Saturday, March 06, 2010
Tuesday, January 26, 2010
The Economist article on European mutuals
Saturday, January 23, 2010
Justification and the four-step vicious circle of "Islamic finance"
- Utopianism: Driven by ideological, religious, and social concerns, they seek economic and social answer in the vague financial commands of the Qur'an and Sunnah (the Qur'an does not explicitly say what the forbidden riba is, and doesn't mention gharar, the Sunnah gives some examples of forbidden riba and gharar, but not sufficiently to give unequivocal definitions thereof). We trust the "Scholars" (back in the late 70s and early 80s Egypt, that included household-name scholars such as Al-Sha`rawi, Al-Qaradawi, and most accomplished Azhari scholars).
- Engagement: As consumers, practitioners, or consultants, the Utopians start to engage the industry, either directly or through closer observation.
- Disenchantment: The engaged Utopians discover that the practice of Islamic banking and finance does not go beyond replicating what was already there, at ridiculously higher interest rates (for example, here in the U.S., "Islamic" auto-loan structures in the 1980s were offered at 22 to 25%, when the going market rates were below 10%.) They become disenchanted. Some disengage, but others remain engaged for one of two reasons: (i) residual Utopianism and dreams of eventually changing the industry through continued engagement (the "young industry" fallacy), or (ii) their livelihood as bankers, lawyers, consultants, etc., has become entangled with the industry, the have become used to higher incomes and living standards and recognize that they have been shut out of the conventional sector because of their "Islamic" identity.
- Justification: Those still engaged in the industry pick up the hobby of themselves criticizing the industry that they have participated in creating (it started with some bankers and lawyers, but now even "Shari`a scholars" who are the second-largest financial beneficiaries after lawyers, and who legitimized the industry by leveraging religious-legal authority, including Taqi Usmani and others, have joined the fray). A new narrative emerges, about the need for a different benchmark to replace LIBOR, new structures that are closer to the "Islamic ideal," etc. Those assertions help to shape a new Utopian vision of "true Islamic finance," which revives Utopianism (if cynical) within the engaged community (serving thus as justification for their continued engagement) and attracts a new wave of Utopians, leading back to step 1.
Sunday, January 17, 2010
UNEPFI Membership: Will Islamic Finance turn to positive injunctions?
إن الله يأمر بالعدل و الإحسان و إيتاء ذي القربى و ينهى عن الفحشاء و المنكر و البغي، يعظكم لعلكم تذكرون"God commands justice, beautiful dealings, and generosity to one's kin, and forbids ugly dealings, blameworthy behavior, and transgression; he admonishes you, so that you may remember."
Friday, January 08, 2010
Panel discussion on Al-Jazeera TV
Sunday, January 03, 2010
Have we learned nothing? Here come the "Islamic Credit Default Swaps"
A group of informed experts on the Islamic finance industry called for a "partnership" between Islamic takaful (insurance) industry and Sukuk, toward the end of assisting the latter in providing "protection" for investors against losing their funds that they invested in these Islamic instruments.
Those calls became louder after the recent registration of the Pakistani cement company Maple Leaf as the last company with defaults on its Rupis 8 billion Islamic bonds.
The experts suggested during their interview with "Al-Iqtisadiya" that Takaful companies should find a new insurance instrument for Sukuk, which can protect the Sukuk holders from the risk of default, by providing "partial" compensation in the case of default.
Friday, December 04, 2009
Pain, not gloating
Tuesday, August 18, 2009
Microfinance experience vs. credit union -- Grameen I
- Interestingly, Grameen itself has a mutual structure, with all members forced to save with the bank, and part of those savings are shares in the bank itself (on which, at least as of 2005, the shareholders did not receive dividends; they received 8.5% interest on their deposits). This begs the question why Grameen was not set up at the outset as a non-profit credit union (more on that later).
- One potential answer is the following: "A major reason for the prior failure of credit cooperatives in Bangladesh was that the groups were too big and consisted of people with varied economic backgrounds... more affluent members captured the organization" (p.18). This suggests, perhaps, that those cooperatives were structured more like mutual savings banks (one share = one vote) rather than credit unions, which are much more democratic in nature (one shareholder = one vote).
- Grameen used presaving to qualify for loans, which I did not know from reading secondary and tertiary sources: "To receive a loan, borrowers were required to save ... [in the form of] deposit[ing] a fixed amount weekly... [in addition to] a 5% deduction from the loan... [as a] group tax. The compulsory weekly savings and loan deductions were used to create a group fund, and the borrowers were paid 8.5% on their deposits." (p.19) This is somewhat reminiscent of JAK structure, except that interest was paid on deposits and charged on loans (mostly at 20% for general loans).
- Branches borrowed from the main office at 12% and lent at 20%, eventually covering their costs and making a profit after three to four years of operation. (p.30) Why is sustainability always associated with profitability? A nonprofit credit union can be more sustainable than a profit-maximizing bank.
- The structure is standard banking practice: the poor had to save and deposit with the bank, earning 8.5% on deposits and 0% on shares; then the bank lends funds at 12%, and the branches lend them on to the poor at 20%. The miracle of Grameen is that it was very successful in growing, mainly by providing credit to those whom the banks did not consider creditworthy or sufficiently lucrative. However, that is not nearly sufficient to suggest Grameen over a credit-union structure, where all deposits were shares earning dividends, and where loans are made at the lowest possible interest rate to avoid losses (without necessarily resorting to the weak argument that at least the interest rate is lower than what loan sharks would charge).
Thursday, August 13, 2009
Microcredit and usury
Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband's vegetable cart. Then she borrowed more."I took from one bank to pay the previous one. And I did it again," says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts -- two for $209, another for $293, and then $356.
At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance "increased our desires for things we didn't have," Ms. Taj says. "We all have dreams."
Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That's equal to about a fourth of her annual income.
As with every other type of credit, when it can be extended for profit, the incentive to overfinancialize can be impossible to overcome. I have made the argument more than once, in part based on works in classical Islamic jurisprudence and legal theory, that profiting from the act of credit extension is the essence of forbidden usury/riba. The approach through non-profit mutuals, credit-union style, is vastly superior, and agrees with the spirit of early experiments in Islamic finance in Egypt and the Subcontinent.
Unfortunately, people's good intentions have been subverted in Islamic finance toward serving the interest of profit-maximizing multinational banks that have, de facto, rewritten modern Islamic jurisprudence to maximize their profitable arbitrage opportunities. Likewise, this article shows how the very essence of microfinance has been subverted by rent seekers to enrich themselves at the expense of the poor debtors (who may benefit briefly, but will ultimately suffer when the bubble bursts).
Tuesday, June 30, 2009
FT Op-Ed: Debt is capitalism’s dirty little secret
The answer is capitalism’s dirty little secret: excessive lending was the only way to maintain the living standards of the vast bulk of the population at a time when wealth was being concentrated in the hands of an elite.
The amount by which the elite has benefited is startling, and illustrates the problem with lightly regulated free markets: the rich get much richer while the rest do not get richer at all. According to Société Générale economists, the inflation-adjusted income of the highest-paid fifth of US earners has risen by 60 per cent since 1970, while it has fallen by more than 10 per cent for the rest. As was recently pointed out in the New York Review of Books, the Walton family, of Wal-Mart fame, is wealthier than the bottom third of the US population put together – about 100m people. These are staggering statistics, confirmed by measures such as the US and UK’s ever-rising Gini coefficients, which estimate income disparity. Another way of putting this is that the share of profits in gross domestic product is at a 100-year high, or was until very recently.
Put simply, the benefits of economic growth have gone into the pockets of plutocrats rather than the bulk of the population. So why has there been no revolution? Because there was a solution: debt. If you couldn’t earn it, you could borrow it.
Tuesday, May 26, 2009
Sunday, May 24, 2009
Islam in America and the Clash of Exceptionalisms
Sunday, May 03, 2009
Parable of the Growth Tragedy
A man lived alone on his island. Every morning, he went out of his hut, jumped into the water, caught two fish, and then sat on the shore cooking and then eating them.
An entrepreneur watched the man for a while. Then, he approached the man, and said: "why don't you give me one of your two fish." The man said: "but I like to eat two fish, why should I give you one." The entrepreneur said: "if you give me one fish, I'll give you some of this green paper." The man said: "but I don't eat green paper, I only eat fish."
The entrepreneur said: "you don't understand: you work harder to catch 3 fish and give me one, then you sell me that extra fish and get some green paper, once you have accumulated enough green paper you can give it to me, and I will give you a fishing rod." The man said: "but I don't need a fishing rod, I can't eat it, and I can catch all the fish that I need without it."
The entrepreneur said: "but with a fishing rod, you can catch four fish with less work." The man said: "but I only eat two." The entrepreneur said: "So, you eat two and give me two, so that I can give you double the amount of green paper." The man said: "we've already been over this -- I don't eat green paper, I only eat fish." The entrepreneur said: "you're really slow -- when you've accumulated enough green paper, you can give them to me, and I'll give you a fishing boat."
The man said: "but I don't eat boats, I eat fish." The entrepreneur said: "with a boat, you will catch 8 fish a day with even less work." The main said: "but I only eat two." The entrepreneur said: "so, you eat two and give me six so that I may give you more green paper, and before you ask me any further, you will soon have enough green paper to have a fleet of fishing boats, and you can eat as much as you want without doing any work and just keep getting more green paper."
The man said: "maybe I am the slow one, but let me ask you this: would I not then be obsessed with useless green paper, lazy, fat, and possibly exploitative of my fishermen?" Then he added: "and with all those fishing boats, do I not run the risk of overfishing the sea to the point that we all starve in the long run?" In the meantime, "I am happy now, catching my two fish, staying fit, and having time for other things."
The entrepreneur left, thinking to himself: "I'll find somebody else who sees the brilliance of my idea, and you will someday work on one of his boats just to survive, as there will be no easy-to-catch fish readily available near the shore."
Sunday, April 12, 2009
Crooks in the name of Islam
Sunday, March 29, 2009
A Potential Model for Islamic Microfinance II: Resisting The Banking Temptation

- Later rounds of the RoSCA, approved by jurists, as described in the previous posting, may be for larger pots. This gets around the problem of introducing interest payments within a single RoSCA cycle -- which is the focus both of commercial "chit funds" and much of the Economics literature (e.g. Besley, Coate, and Loury, American Economic Review, 2003). As I shall discuss below, I think that this focus on a single cycle of the RoSCA misses the main significance of investment in social capital: one is compelled to participate (as a later recipient) in a RoSCA when one is asked. Social capital is the availability of a pool of people willing to lend you at zero interest at some/any point in the future. One should focus on the repeated game rather than one stage.
- Participation in one or more RoSCA has been shown to increase with reported religiosity, as shown in Indonesias' participation in one or more arisan using probit and ordered probit estimation by Sowmya Varadharajan. This is very useful because an individual who cannot in one period fulfill their obligation in one RoSCA may start another of which they are the first recipient to meet liquidity problems. In other words, the social capital invested in one's circle of friends/family/... provides guaranty against default and dissolution of earlier RoSCAs. This can easily be used to manufacture banking products through staggered overlapping RoSCAs: the second recipient of the first RoSCA is simultaneously the first recipient of the second RoSCA, the third recipient is the first recipient of the third, and so on. This way, later recipients of the pot from earlier RoSCAs can receive explicit interest for the loans that they extended by receiving an interest free loan of equal or larger size. It would be very easy to mimic any amortization table using such structures (a simple spreadsheet would do).
- Unfortunately, the latter possibility makes these structures vulnerable to the creation of pyramid schemes. Indeed, in the different but related JAK system, it appears that a pyramid scheme did develop in the earlier experiment before the bank was licensed and regulated. There is an inherent pyramid scheme in every fractional reserve system (otherwise, what is the banking multiplier other than a pyramid scheme), and we have seen ample proof over the past few months to illustrate that our entire financial system is one gargantuan-sized pyramid scheme (as Krugman called it, the decade at Bernie's). Of course, one has to be particularly careful not to build pyramid schemes in the name of Islamic finance, especially given recent decades' experiences in Egypt, Albania, and other countries (in addition to numerous unfortunate web-based pyramid schemes in Malaysia and elsewhere). However, that is a regulatory concern that extends well beyond the specific problem with which we are currently concerned.
Saturday, March 28, 2009
A Potential Model for Islamic Microfinance I.5: RoSCA permissibility
Workers' Cooperative (جمعيات الموظفين)
Among the popular financial dealings between people is that known as "workers' cooperative." There are three main forms of such cooperatives as explained by Associate Professor Abdullah bin Abdulaziz Al-Jibrin in the Teachers' College in Riyadh:
- A group of people agree each to pay the same amount each month. At prespecified periods, they take turns collecting the entire pot. A full round is finished when each member has collected the pot once. At each step, the payments are equal, and the pot is of the same size. Thus, everyone pays the same and collects the same as everyone else. The cooperative may continue for two or more rounds if all parties wish it. Most often, the "banker" of the cooperative collects first followed by the next person to join the cooperative. Sometimes, a lottery determines who collects if all parties to the cooperative were equal. At other times, the one most in need collects first.
- ...
- Another variation would require that two or more rounds must be completed, with the order of collection changing from round to round so that the first borrower in the first round would be the final collector in the second, and so on.
... This is an old practice that has been addressed by classical scholars, including Abu Zar`a Al-Razi, who was one of the leading narrators of Prophetic Traditions, and he indicated that it is permissible, as stated by Dr. Khalid Al-Mashqih, a Saudi scholar.Scholars' Rulings on the Practice... Contemporary jurists have issued two opposite opinions:
- One group of scholars forbid such cooperatives. This group includes Sh. Abdulaziz Al Sheikh the Mufti of the Kingdom of Saudi Arabia, Sh. Saleh Al-Fawzan, a Saudi scholar, and some members of the Saudi Council of Major Scholars
- The majority (جمهور العلماء) opinion among contemporary scholars is permissibility of this practice. This was the opinion of the late Sh. Bin Baz, the late Sh. bin `Uthaymin, Sh. Muhammad Salih Al-Munajjid, Sh. ibn Jibrin, Dr. Abdulla Al-Faqih, and other scholars, including the majority of the Saudi Council of Major Scholars who thus adopted this majority opinion as its official position in opinion #164 dated 26/2/1410 H, during the 34th round presided upon by the late Sh. Abdulaziz bin Baz...
Grounds for disagreementThe reason for differences in opinion regarding this practice is how it is classified juristically. Some viewed it as a loan that is beneficial to the lender, and thus forbade it, and others saw it otherwise and permitted it.The reason that some saw it as a beneficial loan is that participants extend a loan with a stipulated condition of another later loan, which is beneficial. Thus, those who adopted this position cited the Prophetic Traditions: "every loan that is beneficial to the lender is [forbidden] riba" and "if one of you makes a loan and then receives a gift or a favor to ride the borrower's animal, then he should neither ride nor accept the gift, unless such courtesy had occurred before" (reported by Ibn Majah).Those who permitted the practice argued that the benefit that accrues to the lender does not result from any financial loss to the borrower. On the contrary, they argued, the benefits were mutual and virtually equal. Thus, both the lender and the borrower are beneficiaries, without any harm imposed on either party or any benefit at the expense of the other. In this regard, the benefit that is forbidden in loans is the type that accrues only to the lender. However, mutually beneficial loans that benefit both lender and borrower are permissible...Those who permitted the practice also argued that the default ruling for financial transactions is permissibility. Therefore, prohibition requires proof, and there was no valid proof for prohibition in this case. On the contrary, they argued, this is classified under mutual assistance, good charity, and assistance of fellow Muslims.In addition, the "proof" of prohibition is based on the Tradition "every beneficial loan is [forbidden] riba", which is a weak tradition with faulty chain of narration. The scholar of Tradition ibn Hajar said that its chain of narration is weak. In this regard, the weak tradition was admittedly accepted as a juristic rule, but not every benefit in a loan is deemed forbidden. The other tradition ostensibly presented as proof for forbidding the practice is categofically invalid, as Al-Haythami said in Al-Zawa'id: "it contains `Utba ibn Hamid Al-Dabi, whose narrations are rejected by Ahmad and Abu Hatim.Therefore, all proofs of prohibition are weak. In contrast, the proofs of the majority who permitted the practice is much stronger...In this regard, the great scholar ibn Taymiya listed examples of permissible mutual benefit when he said: "There is no harm for a farmer to say to another: `help me to do my work and I will help you to do yours; you work with me today, and I work with you tomorrow'."In summary, "financial cooperatives" (الجمعيات المالية) are permissible Islamically, and it is best to use collateral or guaranty (ضمانات) for participation, to minimize disputes, and to document the mutual debts for all participants in a manner that guarantees each party's rights.(My emphasis at the end, because this is rarely done in a systematic way: which is the opportunity for microfinancial improvement)
A Potential Model for Islamic Microfinance I: Introduction
- Approximately 528 million poor (below $2/day) Muslims in five countries: Indonesia, Bangladesh, Pakistan, Nigeria, and Egypt
- Approximately another 100 million poor Muslims in India
- Incredibly high degrees of financial exclusion of Muslims in OIC countries and India (67-80% of Muslims have minimal or no contact with the formal banking sector)
- A recent Consultative Group to Assist the Poor (CGAP) study by Karim, Tarazi and Reille (2008) reports results suggesting that large numbers of poor Muslims in various countries reject all forms of loans, including Grameen-style microloans, on religious grounds
- "Islamic microfinance" using the same ridiculous and insulting (sorry, I couldn't resist taking another shot at the nonsense that is marketed in the name of Islam) 1970s-style murabaha property flipping and other inefficient structures has failed miserably, keeping this subsector to 1% of overall microfinance even though Bangladesh, the epicenter of microfinance, is obviously mostly Muslim. Apparently, the poor illiterate Muslim majorities want something more than the cosmetic and expensive "Islamic" brand name
- The JAK model is very much focused on mortgage financing, where member loans are secured by the properties financed. (i) This makes it applicable, for example, as an alternative structure for North American or other countries' mortgage markets, but not for the microfinance sector. (ii) Also, the JAK model lacks the ability to utilize social capital through peer-monitoring, which is indigenous to RoSCA structures and successfully adapted by Dr. Yunus in his group-lending Grameen model.
- The RoSCA model suffers from (i) fragility, because one person's withdrawal would ruin the finance facility, (ii) symmetry of contributions to the pot, which makes it difficult for financing smaller consumer and larger business microloans simultaneously, (iii) does not have the flexibility to provide equity positions and/or return on savings for older/richer participants who do not need to receive the pot but would like to participate and receive a return, and (iv) is not conducive to growth and institutional development into bank or credit union structures.
Rebooting Islamic Finance: It's Time
Thursday, March 26, 2009
Substance over form, finally!
To that end, Mr. Geithner said: “Financial products and institutions should be regulated for the economic function they provide and the risks they present, not the legal form they take,” Mr. Geithner said. “We can’t allow institutions to cherry pick among competing regulators, and shift risk to where it faces the lowest standards and constraints.”His full statement is available here.
Wednesday, October 22, 2008
More on rating agencies and sukuk
Oct. 22 (Bloomberg) -- Former executives from Standard & Poor's and Moody's Investors Service told lawmakers today that credit raters relied on outdated models in a ``race to the bottom'' to maximize profits.
Jerome Fons, a former managing director of credit policy at New York-based Moody's, told the House Oversight and Government Reform Committee today that originators of structured securities ``typically chose the agency with the lowest standards, engendering a race to the bottom in terms of rating quality.''
Representative Henry Waxman, the committee chairman, said that the recent history of the credit rating companies ``is a story of colossal failure.'' ``The result is that our entire financial system is now at risk,'' Waxman said.
Sunday, October 19, 2008
Thank you, Secretary Powell
Mr. Powell mentioned Mr. Khan’s death to underscore why he was deeply troubled by Republican personal attacks on Mr. Obama, especially false intimations that he was Muslim.
Mr. Obama is a lifelong Christian, not a Muslim, he said. But, he added, “The really right answer is, what if he is?”
“Is there something wrong with being Muslim in America? No, that’s not America,” he said.
Saturday, October 11, 2008
"Islamic Economics" and the Financial Crisis
I think that the broad lines of the current crisis are indeed as you have described them. I'd be happy to discuss the specifics at a later stage, but I'd like to take this opportunity to disagree respectfully regarding the classical "Islamic economics" solution that you are advocating. Let me organize my thoughts in four main points:1. There is a fundamental tradeoff, as you have suggested, between growth and efficiency on the one hand and equity and stability on the other. In a world where some societies choose a high-growth path and others choose the equitable-stable path, the former societies eventually invade or otherwise overtake the others politically and economically. Hence, there is need for a social contract, which you have put under the banner of morality, to shepherd mankind to the safer more equitable path.2. Morality cannot be legislated, and reliance on social and economic players to exhibit moral conduct voluntarily is a form of Utopianism. There are numerous verses in the Qur'an and numerous Prophetic Ahadith that explicitly characterize mankind as gluttonous wealth seekers. Pious members who are satisfied with little, etc., as you describe, were a minority even immediately following the death of `Umar ibn al-Khattab, as evidenced by the grand fitna and the later paths pursued by the Umayyads, the Abbasids, etc.3. Islamic jurisprudence used and refined many of the earlier scriptural and human-legal provisions for creating the more equitable and less turbulent path, through restrictions on leverage, fragmentation of estates, redistribution of wealth, etc. In the arena of finance, the prohibitions of riba (absolute) and gharar (relative, but absolute for the extreme of maysir) can be seen as regulations of risk taking. In the ancient world, this was accomplished by permitting certain contracts and forbidding others. I have argued that adoption of this approach in the modern era of financial engineering, where transaction costs of circumventing the prohibitions have become minimal, is incoherent.4. The mirror-image-problem of this product-oriented regulation of financial markets has been at the core of the current financial crisis. Insurance markets have been generally regulated to keep them from becoming gambling (maysir) tools. For instance, I cannot buy an insurance policy against another person's losses, lest this may be at best a form of gambling and at worst an incentive to harm that other. Credit default swaps and other modern derivatives may equally be seen as forms of insurance, but ones that lack sufficient regulation to prevent gambling. I was tempted in July to buy put options on oil, thinking that a global recession is inevitable and the price of oil will have to fall. I stopped only because I think that this is a type of maysir, because "markets can remain irrational indefinitely, certainly longer than I can remain solvent." Numerous others made the bets, I am sure, and conditional on counterparty risk, some have made small fortunes doing that. The incentive to gamble is simply too great.There is nothing uniquely Islamic about modesty, contentment, shunning risk and gluttony, or even the prohibitions of riba and maysir. Even those who do not believe in revelation (to Moses, Jesus, or Muhammmad; p) can be convinced that those ancient prohibitions and injunctions were distillations of human wisdom over the millennia. Calling those injunctions and prohibitions "Islamic" strikes many as exclusionary and encourages others to engage in hateful and myopically-triumphalist celebration of our collective failure (Islamic finance is just as guilty as conventional finance for bringing about the current crisis).It is not clear that majority-Muslim societies are particularly better equipped to solve the collective-action problem required to find a low-growth-low-risk social contract. In a world where others will pursue higher-risk-higher-growth paths, it is not even clear that pursuing that lower-risk-lower-growth path is warranted (isn't that how Madinah lost to Damascus during the time of Mu`awiyah?). Is it possible to reconfigure our rhetoric to make it less exclusionary (avoid separatist and triumphalist use of the "Islamic" brandname) and to convince multiple populations at very different stages of economic development to shun fast growth in favor of greater equity and stability? The dialogue would likely be very similar to the one witnessed in negotiations over polluting rights. Perhaps we can learn more from the successes and failures of this global dialogue than we can from inspecting ancient laws for outdated modes of regulating financial markets.


