Dhimmitude 101-Harvard Islamic Finance Forum: An Outsider’s View on Islamic Finance

Islamic finance is, in the words of many of its practitioners and observers, one of the more exciting things happening to the Muslim World today. Many view it as a test case – a potential experimental ground – for how Islam’s Divine Law – the Shariah – is likely to mingle with or adapt to the changing circumstances of modern times. Since its inception in the 1960s and 70s, the popularity, scope, and diversity of what the field of Islamic finance has to offer has only grown with time.

Today, the worldwide market for Shariah-compliant Islamic financial products is estimated to be around $750 billion – a number that continues to grow faster than traditional (conventional) finance. Many countries – most notably Bahrain, Malaysia, and Pakistan but also United Kingdom have positioned themselves aggressively to benefit from and shape this emerging field. Not only have a large number of new “Islamic” banks emerged to cater to a demand for these services but also many western banks, law firms, and accounting firms have opened Islamic finance “windows” to dabble in this growing market.

To support the growing appetite of Islamic financial services, a very lucrative “industry” of Shariah Advisors – strictly regulated in some countries, but not so much in others – has emerged to cater to the needs of the banking industry. Shariah Advisory Boards, at both institutional and national levels, are formed to try to make the field more rigorous and systematic. Training and certification programs have also been devised to meet the growing needs of qualified human resources in the industry. Needless to say, however, that the industry continues to suffer from acute shortage of talent and manpower.

The Harvard Islamic Finance Forum

A plethora of intellectual activities has also ensued with institutions and universities in Bahrain, Pakistan, Malaysia, United Kingdom and the United States playing a major role in developing the theoretical underpinnings of the field. The Harvard Islamic Finance Forum is one such meeting that has consistently attracted the academic community as well as practitioners, especially those living in the West, to participate in stimulating intellectual dialogue on the subject. Hosted and organized by the Harvard Islamic Finance Project (HIFP), this year’s 8th International Forum was held at the Harvard Law School in Cambridge, Massachusetts on April 18-20th, 2008.

This article attempts to report upon and summarize the interesting debate at the Forum by taking an “outsider’s view” as it questions some of the assumptions that underpin the field. Subtitled “Innovation and Authenticity” the Forum engaged some of the leading researchers, thinkers, regulators, and practitioners in the area. Names like Umar Chapra, Robert C. Merton (Nobel Laureate), Frank Vogel, Samuel Hayes, and Shamshad Akhter (Governor, State Bank of Pakistan) were among the speakers at the Forum.

The growth of the Islamic financial industry is indeed astounding and it provides a much demanded service to a certain sub-section of the financial markets – increasing customer inclusion, satisfaction, product innovation and diversity etc. All of these leave ample reason for celebration. Still the cloud of authenticity continues to linger on the field. In many ways, the battle between innovation and authenticity are at the very heart of the controversy and disagreements around the evolution of Shariah and Fiqh since Islam’s inception.

Balancing Authenticity and Innovation

There are two main types of problems that continue to plague the field from an innovation and authenticity standpoint. The first of these deals with largely operational issues that are inherent within the field of Islamic finance as it is practiced today. Addressing some of these problems may range from easy to moderate difficulty as these may, on the one hand, merely require standardization and systematization of certain practices to, on the other hand, extending to Islamic finance some of the well developed regulatory and legal frameworks already available to conventional finance.

Examples of the first type of problem includes issues such as the need for standardization of Shariah rulings, and hence Islamic financial products, across various geographical and sectoral jurisdictions; the need to enhance the authenticity and credibility of Shariah Boards that advise banks and other institutions on compliance; the need to develop regulatory guidelines and audit mechanisms for these institutions; the need to better extend customer rights and protections to Islamic financial transactions; the need to develop legal and regulatory frameworks that support dispute resolution in the Islamic financial context, especially in the Western world; and the need for appropriate disclosure of Shariah-rulings to reduce compartmentalization and allow dissemination, adoption, and cross-examination. As the field of Islamic finance develops and grows, worthwhile progress continues to be made on many of these fronts.

The second of the two types of problems are of a much more broad and substantive nature. These concern the broader issue of what Islamic finance – and economics – really should be? Is there something inherently unique about Islamic finance and economics that extends its importance beyond merely a way of repackage traditional financial services to cater to the specific needs of a distinct market segment? Answering some of these questions and ensuring the development of the field along more “authentic” lines then becomes a major challenge for practitioners, academics, and policymakers-regulators alike.

Islamic Finance and the Issues of Authenticity and Integrity

Driven by strong consumer demand for Shariah-compliant financial products, in many ways Islamic finance is an area where practice has preceded theory. While Islamic financial practitioners and institutions develop new products to meet the diverse needs of their clientele on an almost daily basis – and are aided by Shariah Scholars and others who engage in a discourse focusing primarily on transactional integrity – the broader theoretical development of these ideas continues to lag significantly behind.

For instance, it is an open secret in the Islamic financial community that one of the areas of work is to find ways to create financial instruments that could closely replicate the risk and return profiles of those available in modern finance. For example, one of the overriding principles of Islamic transaction law is the impermissibility, under certain conditions, of undertaking two different transactions within the same contract. Problems like these have been addressed by breaking down the overall questionable transaction into two segments – each of which, individually, being Shariah compliant – whose combination ends up recreating the overall effect of the forbidden transaction.

While some of this may be legitimately undertaken, one finds some cause to question the validity and integrity of such arrangements in a broader context. Specifically, did Islam, in prohibiting the combining of two transactions into one, really mean to discourage the act of combining itself or did it mean to discourage the effect that this produced? If the answer to the question is the former, the above may be deemed legitimate. However, if it is the latter that was intended, then creating a complex instrument by breaking down the component transactions defeats the whole purpose. Similar logic can be extended to other foundational principles of Islamic commercial law such as prohibition of riba (interest) and gharar (i.e. risk) etc. Indeed, should one find this line of argumentation to be convincing, one would look at the proliferation of Islamic financial products today with some degree of suspicion.

If the entire purpose of Islamic finance, as it appears to some observers, is to replicate and validate traditional financial products and instruments then one may begin to ask the question: Does Islamic finance have any inherent intrinsic value other than catering to the needs of certain market segment that continues to demand an aura of Shariah compliance – no matter how flimsy it may be – for their financial needs? How Islamic is Islamic Finance?

The Search for Deeper Meaning: Towards an Islamic Economic System?

Ultimately, it all boils down to taking a fresh look at Islamic finance and economics in the light of the higher objectives of Shariah – the codified Divine Law of Islam. A deep theoretical understanding of an “original” Islamic economic system is precisely the challenge that will rid the field of Islamic finance of its crisis of credibility and authenticity and provide it with a fresh impetus to grow faster and further. Is it even possible – if only as an economic thought experiment – to conceive of a system that works without riba and gharar, among other things? What would this system look like? What was it supposed to achieve when Allah ordained it in the first place, and what and how would it actually help promote justice, equality, and well-being of the society?

Nothing short of taking the current operational understanding of Islamic finance, as it is practiced today, and extending it to develop a much deeper system theory of Islamic finance and economics is the need of the hour. Achieving this worthy goal will require tremendous intellectual power, individuals with deep and sympathetic understanding of both Shariah and the fields of economics and finance, and a sincere desire to marry these together so that the product is more than the sum of the parts.

This massive theoretical and intellectual project must be undertaken in a proactive rather than a reactive mode. That is, the underlying skeleton and structure of an Islamic economic system must be conceived not as a reaction or a critique to capitalism or socialism, as has often been done in the past, but as a standalone economic framework built from scratch from undisputed principles of Muslim commercial law.

What this enterprise really needs today – and has seriously lacked thus far – are the Adam Smiths, Maynard Keynes, and Irving Fishers of Islamic Economics – individuals of deep understanding and grand visions who could interpret economics under a different set of underlying principles, axioms, and institutional structures. What is also needed is that this theoretical project be complimented with serious empirical work to further understand and develop the field on solid empirical footing.

Today, the twin fields of Islamic economics and finance are still in their infancy. They have, however, now reached a point where questions of validity and authenticity are raised with increased seriousness. Almost simultaneously, though, these fields also stand at an inflexion point in their historical development that may lead to unprecedented future opportunity. Proper application, aided by a robust theory, could lead Islamic finance to new heights. The converse may lead to disillusionment and even demise.

The jury is still out on whether Islamic finance and economics can bring anything new to the world of traditional modern finance or will merely remain a replication of the latter. The ambitious intellectual agenda described above may bring some much needed answers.