Thoughts on Sharia Finance

Islamic finance carries specific rules about charging and paying interest. The Quran talks about “usury”, not unlike the Bible, and how this allows the rich to prosper at the expense of the poor. “Usury” means excessive interest. The Quran also outlaws financial speculation.

These principles are perfectly sound and right. Had the global banking community had adopted these principles from the mid-1990s then the severity of the financial crisis in 2008 would have been much reduced. And excessive interest charged by loan sharks only serves to trap the most vulnerable in a perpetual cycle of poverty. The world would be a better place if all financial institutions adopted the principles of Sharia finance.

However, the specific utility of Islamic finance is illogical and dogmatic. In an Islamic mortgage the home buyer and bank buy the house and the bank is repaid over time by charging the householder a rental fee for living there.

The bank ends up making just as much money as in a traditional interest-bearing mortgage. This rental charge is just interest in another name. In Islamic finance one party is not allowed to profit from another. However, profit is the motivation to engage in a transaction and the world would struggle to function without it. In order to generate profit without it being seen as profit an income stream in Islamic finance is simply redefined as something else. The aim is to hide the fact that a profit is being generated.

However, one of the fundamental principles of accounting and finance is transparency - that is, defining assets, liabilities and income streams as what they are and not being deceptive about them. The US company Enron went down because it failed to declare huge liabilities correctly thus deceiving investors and shareholders as to the true extent of the company’s vulnerability. Failing to declare a profit is tantamount to deception and is the principle method of tax evasion. These Islamic financial practices do not sit well with commonly understood ethical principles in accountancy.

This problem arises from taking a literal interpretation of a religious text. It is the underlying principle that the Quran is endeavouring to put across that should be adhered to. The principles are designed to stop the rich “screwing” the poor. But a standard interest-bearing mortgage, which is affordable to the borrower, where the bank makes a little bit of profit – but not too much – and the bank has had to compete on the open market against 500 other mortgage providers, seems to me to be perfectly compatible with the underlying principles of Islamic finance, even though payment of interest is involved. Likewise, an Islamic mortgage where the bank charges an unreasonably high 'rental' fee and is a bad deal for the householder, even though it conforms to the specific rules of Islamic finance, does not conform to the spirit of Sharia finance, so can hardly be considered to be Sharia compliant.

Furthermore, in the past most money lending was carried out by groups of wealthy individuals and institutions. Nowadays, one's pension fund may own shares in the very institution that is providing your mortgage and profiting from you.

The problem of literal interpretation can be seen in the Quran's position on the drinking of alcohol. It says nothing about heroin, so a heroin addict can, if the rules are applied literally, ascend to Islamic heaven but should they eat a mince pie with sherry in it the heroin addict is suddenly condemned to Islamic hell. Interpreted differently, it is the intoxicating effect of alcohol that is banned, so therefore any intoxicating drug should be considered off-limits. And a small amount of alcohol, such is in food, that does not induce intoxication should be perfectly allowable.

When considering a religious text, or any other doctrine, I believe one should focus on the underlying movitation of why it says what it says and not just the literal meaning of the words. There should be no need for a separate Islamic banking system because all banks should, by the very essence of their operations, be compliaint with Islamic financial objectives. These objectives would make banking fairer and prevent rampant financial speculation, even with interest being charged.