Common Questions About Islamic Finance (Part 1 of 5)

This week…
— There was no Islamic bank during the Prophet’s (Allah bless him and give him peace) time, so how can there be Islamic banking now? Sounds like a bid’a.

Coming up…
— Don’t Islamic banks simply change labels, by replacing the word “interest” with “profit”?
— Why does Islam forbid interest when money is just another commodity that comes at a price?
— Where should I keep my money? Islamic banking doesn’t adequately address the inflation problem and you say interest banking is forbidden.
— Stocks are like gambling, but Islam permits stocks and forbids gambling. Why?
— What’s the difference between an ordinary lease and an Islamic lease (ijarah)? They look the same.
— If Islam forbids fixed-income interest, what’s wrong with floating-rate interest? Doesn’t it also rise and fall like profit?
— I don’t have enough money to buy factory equipment (or a car, a home or pay for an education)? How do I avoid interest and still fulfill my short-term financing requirements?
— Is there a secondary market for Islamic instruments?

Islamic bankers, caught between scholar and layman, devote much of their time to educating an often skeptical public about the authenticity of their products. Time well spent. The purgative effects of ridding the Islamic financial sector of pretenders (and there are many) at the hands of an educated consumer are obvious. Too often, however, this educational process is long on theory and short on practical relevance.

Perhaps the easiest way to determine whether Islamic banking is true to Koran, sunna and customer is to see how it actually works in practice. The Islamic banking discussed here is the same one that earns consensual acceptance from the field’s leading scholars of the traditional schools of jurisprudence. And while unscrupulous banks do exist, increasing market regulation and customer sophistication ensure that those Islamic banks that are truly Shariah-compliant lead the industry. By learning the basics about these banks, individuals will be better able to stand their ground when notso-Islamic bankers push non-compliant instruments in the name of Islam.

At the outset, though, it is necessary to emphasize two important points. First, just because an Islamic product and a conventional product are identical does not render the Islamic product impermissible. As obvious as this seems, it is an argument detractors often use to discredit Islamic banking. The vast majority of Islamic financial instruments bear a strong resemblance to their conventional counterparts, particularly equity-based ones. What distinguishes them from conventional instruments is usually nothing more than a set of processes, which leads to the second point.

In Islam, the difference between whether something is forbidden, offensive, permissible, recommended or obligatory usually depends on a validating process. Two couples, one married the other unmarried, may look the same, but the agreement of a simple marriage contract makes the one Islamically valid and the other not. Two hamburgers, one using Islamically slaughtered meat the other not, may look the same, but a simple process makes one valid. So too, two financial products, one Islamic the other not, are differentiable by a set of steps: ostensibly cosmetic, Islamically defensible.

The following are among the most commonly asked questions by customers new to Islamic banking (ordered in increasing degree of complexity):

There was no Islamic bank during the Prophet’s (Allah bless him and give him peace) time, so how can there be Islamic banking now? Sounds like a bid’a.

Microchips, potato chips and Islamic banks are examples of permissible things for which the Prophet (Allah bless him and give him peace) gave us no specific guidance. Rather, he forbade us from engaging in blameworthy innovations (bid’a) that would contravene the Islamic Sacred Law (Shariah), rather than from new things that possess no intrinsic blameworthiness. The bid’a is in the blameworthiness, not in the newness.

Admittedly, some Islamic banks do carry out impermissible transactions, but that implicates the entire field of Islamic banking no more than the sins of a few Muslims incriminate the entire Islamic community.

As for the claim that Islamic banking is just part of the “system” and is therefore best avoided, is to put one’s head firmly into the sand; romantic anachronists need not apply. As long as Muslims, money and capital markets co-exist, there will always be a need for Muslims to put their money into some kind of a market (even a little money in a checking account circulates into global capital markets). The question Muslims should really be asking themselves is: what now? Whether they would not rather keep their money in the most Islamically acceptable manner available to them given the options. And while new customers might be forgiven some level of healthy skepticism, we should all understand the limits of our own unqualified ijtihads when declaring something a bid’a.

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