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Islamic economics revolves around the concept of economics restructured along Islamic philosophies. It emerged after the end of World War II, during the ongoing decolonization process (Sramek , 2009). It is part of the Islamic fundamentalist movement that is quickly gaining ground in many of the Islamic countries. The defeat of the Arab countries in the six-day war against Israel is said to have boosted Islamic fundamentalism. Many thought this defeat to be a punishment from God (Allah) for turning away from Him and embracing foreign Western, ideologies. (Bjorvatn, 1998) They were inherently opposed to the basic Islamic principles. As such, they were unable to resolve the problems that the Muslim world faced. In response to this, the fundamentalists urged a return the Islamic law (Sharia), which they believed would solve all their difficulties, both social and economic. Islamic economics emerged as part of the Islamic resurgence, which was an effort to cut off all ties to the social, economic, political and cultural heritage inflicted on Muslim countries by the Western colonial powers (sramek). This paper will explain the history of Islamic economics, the Islamic banking system and its impact in the present world economy both in Islamic and non- Islamic countries.
The concept of Islamic economics has been gradually attracting attention since its inception. Its fastest growing segment has been Islamic banking. This is proven by the fact that in the 1970s, such banks were mainly in Muslim countries and even then they accounted for a mere 2% of the existing banking market. Three decades later, it had grown to 15% (2009). In addition to this, it is vital to point out that Islamic banks are not only confined to Muslim countries. Currently, even large Western banks offer services that are compliant to the Sharia law. The message to revert to sharia law had great appeal due to widespread unemployment, poverty and inequality. Many Islamic scholars have attributed the economic success to the high moral standards among the people in those days as well as religious inspiration (1998).
Current literature on Islamic economies focuses on Islamic institutions and financial instruments. This tends to give an impression that the disparity between Islamic and conventional economics is in the instruments as opposed to the foundational aspect (Aydin, 2013). However, Islamic economics is not limited to the prohibition of specific services, rather, it is a vastly different economic system. It attempts to answer core economic questions in a different and unique but understandable way. This explains why it is has been widely accepted even by non- Muslim individuals.
The end of the last century marked the fall of all socialist regimes ushering free market capitalism into Europe as the dominant system the world over. The 2008 financial crisis was the worst one recorded after the Great Depression. Several years later, the world is still reeling from its effects and is trying to recover. With the crisis, many questioned the future of capitalism. Aydin (2013) considers the 2008 financial crisis to be quintessentially a moral crisis dating back to the Enlightenment period. Adam Smith’s metaphor of the “the invisible hand” is widely accepted by economists as an elucidation of the strength of the free market economy. It explains that supply and demand if molded by self- absorbed human nature may be sufficient to resolve most if not all of the economic problems experienced in a said society. However, in the current case, the invisible hand lacks a moral compass turning it into a “stealing hand”.
The anti-thesis of capitalism was communism. However, it failed because it misconstrued human nature. It wrongfully attributed all the problems of capitalism to “private ownership”. Thus, it established its practicalities on collective ownership that killed the individual incentive that drove capitalism. Communism considered religion as poison for the masses and instead attempted to create a considerate society solely based on secular values. Eventually, the system collapsed due to its paradoxical ideologies. With the recent financial crisis, there is a need for an alternate paradigm. Islamic economics may just be this alternative if it can go beyond the existing frame of conventional economics. However, for it to be a suitable alternative, it may have to contradict the existing frameworks. Islamic economics has to offer new and appropriate techniques for it to be widely acceptable. Since it is based on moral grounds, it could form a suitable alternative over time.
With regard to economics, two worldviews exist: the materialist and secular as well as the spiritual and religious. The former tends to reject the spiritual realm proposing that there is nothing beyond the material realm. In order to understand the difference between Islamic and conventional economics, it is imperative to understand the Islamic worldview based on the Quran, their holy book, and Hadiths. While conventional economics was based on the materialistic views, Islamic economics is founded on Divine guidance and human reason and morality. Islam recognizes both the material and spiritual, social and moral need of man. In this case, man’s well being is defined by moral, social and spiritual perspectives as opposed to a hedonic one. As much as Islamic economics supports the free market, it provides certain filters that protect one from the unfairness and madness associated with the market. Since Islamic economics depends on different principles, it could be considered a distinct economic paradigm.
Several people have attempted to describe Islamic economics. The first attempt at a comprehensive description was that by Hasannuzzaman. He explains that “Islamic economics is the knowledge and application of injunctions and rules of the Sharia that prevent injustice in the acquisition and disposal of material resources in order to provide satisfaction to human beings and enable them to perform their obligations to Allah and the society.” However, this description has some shortcomings most prominent of which is that it is vague, as it doesn’t point out which rules are relevant to Islamic economics.
Umar Chapra created the most comprehensive definition: The primary function of Islamic economics, like that of any other body of knowledge, should be the realization of human well being through the actualization of the maqasid. Within this perspective Islamic economics may be defined as that branch of knowledge which helps realize human well-being through an allocation and distribution of scarce resources that is in conformity with Islamic teachings without unduly curbing individual freedom or creating continued macroeconomic and ecological imbalances.”
Islamic banking, also known as sharia compliant finance, refers to banking consistent with Islamic law (sharia) and its application through Islamic economics.
The dominant principle on which Islamic banking is based is the prohibition of usury (Riba). Riba refers to excessive profit levied on money lent out. The prohibition of usury is not unique to Islam; it was a common practice in the past. During that period inability to repay one’s debt could lead to slavery and this became generally unacceptable. In response to this, interest rate regulations were put in place. Such protocols were also probably put in place to curtail exploitation by important goods, like crops and animals. The Muslim community being barter traders was heavily dependent on such goods.
Islamic proponents believe that any rate of interest, even the lowest one constitutes usury and should be banned entirely.
Apart from the prohibition of Riba, several other Quranic principles exist that underlie Islamic banking. One such principle is the obligation of Muslims to give alms to the poor. This is termed as Zakat. For the liberal Muslims, zakat is considered to be their personal religious duty. However, for the conservative Muslims, they maintain that zakat should be institutionalized and that the collection should be centralized and enforced bylaw. In addition to this, they believe that the government should redistribute the collected revenues equitably (sramek). Another principle is the prohibition of speculation and gambling (gharar). It renders a ban on financial derivatives and futures under some interpretations. Gharar also considers conventional insurance unlawful as an attempt to protect oneself from the will of Allah. Takaful is the Islamic alternative to insurance. It is based on mutual risk sharing and cooperation. It is based on the idea that a situation considered uncertain to an individual might cease to be uncertain if a large number of similar individuals are involved. Thus, insurance results from combining the risks of many people. As a result, each ‘insured’ individual enjoys the benefits afforded by the law of large numbers.
Islamic Banking Instruments
Due to the prohibition of riba, there is a need for interest-free banking methods. Two main transactions are used in Islamic banking; profit and loss sharing (PLS) and mark-up methods. The two Sharia compliant profit and loss sharing partnerships are known as mudaraba and musharaka.
Under a mudaraba agreement, the individual with the capital gives it to the entrepreneur who carries out the business. Profits are then divided between both parties based on pre-agreed proportions. In the event of business failure, both parties are affected, the lender losses his investment and the entrepreneur losses his effort and time. Mudaraba is an equivalent to limited partnership in conventional economics.
Musharaka on the other hand involves all interested parties contributing the required capital. They then share the profit or loss together appropriately thus is similar to a general partnership.
In cases where partnerships are not permissible, mark-up methods are utilized instead. The two major methods used are ijara (leasing) and murabaha (deferred payment).
In the case of murabaha, the bank purchases the property for the client, it then marks-up the price before selling it to the client. In most cases the client pays the bank later commonly in installments. Murabaha is thus considered similar to a loan or mortgage. Under ijara, the bank owns the property and rents it out to the client for a fee. This rental fee is fixed for the entire duration of the contract and gives the client the right to enjoy full use of the item. It may result in transfer of ownership or not.
There has been some controversy surrounding the use of mark-ups in Islamic banking. Some individuals believe it to be a disguised form of interest. As such, they believe that Muslims do not have the right to refuse interest while imposing high mark-ups. However, proponents of Islamic economics insist that murabaha is only permissible to a limited extent thus cannot be considered interest. Diminishing musharaka is considered an attempt to disguise mark-ups. In such a case, the bank and individual buy a property as equal partners. Afterwards the buyer gradually pays the bank a rental fee over time such that eventually, the buyer has complete ownership of the property. The installments to be paid are based on mark-ups.
Current Islamic Banks and Products of Islamic Banking.
Islamic banks are mainly but not exclusively located in Islamic regions such as North Africa, South East Asia and the Middle East.