “that the Dragon could not hear the can rattle.” Then they all remained silent for a time, thinking so hard that their heads began to ache; but no one seemed able to think of the right thing to do. Finally, the King himself made a proposition. “One thing we might attempt with some hope of success,” said his Majesty. “Should it fail; we cannot be worse off than we are at present. My idea is for us to go in a great body to the castle of the Dragon, and pull out its teeth with a pair of forceps. Having no teeth, the monster will be harmless to annoy us in any way; and, since we seem unable to kill it, I believe this is the best way out of our difficulty.” The King’s plan pleased every one, and met with shouts of approval. The council then adjourned, and all the members went to prepare for the fight with the Purple Dragon. First the blacksmith made a large pair of forceps, to pull the Dragon’s teeth with. The handles of the forceps were so long that fifty men could take hold of them at one time. Then the people armed themselves with swords and spears and marched in a great body to the castle of the Purple Dragon. This remarkable beast, which for so long had kept the Valley of Mo in constant terror, was standing on

43

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the front porch of its castle when the army arrived. It looked at the crowd of people in surprise, and said: “Are you not weary with your attempts to destroy me? What selfish people you must be! Whenever I eat anything that belongs to you, there is a great row, and immediately you come here to fight me. These battles are unpleasant to all of us. The best thing for you to do is to return home and behave yourselves; for I am not in the least afraid of you.” Neither the King nor his people replied to these taunts. They simply brought forward the big pair of forceps and reached them toward the Dragon. This movement astonished the monster, who, never having been to a dentist in his life, had no idea what the strange instrument was for. “Surely you cannot think to hurt me with that iron thing,” it called out, in derision. And then the Dragon laughed at the idea of anyone attempting to injure it. But when the Dragon opened its mouth to laugh, the King opened the jaws of the forceps, quickly closing them again on one of the monster’s front teeth. “Pull!” cried the King; and fifty men seized the handles of the forceps and began to pull with all their strength. But, pull as they might, the tooth would not come out, and this was the reason: The teeth of Dragons are different from ours, for they go through the jaw and are clinched on the other side. Therefore, no amount of pulling will draw them out.

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The King did not know this fact, but thought the tooth must have a long root; so he called again: “Pull! My brave men; pull!”53 Frank Baum (1896) Pulling the teeth of the beast may not bring about the ­Pareto optimal state; instead, taming it should serve humanity. Having a tamed monetary system would greatly serve humanity; moreover, Islamic economics and finance can help address the defects of the contemporary monetary system and make use of the merits of past systems. In this regard, the key issue is that money creation in Islam should observe the following: (1) The monetary system should originate from the grass roots of the supply chain and expand through trade and commerce, as is the situation throughout human history, starting with barter. (2) Money is to be created out of work effort to encourage value addition and cooperation as opposed to the zero-sum game and unfair competition. As long as people produce things demanded by other people, they should be able to create money and have free access to money. (3) Money creation should not be based on riba contracts such as T-bills. Money can be created based on shari’ahcompliant non-riba contracts facilitating bona fide economic activities. (4) The money supply should be linked to amount and worth of commodities and goods in the market. Amount and worth should be determined in the free market based on a unit of account similar to scruples or e-currency.

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(5) Inflation and asset bubbles should be hindered by strictly linking the value of money to goods produced and market commodities. (6) In order to decrease money demand for the daily exchange of goods, an electronic trading platform should match the demand for, and supply of, merchandise in a chain barter. Bilateral barter matching should be avoided and electronic currency, as a unit of account, should be employed to abate barter’s pitfalls.54 (7) Rules and regulation of exchange, trade, and commerce should pave the way for fair price formation and protect the rights of all parties. (8) In contrast to the fractional reserve banking system of the contemporary monetary system, non-riba financing mechanisms should be in place to finance the supply chain and expand the monetary system to support the economy. (9) A monetary system can only be sustainable if there is a reasonable wealth redistribution mechanism (zakat). Contemporary fiat currency has problems that have caused the recent trend of cryptocurrencies, which are not shari’ah compliant. The reason they are not shari’ah compliant is because of the way in which money is created, which involves maysir and gharar. Moreover, the lack of a legal infrastructure with government regulation leads to unsolvable legal conflicts and swindling. Otherwise, the concept of money in electronic form is consistent with the Islamic perspective as long as money is created based on value adding work effort and not pseudo mining. Unlike the common perception, gold is not an ideal form of money in Islam. Indeed, it could be the worst form of money because there are clear verses against gold in the Qur’an.55 The issue of money creation is critical

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from the Islamic perspective; moreover, gold and silver hoarding is condemned, while work effort is appreciated, in the Qur’an.56 For these reasons, Islamic money creation should be based on work effort. The Islamic microfinance structure for farmers, in which Islamic banks provide agricultural input and offset the debt with products after the harvest, is a good example for the creation of Islamic money (see Fig. 4). Indeed, the system can be expanded from the supply chain to international trade. Fig. 4 depicts the Islamic microfinance structure as practiced by some Islamic financial institutions. Under such a structure, a microfinance institution (MFI) is not only the fund provider but also the supplier of input and off-taker of products produced by microfinance clients. The extended role of an MFI as a bulk buyer of input and a major seller of ­products on behalf of microfinance clients enables vulnerable people to gain better bargains and fair prices. Within the Islamic microfinance credit system for farmers, Islamic money based on work effort can develop if the legal tender in the contracts between an MFI and farmers is altered.

Agricultural Input Seller

2.

MFI as • Lender • Supplier • Off-taker

5.

Primary Industry (Coon Ginner, Wheat Fluor Producer)

1.

3.

4. Micro Finance Beneficiary

Fig. 4.  Islamic Microfinance as Practiced by Some Micro­ finance Institutions. Source: Author.

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(1) The farmers and MFI sign murabaha, musharaka, or mudaraba microfinance contracts for the procurement of agricultural input for the farmers. The currency is the e-dinar, an electronic version of the unit of account of the Islamic Development Bank (IDB), the Islamic dinar.57 (2) The MFI supplies agricultural input worth 100 e-dinars from the input providers to fulfill its supply obligation to the farmers. (3) The MFI sells, in the case of a murabaha contract, agricultural input of seeds and fertilizer with a six-month tenor for 106 e-dinar. (4) The farmers fulfill their repayment obligation after six months by bringing their harvest, worth 306 e-dinar, to the MFI, which deducts 106 e-dinar as repayment. The MFI then credits the remaining 200 e-dinar to the farmers’ accounts. (5) The MFI can sell the harvest for the equivalent amount of 400 e-dinar in hard currencies to primary industries on behalf of the farmers. The MFI creates 306 e-dinar based on the work effort of the farmers and input providers. This approach to supply chain finance and production can address the major defect of fiat currency: “Money is created by borrowing with interest, hence, the system is always short of funds, and default cases for governments, companies or people become unavoidable at the end since the interest portion does not exist in the form of money.”58 The MFI will reserve hard currency to back the e-dinars created in every purchase based on a market reference price. Indeed, this is a complementary currency as implemented for poverty alleviation in rural areas. It has been used to produce a better monetary system since the 1990s in barter systems.59 Although there is a direct conversion option from

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e-dinars to hard currencies, after a critical mass of transactions with electronic complementary money and an electronic trading platform, the reference market prices for all commodities is nonetheless determined. Afterward, the complementary currency, the e-dinar, can be debased from the basket of hard currencies, as occurred with fiat currency in terms of the gold standard. The system requires an electronic trading platform for market participants. The presence of such a platform resolves the major defect of the barter system: matching coinciding demand and supply. In contrast to bilateral matching, chain matching in barter, with an increased number of bids and offers with complementary money, addresses the pitfalls of barter and abate the demand for money. Participation in an organized market is needed for the success of trade that serves people’s prosperity. Such participation was encouraged by Muhammad (PBUH) as soon as he arrived in Medina. He looked for a marketplace after visiting Qaynuqa’, then stamped on a stone in the new marketplace and declared: “This is your market, let its space not be diminished and let no tax be taken in it.”60 Islam encourages efficient markets where there are no transaction taxes, entry barriers, and monopolies. By doing so, informal market formation can be avoided and fair prices can be formed for society’s benefit. Having an electronic trading platform assures barrier-free entry to all participants, while tax exemption for the transactions on the trading platform is required for a healthy ­business environment. A further requirement for the use of a complementary currency is a legal framework established by governments. Moreover, other aspects for enabling a trading environment are providing proper storage facilities and linking the goods and commodities in the storage facilities to an electronic trading platform. The existing licensed warehousing structures and

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electronic warehouse receipt (e-WR) systems enable properly running and risk-free markets if they are embedded into the electronic trading system of the e-dinar. This approach also requires a legal framework. Most importantly, in order to have a globally functional monetary system, public authorities should allow the use of e-dinars in international trade for customs clearance and cross-border money transfers. Such a system would contribute to poverty alleviation efforts by supporting local supply chains and expanding international trade. One of the very few propositions that economists agree upon is that supporting trade encourages economic growth.61 This is also the view of Islam as stated in the hadith of the Prophet (PBUH): “Nine-tenths of the sus­ tenance (rizq) is derived from trade.”

NOTES 23.  This is a different version of Aesop’s Fable and is called the “Milkmaid and her Pail.” 23. Levy, To Pixar and Beyond. 24.  Gundogdu, “Developing Islamic finance opportunities for trade financing: Essays on Islamic trade vis-à-vis the OIC ten-year programme of action”. 25.  For extensive detail on the history and theoretical background, one may refer to Smithin, What Is Money? (London: Routledge Publishing, 2000) 26. Lietaer, The Future of Money: Creating New Wealth, Work and a Wiser World. 27.  Huszagh and Barksdale, “International barter and countertrade: an exploratory study”.

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28.  Sahih Muslim, No: 9870. 29. Riegel, Flight from Inflation: The Monetary Alternative. 30.  Kameel, Meera and Larbani, “Seigniorage of fiat money and the maqasid al-shari’ah: the compatibility of the gold dinar with the maqasid”. 31. Levy, Conquistador: Hernan Cortes, King Montezuma, and the Last Stand of the Aztecs. 32.  Ritter, “The transition from barter to fiat money”. 33.  The correlation between money growth and inflation under the fiat money system is identified in many academic works (McCandless & Weber, “Some monetary facts”; Rolnick & Weber, “Money, inflation, and output under fiat and commodity standards”). 34.  Referring to World Bank data available online at https://data. worldbank.org/. 35.  Lietaer, Arnsperger, Goerner, and Brunnhuber, Money and Sustainability: The Missing Link. 36.  Lietaer and Dunne, Rethinking Money: How New Currencies Turn Scarcity into Prosperity; Mouatt, “The Case for Monetary Diversity”; Greco, The End of Money and the Future of Civilization; Brown, Web of Debt; Meera, The Theft of Nations; Shakespeare and Challen, Seven Steps to Justice. 37.  Hülsmann, J.G., “Fiat money and the distribution of incomes and wealth”, in The Fed at One Hundred, Eds D. Howden and J.T. Salerno (Springer Publishing, 2013): 127–138. 38. Hall, Theorizing Crime and Deviance: A New Perspective. 39.  If a government issues US$104 of government bonds with an interest rate of 3.845 percent p.a., it will receive only US$100 as cash and at one-year maturity needs to issue another debt instrument for the remaining US$4. If the government spends all the US$100 and collects tax of US$50 only, it needs to issue new debt of US$54. 40.  Falaschetti and Orlando, Money, Financial Intermediation and Governance.

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41.  Ryan, Garonna, and Edwards, The Problem of Youth. 42.  The debate on the effect of population growth has been extensively discussed by Barro, “Determinants of economic growth: a cross-country empirical study”, NBER Working Paper No. 5698 (Cambridge, MA: National Bureau of Economic Research, 1996) 43.  Referring to World Bank data available online at https://data. worldbank.org/. 44.  Refers to statistics of the US Bureau of Labor available at https://www.bls.gov/. 45.  The scruple, a unit of weight in the apothecaries’ system, is equal to 20 grains, one-third of a dram, and 1.296 g. It was sometimes mistakenly assigned to the avoirdupois system. In ancient times, when coinage weights customarily furnished the lower subdivisions of weight systems, the scruple (from Latin scrupulus, “small stone” or “pebble”) was a unit of Roman commercial weight as well as a unit of coinage weight. One drachma, the basic Greek silver unit, consisted of three scruples (Encyclopedia Britannica). 46.  Oxford Dictionary of English. 47.  This work is licensed under the Creative Commons AttributionShareAlike 3.0 Unported License. To view a copy of this license, visit http://creativecommons.org/licenses/by-sa/3.0/ or send a letter to Creative Commons, PO Box 1866, Mountain View, CA 94042, USA. 48.  Syrett, “The making of an Ottoman port: the Quay of Izmir in the nineteenth century”. 49.  It is important to note that such intervention between countries also created positive externalities for economic development. Looking at GDP per capita figures of East Asia reveals that the earlier a country opened for free trade, the higher the GDP per capita. Japan was forced by the USA to engage in free trade. Japan then forced Taiwan, Korea, and China to engage in free trade, although through arms.

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50. Vissering, On Chinese Currency: Coin and Paper Money. 51.  Akram, “Commodity prices, interest rates and the dollar”. 52.  The Prophet said: “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt – like for like, equal for equal, and hand-to-hand; if the commodities differ, then you may sell as you wish, provided that the exchange is handto-hand.” (Muslim, Kitabal-Musaqat, Bab al-sarfi wa bay’i al-dhahabi bi al-waraqi naqdan; also in Tirmidhi.) 53.  Excerpt from F. Baum, The Surprising Adventures of the Magical Monarch of Mo and His People. First published in 1896. 54.  Lack of store value and time; lack of double coincidence of wants; indivisibility of certain goods; lack of a common measure of value. 55.  “O you who have believed, indeed many of the scholars and the monks devour the wealth of people unjustly and avert [them] from the way of Allah. And those who hoard gold and silver and spend it not in the way of Allah – give them tidings of a painful punishment” (– 9:34 –). 56.  “And that man hath only that for which he maketh effort” (– 53:39 –). 57.  The Islamic dinar is the unit of account of the IDB. It is equivalent to one special drawing right of the IMF. Detailed information is available at https://www.isdb.org/irj/portal/anonym ous?NavigationTarget=navurl://9b3c5d9e74a0599c3de9b7ce7d98 de1b. 58.  As stipulated by Lietaer, Arnsperger, Goerner and Brunnhuber, Money and Sustainability: The Missing Link. 59. North, Money and Liberation: The Micropolitics of Alternative Currency Movements. 60.  Kister, “The market of the Prophet”. 61.  Gundogdu, “Determinant of intra-OIC trade: Policy or exchange rate”.

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Part III: Caravan IMPORTANCE OF TRADE IN ISLAM

The following account was given by Ibn Sa’d. When his nephew was five-and-twenty years of age, Abu Talib addressed him in these words: “I am, as you know, a man of scanty means, and truly the times are hard with me. Now there is a caravan of your own tribe about to start for Syria and Khadijah, daughter of Khuwaylid, is in need of the services of men of our tribe to take care of her merchandise. If you offer yourself for this enterprise, she would readily accept your services. “Muhammad (peace be on him) replied, “Be it as you say.” Abu Talib went to her and inquired whether she would entrust this enterprise to his nephew. Khadijah, who had already heard of the honesty, trustworthiness and high moral character of Muhammad (peace be on him) lost no time in accepting this offer and said: “I would give him twice of what I would give to the other men of your tribe.”62 55

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Muhammad (PBUH) was an experienced international trader. He enlightened, with many hadiths, adherents of the Islamic faith about a healthy business environment that supports free trade. Islam highly appreciates international trade because it urges humans to cooperate for sustenance, which in turn ­contributes to peace and harmony on earth. The Islamic understanding of economy and finance is a type of managed liberal economy in which to-do and not-to-do lists are imposed on market players. These players are free and s­trongly encouraged to work within these boundaries. The central element of the Islamic view on the business environment is “fair price formation.” Islam does not welcome, and ­strictly prohibits, interference, in the form of price controls and monopolies, with price formation in the market. The reason is not an appreciation of the invisible hand of Adam Smith; instead, there is a distinct philosophy: The Almighty improves or deteriorates the sustenance of humans with changes in ­relative prices. For this reason, there are many hadiths on the subject. For example: One person came to the Prophet (PBUH) and requested him to fix prices in the market but he refused. Another man came and made the same request; the Prophet (PBUH) said it is Allah who pushes prices up or down, I do not want to face Him with a burden of injustice. Muhammad (PBUH) identified interference with market prices as the equivalent of zulm (injustice) because the Almighty distributes sustenance among people by changing prices, thereby making some people better off and some worse off. Since it is the Almighty determining relative prices in the market, unnatural intervention that distorts fair price formation in the market is unacceptable in Islam. Fair price formation requires competition law, which is the first of its

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kind stated by Muhammad (PBUH). When the Messenger of Allah established a market for Medina, he declared: “This is your market, let its space not be diminished and let no tax be taken in it.”63 No one was allowed to establish a pitch or draw boundaries to create a permanent place in the market, thereby inhibiting some market players from exploiting their dominant positions. Taxes on transactions were forbidden in order to deter informal markets from developing and to encourage formal markets where prices were transparently and fairly formed, in a similar way to contemporary organized exchanges. There is a substantial difference though: In Islam, one cannot sell items that one does not own. The entrance of commodities and goods to a market should be assured for the purpose of fair price formation. Prophet Muhammed (PBUH) said: “Do not go forward and meet the caravan carrying grain etc. (for trade) (before it had reached the market-place). The trader who went ahead and bought the goods in the way, the owner would, then, have the right to cancel the deal, (if he wished), on reaching the market.” The Muslim cross-border caravan business expanded after Islam began and brought huge prosperity, dynamism, and knowledge accumulation. Unsurprisingly, the concept of contemporary Islamic finance is based on the financial instruments developed to support the former days of the caravan trade. As with Western Europe’s financial system, the origin of the Islamic financial system is also international trade. Murabaha, mudaraba, and sukuk were invented in order ­ to venture in and facilitate the caravan business in a similar way to Western ventures of the East India Company. Muslim traders also invented an international payment system, called suflaja, which inspired Western Europeans.64

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The Muslim world strongly adhered to the Islamic creeds concerning international trade and for centuries facilitated free trade, which flourished. In a similar way to the modern age, major world trade was between East Asia and the West. Thus, Muslim countries enjoyed prosperity that came from the transit trade between the East and West. Such prosperity lasted until some rulers in the Muslim World who regarded their predecessors as foolish decided to exploit their dominant positions on the transit routes by charging taxes and forbidding access to caravans at their discretion. The first catastrophe occurred when Khwarezmian arrested Mongol caravans. This action led to the Mongol invasion of the Middle East as far as Egypt.65 The old wisdom was lost and small Muslim countries on the Silk Road exploited the traders as much as they could to the extent of forcing westerners to look for alternative trade routes. Indeed, Western Europeans found tax-free routes by sea to the East during the early years of the sixteenth century. The impact on the Muslim world was empty ports and caravansaries, and the unpreventable decline of Muslim civilization. “If there is no trade there is no wealth, and if there is no wealth there is no civilization.” It is as ­simple as that. Reflecting on the contemporary world, the lesson learned is very clear: support free trade and avoid protectionism in economic policy. Imagine a monetary system where money is created as long as people produce goods demanded by other people. In such a circumstance, everybody would wake up early and produce something in order to access money. However, they would have a problem. All locals naturally produce the same items; for example, bananas in West Africa, wheat in Central Asia, and rice in Southeast Asia. There would be an oversupply of bananas in West Africa, wheat in Central Asia, and rice in Southeast Asia. If West Africans decided to cultivate rice instead of excess bananas, they would need to

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expend twice as much effort and input to produce the same amount of rice produced in Southeast Asia, yet the quality would be ­lower. The same would happen if Southeast Asians and Central Asians opted to replace part of their staple crop ­production with exotic bananas. Some glorify this approach as self-­sufficiency, although West Africans would never enjoy croissants and Central Asians bananas. There is a better way: Let every region produce as much as it can as its main crop and sell the excess to other regions. This system is called comparative advantage and is a good reason for free trade internationally. Introduced by Ricardo in 1817 with a book, On the Principles of Political Economy and Taxation, the concept of comparative advantage explains the way international trade creates the wealth effect.66 With international trade, all regions are more prosperous, overall. Maximum production is achieved globally with minimum effort. Nevertheless, this is not the full story. There is a side effect of free trade: income inequality within a country. In a similar way to financial inclusion, international trade increases overall wealth; however, some people obtain a greater share of the created wealth to the extent that some other parties are worse off. Unfortunately, throughout human history, excellent ideas have rarely been developed for the overall well-being of all; instead, ideas and systems support interest groups. Moreover, scholars believe that self-interest is not confined to a country taking advantage of another country but is more often connected with exploitation within a country. If someone had a stake in the corn importing business in the early nineteenth century, he would probably use comparative advantage arguments to convince policy makers to remove any tax on corn imports. With the introduction of steam engines, such an approach to imports of agricultural commodities gave rise to an inundation of agricultural products in Europe. Many farmers in Europe had to leave their rural settlements to search for informal jobs

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in urban areas or migrate to the New World since they were not able to compete with low price imports from overseas colonies. The prices dropped to the extent of triggering the 1873 agricultural crisis because no adjustment mechanism existed to compensate for farmers’ losses. The fall in prices supported the urban population and industries, and incentivized the migration of rural Europeans to the New World.67 Overall, Western Europe became richer; however, cities were beset with criminality until the flaw in the system gave rise to “my country first” slogans and the First World War.68 Protectionism against international trade and positions against financial diffusion could be chosen as second-best alternatives under such circumstances.69 However, the results would have been impoverishment. The Islamic approach to the issue is straightforward and in favor of free trade and financial inclusion to support trade. With regard to the inequality created by international trade and financial inclusion, Islam urges countries to adopt a wealth redistribution mechanism with zakat, which should not be confused with taxation. Tax is collected from the income stream and in Islam should be avoided on trade transactions, while zakat is the redistribution of calculated wealth based on individuals’ net worth.

3.1. INFANT INDUSTRY In the 1950s, a German trade mission to Japan tried to use the comparative advantage theory to convince the Japanese not to invest in the automobile industry. The trade mission’s argument was simple: Germany has comparative advantage in automobile production and Japan has comparative advantage in textile production; thus, the two countries should develop a trade arrangement in which Japan sells ­textiles while ­Germany sells automobiles. The Japanese did not appreciate

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Ricardo’s wisdom of comparative advantage and today Japan produces more motor vehicles than Germany. Although Islam supports free trade, it assures fair price formation, which requires the removal of entry barriers to the market. Such barriers can be established in the form of governmental licensing, non-tariff barriers, monopolies, oligopolies, and cartels. All of these are unacceptable from the Islamic perspective. The most disguised entry barrier, however, is economies of scale. A well-established producer has lower production costs per unit of output because it manufactures large quantities with economies of scale. If another party tries to enter the market, the fixed cost investment that is required does not enable the new party to compete with the existing players. Such a barrier created by economies of scale should be taken into consideration when supporting free trade. This entry barrier distorts the market, as in the case of Japanese car manufacturers. Once these manufacturers reached breakeven points, they could offer more reliable cars than existing brands with lower costs. It was Alexander Hamilton who first introduced the infant industry argument in 1790 in his Report on Manufactures.70 In a similar way to many theories on economics and finance, the argument was proposed to support self-interest. The pattern of trade between the United States and the British Empire was at the expense of the United States. The latter was exporting cotton to mills in Britain and importing value-added textiles from Britain. Further, in order to keep Britain in front of other countries, there was a strict ban on the export of weaving machines and the designs for such machines. Soon after, Americans were able to smuggle out some machine designs. Then, they implemented high tariffs to protect their infant weaving industry. Within 100 years, rural United States for the most part was transformed and became an industrial giant.71 From the Islamic perspective, the issues should be e­ valuated based on their effects on fair price formation. The protection

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of an infant industry supports fair competition and price formation. For the same reason, specific export subsidies or industry-wide subsidies such as subsidized energy costs as well as dumping are unacceptable. Countries facing such unfair competition should impose anti-damping and countervailing duties in order to safeguard the market. The same holds true for the exchange rate, which is also a price. Some countries that have an export-oriented development strategy keep their national currencies undervalued to support their exports; hence, they support domestic production and employment. Such distorted currency prices undermine the livelihood of workers in export markets and transfer wealth inside the countries to those in export businesses. This approach represents unjust enrichment, which derives from the unfair price formation of foreign exchange (FX) prices. In a similar way to the price of goods, FX prices also need to be determined in the free market under governmental supervision, which should safeguard against price distorting activities such as subsides, dumping, and undervalued currencies while encouraging infant industries to restore fair competition. Islam accepts competition as long as it is fair; however, it also encourages the cooperation that can be derived from fair competition. It is clear that Islam does not accept tariff and non-tariff barriers except when a counterparty engages in market distortion activities. As can be seen from the case of FX, the notion of fair price formation in Islam expands the scope of trade policy into a wider understanding of the business environment.

3.2. A TALE OF TWO CITIES: SINGAPORE AND HONG KONG Although there is much speculation on the perils of a multilateral trading system in the world, from the Islamic p ­ erspective

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its merit is obvious. Further, there is no need to oppose all the novelties introduced by non-Muslims because, unlike the financial system, the proposed trade system is consistent with the Islamic creed. In order to regulate the delicate issues of international trade for the benefit of all nations, the International Trade Organization of the Bretton Woods system was transformed into the World Trade Organization (WTO) in 1995. After the establishment of the WTO, in addition to the conventional areas of interest regarding international free trade, four issues were introduced in 1996 by the WTO ­Ministerial Conference in Singapore.72 (1) Trade and Investment. Rules were instituted to protect foreign investors against the arbitrary actions of host countries. (2) Trade and Competition Policy. This policy created a rule of fair competition among foreign companies, domestic companies, and governmental monopolies. (3) Transparency in Government Procurement. Such transparency enables foreign companies to participate in governmental procurement without discrimination from local companies. (4) Trade Facilitation. These activities simplify cross-border transactions and reduce their cost. The fourth item, on trade facilitation, transformed into a multilateral trade accord in 2017 called the “Agreement on Trade Facilitation.”73 Apart from trade facilitation, the other items were dropped; however, they offer valuable insights from the Islamic perspective. We are reasonably clear about ­Islamic encouragement of trade facilitation. Bearing in mind the important point about fair price formation from the Islamic perspective, the first three items provide a business ­environment

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in which foreign direct investment (FDI) flows and fair competition is encouraged. The Islamic perspective encourages FDI since it creates added value by transferring technology to support economic growth in a much shorter time and to higher standards of quality than domestic investment. FDI also protects the domestic population from local monopolies and enables lower prices.74 Nevertheless, even with FDI and/or trade facilitation, emerging economies may not benefit from international trade because of significant infrastructure gaps that hinder their exports. In 2005, the WTO’s Hong Kong ministerial declaration recognized this fact and the Aid for Trade concept emerged.75 This initiative fine-tuned Official Development Assistance in order to improve the infrastructures of emerging markets and thereby enable them to export. Thus, such markets could be integrated into the global supply chain. For example, West Africa has a competitive advantage in cotton production but needs investment in its energy sector and transport infrastructure, in the form of reliable power grids, roads, and efficient ports for example, in order to move upstream in textile manufacturing or sell its cotton for higher prices. Without an appropriate infrastructure, investment in West African countries cannot benefit from international trade. However, unlike FDI and cross-border trade, cross-border real estate and stock investment cause price distortion and speculation (maysir) and are contrary to maqasid.76 Today, the ultra-rich have real estate portfolios in every major city in the world, while local populations suffer from a lack of proper shelter due to real estate bubbles. Further, serious problems exist with financial markets and stock investments in the contemporary world because modern finance theory is developed on a notion forbidden in Islam: maysir. Pioneers of modern finance theory stylishly refer to the notion as random walk hypothesis as if it is a scientific aspect of finance and not an adjunct of the casino business.

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3.3. RANDOM WALK VERSUS ISLAMIC REASONING A major deviation in finance took place in two stages in the Western world. Christian scholars issued innovative verdicts such as Contractum trinius to relax interest restrictions; then, physics and mathematics dropouts entered the economics and finance field in the twentieth century. Unfortunately, the significant amount of economics and finance literature should not be referred to as science or art but vanity. It should not be called science because (1) it cannot explain what is taking place in real life, (2) it is unable to accurately identify problems that humans face, (3) it does not propose decisive actions for solving problems, and (4) it cannot make any accurate predictions of the future. Unlike modern economics and finance theories, Islam proposes a to-do list and a not-to-do list. It also explains the reasons why humans ignore the lists. Most importantly, it predicts that as long as we keep ignoring the lists, the same problems will be repeated in a vicious circle. Modern economics and finance theory appears to be scientific compared with the Islamic approach. However, if looked at in detail, one can discern that the reverse is true. Modern portfolio theory and the statistical methods used by econometricians assume “random walk” and “independent and identically distributed (IID) random variables.” Based on such unrealistic assumptions, econometricians try to make predictions that will never be valid because the assumptions are incorrect. From the Islamic perspective, some of the exogenous variables (such as maysir, riba, and gharar) lead to endogenous variables (such as Wall Street speculation) and financial crises.

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It is dangerous to copy and paste the concepts of life ­sciences, such as physics, onto social sciences. Unfortunately, this situation arises with economics and finance because it facilitates academic publication. There are no publications of the quality of The Wealth of Nations; instead, there are academic publications that contain low-quality mathematical scraps that tell you as little as possible after guiding you across professedly complicated formulas. In 1827, the English physicist Robert Brown, while looking through a microscope, discovered that molecules randomly collide in space. Niels Bohr, while laying down the foundation of quantum physics, illuminated the pattern of electrons with random probability. The inspiration from new ideas in physics led the subject of finance astray. In 1900, Bachelier, in his work called The Theory of Speculation, introduced a mathe­matical formula using the notion of Brownian motion, later referred to as random walk theory, for stock price prediction. Bachelier claimed that his theory, by the calculus of probability, solves the problems in the study of speculation. In 1952, Markowitz introduced his modern portfolio theory based on Bachelier’s forgotten work. In contrast to what many scholars believe, Markowitz’ success with his theory does not come from random walk theory but the use of the efficient frontier concept. This concept developed from Koopmans’ linear programming. While working for a shipping agency, because he faced destitution, Koopmans employed his knowledge of mathematics to find the most efficient way to allocate ships among sea routes. Thus, Koopmans solved an important problem in the shipping business with an efficient frontier and made a significant contribution to science. As you can see once again, if we investigate in detail, international trade is the starting point of contemporary finance theory, which then strayed because it “walked randomly” later on. Economic and finance theories have both made assumptions and developed hypotheses

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to match physics theories with social sciences. For example, in the 1960s it was suggested that in accordance with the efficient market hypothesis, stock prices reflect all available information about individual companies and economies. Theories were then developed based on this unrealistic assumption. However, random walk theory, the Dow theory of waves on stock prices, and the Cowles Commission for Research in Economics (1932) that used econometrics for future predictions failed to yield results.77 The motivation behind the formation of such theories was high because precise predictions of the future would translate into fortunes in Wall Street. One of the major shortcomings of all these initiatives, though, was their reliance on historical data and the expectation that past patterns would be repeated in the future. Indeed, this principle is valid in physics. For instance, if you repeat Max Born’s 1935 wave mechanics experiment today, you will obtain similar results because randomly colliding electrons constitute a pattern of waves with a certain probability; moreover, the probability of distribution can be predicted. Such repeated results may apply in physics but not in the context of humans. Humans may react differently to the same stimuli at different times and locations. Asset pricing under portfolio management concepts such as the capital asset pricing model (CAPM) of Sharpe (1961) and the arbitrage pricing theory of Ross (1976) suffer from the same flaws because they were developed on the basis of the same fallacies: random walk theory, identically independent random variables, and the use of past data for predictions in the hope that the same pattern will repeat itself. Unfortunately, many publications have appeared on “Islamic” CAPM, as if preceding the initialism “CAPM” with “Islam” makes sense of the model. Besides, CAPM itself fundamentally contradicts the principle of Islamic finance that forbids maysir (speculation). However, some valuation concepts developed by conventional finance are helpful and should be used in Islamic

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finance. These concepts particularly include those related to the time value of money such as the dividend discount model first introduced by Burr Williams in 1938 and then further developed by Myron Gordon in the 1950s.78 The major problem with modern economics and finance theories is their assumptions.79 If the assumptions are untrue, economics and finance models do not reflect reality; neither do they explain the existing situation properly. Assume that a = b. Then a2 = ab a2 – b2 = ab − b2 (a + b) (a − b) = b(a − b) a+b=b b+b=b 2b = b 2=1 If you assume “a” is equal to “b,” as illustrated in the foregoing equation, you can derive any result from a complicated formula based on your personal preferences. Those who consume interest cannot stand [on the Day of Resurrection] except as one stands who is being beaten by Satan into insanity. That is because they say, “Trade is [just] like interest.” But Allah has permitted trade and has forbidden interest. So whoever has received an admonition from his Lord and desists may have what is past, and his affair rests with Allah. But whoever returns to [dealing in interest or usury] – those are the companions of the Fire; they will abide eternally therein. – 2:275 –

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If one assumes that riba is equal to trade, then the result is the contemporary financial environment in which c­ urrency gambling in FX or stock exchange speculation are called ­trading and those engaging in it are called traders as if they operated caravans along the Silk Road. In detail, the foregoing verse (ayah) would reveal another fact called deferred sale or supplier financing. Islam accepts such a concept as part of trade but not riba. Some claim that deferred sale or supplier finance is the same as riba. While trade and the financing of trade are encouraged in Islam, riba is forbidden, as the ayah reveals. It is unsurprising to see that the conventional products of trade finance, leasing, and project finance also resemble Islamic finance products. However, when it comes to the contemporary novelty of Wall Street, they are unacceptable from the Islamic perspective because they have been developed based on random walk theory or speculation (maysir), which are clearly forbidden in Islam. All such novelties of Wall Street are tactics in a ­zero-sum game. If people become used to such a game, they ­forget about value addition and the economy starts to decay. ­Perhaps this is  what has been happening as we observe the content of finance news outlets. Finance is perceived as a means to obtain money easily, not as a tool to support bona fide ­economic activities and emerging economies. Emerging economies require finance for input, imports and exports, tolling for processing, CAPEX projects, and infrastructure for transporting strategic commodities to ­seaports; namely, finance is needed for integration into the ­ global supply chain. Because many countries are landlocked, an ­ infrastructure for trade is very important to enable commodities to reach the sea and the rest of the world. Thus, financial intermediation to support free trade, finance p ­ rojects, and invest in infrastructure development under Aid for Trade

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are ­ encouraged from the Islamic perspective. Such financial ­support is consistent with maqasid; consequently, Islam champions such finance as long as the structure is shari’ah compliant.

NOTES 62.  Ibn Sa’d Vol. I, p. 129. 63.  Kister, “The market of the Prophet”. 64. Bayindir, Faizsiz bankacilik (Istanbul: Ragbet Yayinlari, 2005) 65. Hildinger, Warriors of the Steppe: A Military History of Central Asia, 500 B.C. to A.D. 1700. 66. Ricardo, On the Principles of Political Economy and Taxation. 67.  Friedman and McMichael, “Agriculture and the state system: The rise and decline of national agricultures, 1870 to present”. 68.  Oliver Twist by Charles Dickens and George Gissing’s novels depict how safe London was in the nineteenth century: It was not safe at all. 69.  Krugman, “Is free trade passé?”. 70.  Alexander Hamilton was the Secretary of the Treasury in the United States. The report was submitted to Congress in 1791. 71. Irwin, Against the Tide: An Intellectual History of Free Trade. 72. Holden, A Dictionary of International Trade Organizations and Agreements. 73.  The full legal text of the accord is available at https://www.wto. org/english/docs_e/legal_e/tfa-nov14_e.htm.

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74.  Organization of Economic Cooperation and Development (OECD) report, Foreign Direct Investment for Development: Maximising Benefits, Minimising Costs. Available at: https://www. oecd.org/investment/investmentfordevelopment/1959815.pdf. 75.  Njinkeu and Cameron, Aid for Trade and Development. 76.  Borenszteina, De Gregoriob and Leec, “How does foreign direct investment affect economic growth?” 77.  Cowles finally accepted that the future is unpredictable. 78.  For those interested in the details about the history of modern finance theory, see Bernstein, Capital Ideas: The Improbable Origins of Modern Wall Street. 79.  The most notorious assumption in economics is ceteris paribus. Literally, this means holding other things constant. Another notorious instance is the IID assumption in econometrics.

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Part IV: Eleven Rounds FINANCING IN ISLAM

“Oh, by the way, he [the banker] added after every family had received their 10 rounds, in a year’s time, I will come back and sit under that same tree. I want you to each bring me back 11 rounds. That 11th round is a token of appreciation for the technological improvement I just made possible in your lives.” “But where will the 11th round come from?” asked the farmer with the six chickens. “You’ll see,” said the man with a reassuring smile. Assuming that the population and its annual production remain exactly the same during that next year, what do you think had to happen? Remember, that 11th round was never created. Therefore, bottom line, one of each 11 families will have to lose all its rounds, even if everybody managed their affairs well, in order to provide the 11th round to 10 others. Charles Eisenstein (2011)80 The story above assumes that production remains exactly the same for the given period. Indeed, proper financing can 73

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increase production by moving future demand to today; if not, the finance would instigate a zero-sum game. In a zero-sum game, the overall sum does not change, while some people have to lose to ensure others survive or prosper. The game fuels competition and does not allow cooperation for value addition in a society. This is, in brief, the philosophy behind contemporary finance and the work of academic literature in support of it. Unlike some contemporary Ponzi schemes, the idea of cooperation comes from establishing a platform on which people can cooperate to provide goods and services demanded by other people. After assuring money is created as long as people produce things demanded by other people, the most critical point for the survival of cooperation in order to fulfill obligations is managing receivable and payables. The bulk of finance literature today relates to portfolio management and then project finance. However, in real life, most day-to-day struggles of companies relate to working capital, namely, trade finance. A company ultimately makes two or three large project investments in 50 years, while working capital management is needed every day and is detrimental for sustainability. A balance sheet of a company can be divided into four parts: current assets as opposed to current liabilities and noncurrent assets as opposed to long-term resources. C ­ urrent assets such as account receivables from sales should ­ideally be financed through supplier finance, while non-current assets such as green-field projects or CAPEX should ideally be financed with equity. If equity or supplier finance is unavailable or expensive, a company can opt to resort to a working capital loan to replace supplier finance and resort to long-term project finance to replace equity. In Islamic finance, working capital needs can be financed with murabaha contracts, while long-term project finance and CAPEX required for purchases such as machinery are financed with istisna and ijara (leasing) contracts. Islamic finance has enough means in

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order to play a role as a financial intermediary to support economic activity without creating systematic risk if it abides to the rules; namely, facilitating bona fide transactions with shari’ah restrictions on financing contracts.

4.1. FINANCING WORKING CAPITAL As long as there is a bona fide transaction, a way can be found to develop shari’ah-compliant products to support value-­ adding transactions. Islamic working capital finance contracts can be categorized, in a way that is akin to a separation of the balance sheet, into account payables and receivables. Both receivable finance and payable finance can be asset-based or asset-backed. If a company gives the control of goods to financiers as collateral, financing is called asset-backed. Asset-based refers to an obligation to financiers created from bona fide sales without the financier obtaining control of the collateral given for the financed goods. Fig. 5 illustrates the categorization. Receivable (Sales) Financing

Islamic Working Capital Finance Contracts

Asset Based

Asset Backed

Payable (Purchase) Financing

Fig. 5.  Islamic Working Capital Finance Contracts. Source: Author.

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With payable finance, a company uses murabaha finance from a bank, whereby the bank buys goods from a supplier and sells the same goods to the company in a deferred payment arrangement with a markup. The company replaces supplier finance with a facility through murabaha finance. If  the bank makes a murabaha sale without obtaining any collateral for, or establishing any lien on, the goods financed, this situation is called asset-based. If the bank establishes a lien on the goods financed in the form of ownership or a pledge, such payable finance is called asset-backed. The company receives the goods, adds its markup, and makes onward sales. This is not a zero-sum game because financing creates value in this transaction by making exchange possible. Traditionally, most murabaha contracts are in the form of payable finance and are asset based. Although Islamic banks have become the target of severe criticism about the widespread use of murabaha, such criticism is unjustified because 90  percent of the finance needs of companies come from payable finance.81 Islamic banks fulfill their duties with such murabaha; however, more asset-backed structures, which are more robust from the shari’ah perspective, should be implemented. As part of payable finance structures, Islamic banks are well versed in import finance instrumented through a letter of credit (LC) and documentary collection. As long as standards, namely Financial Accounting Standard No. 2: Murabaha and Murabaha to the Purchase Orderer of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), are observed, the use of murabah is perfectly fine and beneficial to an economy. There is no need to be shy about defending asset-based murabaha as long as it is perfectly fine from the shari’ah perspective and supports bona fide economic transactions. Nevertheless, murabaha loans, in a similar way to conventional loans, have aspects of debt accumulation in society, profit rates, risk and agency

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concerns, and collateral issues. If repercussions due to these issues are not addressed, murabaha loans can have the same results as conventional loans.82 Most prominently, default interest implementation in the case of late payment can transform a murabaha into a conventional loan. With regard to Islamic contracts for export financing, recourse to the seller in case of default converts Islamic finance into conventional factoring finance. Shari’ah scholars and technicians should be vigilant about these key issues. However, the expansion of asset-backed murabaha in the lending landscape can mitigate criticism about Islamic finance. The use of asset-backed murabaha requires totally different risk management practices to manage collateral, price risk, market risk, product quality and quantity risk, and third-party risk. This method of undertaking business is totally different to common banking practices and requires not only unique risk management practices but also new approaches to bank regulation and supervision. The payable finance of Islamic banks through murabaha replaces supplier finance and is well appreciated. However, with regard to receivable finance, Islamic finance can become very close to the debt trading and factoring, of conventional finance. Receivable finance is used in a business environment where companies are unwilling to wait for six months to receive money from sales on account. With Islamic receivable finance, a company may sell goods to a financier and, on behalf of the financier, sell the goods to the final buyer. This process evokes factoring or debt trading. However, a subtle line exists between these Islamic finance contracts and factoring: The prohibition of recourse to the company if the final buyer defaults in honoring its payment obligation. This shari’ah-compliant feature and requirement makes such finance risky for financiers. Under this circumstance, a financier may take receivable insurance (takaful) for assignments of receivables. Alternatively, in asset-backed cases, a financier

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may hold the ownership or established lien of goods until a final buyer’s cash and carry. Insurance can distort the market if it creates moral hazard; however, if it supports trade it is in the to-do list of Islamic finance, as is the case with payable and receivable finance. The key here is the presence of bona fide transactions and not mere buying and selling. A shari’ah review similar to a credit review does not yield the desired result if it revolves around a checklist. Most failed loans meet the requirements of the standard checklists of credit administrators; however, the ultimate purpose, timely repayment, is missed because fundamentals are ignored. The same holds true for shari’ah compatibility if a review focuses merely on certain criteria: the buying and selling in a bona fide transaction among three parties. For example, bill discounting, or bai al-dayn, received a green light in the Islamic finance industry to some extent. Although a bona fide transaction among three independent parties can exist, it cannot qualify as shari’ah compliant. The name “bay al-dayn” or “Islamic discounting” disguises that the process is a conventional factoring transaction. With regard to murabaha, an exchange of goods is financed, while in bay al-dayn or Islamic factoring it is debt that is traded. Although many Islamic banks received shari’ah clearance, bay al-dayn was forbidden by the Islamic Fiqh Academy.83 The foregoing case clearly shows that every transaction in Islamic finance actually needs to be reviewed by shari’ah scholars and shari’ah technicians, regardless of whether the name of the product is Arabic or whether the name recalls one of the acceptable contracts in Islam. With regard to bai al-dayn, the prohibition relates to a fundamental principle in Islam: “no sell-off before actually possessing it.” Short selling, which is prohibited by hadith, leads to uncertainty and injustice.84 Hence, the issue is categorized under gharar in Islamic finance.

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Because the debt trading market is mature, regulated, supervised, and easy to operate, bai al-dayn is indulged by some Islamic financial institutions without hesitation, regardless of its disparity with the basic principles of Islam. Indeed, those banks that received shari’ah clearance in the form of a fatwa are defended by some scholars with maslaha as follows: If Muslims do not have a receivable finance system similar to the factoring of conventional finance, support cannot be given to the expanding exports of countries of the Organisation of Islamic Cooperation, which amount to US$1,573 million as of 2016.85 The maslaha concerns are valid; however, the way in which the issue is addressed is unacceptable. Bai al-dayn is a short-term solution that has repercussions in the long term. For this reason, the development of shari’ah-compliant receivable finance products, the alternative to the factoring practice of conventional finance, to facilitate export financing is essential. Such an approach necessitates sui generis risk management guidelines, regulation, and supervision. Such an infrastructure would make Islamic bankers and governmental officials work hard. However, they are unwilling to do so given that the infrastructure for conventional alternatives are already in place. With regard to import finance (payable finance) since the obligor and the bank are in the same country, an Islamic bank can easily entertain such a transaction with a mura­baha ­contract in which the bank buys goods from an ­exporter abroad and sells the same to an importer in its country. The challenge emerges if the buyer of the goods is in another country (receivable finance). In this instance, establishing legal obligations are a hurdle because of the domicile. Further, this ­situation occurs with export financing. Given the legal domicile effect on risk management, some Islamic banks discount bills and drafts received from buyers abroad; however, they retain the legal right to have recourse to the seller

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(exporter) in the case of default. The recourse feature makes this p ­ rocess debt trading. Supporting exports with financing is essential but should be undertaken properly. There are alternative shari’ah-compliant proposals to bai al-dayn (debt trading) with wakala agreements, in which a seller/exporter acts on behalf of Islamic banks to conclude export transactions and assign receivables to the banks. The structure for an Export Credit Agency (ECA) system is illustrated in Fig. 6.86 The key in this structure is takaful as export receivable insurance to mitigate risk. Takaful is an alternative to risk mitigation by recourse to a seller/exporter regarding non-payment of receivables. (a) The exporter and the ECA sign a wakala framework agreement. Upon the prior consent of the ECA, and on behalf of the ECA, the exporter signs a contract with the importer to sell goods. The contract between

ECA

(2) Cash Payment

alance et rn ( )

( ) Present Declarati n

rms

rt

E

( )S essa e f r cce tance f D c ment s

(3) Deferred Payment Sale Price

Fig. 6.  Transaction Flow for Islamic Export Financing. Source: Gundogdu (2016a).

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seller/exporter and buyer/importer highlights the assignment of receivables to an escrow/collection account, which is under the ECA’s control. (b) In the agreement between the exporter and the importer, the importer commits to purchase goods based on traditional payment methods such as documentary collection, LC, and open account. (c) The ECA makes payment based on the presentation of export declaration forms as the proof of sale by the exporter. There is no need for a bill of lading (B/L), invoice, certificate of origin, inspection report, or other supporting documents to be presented since the export declaration forms comprise all the necessary information to operate an Islamic transaction. This process provides much stronger proof of bona fide transactions than invoices because the forms are issued by customs authorities, while invoices are issued by companies. (d) The ECA pays the exporter upon acceptance of the documents by the importer. The acceptance confirmation is received via an authenticated Society for Worldwide Interbank Financial Telecommunications message from the importer’s bank. The exporter instructs the importer’s bank not to release the documents without draft/bill acceptance, as legal proof of debt, from the importer. (e) At this stage, the risk mitigation structure can be established in two ways. The first is to receive endorsement of the importer’s bank on the bill/draft accepted by the importer. The alternative is takaful as export receivable insurance to mitigate risk. With both, there is no recourse by the ECA to the seller/exporter regarding non-payment of receivables.

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(f) In order to avoid risk related to the acceptance of goods under the pretext of quality and quantity problems, the exporter, under the wakala agreement, arranges a proper inspection report by a third-party inspector. As an alternative, the exporter can also instruct the importer’s bank to release a B/L to the importer only after the latter’s acceptance of the goods in writing. (g) In the first place, a sale occurs for the account that necessitated export finance. At maturity, three or six months after the exportation, the ECA receives the sale price (invoice price), into the collection/escrow account. After accruing its sale price (the principle plus the markup), the ECA transfers the remaining balance to the exporter. The novel case of Islamic export finance proves that if there is a bona fide transaction, enough room exists within Islamic shari’ah to develop proper products to facilitate economic activities. Assuming the problems concerning working capital are addressed properly, the remaining issue about working capital finance is resource mobilization. Thus, how should resources be mobilized to finance the significant amount of day-to-day trade in the market?87 The solution emerges from traditional resource mobilization tools for murabaha transactions; in other words, two-step murabaha, which is the most efficient shari’ah-compliant trade finance resource mobilization contract. In sum, the foregoing represents a back-to-back murabaha sale in which the ownership of goods is simultaneously transferred from a liquidity managing bank to a resource mobilizing bank and from the resource mobilizing bank to the final buyer in the context of international trade, as shown in Fig. 7.88

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Fig. 7.  Two-step Murabaha. Source: Gundogdu (2009a). Unlike line of financing, which takes months to finalize a transaction, two-step murabaha enables a same day response to a disbursement/fund usage request. (1) Upon a request from RMB the resource mobilizing bank, LMB, a bank with excess liquidity, pays the invoiced price directly to the seller/exporter. Then, the importer receives the shipping documents so as to access the goods. (2) The importer, at the tenor’s maturity, pays RMB, which subsequently pays LMB. There is one bona fide transaction and two murabaha sales in this structure. The first sale is between the importer and RMB and the second is between RMB and LMB. The tenor and markup of the two murabaha sales can d ­ iffer. This silent feature enables the transformation of this contract into a panacea for Islamic liquidity management. The product’s efficiency can be improved by information and communication technology for capital markets. However, the expansion of

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this product would require a major change in regulation and supervision in the financial system because a two-step murabaha structure, similar to murabaha, requires assuming the ownership of goods financed by banks. Contemporary regulation does not allow most banks, except investment and development banks, to own the goods they finance. Thus, much more needs to be done concerning regulation and supervision to provide an enabling environment for Islamic financial institutions, and society, to flourish properly.

4.2. REGULATION AND SUPERVISION It is common to label Islamic finance as a bad copy of the conventional system. Such a proposition is deceiving, particularly where the examples of leasing and receivable/payable finance are concerned. Indeed, the criticism is baseless because leasing and receivable/payable finance are activities whereby not only Islamic but also conventional financial institutions facilitate bona fide transactions. There is no harm in this as long as conventional financial institutions offer products based on Islamic finance philosophy. Nevertheless, Islamic finance still has an important distinction: default interest charges in a case of delayed repayments. This feature may appear insignificant to the lay person; however, financiers easily discern the significant effect of such a micro rule on financial stability. The presence of multiplied overdue rate clauses in conventional financing agreements encourages adverse selection by banks. They choose companies that are not sustainable and pay higher interest rates instead of value-adding companies that pay less. The adverse selection of, and transfer of resources to, unproductive companies particularly intensify the taking of collateral in the form of available real estate mortgages. If the collateral’s qualities are the same, banks choose between two companies

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based on yield opportunity. A delay in payments also generates increased revenues. Adverse selection gives rise to the inefficient allocation of resources and systematic risk in the long term. The problem can be solved with two measures: prohibit real estate mortgages as collateral and prohibit default interest charges. Unfortunately, such prohibitions are not easy because of subtle balances. Prohibiting real estate mortgages as collateral discourages financial intermediation. An ideal solution is to enable banks to take collateral that is related to what they finance. If they finance real estate development, a mortgage is acceptable. However, a commodity financier should not be allowed to obtain real estate mortgages as collateral; instead the financier should obtain collateral in the form of a lien on the financed commodity. With regard to export finance, risk should be mitigated for the assignment of receivables with export receivable insurance. The issue of collateral prevails for conventional banks and Islamic banks: Islamic banks are not immune from criticism in this matter. However, Islamic banks differ from their conventional counterparts regarding, apart from upfront fee and commitment fee in financing agreements, late payment charges because sale prices are determined at the time of disbursement and fixed with a repayment date. Even if there is a delay, no late payment charges are allowed. Moreover, the Qur’an inspires devout Muslims to be restrained with a debtor when the debtor is unable to pay. And if the debtor is in straitened circumstances, then (let there be) postponement to (the time of) ease; and that ye remit the debt as almsgiving would be better for you if ye did but know. – 2:280 – Devout Muslims are very often deceived by crooks who say that they are in straitened circumstances, even though they are able to pay. The purpose of Islam is to elevate p ­ eople’s

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c­onsciousness level. Deceit is prohibited in Islam; further, being deceived is not allowed. The situation is straightforward: “do not deceive and be not deceived.” This circumstance is similar to that of riba: paying riba is no less of a sin than receiving riba. In order not to be deceived, Islamic banks impose late payment charges. The late payment charges go to charitable endowment (waqf) funds that are under the control of banks. In theory, the banks are not allowed to benefit from the funds; however, in practice the funds are used for social responsibility projects, which are a form of advertising and a marketing strategy. Nonetheless, even such practices can be deemed innocent, given that some Islamic banks have found shari’ah scholars who have approved the accrual of late payment charges as “profit deprivation.” This approach by the banks is called fatwa shopping and is a well-established institution in the Muslim world. The practice began when rulers found that they could replace orthodox religious scholars with innovative ones if they were not able to obtain fatwas from the former. Of course, innovation deserves a lump sum payment. The more that innovation is needed, the greater the amount of the lump sum payment. This practice generated innovative religious scholars who gave fatwas for the murder of babies, usually the immediate relatives of the ruler, in the cradle. These scholars defended their cases under the pretext of maslaha. Thus: We gave a fatwa to avoid future bloodshed because the death of one person now is better than thousands in the future. Innovation does not always lead to progress. With regard to the Muslim world, neither such innovation nor maslaha have paved the way for progress; indeed, the opposite has occurred. Returning to “profit deprivation” and leaving behind the reincarnation of former religious scholars, the practice was clearly prohibited by the Islamic Fiqh Academy regardless of existing fatwas. The members of the Islamic Fiqh Academy

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are not paid by banks; hence, there is no conflict of interest. The issue of a conflict of interest in such cases can explain a great deal. The reason behind the prohibition of late payment charges is very clear: Allowing such a practice would transform Islamic finance contracts from murabaha for payable/ receivable finance and ijara for CAPEX finance into conventional working capital finance and the leasing transactions of conventional banks. Such a possibility has significant implications because customers of Islamic banks are deceived by greed-driven wolfs. A pack of Wolves lurked near the Sheep pasture. But the Dogs kept them all at a respectful distance, and the Sheep grazed in perfect safety. But now the Wolves thought of a plan to trick the Sheep. “Why is there always this hostility between us?” they said. “If it were not for those Dogs who are always stirring up trouble, I am sure we should get along beautifully. Send them away and you will see what good friends we shall become.” The Sheep were easily fooled. They persuaded the Dogs to go away, and that very evening the Wolves had the grandest feast of their lives. Fables of Aesop Conventional banks propose the deregulation of financial markets and the elimination of governmental intervention for a well-functioning liberal economy that benefits consumers. Islamic bankers call for flexible shari’ah boards to the extent of having fatwas outsourced so they can shop for them. The moral of the story is not to be a sheep and to ask your government to protect you against organized establishments, particularly if they have resources that enable them to influence opinion makers and decision makers. There is no need to be

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hostile toward wolves because they carry out a duty: They are needed to encourage sheep to develop their intellects. The reintroduction of wolves, in 1995/1996, to Yellowstone National Park in the United States, for example, restored the park’s ecological health. During the non-presence of wolves, the elk population grew so large that the elk ate all the young willow trees and destroyed the habitat of many animals and plants.89 Being deceived is not an acceptable excuse in Islam because fools are not good for willow trees and can destroy balance in the human habitat. The state is accepted as a legitimate establishment not because it collects tax and unfairly distributes resources to those close to the state’s leadership. It becomes legitimate if it protects certain rights of the citizens. The states that lasted for centuries all had high standards, particularly in terms of market regulation and supervision. Serious states would not allow innovative entrepreneurs who used donkey meat in sujuk (a dry, spicy sausage). If something is labeled as sujuk, it should be made from beef or mutton and based on a tried and tested assortment of spices. The state should first give permission to a sujuk producer based on standards set specifically for sujuk production and more generally for food production. Afterward, the state should supervise the market and punish perpetrators who do not comply with the food codes. If the state delegates this duty to private entities that are paid by the sujuk producer, the probability of eating proper sujuk significantly diminishes. Unfortunately, sukuk consumers, namely investors, are not as lucky as sujuk consumers. The state should become involved in the regulation and supervision of the Islamic finance industry and have the authority of fatwas to certify the shari’ah compliance of products offered by financial institutions. Today, public authorities totally close their eyes to the issue of shari’ah compliance and ­confine themselves to regulation and supervision. H ­ owever,

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r­egulation and supervision in the Islamic finance sector is based on the conventional system. The situation regarding Islamic banks is similar to that of a team trying to play ­basketball in a football field. The team are barefoot and there is no backboard. The wrong regulatory and supervisory environment is reflected in risk management. Islamic banks are unable to develop p ­ roducts based on bona fide transactions. They replicate conventional finance and change from basketball to football. The convergence to the conventional system is particularly intense in treasury operations regarding hedging, resource mobilization, and, most importantly, liquidity management.

4.3. LIQUIDITY MANAGEMENT Islamic banks can finance the projects and CAPEX investment of companies with istisna and ijara. The working capital needs (payable/receivable finance) of companies and consumer demand can be addressed with murabaha and wakala contracts. Agricultural finance can be undertaken efficiently with salam contracts. The involvement of Islamic banks in infrastructure finance in the form of public–private partnerships (PPPs) is much encouraged in order to integrate the supply chains of local economies with the world’s markets and provide an enabling environment for international trade that is consistent with the concept of Aid for Trade. Islamic banks can provide, in addition to financing, most of the services, such as money transfers and currency exchange, provided by conventional banks. All these indicate that solutions exist to fulfill the necessary needs of economic actors, whether companies or individuals, with shari’ah-compliant products. Islamic finance represents a viable alternative to the conventional system. Although they are criticized for

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i­mitating c­ onventional banks, mainstream Islamic banks still do not offer debt restructuring or overdraft facilities. At least no shari’ah scholar is a strong proponent of such practices, which give rise to high credit risks and loan bubbles. Nonetheless, there is a need for shari’ah-compliant hedging products to protect companies from severe commodity prices and foreign exchange fluctuations. Companies are under pressure to fulfill their obligations to deliver goods and services in accordance with their contracts. However, sharp commodity price fluctuations in the market in many instances may lead to an inability to honor contractual obligations; bankruptcy of companies may then follow. With regard to finance for services, it has been revealed that from the maqasid perspective, there is a good reason for not providing such finance; thus, there is no need to explore new methods. With regard to the provision of hedging for companies, however, a good reason exists to provide hedging products: sustaining the continuity of a business. In many instances, if companies can overcome one period of unfortunate price fluctuations, they may continue adding value to society for decades. This approach to sustainability is akin to insurance for shipowners. In ­Western Europe, insurance for ships enables the transmission of accumulated capital and knowledge from one generation to another; hence, it has contributed to generations of economic progress. The hedging products of conventional banks, derivatives, are not shari’ah compliant because they involve gharar and maysir. This situation is bewildering because hedging is undertaken to avoid uncertainty; however, most hedging techniques are not shari’ah compliant because of gharar. The concept of hedging to avoid gharar is part of Islamic finance and should be part of the product development of Islamic finance. In doing so, we need to avoid gharar and maysir in such products. With regard to hedging against commodity price fluctuation, there are

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shari’ah-compliant possibilities with asset-backed murabaha contracts. It is possible to develop shari’ah-compliant Islamic futures commodity contracts with physical delivery. As for hedging against FX fluctuation, as long as import and export transactions are undertaken with murabaha contracts, banks can provide Islamic hedging that is related to specific transactions. However, there still remain serious problems with Islamic finance as a facilitator of a healthy economic environment: liquidity management and resource mobilization. These are required in order to properly intermediate between those who have excess funds and those who have viable ideas. Instead of developing shari’ah-compliant alternatives, Islamic banks have opted to provide all derivative products without any boundaries. So-called Islamic derivatives have been developed based on organized tawarruq, and to some extent non-shari’ah compliant waad, which are contracts that are undertaken regardless of a clear prohibition by the ­Islamic Fiqh Academy.90 Indeed, organized tawarruq was initially introduced as a treasury liquidity management tool. Moreover, from the very beginning of its use, tawarruq was clearly not shari’ah compliant. However, in due course, it became mainstream; further, with serious of connected contracts, tawarruq laid the foundations for non-shari’ah-compliant Islamic derivative products and consumer loans.

Case Box 2.  The Resolution of the Islamic Fiqh Academy Regarding Tawarruq as it Is Currently Used by Banks Praise be to Allah alone, and peace and blessings upon the Messenger of Allah, his household and his companions. To  proceed: the Islamic Fiqh Academy of the ­Muslim World League in its 17th session held in Makkah,

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19–23/10/1424 AH/13–17/12/2003, examined the topic of Tawarruq as it is being practiced by some banks at present. After listening to the research papers presented on the topic, and after discussions about it, it became ­apparent to the Academy that the Tawarruq which is being e­ xecuted by some banks nowadays is that, typically, the bank will undertake to sell a commodity (other than gold or s­ ilver) from the international commodity markets, or some ­other market, to the seeker of Tawarruq (Mustawriq) for a deferred payment, with the bank committing itself – either by a stipulation in the contract or in accord with ­customary practice – to represent the buyer in selling it to another buyer for cash and delivering the payment to the Mustawriq. After consideration and study, the Academy has decided the following: First: Dealing with the form of Tawarruq described in the introduction is not allowed, for the following reasons: (1) The commitment by the seller in the contract of Tawarruq by proxy to sell the commodity to another buyer or to line up a buyer makes it similar to the prohibited Inah, whether the commitment is explicitly stipulated or is merely customary practice. (2) This practice leads in many cases to violation of the Shari’ah requirement that a buyer must take possession of a commodity in order for any sale after that to be valid. (3) The reality of this transaction is based on the bank providing cash financing with an increase to the party called the Mustawriq through purchase and sales transactions it conducts, which are in most

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cases pure formalities. The aim of bank from this procedure is to get an increase on what it gave in the way of financing. This dealing is not the real Tawarruq known to the scholars, which the Academy previously ruled was lawful in its 15th session, if the transactions are real and if certain conditions that the Academy explained in its resolution are fulfilled. The differences between the two have been made clear in the research papers presented on the topic. Real Tawarruq consists of an actual purchase of a commodity for a deferred payment that brings it into the ownership of the buyer and which he takes actual possession of and becomes responsible for; after which he will sell it for cash to fulfill his need. He may be successful in achieving that goal or not. And the difference between the two prices, the spot price and the deferred price, does not enter into the ownership of the bank, which involves itself in the process in order to make acceptable the increase it obtains on the financing it provides to the person through what are in most cases only formal transactions. The features of real Tawarruq are not present in the previously explained procedure practiced by some banks. Second:  The Academy advises all banks to stay far away from forbidden dealings in obedience to the command of Allah, the Exalted. As the Academy appreciates the efforts of the Islamic banks to rescue the Ummah from the tribulation of Riba, it advises them to use real Islamic transactions, not purely formal transactions, which, in reality, are nothing but financing operations with an increase for the financer.

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Allah is the One Who guides to the right path; may the peace and blessings of Allah be upon our Prophet, his household and companions. Source: Islamic Fiqh Academy. Since the inception of the Islamic finance industry, liquidity management has been a major issue. Since Islamic banks cannot conduct interbank placements without an underlying bona fide transaction, the treasurers of Islamic banks, who are trained in conventional banks, search for alternatives to carry out their day-to-day cash management duties. In this regard, they have created a product called “commodity murabaha,” which also has the less popular name of “reverse murabaha.” Murabaha is inserted in the name to convince people that a transaction is bona fide. However, the practice has nothing to do with any form of acceptable murabaha; instead, it is an organized tawarruq that is prohibited in Islam, according to the Islamic Fiqh Academy. Commodity murabaha transactions have been used in the London Metal exchange with pseudo exchanges of metal contracts without any intention of physical delivery. Financial intermediaries in London have benefited from such transactions; indeed, this monetary benefit has attracted the attention of some Muslims. In order to retain money in their Muslim jurisdictions and enjoy the financial benefits of intermediation, central banks and monetary authorities established a body called the International Islamic Liquidity Management Company. The primary objective of this institution was to provide liquidity management solutions to Islamic banks. The institution, however, merely imitated structures implemented in London that were not shari’ah compliant. These structures, sukuk, and commodity murabaha, were based on organized tawarruq, which is

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also not shari’ah compliant. Thus, liquidity management is a major issue that is yet to be addressed properly in order to stop the convergence of Islamic finance with conventional finance. The solution to the problem could come in the form of shari’ah-compliant project investment, sukuk, particularly PPP-based projects, and two-step murabaha trade finance lines. Both of these finance structures are not based on ­ organized tawarruq and facilitate bona fide economic activities. In  this regard, where shall the solution to liquidity management emerge: with sukuk, two-step murabaha, or both working hand in glove?

NOTES 80.  Excerpt from C. Eisenstein, Sacred Economics: Money, Gift, and Society in the Age of Transition (Berkeley, CA: North Atlantic Books, 2011). 81.  A.S. Gundogdu, “Islamic electronic trading platform on organized exchange”, Borsa Istanbul Review, 16, no. 4 (2016b) (2016b). 82.  Gundogdu, “Margin call in Islamic finance”. 83.  Resolution No. 66/2/7, 1992. “Reduction of a deferred debt in order to accelerate its repayment, whether at the request of the debtor or the creditor is permissible under Shari’ah. It does not constitute a forbidden Riba if it not agreed upon in advance and as long as the creditor-debtor relationship remains bilateral. If, however, a third party is involved it becomes forbidden since it becomes similar to the discount of bills.” 84.  Abu Dawood (3504 and 3505). 85.  Referring to Islamic Center for Development of Trade Database available online.

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86.  Gundogdu, “Exploring novel Islamic finance methods in support of OIC exports”. 87.  According to World Bank data 2016, available at https://data. worldbank.org/, world GDP is US$75 trillion, while exports are US$20 trillion. 88.  Gundogdu (2009). 89.  Ripple and Beschta, “Trophic cascades in Yellowstone: the first 15 years after wolf reintroduction”, Biological Conservation, 145, no. 1 (2012): 205–213. 90.  Details of the issue of Islamic derivatives and Islamic futures contracts with physical delivery are available in Gundogdu, “Islamic electronic trading platform on organized exchange”, Borsa Istanbul Review, 16 no. 4 (2016b).

Part V: Conquistador A PARADE FROM GREENFIELD TO CAPITAL MARKETS

In the history of Islam, sukuk were issued for ventures in the caravan trade in a similar way to the first public offering of the Dutch East India Company. Sukuk are an investment tool. Surprisingly, in contemporary Islamic finance business, sukuk dominate liquidity management in the treasury departments of Islamic banks and are debt obligations rather than investment tools. Sukuk are the conquistadors of Islamic finance because there are limited alternatives among Islamic banks for liquidity management tools. There is an urgent need for Islamic finance to introduce alternative tools for liquidity management and resource mobilization. Sukuk are important tools in Islamic finance while such finance supports project investment as an investment facilitator rather than debt trading. Given this, Islamic finance cannot merely rely on the use of sukuk for liquidity management in the future. Alternative murabaha-based platforms can fill the liquidity management gap. It is also important to acknowledge the causes of this gap in Islamic finance. It has occurred because of the wrong business model, deposit banking, which was adopted

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for Islamic finance at the very beginning of the industry. The prevalence of sukuk is a side effect of this fundamental flaw. Indeed, most controversial issues in Islamic finance, including the prevalence of non-shari’ah-compliant sukuk, stem from the deposit banking business model. This model cannot directly link lending with resource mobilization; hence, it leads to non-shari’ah-compliant capital market operations for liquidity management, which constitute the main criticism of Islamic finance.

5.1. INTRODUCTION TO THE UNTOLD STORY OF SUKUK The Islamic finance industry has received greater attention because of the increasing size of its assets and the development of sukuk in the capital markets. Some people have supported the industry in emotional terms because it is a way of consolidating ummah through financial independence. However, others have argued that Islamic finance as currently practiced yields similar results as those of the conventional finance system; hence, it is not ideal for maqasid al-shari’ah and the salvation of humanity worldwide. Accordingly, the question arises about the way in which Islamic finance differs from conventional finance.91 Sukuk and murabaha are at the front line of this debate. The criticism of the significant use of murabaha is unjustified because Islamic finance should reflect the real economy, in which trade comprises 90 percent of all transactions.92 In order to finance trade transactions, it is essential to use murabaha contracts. Further, the prevalence of murabaha in the lending activities of Islamic banks shows that such banks are fulfilling their role to facilitate economic transactions. Because a great deal of conventional finance directly

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facilitates economic activities such as trade finance and leasing, it is certain to resemble Islamic finance. However, the view that sukuk are replicas of securitized bonds appears to be justified. The criticism of Usmani (2007) in particular has ignited a significant debate regarding the shari’ah compliance of sukuk; since then, the question of whether sukuk differ from conventional bonds has arisen.93 The real reason for such concerns has a notable relation to Islamic banks’ deposit banking system. As deposit collecting banks, Islamic banks are under the strict control of regulatory bodies that do not allow them to engage in proper resource mobilization tools to support shari’ah-compliant financing. Most Islamic banks still use musharakah deposit accounts and follow the rules and risk management guidelines for deposit collecting banks. Although they indirectly fulfill their duty as financial intermediators for consumer financing, project finance, and working capital (trade finance), the way in which resources are mobilized for such intermediation is reflected in liquidity management. Since financed projects and transactions, and mobilized resources, are not directly connected in deposit banking, Islamic banks need to tap into capital markets to fill the liquidity shortage that becomes narrow at the time of economic downturns. If Islamic banks could use investment accounts as alternatives to deposits to collect money (mobilize resources) for lending, the need for treasury juggling would be abated since resources collected from the market could correspond to transactions. This type of business model would turn Islamic banks into profit- and loss-sharing institutions that fulfill their duty as financial intermediators. Islamic banks would participate in lending with a portion of the needed funds, undertake risk assessments, and mitigate risk on behalf of those have access to funds, namely depositors, for investment. For example, an Islamic bank could contact its customer to

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suggest an investment opportunity in a specific trade finance deal or project finance deal based on musharakah in order to share the return and risk on a pro rata basis. This approach is similar to that of syndicated loans whereby lead arrangers call potential investors to participate in financing. Moreover, modern technology enables the mass implementation of such practices across bank depositors. Since such a practice is not present in the industry, even much-needed deferred sales by murabaha contracts receive criticism. Essentially, commercial enterprises resort to loans for working capital if they are unable to obtain supplier finance or of such finance is very expensive. With a murabaha sale, Islamic banks are particularly well-suited and stabilize the market. If the banks mobilize resources to finance murabaha transactions based on profit- and loss-sharing through investment accounts, such a model greases the gears of the real economy. In a similar way to conventional financing, debt is created; however, such debt is directly linked to trade transactions, with the pool of investors sharing the risk with banks for each specific deal. Hence, if shari’ah compliance and economic policy are properly implemented, such a structure would benefit the economy without creating systemic risk because it would not increase the leverage ratio of financial institutions that is inherent in the conventional system. Since the resource mobilization of Islamic banks is not directly linked to lending, sukuk emerge as conquistadors. As patches and conquistadors, sukuk receive serious criticism because they are frequently used to fill the funding gaps of Islamic banks. Although sukuk are supposed to be an investment tool, they are now perceived as debt trading instruments akin to securitized bonds. Unfortunately, most sukuk, unlike murabaha, justify such criticism. Sukuk numbers indicate a great deal: Like Islamic bank assets, sukuk issuance i­ncreases with oil price rises, as indicated in Fig. 8.94 This  finding

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Fig. 8.  Sukuk and Oil Prices. Note: Sukuk data are from Thomson Reuters Report, “Innovation in Islamic liquidity management 2017; Transforming Islamic finance business”. The right-hand axis is for oil prices. s­uggests that Islamic banks are significantly affected by the economy where they operate rather than being sound and solid.95 Sukuk issuance increases during the good days of high oil prices, during which Muslims have excess money to invest. In an economic downturn, an increase in debt issuance in the form of sukuk would be expected; however, this situation has not occurred. The reason may be that Muslims have a different perception of riba in terms of receiving it as opposed to paying it. In principle, both activities are equally impermissible, namely, they are haram. This discerned pattern could be the subject of an academic question about the Muslim perception of riba in terms of earning or paying. Any liquidity management product that is developed based on a shari’ah-compliance flaw does not offer a longterm solution for the Islamic finance industry. In this regard, developing liquidity management instruments based on existing sukuk would give rise to fundamental problems for the industry. However, sukuk, as an investment tool for projects

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rather than an unfruitful zero-sum game debt creation tool, would yield much better results from the maqasid al-shari’ah perspective and encourage economic development. If so, without going into the detail of an impermissible sukuk structure based on organized tawarruq, bai al-inah and its derivatives, or exotics, sukuk may be useful from the maqasid perspective. From this perspective, sovereign sukuk, banks’ sukuk, and corporate sukuk require a spirit of inquiry. If used to finance sovereign infrastructure projects, sukuk should be accepted as suitable for maqasid. However, in many instances, the link between infrastructure development and sukuk is weak or non-existent. Most sovereign sukuk use state assets in the form of bai al-inah and its derivatives, bai al-wafa and bai ­al-istiglal, to mobilize resources. From the shari’ah compliance perspective, such sales, with obligations to buy the underlying assets back, are not permissible and akin to selland-lease back structures of conventional finance. Besides, shari’ah compliance requires access to assets, at least to some degree. Nevertheless, there are common clauses seen in sukuk documents that state the following96: • No investigation or enquiry will be made, and no due diligence will be conducted in respect of any of the constituent assets. • In particular, the precise terms of any of the constituent assets will not be known. • No steps will be taken to perfect any transferor regarding any of the relevant constituent assets. In practice, there is no legal possibility of establishing a lien on governmental assets. Can a sukuk holder ask a government to vacate a treasury department building if the sukuk fails? Since the right cannot be exercised legally, it cannot be claimed that the condition of shari’ah compliance is fulfilled.

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In most instances, governments use sukuk as a cheaper alternative to treasury bonds.97 The resources mobilized through sukuk can be used for financing budget deficits or unsustainable social transfers; however, they are not being used for the infrastructure development that is much needed in order to generate employment and sustainable economic development for youth. In this regard, such implementation of sukuk distorts the efficient allocation of resources in an economy in a similar way to conventional bonds. Governmental debt securities give rise to the inefficient use of funds for the unproductive short-term spending patterns of governments for political purposes. They also place a greater burden on taxpayers in the long term. Like sovereign sukuk, there are fundamental problems with banks’ sukuk. Banks are deemed an integral part of the economy in terms of shouldering project finance. Sukuk would be a perfect fit to fulfill such intermediation. However, today, most banks’ sukuk are not linked to project finance; instead, they are used as instruments to meet Basel requirements to raise banks’ capital levels. Banks’ sukuk are collateralized by their assets such as ijara receivables and tangible assets. In many jurisdictions, the assignment of banks’ assets is forbidden by law. What happens when banks fails? Who has rights on these assets: depositors, lenders, or sukuk holders? Even if there is no legal restriction, it may be unfair to depositors, as unqualified investors, who placed their money in the expectation of an as-is situation for banks’ assets. Banks’ sukuk, based on collateralizing balance sheet items, may also lead to systematic risk from high leverage. This situation may open doors for QE, in which central banks step in and print money in order to buy toxic assets. Central banks resort to QE to avoid an economic crisis; however, someone, the general public, ultimately has to pay for such a strategy.

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The most misleading sukuk, however, are corporate sukuk issued through Islamic banks. Banks offer such a service to their clients as an alternative to direct lending. Corporate sukuk have tax advantages and reduced prices, which makes them attractive for companies. These benefits derive from banking rules and regulation. Instead of mortgaged loans, banks securitize the assets of their clients under sukuk and then buy the sukuk. Indeed, the result is the same as lending. However, since sukuk appear as investments in banks’ balance sheets, banks do not allocate reserves with a central bank. Such reserves must be allocated for regular lending, unlike investment in sukuk. Hence, the cost of lending decreases. Moreover, in cases of corporate bankruptcy, sukuk have a higher rank than loans. Such debt seniority makes ­corporate sukuk more attractive for banks than direct loans. By securitizing the assets of a company under sukuk, banks separate these assets and ring-fence collateral against any possible future lien on the assets by other lenders. All these points, in addition to the embellishment of banks’ balance sheets, make corporate sukuk a good alternative to standard loans. Indeed, the same pattern is observed with sovereign sukuk. Banks prefer investing in sovereign sukuk instead of lending direct to governments for similar reasons. In addition to the aforementioned benefits, holding sukuk also helps liquidity management if the sukuk can be traded in a secondary market and support profitability.98 The rush for profitability with annual, quarterly, monthly, and even daily targets creates stress for banks’ employees in the long term, leading them to take actions that they would not normally consider. Senior staff in banks focus on profitability in order to obtain bonuses before their fixed employment terms are over. However, this short-term benefit for very few people leads to financial crises, the cost of which is paid by

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the ­public. On the one hand, if a bank is profitable, senior staff and shareholders obtain the benefits; on the other, if the ­system fails, the failure is labeled systematic risk and an act of God. The government is then asked to save the so-called necessary system with the public’s money. The system is unfair; moreover, this unfairness occurs because of the public’s lack of financial knowledge. The present use of sukuk as collateralized bonds encourages Islamic banks to contribute to the systematic risk created in the financial sector. For this reason, it should be expected that Islamic banks will fail in a similar way to conventional banks in cases of market failure in the countries where they operate. Ideally, sukuk should provide opportunities for investors to finance projects with the possibility of secondary markets. Prevailing sukuk structures have maqasid al-shari’ah and shari’ah compliance issues. Hence, neither shari’ah-compliant investment nor secondary market trading can be undertaken. One solution would be to restrict sukuk to the financing of projects. In this regard, usufruct and simple ownership of a project’s assets may be separated during the tenor of financing. This would allow an exchange of usufruct rights during the tenor of financing; hence, a shari’ah-compliant secondary market is created. Usufruct is ownership; further, such a practice converts debt trading into asset trading. In this regard, PPP projects are a very good opportunity for healthy sukuk market development. Through such engagement, Islamic banks contribute to filling the significant infrastructure development gap. With regard to risk management, initial project finance should be structured solidly and sukuk should be issued only after repayment from a project’s start in order to reduce project completion risk for sukuk investors. Such an approach requires Islamic banks to develop their capacity for project finance structuring in order to create underlying assets for sukuk issuance.

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5.2. HOW EXPANDABLE IS SUKUK FOR LIQUIDITY MANAGEMENT? Prior to sukuk, murabaha transactions with commodity houses were used by Islamic banks to manage their liquidity. Unlike monetary transactions, the substance of the transactions was real; profit came from the markup on sales. However, because of the lack of a secondary market and proper risk management, the issue of the bankruptcy of commodity houses encouraged Islamic banks to look for alternatives similar to money market tools. Sukuk revisited by Islamic banks could be suitable.99 One of the important aspects of sukuk as a tool for liquidity management is the availability of a secondary market. Unlike commodity murabaha-based sukuk, musharaka-, ijara-, mudaraba-, and wakala-based sukuk are accepted ­ for secondary market trading by shari’ah scholars; however, ­initial structuring in many instances may not be shari’ah compliant. For example, bai al-istiglal are akin to the sale-andlease back of the conventional finance system. Such structures do not provide real sales with the intention to transfer ownership; instead, they are mere arrangements to buy the underlying asset back at the end of maturity. Accordingly, sukuk cannot be called an investment but a securitized debt. Trading of such sukuk is also debt trading (bai al-dayn). With regard to other sukuk accepted for secondary market trading, wakala, mudaraba, and musharaka underlying assets are mixed with commodity murabaha (tawarruq). The AAOIFI permits trading of such sukuk if tangible assets are 33 percent, while the Islamic Fiqh Academy accepts 51 percent. Can we offer Muslims milk that is diluted with 49 percent alcohol? The Almighty may pass humans if human pass an exam with 51 percent; however, we must not put ourselves in a position to replace the Almighty’s jurisdiction by giving such ­flexibility

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to divine rules. Ultimately, what is the rationale behind any percentage and what is the calculation method? Shari’ah scholars should not study maslaha in order to find leeway based on an analogy that dilutes the strict codes of Islam. By doing so, they delay the development of correct Islamic finance structures and create room for sharks that prey on vulnerable people. Aside from shari’ah compliance issues with initial structuring, sukuk structured as a tool for project finance may still not qualify as a good liquidity management tool. An example is the International Islamic Liquidity Management Corporation’s issuance of short-term sukuk for three, four, and six months based on sukuk pertaining to the aforementioned shari’ah compliance issues. The reason behind issuing short tenor sukuk relates to the price risk of holding sukuk for investment. From the accounting perspective, if sukuk are held for investment, based on prevailing interest rate fluctuations, their value is marked-to-market by calculating net present value (NPV) with the market interest rate. For example, with a US$100 million sukuk issued at a 5 percent rate-of-return with a 15-year tenor, the mark-to-market effect if the interest rate increases to 10 percent after the first year is approximately a US$34 million loss on the accounts.100 In this scenario, the bank holding such sukuk for liquidity management would register an approximately US$34 million loss in its financial statement. Because of the discounting factor, the higher the tenor, the greater the effect of an interest rate change on the NPV of sukuk. In addition to the interest rate risk, with long tenors the inflation risk exists for fixed rate sukuk. A sukuk scheme in which the Liquidity Management Corporation in Malaysia holds the sukuk for maturity and issues three-, four-, and six-month sukuk linked to other sukuk was considered a solution. Sukuk held for maturity for  a corporation would not need such a mark-to-market

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requirement in accordance with accounting principles. However, in such cases, underlying sukuk should be shari’ah compliant without mixing already questionable structures with tawarruq-based commodity murabaha. Issuing sukuk based on PPP projects can address the problems of maqasid alshari’ah and shari’ah compliance. In this way, Islamic funds would be directed toward much-needed infrastructure investment. However, the existence of governmental undertakings in PPP projects should not prevent Islamic banks from calculating the efficiency of such projects. Counting on mere governmental undertakings and guarantees in such projects would lead to moral hazard, which would translate into a significant burden on taxpayers in the long term. Evaluating different sukuk alternatives for liquidity management reveals a major common flaw: unmoving stocks securitized for cash lending. These sukuk alternatives were initially proposed because of severe criticism about commodity murabaha; namely, there are no real assets and commodity murabaha transactions are undertaken in a non-Muslim territory, London. Islam does not propose asabiyyah: Committing a bad deed in a Muslim country is not superior to doing so in a non-Muslim country. Perhaps, the situation is the other way around. What matters is abiding by divine principles and not indulging in maslaha and asabiyyah. Having real assets, as is the case with most sukuk, is not enough for shari’ah compliance. For example, the proposals of the Gulf Cooperation Council for alternative liquidity management tools, which are also frequently used for cash lending in consumer loans, are good examples.101 (1) Tadawul (share financing): A bank sells stocks to its customer in a deferred sale; the customer sells the stocks immediately.

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(2) The sukuk platform of the National Bonds Corporation: A bank sells sukuk to its customer in a deferred sale; the customer sells the sukuk immediately. (3) Commodity sale: A bank sells a commodity to its customer in a deferred sale; the customer sells the commodity immediately. Even if these underlying assets are present, this would not make transactions shari’ah compliant. Very often, a bank has a “binding agency” obligation for the second sale made by its customer. Putting rice in a warehouse, or buying company shares or sukuk, as means of cash lending are obvious contradictions with maqasid al-shari’ah. All these dubious activities have one common characteristic: they are based on unmoving stocks/assets. Liquidity management should be based on moving asset transactions, such as project finance and trade finance, and not unmoving stocks/assets. Abiding by this principle would assure the link between direct lending and mobilized resources, thereby putting Islamic finance on track to be a profit- and loss-sharing intermediary in the service of the economy and a stable alternative to conventional banks.

5.3. RESOLUTION OF DISSOLUTION FOR ISLAMIC CAPITAL MARKETS First, in order to be compliant with maqasid al-shari’ah, ­neither sukuk nor other liquidity management tools should be used as means of cash lending. It is obvious that contemporary tools have serious flaws because they were directly developed to be liquidity management instruments; however, they are not shari’ah compliant. Shari’ah-compliant a­ lternatives

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emerge from trade finance and project finance. In the process of fulfilling financial intermediation in support of the real economy, we may come across useful products that can be used for liquidity management. Project finance is one such; another is trade finance. A PPP project can be a good source of sukuk investment. The structuring of such a project and the issuance of sukuk require Islamic banks to improve capacity. As long as the underlying transaction is shari’ah compliant, the bottlenecks with a secondary market can be addressed. For example, interest rate risk can be mitigated by the intermediation of a multilateral liquidity management corporation, which can hold sukuk for maturity and create short-term sukuk for a secondary market. Establishing a secondary market in such a way fulfills maqasid al-shari’ah requirements since it directs funds to projects and supports the supply chain. However, project finance alone may not reach a sufficient volume to be merely a source for liquidity management. Trade finance, with its annual turnover of trillions of dollars, can be an additional alternative. An Islamic electronic platform (see Fig. 9) can facilitate the use of assetbased and asset-backed murabaha for up to six months for

Fig. 9.  Islamic Electronic Trading Platform.  Source: ­Gundogdu (2016b).

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liquidity management.102 Unlike sukuk, a tenor with trade finance is short term; hence, the price risk with holding assets can be mitigated. Nevertheless, in a similar way to commodity murabaha sukuk, asset-based two-step murabaha cannot be traded in a secondary market; however, unlike commodity murabaha sukuk, asset-based two-step murabaha is shari’ah compliant. Nonetheless, asset-backed murabaha for agricultural harvest financing based on e-warehouse receipts, which is also an Islamic commodity futures contract with physical delivery, can have a secondary market because it involves an exchange of commodities owned by banks.103 Unlike the pitfalls of products based on unmoving stocks, both asset-based and asset-backed murabaha are based on moving assets. Assetbased two-step murabaha is based on financing international trade through LCs. Asset-backed Islamic commodity futures are a form of asset-backed murabaha with the physical delivery of commodities. Islamic commodity futures represent resource mobilization for agricultural harvest financing and can serve as a liquidity management tool for Islamic banks. Similar initiatives such as the Tradeflow platform of the Dubai Multi Commodities Centre (DMCC) enable physical commodities located within the United Arab Emirates to be used for liquidity management. Bursa suq al-sila in Malaysia and the Jakarta Futures Exchange also offer similar physical commodity-based platforms, which keep commodities for money exchange. Nevertheless, there is a shari’ah compliance problem with these initiatives because of the lack of delivery of physical commodities and the lack of an independent thirdparty presence. As a common attribute, the systems operate on the basis of non-moving stocks. The key issue in Islamic futures contract is the market maker, which has the ability to purchase commodities at ­ a predetermined price. It is difficult to find a reliable party

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to carry out such a function. Ideally, national grain boards can assume such a role. Indeed, the main role for national grain boards is price stability to protect farmers. Moreover, the boards can fulfill this duty through an Islamic futures contract platform. Farmers would have access to financing, Islamic banks would have an investment opportunity and liquidity management tools, and the government can regulate the market for fair price formation through national grain boards as the market maker. The only party not to benefit would be informal lenders who gain an unjustified profit out of the farmers’ need for cash. Since in this instance there are commodities owned by banks, the banks can sell the commodities through e-warehouse receipts if they need liquidity. Further, the existence of a market maker and predetermined undertaking price mitigate commodity and price risk. If investment sukuk is also embedded, this platform can generate a much-needed interbank lending rate as an alternative to the London Interbank Offered Rate for Islamic banks. Nevertheless, even if there is a platform that observes maqasid al-shari’ah, a major impediment connected with Islamic banks is still present: their role as deposit collecting banks. This role would restrict their involvement in profitand loss-sharing products because of the risk management guidelines imposed by regulators. Governments have the right to impose such restrictions because the failure of banks means a burden to pay the subsequent bills with deposit insurance and collected tax. It would be much better to establish Islamic banks as investment or development banks. As a quick solution, Islamic banks could be allowed to accept investment accounts, whereby the banks could offer project finance and trade finance deals based on transaction-specific musharaka in a similar way to syndicated loans for corporations. Islamic banks would provide services to evaluate the risk, take the necessary collateral, sign legal documents, and participate

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with a fraction of a deal’s amount to assure their commitment to unqualified investors. This process would allow the creation of primary and secondary markets for liquidity management with shari’ah-compliant capital market securities upon the start of repayment from financing. With the establishment of a secondary market, other investors could buy the ownership, with sukuk, of PPP projects or agricultural commodities. With regard to asset-based two-step murabaha, a secondary market is not possible because of the debt trading, bai al-dayn, restriction of Islamic shari’ah. However, since the subject transactions are short term in nature, they can also support a liquidity management platform. Most importantly, all the structures would support economic activity. Investors and banks could put their excess liquidity in infrastructure sukuk and supply chain financing, starting from an agricultural harvest and continuing through to international trade. This system is a parade from greenfield to capital markets. While doing so, investors and banks would support real ­economic transactions and ­contribute to economic progress and prosperity. The major motivation behind Islamic finance is providing the means to finance investment projects and support the supply chain in order to boost the economy. As long as banks cater for this vision, profit that accrues afterward is permissible. However, Islamic banks should not imitate the conventional system, which keeps the economy hostage. Islamic banks should be mere financial intermediators to support investment and trade, thereby supporting employment and economic growth. Nevertheless, criticism of the debt-creating aspect of Islamic banks should be noted and should be the subject of economic policy. Public authorities should not allow increasing debt levels if additional lending does not cause increased productivity, employment, and economic growth. Measures to assure the ­purchasing power of

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households, such as the strict implementation of competition law against unfair price formation, are essential. These would necessitate scrutiny to prevent the establishment of mono­ polies and oligopolies. It would also be necessary to assure international openness in order to protect households from the exploitation of local industries, while at the same time safeguarding local infant industries and markets with antidamping and countervailing ­measures against unfair foreign competition. Having shari’ah-­compliant liquidity platforms or putting Islamic finance in good order may not yield the intended results if the wider economic vision of Islam is overlooked. The key here is wealth distribution, zakat, to assure the sustainability of economic and financial systems because financial inclusion and free trade may not sufficiently address the issue of poverty and fuel inequality. Regardless of advance in international trade and massive infrastructure investment, the issue of hunger and poverty is still prevalent in the world. We have enough reason to question the side effects and emphasis on ways to alleviate hunger and poverty.

NOTES 91.  Beck, Demirguc-Kunt and Merrouche, “Islamic vs. conventional banking: business model, efficiency and stability” stated that “empirical findings suggest that conventional and Islamic banks are more alike than previously thought.” As also highlighted by Beck, Demirguc-Kunt and Merrouche, “Islamic vs. conventional banking: business model, efficiency and stability”, the fundamental reason would be that many conventional finance contracts can be converted to Islamic finance contracts with little change.

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92.  Gundogdu, “Islamic electronic trading platform on organized exchange”. 93.  There are also critiques, such as those of Miller, Challoner and Atta, “UK welcomes the sukuk”; Wilson, “Innovation in structuring of sukuk securities”; Chin and Abdullah, “Announcements effect of corporate bond issuance and its determinants”; and Rahim and Ahmad, “Asymmetric market reactions to Sukuk issuance”, that claim that sukuk instruments are no different to securitized bonds. Further, Sherif and Erkol, “Sukuk and conventional bonds: Shareholder wealth perspective” found that there is only insignificant reaction to sukuk and conventional bonds from the financial market. 94.  The oil price data are annual averages; hence, the price rise in 2008 and its effect on sukuk issuance is not revealed in the graph. 95.  Asutay, “Conceptualisation of the second best solution in overcoming the social failure of Islamic finance: Examining the overpowering of homoislamicus by homoeconomicus”. 96.  The clauses are from Sukuk Challenges and Prospects for Innovative Design, Financial Product Development Center, IDB. 97.  Haneef, “From asset-backed to asset-light structures: The intricate history of sukuk” concludes that “today all Sukuk offerings are asset-based. The asset-based Sukuk are treated as senior unsecured securities similar to unsecured conventional bonds.” 98.  As stipulated in a Thomson Reuters Report, “Liquidity management through sukuk 2017; Innovative solutions”, “The introduction of these products puts Islamic banks in a much stronger position because they can hold cash and cash equivalents without sacrificing profitability relative to their conventional competitors.” 99.  Hamza, “Islamic sukuk securities as financing instruments: An examination of bond pricing in the conventional and Islamic setting and a survey of literature on alternative benchmarks to the Interestbased system”.

5

5

5

5

5

5

5

5

5

5 5

5

105

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

Year 10

Year 11

Year 12 Year 13

Year 14

Year 15

Source: Author.

5

Cash Flow in US$ Million

Year 2

Year 1

100. 

53.03213506 100

Mark-to-Market

2.651606753

2.923396445 2.784187091

3.069566268

3.223044581

3.38419681

3.553406651

3.731076983

3.917630832

4.113512374

4.319187993

4.535147392

4.761904762

NPV in US$ Million (Case 1)

1.979931599

1.885649142

1.710339358 1.795856326

1.628894627

1.551328216

1.477455444

1.407100423

1.340095641

1.276281563

1.21550625

1.157625

1.1025

1.05

Discount Factor if Market Rate Stays at 5% (Case 1)

3.624884775

3.295349796

2.723429583 2.995772541

2.475845076

2.250768251

2.046152955

1.86013905

1.6910355

1.537305

1.39755

1.2705

1.155

1.05

Discount Factor if Market Rate Jumps to 10% after the First Year (Case 2)

66.17449427

28.96643797

1.517289608

1.835920426 1.669018569

2.019512468

2.221463715

2.443610087

2.687971095

2.956768205

3.252445026

3.577689528

3.935458481

4.329004329

4.761904762

NPV in US$ Million (Case 2)

116 A Modern Perspective of Islamic Economics and Finance

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101.  Thomson Reuters Report, “Innovation in Islamic liquidity management 2017; Transforming Islamic finance business”. 102.  Gundogdu, “Islamic electronic trading platform on organized exchange”. 103.  Gundogdu, “Islamic electronic trading platform on organized exchange”.

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Part VI: The Miser WEALTH DISTRIBUTION THROUGH ZAKAT AND POVERTY ALLEVIATION An old man sells all of his goods for a large lump of gold, which he then proceeds to bury in a hole just outside his property. Every day he visits the spot, uncovering the gold, looking at it for a bit, then covering it back up. One of the man’s employees notices this odd behavior and follows the old man. He sees the buried gold, and when the old man returns home, the employee removes the gold and runs away with it. The next day the old man finds that his gold his missing and cries out in agony. A neighbor hears the old man’s story and suggests that he place a rock in the hole and cover it back up. “It makes no difference, does it? You didn’t do anything with the gold anyway.” Fables of Aesop We have enough reasons to crown international trade with auxiliary financial services as champions for economic growth. However, what does this do for poverty alleviation?

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The research on this question has proved that the overall impact of international trade is positive for wealth creation. However, it has also been found that wealth created with international trade, in a similar way to financial inclusion, fuels inequality. This part of the problem relates to the unfair competition of foreign goods and services that are supported with subsidies and dumped into the local market. Addressing this should not be difficult as long as public authorities are well versed in tackling such cases with anti-dumping and countervailing measures. Even then, free trade would still create inequality since those endowed with non-tradable goods and services would be more prosperous, as, unlike tradable goods, their supply is not exposed to foreign competition. If you are a car producer, in a free trade environment you need to compete with foreign brands to sell your car in your home country. However, this is not the case for house sellers. The inequality created out of free trade has led to criticism in almost all countries, whether emerging or developed. Some countries have adopted protectionism as a second-best policy, in the form of tariffs and non-tariff barriers, to tackle the side effects of free trade, which have impoverished them. Islamic economics and finance thinking recognizes that inequalities are created not only through free trade but also debt-creating financial inclusion. The solution of Islam, however, is directly linked to inequality itself, unlike second-best policies. Islam proposes zakat for a wealth distribution mechanism in society to abate the side effects of free trade and financial inclusion. The concept of zakat is very simple: A wealthy person should give 2.5 percent of his/her net worth to the needy. Moreover, zakat has two elements as follows: (1) Zakat is an obligation of people toward other people who live in their society and are in need. It is not a kind of tax that is invested or spent by the government as it pleases.

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(2) The zakat base is net worth or assets minus liabilities, which equates to the stock of wealth and not the income stream. Regardless of the straightforward features of zakat, like anything related to the message of the Almighty, some humans have made it complicated. History proves that the special interests of some humans are hidden behind complicated mechanisms. The literature on Zakat is full of complicated calculations that show how to collect zakat from companies using their income statements as opposed to their balance sheets. The debate that has arisen concerning zakat collection on income statements as opposed to balance sheets is a subtle deceit. Zakat is an obligation on natural people not legal entities. Making corporations pay zakat cannot relieve zakat obligations. First of all, the payment of zakat based on transactions is similar to taxation on income statements and does not yield the desired results. Such practice is similar to taxation and causes inefficiencies in the economy, which explains the reasons for the Islamic aversion to taxation. Taxes are collected and spend by governments inefficiently; indeed, in most cases, resources are transferred from taxpayers to politically favored actors. Such patronage reinforces the establishment of oppressive power structures that inhibit humanity’s progress. Besides, the inclusion of inefficient taxation on goods and services increases price levels, which pushes those at the bottom of the pyramid into poverty. Unlike taxation, zakat has an effect on healthy price formation in addition to being a means of wealth distribution. By deducting 2.5 percent of wealth from the top of the pyramid, zakat assures that the production factor is not concentrated in the hands of a few. Hence, zakat reinforces fair competition structures and prevents monopolistic, oligopolistic, and cartel price-setting formations. Further, unlike social security systems, zakat is

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a sustainable social safety net mechanism. Social security systems are unsustainable: They create a vicious circle of economic decline by transferring resources from productive generations to unproductive generations, which deteriorates public finance and places a heavy burden on the younger generation. The way zakat is exercised in the contemporary world, however, would not yield the results of zakat as ­commanded by the Almighty. Similar to zakat, another Islamic institution for poverty alleviation, waqf, has been derailed. The best example is the case of cash waqf implementation in the Ottoman Empire, which has been reported in detail in the fifteenth century. As expected, there is an untold story regarding this issue. Under Ottoman rule, the ruler had a musadara right whereby the Sultan could seize the assets of wealthy people after their deaths so as to prevent inheritance. The main reason was to avoid capital accumulating in the hands of some groups that might develop the ambition to seize power from the royal family.104 Unlike corporations or personal property, a waqf, by an article of association, belongs to Allah, at least on paper. Thus, it was assured that the Sultan would not dare to confiscate that which belongs to Allah. In order to circumvent the musadara system, informal moneylenders established a cash waqf system that was mandated to lend money, mainly with murabaha contracts, to traders. However, after the system’s implementation, some shari’ah scholars issued a fatwa in order to accrue late payment interest charges in cases of loan defaults, which technically converted murabaha contracts into conventional Venetian-style moneylending contracts. In the fatwa, the scholars called the late payment charge “muamelei sherriye,” which translates as “shari’ah treatment.” It was called shari’ah treatment even though a late payment charge is a clear breach of Islamic shari’ah. This situation resonates with the contemporary fatwa for Islamic banks to charge “profit

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deprivation” as default interest. The centuries have unfolded; yet, humans keep repeating the same mistakes.

6.1. POVERTY ALLEVIATION Zakat and waqf together have been a traditional social safety net and have acted as poverty alleviation and social infrastructure development tools in Islam. However, the effect of zakat and waqf on poverty alleviation is indirect. Zakat directly addresses the issue of inequality and hunger while waqf is a social infrastructure development business model. The main tool proposed by Islam for prosperity and poverty alleviation is still trade and auxiliary services to support trade; namely, commerce. Historically, Muslims have had times where they have implemented supportive Islamic verdicts for commerce and reaped the rewards as wealth and civilization were created from it. Systematic and proper widespread implementation of zakat and waqf has not occurred, though. This is why Muslims were able to create wealth generated from commerce in a similar way to other civilizations throughout human history; however, Muslim societies also suffered from the side effect of wealth inequality in a similar way to other civilizations. For example, the British Empire at the height of its glory during the reign of Queen Victoria was afflicted with pickpocketing crimes. No wonder the stories known as the Arabian Nights revolve around a rich Sultan and a thief such as Aladdin. When it comes to poverty, we may claim that we are in a better shape in the world today compared with the past. However, poverty is still a challenge because many desperate refugees use historical trade routes to flock into Western economies, which have been struggling since 2008. The poverty alleviation work of development endeavors cannot yield the desired results because of the following reasons. First of all, poverty is a rural occurrence

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that extends to urban areas and further expands to the cities of developed countries because of the failure of emerging economies. If the sustenance cycle of rural people is broken, they migrate to cities where they do not have the necessary skills to integrate into an urban economy. At a later stage, this situation fuels violence and economic hardship in emerging economies and forces the unfortunate masses to seek refuge in developed countries, even if they risk their lives. It is not a pleasant experience for the already ­pressurized citizens of developed countries; however, the experience is a more stressful process for refugees. In Islam, the free movement of people is well assured, but it is up to us to make this process a productive and pleasant experience for all. Pouring more money into emerging markets to keep people there has not yielded the desired results, neither would zakat or waqf do so if not supported with the art of economics and finance. Looking at the experience of different countries, there is one fundamental “to-do” that countries with lower poverty levels have implemented. They have improved their supply chains to ring-fence the rural population. The major reasons for developmental endeavors’ ineffectiveness are also as follows. (1) Countries lack integrated programs to tackle the key components of poverty through their supply chains. (2) Countries lack programs that can generate their own resources. They keep throwing water (money) down a well but not enough water comes out, regardless of this pouring of resources into the well. The microfinance business model has great potential to develop integrated programs for poverty alleviation. In a similar way to any good model, it has also been corrupted by some humans in order to establish an exploitation mechanism. The way the model is implemented in India is a useful example of a good initiative ending in horror. Microfinance has proved to be effective

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if it is used to support agricultural production; otherwise, it can give a competitive advantage to microfinance beneficiaries compared with others. Alternatively, microfinance beneficiaries are oppressed by the riba charges of microfinance loans when they do not perform well in a competitive environment. This situation reveals a dire difference between faith-based understanding of economics and finance, and the positivism of capitalism, communism, nationalism, and theocratic dictatorships. Islamic understanding urges people to work for their sustenance. It also supports cooperation among humans for this purpose. The alternative understanding of life through positivism in the form of capitalism, communism, nationalism, and theocracy is based on competition: the survival of the fittest. No matter how well they hide their ugly faces behind humanism, comprador religious clergy, and so-called enlightened philosophers, all these systems are the same in hoping for the destruction of others as their way to success and prosperity. They also have another commonality: They fuel competition, in order to expand their resources, among those at the bottom of the pyramid, while the privileges of those at the top are well protected. Developing integrated microfinance programs to ring-fence the rural population against exploitation and encourage cooperation is a means of poverty alleviation. In addition to financing, an integrated microfinance program should provide the following benefits to farmers. A. The microfinance provider should organize the bulk purchase of agricultural input such as fertilizer and the bulk sales of harvests to assure good prices for farmers. B. The microfinance provider should provide secure storage, to save farmers’ produce, in licensed warehouses. Further, e-warehouse receipts with the necessary insurance should be used to commoditize the produce (see Fig. 10).

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Controlled by a Collateral Manager which have Professional Indemnity Insurance

Warehouse Warehouse with cerfied Lab for Quality Cerficaon

MFI

1: Commodies

2: e-WR

Farmers Fig. 10.  Licensed Warehousing and Electronic Warehouse Receipt. Source: Author.

Fig. 10 illustrates the e-WR system and how the e-WRs are issued. (1) Upon receipt of produce from the farmers, a licensed warehouse operator registers the produce after weight bridging and obtaining quality certification from a certified lab. (2) The licensed warehouse operator notifies the quality and quantity of physical produce to the MFI, which, afterward, issues e-WRs in specific quantities, such as one ton of wheat, based on market practice. The issuance of e-WRs is credited to the investment account of each farmer, as appropriate. The produce is then transformed to a commodity that can be sold online. Produce in a field is not worth much

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unless it is transformed into a commodity that is stored in a suitable and accessible warehouse with quality and quantity certification. C. Farmers should be given necessary financial services as follows:

Current Accounts. The purpose of these is to enable farmers to keep their money safe against theft. The accounts should be complemented with money transfer services from account to account, and from an account to any person.



Savings Accounts. The system should allow poor-to-poor financing, with farmers being able to invest money in microfinance programs through Islamic finance contracts. This approach would support the snowball effect.



Investment Accounts. Farmers should be provided with investment accounts in which they can keep their e-WRs ready for trading on electronic platforms. In addition to providing fair price formation, e-WRs and an electronic trading platform would protect farmers against natural perils.

With licensed warehouses and an electronic trading platform, the exploitation of rural populations can be mitigated. Every harvest season, farmers load trucks to take their produce to markets. In many instances, intermediaries establish procurement hubs on the way and promise to buy on the spot. Lacking market knowledge, farmers sell their produce for less than its worth in the marketplace. Moreover, even if farmers attend markets, intermediaries know that the farmers must sell all their produce because returning it to their villages would cost a great deal. They do not have the option to sell some part of their produce to cover their costs and wait for another time at which they might obtain a ­better  price.

128

A Modern Perspective of Islamic Economics and Finance

Since all farmers sell their produce at the same time because of harvest seasonality, a supply glut pushes prices down. Licensed warehouses connected to an electronic trading platform can ring-fence farmers against exploitation by intermediaries. However, running a licensed warehouse with a quality certification laboratory, weight bridge, and insurance is a costly enterprise. In this regard, the licensed warehouse operating cost would need to be paid by money created within the integrated program. There is a way to achieve this if complementary currency is used for trading while hard currency created out of the supply chain is invested for a return. In the proposed system, complementary money should be created without contradicting Islamic principles in the form of electronic money. This money creation should be based on Islamic microfinance contracts; further, the money should be created from work effort and people should be allowed to access trading platforms through the credit money concept of barter, even if they do not have any money.105 Most importantly, the money should be stable and not prone to sharp depreciation, which is one the causes of rural poverty. The present money system is one of the major reasons for rural poverty because local currency depreciates. Farmers also suffer because of a lack of financial knowledge. Farmers receive the rewards of their harvests in the form of local currency. If the currency depreciates, they are unable to procure agricultural input such as fertilizer for the next season. The sustenance cycle is then broken and the only alternative is informal employment in urban areas. The same situation applies in terms of the perils for produce after harvesting and the theft of money, which can be eliminated by the introduction of licensed warehouses and bank accounts. Although these measures ring-fence the rural population against destitution, a substantial investment would still be needed for rural development. Poverty starts in rural areas and extends

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to urban areas. If the rural population can be ring-fenced against exploitation, we can tackle the poverty issue worldwide. Without addressing the rural problem, the focus on urban poverty is futile and cannot be abated.

6.2. COMPLEMENTARY CURRENCY AS AN ANTI-VENOM If we can make rural life comfortable enough with transportation enablers and health and education services, we may even help urban people to be free from highly congested cities. This development would require continuous investment. The lack of continuous investment is why rural development programs cannot succeed. Microfinance for agricultural financing appears to provide ring-fencing for rural populations. However, in order to make the system sustainable, there needs to be a proper infrastructure, such as irrigation, licensed warehousing, roads, and ports, to improve value addition in the supply chain. Moreover, an improved supply chain is insufficient to make rural life attractive if there are no health and education services. One of the achievements of humans is understanding the philosophy of innovation for decisive results. A good example is the use of snake venom to save those who are inflicted with snake bites. Anti-venom is produced from venom. In the same fashion, we can use the present monetary system to alleviate poverty through the use of a complementary currency concept within integrated agricultural microfinance programs and a credit complementary currency for chain barter within an electronic trading platform. The concept of complementary currency is novel to barter. Contemporary communities have initiated the use of vouchers, the values of which are pegged to legal tender, as money with which to bid for and

130

A Modern Perspective of Islamic Economics and Finance

offer stocks. If a barter company can give vouchers based on the valuation of the stock of each party, a new system for the exchange of goods and services would be created.106 Then, people can fulfill their needs without creating a demand for money; hence, the opportunity for riba seekers disappears. Besides, withheld legal tender can be used for social infrastructure development for the community. However, the flaws of the system can soon generate problems if not treated. The voucher system is prone to counterfeiting. Money should be in an electronic form. Besides, although services are perfectly fine and needed for an economy, as aforementioned, basing financial structures on trade-in-services can derail the system. Hence, money creation should be based on tangible moving assets but not services.107 Islamic finance philosophy also mentions that monetary operations based on unmoving stock are inappropriate, as is the case with disastrous commodity murabaha and nonshari’ah compliant sukuk.108 Hence, money should be created from bona fide transactions, as illustrated in Fig. 11. Fig. 11 shows an ideal form of an Islamic microfinance structure as implemented by some Islamic banks. In this structure, the MFI is not only the lender but also the supplier of agricultural input such as fertilizer and seed. The MFI also offtakes the farmers’ produce during harvest. The bulk purchase of agricultural supplies and the consolidated sale of a harvest would improve the bargaining power of the farmers, who alone could be victimized at the bargaining table. A novel monetary system, in which a complementary currency plays an important role for poverty alleviation, can be initiated by a change of legal tender in the microfinance contract signed between the MFI and the farmers.109 After the harvest, the money is backed with hard currency obtained from the sale of commodities to the final off-­ takers. The farmers can use complementary currency for their

Part VI: The Miser

Sustainable Village Programs

4. US$ 22.95 5% return from investment

131

MDB

3. US$ 459 Invested in 5%

Agricultural Infrastructure Sukuk with Sovereign Guarantee

2.a. US$ 459 MFI as • Lender • Supplier • Off-taker

1. US$ 600

Primary Industry (Co‚on Ginner, Wheat Flour Producer)

2.b. US$ 41 as MF loan

Micro Finance Beneficiary

Fig. 11.  Creating Complementary Currency in Microfinance. Note: MDB, Multilateral Development Bank. Source: Author.

day-to-day exchange, while hard currency can be invested in project sukuk to support infrastructure projects such as irrigation, electricity gridding, roads, and ports. The return on sukuk can be invested to improve the quality of life in rural areas in the form of services such as health and education. The good aspect of this system is that it creates hard currency every year on top of existing stock. A simulation, assuming a 5 percent annual return on sukuk, is presented in Table 1.110 As can be seen in Table, after 10 years the investment of the integrated program reaches US$4,590 million of infrastructure development, which improves the supply chain, and US$1,262 million in health and education. The calculation is undertaken based on an assumption of 100,000 farmers, each producing US$4,590 worth of a soft commodity such as wheat or rice in a year. It is surprising to see that with a small amount of US$4,590 a year, farmers produce enough value addition, if the system is used properly, to return a

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A Modern Perspective of Islamic Economics and Finance

Table 1.  Return on Infrastructure Sukuk. Money ­Invested in Project Sukuk, US$ M

Cumulative Money in Project Sukuk, US$ M

Money Invested in Health and Education, US$ M

Year-1

459

459

23

Year-2

459

918

46

Year-3

459

1,377

69

Year-4

459

1,836

92

Year-5

459

2,295

115

Year-6

459

2,754

138

Year-7

459

3,213

161

Year-8

459

3,672

184

Year-9

459

4,131

207

Year-10

459

4,590

230

Cumulative

1,262

Source: Author.

US$4,590 million supply chain infrastructure investment and a US$1,262 million investment in health and education. Some part of the return on investment can also be used to cover warehouse operating costs and insurance. If such investment is undertaken for 100,000 microfinance beneficiaries in 10 years’ time, there should be no poverty on earth and people should prefer to live in rural areas rather than polluted and congested cities. This finding clearly shows that rural populations generate enough value addition; however, they are poor and forced to migrate to large cities and take refuge in developed countries. There can only be one reason: exploitation, by financial institutions with artificial demand created for money and by intermediaries that do not allow fair price formation.

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6.3. AN ISLAMIC MONETARY SYSTEM BASED ON FAIR TRADE Using barter vouchers instead of fiat currency does not change the possibility of riba in the system. After a while, because of demand for vouchers to carry out exchanges, some people start offering vouchers with riba. The key here is to decrease the demand created for money because of the day-to-day exchange of goods. An example of an economy composed of a million farmers can explain this situation more clearly. Imagine that 500,000 farmers are wheat producers and 500,000 industrial producers make fertilizer. In this scenario, 500,000 farmers want to buy fertilizer and 500,000 industrial producers want to buy wheat. Assume that each has one unit and each unit is 10 Islamic dinar. In order to exchange wheat for fertilizer, the farmers need to sell 500,000 wheat’s worth of five million Islamic dinar. The fertilizer producers also need to do the same. During the process of selling, both parties create a demand for money equal to 10 million Islamic dinar. Who keeps the money? A bank, of course. Further, the bank charges to fulfill such demand. After so much hard work, the farmers and industrial producers find that the bank is standing by like a shark as their partner in business. Indeed, they can only barter without creating a demand for money; hence, the opportunity for riba de-escalates. Ultimately, supply and demand are equal in an economy. If all the supply and demand are placed in the same pool, they would match in a chain barter.111 With modern technology, unlike in the past, it is now possible to pool all supply and demand on an electronic trading platform. With the large size of the given sample, much of any exchange can be undertaken in a chain barter, but not a bilateral barter. The remaining exchange can be completed with electronic money created from the grass roots of the supply chain though Islamic microfinance contracts. Fig. 12 shows an example of trading in a local context.

A Modern Perspective of Islamic Economics and Finance

134

Ferlizer

MFI and/or Ferlizer Seller

Wheat Seller-1

Super Market

Wheat

Co on Seller-1

MFI and/or Coon Ginner

Flour Mill-1

Flour

Imports of Ferlizer

Co on Seller-2

Exports of Ginned Co on

Co on Goods Money

Electronic Trading Plaorm Managed by MDB

E-Dinar

Fig. 12.  Electronic Trading Platform for Microfinance. Source: Author. The key issue for the platform is the rule of trading to assure fair price formation. The following are the following opening session rules: (1) Sellers place their goods in an MFI’s custody in MFIcontrolled warehouses. Based on valuation reports by the MFI, the sellers receive e-dinar credited to their MFI accounts. (2) The sellers’ asking (offer) prices are published. (3) For one hour, buyers’ bids are collected in a pool. At the end of the hour, the computer matches the bids and offers in the pool. The MFI premises can be used as a trading room by the farmers. (4) Price formation is to be based on the urgency principle: The matching starts with the lowest price asked for the same quality commodities; for the lowest ask price,

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the first highest price bid is matched at the bid price. If there are identical bid prices, the highest quantity bid is matched first. For identical bids, the timing determines the matching order. (5) Sellers can bid to purchase goods of other sellers with credit money based on the valuation of their goods by the MFI. Should a seller not sell the goods for which s/ he received credit e-dinar and does not have e-dinar in his account, the matching algorithm cancels his match and recalculates the matches. (6) The reference prices, calculated based on weighted average prices, are published at the end of each session.112 An electronic trading platform linked to licensed warehouse storage with e-WR would substantially improve farmers’ prosperity because demand for their products would be higher and their products and money would be securely saved. The system would also support value addition in the supply chain because soon afterward, farmers would realize that higher quality products are more liquid and give better profit. In addition, the presence of a licensed warehouse consolidates a healthy market since the quality of commodities in the warehouse is assured with a laboratory test and insurance. The drawback of licensed warehouses and e-WR is that they work for standardized commodities, fungibles, and cannot be used for non-fungibles. The system is good for Islamic money creation since it operates on fungible commodities but excludes other needs of rural populations. Can you sell a cow with an e-WR? You may not be able to sell it with an e-WR but you may list such items with visual and audio content, and quality and quantity indications through the intervention of the MFI as long as the MFI can control the items in a p ­ roper

136

A Modern Perspective of Islamic Economics and Finance

store during electronic listing. The system is no different than that of the Old Bazaar of the Prophet Market in Medina. The difference is the use of an electronic trading platform for price formation and a strong warehousing i­ nfrastructure supported with proper insurance against (1) quality deterioration and misappropriation, and (2) natural perils and theft. The traders, both buyers and sellers, would be protected in the event of unpredictable occurrences. Governmental control of warehouses would substantially decrease insurance costs because the probability of theft and misappropriation would decrease. If licensed warehouses are established in customs areas, in the next step the trading platforms of different countries can be merged to enable international trade. Further, money transfers can be undertaken by mere debit and credit. In addition to poverty alleviation, this system would enable a comprehensive monetary system where people create their money as long as they produce something demanded by others, prices are formed fairly, and people are free to trade with anybody worldwide without the interference of banks. The root causes of all misery in the contemporary world are the monetary system, more specifically the money creation mechanism, and the lack of fair trade. These do not allow the Islamic economic and finance system to fulfill its duty as an enabler of an environment where humans are happy and free from financial stress. Nonetheless, even operating within the contemporary monetary system, the covenant of Islamic finance in the name of riba, maysir, and gharar would still protect people to some extent. The way forward is to use finance as a means to grapple with the protracted problems of humanity such as poverty. However, drastic change is required to the monetary system. In addition, integrated

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poverty alleviation programs targeted to increase agricultural surplus, as presented herein, must be implemented for rural development.

NOTES 104.  This concern was related to the example of the Medici family in Italy. 105.  See Section 2.3 for a description of e-dinar creation. 106.  Melis, Giudici and Dettori, “Revitalizing the Barter: The case of Sardex.Net”. 107.  Please refer to Section 1.3 for elaboration. 108.  Please refer to Section 5.3 for elaboration. 109.  See Section 2.3, Fig. 4. (1) The MFI signs a restricted mudaraba contract with a MDB, which is the initial fund provider. (2) The MFI and a farmer sign salam or murabaha contracts. The complementary currency is to be linked to the Islamic dinar. (3) The MFI supplies agricultural input to the farmer after receiving supplies worth 100 e-dinar. (4) In the case of a murabaha contract, the MFI sells the agricultural input to the farmer with a six-month tenor and a markup, making the total payable 106 e-dinar. (5) After the harvest six-months later, the farmer hands the harvest, worth 306 e-dinar, to the MFI. After deducting 106 e-dinar, the MFI credits the remaining 200 e-dinar to the farmer’s account. The MFI determines the purchase price and declares this price only after assuring an onward sale contract with final offtakers in order to avoid price risk. (6) The MFI sells the commodities to the final ­ off-takers for 400 e-dinar or the equivalent amount of hard currency (US$600). 110.  Withheld US$600 million is invested by the MFI and MDB into infrastructure sukuk and microfinance loans, US$459 million and US$41 million, respectively. Assuming a 5 percent return per

138

A Modern Perspective of Islamic Economics and Finance

annum on the sukuk investment, about US$23 million can now be allocated for social investment, such as in education and health services, every year. 111.  See Section 2.1 for further details of barter. 112.  For example, for 5 units of fertilizer with two price matches, є 98 and є 97, the weighted average price for fertilizer in the opening session would be published as є 97.4 e-dinar ((98×2+97×3)/5) before the day trading.

Part VII: Except by Taqwa “CONCLUSION”

O people! Indeed, your Lord is one and your father is one. Indeed, there is no superiority of an Arab over a non-Arab, nor of a non-Arab over an Arab, nor of a white over a black, nor a black over a white, except by Taqwa. Have I conveyed the message? (The last sermon of the messenger of Allah.)113 Never end a book at Part VI. A book without a word of wisdom in Part VII is incomplete. Ultimate wisdom comes from the Almighty, who from time to time connects to sound hearts in order to lead humans to the right path for their well-being, happiness, and contentment. It was Moses (PBUH) who kept asking the Almighty for divine rules for social order in the desert, not the Almighty. It is up to humans to accept divine guidance in order to develop structures to solve contemporary problems and progress or to make designs based on maslaha and stagnate. The second course has proved to serve the interests of a few privileged people at the expense of the human masses. Religion just requires honest effort to understand it. It should not be used for self-interest or maslaha. 139

140

A Modern Perspective of Islamic Economics and Finance

Unfortunately, as humans, it seems that we have never tried the former course but tend to have recourse to the latter. Each time a maslaha-based design has faltered, internal traitors and external enemies are created, and “Make the Country Great Again” leaders emerge, not only in Muslim countries, of course, but also in the East and the West. Regardless of our countries of origin, we humans are very similar. We are imperfect and this religion, Islam, is perfect for imperfect people.114

NOTES 113.  Muhammad (PBUH) lists Arabs and white men at first. Perhaps this is because they are more prone to claim superiority. 114.  “Those who avoid the major sins and immoralities, only [committing] slight ones. Indeed, your Lord is vast in forgiveness. He was most knowing of you when He produced you from the earth and when you were fetuses in the wombs of your mothers. So do not claim yourselves to be pure; He is most knowing of who fears Him.” (– 53:32 –)

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149

Governance

Area

State ownership Musadara (confiscation by state) Dependency on state for sustenance Maslaha (silence in oppression and injustice)

Individual property ownership Inheritance right Freedom of entrepreneurship Freedom of expression

Human rights

Maslaha

Legal certainty

Legal system

Asabiyyah

Not-to-Do

Merit and trustworthiness

To-Do

Selection of leadership and appointments

Sub-area

APPENDIX: TO -DO LIST AND NOT-TO -DO LIST

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

Category*

Sub-area

Trade policy

Monetary system

Economic policy

Area

(Continued)

Cryptocurrencies under no control

electronic money under government control

Transaction tax (such as VAT) and non-tariff barriers

Money created with gold, silver, computer mining, Riba contracts and fractional reserve banking system

Money created with work effort and Islamic Finance Contracts

Trade facilitation

Bilateral barter

Payment of fatwa, audit, and supervision fees by the audited and supervised party

Government agencies for fatwa, auditing, regulation, and supervision (to avoid the distortive effects of the agency relationship in which agents are paid by interest groups) Chain barter

Not-to-Do

To-Do

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

Category*

150 Appendix

Finance

Funded

Social Policy

Bai Al-Dayn (debt trading) Financing trade in services

Financing mercantile trade

Social security system/ social transfer/sadaka

Wealth re-distribution mechanism with zakat Trade finance with murabaha

Microfinance in informal urban sectors

Cross-border investment in stocks and real estate

Foreign direct investment (FDI)

Microfinance in agricultural sector

Fixed exchange rate

Managed exchange rate

Microfinance fueling competition

Monopoly

Free access to markets and trading platforms for all (no rent creating entry barrier)

Microfinance creating value addition

Protectionism

Protect infant industry

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

ϾϿ

Appendix 151

Area

(Continued)

Sub-area

Not-to-Do Organized tawarruq Bai Al-Inah-vefa-istiglal Real estate mortgage as collateral for risk management Default interest for financier Riba Maysir Conventional forward contracts Conventional future contracts

To-Do Asset-based murabaha Project finance with istisna, ijara Taking collateral and mitigating risk based on the transaction financed Have default interest to avoid moral hazard of Borrower Profit sale Natural hedging Islamic FX forward contracts Asset-backed murabahabased Islamic future contracts with physical delivery of commodities

✙

✙

✙

✡

✡

ϾϿ

ϾϿ

ϾϿ

Category*

152 Appendix

Unfunded

Insurance: Takaful leading to price bubbles

Connected buyer, supplier, and finance for arranged cash lending

Independent buyer, supplier, and financier

Insurance: Takaful providing safety net

Gharar

Written agreement without uncertainty

Insurance: Takaful leading to moral hazard

Short selling (selling what you do not own)

Salam for agricultural production without option

Insurance: Takaful ­supporting trade finance and project finance

Options

Takaful for value-adding bona fide activities without leading to moral hazard

ϾϿ

ϾϿ

✙

✙

✙

✙

Appendix 153

Securitized bonds/ sukuk-based on Bai Al-Inah-vefa-istiglal and tawarruq Commodity murabaha for liquidity management

Investment sukuk-based on usufructuary rights

Two-step murabaha for liquidity management

Capital markets

Not-to-Do

To-Do

Sub-area

* Ͼ Ͽ: Relates to economic and finance policy ✡ : Relates to riba ✙: Relates to gharar and maysir

Area

(Continued)

ϾϿ

ϾϿ

Category*

154 Appendix

INDEX Note: Page numbers followed by “n” indicate notes. Account receivables from sales, 74 Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), 76, 106 Agreement on Trade Facilitation, 63 Agricultural finance, 89 Aid for Trade concept, 64, 69–70, 89 Al-Maqasid Al-Shari’ah, 21n2 Al-Rumi, 9 Anti-venom, complementary currency as, 129–132 aql (intellect), 5, 21n2 Arabian Nights (stories), 123 Arabian Peninsula, 40 Arbitrage pricing theory, 67 Asabiyyah, 5–7, 9, 108 Asset bubbles, 46 Asset-backed financing, 75, 76 Islamic commodity futures, 111

murabaha, 77, 111 structures, 76 Asset-based financing, 75, 76 Asset-based two-step murabaha, 111, 113 Back-to-back murabaha sale, 82 Bai al-dayn (bill discounting), 78–80, 103, 113 Bai al-inah [selling and lease-back structure], 11, 102 Bai al-istiglal, 102, 106 Bai al-wafa, 102 Balance sheet of company, 74 Barriers to the market, 61 Barter company, 30, 130 chain matching in, 49 Bay al-dayn, 15 Bilateral barter matching, 46 transactions, 28, 29 Bill discounting, 78 Bill of lading (B/L), 81

155

156

“Binding agency” obligation, 109 Bona fide transaction, 75 Bretton Woods system, 27, 36 British Empire, 39–40, 61 Brownian motion, 66 Bursa suq al-sila in Malaysia, 111 Buyer/importer, 81 Calculus of probability (Bachelier), 66 Capital asset pricing model (CAPM), 67 Capital expenditure (CAPEX), 19, 69, 74, 87 Cash loans, 37 Central Asians, 59 Central banks, 12, 31 interventions, 12 Chain matching in barter, 49 Charity, 22n12 Commerce, 123 Commercial enterprises, 100 Commodity map of Roman Empire, 39 sale, 109 Commodity murabaha, 94 Commodity murabaha sukuk, 111 Communist economic system, 38 Comparative advantage, 59, 61 theory, 60

Index

Competition law, 56–57 Complementary currency as anti-venom, 129–132 money, 128 Contemporary fiat currency, 46 finance theory, 66 Islamic finance, 57 monetary system, 40 society, 34 Contractum trinius, 27, 65 Conventional banks, 87 Conventional finance, 10–11, 15, 79, 89, 95, 98–99 fundamentals of, 28 valuation concepts developed by, 67–68 Conventional system, 113 Cooperative insurance business model, 19 Corporate sukuk, 102, 104 Court decisions, 21 Cowles Commission for Research in Economics, 67 Cross-border real estate, 64 Cryptocurrencies, 46 Current Accounts, 127 Current assets, 74 Debt trading, 106 market, 79 Deferred sale, 69 Deposit banking, 97–98

Index

din (faith), 5, 21n2 Dinar (currency), 38–39, 53n57 Dirham (currency), 38–39 Distorted currency prices, 62 Dividend discount model, 68 Divine rules, purpose of, 5–9 Documentary collection, 76 Dow theory, 67 Dubai Multi Commodities Centre (DMCC), 111 Dutch East India Company, 26 E-dinar, 48–49 Econometricians, 65 Econometrics, 67 Economic growth, 35 policy, 100 theories, 66–67 Education costs, 36 Electronic trading platform, 46, 49, 127, 129, 133, 135–136 Islamic, 110 licensed warehouses connected to, 128 for microfinance, 134 Electronic warehouse receipt systems (e-WR systems), 50, 111, 125–126

157

Endogenous variables, 65 Enlightened philosophers, 125 Equity, 74 Escrow/collection account, 81 Exchange rate, 62 Exogenous variables, 65 Export Credit Agency (ECA), 80–82 Export-oriented development strategy, 62 Exporter, 82 Fair price formation, 56–57, 61 Fasad, 11 Fatwa (ruling), 19, 79, 87–88, 122 shopping, 86 Fiat currency system, 31–33, 40 Financial/finance (see also Conventional finance; Islamic finance; Microfinance), 45 agricultural, 89 Financial products, 36 inclusion, 120 institutions, 11 intermediaries in London, 94 murabaha, 76 payable, 75, 77 project, 110 public, 32–33

158

receivable, 75, 77 services, 14 supplier, 69, 74 system, 12, 26–27 theories, 66–67 trade, 10, 74, 99, 110 Financing in Islam, 73 financing working capital, 75–84 liquidity management, 89–95 regulation, 84–89 supervision, 84–89 Financing working capital, 75–84 Flawed monetary system, 27 Foreign direct investment (FDI), 64 Foreign exchange prices (FX prices), 62 Free trade, 58 side effects of, 120 Gharar (uncertainty), 10, 14, 16, 19–20, 28 in exchange, 29 Gold, 31, 41 Governmental debt securities, 103 Governmental supervision, 62 Greenfield projects, 74 Greenfield to Capital Markets Parade, 97 resolution of dissolution for Islamic capital markets, 109–114

Index

sukuk for liquidity management, 106–109 untold story of Sukuk, 98–105 Gross domestic product (GDP), 38 Hadith of Prophet, 50 Hamilton, Alexander, 61, 70n70 Hard currency, 131 Healthcare costs, 36 History of Interest Rates, A (Homer & Sylla), 30 Hokushin-ron, 40 Hong Kong, 62–64 House financing, 16 Housing prices, 36 Ibni Abidin, 19, 23n22 Ijara (leasing), 74, 87, 89, 99, 103 operations, 10 Importers, 15 Inah, 92 Independent and identically distributed random variables (IID random variables), 65 Industry-wide subsidies, 62 Inequality, 33 Infant industry, 60–62 Inflation, 46 Infrastructure development, 131

Index

Initial public offering (IPO), 26 Insurance business, 18, 26 Integrated microfinance program, 125 Interest rate, 30 risk, 110 International Islamic Liquidity Management Company, 94 International Trade Organization of Bretton Woods system, 63 Investment Accounts, 127 Investment sukuk, 112 Islam(ic) (see also Zakat), 6–7, 9 approach, 38, 60, 65 banks, 12–14, 17, 47, 76, 85, 89, 91, 99–100, 113 commodity futures, 111 derivatives, 91 dinar, 53n57 discounting, 78 economics, 45 electronic platform, 110–111 institution for poverty alleviation, 122 Islamic capital markets, resolution of dissolution for, 109–114 jurisprudence, 8

159

microfinance structure, 47, 130–131 monetary system based on Fair Trade, 133–137 reasoning, 65–70 working capital finance contracts, 75 Islamic Development Bank (IDB), 48 Islamic Electronic Trading Platform, 110 Islamic finance, 10, 14, 74–75, 77, 84, 89, 98, 113 export finance, 82 financial institutions, 14–15 industry, 98 in Maqasid, 10–14 philosophy, 130 Islamic Fiqh Academy, 86–87 resolution, 91–94 Islamic money, 25 key issue in, 41 probable origin of monetary system, 26–34 scruples of Islamic money creation, 38–50 Istisna, 74, 898 Jakarta Futures Exchange, 111 Khaibar date exchange case, 29

160

Late payment charges, 22n12, 122 Leasing (see Ijara (leasing)) Legal systems, 8 Letter of credit (LC), 76 Licensed warehouses, 127–128 operator, 126 Life sciences, 66 Line of financing, 83 Linear programming (Koopmans), 66 Liquidity management, 89–95, 98, 109 Lloyd’s Coffee House, 18 Loan defaults, 122 mal (wealth), 5, 19, 21n2 Maqasid Al-Shar’iah Islamic finance in Maqasid, 10–14 moral hazard, 14–21 pillars of Islamic finance product development, 18 purpose of divine rules, 5–9 Maritime cargo insurance, 18 Mark-to-market effect, 107 Market maker, 111 Maslaha, 7, 9, 79, 86, 107–108, 139 Maysir, 10, 28, 46, 69 Microfinance for agricultural financing, 129

Index

business model, 124–125 provider, 125 Microfinance institution (MFI), 47–48, 126 Mills Frigate case, 20 Modern finance theory, 64 Modern portfolio theory, 65–66 Monetary system, 45, 46 origin of, 26–34 Money, 27, 45, 48 creation, 30, 32–33, 45 supply, 45 Moral hazard, 14–21, 108 “Muamelei sherriye”, 122 Mudaraba, 48, 57, 106 Muhammad (founder of Islam), 2, 29, 49, 56–57, 140n113 Multilateral liquidity management corporation, 110 Murabaha, 12–13, 15–17 asset-based modern, 11 finance, 76 transactions with commodity houses, 106 Musadara, 7, 11, 57, 98 credit cards, 11 experience, 12 Muslim cross-border caravan business, 57 jurisdictions, 94 Mustawriq, 92

Index

nafs (human self), 5, 21n2 protection, 7, 19 Narragonia, 6 nasl (posterity), 5, 21n2 National grain boards, 112 Negative interest rates, 30 Net present value (NPV), 107 Non-current assets, 74 Non-riba financing mechanisms, 46 Non-shari’ah compliant, 91 Not-to-do lists, 4–5, 9–10, 17, 41, 56, 65 Official Development Assistance, 64 Oil, 40 On the Principles of Political Economy and Taxation (Ricardo), 59 Organisation of Islamic Cooperation, 79 Organization of Economic Cooperation and Development (OECD), 71n74 Organized exchanges, 26 Organized tawarruq, 11, 14–15, 17, 91, 94–95, 102 Ottoman Empire, 40, 122 Ottoman rule, 122 Payable finance, 75 of Islamic banks, 77

161

Physical commodity-based platforms, 111 Population growth, 35 Poverty alleviation, 123–129 Precious metals, 29 Price bubbles, 16 Price formation, 134–135 Product development, 17 Profit deprivation, 86, 122–123 charges, 12 Project finance, 110 Protectionism, 60 Public finance, 32, 33 Public stock offering, 26 Public–private partnerships (PPPs), 89 projects, 105, 110 Purported services, 17 qalb-i selim (see Sound heart) Quantitative easing (QE), 12 Random walk, 65–70 theory, 66 Receivable finance, 75, 77 Regulation, 84–89 Repercussions, 34, 77 of money, 31 Report on Manufactures, 61 Reproduction rates, 38 Resolution of dissolution for Islamic capital markets, 109–114

162

Resource mobilization of Islamic banks, 100 Riba (interest), 10, 28, 69, 93 element, 34 Riba-based monetary system, 27 Riba-based treasury bills, 32 Risk management deficiency, 11 mitigation structure, 81 Savings Accounts, 127 School of Salamanca, 27 Scruples of Islamic money creation, 38–50 Secondary market, 104–106, 110–111, 113 Seller/exporter, 81 Share financing, 108 Shari’ah (Islamic law), 92 compliance, 17, 100 Shari’ah-compliance flaw, 101 Shari’ah-compliant alternatives, 109–110 Shari’ah-compliant product, 13 treatment, 122 Sharp depreciation, 128 Ship of Fools (Brant), 2 Short selling, 78 Silk Road, 58 Silver, 31, 41

Index

Singapore, 62–64 Social psychology, 6 Social responsibility projects, 86 Social security systems, 122 Sound heart, 5 Sovereign sukuk, 102 Specific export subsidies, 62 Statistical errors, 12 Statistical methods, 65 Steam engines, 59 Stock investment, 64 Student loans, 14, 15, 37 Suflaja (international payment system), 57 Sui generis, 79 Sujuk (dry, spicy sausage), 88 Sukuk, 57, 97, 102–103 for liquidity management, 106–109 and oil prices, 101 platform of National Bonds Corporation, 109 prevalence, 98 untold story, 98–105 Supervision, 84–89 Supplier finance, 69, 74 Sustenance, 56 cycle, 128 Tadawul (share financing), 108 Takaful (receivable insurance), 15, 19, 77, 80

Index

Tawarruq, 11, 14–15, 17, 91–95 Tax-free routes, 58 Theft of money, 128 Theory of Speculation, The, 66 To-do lists, 4–5, 9, 17, 41, 56, 65, 78, 124 Trade, 26 and competition policy, 63 facilitation, 63 finance, 10, 74, 99, 110 importance in Islam, 55 infant industry, 60–62 and investment, 63 Islamic reasoning, 65–70 random walk, 65–70 tale of two cities, 62–64 Tradeflow platform of DMCC, 111 Traders, 69 Trading, 69 environment, 49 Traditional resource mobilization tools, 82 Transaction flow for Islamic export financing, 80 Transparency in government procurement, 63 Treasury bills (T-bills), 32–33, 45 True Believer, The (Hoffer), 5, 21n3

163

Two-step murabaha, 82, 83 product development case, 13 Ummah (community), 2, 93 Unjust enrichment, 62 Unproductive governmental spending, 32 US Bureau of Labor Statistics, 23n19 waad (non-shari’ah compliant), 91 Wakala framework agreement, 80, 82 Waqf (charitable endowment), 86, 122–124 Wave mechanics experiment (Born), 67 Wealth of Nations, The (Smith), 66 Western Christianity, 2 Working capital needs, 74 World Trade Organization (WTO), 63 Hong Kong ministerial declaration, 64 Youth employment, 34 Zakat (wealth redistribution mechanism), 13, 60, 119–120

164

complementary currency as antivenom, 129–132 Islamic monetary system based on Fair Trade, 133–137 licensed warehousing and electronic warehouse receipt, 126

Index

poverty alleviation, 123–129 return on infrastructure Sukuk, 132 Zero-sum game, 69, 74 Zulm (injustice), 56