Whither Islamic Finance? Part II

Abu ‘Arqala (AA) at Suq Al Mal raised a few valid questions after reading my earlier post on the topic. Below I have copied his questions and my answers to them.

AA: There have been objections to your point of view – by some who I would characterize as serious parties. While they have a variety of arguments, there are three related topics that I would be interested in your thoughts on:

(1) Putting aside the qard hassan, can there be debt in Islamic finance? Or is Islamic finance equity only? With all the implications these imply.

My Answer: It depends on how you define debt. Leasing provides a very good example of conventional asset backed financing that is very close to islamic financing. Simplistically speaking, in a conventional lease, the lease originator or lessee owns the equipment and lends it to lessor. The transaction documents however mention the equipment value as loan and charge interest on it. In Islamic Finance, this will be replaced by Ijara and transaction documents would show the lessee renting out the equipment. From financial perspective (cashflow/IRR/NPV calculation) the effect would be the same to the extent that the rent amount would be equal to interest amount. However, if things go wrong, the Islamic finance lease/ijara should be decided as a rent transaction as opposed to conventional leasing transaction where it might be treated as a money loan.

It all boils down to your definition. Though in both cases lessor owns the property, but from accounting perspective one may be treated as debt and other equity.

The question here is not whether there can be debt in Islamic Finance. The question is are we allowed to charge interest on debt and the answer is NO.

(2) “Ease” and “The Middle Way” As I understand the teachings of Islam, a Muslim may eat pork if there is no other food and he is starving. Is there an analogy in financing? In order to build up an Islamic finance alternative, are IF practitioners allowed to engage in non Shari’ah compliant structured transactions? If so, is that temporary? Or if we can get partially to IF is that better than remaining stuck in conventional (non Shari’ah) financings? And so the partial state of true IF could be longer term.

My Answer: Till sometime back (when I did not have a chance to work in Islamic banking) I was a strong proponent of “middle way” using the argument that it took almost 500 years for conventional banking to reach from its roots in streets of Italy to where it is today. We should give Islamic Finance at least 50 years if not half that or more to reach maturity.

However, from my working, dealings and the information that is being posted about Islamic banks (most recent being the ADIB case highlighted by you) I have realized that the most of the sponsors behind Islamic banking do not have sincere intentions (niyyah). Large number of Muslims are reluctant to bank with conventional banks hence it presents a huge untapped potential/market. So by labeling conventional products as Islamic or structuring them to appear as such, they are trying to reach this market.

We have a saying that most islamic banks structure the products so that it follows the letter of the law but not the spirit of the law.

Recently National Bank of Kuwait (largest and most profitable bank of Kuwait) has acquired Boubyan Bank (islamic bank). NBK and its shareholders do not and should not care about Islamic banking and from what I have been hearing, changes are coming in Boubyan bank in terms of kind of products being preferred that do not follow the spirit of the islamic law. NBK has no mandate to promote islamic banking. They are interested in profits (and they should be) and intend to make maximum profits in Boubyan Bank by just following the letter of the law.

Most islamic banks have stopped after reaching mid-way. One could justify it as half is better than none at all. True, but that would have held if you are on your way to full islamic banking and in transition. The way banking is being done at the moment, they have stopped completely at midway and most of them are moving backwards.

The example of ADIB LC transaction is a case in point. If this is midway, I say lets stick with conventional banking. At least we are not fooling ourselves or the shariah board this way.

How can one consider a transaction to be kosher if the approval was obtained by misleading the Shariah board.

(3) Practicality – The IF you describe requires a great deal of due diligence. Can the depositor do the work necessary to evaluate where to place his funds? Primarily I’m thinking about the average Abdullah on the street with a relatively small amount of money. How does he find a way to invest and make a return? Especially in the era of paper money where inflation may erode the measure of value. My dinar today might buy a qantar of dates. But ten years from now only .9 qantar. (Which I suppose leads to the interesting topic of Islam’s view about paper money, inflation etc).

My Answer: I was implying that an IF should do extra due diligence when making investments compared to conventional institutions because in addition to ensuring that investment generates a decent return, they have to ensure that the investment meet the islamic finance criteria in terms of nature of business etc. Till couple of years ago, it would have seemed absurd for an average person to carry out due diligence for depositing his money even in a conventional institution but the credit crisis has put those all those notions to rest. However, I am not sure what benefit would have accrued had he done due diligence. With Chuck Prince dancing, nobody would have a reason to doubt that Citibank or others are as good as dead.

Take the example of Gulf Bank in Kuwait. On paper, it was a sound bank. Derivative transactions with one party was enough to bring it down. Even a highly sophisticated investor would not have any idea what is in store for her if she deposits her funds in Gulf Bank.

I can suggest that we should have islamic rating agencies, islamic audits etc to help an average investor but it has been proven time and again that the bank could easily maneuver transactions/accounts and get the ratings/approvals required.

To answer your question, he is expected to do at least that level of due diligence that he would do when placing money in conventional bank.

Will get back to you some other time with respect to inflation and paper money etc as my replies have already become very long.

Journalistic mindfuck of the day : Air crash edition

Yesterday’s crash of Air Blue jet in Islamabad killing all 152 people on board was a national tragedy. However, what made the situation worse for the grieving nation was the pathetic reporting by major news outlets.

Cafe Pyala has done an excellent coverage of it here:

No tragedy, however, is big enough that a few misguided souls cannot subvert through their unmitigated idiocy.

Exhibit A: ARY reporters take away identity cards from crash site to show on camera as a scoop. Geo reporter threatens that his cameraman has two ID cards of the deceased as well. So what if we can’t show bodies anymore?

Exhibit B: Someone wonders on a blog if the crash could be a conspiracy to turn public attention away from the fake degrees issue.

Exhibit C: Geo believes it’s important that an animated loop of a plane crashing repeatedly into hills and going up in a fireball is important to drive home the story. Particularly for friends and relatives of the deceased.

Commentators on the same blog provide additional examples of stupidity. You can read the comments here.

In contrast, DAWN’s deputy editor has written a very sensible blogpost on the shameful media coverage of the event:

Just the way you wouldn’t hand weapons to an untrained army, you wouldn’t hand cameras and a press pass to untrained media representatives. However, fact of the matter is that time and time again we are reminded that the latter has been taking place in Pakistan almost constantly.

You can read the rest of the blog post here.

Whither Islamic Finance?

Since the credit crisis hit Middle East, people are constantly bashing Islamic Finance as a failure. I just intend to expose the ridiculousness of one of their arguments over here.

One can easily Google info about Islamic Finance over the internet, so I will not expend large amount of words on explaining it.

If you have taken Econ101, it defines three roles of money:

1. Money is a medium of exchange
2. Money is a measure of value
3. Money is a commodity (trade-able)

In Islamic Economics, the third one does not stand or is not allowed. You can not trade money, you cannot make a profit on it. As such, interest (or profit) on monetary loans is forbidden. This is the essence of Islamic Finance, the implication being that one can only trade hard assets. Hence Islamic finance is also known as asset backed finance.

People claim that money is also an asset like other assets and should be tradeable. Islam does not deny this, it just forbids you to treat it like one. It is clearly mentioned in Quran that they will claim that Riba (profit on money – interest) is like trading but Allah has allowed you to trade (assets) and forbidden you from Riba.

It is very clear that anything above principal in a money lending transaction is Riba, however, the naysayers are at pains to point out that translation of Riba is Usury and not Interest ( I have no idea where did they come up with this arbitrary differentiation). Thankfully Quran remains in its original language of Arabic otherwise I shudder to think that what else people would have claimed as lost in translation.

Now we come to the question of failed investments in Islamic Finance _ falling investment values, defaults on sokouk etc. Like any other investment, islamic (shariah compliant) investment vehicles also face risk and rewards.

Just because a company has raised money through shariah compliant means does not mean that it will definitely be profitable. If that money is used to make speculative deals in real estate (like Dubai companies have done) Shariah compliant or no shariah compliant, the investment has to go kaput.

Investing through Shariah compliant products may require you to maintain similar or even harsher level of due diligence than conventional finance because it not only restricts you from certain forms of raising money but also forbids you in making certain type of investments. If you do not do your homework, you are bound to fail.

People have used a default of a few sokouks and failed performance of few institutions to decry Islamic Finance.

If we want to use the same logic, I think the conventional banking in US, UK and Europe should be shut down as this credit crisis has shown them to be the most failed institutions/systems in the world requiring massive amounts of government funds to stand up. Similarly, such well regarded investment banks as Bear Stearns, Lehman Brothers, Merill Lynch have blown up within a year. Does this mean that investment banking and conventional commercial banking is a failure?

An argument that seems totally reasonable to decry conventional finance, people find it reasonable to bash Islamic Finance.

Islamic Finance is viable and workable economic model and is working fine wherever it is implemented. However, it has failed to gain traction not because it is flawed but the way it is practiced today. A few examples:

1. Replicating conventional methods
Most of the IF institution deal with borrowers that also borrow from conventional institutions. In order to make the borrower comfortable and  avoid teaching him intricacies of IF, IF institutions try to make their instruments look as similar to conventional instruments as possible that the only thing that is different is the word “profit” instead of “interest” in the loan agreements.

2. Offering similar investment products
By definition, derivatives are haraam in IF. Now if you go and create instruments and structures that offer you the same risk/return profile as derivatives but with a label “islamic”, then you are just trying to fool God. Might as well slaughter pigs and sell them as “halaal” pork.

3. Manpower
Conventional banks with their promises of bonus and high payscales attract top graduates. In order to not be left with low class talent, IF institions try to attract employees from conventional banks. These employees  have been trained to offer conventional instruments and are only interested in their bonuses and neither care about Islamic Finance nor educate themselves about its products. Rather than learn about the product and make a concerted pitch to the customer, they take the easy way out saying that this is a conventional product with the Islamic label.

These are some of the factors that bring a bad name to Islamic Finance and are the reason behind the infamous Urdu quote  “kaan ko, sar kay uper say haath ghuma kar, pakarna” (To grab the ear, with the hand coming around the head).

UPDATE: You can read the subsequent post in the series Whither Islamic Finance – Part II.

Introspection : Pornistan

The pundits are saying that internet spells doom for newspapers and journalism as we know it. As news is available freely over the internet, less and less number of people are really interested in shelling out money for subscribing to the printed material. All sorts of blogs are coming up which use online materials, mailed in videos/pics from mobiles to report on a story in real time thus making newspapers obsolete.

For newspapers to survive, they have to change their model. They cannot rely on press releases and Associated Press reports. They need to add value. This is where investigative journalism comes in, something that is almost dead in Pakistani newspapers. This is where the online blogs and associate presses of the world cannot compete. The journalists have to roll up their sleeves and find out about issues and turn in reports that actually raise lids off simmering issues and help in highlighting problems.

The blogs and news aggregators do not make efforts to verify the news. They pick up any tidbit or rumor and report it world over (with a disclaimer if they like). If it is controversial, it becomes viral in 24 hours. In the race to be the first to give their two cents, everyone through their blogs, tweets, sms, facebook status updates helps in spreading the rumored news item.

This is what happened with the most recent story about porn fetish in Pakistan. Fox News published a malicious report on Pakistan, The News (part of Jang Publications) reported it verbatim and pretty soon the Pakistan websphere was wild with it everyone emailing each other, posting the news on their facebook page, blogging about it and tweeting it to each other. If Google counted how many times the porn fetish words were repeated, typed in, emailed to each other by Pakistanis, it would have multiplied the already misreported statistic turning it into a self fulfilling prophecy (but thats not how Google works).

What amazed me was that without verifying the underlying numbers which is quite easy to do, everyone had blogged, tweeted and updated the status about it. Just imagine the visitors it would bring to my blog site if I pepper my post with the search titles in that report.

As usual,  introspection was the name of the game with everyone in Pakistan (bloggers, columnists and editors) attributing such sick fetishes to repression of sex in everyday life, religious mores that enforce segregation of sexes and conservative values.

Had anyone done a teeny weeny bit of research, they would have found out that the report did not represent a true picture. Below I reproduce in comments by Indian scholar Namit Arora on the report which shows that the research methodology was flawed.

Ok, let’s say that I decided to study the frequency of keyword searches as a scholar might, and then see what conclusions are warranted from it. I will need to do at least the following:

1. First, I’ll need to normalize the searches across languages, across equivalent terms used in, say, Russian, Italian, Serbian, etc.

2. Then I’ll need to normalize across the demographics of Internet users. If males dominate Internet use in a country, might they be skewing their country’s per capita occurrence of certain search terms? In Pakistan, males outnumber females by more than 3:1 for regular use and 7:1 for occasional use of the Internet.

3. Then I’ll need to normalize for how integrated the Internet is in a culture’s way of life – do people widely turn to it to look up kebab joints, street maps, movies, sports, and banking, or is it still early days – not enough local info online yet and people prefer newspapers, radio, TV, and word-of-mouth, perhaps it’s still a relatively novel and foreign import, with porn being much more of a “killer app” at this stage.

And so on. Then I might begin to have some apples-to-apples data. Making sense of it and drawing reliable conclusions about, say, sexual repression will be my next challenge.

FOX looked up some keywords on Google Trends. So I did the same and found these interesting tidbits:

1. On searches for “horse sex” worldwide, Finland ranks 4, Australia 6, Denmark 8, US 9, Canada 10.

2. On “violent rape”, Belgium is 3, Australia 4, Canada 6, UK 7, US 8, France 9, Italy 10.

3. On “dog sex”, Australia is 5, US 6, Canada 7, Finland 8, UK 9, Hungary 10.

4. On “sheep sex”, Ireland is 1, New Zealand 2, Australia 3, UK 4, US 5, Canada 6.

5. On “child rape”, US is 7, New Zealand 8, Australia 9, Canada 10.

6. On “child porn”, New Zealand is 3, Australia 6, Canada 7, Norway 8, US 10.

7. On “pregnant rape”, UK is 2, US 3, Canada 4, Germany 5.

Note that these are English search terms, so non-English speaking countries (at least on the Internet), are less likely to show. Pakistanis on the Internet use English (despite limited average proficiency and vocabulary); it’s more surprising to see the French and Italians searching for “violent rape”.

The search for “camel sex” understandably brings in Israel, UAE and Saudi Arabia in the top 10, but also Portugal and Switzerland. People in the Alps dreaming of humping camels? Go figure!

One can make a lot of logical arguments against banning of Facebook or other website but using some cooked up statistics to do it was the most criminal thing for FoxNews to do.

What was more absurd is that English speaking/writing elite in Pakistan tried to find justification for the false report in whatever factor (mainly repression of sex) that struck their fancy.

Despite how disgusting one might find porn, one has to realize that porn has been at the forefront of some of internet technology development. They were the pioneers of web based payments, forced companies as well users towards server and bandwidth upgradation, improved online webstreaming etc. Part of the growth of internet is due to adult content. However, this growth was not geared towards the poor people of developing or depressed economies. These sites exist to cater to their paying customers in the West and not some backward Pakistani rural male who may not even have a bank account much less a credit card without which he could not access it.

Introspection : Jinnah, Constitution and National Anthem controversy

This is loosely related to my earlier blog post Introspection: Secularism_a panacea? and was initially written on June 8 so the topic might seem a bit dated.

The introspection process is still on if I go by what I read in newspapers as well as blogosphere. Every one is picking up speeches of Quaid-e-Azam and using it to justify what they think Jinnah wanted: a secular country or country based on Islamic principles. If I had a penny for every time a columnist, a writer or a blogger gets all worked up and excited about a speech of Jinnah, I would be a rich man by now.

In defence of secular country/constitution, the most oft quoted is his speech of August 11, 1948:

“You are free; you are free to go to your temples, you are free to go to your mosques or to any other place or worship in this State of Pakistan. You may belong to any religion or caste or creed that has nothing to do with the business of the State.”

If this quote alone is not enough to justify a secular constitution, then there are efforts to describe Jinnah as a aristocratically attired person, a pork eating Muslim, belonging to a minority sect (Ismaili khoja), his marriage to a Parsi etc to classify him as a secular person. The argument goes that a secular father of nation would have wanted a secular state.

However, Jinnah had also provided more than enough fodder to ‘Islamists’ in terms of his speeches that one could very well classify him as a closet ‘islamist’ for lack of a better term.

“No doubt, there are many people who do not quite appreciate when we talk of Islam. Islam is not only a set of rituals, traditions and spiritual doctrines. Islam is also a code for every Muslim, which regulates his life and his conduct in even politics and economics and the like.” (Bar Association Karachi on 25th March 1948)

We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality of manhood and social justice. (Speech at the opening ceremony of State Bank of Pakistan, Karachi.. July 1, 1948)

If thats not enough for initial tete-a-tete between Islamists and Secularists, the debate can be carried forward with his other quotes as Jinnah had stated that he does not want Pakistan to be a “theocracy” and on another occasion he wants Pakistan to be “laboratory of Islam”.

One can google the internet and there are hundreds of articles arguing whether Jinnah was a secularist or ‘islamist’.

Now another issue has been added to the fire: the national anthem controversy. It gained traction by first appearing on the website All Things Pakistan and then suddenly going viral last month with even Hamid Mir conducting a show on it.

There is no doubt that it was one of the earliest national songs but was it a national anthem is mired in controversy. One researcher even went to the extent of digging up Jinnah papers and his visitors book to set the record straight.

Personally, I don’t care whether he was a secularist or a ‘islamist’. The guy is dead and I am sure he would not have liked himself to be classified as into a box. He would have also looked down upon calling the country as Jinnah’s Pakistan because as per democratic principles that he subscribed to Pakistan belongs to its citizens and its not Kingdom to be attributed to a particular person. He would not have objected to being described as “democratic” .

True to his democratic credentials, he did not devise a constitution or bill for Pakistan. He let the responsibility lie with the people of Pakistan through their representatives in the Assembly to devise a constitution. Now whether to give it a secular flavor or islamic flavor is up to the people of Pakistan.

I think people on both sides of debate do a great disservice to Jinnah by using his sayings to achieve their objectives. By not interfering in the constitution making process, Jinnah showed by his actions that he subscribes to the highest level of democratic credentials.

We should let Jinnah rest in peace and not use his words to achieve our twisted objectives. If we want to give a constitution a particular flavor, go to the grassroots, start movements, let the people know what is best for them and encourage them to ask their representative to add/amend/retain the constitution. It is hard work but not impossible.

With the movement for restoration of judiciary, it has been showed that the people can be galvanized into action if the issue touches their heart. Galvanize them again. But don’t take the easier route by attributing something to Jinnah and using it to achieve your objectives.

Is democracy unislamic? Is Khilafat only form of government acceptable in Islam?

Other day a friend of mine was talking about Khilafat being a solution  as democracy has not been able to solve our problems. He was probably influenced by Hizb-ut-Tahrir propaganda. Having met a few of these Hizb-ul-Tahrir aficionados, I find them educated, intelligent and much more world-wise than what passes for liberal-educated class in Pakistan (but then this is just my opinion). However, whenever I ask them how will they choose their Khalifa (will it be a democratic process, will Khalifa nominate himself, or have they already decided on a Khalifa but he is invisible/underground like the 12th imam etc) I have always drawn a blank. Lets assume that some how Khilafat is established and against all odds we accept a Khalifa. Will he be Khalifa for life? Once he steps down, how will we agree upon the next Khalifa?

I have heard some people (mainly liberals) criticize the Prophet that he left his companions without telling them how to choose their leader. Its my belief that the Prophet was Divine messenger and the Divine had given us a choice of whatever method we deem suitable for selecting who rules over us. Obviously certain things are common sense that the leader should be of clean character, just in his dealings etc. I am sure that if some method had been suggested or recommended by the Prophet for selecting a leader, the liberals would have hounded it as another example of rigidity of Islamic rules even if it had been democracy. Another so called secular liberal had said that democracy does not suit the genius of [Pakistani] people and later words to similar effect were uttered by the last dictator but that does not bother the liberals.

Since none has been divined, I believe all methods of ruling whether it is Khilafat, Monarchy, Democracy are fine as long as they don’t usurp on anyone’s rights and work towards the betterment of people. If democracy does not work, replace it with Khilafat but then there needs to be a system in place for choosing and replacing the Khalifa which is not clear or which has not been made clear to us by the proponents of Khilafat. Even if the monarch is just, I would not mind living under his rule.

Couple of years ago I remember surfing the channels and I chanced upon Zaid Hamid being interview by Lucman. The Commando was ruling us at that time. Someone, probably a Zaid Hamid fan, telephoned in the show and he wanted Zaid Hamid to say that democracy is un-islamic. The guy calling in sounded educated. However, the reason he wanted democracy to be labelled un-Islamic was that movement for removal of Musharraf and restoration of democracy had gained momentum and he wanted a justification for his support of Musharraf. One of the most ridiculous way for justifying a dictatorial rule.

US citizens were celebrating 4th of July few days ago and I had a chance to read through their declaration of independence. What a marvel of human thought.

This comes from the second sentence of declaration:

….Governments are instituted among Men, deriving their just powers from the consent of the governed, That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

Here they do not talk about democracy or any other form of government. They just say that if the system government does not deliver, they can throw away the system and put in place a new one. However, they add a little qualifier that prudence should taken when making such a decision.

Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.

What beautiful prose and ideas. I could not have said it better myself :).

I don’t consider the takeover by military or military rule removal of a despot or change of a system. They are as much a despot as the despot they are replacing. A game of musical chairs between democratic despots and military despots is played and we are the spectators.

The way things are moving, a time will come that our troubles will become insufferable, we will need to walk out and demand our rights even if it means changing the system. We have done it before (most recent example being restoration of Judiciary which showed two things: 1) if we get together we can get the military man to remove his uniform and even give up his seat and 2) that sometimes there is no difference between military and civilian despot _ both refusing to reinstate the judiciary) and when the time comes, we need to do it again.

Shot of the day

Afridi’s interview in Cricinfo which has a subheading as “Pakistan’s explosive and controversial allrounder talks about the challenges of leading the side”

The best of Q&A

When Australia heard you were leading Pakistan for the series Ricky Ponting said “We’ll sort him out pretty quick.” Does that mentally spur you on?

[Afridi’s reply] Allah has given me two ears: I hear with one and throw it out with the other. Whatever happens on the ground, we will know soon.