Thursday, August 18, 2005

The dangers of Islamic finance fatawa

In his comment on an earlier blog post, heraish pointed me to this article on "random fatwas" affecting investment patterns in Saudi Arabia. His prescription, and the one endorsed by the article, is to follow the opinions of some higher council or academy of specialized `ulama. While this approach would add some predictability, and reduce confusion in a period of market development, it has its great shrotcomings.

The first problem is that traditional `ulama, including specialized ones, have a very limited understanding of the economic and financial issues with which they deal. For instance, I gave the example of the strange and economically incoherent fatwa regarding indexation by the OIC Fiqh Academy, which is perhaps the most respected international juristic body.

As if jurists' misunderstanding of economic and financial affairs, and their inability to reason coherently on such issues, is not enough, Islamic finance has now made jurists the gate-keepers for new innovations, the market effects of which are often not known even by bona fide financial experts. Shari`a board-certification of products is solicited before the products are offered, and the possibility of abuse to effect riba and gharar -- or lack thereof -- is not yet understood.

The institution of fatwa (responsa) was put in place so that jurists/mufti who fully understood the circumstances of the mustafti (questioner), and fully understood the issue about which he was asked, can tell the questioner whether or not a specific activity violated Islamic law. Making jurists part of financial engineering and product development, under the excuse that this ensures Islamicity of the products, is the ultimate in incoherence, for even a very informed jurist should only be able to issue such an opinion after they have observed the product in action for some time.

The net result is very bad finance, which frustrates true innovation, Islamic or otherwise. Moreover, many of the rules devised by jurists (e.g. the incredible one-third debt to market capitalization screening rule that forces Muslims to buy-high and sell-low!) become difficult to replace, even if their financial effects are proven to be disastrous, and/or if they are found later to be ideal vehicles for effecting the forbidden riba (if at a higher cost).


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