The Real Face of Shar’ia
posted by Nate Oman
Generally speaking, when Americans hear about shar’ia it conjures up images of bearded and turbaned Taliban executioners gleefully stoning women to death in an Afghan soccer stadium. It is an unfair stereotype of a great legal tradition, and it is also one that misses some of the most important issues that shar’ia raises for the modern world. As usual, if you want to find the real action follow the money.
In a nutshell, there is a lot of money sloshing around the Islamic world. 20 percent of the world’s population is Muslim and at least part of the population sits atop oil fields that churn out an enormous amount of cash every day. What is an observant Muslim, one who cares about Islamic strictures against usury to do? Islamic law forbids the taking of interest, but certain transactional structures that allow some return in exchange for tying up capital are allowed. For example, a straight out purchase-money loan with interest secured by a mortgage on a the purchased house would violate Islamic injunctions against usury. On the other hand, if the bank buys the house, leases it to the resident for a period of years, followed by the resident’s purchase of the house at the expiration of the lease for a nominal sum, it does not violate the injunction. The game in Islamic finance is to come up with ways of structuring transactions so as to generate an attractive rate of return for investors without running afoul of the strictures of shar’ia. The result has been a cottage industry of banks and lawyers experimenting with various transactional structures and then rushing to find a reputable Islamic legal scholar willing to issue a fatwah validating the deal for Muslim investors.
The Economist just put up a rather good briefing article detailing some of the growing pains that the industry is facing. At least part of this problem is legal. To give one example that interests me, UCC 9-109 states that the Article 9 governs “a transaction, regardless of form, that creates a security interest in personal property . . . by contract.” The rule is aimed at precisely the kind of sale-and-lease-back transactions that are used in Islamic finance, a transactional gimmick that has also been tried as a way of avoiding the strictures of the UCC. The result of the rule, however, is that despite their best efforts parties may be forced, legally speaking, into an interest bearing loan. There is also the simple problem of complexity and the associated transaction costs. Still, according to the Economist:
None of these tensions need derail the growth of Islamic finance just yet. There is plenty of demand, whether from oil-rich investors, the faithful Muslim minorities in Western countries or the emerging middle classes in Muslim ones. There is lots of supply, in the form of infrastructure projects that need to be financed, Western borrowers looking for capital and ambitious rulers eager to set up their own Islamic-finance hubs. The industry is innovative; new products keep expanding the range of shar’ia-compliant instruments. And as in conventional finance, the economics of the Islamic kind improve as it gains scale.
If they are right, then Islamic finance is likely to be the real face of shar’ia in the modern world. In 2007, for example, over 150 new Sukuk (essentially a form shar’ia compliant bond) funds were launched with a value of nearly $50 billion. Given the less than inspiring ethical performance of certain aspects of the American lending market of late, a dose of financial puritanism from the desert might not be such a bad thing.
(Image source: Wikipedia)
September 5, 2008 at 10:11 am
Posted in: Contract Law & Beyond, International & Comparative Law, Jurisprudence, Religion
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Responses (10)
matt - September 5, 2008 at 10:29 am
Is the ban against _making_ a loan with interest only, or also against _taking_ such a loan? I’d guess it must be against both or else you’d just get a non-believer bank to do the actual banking but it seems funny for their to be a ban on taking loans. Then again, if the stuff made sense it wouldn’t be what it is.
Nate Oman - September 5, 2008 at 10:43 am
My understanding is that there is an injuction on both sides of the transaction. Hence, you have a demand for shar’ia compmliant insturments on the lender side, with sovereign wealth funds in the gulf, for example, looking for ways of in effect lending their money. At the same time, you get a demand for shar’ia compliant mortgages among, for example, pious Muslims in Northern Virginia who want to buy a home.
Nate Oman - September 5, 2008 at 10:47 am
Incidentally, matt one needn’t condescend to the pious — “if the stuff made sense, it wouldn’t be what it is” — to make sense of a Muslim borrowers discomfort with paying interest. It goes back to the moral idea of complicity, something that also motivates, say, righteous middle-class liberals who refuse to shop at Wallmart.
matt - September 5, 2008 at 11:32 am
Thanks for the clarification, Nate. I don’t think my last remark is condescending at all. It certainly wasn’t meant to be. Rather, I think that most religious believers are happy to agree that many aspects of their faith don’t make straight-forward logical sense but think they should be followed anyway because God is smarter than we are and knows what’s best, even if it makes no sense to us. Working in mysterious ways, God’s ways not being Man’s and all that sort of stuff. My question was more along the lines of whether this was like the ban on usury that most Christians also held for a long time, that allowed them to borrow from non-Christians (there’s a reason why Jews are stereotyped as bankers) but not to make loans themselves.
Patrick S. O'Donnell - September 5, 2008 at 11:43 am
Nate,
Thanks for looking at this subject with an open mind and your customary acumen.
Below is a small list of book titles to help those new to the subject become acquainted to economics in the Islamic world in general and “Islamic finance” in particular.
As-Sadr, Muhammad Baqir (Roy Parviz Mottahedeh, tr.). Lessons in Islamic Jurisprudence. Oxford, UK: Oneworld, 2003.
El-Gamal, Mahmoud. Islamic Finance: Law, Economics and Practice. Cambridge, UK: Cambridge University Press, 2006. (Pbk. due out soon)
Henry, Clement H. and Robert Springborg. Globalization and the Politics of Development in the Middle East. Cambridge, UK: Cambridge University Press, 2001. [Keeping in mind here and with the Richards and Waterbury title below, that most Muslims reside outside the Middle East.]
Kuran, Timur. Islam and Mammon: The Economic Predicaments of Islamism. Princeton, NJ: Princeton University Press, 2004.
Mallat, Chibli. The Renewal of Islamic Law: Muhammad Baqer as-Sadr, Najaf and the Shi’i International. Cambridge, UK: Cambridge University Press, 1993.
Richards, Alan and John Waterbury. A Political Economy of the Middle East. Boulder, CO: Westview Press, 2nd ed., 1996.
Tripp, Charles. Islam and the Moral Economy: The Challenge of Capitalism. Cambridge, UK: Cambridge University Press, 2006.
Warde, Ibrahim. Islamic Finance in the Global Economy. Edinburgh: Edinburgh University Press, 2000.
See too: Hamoudi, Haider Ala, “The Muezzin’s Call and the Dow Jones Bell: On the Necessity of Realism in the Study of Islamic Law,” American Journal of Comparative Law, Vol. 56, No. 2, 2008
Available at SSRN: http://ssrn.com/abstract=1014670
And the blog post by Professor Hamoudi (and the comments that followed) on this subject at Opinio Juris back in January of this year: http://opiniojuris.org/2008/01/29/muhammad-baqir-al-sadr-and-the-origins-of-islamic-finance/
A.J. Sutter - September 5, 2008 at 12:58 pm
As I understand it: Islam prohibits the payment of “Riba” in business transactions. This is usually translated as ‘interest’, but the concept is more complex. I think the attitude is that money is something to be used for a purpose, not just for creating more money. (Kind of like classical Western economists’ view of capital.) Not only interest, but a “premium” paid as a condition for a loan may be Riba it if must be paid regardless of the outcome of the borrower’s use of the loan. Other elements of Riba are that it is an amount or proportion fixed in advance, is tied to the time period and amount of the loan, and can be enforced using courts or other state institutions. BTW, the charging of premiums was a typical way that Christian moneylenders like the Lombards got around the usury prohibition; e.g., they’d give the Pope 100 florins today and the Pope would agree that on some future date he’d pay them 110 florins (or whatever the effective rate was). To my outsider’s eye that doesn’t seem as if it would be kosher, so to speak, under Shariah. (Does ‘halal’ have the same figurative connotations as ‘kosher’?)
Actually, some of the Islamic financial institutions are, prima facie, quite idealistic and lovely. Such as Mudarabah, where people entrust their money to an agent and trust him to invest it well. The agent shares in the upside, but not in the downside — kind of like a hedge fund manager. How well this works in practice, though, I have no idea.
A highly readable and practical introduction is Z. Iqbal & A. Mirakhor, “An Introduction to Islamic Finance: Theory and Practice” (Wiley 2007) — both title and subtitle are very accurate. Also interesting is the volume edited by C. Henry and R. Wilson, “The Politics of Islamic Finance” (Edinburgh UP 2004).
A.J. Sutter - September 5, 2008 at 1:13 pm
Actually, Nate’s Article 9 point raises a couple of questions:
(i) if a deal is deemed Shariah-compliant by appropriate authorities, does it matter to religious participants in the deal if it is also subject to Article 9?
(ii) is a transaction subject to Article 9 necessarily interest-bearing?
Nate Oman - September 5, 2008 at 1:31 pm
Quick and conjectural answers:
(i) treating the transaction as a secured loan rather than a sale or lease back would change the property rights of the parties in the collateral, which might be deemed to have legal significance.
(ii) No. But if the lease included an implicit return on capital, then the transaction would be an interest bearing loan under Article 9.
Nate Oman - September 5, 2008 at 1:33 pm
by “legal significance” I mean significance under shar’ia, btw…
A.J. Sutter - September 6, 2008 at 9:39 am
Thanks for your reply. I admit to not being an expert on Article 9; it’s been many years since I’ve had to deal with it in any detailed way. So please feel free to correct the following obervations:
(i) I can’t find that the concept of interest-bearing loan appears anywhere in Article 9, at least in the California or Michigan versions (not that I’m a Michigan lawyer, but it was available online). As far as I can tell, loans are rarely mentioned, and the word “interest” is almost never used outside the context of “security interest,” and the exceptions are not the type that accrues on a loan (German ‘Zinsen’). So maybe there’s no need to worry about being characterized as an interest-bearing loan “under” the Article.
(ii) Nonetheless, it is possible someone could be characterized as a “debtor” under § 9102(a)(28) (all my refs are to California version), even if that person isn’t a debtor. The term includes anyone with an interest (other than a lien or security interest) in the collateral, even if that person is not an “obligor” as defined in subparagraph (a)(59).
(iii) I don’t know how Islamic jurists reason, but to my mind: Suppose a law in some legal system (call it “System 2″) other than my own characterizes someone as a “debtor” while explicitly acknowledging that this formal term can apply to persons who aren’t actually obligors or debtors. Then I’d probably take System 2′s characterization of someone as a “debtor” with a grain of salt, and not let it affect my reasoning under my own law. (Let’s assume that, as in the pertinent case, we’re not talking about doing something that would violate some law of System 2.) Do you think this approach is too simplistic, or do you have experience that would suggest a different outcome?
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