Substance Over Form
:
○ Every one of your future clients is part of a system
○ Your job is to identify that system
○ Evaluate it
○ And then help your client’s individual issues directly
○ As well as indirectly, by helping make improvements in the system
:
○ Every one of your future clients is part of a system
○ Your job is to identify that system
○ Evaluate it
○ And then help your client’s individual issues directly
○ As well as indirectly, by helping make improvements in the system
Why go through the trouble of forcing an Islamic bank to buy a property first and then sell it to the customer on credit if the actual objective can be achieved more directly, through a secured lending transaction? In order for Muslim communities to go beyond formalistic adherence to premodern jurisprudence, they needed to revive the substance of classical Islamic jurisprudence in an enlightened modern manner. [1]
It is important to not get caught up in semantics. The phrase “interest rate” may have originated from an exclusive reference to interest on loans, but modern understanding is that this term now applies to any time-value compensation. It is a fact that the time-value of funds is acknowledged even in classical Islamic legal theory. Jurists of all major schools of jurisprudence recognized that compensation for time value of money is permitted, and warranted, in contracts such as credit sales and leases.[2] There are forms of interest that are not considered riba (e.g., credit sales and leases), as well as forms of riba that are not considered interest (e.g., so-called riba al-fadl in hand-to-hand trade with no time component). Therefore, it behooves Islamic finance providers to clarify any misconceptions that “Islamic law does not acknowledge the time-value of money.” In this way, the credibility of the industry would improve for both its customers and regulators. There is no shame in clarity, because those same Islamic financial practitioners have already adapted the classical forms of salam and istisna and spliced them with other forms of transactions to mimic conventional financing, including interest-bearing loans, interest-bearing bills and bonds, and build-operate-own infrastructure and other project financing, etc.[3]
We must return to the objective of classical Islamic jurisprudence which has been to enhance economic efficiency, according to the best benefit analyses of premodern jurists. The process is what matters, not the final form. Contemporary fixation on inefficient premodern forms simply does not due justice to the “Islamic” brand name. Rather, just as sound classical jurisprudence of financial transactions was driven by benefit analyses, so too postmodern Islamic finance should aim at maintaining conventional practice (urf) rather than seeking alternatives thereof, especially if those alternatives are inefficient.
In the case of legitimate credit sales or lease-to-purchase financing secured by real estate, vehicles, equipment, and the like, instead of benchmarking the Islamic finance “profit rate” to the “interest rate,” benchmarking should be to the market rental value of property. In this way, the borrower and lenders can better determine whether or not the prospective loan is justifiable. In contrast, the “rental” value on commodities used in tawarruq is precisely the rental value on money: that is, market interest rates that are not linked to the object of sale in any meaningful way. In other words, the “bundling of credit” in this transaction serves no economic purpose. It is a mere legal stratagem or ruse (hila) to legalize otherwise forbidden interest-based lending.
In cases where current practice in Islamic finance serves legal form alone and ignores substance, the credibility of the industry erodes. As a result, there were more scholarly and public attacks on the contemporary practice of murabaha financing as merely inefficient lending. The upside to this trajectory is that pressure from without and within the Islamic finance community has stimulated more faithful alternatives to be developed. For example, there is now increased use of lease-based financing where marking-to-market rent is more straightforward.[4]
Real Financial Ethics
If the economic substance of Islamic home finance is deemed to be functionally equivalent to conventional banking forms of secured lending, why should we not say that secured lending is more akin to trade or leasing than to forbidden interest-based cash loans? As shown above, the argument for equating interest-based secured borrowing as practiced today to be equivalent to interest-bearing monetary loans of premodern times appears very weak according to the standards of premodern jurisprudence.
The Sharia arbitrage method of the past few decades sees Islamic finance as an alternative to conventional finance, rather than a minor modification thereof. Modern jurists who espouse this paradigm recognize that the functions performed by conventional financial institutions (financial intermediation, amelioration of risk, etc.) are necessary for the functioning of any economy. In other words, they are already sold on the idea that these transactions are part and parcel of modern business. However, since they want to reinvent the transactions from the ground up, they work closely with bankers and lawyers to “Islamize” any given set of financial services or products. This approach will soon reach the limit of its feasibility, not to mention the limit of its credibility.
The other approach is more minimalist or reformist in philosophy. Modern jurists who espouse this paradigm start with the assumption that conventional financing transactions are permissible, and only a few minimal modifications or regulations need to be added to make it comply with Sharia. There is no need to reinvent conventional financial institutions. As a consequence, this approach would abolish Sharia-arbitrage opportunities and merely add consumer protection and prudential regulations as derived from Islamic canonical texts and premodern juristic derivations therefrom.
Conclusion
In conclusion, the two main prohibitions in Islamic jurisprudence, those of riba and gharar, are best characterized as trading in unbundled credit and trading in unbundled risk, respectively. For the case of riba, disallowing unbundled trading of credit can protect individuals who are vulnerable to excessive borrowing from falling into debt cycles and should mark interest rates to the asset-market, rather than the loan market. Similarly, prohibition of trading unbundled risk aims to protect individuals from exposure to excessive financial risk as the substance and spirit of Islamic Law aspires.
The main difference between Western and Islamic economics is debt-based financing versus asset-based financing. By enforcing actual asset-trades, the Islamic Bank should be more invested in the product or project it is being approached to help finance. The spirit of Islamic jurisprudence allows transfer of credit and risk only if bundled within a financial transaction such as sales, leases, and partnerships. Such bundling regulates the riskiness of financial transactions, thus allowing for necessary risk taking to encourage investment and economic growth, while minimizing individual and systemic risks of bankruptcy and wild fluctuations in economic values.
[1] (Al-Qaradawi 1996, 17)
[2] (Usmani 1998, 22)
[3] (El-Gamal 2006, 81)
[4] (El-Gamal 2006, 63)
