Finance & Banking


Shari’a is the foundation of the Islamic finance industry. It differentiates the industry with conventional
finance. But the replication of products creates substantive issues for the industry. The industry fails to
recognise that law has the power to influence behaviour. In this article, we explore the concept of law and
how it is pivotal in creating a defined culture.

That the Islamic financial industry is growing is
seen by exponents to be a reflection of the support
for the principles and products of the industry. It
highlights both increased religious sensitivities of
the people along with an acknowledgement that
the industry has the products to meet the needs of
a discerning clientele.

That the Islamic finance industry is growing is not
providing detractors any comfort. The industry is as
capitalist as the interest based financial system, its
substantive values are the same, the difference is
only terminology (and even then some would argue
we should change product names to their English
counterparts). The never-ending form vs. substance
debate plagues the industry but it is not destroying
the industry. It is just benign tumor: frustrating, not

That the Islamic finance industry is growing is good,
or is it? The industry is only 40 years old; it could
have furnished any model it wanted, but it chose
this model, and it is this model that is flourishing. It is
a model where clients, bankers, lawyers, marketing
managers and Islamic scholars butt heads and form
a unified opinion which meets the objective of
each. For the banker and client, it is profit; for the
market manager it is revenue; for the Islamic scholar
it is Shari’a complicity, and for the lawyer, it is
simply the harmony of client needs with regulatory

So what is the contemporary Islamic finance model?
For all the many laws and products, fatwas and
industry standards, the fundamental premise is
simple: if the Prophet Muhammad was present
today, these are the rulings he would have passed.

This is hardly an easy feat; there is bound to be
disagreement on the legislative intent of the
Prophet. Thus Islamic finance, like Islamic law as a
whole, has been confronted with differences of
opinions. Nevertheless, there is much the industry
does agree upon allowing there to be a unifying
bond between most Islamic financial scholars.

Even so, transposing the opinions of a 7th century
legislator to the 21th century is wrought full of
uncertainty. Contextual (and temporal) differences
make it difficult for the Islamic scholar living many
miles and years from desert Medina to empathise
completely. What is harder is providing a Shari’a
opinion for new phenomena. A mistake is to assume
that an opinion on new phenomena that has no
precedent during the time of the Prophet is part
of the Shari’a. Today’s banking and finance sector
is completely novel and unique. Contract practiced
at the time of the Prophet, such as mudaraba, are
different to that is practiced today. For one thing, the
former was used for single projects, whereas today’s
mudaraba can be used to fund multiple projects.
The best scholars can do is to relate principles.

In addition to this Shari’a engineering, we hear of
the industry being ethical and an alternative to the
conventional financial industry. Emphasising the
ethical element presupposes the capitalist system is
unethical, a quite damning statement for a sector
that is operational in every country in the world
and remains in demand despite concerns. There
are undoubtedly unethical elements in banking
and finance, but its universality shows its strength.
People willingly go to banks for their financial
requirements and are generally satisfied. To boast
of being an alternative, the industry proclaims that
its offerings are substantively different. This does
not appear to be the case. For example, businesses
wishing to build capital can access bank loans
or sukuk. Both instruments ultimately place the
business in a position of debt.

Even though the industry is currently not
substantively different, it is attractive because
scholars deem that products and services are Shari’a
complaint. In other words, products and services
are those that the Prophet, as legislator, would have
accepted if he had been present today. As it is, the
derivation of the law is assumed to be an objective
task, without being mired by the subjectivities of
the scholar and fully connected to the canonical
sources of Islamic law: the Quran and the Sunnah.
In consequence, the law, by having this connection
has more immediate power than the effect of the
law. Hence, strange decisions have been proffered in which validation for the legal opinion comes from
tenuous links to the source. As one example, the
33% threshold for debt to equity ration in stock
screening methodologies derives from a hadith on
inheritance and perhaps one on culinary habits. The
link is fallacious.

The formalist approach – relying exclusively on the
Quran and Sunnah – towards law originates from
the thought of Imam Shafi, who was committed
to ensuring that the subjective opinions of the
scholars were minimised. But this could not always
be maintained, and thus scholars relied on concepts
of maslaha (public benefits) or darura (necessity)
to show that the Shari’a had the power to adapt
to changing exigencies. This is the instrumental
approach. In Islamic finance both approaches are
used and through their utilisation substantive values
of the law are conveyed. Any form of law carries and
confers a set of values which imbues itself in the
law and spreads in the action that is commanded,
or in the absence of an action that is prohibited.
Islamic finance is no different, but the substantive
values of the law appear to be very similar to that
of the conventional financial service sector. This is
forgotten and could be detrimental for the industry
in the long run.

Returning to the original question, what is the
contemporary Islamic financial model, the answer is
that today’s model of Islamic finance is one rooted in
the Islamic sources but shaped to meet the needs of
a capitalist mentality. The term, capitalism, is casually
used in the Islamic finance industry and is considered
as a negative. Generally, detractors of capitalism are
quick to deplore it, slow to offer any alternative.
They shout inequality, while probably working in
a capitalist organisation. Capitalism is to do with
the private ownership of land, labour or capital. Its
opposite would be state ownership. By owning the
factors of production, a private organisation profits
off what it owns. Thus, the capitalist mentality of a
person is to profit off that which they own.

The financial sector exists to allocate money. They
help an individual or business to gather money in
order to 1) transact for day to day needs; 2) be
secure in emergencies; 3) speculate for profit;
4) spend charitably. The Islamic finance industry
attempts to encourage the fourth, but this is more
of an afterthought especially as very few, if any,
commercial enterprise is preoccupied with profiting
in order to disburse charitably.

Islamic finance uses a combination of the formalist and instrumental approach to the Shari’a, but as few
if any 7th century law offers appropriate analogies in
the 21st century, most of the laws in Islamic finance
are in fact instrumental.

This means the subjectivities of the Islamic finance
scholars will affect the law passed. At this juncture,
we turn to look to the concept of law in order to
explain the impact of subjectivities on law. All laws
exist to guide behaviour by rules. It is typically issued
by a higher authority, which is usually the state. For
religious laws, the authority would be God and His
messenger. The state uses the law as a means to
ensure order in society. Any descent into anarchy
would weaken the state and create disunity. Creating
order does not simple mean limiting violence; it also
means justice and fairness prevails between citizens.

For political philosophers, the state is the natural
evolution of men’s communal needs. Aristotle
argues that the state commenced with individuals.
Individuals create families. Numerous families create
communities and numerous communities create
the state. The objective of each group is to secure
happiness, and the state’s objective is to ensure
that each grouping under its authority achieves
happiness. To achieve this happiness, each member
of society should be virtuous, and the state, through
the issuance of law, encourages the inculcation
of virtue. Part of virtue is being just, and justice
between members of society should be equal or it
should be the consequence after one party has lost
something in a transaction with another party.

However, the consent of virtue is going to reflect
the substantive values of the ruling regime. Aristotle
believed the regime could either function as an
authority looking out for the best interests of the
citizens, or it could look out for itself. Each regime
has their own unique set of values, which would be reflected in the laws that were passed. Hence, there
is an axiological unity between the regime, the laws
passed and the overall morality of society.

In relation to making laws, these could be created
by customary practice of different communities or
enacted by the state. Aristotle opined that the best
system is the former, where precedents are formed
and these are utilised to determine similar cases.
Here he is preempting the common law system used
in the UK and former British colonies. In terms of the
latter, this alludes to the passing of statutes. Statutes
are passed either as a codification of customary law
or to account for a new development. In light of
the notion of separation of powers – the idea that
a state should rule by dividing their authoritative
powers into three independent organs: Executive
(the power to administer a state); Legislature (the
power to issue laws); and Judiciary (the power to
adjudicate whether citizen has followed the law) –
only the Legislature can pass laws. So, for any new
phenomena a judge cannot promulgate law and
must wait till new statute is ordained.

The judiciary, then, only has recourse to the
customary and enacted law, and occasionally the
facts may not fit the law. It is up to the judiciary to
pull the law to the case. Aristotle gives the example
of a law that makes it illegal to injure a person with
an iron instrument. In a case, a man hits another, and
on his hand is a ring made of iron. Should the man
be prosecuted under this law? The literal meaning
of the law would suggest yes, but intuition would
suggest otherwise. In situations where the law is
not exact – and these situations are many – then
the judiciary has to place themselves in the shoes
of the legislator, to think of the purpose of the law and what could be captures under it. In this case,
rings were unlikely to have been captured by the legislator.
To summarise, law according to Aristotle:

  1. Passed to encourage virtue amongst citizens
  2. Reflects the substantive values of the regime
  3. Can be based on customary practices or
    enacted by the regime
  4. Interpreted by the judiciary who attempt to
    empathise with legislator when passing the law.

Returning back to our discussion on Islamic finance,
there is no sovereign authority present. Law is
traditionally assumed to emanate from the regime.
Previous regimes can pass laws which still perdure
long after the individuals within have expired. The
same is true with Islamic finance. The Prophet
passed a set of laws, many of which are still relevant
today. However, regimes change and are considered
to be the new legislative power. In theory legislative
power always resides with the Prophet.

That is theory. In practice, legislative power shifts
in each and every generation. To deal with new
phenomena requires new thinking. It means that
Islamic finance scholars in fact create law. To create
the law, they should be influenced by the “regime”,
which would be the Prophet. But once again this is
not the reality given that there are many different
parties in the product structuring process. One
could argue that there is a constructed regime in
Islamic finance. The bank, the client, the lawyer, the
standard setting bodies are all part of the regime
that administers, passes laws and adjudicates. The values of all parties of the regime will be imbued in
the products created.

Yet any law passed has to be anchored to Islamic
law, and this leads to frequent conflicts due to
the tenuous connection between pre-modern
Islamic law to modern exigencies. The Islamic
finance scholars will then have to empathise with
the legislator, and the best way is to rely on the
maqasid (the higher objectives of Islamic law). This
has become a buzzword for Islamic law as a whole
as it is seen as an interpretative method that divests
from a slavish following of rules passed in a context
different to the modern day. The maqasid endevour
originate with scholars searching by induction
for purpose of laws. They aggregated the laws to
find that Islamic law is to protect five things: Life,
Religion, Lineage, Wealth and Intellect.

In situations where a direct law is not present
or cannot be analogised from an existing text,
considering the maqasid helps the Islamic jurists
to pass law. So, with a lot of Islamic financial laws,
they are to protect wealth. But, as mentioned above,
the laws are there to also encourage a capitalist
mentality – that is to make profits. There is thus a
dual aim to the construction of Islamic financial laws.

A case in point is the perspective on interest and
its dissimilarity from the profit rate on a murabaha.
Exponents argue that interest- based products are
like pork – haram is haram. But let us look at it in
another way. Khamr or grape wine is prohibited;
there is no mention of beer or marijuana. Yet
scholars find the reason of the prohibition is due
to the intoxication resulting from consuming
these products. They use analogy to connect the
prohibition to all intoxicants. With interest-based
products, the notion is that paying extra on loan is
not allowed. The difference with murabaha is that it
is a trade base product, but parties appear to be in
the same position as of parties in a loan transaction.
There is debt, and the repayment looks awfully like
interest. Scholars did not analogise the effects of
interest-based products with other products, yet
they did so with Khamr.

Now it is not the purpose of this article to criticise
the judgements of scholars. It is to show that a
certain thinking prevailed to distinguish between
interest-based products and murabaha. Another
mode of thinking could have focused on the effects,
which would have meant that murabaha as it is practiced today would not have existed. But it does
exist, and indicates the values of the Islamic finance regime.

That the Islamic finance industry has grown is
definitely good and impressive. But it has to be
self-aware. The power of law to motivate behaviour
is rarely considered, and it has to be conscious
that if the products are imbued with values of
capitalism, then the overall industry will reflect that.
The consequence of this is the development of a
culture which may regard as not being “Islamic”. At
the very least, and at the very worst, the industry
will continue to be accused of being similar to
the conventional finance sector if it remains on
its present trajectory. Thus, to argue that it is an
alternative, without providing an alternative way
of practicing with substantial differences in value,
will become more difficult as Muslims become more
affluent. The industry itself may grow impressively
with the growing demand. However, if it does
not reconsider the content of the laws, there is a
real possibility that the problems that afflict the
conventional financial services sector will damage
Islamic finance.

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