Haraam to Halal

While the West continues it's 'war on terror' in places like Afghanistan and desperately tries to staunch the flow of bank losses with ever growing bank bailouts, the Muslim world is quietly going about doing things in a different way. In case you missed it, the new president of Somalia Sharif Sheikh Ahmed bowed Saturday to demands from Islamist insurgents, agreeing to a truce and the introduction of Sharia law. Meanwhile, the Pakistani government agreed to the adoption of Sharia law in the Swat Valley in return for a pledge from local Islamist leaders to lay down their arms. Of course, we're up in arms over the agreement, particularly with Pakistan, where Taliban-like forces now control an area 250 km away from Islamabad, the capital of the nuclear-armed nation. Images of thieves' hands being cut off, girls' schools being closed down and women being stoned to death for venturing to the market saturate the western press. While it's hard to defend any of these practices, one story from the Muslim world and it's Sharia law seems to be thriving, Islamic banking.

RBS lost £24 billion last year; AIG lost $62 billion in 3 months! Inconceivable numbers. Too big to fail, so the British and American government continue to throw good money after bad. Banks losing money in a system they created. Their punishment? $180 billion dollars so far in handout for AIG so they can pay their executives 'retention bonuses', while the former RBS chief executive Sir Fred Goodwin, who was forced out last autumn, gets a £700,000/year pension at the age of 50! Yeah western banking system! Working well I see. Can we still sign up for that Sharia hand cutting off thing? Apparently, it doesn't even need to be that drastic. Sharia compliance in finance boils down to a couple of important points. One, the prohibition of Riba, or usury - interest; two, transactions must be backed by real assets with risks and profits that are shared by the bank and the customer - Mudaraba - therefore giving incentive to the banker to ensure the deals are sound. Investing in casinos, pornography, arm dealers or anything to do with pork is out; long-term investments in projects considered to benefit society are in. Interest payments, short selling and contracts considered excessively risky are also prohibited. That rules out some of the products that got Western finance into so much trouble such as sub-prime mortgages, collateralized debt obligations or credit default swaps.

As financiers are required to share borrowers’ risks, depositors are treated more like shareholders, earning a portion of profits instead of haraam (forbidden) interest. Financing deals resemble lease-to-own arrangements, layaway plans, joint purchase and sale agreements, or partnerships. The most commonly used loan is a type of mortgage, known as a diminishing musharaka (partnership) contract in which the bank and the client form a partnership, with the bank providing up to 90 percent of the purchase price, and the client at least 10 percent. Over a period of usually 10 to 25 years, the client buys out the ownership share of the bank which makes its profit from the rent paid by the client for the share the bank owns. In the event of a rental or repayments default, the bank may advance the clients an interest-free loan (qard hassan in Arabic) to enable them to continue their payments during tough times in anticipation that they will pay in full when the economy rebounds. Sukuks are the equivalent of bonds, but instead of selling a debt, the issuer sells a portion of an asset which the buyer is allowed to rent. There are some who don't believe these instruments are Sharia compliant and this is where things get foggy. An example of this is Muhammad Yunus, the Nobel prize winner in 2006 along with his Grameen Bank whose micro-credits have raised millions out of poverty in Bangladesh but are often criticized by fanatics for not being true Islamic banking. "Islamic finance does demonstrate good banking behavior that has been perhaps lost over the last 10 years or so," said Neil Miller, head of Islamic finance at Norton Rose and an adviser to the British government. "Islamic banking is saying we are close to our clients and we're only going to do genuine transactions where we can see the asset, we understand the asset, we can make an assessment of that asset: whether it's financing a ship or an aircraft they will go and have a look at the business. It's giving guidance as to what banking should be."

Still growing at 10-15% a year and valued at about a $1 trillion, 5 times higher than 2003, Islamic banking has been around since the time of Mohammed, but it's modern incarnation came into being in the late 60's in Egypt and the 70's with the first full fledged Islamic bank being the Dubai Islamic bank, born in 1975. Of course the gulf is still the heart of the movement where Al Rajhi Bank of Saudi Arabia has become the world's largest Islamic retail bank, but Britain is now home to five wholly Sharia-compliant banks, France and Australia are trying to lure business while Citibank, HSBC Amanah, Deutsche Bank and UBS of Switzerland all offer Islamic deposits and Sharia-compliant financing facilities. Future growth lies in Asia however, particularly Indonesia and Malaysia. Before we scoff at the prudishness of the no-interest clause in Islamic banking, westerners should remember that charging high interest rates to lend money is repeatedly condemned in the Bible. The Greek philosopher Aristotle denounced it, the Romans limited it, and the early Christian church prohibited it. Hoarding is frowned on in the Koran, so savings earn no return unless put to productive use. “Money should be used for creating better value in the country or the economy,” according to Rasheed Mohammed al-Maraj, governor of the central bank of Bahrain. “Money cannot generate money.” Well, not forever at least.

Money in our financial system is debt. What we're experiencing today is the result of nearly a century of creation of wealth from debt. It should come as no surprise that it is taking ever greater amounts of debt creation to sate the appetites of the banking behemoths. Their greed and disconnectedness from the source of the debts they created reached absurd proportions and now the price is being paid as the wheels of global finance grind to a halt. Clearly a system where every new product needs the religious stamp of approval isn't the answer to the world's financial woes, but maybe taking a lesson from Sharia will help us rediscover the connection between lender and debtor and help us get from haraam to halal.