By Dr. Masudul Alam Choudhury
Following the Great Recession, the financial volatility and slump globally, the financial community everywhere came to hear the announcement that Islamic financial instruments are the answer to a return to stability and profitability. Islamic banks are thus slated as the financial model for sustaining growth, profitability, stability and well being. In all of these social, economic and financial goals the flag of the shari'ah is hosted.
What are the realities regarding the meaning and performance of Islamic finance in general and Islamic financing in particular? This question despite its importance in evaluating the performance of Islamic financial outlets and thereby to recommend paths and possibilities of change cannot be answered objectively. There are no adequate information and data available except the clamor by the enthusiastic corporate agents. There is paucity of information both on the financial side and on the side of social responsibility by Islamic banks.
Consequently, neither the objective and purpose of the Shari'ah (Maqasid al-Shari'ah) nor the material performance from Islamic financing can be objectively gained. There is no comprehensive databank; some are planned for development. The International Association of Islamic Banks has not been traditionally active and has not been successful in establishing such databanks. Where some data exist, they are on a narrow base of financing by projects, sectors, target groups and for insufficient lengths of time. Financing data that exist for short time-periods are aggregated to totals.
Illustrative facts
Financing has become lumpy on Sukuk, Islamic bonds. Primary financing modes of mudarabah (profit- sharing), musharakah (equityparticipation) have been increasingly abandoned. This is the Malaysian case. Murabaha, a controversial instrument of Islamic financing as a debt-instrument with a subjectively determined risk and profitability premiums by mark-up, has been oversubscribed. In the end, Sukuk becomes an independent debt-financing instrument mostly revolving around debt instruments.
There are plans presently by Saudi Arabia, Qatar and Malaysia to finance Sukuk projects to the tune of 1trillion dollars. On this matter HSBC Holdings Plc and BNP Paribas SA remark that -this amount of funds will overwhelm Islamic banks. The bulk of the fund will go into Islamic bond sales to build oil refineries, steel mills and petrochemical plants. Saudi Arabia is expected to spend $3.9 billion in these directions. Qatar will enter Islamic bonds to finance its $100 billion requirements for building the facilities of the soccer World Cup in 2022. Malaysia will spend $444 billion to finance economic developments that started 2010. This will mean that a good deal of Islamic bonds will be floated to raise this amount.
On such oversubscription of funds for financing mega projects HSBC comments: -The capacity of the Islamic commercial banking sector may not be sufficient to satisfy demand for capital, said Rafael Dalmau, the Singapore-based head of the Islamic portfolio unit at BNP Paribas, in an interview Jan. 18, 2011.
Explanation by ilustrative example
All sukuk issues revolve around debt instrument, typical ones, of which are murabaha, istisna and ijara. The first question is that when the end user buys the needed equipment or loan from the sukuk issuer on the basis of the investors funds, the payment inevitably has a profit and risk component to it besides an installment pay-down of the principle. Unless the market valuation of the profit portion of mark-up and the risk portion of the mark-up are not determined, these portions remain as surcharges on the end user. The indeterminate rates in such a case are tantamount to riba. In this way all debt-financing is simply riba.
While a debt-based financing instrument is repugnant to Islam, yet a murabaha-type debt-related problem is solvable for the mutual benefit of the sukuk issuer and the end user, and also for the overall categories of participants -- if the financing instrument becomes a participatory one by way of calculating, deferring, or capitalizing the overcharge into negotiated future liquidation of liabilities and returns.
The emergent method of participatory liquidation of liabilities and the availability of options in the alternative use of overcharges by markups would be mutually good for all: Market-institution determined markup is fair and soft for the end user. It is fair and properly calculable for profit-sharing and risk-sharing between all participants. The distributive savings in mark-up can extend possibilities in product development by the use of financial options that can now become available for using a proportionately lower level, market determined, and institutionally driven use of the mark-up.
By this new method of murabaha financing or deferred financing (tawarruq), istisna, ijara, the ad hoc mark-up as debt instrument would fade away. It is now replaced by recontracted liquidation ratios of risk and profit obligations on a determinate basis at various moments of the joint institution-market engaging discursive process. As a result, there comes about more redistributive productive capital in the participatory financing system.
The debt-based sukuk financing as Islamic bonds is thus changed into a participatory one. The nature of participatory change is shown by means of the below diagram.
Figure 1 points out a system-wide participatory linkages between all categories of suppliers and users arising by means of two-way directional arrows. For instance, while a supplier is financially protected by insurance and reinsurance (takaful), an end user can also take benefit of such a function in its financial obligation with the sukuk issuer. Likewise, an investor could also be one of the suppliers and end users on specific items of end use. The sukuk system now shows market-institution based discursive mechanisms overall.
The maqasid al-Shari'ah is better served in such an extendable social picture of sukuk financing. Now the extension of the market-institution relationships overarches the marginalized groups in society at large. Sukuk financing ceases to be bondfinancing and becomes share-capital as soon as the debt element is taken out of it and the participatory nature of asset development is turned into a social one. Now the marginalized and other kinds of participants can interact for a common goodwill, financially and socially.
So whither is Islamic financing today?
Almost all of Islamic financing financing is locked in debt-based instruments. Emergent instruments are sukuks revolving around secondary outlets such as murabaha, tawarruq, ijara and the like; and a decreasing amount revolving around mudarabah and musharakah, the Malaysian case.
As long as Islamic financing instruments are so formed and capital so raised, these would defy the moral purpose and objective of the Shari'ah.
There is no distributive moral effect while maintaining business profitability in a corporate social responsibility model as would be arising from participation across a wide range of the social spectrum. The poor does not benefit from a closed financing concentrate; the Muslim world (ummah) does not benefit by catalysis of change in forming an ethically sensitive and sound capital market and inter-communal trade. No challenging intellection emerges from the idea of Islamic financing that otherwise could benefit academia everywhere.
The end of prevalent Islamic financing is a fiasco of capitalism. Its model overwhelms the much needed ethical market transformation along with guidance as regulation accumulating into an ummah-wide regulatory institution. Alas, the contrary is the end in sight with the cause and effect of debt-based financing, defying trade-centered moral transformation by the scheme and meaning of masqasid al-Shari'ah.
About the Author
Professor Dr. Masudul Alam Choudhury- Department of Economics and Finance, Sultan Qaboos University, Muscat, Sultanate of Oman masudc@squ.edu.om
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