Islamic Banking Rules Reflect the Tenets of Muslim Holy Book; Worldly Success Is Seen as a Sign of Allah's Blessings, but Self-Interest, Conflicting with Public Good, Is Tabu

By Smith, Pamela Ann | American Banker, November 23, 1984 | Go to article overview

Islamic Banking Rules Reflect the Tenets of Muslim Holy Book; Worldly Success Is Seen as a Sign of Allah's Blessings, but Self-Interest, Conflicting with Public Good, Is Tabu


Smith, Pamela Ann, American Banker


Only a few years ago, the idea of "Islamic banking" was likely to provoke laughter rather than serious consideration. But, as a September conference on the subject in London Demonstrated, Islamic banking is now attracting considerable attention in the world's money centers.

More than 100 bankers, including representatives from such august institutions as the Bank of America, Citicorp, and American Express, turned up to hear esoteric lectures about concepts such as musharaka, mudaraba, and takafful interspersed with praise for the seventh century prophet, Muhammad, and the holy book of Islam, the Koran. But what, one might wonder, does an ancient religion have to do with that most earthly of commodities, money?

In Christianity, the maxim, "Render of Caesar that which is Caesar's and to God that which is God's," sums up an attitude that looks askance at the acquisition of wealth for its own sake. Islam, in contrast, makes no distinction between the material and the spiritual.

The pursuit of gain is totally compatible with righteousness. Worldly success, rather than being disdained, is seen as a particular sign of Allah's blessings.

What is frowned upon is individual self-interest, especially when it conflicts with the public good and the needs of the community of believers, the umma. Adam Smith's dictum that all men seek ultimately to maximize their own economic interest, when pursued as an end in itself, is regarded as a Challenge to God's will and heresy of the worst kind.

Instead, Muslims must engage only in activities that do not exploit their fellow men and women and that contribute to the betterment of all. Riba, or interest, is banned on the grounds that it benefits the provider of finance at the cost of those who do the work.

Also banned is excessive speculation, which is seen as promoting the individual's interests at the expense of those who produce goods and services needed by the community. Muslims, to comply with the Koran, must share the risks -- and the potential for both profit and loss -- rather than stipulating a fixed rate of return on their investments prior to the undertaking of a particular project.

No doubt all this would be ignored in the West were it not for the recent flood of oil money to Arab countries that have large Muslim populations. But it should not be forgotten that the Islamic financial system was largely responsible for the considerable prosperity that the Arab world, Persia, Central Asia, Spain, and North Africa enjoyed in the Middle Ages.

The partnership form of contract, known as musharaka, distributed profits and losses equally among those who provided the capital and those who provided the labor, thereby encouraging investment and incentives to start new projects. Mudaraba, another form of contract, allowed entrepreneurs to determine with their financiers the share of profits each would receive and greatly facilitated the financing of trade across long distances. Islamic forms of insurance, known as takafful and tadamun, provided mutual guarantees against the hazards both parties encountered.

The decline of the Islamic empires, however, and the conquest of the Arab lands by the British, French, and Italians at the end of World War I put an end to this system, which had already been abused for two centuries by the Ottoman sultans. Exploited by their Western masters, Muslims all over the Middle East and North Africa turned their backs on the new British, French, and Italian banks being set up in the region. They either stuffed their cash under their mattresses or opened up small savings accounts with fellow Muslim traders who invested their funds in small local projects that were set up outside the colonial economies imposed from above.

As a result, a parallel economy grew up with the capitalism brought by the West. One recent study, carried out in Saudi Arabia, estimated that as much as 40% to 60% of the cash -- or some $30-$40 billion -- held by Saudis even today is still invested in noninterest bearing accounts or simply kept in cash boxes to be used as needed. …

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