Chapter 1
Easing into Islamic Finance
In This Chapter
Examining the core ideas of the Islamic finance industry
Getting to know industry products and institutions
Recognizing current and potential demand for Islamic financial products
Islamic finance has become an especially hot topic since 2007, when the global financial crises started doing serious damage. Nearly everyone felt the pinch of these crises. Now, academics, businesspeople, politicians, and religious leaders â in Muslim and non-Muslim nations, in the East, Middle East, and West â are talking about the significance of the Islamic finance industry. In part, thatâs because the Islamic system has survived these crises with less stress and better performance than many nationsâ conventional industries. People are curious to find out why thatâs the case and how Islamic finance differs from its conventional counterpart.
In this chapter, I offer a broad overview of the Islamic finance industry to help you get a handle on the concepts behind it, the principles that define it, the products that support it, the people who participate in it, and more. I then touch on the industryâs current level of demand and project how much (and how quickly) itâs likely to grow â topics that receive much more attention later in the book.
Defining the Concepts and Principles of Islamic Finance
Islamic finance is a financial system that operates according to Islamic law (which is called sharia) and is, therefore, sharia-compliant. Just like conventional financial systems, Islamic finance features banks, capital markets, fund managers, investment firms, and insurance companies. However, these entities are governed both by Islamic law and the finance industry rules and regulations that apply to their conventional counterparts.
Although the Islamic finance industry itself is quite young, Islamic theories of economics have existed for more than a millennium; by the mid-12th century, in fact, many Muslims scholars had presented key concepts of Islamic economics that are still relevant today. But political and social turmoil put the brakes on Islamic finance for a very long time; only in the 20th century did Muslim scholars and academics seriously begin to revisit these topics (and, in doing so, set the stage for the modern Islamic finance industry to emerge in the 1970s). Chapter 3 offers some details about the history of the Islamic finance industry, starting in the 6th century and including the explosion of activity that occurred in the late 20th century.
In this section, I introduce the concepts that support the Islamic finance system and the principles that every institution within it must apply.
Searching for balance
As I explain in detail in Chapter 2, Islam is more than a religion; itâs also a code of life that deals with social, economic, and political matters. A person who follows Islam is a Muslim, and every Muslim is expected to live according to the Islamic code, which is sharia (Islamic law). Each issue addressed by sharia is entwined with all other issues; therefore, economic matters are related to religion, culture, ethics, politics, and so on. (Contrast this perspective with the economics of Adam Smith or Karl Marx, for example, whose philosophies exist independent of religious principles, beliefs, and culture.)
Islamic economics is based on core concepts of balance, which help ensure that the motives and objectives driving the Islamic finance industry are beneficial to society. I explore these core concepts here.
Balancing material pursuits and spiritual needs
Islam encourages spirituality in all pursuits. That doesnât mean that Muslims are ordered to avoid economic activities or the pursuit of wealth. Instead, a Muslimâs economic activities and pursuit of wealth should correlate with the spiritual aspects of life. For example, someone shouldnât focus on business success so much that he neglects worship.
The sources of Islam (which I describe in Chapter 2) teach Muslims that economic activity conducted according to sharia is, itself, an act of worship. That is, Muslims will be granted rewards or merits for sharia-compliant economic activities just as theyâre rewarded for worshipping Allah (God). But the key to achieving such rewards is to find balance between economic activities and spirituality, as I explain in Chapter 5.
Balancing individual and social needs
Islamic economics is also framed on the balance between the individualâs needs and those of other people. A Muslim is expected to consider society in general when enjoying the bounties granted to her by Allah. These considerations include promoting justice in all economic activities, remembering that all people have mutual responsibility for all others, and using the earthâs resources wisely. I devote Chapter 5 to Islamic commercial ethics, which include these topics and more.
If youâve studied conventional economics, you may be wondering how Islamic economics deals with supply and demand. From a conventional perspective (such as capitalist or socialist), the question is, âHow does an economy satisfy unlimited wants with limited resources?â The way a given economy answers this question influences what is produced, how itâs produced, and for whom itâs produced.
According to Islam, the economic problem at the heart of this debate canât arise because Islam doesnât accept that all human wants must be fulfilled. In other words, the religion establishes limits on demand based on guidance from Allah.
Islam promotes moderate consumption and prohibits extravagant spending. That word extravagant applies both to spending too much on acceptable products and activities and to spending any money at all on prohibited ones. For example, people are involved in extravagant spending when they use consumable resources (especially food and drink) in an irresponsible manner but also when they drink alcohol, gamble, hire a prostitute, purchase pornography, or promote the production of weapons of mass destruction â all prohibited activities according to Islamic law.
So even though the supply of resources in this world is limited, Muslims believe that Allah has provided everything that humans need (and in an appropriate quantity). Islam ensures that humans use resources wisely by placing limits on demand through the directive to be moderate in consumption. While nations with conventional economic theories struggle with how to handle the push and pull between supply and demand, Islamic nations find the solution within the religion itself.
Believing that Allah is the owner of all wealth
Capitalistic societies are based on a concept of private ownership of property: Individuals hold different kinds and levels of wealth, and the government intervenes only when public interest demands it. Socialist theory is based on collective ownership, wherein wealth belongs to the state or the public; no individual ownership exists, and individual efforts donât result in a greater or diminished accumulation of wealth.
A core concept of Islam is that Allah is the owner of all wealth in the world, and humans are merely its trustees. Therefore, humans need to manage wealth according to Allahâs commands, which promote justice and prohibit certain activities. At the same time, Muslims have the right to enjoy whatever wealth they acquire and spend in sharia-compliant ways; they donât need to feel shame about being wealthy as long as their behavior aligns with Islam.
To promote justice related to the distribution of wealth, Islam imposes a property tax called zakat (which is one of the obligations of Muslims; see Chapter 2). Every Muslim who meets certain criteria regarding the accumulation of wealth must pay zakat, which is distributed to people in need. In other words, zakat is a mechanism that promotes a just distribution of wealth among people. Islam also encourages charitable activities in addition to zakat according to an individualâs preferences.
So how can a Muslim acquire wealth in a shar...
