SOME CONSIDERATIONS ON ISLAMIC FINANCE AS A SOCIAL EXPERIMENT FOR A REFORM OF THE CURRENT FINANCIAL ORDER THAT RESPECTS HUMAN RIGHTS.

Author: Enea Franza, economist

It is a well-known fact that the capitalist system is based on the logic of maximizing profits and that finance is permeated by the concept of speculation. Capitalism, as is well known, is an economic system that recognizes the right to private property and its investment, in the form of capital, in productive enterprises competing with other companies active on the market that operate in free competition with each other.

The main human figures of capitalism are the entrepreneurs: they find capital, their own or that of others, and invest it in a company with the intention of recovering what they have invested with the addition of a profit.

It must be said, even if the thing I am going to say may bother some, that this system has allowed (until now) a consistent consensus on the assumption that in this way a generalized social well-being was achieved, so much so that it has become, at least in the last 40 years, the undisputed protagonist of the global panorama. It should be noted, in particular, that the capitalism we are experiencing is the one that was established with the attacks on welfare systems, initiated by Ronald Reagan in the United States and Margaret Thatcher in England, which led to the progressive affirmation of so-called neoliberal policies and institutions. The foundations of neoliberalism, which is now prevalent throughout the Western world, are the institutions of deregulation and privatization of public goods.  

For the sake of truth, along with a generalized well-being, the capitalist system (in its various versions and variants[1]) has also shown many limitations; from general environmental degradation to an apparent increase in economic inequality, which places very few people at the undisputed top of economic, financial and, ultimately, even political power. In fact, on closer inspection, a decentralised system of choice makes it easier for systemic crises to erupt and spread, and does not seem to be able to take into account general interests such as, for example, social and ecological sustainability[2].

But it is precisely the inclusion of the Sustainable Development Goals (SDGs) in the international development agenda of Western nations[3] that has contributed, at the very least, to linking the concept of growth to humanitarian values[4], helping to reignite a debate on the limits of capitalism and finance in the era of globalization[5].

In the intellectual debate that has brought environmental and social issues to the surface, the so-called shareholder capitalism has given way to the so-called stakeholder capitalism, that is, to a system of organization of companies in which companies are oriented to serve the interests of all their stakeholders; among the main stakeholders there are customers,  suppliers, employees, shareholders and local communities[6].

In fact, Thatcherite capitalism's idea has proved irreconcilable with the impact that industrial activity has on the environment in the first place. Today, it seems increasingly simplistic to argue that companies have only one purpose to achieve, which is to generate revenue and ensure that things are profitable for shareholders (i.e. those who own the company's shares) and that, losing sight of the interests of shareholders, who should be the main party to be pleased,  It only has the effect of backfiring on the company's success and decreeing its exit from the market. On the contrary, the purpose of a company increasingly seems to be to create long-term value and not to maximize profits and increase shareholder value (as seen with shareholder capitalism) at the expense of other stakeholder groups.

Proponents of stakeholder capitalism have always believed that serving the interests of all stakeholders, and not just shareholders, is essential to the long-term success of any company. They argue that stakeholder capitalism is a sensible business decision as well as being an ethical choice.

Even this approach, however, does not appear to be sufficient to scratch the contradictions of capitalism, which above all in finance has found its concrete realization. In this form, capitalist accumulation has increasingly become a separation from the creation of surplus use-value, as financialization has made capital increasingly autonomous from its previous material supports, causing harmful effects on employment, on the precarization of work and on the weakening of small and medium-sized enterprises[7].

The development of an alternative financial theory, in our view, has already found an elaboration (and a concrete practical and theoretical) in the so-called Islamic finance, which, as we will take it upon ourselves to illustrate, strikes at two of the main paradigms on which the current Western capitalist system is based: the interest rate and speculation.

Let's take a closer look, making it clear from the outset that one cannot understand the nature of Islamic finance without understanding the fact that it aims, at least in theory, at social justice and the abolition of exploitation by prohibiting, for example, investment in activities that cause harm such as alcohol, betting, or tobacco.

The term Islamic finance means, therefore, a way of doing finance that seeks to comply with the Islamic rules of Sharia, i.e. the set of rules that are taken from the Qur'an and that also contain references to the economic world. The biggest difference compared to the Western system is based on the concept of riba, which literally means "extra" in Arabic, and which can in fact be translated into cheaper terms as interest. Sharia[8], as we remember Christianity for many centuries, has always considered "usury" and, therefore, sin interest, that is, lending a quantity of money in exchange for a larger one[9]; for this reason, the riba (prohibition of the interest rate) is strictly banned from Islamic finance.

The religious economic principles on which Islamic finance is based, taken from the Qur'an, are the following: Riba; Gharar (prohibitions of uncertainty) and Maysir(prohibition of speculation and gambling). The fundamental principle for managing uncertainty and speculation is to provide that every Islamic banking and financial operation is based on the movement of real assets and that, consequently, derivatives cannot be used to manage debit/credit. In addition, all Islamic products, both in the capital market and in consumer banking products, are structured based on two main methods that also ensure compliance with the religious norm of the prohibition of interest.

The first is the so-called "so-called” Profit – Loss Sharing, which consists of sharing risks and investments. The main contracts are i. Mudarabah – mixed capital-labor contract in which the rabb al mal invests the capital and assumes the risks and profits of the enterprise, while the mudarib invests his labor and assumes the profits. ii. Musharaka – joint venture, i.e. both parties share profits and risks. iii. Takaful: PLS-based mutual insurance.

The other type is that of non-Profit-Loss Sharing, which includes all those financing techniques that are not based on a contract for sharing the profits and losses of the financed operation.  In most cases, non-PLS techniques make use of mechanisms for the exchange of goods and services with the application of a mark-up on the resale price. The main contracts are the Ijarah (leasing of an asset purchased by the bank and offered for use to the customer for a fixed period), the Murabaha – consumer financing which provides for the purchase by the bank of an asset then resold to the consumer with a mark-up, a predefined payment for the service, the Salam – advance payment for goods delivered later and the Istisna – payment in instalments of a loan.

Islamic finance was born with Sayed Abu A'ala Maududi, one of the most important Pakistani theologians and politicians of the twentieth century who, in 1947, developed a new economic science inspired by the principles of the Qur'an and in the perspective of an Islamic modernity[10]. The first Islamic financial institution was founded in Egypt, in a small village on the banks of the Nile, where in 1963 the economist Ahmad Al-Najjar created the Rural Savings Bank of MitGhamr which, thanks to the granting of microcredits, gave life to a class of small private entrepreneurs.

In the 1970s, with the oil boom, the spread of Islamic finance began, first with the establishment of the Islamic Development Bank in 1975 by the Organization of the Islamic Conference, followed by the opening of a series of banking institutions in the United Arab Emirates, Qatar, Kuwait, Saudi Arabia, and Malaysia. The first country to completely convert its national banking system to Shari'ahwas Iran in 1979, followed by Pakistan and Sudan.

The second phase of growth and evolution took place in the 1980s, when Islamic banks landed in the USA and Great Britain together with Middle Eastern and Southeast Asian students who, by immigrating to these countries, contributed to the consolidation of large Muslim organizations such as the Islamic Society of North America and Britain Etc. Despite the crisis that has hit the financial markets with heavy implications on the real economy, Islamic finance, over the last ten years, has recorded an average global growth rate of Shari'ah compliant assets of 10-15% per year in the last ten years (about double the growth rate of conventional activities) while the revenues of Islamic banks have grown in the last five years by about 44% per year. This has happened, mind you, even though the Islamic financial market accounts for only about 1% of the world's financial assets.

Islamic finance, thanks to its constant connection with the real economy (any Shari'ah compliant financial transaction, in fact, must arise from and/or have as its underlying an asset of a real nature), in fact offers a valid alternative to today's excessive financial engineering and the disconnect created between financial and real activity.

In addition, the juridical-religious principles of Shari'ah oblige segregation between Islamic assets and conventional assets. Each Islamic product must be certified by the Shari'ah Board, an independent control body, composed of experts in Islamic law (Shari'ah Scholar), which has the task of providing binding interpretations for management (fatwas) on compliance with the principles of Shari'ah and redeeming any disputes.

Today, Islamic finance has expanded its range of action and is divided into types of markets and related services and products that can be identified in Islamic banking. Islamic banking  offers banking services and products aimed mainly at the market of immigrant communities in Europe and the United States and in the Islamic finance-capital market, that is, in the Islamic stock market that offers Islamic bonds and equity funds aimed at attracting large capital from the Gulf countries to Europe and the US (and which arrives in Europe, with the first bond issued in Germany in 2004). Finally, the Halal market is aimed at Islamically connoted tourism, with the leading sectors of food and hospitality.

The main hubs of the financial and banking market are in Malaysia, Indonesia, USA, UK, and the Arabian Peninsula, while in those countries that have officially Islamized their economy (Brunei, Sudan, Pakistan, etc.), it is not particularly developed. This shows how today it is above all a phenomenon that arises from the need to combine the diversity of communities that want to be denounced with religious beliefs and that live and operate within conventional markets[11]. Europe, as anticipated, has also opened up to Islamic finance, starting with England, which in 2004 authorized the first Islamic retail bank (Islamic Bank of Britain) and where today, in addition to some Islamic windows of conventional banks, the following five entirely Islamic banks operate, namely, the Islamic Bank of Britain, with retail operations, the European Islamic Investment Bank, the European Islamic Investment Bank, the Islamic Bank of Britain, the Islamic Bank of Britain, the Islamic Bank of Britain, the Islamic Bank of Britain, the Islamic Bank of Britain  the Bank of London and the Middle East, the European Finance House and the Gatehouse Bank. In other countries such as Germany, France and the Netherlands, some conventional banks have launched financial products specifically designed for Muslim investors. Western banks that have opened Islamic windows include Goldman Sachs & Co, HSBC, Barclaysand Citibank. To date, however, there are no Islamic banks offering retail services in the Euro system, but the British example and the growth trends in the sector suggest that Islamic banks may also start operations in the euro area soon.

That said, in our view, Islamic finance can represent a point of reference for converting, in a system based on democracy, capitalism to a logic closer to the interests of citizens, striking at the core of what led to the so-called financial capitalism.

However, the restrictions imposed by Islamic finance have made this financial system immune to the expansion of liquidity, speculative mania, and exposure to "toxic assets", which were among the main causes of the financial crisis that has hit the West, has not made Islamic banks completely immune to the financial crisis, confirming a progressive "emancipation" of the Islamic economy and finance from religion. Islamic financial intermediaries were severely affected when the crisis shifted to the real economy, suffering the downturn in the real estate market to which they are highly exposed.

However, such losses cannot call into question the ability of Islamic finance to reduce systemic risk, but rather its ability to develop in a highly competitive environment while remaining consistent with its primary objectives. In particular, the need to offer depositors sufficient remuneration to induce them to keep their funds with the bank, rather than withdraw and invest them elsewhere, was identified as the source of a liquidity risk that Islamic banks were unable to address with existing Islamic financial instruments.

More specifically, it has been seen that the narrowness of supply channels and the lack of efficient and tradable monetary instruments have forced Islamic banks to accumulate excessive reserves on their balance sheets for prudential purposes, to the detriment of their profitability and resilience. Finally, the analysis of alternative solutions proposed by some countries (Malaysia in particular) to manage short-term liquidity confirmed the tendency of Islamic banks to adopt the practices of conventional banks due to the lack of sufficiently liquid and efficient Islamic monetary instruments. The result, in fact, has been a progressive rapprochement of the Islamic financial system with the conventional one, through an adaptation to the market logic that is the basis of Western economic-financial systems.

Ultimately, many of the Islamic financial institutions have adopted a strategy of contiguity with the capitalist market which, in our view, has rather hindered the development of the sector because it has undermined their credibility (as subjects of Islamic finance) and reinforced the existing divergences between the different Islamic legal schools and the different countries hosting Islamic banks.

On the other hand, it cannot be ignored that the adoption of a common regulatory framework and the harmonious development of Islamic finance are characterized by delays that originate from the persistence of divergences in the theoretical-religious approach to finance, regulatory inhomogeneities within national markets, and the lack of adequate regulation of capital markets that guarantees liquidity to the financial instruments currently in circulation.  As mentioned above, various multilateral bodies have been set up to draw up a discipline that is as common as possible.

It goes without saying that convergence towards the most homogeneous possible system is a necessary step, significantly influencing the credibility, systemic stability and coherent development of the Islamic financial system.

The sore point of the alternative system represented by Islamic finance and that the various crises of the traditional financial system have highlighted, starts from the need for Islamic banks to build their own identity and to create an "Islamic liquidity market", i.e. an interbank market parallel to the conventional one where to invest excess liquidity and find the necessary liquidity, according to Sharia-compliant instruments. Therefore, fundamental to the success of this alternative finance lies in the ability and success of the growth of alternative and innovative liquid instruments compatible with Islamic law.

Evidently, all this is a necessary but not sufficient condition, as it is also indispensable that Islamic banks (and their supervisors) work together to develop the necessary human capital. In fact, to support the subversion of the operating principles of the current financial system, the presence of specialists is necessary not only a deep idealistic conviction.

The lack of adequate staff, who have not been trained in Western universities, has so far been - in our view - the real obstacle to innovation and the effective management of risks relevant to the sector, including the lack of tools to hedge against price level volatility and tools for liquidity management. And specialized economists do not struggle to point out that the growth of the Islamic banking sector will be possible when banks develop the culture and knowledge necessary to promote more widely instruments based on the principle of profit and loss sharing.

That said, it is undoubtedly true that the present period seems particularly favourable to the emancipation of Islamic finance and its development. On the one hand, for economic reasons, because the "post-crisis" phases are good opportunities to reform a financial system. Suffice it to recall what happened in 1997 when Malaysia, refusing the intervention of the International Monetary Fund and the World Bank, developed the national Islamic financial system, turning to wealthy Saudi investors to obtain a rescue package with loans and investments in accordance with the principles of Islamic finance. But also, the probable reversal of restrictive policies, which is clamoured for in the West after the phase of anti-deflationary interventions and which should generate a period of low interest rates, should be an opportunity to be seized to rethink the functioning of Islamic banks, in a perspective closer to the sacred texts.

On the other hand, for political reasons. Wars, particularly the one in the Middle East, seem to cement opposition to Western imperialism and strengthen the cultural and religious identity of the Muslim community, much more so than what happened in 2001 with the attacks on the Twin Towers that convinced Muslim investors to Islamize their portfolios, fearing the stricter controls introduced in the United States by the Patriot Act[12].

On the issue of usury, a decisive contribution could come from the Church, given that, in a dynamic economy such as the contemporary one, many of the states of the West guarantee their survival thanks to the interest-bearing loan that they have to pay more and more to international financial lobbies.

Pope Francis has intervened several times arguing that "Usury is a grave sin: it kills life, tramples on the dignity of people, is a vehicle of corruption and hinders the common good" and he has done so on several public occasions, also emphasizing that no State can plan "a serious economic recovery" with "so many poor people, so many indebted families, so many victims of serious crimes and so many corrupt people".[13]  

On this question, despite the changed economic and social conditions, the official pronouncements of the Church in modern times have always reaffirmed the central nucleus of the traditional doctrine on usury, which is more than adequately summarized in the conclusion of an Instruction of the Sacred Congregation of Propaganda Fide, of 1873. Moreover, the Catechism of the Catholic Church, approved on October 11, 1992, by Pope John Paul II, although it does not expressly deal with the theme of usury, reports in the commentary on the seventh commandment the remarks that both maintain and innovate the traditional doctrine, whose principles on usury are underpinned.

The Church has fought for centuries, trusting in the word of God, the very existence and then the social spread of lending at interest, and has always remained firm in the principle that money, as such, does not produce money, because its apparent productivity is the consequence of the fruit of man's labour. Therefore, the prohibition of interest is connatural to the very nature of the thing, from the commutative justice inherent in the loan relationship. The fact that men are not easily disposed to lend their money to others, unless urged by the spring of interest, is explained in the light of the decadence of human nature post peccatum[14].

If the cornerstones are written in stone in the documents of the Faith, it is nevertheless necessary to provide for the "detoxification of the social body requires a return to the principle that man's work must be recognized as having primacy over things: money does not produce wealth by itself, but only if it bends to the service of effort, commitment, creativity and the transforming and creative responsibility of man's work"[15]. And on this point, we Christians engaged in economics await a strong call from the Pope to renew and re-establish the study of the economic sciences, overcoming the utilitarian principle that identifies the good with the useful, which is the basis of the theoretical elaborations of modernity and bringing back to the centre solidarity and the construction of a system of values founded on human rights.

[1] "HistoricalMovement of Capitalism", Dario Preti · Gruppo Albatros Il Filo 2023.

[2] Among the many: "Capitalism and the state. Crisis and Transformation of Economic Structures", by Paolo Leon · 2014.

[3] The 2030 Agenda for Sustainable Development is an action programme for people, planet and prosperity signed in September 2015 by the governments of the 193 UN member countries. It contains 17 Sustainable Development Goals (SDGs) in a major action programme, for a total of 169 goals to be achieved. The 2030 Agenda and the Sustainable Development Goals came into force on 1 January 2016: countries have committed to achieving all the goals within 15 years.

[4] It refers to a set of values based on a profound conviction of the equal dignity of all human beings, and of the universal obligation to alleviate suffering, and to ensure that everyone has respect for his fundamental rights and that his or her essential needs are met. These core values, for example, were inspired by and partly established by the Code of Conduct for the International Red Cross and Red Crescent Movement and NGOs in Disaster Response. To date, the Code has been adopted by more than 450 international organizations.

[5]Anglo-Saxon shareholder capitalism has dominated the economic world over the last forty years, but it has shown its inadequacy in the face of the challenges of the present, creating a situation of social and environmental unsustainability. Social, because it has created ever greater inequalities, without being able to ensure their reduction; environmental, because the industrial economy has developed without considering the so-called "externalities": the consumption of non-renewable natural resources, pollution, greenhouse gas emissions responsible for global warming. Some corrective measures have been introduced, such as the Emissions Trading Scheme (ETS) enshrined in the Kyoto Protocol, but they have not been enough to put a stop to the degradation of the planet.

[6] "Stakeholder capitalism. An economic model that puts progress, people and the planet at the centre" By Klaus Schwab, Peter Vanham · Franco Angeli Editions, 2023

[7] Ö. Orhangazi, Financialization and the US economy, Edward Elgar, Cheltenham 2008; Orhangazi, Financialisation and capital accumulation in the non-financial corporate sector: A theoretical and empirical investigation on the US economy, 1973-2003, cit.

[8] In Islam, Sharia is the set of rules of life and behavior dictated by God for the moral, religious, and juridical conduct of his faithful. In the metaphysical sense, sharia is the Law of God and, as its direct revelation, it remains absolute and incontestable by men and to this day a law for the faithful.

[9] It is a judgment, that of Christianity that has its roots in the Old Testament, rich in passages that stigmatize usurious behaviour and exhort us to help the poor and needy. Fundamental on this subject are the passages contained in the Book of Exodus, 22:24: "If you lend money to anyone of my people, you shall not behave to usurer to the needy who are with you: you must not charge him any interest"; in Leviticus 25:35-38, and in Deuteronomy, 23:20-21: "Thou shalt not lend to thy brother at interest, neither of money, nor of food, nor of anything that lends itself at interest. To the stranger you may lend at interest, but not to your brother, so that the Lord your God may bless you in all that you put your hand to in the land which you are about to take possession of." The Prophets denounce the oppression of the government and the greed of the rich. Psalm 15 defines the Lord's guest as one who "lends money without usury, and accepts no gifts against the innocent."  The contemporary doctrine of the Church is adequately summarized in the conclusion of an Instruction of the Sacred Congregation for the Propagation of the Faith, of 1873, a repetition of eleven documents dealing with earnings by interest from loans. For further information, see "Usury and Christianity. For a History of the Genesis of Modern Ethics", by Benjamin Nelson (author), Sansoni, 1967.

[10] Among his written works, Maududi is remembered for his Qur'anic exegesis  (tafsīr) The Meaning of the Qur'an (Tafhimul-Quran (lit. "The Understanding of the Qur'an")

[11] G. Gomel et al., Islamic Finance and Conventional Financial Systems. Market trends, supervisory profiles and implications for central banking activities, in Questioni di Economia e Finanza (www.bancaditalia.it), October 2010, no. 73. Bank of Italy, Islamic Finance and Conventional Financial Systems. Market Trends, Supervisory Profiles and Implications for Central Bank Activities, in www.olir.it, 2011

[12] The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 is a U.S. federal law  countersigned by U.S. President George W. Bush 26 October 2001. Sunset provisions have been added to the law, limiting the validity of some of the provisions of the Patriot Act that are most detrimental to citizens' freedom and privacy, such as those on full access to personal information, as of December 31, 2005. But according to various organizations, including the civil rights organization ACLU, these sunset provisions are not enough. The Center for Democracy and Technology (CDT) is of the same opinion.

[13] "ADDRESS OF HIS HOLINESS POPE FRANCIS TO THE MEMBERS OF THE NATIONAL ANTI-USURY COUNCIL", Sala Clementina Saturday, 3 February 2018.

[14] In detail, in paragraph 2411, where it is reiterated that contracts are subject to commutative justice, the foundation of every other form of justice, which regulates exchanges between persons in respect of their rights and which strictly obliges each contracting party under pain of reparation for injustice in the form of restitution, and in part six, paragraph 2443, Love for the poor  where the text draws attention to the Gospel passages that traditionally found the prohibition of lending at interest^[14]. Finally, paragraph 2446 recalls the teaching of the Second Vatican Ecumenical Council (1962-1965) according to which "the obligations of justice should be fulfilled above all, so that what is already due by way of justice is not offered as a gift of charity" (ApostolicamActuositatem).

[15]"Usury and Catholic Social Morality" 20 February 2017 - Author: Mauro Ronco