Chicken, adultery, and other bad "Islamic finance" analogies

The pietist view of Islamic finance is often defended based on bad analogies. A version of the first analogy was heard repeatedly at the Harvard Islamic Finance Forum, following a National Bank of Pakistan assertion that beef burgers at McDonald's in Karachi taste the same as beef burgers in Boston, but the former is halal and the latter is haram. I'll get to this analogy later, at the risk of losing credibility with many Muslims (since I do eat McDonald's burgers both here in the U.S. and elsewhere, after saying the basmala).

Let's first get to the second bad analogy, which is easier to dismiss: It is asserted that the only difference between marriage and adultery is a proper marriage or nikah contract. Similarly, the argument goes, the difference between a secured loan and murabaha financing (the ludicrous contract in which the bank buys a property and then sells it, assigning the ultimate buyer as an agent to buy the property on the bank's behalf and then to sell it to himself, incuring additional costs to sustain a fiction of "trade" as opposed to "loan") is merely the difference in contract.

The obvious reason that this analogy never gets off the ground is that the default ruling in sexual relations (or bud` as classical jurists said, most graphically) is impermissibility, unless there is a valid marriage contract. In contrast, the default ruling in financial transactions is permissibility, unless there is proof of existence of riba or gharar. In this regard, see my earlier challenge on secured lending operations, such as mortgage financing, wherein legal and equitable title are separated, and which cannot be classified under the same category as the classical qard, wherein interest is forbidden riba. In fact, as the OCC has concluded, murabaha and other "Islamic" financial forms are nothing but elaborate variations on the standardized western models of secured lending -- which are part of the business of banking.

In addition, there is clear benefit in requiring proper marriage contracts: Those contracts protect the rights of married parties to inheritance, protect the rights of unborn children, etc. Were one to write another contract that fulfills all of those legal functions (e.g. civil marriage contracts in western societies), without using the Arabic word "nikah" as Al-Shafi`i required, for instance, one would still have a valid marriage. Hence, the purpose of using the contract name is substantive (in the absence of complete contracts, the contract name provides many unwritten provisions, as dictated by jurisprudence or custom) rather than spuriously formalistic.

Now we get to the issue of halal meat, chicken, etc. There, too, one can argue that the prohibition technically disallows Muslims from eating two types of meat: (i) meats of animals or birds that were not properly slaughtered, and (ii) meats of animals or birds that were slaughtered as ritual sacrifices for pagan gods. In the first instance, (a) there may be health hazards due to blood not being drained properly, and (b) there may be inhumanity in the way that the animal was killed (e.g. painfully, or slowly), which Muslims should never support. In the second instance, eating animals that were sacrificed for pagan deities may support the pagan cults, help them to recruit more members, etc., which also should never be supported. Otherwise, if the animal was properly slaughtered, and the names of pagan or other deities were not invoked in its slaughter, one can take the juristic opinion of saying "bismillah" and eating -- which I do, as do most Muslims whom I know.

Of course, there are Muslims who insist on halal dhabiha, and would pay extra for its meat. That is their choice, but they shouldn't call that meat "Islamic" (implying that other meat is haram or un-Islamic). Likewise, I may be willing to buy financial products and services from Muslims, even if they cost more, just to support their businesses, in the same way that I support Muslim food stores that sell "halal meat", even though I consider the other meat halal as well (either as food of "people of the book", or as properly slaughtered meat on which no names of deities were invoked, thus allowing me to say the basmala). If they call it "Islamic meat", however, I would probably be just as offended as I am by the cheap marketing brand name "Islamic finance", which insults the name of my religion.

To the new breed of Islamic finance jurists

At a conference last weekend, I might have gone overboard in criticizing Islamic financial practice as smoke and mirrors with no value added to Muslim customers. Mr. Nizam Yaqubi's response was to say that I may agree with Sheikh ul-Azhar that bank interest is not the forbidden riba, but that the majority of Muslims do not accept that opinion.

Of course, the various fatawa by the current Sheikh ul-Azhar Dr. Tantawi, Mufti Dr. Gum`a, previous Mufti Sh. Wasel, and others, were not categorically to permit all types of bank interest. Moreover, in my own writing, I have argued that much of the improperly collateralized lending by Egyptian banks, which put them in deep trouble with large nonperforming loans, was obviously ribawi from economic as well as juristic perspectives.

The point, though, is the following: Perhaps the new breed of Islamic finance jurists (Dr. El-Gari, an economist who was or still is an Associate Prof. of Economics at King Abdulaziz University; Mr. Yaqubi, an economics BA holder from McGill and private businessman, etc.) view much of conventional financial practice as perfectly fine, and view classical Islamic jurisprudence as an impediment to its utilization by pious Muslims. Their job, according to this view, would be simply to synthesize every possible conventional practice from ancient contracts, and to do it as efficiently as possible.

Of course, that is the perspective of the non-Muslim lawyers, and their view can be that they are in fact providing value to the customers of Islamic finance: at least the value is psychological if they were using financial products but feeling guilty about it, and the value may even be material if they had refrained from using the conventional products before they were synthesized "Islamically". I find it more difficult to recognize that Muslims can also hold the same view: "I'm providing some value, and if I make some money in the process, what can be wrong with that?". Mr. Yaqubi even said at a conference in KL -- chastising people like me who criticize them for taking so much money -- that the lawyers make a lot more money than they (the "scholars") do. Dr. El-Gari also chastized me once at a conference in Dubai that my arguments -- regarding the aforementioned Azhar fatawa, which date back a century -- were not appropriate for a conference on Islamic finance.

It would be much less lucrative for them, but wouldn't it be better for those modern-day economist-jurists to educate the public about the nature of Islamic jurisprudence of transactions instead of perpetuating the misguided pietist approach and profiting therefrom? Would they not have a clearer conscience doing that? Wouldn't it be more Islamic?

The monumental mistake: Contract-centric thought

There is much that is depressing in the house of Islam today. As an economist, I find little that is more depressing than what is falsely called "Islamic" finance. The premise of that industry is that Islam permits or forbids contracts only. Thus, all that we need to do is to synthesize the forbidden contracts with permissible ones. Indeed, that is much for what is peddled today as Islamic finance: e.g. if you can't take a loan -- just buy some commodity on credit and sell it for cash, paying the same interest you would have paid for loans plus added transaction costs for the trades. That so many Muslims can view this as permissible is truly symptomatic of the malady that has afflicted Muslim minds. Contrast this with what Ibn Qayyim reports of his teacher saying about tawarruq (in I`lam Al-Muwaqqi`in in the book on changes in fatwa -- proof of the prohibition of hiyal:

And our teacher (God bless his soul) forbade Tawarruq. He was challenged on that opinion repeatedly in my presence, but never licensed it [even under special circumstances]. He said: “The precise economic substance for which riba was forbidden is present in this contract, and transactions costs are increased through purchase and sale at a loss of a commodity. Shari‘a would not forbid the smaller harm and allow that which is more harmful”.

In other words, Ibn Taymiyya did not simply look at the contract, but how and why it was used. Even though tawarruq technically used sales, it was clearly a device for extending an interest-bearing loan, in which we cannot verify if the interest rate charged was fair -- hence forbidden riba. In other words, if the purpose of the sale was not genuine interest in that commodity, then one could trade Aluminum to mimic the rate of return to LIBOR, or to mimic the rate of return on pork bellies, etc. In what sense would one be a trader of Aluminum? In what sense is this genunie bay`.

Given the advances in structured finance, one can easily disguise riba in any contract, and it would be the ultimate of disingenuousness to say "but this is bay` (sale), and Allah has permitted bay` and forbidden riba". The objective of the Legislator (S) cannot possibly be to enrich lawyers and consultants at the expense of Muslims who receive no value for the added price that they pay for credit or other financial services. This was done in the past by loan sharks, who would sell a piece of cloth to a needy farmer for a credit price of 200, when its cash price -- which everyone knew was the only thing that the farmer sought -- was only 100. That is riba of the worst kind, an unjustified increase that can eventually enslave the poor farmer, as had happened for many centuries.

Conversely, advances in structured finance, information technology and regulatory frameworks can also allow us to remove riba and gharar from forbidden contracts. For instance, in the famous Hadith of trading dates for dates, the Prophet (p) told Bilal (in one narration) to sell the low quality dates and buy high quality dates with their proceeds. If there were posted spot prices on an exchange, forcing the barter trade to take place at the appropriate ratio of spot prices would effect the same equity in exchange that the Prophet (p) sought.

Should we then look for the objectives of the Law: justice and fairness in exchange, and see how best to achieve them by utilizing the advances in legal and information technologies, or should we use those technological advances to arbitrage the gap between ancient contract forms and modern financial practices? In the former case, Muslims would prosper by achieving fairness and justice while cutting down costs. In the latter case, they will pay more and receive less, without necessarily ensuring equity and fairness.

Is this really a difficult choice to make?

I suppose that it is only a difficult one to make if you decide that Islamic law need not make sense. That it is a set of formulae to follow, and the only objective is thus to follow the rules, even if you incur what some bankers have been calling "cobm" (cost of being Muslim). Of course, that would require abandoning the primary Usuli principle (as articulated, e.g. by Al-Shatibi) that God never forbids beneficial things unless there is a greater harm.

Of course, one may argue that there may be a greater harm that we cannot see with our current economic knowledge. However, that argument cannot possibly be reconciled with consulting "Shari`a scholars" who have extremely limited knowledge of economics and finance, let alone ones who are hand-picked by bankers and paid handsomely for sanctioning their "Islamic" products.

Do those sincere people who give this sanctioning so much weight fail to recognize that jurists of the classical period were the economists of their time, and thus were the best qualified to rule on the basis of benefit-analysis?

Do they simply wish to hang their potential sins on someone else's neck (the literal meaning of imitation or "taqleed")?

Do they not distinguish between issues that relate to man's relationship with the incomprehensible Deity (e.g. acts of worship), wherein logical analysis plays a minor role (although we do defer to engineers on the direction of qibla, for instance, despite early resistance by jurists who thought only in terms of Cartesian maps), and matters that relate to life and transactions, where the vast majority of today's jurists are clearly unqualified to issue opinions?

I can't understand my fellow Muslims' minds.

Sacred authority and theatrics

The late Sheikh Muhammad Al-Ghazali (a real scholar, the da`iya of our time, as Al-Qaradawi is the faqih of our time) made fun of those whom he saw in London wearing clothes made for the desert of Najd, as if religiosity had anything to do with costumes. But those who have attended a number of conferences on Islamic finance have surely seen the increase in theatrics. People who are marketed as "religious scholars" have increasingly been attending conferences wearing their national costumes, which naive Muslims and non-Muslims wrongly associate with piety. Of course, we have seen the same costume-based status in our local mosques, making one wonder: why does a checkered red and white cloth on your head -- with "made in England" printed on it -- make you pious or knowledgeable. King Abdul-Aziz Al-Saud wore that type of head covering while establishing his kingdom, and it has become a national symbol. So, if people wish to wear that national costume for nationalist reasons, there is obviously meaningful symbolism in it. But now we have those national costumes, which do appear exotic in London or Boston, implicitly signaling religious knowledge.

The majority of Muslims cannot read or understand Arabic. So, as someone told me at a conference, as soon as a person in an exotic costume starts to cite Qur'an, Hadith, or even mediocre juristic analysis from eight centuries ago, it sounds like a priest speaking in Latin. It sounds sacredly authoritative.

Never mind that the speaker may have no formal advanced degrees in religious studies, finance, or any relevant field. They can simply cite an unverifiable list of names of "shuyukh" with whom they studied, and without formal degrees, you'll never know whether they ever understood what those shuyukh were saying (or if those shuyukh themselves understood the practical areas about which the self-made expert is supposed to be knowledgeable). Just imagine if a medical doctor performing an open-heart surgery on you had as his credentials the fact that he had sat down -- with many other wanabe doctors -- and listened to other doctors. Here is the recipe:

• Put on a costume. Even if you traveled in regular western clothes, you need the costume for appearances when you attend the meetings. If you are worried about being seen in the western clothes, you may want to keep the costume on more often.
  
• Thicken your accent: it makes you sound more exotic and knowledgeable.
  
• Pepper your talk with superfluous Arabic words, for which perfectly good English terms exist.
  
• Try not to mix with the masses: Always walk with an entourage. Instead of going to the microphone like others, ask for the microphone to be brought to you, etc.
  
• Make sure to use at least one dirty joke in each appearance: it helps break the ice and make you seem more exotic and learned.
  

Interestingly, some of the real scholars, like Dr. Hammad, actually come to conferences in a suit and tie -- even when the conference is held in Dubai or elsewhere in the Arab world. I guess they have legitimate degrees and do not need costumes.

But that doesn't sell as well to the second-rate bankers looking for a distinctive brandname that will allow them to get as rich as the better bankers. It doesn't sell well because most Muslims suffer from the need for authoritative figures who can claim possession of sacred knowledge. So, you just need someone who is moderately literate, and has good theatrical abilities, and voila: your second-rate product is "Islamic".

That is an affront to a great religion and a great tradition. Those who engage in this charade should be ashamed of themselves.

I strongly recommend the sadly funny cartoons by Tarek El-Diwani posted here. I would laugh harder if they were not so true

VE RI TAS

"Why am I here?" the dissilusioned economist wondered as he stared unbelievingly at the shield and the letters written on it: VE RI TAS.

Veritas?
Which truth and which reality?

Here is the truth and reality of Islamic finance, according to Newsweek. Is this the truth that was discussed? The truth that plagues the poor Muslims. The truth of poverty, malnutrition, illiteracy.

Some tried to talk about this, but no, we were told that "Islamic finance" only has the mandate of allowing businessmen to conduct their buiness "according to the Shari`a" [according to whose interpretation, one might ask!].

Veritas?

The truth and reality of bankers recodifying Islamic law by buying their favorite fatwas ($100,000 a year per "Shari`a scholar" should get you the very best), buying their regulators' accommodation (intimidation by playing the religion card gets you a long way), and buying their academic hosts' credibility (I don't know how much academic credibility is sold for nowadays)?

No, of course not. That cannot be said.

The truth and reality of making a mockery of Islam and Muslims?

No, of course not. We can't be that honest.

"Of course, the Islamic sukuk will cost around $50,000 more [incoherent mumbling about "different asset class", and comparing "Islamic sukuk" to Yen-denominated assets, even though those bonds have nothing left but credit risk, and are priced based on credit ratings by the same credit agencies that have made that determination] but that is much better than before", the speaker said. "International banks will have an advantage in Islamic finance... because they have a lot of available hamburgers, and all we have to do is to Islamize some of them", he continued.

Religious peddling of the worst type? Capitalizing on the religious insecurity of Muslims? Our own self-creation of a culture of indulgences and money changers' tables? How can we start with a religion that is inherently a reformation religion and then regress to this level?

If the Prophet Muhammad (p) was there, would he not have been outraged? If Jesus (p) was there, would he not have turned over the money changers' tables? If Moses (p) was there, would he not have burned this golden calf and thrown it into the sea? Where is the Islam in Islamic Finance?

Will anyone speak the truth about this depressing reality?

Veritas -- the shield said, but very few could even bring themselves to hint at it.

Who needs truth and reality when lies, deception, smoke and mirrors can be so profitable?

Do you think that if anyone tried to market this nonsense as Christian or Jewish finance they would have gotten this platform to give credibility to their craft? Whom should we blame? The Muslims who allow the name of their religion to be abused in this fashion, or the snake-oil salesmen who exploit the arbitrage opportunities that we create for them?

Veritas? What Veritas?

Riba as an extreme form of gharar -- Thinking aloud

I had taken it for granted that if you accept the view of the forbidden bay`u al-gharar as trading in risk, then you would recognize riba as an extreme special case of trading credit risk. Dr. Siddiqi objected that the essence of gharar is uncertainty, but -- he said -- there is no uncertainty in riba. I guess classical writers and Islamic economists for too long have been saying that riba is forbidden because the interest received is not compensation for commensurate risk, to the point that people have taken this to be true. This means that I need to have a full section dedicated to this issue in my academic paper. For now, let's see why it should be obvious that riba is an extreme form of gharar.

Economists regularly divide the types of asymmetric information that lead to market failure (due to uncertainty) into two categories: adverse selection and moral hazard. Let's look at the manifestations of those problems in riba and gharar, using examples from canonical texts and classical jurisprudence. We begin with adverse selection:

• Adverse selection in gharar examples:
  
  
  
  • Defective merchandise: seller knows if the good is defective but buyer doesn't
    
  • Diver's catch: diver knows if this is a good spot to dive but buyer of catch doesn't
    
  • Unborn calf: seller knows if cow has had previous miscarriages, etc., but buyer doesn't
    
  
  
• Adverse selection in riba examples:
  
  
  
  • Debtor knows if he has defaulted before, creditor doesn't
    
  • Debtor knows better the chances of solvency at maturity of debt
    
  
  

Then, of course, there is moral hazard:

• Moral hazard in gharar examples:
  
  
  
  • Defective merchandise: temptation to deliver lowest quality acceptable goods
    
  • Diver's catch: temptation to shirk
    
  • Unborn calf, unripened fruit, etc.: temptation not to care for cow or orchard, since risk has already been transferred to buyer
    
  
  
• Moral hazard in riba examples:
  
  
  
  • Of course, this is the classical example: debtor has an incentive to take large risks with the creditor's money, since all return up to the interest payment goes to creditor, and -- depending on bankruptcy laws -- liability may be limited.
    
  
  

Classical writers looked at the creditor/debtor relationship as creditor receiving return without commensurate risk, which is obviously incorrect. If that were the case, other crediors would compete for that riskless return opportunity, driving the interest rate all the way to zero. The problem is that the risks are difficult to quantify, and there is too much asymmetric information, which modern financial markets and institutions reduce with various structures and regulations:

• The creditor is exposed to credit risk and interest rate risk, thus favoring that the debtor takes very little risk with his money (explaining in part why a deposit, which is a contract of trust, turns into a loan, or contract of guaranty, if the depositary uses the property). However, due to moral hazard conditions, debtor may be tempted to take excessive risk.
  
• The debtor is exposed to business risk and bankruptcy risk. Of course that risk was substantial not only in antiquity, but well into the modern age, where quasi-slavery still resulted from excessive indebtedness to loan-sharks, white-slave traders, etc.
  

So, we can see that for the creditor (buyer of credit risk), the risk is very extreme, since incentives could encourage the debtor to take excessive risk and expose him to the possibility of losing all his money.

For the debtor, the risks may be substantial if bankruptcy laws are not in place to protect him, and may still be substantial if default makes it impossible to obtain further credit or get into other business arrangements.

Hence, riba is an extreme form of trading in risk (credit risk), or an extreme form of gharar.

Continued discussion on Mutuality and Riba with Dr. M. Nejatullah Siddiqi

See previous two posts for background. This is continuation:

MNS: Salam alaikum. I mean to press on the point relating to gharar. The essence of gharar is uncertainty. But there is no uncertainty about riba.

ME-G: wa `alaykumu s-Salamu wa raHmatu Allahi wa barakatuh. Yes there is [uncertainty in riba]: You do not know if the debtor will be solvent and able to pay (credit risk, which is very difficult to quantify), and for solvent debtors, there is uncertainty as to whether the interest collected is lower or higher than short term rates at collection time (interest rate risk).

MNS: I think you are alone in regarding riba an extreme kind of gharar.

ME-G: I recognize that this is a new statement, but I think that it has plenty of economic backing, and has great potential to solve a number of outstanding problems in Islamic economics.

MNS: The view has no support, neither in classical literature nor in modern writings.

ME-G: I agree, and it may be presumptuous on my part to propose this. However, it is a standard way conventional economics and finance looks at debt (credit and interest rate risk), and in that regard, all that I am doing is bringing our best economic and financial knowledge to bear on the religious issue.

MNS: I do not remember what you are referring to as Rachid Rada stuff. Please remind.

ME-G: It wasn't part of this debate. I had made earlier entries in my blog on Rachid Reda's response to the Hayderabad fatwa -- which argued that interest on loans that is stipulated at the inception of the loan is not the forbidden riba (even saying that Abu Hanifa only made it reprehensible). The translations and comments on that publication are posted in three parts:

• http://elgamal.blogspot.com/2005/07/rashid-rida-on-riba-i-hayderabad-fatwa.html
  
• http://elgamal.blogspot.com/2005/07/rashid-rida-and-muhammad-abduh-on-riba.html
  
• http://elgamal.blogspot.com/2005/07/rashid-rida-on-riba-iii-rationale-for.html
  

MNS: Ibn Araby text you qoute in the Blog has nothing to do with gharar.It refers to one of several kinds of riba.

ME-G: Yes, I had raised it as proof that the riba al-jahiliyya mentioned in Qur'an was regarding debts from credit sales, not interest at the inception of loans [please see the context of requesting the Ibn Arabi quote in previous messages]. The "Riba as an extreme form of Gharar" (just as "maysir is an extreme form of gharar") argument is separate.

Discussion on Mutuality and Riba with Dr. M. Nejatullah Siddiqi

I have received Dr. Nejatullah Siddiqi's approval to post my email discussion with him regarding my call to mutuality. His comments and questions are indented and in red and prefaced by MNS:. I am hoping to learn a lot from this exchange. (For those who do not know the field, Dr. Nejatullah is arguably the best living Islamic economist, and the most prolific writer on the subject. I am grateful that he took the time to have this e-discussion with me. As I told him, I see this as receiving instruction from him through the Socratic method). The discussion below is extracted from two rounds of email (separated by lines, see below). The second round addresses important methodological issues, as well as substantive ones.

MNS: I am making a partial response to you mutuality centered Harvard presentation. What is the basis of your claim that riba is an extreme form of gharar?

ME-G: My claim is based on the two economic analyses I had done, which resulted in defining riba as trading in credit, and gharar as trading in risk. Based on those arguments, it is clear that trading in credit is the same as trading in credit risk, thus making riba a type of gharar. Just as one who is involved in a trade with major gharar doesn't know if the trade is good or bad (due to randomness, incompleteness of contract, etc.), the one who trades credit risk for a particular amount of interest does not know whether or not he can even recover the principal (credit risk), and whether the interest he will collect will be enough to compensate him (interest rate risk).

That is the sense in which I depart from the conventional juristic and Islamic economic view of interest as a reward without taking risk. On the contrary, I argue, it is a peculiar kind of risk that is being taken, and one which -- if the credit extension is made commutative -- can be quite hazardous to individual lenders and borrowers, as well as to the entire system.

MNS: As regards Qarafi quote, it is his /jurist's rationalization.

ME-G: Yes, of course, and during his time, there would be no distinction between the human juristic rationalization and an economist's. What I am trying to do is to engage his logic and update it based on my contemporary human economist's perspective.

MNS: Allah allows qard, fa lakum ru'usu amalikum. That's it.

ME-G: Indeed, that is all we know with certainty, and the rest is human speculation.
Do you feel that I am not going after the maqsid behind this prohibition in the right way?
I figure that the economist's approach must be like this:

1. Allah only forbids harmful things
   
2. The types of credit extension available now are different from the ones on which the Qur'an commented directly (e.g. as explained in Ibn Al-Arabi's Ahkam Al-Qur'an)
   
3. Everything we permit or forbid today based on that verse is based on a form of qiyas
   
4. Here comes the difficult step: like Ibn Rushd, I prefer the economist's demonstrative proof over the jurist's rhetorical proof
   
5. My economic analysis (which is human, almost certainly wrong, and subject to change) is the best I have for now, and it tells me that what is being forbidden is profiting off of the act of credit extension itself.
   

Note: as described in AHkam Al-Qur'an, the debt could have resulted from a credit sale. The merchant could have made a profit on the genuine trade part, but he is not being allowed to make a profit off of the credit-extension component, which must thus be non-commutative.

As proof that this line of reasoning is not totally divorced from classical juristic scholarship, I use Qarafi's analysis as further corroboration.

Which step do you find lacking or mistaken?

MNS: Third point, profit motive is a sronger force than urge to cooperate/mutuality. Why must I replace a sronger motor with a weaker one?

ME-G: The profit motive can stay, and the multinational banks can play an important profit-motivated role in taking the mutual financial products to market.

However, allowing the profit motive in the act of credit extension itself invites the types of Shari`a arbitrage that have naturally led to tawarruq (I see very little difference between tawarruq and murabaha in this regard, please see my reply to the last point).

MNS: Shariah does not insist I do so. If your recommendation is basedon masalih, you have yet to prove it. You enumerate advantages, what about disadvantages of mutuality model applied to the financial industry as a whole?

ME-G: Perhaps first and foremost, I am basing the argument on the rule of sadd al-dhara'i`. Do you disagree that Islamic finance as practiced today has found many dhara'i` for the practice of riba, only charging the customer more? (more again in my reply to the last point).

Of course, mutuality has its disadvantages relative to other corporate forms. The primary disadvantage is the inability of mutual financial institutions to capitalize on economies of scale quickly by drawing funds from profit-oriented shareholders.

This is a tradeoff between low-risk low-return at the individual and macro level using mutuality models, and higher risk and return based on profit-motivated financial intermediation.

Your previous emails bemoaned the speculative and risky business of credit proliferation: that is what happens with profit-oriented and fast growing financial conglomerates, that's how they grow: by increasing their capital and increasing the amount of credit they extend.

MNS: Fourth, what you call fiction does bring in real assets into the act of credit extension. Why do you ignore it?

ME-G: Sometimes it does, but other times, as in tawarruq or murabaha with aluminum that never leaves a warehouse, the asset is just a mirage.

What I call fiction is not the asset, but the story being told: We pretend that the bank is making a profit trading in homes, when in fact it never does -- it is a financial intermediary in the business of selling credit. If it profits off the extension of credit, my economic analysis (which is not definitive, of course, and subject to error: I am mainly trying to stimulate debate)
says that profiting of that extension of credit is riba (net interest income being profitably large, whether the interest income is called interest, rent, price mark-up or anything else).

MNS: Why not make this involvement real, making Islamic finance really asset-based?

ME-G: I am all for doing that, but I am arguing that making the contract asset-based in form is insufficient, as long as the profit motive is there to encourage rent-seeking legal arbitrage. Indeed, I envision that a network of Islamic credit unions would in fact insist that credit extension is asset-based in a meaningful way.

I am merely saying that the restricted focus on contracts is insufficient. To regulate financial intermediation Islamically, we also need to say something about corporate form, if only saddan lil-dhara'i`.

---

Second email round

---

MNS [referring to the numbered bullets above]: 1.Riba is what Quran means by it in al-Baqarah:275-80 and other verses and, in that light,what Sunnah's application tell us.I do not accept "trading in credit" characterization.

ME-G: What other economic definition would you choose? As I have argued in my paper on riba (which you read a few years ago), "usury" is not a correct term, since it means to us excessive interest, whereas jurists -- based on Qur'an and Sunna -- tell us that even zero interest in selling one ounce of gold today for one ounce tomorrow is riba. Next, "interest" is also unacceptable, since Sunna clearly shows types of riba that do not contain interest.

I have looked for economic definitions, or even an English word that provides an appropriate definition of riba (jami` mani`; containing all types of riba and excluding all types of non-riba), but have not found any. I cannot make or understand any economic analysis unless the term has a clear economic definition.

MNS: The gharar line of argument is Sunnah based. How can I subject a Quranic category/a Quranic prohibition, to a Sunnah category/ a Sunnah prohibition? Neither should you.

ME-G: This depends on whether we agree on definitions, which you have said we don't, so I need to work more on that dimension. Your use of the Qur'an/Sunna dichotomy does not apply, however, in my case for two reasons:

• This is not the case of using Sunna to overrule the Qur'an, only a case to explain it
  
• All writers, as far as I know, agreed on the following: the Qur'an speaks about maysir (gambling), and that is an extreme form of the forbidden gharar. It can be avoided by making the deal non-commutative: a random prize is not forbidden, as long as the beneficiary never pays a price for it!
  

That is the same as what I am doing if you accept my definitions of gharar and riba. So, the issue is not methodological, only an issue of whether my economic analysis is correct, and what analysis we can put in its place.

MNS: 2.In the part beginning Allah allows qard...I do not accept#2 and therefore,#3 of your response. Please quote Ibn al Araby for me or give a link so I fish it out at al-islam.com riba bearing debt can arise from a sale on deferred payment deal.

ME-G: I am not sure if it is available online. I believe that the same explanation of riba al-jahiliya is also in Tabari, so I will try to get that online first.

[Under separate cover, I sent the following quote from Ibn Al-Arabi's Ahkam Al-Qur'an:

المسألة الثالثة : قال علماؤنا : الربا في اللغة هو الزيادة , ولا بد في الزيادة من مزيد عليه تظهر الزيادة به ; فلأجل ذلك اختلفوا هل هي عامة في تحريم كل ربا , أو مجملة لا بيان لها إلا من غيرها ؟ والصحيح أنها عامة ; لأنهم كانوا يتبايعون ويربون , وكان الربا عندهم معروفا , يبايع الرجل الرجل إلى أجل , فإذا حل الأجل قال : أتقضي أم تربي ؟ يعني أم تزيدني على مالي عليك وأصبر أجلا آخر . فحرم الله تعالى الربا , وهو الزيادة ; ولكن لما كان كما قلنا لا تظهر الزيادة إلا على مزيد عليه , ومتى قابل الشيء غير جنسه في المعاملة لم تظهر الزيادة , وإذا قابل جنسه لم تظهر الزيادة أيضا إلا بإظهار الشرع , ولأجل هذا صارت الآية مشكلة على الأكثر , معلومة لمن أيده الله تعالى بالنور الأظهر

[My translation] Third Point: Our scholars said that riba linguistically means "increase", which requires something over which increase is manifest. Thus, they differed over whether the verse universally forbids all types of riba, or abstract, requiring other texts to explain it. The correct view is that it is universal, since [the Arabs] used to trade and increase [the price for further deferment]. Thus, riba was known for them: a man would trade with another on credit, then when the debt matures, he would tell him: will you pay, or will you increase the debt? Meaning: will you give me more money so that I will give you more deferment? Thus, Allah forbade riba, which is increase. However, since -- as we said -- increase can only be computed relative to a baseline level, and since anything traded for a different genus would not make the increase manifest, and when traded for the same genus, increase is also not manifest except through the Law, this verse became problematic for most, understood only to the ones that Allah has given the most manifest light.
[ME-G] Is that the light of reason?

I found the book online at islamweb.net, which is also a reliable site.
Here is the link to this particular verse:

http://www.islamweb.net/ver2/library/BooksCategory.php?idfrom=364&idto=364&bk_no=46&ID=365

It makes it very clear that this was a debt based on a credit sale, where the credit component was originally either priced or unpriced, but the murabi wanted to tag a price on further credit extension. Most importantly, this was not -- at least not necessarily -- debt from a loan... See also my blog entries on the Hayderabad fatwa and Rachid Reda's discussion thereof.]

MNS: But we start from the primary case of a cash loan/money loan given for a period of time. Based on this, lakum ru'usu amwalikum is simple, clear, categoric, no rationale attached.Rationales will go on changing with time and place( and intelligence of the scholar!). Your rejection of Islamic economists' rationale does in no way oblige me to accept your rationale, or that of Qarafi, Ibn Rushd or Ibn Araby.

ME-G: Of course not. We all should only accept the rationales offered if they make sense to us. None of us speak with divine authority, so we should toss our ideas in the market for ideas, and hope that debate (like this) can bring us all to better understanding.

MNS: 3.it is too much,excluding profit motive from financial business on the ground of sadd al-dharai'.We may lose more than we gain.We have not exhusted possible remedies for the wrong discovered in contemporary practice of islamic finance based on old contracts, have we?

ME-G: You are almost certainly right, and we should look for all possible solutions.

Notice that my argument was not about excluding profit motives from all financial business, only from the retail-level credit and risk intermediation parts, and only after observing that over more than a century not-for-profit intermediaries here in the U.S. (both in insurance and in credit) have been resilient to economic cycles, and have continued to offer excellent
service to their customers. So, that seemed like a good off-the-shelf solution that was motivated by similar concerns, and which achieved very good results.

That's it for now. I have learned a lot from Dr. Nejatullah's writings, and look forward to learning more from future writings and similar discussions.

A (Forceful) Call for Mutuality In Islamic Financial Intermediation -- Or: Can "Islamic Banks" Be More Usurious Than Regular Banks?

Although this may be unorthodox, I have decided to post my presentation before actually delivering it. I have posted some of the slides from the presentation that I plan to make at the Harvard Islamic Finance Forum (April 22) here. I summarize the main points below (slides can be cryptic):

• The case for mutualization in Takaful (insurance alternative) is obvious. The very name chosen by the industry (meaning mutual-protection or guaranty) suggests this mutuality. In fact, however, mutuality in that industry is largely a fiction. In reality, so-called takaful companies are owned by profit-oriented shareholders, and thus the juristic solution of avoiding gharar through making the contract non-commutative (gharar only invalidates commutative financial contracts) is contrived through unconvincing claims that the shareholders voluntarily contribute insurance claims payments to their customers (this also raises many juristic issues on hiba and its rules, but that is not the point here).
  
• The juristic solution can make economic sense if we align rhetoric with reality, and actually make takaful companies mutually owned. In other words we need to shift focus from contract forms to corporate structure and incentives.
  
• The same argument can be made for the avoidance of riba. In fact, I argue, riba is just an extreme form of gharar, where the latter is profitable trading in risk, and the former is profitable trading in credit. Of course, trading in credit is the same as trading in credit and interest rate risks -- as every undergraduate student who has studied money and banking knows. Contrary to the statements of classical jurists and Islamic economists, the prohibition of riba cannot be explained by the lender earning a return without taking commensurate risk. (If that were the case, lenders would be competing for the opportunity to get such riskless return, and the interest rate would fall to zero! You would also need a monopoly constraint, that the borrower could not seek lenders at lower rates, but then we are in other impermissible territory, and not speaking only about riba.) On the contrary, the problem with riba may arise precisely because credit risk is so difficult to quantify, and hence it is difficult to draw a line between legitimate interest and predatory lending or loan sharking (the Fed and the OCC are struggling with cases of possible predatory mortgage lending to minority groups in the U.S.; precisely because credit risk is so difficult to calculate).
  
• To make a long story short, the fear of predatory lending or injustice in credit extension, riba may be best solved by excluding the profit motive from credit extension. In reality, so-called Islamic banking providers may in fact be committing a worse riba than the banks from which they sprung and which they continue to serve: If they charge extra interest over and above the level that was profitable to the bank in the first place (what I have previously called rent-seeking Shari`a arbitrage), then they may increase the riba (unjustly priced credit), or introduce substantive riba where none may have been before. Take the profit motive out, and you don't have to worry about that. Shift the focus from contract forms (which invite rent-seeking legal arbitrage) to corporate forms and incentives.
  
• As evidence of partial agreement and disagreement with classical Islamic scholarship, I refer back to Al-Qarafi's Furuq, especially the point that interest-free loans would themselves have been riba (how do you know that zero interest is the fair rate; think of all the 1970s debates about indexing, inflation, etc.). Loans were excluded from the rules of riba, he says, because of their charitable nature. Any compensation would transform a loan into a sale, hence requiring application of the rules of riba to ensure equity in exchange (see my earlier analysis of Ibn Rushd's analysis of the rules of riba and argument that it is all about equity in exchange). In other words, the solution to the problem of riba was non-commutativity, i.e. the same as the solution to the problem of gharar. My argument is that non-commutativity in finance requires a mutual corporate form, and cannot in reality be implemented by for-profit corporations, who have every incentive to exploit contract rules (legal arbitrage) for profit.
  
• Of course, Qarafi's argument that l`ariya or simple loans would become leases if compensated, and that riba is not envisioned in leasing, predates the structured financial uses of leases as loans (originally in 1980s leveraged buyouts, and most recently in so-called Islamic bonds -- marketed under the name sukuk). Economically, those leases are not sales of usufruct, but sales of credit, and hence should be made subject to the same rules of riba as loans. As proof, check the legal provisions that require continuation of the rent payments (recharacterized as price repayment) even if the property is destroyed -- i.e. where there is no longer usufruct. There is no lease there, only a loan, which -- compensated -- is a sale of credit wherein we need to worry about riba.
  
• Hence, I argue, the solution is in mutuality, through credit union, mutual saving banks, and other forms that originated in the west, driven mostly by faith communities and working-class organizations wishing to avoid unfair lending practices of commercial banks.
  
• I can't post copyrighted material on the web, but you can look at Wall Street Journal on March 7, 2006, discussing the tremendous growth of credit unions in the U.S., and commercial bankers' attempts to stop their growth. I will also show two quotes by Sh. Saleh Kamel, which suggest that Islamic banks are in fact mutuals ("depositors are partners...") and that they have a social agenda (provide investment opportunities, etc.), which in fact the bulk of Islamic finance has not been.
  
• The recipe that I am suggesting is simple: MUTUALIZE. Abolish the profit motive in Islamic finance, and align its rhetoric with reality. Then, the industry will not be dominated by western banks who are seeking rents -- by charging higher interest rates to a captive Muslim audience under different guises.
  

Feedback very welcome (elgamal@rice.edu, or request membership of the blog, and then you can post comments -- a necessary evil after having received numerous spam comments on the blog).