I became interested in Islamic finance after reading the CFA Institute’s Primer (2009) and was happy to see the successor monograph - Islamic Finance: Ethics, Concepts, Practice (2014).

I see Islamic finance as a conceptual failure, but then I am a confirmed Islamic finance sceptic. I would advance the following arguments:

• Mahmoud El-Gamal’s assertion that Islamic finance has abandoned its original ethical content and placed excessive emphasis on legal form is quite convincing (See his Islamic Finance: Law, Economics, and Practice, 2006) . The devotion of considerable energies to the creation of sharia compliant copies of existing interest based financial instruments is inefficient and costly to the users of these instruments. I personally met an issuer of sukuk who said that many (non-Muslim) investors bought them simply because they paid higher yields than otherwise similar bonds. The issuer seemed to view the pressure to issue sukuk as an annoyance.

• The CFA Institute Research Foundation’s Islamic Finance: Ethics, Concepts, Practice is a balanced and thorough literature review. It perhaps wisely (!) does not attempt a translation of the forbidden riba because of the confusion surrounding its real meaning. Is it interest? usury? excessive interest? exploitation of debtors? predetermined profit? We must conclude that there is confusion around one of the central tenets of Islamic finance – the meaning of riba. The fatwah of Sheikh Tantawi, of Al Azhar University in Cairo in favour of some forms of bank interest as predetermined profit (p. 27 of the CFA review) – although perhaps politically motivated - created much turmoil, debate pro and con, and rebuke within the Islamic community. Tantawi’s institution is reputed to be a respected centre of Islamic scholarship, and to my understanding, as a leader of Sunni scholarship, he had espoused his views for some time before. The fact that there is such controversy calls into question the claims by Islamic scholars of the existence of a consensus that all interest is riba. It would appear to be wishful thinking on their part, if not intellectual dishonesty.

• In my admittedly limited search for Islamic advocates of the ban on interest, I read some of Justice Usmani’s judgment on interest (Pakistan). To my dismay, a central part of the argument there (see the judgment’s sections 135 and further) is the Aristotelian notion, shared by many classical philosophers and the other Abrahamic faiths, that money is unproductive. Consequently it should not earn a return. The insight of modern market based economics and finance - which is missed by those scholars - is this: while money is not a fertile farm, a manufacturing plant, or a computer program, it is fungible with all of these and all other market traded commodities, services and spot and forward financial instruments with holding period returns. Market arbitrage will price out these relationships and establish a time value for money.

• To those of us schooled in western based finance and economics, agents’ time preference and the time value of money will demand compensation through market arbitrage, whether through interest or through Islamic deferred mark-up structures. Islamic finance advocates have not been able to address successfully the intellectual contradiction between this market tendency and a ban on interest. Part of their confusion results from a tendency to mix normative (moral) and positive (analytical) deduction.

• Risk sharing on the surface sounds like a good idea. However, if honestly and rigorously applied to banking, it would lead to a gross asset-liability risk mismatch, or it would turn banks into venture capital companies, with bank runs when they fail! Thankfully, Islamic bankers have enough sense not to engage in true risk sharing, and instead use the Islamic copies of conventional mortgages and loans.

While a conceptual failure, Islamic finance is clearly expanding at a good rate, and global financial markets and firms see opportunities to satisfy the preferences of Islamic investors and borrowers. In that sense it could be deemed successful.
Islamic finance does have something to say about issues such as excessive financial leverage, the capitalization of banks, risk management, and financial market ethics. Instead of erecting a parallel financial system, Muslims’ energies would be better directed towards engaging with regulators and legislators to communicate their views on these issues.

Bob Hannah, CFA
Gatineau, Canada