Eid Mubarak to all Muslims

Abbas Mirakhor, former executive director at the International Monetary Fund (IMF), and Noureddine Krichene, economist at the IMF and former advisor at the Islamic Development Bank in Jeddah, examine the issue.

In contrast to conventional finance which has periodically experienced crises, Islamic finance is considered as a stable financial system capable of promoting sustained growth of income and employment. Prohibiting interest, speculation, and debt trading, Islamic finance establishes one-to-one mapping of financial and real sectors of the economy. That is, it is based on real trade and production activities. The financial sector cannot expand beyond the real economy, and is immune to unbacked credit expansion and speculation that are characteristics of conventional finance and that have destabilised even the most sophisticated and complex financial systems.

Conventional finance is inherently unstable

The financial crisis that broke out in August 2007 is considered to be the worst in the post-war period. Representing the collapse of trillions of dollars of fictitious credit derivatives and the meltdown of uncontrolled credit growth, the scope of the crisis could reach unmanageable size. The crisis has shown that advanced financial systems are very vulnerable. Massive bankruptcies were avoided only at the cost of gigantic government bailouts. Capital markets are frozen. Consequent de-leveraging led in turn to an unexpected crash in stock markets, wiping out trillions of dollars in share values and in retirement investment accounts.

Economic uncertainty has never been as high. Has the crisis been correctly tackled or has it only been made worse? Could affected industrial countries grow with unsustainable public debt? In view of the incredibly high liquidity injection by major central banks, is money supply growth out of control? What will be the crisis’ impact on growth and employment? What will be its fiscal and inflationary cost? While precise answers are not possible, the present crisis has already slowed down economic growth in industrial countries, triggered food riots and energy protests in many vulnerable countries, increased unemployment and imposed extraordinary fiscal costs. Notwithstanding its devastating consequences, the crisis has made the quest for financial stability a pressing and fundamental issue in economics and finance. Such was the purpose of the G20 Summits in November 2008 and April 2009.

Financial instability has been a recurring phenomenon in contemporary economic history, affecting countries with varying intensity. The most enduring crisis was the Great Depression of 1929–33. Eminent economists who lived through the Great Depression fought very hard to establish a banking system capable of achieving and preserving financial stability. Their proposals became known as the Chicago Reform Plan, as they were elaborated by some members of the economic faculty of the University of Chicago. Although unaware of Islamic finance, their proposals were a natural restatement of some basic pillars of Islamic finance. The Chicago Plan basically divided the banking system into two components: a depository component with 100 per cent reserve requirement and an investment component with no money contracts and no interest payments, where deposits were considered as equity shares and were remunerated with dividends, and where assets’ and liabilities’ maturities were fully matched. Independently of this plan, Muslim economists reached the conclusion that if Islamic finance were to achieve stability, the banking system had to be organised along a similar ‘two-tier’ structure.

In view of its devastating effects, considerable effort has been devoted to explaining the causes of financial instability and to prescribe remedies that would reduce risk of deep contraction in output, large-scale unemployment, bankruptcies, dramatic fall in real incomes and social hardship. The classical economists attributed financial instability to money and credit expansion. They considered excessive credit expansion and contraction to be caused by deviation of the money interest rate from a non-observable natural interest rate which equilibrates real savings and investment in the economy. The natural rate of interest was defined in many ways; mainly, it was seen as a rate of profit, productivity of capital in roundabout production, or marginal efficiency of capital.

Irving Fisher, a prominent American economist of the Great Depression era, strongly argued that two dominant factors were responsible for each boom and depression: over-indebtedness in relation to equity, gold, or income which starts a boom, and deflation consisting of a fall in asset prices or a fall in the price level which starts a depression. He noted that over-investment and over-speculation were often important, but they would have far less serious results if they were not conducted with borrowed money. That is, over-indebtedness may reinforce over-investment and over-speculation.

Another American economist, Hyman Minsky, considered that conventional finance dominated by interest-based debt contracts is inherently unstable. This assertion is based on a construct known as Financial Instability Hypothesis (FIH), which posits that stability is inherently unsustainable. A fundamental characteristic of a conventional financial system, according to Minsky, is that it swings between robustness and fragility and these swings are an integral part of the process that generates business cycles. In the early 1990s, Minsky addressed financial innovation, which he considered to be evolving at a fast pace and to be driven by fierce competition among financial institutions for profits. In his view, the proliferation of innovations in deregulated capital markets would lead to a huge inverted credit pyramid based on a thin real basis, i.e. over-leverage. Any small fall in expected cash flows would send this pyramid crumbling.

Central banks’ cheap money policy is a key factor in a major financial crisis. Notably, the present crisis was caused by major central banks deliberately setting interest rates at record lows irrespective of risk. As a consequence, total credit expanded at an unsafe high rate of twelve per cent per year in the United States during 2001–08. This phenomenal credit growth was at the cost of creditworthiness and erosion of underwriting standards. George Soros wrote, ‘when money is free, the rational lender will keep on lending until there is no one else to lend to’. Rapidly expanding money and credit combined with an ideologically-based fierce de-regulation movement which began in the early 1980s in industrial economies and continued throughout the next two decades. It put at high risk the financial stability of these countries and, as the result of rapid financial globalisation, the rest of the world as well.

Islamic finance is inherently stable

The sources of financial instability in the conventional system, i.e. interest, unbacked credit, abundance of liquidity and highly leveraged financial transactions, as well as opportunities for speculation are by and large absent in an Islamic financial system basically because of absence of interest-based debt contracts and the 100 per cent reserve requirement that protects the nations' payment system, thus ensuring the inherent stability of this system.

In the Quran and Sunnah, Islamic finance has always been conceived as existing within an institutional framework composed of rules of behaviour such as sanctity of contracts, strict rules of conduct for all market participants, including rules regarding distribution and redistribution of income, and wealth resulting from production and sale of goods and services which guarantee equitable and just distribution in the society as well as rules regarding governance, transparency, cooperation and social solidarity. In such a system, finance will be guided toward employment creating investment and wealth creation.

In Islamic finance there are no risk-free assets and all financial arrangements are based on risk and profit-and-loss sharing (PLS). Hence, all financial assets are contingent claims and there are no debt instruments with fixed or floating interest rates. Investment accounts could be conceived as non-speculative equity shares. The rate of return on financial assets is primarily determined by the return to the real sector, and therefore in a growing economy, Islamic banks will always experience net positive returns.

Financial intermediation in Islam is different from that in a conventional system. Banks do not contract interest bearing loans and do not create and destroy money. They participate directly in production and trade operations on a PLS basis. Banks do not act as simple lenders; they have to be directly involved in trade and investment operations, and assume direct ownership of real assets.
There is no credit creation out of thin air in Islamic finance. Under conventional fractional reserve banking, deposits at one bank can be instantaneously loaned out or used to purchase a financial asset and become
reserves and a basis for a new loan at a second bank. The credit multiplier is determined by the reserve requirement and could be high. In case of securitisation and over-leverage, the credit multiplier is theoretically infinite, leading to violent asset and product price fluctuations. Such a phenomenon does not exist in Islamic banking because of the 100 per cent reserve requirement. Deposits intended by their owner for investment purposes find their way directly as investment in trade and production activities to create new jobs as well as lead to additional flows of goods and services. New money flows arise from the proceeds of sales of goods and services. Money expansion is determined by the savings ratio in the economy and the money multiplier is very small, ensuring price stability. Investment is equal to savings, and aggregate supply of goods and services is always equal to aggregate demand. The liabilities of the financial institutions are covered by tangible real assets that are owned directly by the institution. They are not covered by financial assets. Risks for Islamic financial institutions are mitigated as they relate essentially to returns from investment operations and not to the capital of these institutions.

Architecturally, an Islamic banking system is composed of two tiers: amanah or safekeeping plus payments, transactions services, and transfer activities. In this tier, banks are required to keep 100 per cent reserves against deposits which remain highly liquid.

The second tier is composed of investment activities whereby deposits are longer-term savings and placed for the sole purpose of investment in trade, leasing, and productive activities in agriculture, industry, and services. The most important characteristic of this activity is that it is immune to unbacked expansion of credit. Returns to invested funds arise ex-post from the profits or losses of the operation, and are distributed to depositors as shareholders of equity capital.
The expansion of finance is fully determined by real growth in the economy and not by unstable speculative finance or money creation by financial institutions. Accordingly, an Islamic system would not be expected to experience deep boom and busts cycles. Moderate and brief booms and recession may be generated by good crops, productivity, technical change, or by adverse shocks. They cannot be generated by the financial system itself. Equilibrium in an Islamic economy thus structured will be stable and the rate of return to the financial sector will be fully aligned with the profit rate in the real sector of the economy.

Risks in Islamic finance consist of credit risk, market risk, displaced commercial risk, operational risk, and governance risk. While the individual financial institutions engaged in investment activities face these risks, in and of themselves these are not systemic and do not impact the overall stability of the financial system, as this system is immune to speculative mania, liquidity expansion, and instability of returns. The latter is due to the fact that there is no value or maturity mismatching between assets and liabilities of the institutions. If asset prices decline, so will the liabilities, unlike what happens in a system dominated by interest-based debt contracts.

Many types of financial transactions and instruments are excluded from Islamic finance, particularly interest rate-based bonds, securities, finance based on securitisation of fictitious assets, speculative finance, hedge funds, and consumer finance that is not backed by real assets. In all of this type of finance, either the acquired assets are financial papers, or loans that are not backed by real assets and do not contribute to generate real activity and income.

In Islamic finance, the central bank has the sole monopoly for creating money. An interest rate cannot be used as a policy instrument. The central bank does not refinance banks as in conventional banking. The central bank has to apply a quantitative ceiling on money aggregates. Such policy when and where implemented has been effective in maintaining financial stability and precluding speculative booms and inflation. Money injection occurs through the central bank buying foreign exchange, gold, or non-interest bearing government debt, possibly indexed to gold, a commodities basket, or a portfolio of real assets created by the government.

Conclusion

History is replete with episodes of instability of the conventional financial system. Prominent economists have argued that such a system is inherently unstable and prone to severe financial crisis. They have considered the interest rate to be a cause of large fluctuations in asset and commodity prices, a source of financial instability and cumulative inflation, and detrimental to long-term economic growth. They have called for a separation of deposit and investment banking.

Islamic finance prohibits interest and speculation and engages directly in trade and investment operations. Unbacked expansion of credit is preempted, and banks cannot initiate and accentuate a speculative process. Credit is based on real savings. Hoarding for the sake of earning interest does not take place. Savings can only earn a return if directly invested in employment creating activities. Not only does hoarding earn no monetary reward, there is also a direct disincentive for doing so since whatever is hoarded is subject to zakat which will continuously erode its base. In such a system, no excess purchasing power can be created by a stroke of the pen. Money flows arise from sales of goods and services and transit through the banking system for payments or investment purposes. Islamic banks do not compete to issue loans to borrowers for liability management purposes arising from mismatched maturities between assets and liabilities; they compete only for real investment opportunities; their resources are reinvested in real activities. Given the stability of its financial system and resilience to monetary shocks, an Islamic economic system would experience sustained economic growth and avoid detrimental impacts on social justice since inflation cannot be used to tax creditors and wage earners in favour of debtors and speculators. Although reforms of the conventional system along the lines comparable to Islamic finance system were strongly advocated by some leading economists in the 1930s in the aftermath of the Great Depression, these reforms were not fully implemented. The intensity of recent financial instability has renewed calls for such reforms which many consider as the only path in the quest for stability. The chart below contrasts distinctive features of conventional and Islamic finance.

When developing an Islamic financial model, the temptation is very strong to try to mimic what bankers already know. Indeed, that has been the history of Islamic banking and finance: start with the conventional practice that you forbid but want to mimic (e.g. an interest-bearing loan), break it down into its pieces (e.g. money now from A to B, more money later from B to A), and then reconstruct the pieces with some degrees of separation (e.g. goods sold for money now from C to A, goods sold on credit for more money later from A to B, and goods sold for money now from B to C -- this is tawarruq if the bank conducts all three transactions, or commodity murabaha if the bank only does the first two pieces and leaves it up to B to make the spot sale to C or another party D). This is the silly model marketed variously as commodity murabaha or tawarruq (including red arrows formally):
A comment to the previous post mentioned the practice of "chit funds" in the Indian-Pakistani subcontinent, wherein participants in a RoSCA who have not yet collected the pot bid for the pot at each stage of the cycle. This adds an explicit interest rate (discount pricing, similar to the way Treasury Bills are sold) to the implicit one imposed only by the order of collection.

There are many other ways that one can explicitly add interest rates to the basic structure of a balanced RoSCA:

* Later rounds of the RoSCA, approved by jurists, as described in the previous posting, may be for larger pots. This gets around the problem of introducing interest payments within a single RoSCA cycle -- which is the focus both of commercial "chit funds" and much of the Economics literature (e.g. Besley, Coate, and Loury, American Economic Review, 2003). As I shall discuss below, I think that this focus on a single cycle of the RoSCA misses the main significance of investment in social capital: one is compelled to participate (as a later recipient) in a RoSCA when one is asked. Social capital is the availability of a pool of people willing to lend you at zero interest at some/any point in the future. One should focus on the repeated game rather than one stage.
* Participation in one or more RoSCA has been shown to increase with reported religiosity, as shown in Indonesias' participation in one or more arisan using probit and ordered probit estimation by Sowmya Varadharajan. This is very useful because an individual who cannot in one period fulfill their obligation in one RoSCA may start another of which they are the first recipient to meet liquidity problems. In other words, the social capital invested in one's circle of friends/family/... provides guaranty against default and dissolution of earlier RoSCAs. This can easily be used to manufacture banking products through staggered overlapping RoSCAs: the second recipient of the first RoSCA is simultaneously the first recipient of the second RoSCA, the third recipient is the first recipient of the third, and so on. This way, later recipients of the pot from earlier RoSCAs can receive explicit interest for the loans that they extended by receiving an interest free loan of equal or larger size. It would be very easy to mimic any amortization table using such structures (a simple spreadsheet would do).
* Unfortunately, the latter possibility makes these structures vulnerable to the creation of pyramid schemes. Indeed, in the different but related JAK system, it appears that a pyramid scheme did develop in the earlier experiment before the bank was licensed and regulated. There is an inherent pyramid scheme in every fractional reserve system (otherwise, what is the banking multiplier other than a pyramid scheme), and we have seen ample proof over the past few months to illustrate that our entire financial system is one gargantuan-sized pyramid scheme (as Krugman called it, the decade at Bernie's). Of course, one has to be particularly careful not to build pyramid schemes in the name of Islamic finance, especially given recent decades' experiences in Egypt, Albania, and other countries (in addition to numerous unfortunate web-based pyramid schemes in Malaysia and elsewhere). However, that is a regulatory concern that extends well beyond the specific problem with which we are currently concerned.

So, it is clear that we can deform RoSCAs the way that Islamic finance lawyers and consultants have subverted classical Islamic contracts (e.g. structuring loans cynically through the trust sale known as murabaha, which was simply negotiation of a profit margin instead of the final price, trusting the seller to reveal their cost -- i.e. negotiating markup over invoice, without any credit sale component). However, this would defeat the purpose of trying to reboot Islamic finance.

The idea is not to have as one's goal replication of the existing conventional finance. Indeed, my argument has been that if we can replicate a conventional practice, then we should use that replication as a form of juristic identification (تكييف فقهي), for example of mortgages, to permit the more efficient conventional practice in such cases. In cases where we or our target audience find a conventional practice to be forbidden Islamically, the objective should be to take an existing practice that is generally accepted by the Muslim public, and (credibly) approved by religious scholars who issued their opinions independently from institutions that make profits based on their religious opinions, and then to see if we can make the practice (e.g. RoSCAs) more efficient. In this quest, we should keep the structures as simple as possible, in order to avoid confusing religious scholars or potential customers.

My proposal (to discuss in the next post) is to organize the leveraging of social capital inherent in RoSCAs using a hybrid of the mutual banking structure of JAK (which is conducive to development into a credit union model) and the theory of takaful (literally: mutual cooperation, but the term is used for non-commutative forms of insurance marketed by Islamic finance providers, albeit not structured properly as mutual insurance).

posted by Mahmoud El-Gamal at 8:05 AM

When facing problems -- either marital trouble, financial difficulties, or otherwise -- many Muslims are reluctant to seek professional counseling. Some people consider it degrading or inappropriate to speak of one's troubles to others.

Nothing could be further from the truth. Islam teaches us to give good advice to others, and to offer guidance and support when needed. Friends, family, and Islamic leaders may be good listeners but are probably not trained to offer professional guidance and support.

Professional counselors, psychologists, and psychiatrists offer mental health services which can help save a person's happiness, marriage, or life. Muslims should not feel reluctant to seek support if they feel that they cannot cope. These organizations can help; do not be afraid or ashamed to reach out for help.

* Sakinah Muslim Counseling Services - UK
* Sakina Center - Online Counseling for Muslim Youth via Facebook
* MCA Bay Area Counseling Services - San Francisco, California, in person or by phone
* IslamOnline Cyber Counselor - Online Advice/Q&A
* IHW Personal & Family Counseling - Michigan (Shia)
* Idriss Mosque Counseling Services - Seattle, Washington
* Zentrum fur Islamische Frauenforschung (ZIF) - Germany
* Center for Islamic Counseling & Guidance- Jonesboro, Georgia
* Muslim Family Services - Detroit, Michigan

Need Immediate Physical Protection? See this list of services and shelters for battered/homeless Muslim women.

By Khedr Abd Al-Mo'ti Khedr
Khedr Abd Al-Mo'ti Khedr
Khedr Abd Al-Mo'ti Khedr

Thank God whose blessings insure all good for the launch of the EU Muslim family campaign under the slogan "a stable family forms a stable community." We shall pray for the best father, grandfather, husband, brother-in-law, and the last of the prophets and messengers: Prophet Mohammed, may God's blessings be upon him.

This fortunate campaign is led by the Federation of Islamic Organizations in Europe (FIOE) in coordination with all its institutions in more than 30 European countries. The FOIE, in supporting the campaign financially and intellectually, massed all its scholars, preachers, spiritual guides, and intellectuals with full capacity and strong enthusiasm to awaken people and correct illusions. Various activities have been prepared to approach individuals and families in the West. This campaign, in my view, will be very fruitful for the whole European community as well as being a fundamental fortification especially for the Muslim family. Thanks to this campaign, both Muslim and non-Muslim communities will soon co-live in an atmosphere of security and prosperity due to two reasons.

Reforming the EU Muslim Family

The first reason is the reformation of the Muslim family, which is now part and parcel of the European community. Such reformation will definitely lead to a wide amelioration in the European society. To elaborate, a stable community can be seen in many shapes such as a good husband-wife relationship and effective parenting. Any society has to guarantee a healthy environment for upbringing children.

There is an educational theory that a child has to have some fun and joy during his / her first seven years. Within those years, the child might be guided without deterrent punishment so that he/she could acquire decency and have, their parents, as a good example to follow. Then, the following seven years the child directly learns regulations, laws, and disciplines. After this phase, the young boy will be able to show responsibility and can support his family as well as his country. This theory is mostly conforms to our God's, Most Glorious and Most Merciful, verse: (My Lord! Bestow on them thy Mercy as they cherished me in childhood) (Al-Israa, 24). Many institutions suffering from raising family problems will benefit from this campaign. The Muslim family has many hanging issues in different fields such as social affairs, police, legislation, education, etc. All these problems will be tackled by the campaign in conferences, forums, field visits, and researches.

Exploring New Role Models

The second reason, which reveals the importance of the EU Muslim family campaign, is that the European family will be able to find a model role for its members to guide them through the way, that is the model of its stable Muslim family in the neighborhood. The most wonderful way to approach our goal for all families is to adopt the holistic methodology that will lead us all to stability and happiness. That divine path softens the dry materialistic life which cannot guarantee man's happiness despite its strength and discipline. Neither did the scientific progress secure a life-loving human being free from fears, and selfishness. As the British philosopher Bertrand Russell says, "Though man won his battle against nature thanks to knowledge, he lost his war against himself where knowledge did him no good." He also admits that religion can handle such war.

The EU family campaign, seeking both Muslim and non-Muslim families in Europe, has carried the wholly congenital righteous lamb. Obviously, it tackles all the problems facing teenagers and matrimonial conflicts, as well as defending the rights of the European woman when she gets married to a Muslim man. This campaign encourages the couple to have patience with each other - we shall explain this in the following paragraph.

Raising Generations

In order to illustrate this, we must say that human beings sometimes ignorantly adopt wrong concepts for a life time. This cannot be changed easily but with patience, understanding, and counseling. According to this theory, both husband and wife should tackle all negative issues in their life. Any couple should help each other to raise a good generation that respects its identity and its origins of both parents. This generation should be aware of the social hierarchy inside the family and respect it.

The EU family campaign aims at achieving integration and settlement without prejudice or ingratitude. Additionally, it is a reminder for all who forgot the real goal of a Muslim in life so that money and kids will not turn into a plague for them. Many Muslim families' faiths have been tested during their journey, especially the early immigrants. Their children, for example, have strayed from the right path despite their luxurious life. This comes as a proof of our Lord saying (Let not their wealth nor their (following in) sons dazzle thee: in reality Allah's Plan is to punish them with these things in this life) (Al Tawba, 25) Another verse assuring that concept is "truly the flimsiest of houses is the spider's house," an approved scientific fact. This great image from our Holy Book shows how a family that is not deeply based on the Islamic principles would meet the same fate of a spider's house; to be crashed and destroyed. The family weakness comes from a materialistic father and an unfaithful wife. Then follows the impious children. All these reasons confirm the goals of the family campaign.

Learning many sciences and achieving academic excellences is the main road towards fortification. European Muslims should also use their countries' language together with their mother tongue, not to forget it. Most important of all is to learn the Arabic language, that of the Holy Qur’an. Applying all these pieces of advice, we will ensure having good offspring with all useful knowledge, languages, and tempers.

Also a Campaign for Women

It’s a fortification campaign for women as well; a campaign that will synchronize with the European celebration of Woman's Day on March 8th. This campaign aims at wiping out the bad image of women in the developing countries, then resetting their roles in the European countries by giving good and righteous Muslim examples. Thus woman will be honored and appreciated and her role in family, society, and life will be stressed.

This initiative is considered a comprehensive methodology to reform all family affairs introduced by the EU family campaign in Europe. However, none can deny the importance of materialism for people and countries.

With God's blessings, we launch the EU family campaign in Europe, we call all the honest and sincere intellectuals and media men, not only in the FOIE but in all free and moderate institutions in Europe, to get involved in this campaign, each with whatever they can do and what they are destined to.
* Khedr Abd Al-Mo'ti Khedr is a member of the European Assembly for Imams and Spiritual Guides.


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http://www.youtube.com/watch?v=vjEBQ_bE7uA
The old lie that palestine was dry desert waiting for a people is just that--a lie. This clip for all people to see the Beauty of the Palestinian People before they were ethnically cleansed and murdered and made into refugees by the State of Israe.
Music Joaquin Rodrigo, lyrics Helmut Lotti, sung by Lotti

By Howard Schneider
Washington Post Foreign Service
Saturday, March 21, 2009
JERUSALEM, March 20 -- A soldier involved in Israel's recent military offensive in the Gaza Strip said in published reports Friday that the military's rabbinical staff distributed material characterizing the operation as a religious mission to "get rid of the gentiles who disturb us from conquering the holy land."
In the second day of published accounts from soldiers critical of the conduct of the Israel Defense Forces in Gaza, the daily Maariv ran excerpts of an interview with a squad commander in Israel's Givati Brigade. He was identified only by his first name, given as Rahm.
The daily quoted him as saying that the Gaza operation from the beginning had "the feeling of almost a religious mission."
While military rabbis provided routine services -- such as distributing books of psalms and leading prayers at the start of the operation -- some religious materials veered in a political direction, he said.
"The military rabbinate brought many magazines and articles with a very clear message: 'We are the Jewish people, a miracle brought us to the land of Israel, God returned us to the land, and now we have to struggle so as to get rid of the gentiles who disturb us from conquering the holy land.' All the feeling throughout all this operation of many of the soldiers was of a war of religions," he said. "As a commander, I tried to explain that the war is not a war of Kiddush Hashem [the sanctification of God's name, including through martyrdom] but over the stopping of the launching of the Qassam rockets."
The rockets are one of several types that Hamas and other Islamist groups fire from Gaza into Israel. Palestinian health officials said about 1,400 Palestinians died in the three weeks of fighting in December and January, including what United Nations officials said were hundreds of civilians. Thirteen Israelis died, including three civilians.
The publication of the soldiers' accounts has elevated a set of issues that Palestinian organizations and human rights groups have raised since early in the Gaza operation. On Thursday, the IDF's chief lawyer opened an investigation following the publication of reports in which soldiers spoke of unnecessary civilian deaths and needless property destruction.
The soldiers' accounts were elicited by the head of a training school for future military recruits. At a recent gathering, graduates of the school described how the realities of military life clashed with the values taught in the school's curriculum.
The school is named in honor Yitzhak Rabin, the Israeli leader who signed the 1993 Oslo peace accords with the Palestinians and who was assassinated by an Israeli who opposed the agreements. The school is secular in nature and its graduates would likely be sensitive to the intrusion of religious politics into the conduct of a military operation, said retired Brig. Gen. Meir Elran, a security analyst with the Israeli Institute for National Security Studies at Tel Aviv University.
Given that one of Israel's chief struggles is against organizations, such as Hamas, that entwine religion and violence, the presence of similar material among Israeli soldiers is disturbing, Elran said.
"You cannot but think about the other side, too," said Elran, who noted that the traditional role for military rabbis was to ensure that kitchens were kosher and to conduct services as needed. Although ultra-Orthodox Jews are exempt from military service on religious grounds, Elran said the number of religious Jews in the military has been increasing.
Still, "when you talk about the military in a country where you have compulsory service, I find it a bit odd that military rabbis would go further than just giving religious services to those who want it or need it," he said.
The issue surfaced publicly shortly after the Gaza operation, known as Operation Cast Lead. An Israeli human rights group publicized material that encouraged soldiers to show no mercy to their enemies and that said there was a biblical ban on surrendering Israeli territory to non-Jews.
The material, according to excerpts published at the time in the daily Haaretz, cut to the core of the conflict between Israel and the Palestinians, comparing the Palestinians to Old Testament invaders who now "claim they deserve a state here."
IDF spokesman Elie Isaacson said that there was an investigation at the time and that a member of the rabbinical staff was reprimanded for distributing unauthorized material. Isaacson said it was considered an isolated incident.
"If you are religious, the army gives you the right to practice, but the mixing of politics and religion -- it is a big taboo," he said. The military rabbis "don't make policy. They don't make decisions."
Posted by Medeshi on Saturday, March 21, 2009

Dr Umer Chapra, senior research advisor at Islamic Research and Training Institute of the Islamic Development Bank (IDB), explores this issue in the first of the IIBI lecture series, dedicated to Ibn Khaldun*.

The whole world is now in the grip of a financial crisis which is far more serious than any experienced since the Great Depression. It has taken more than $3 trillion of bailout and liquidity injections by a number of industrial countries to abate somewhat the intensity of the crisis. Nevertheless, there are fears that this crisis may have exposed the world economy to a long period of economic slowdown. There is, hence, a call for a new architecture that would help minimise the frequency and severity of such crises in the future.

Primary cause of the crisis

It is not possible to design a new architecture without first determining the primary cause of the crisis. The generally recognised most important cause of almost all crises has been excessive and imprudent lending by banks over a long period. This is clearly acknowledged by the Bank for International Settlements (BIS), which states as much in its annual report (released on 30th June 2008).

This raises the question of what makes it possible for banks to resort to such an unhealthy practice which not only destabilises the financial system but is also not in their own long-run interest. There are three factors that make this possible. One of these is inadequate market discipline in the financial system resulting from the absence of profit-and-loss sharing (PLS). The second is the mind-boggling expansion in the size of derivatives, particularly credit default swaps (CDSs), and the third is the ‘too big to fail’ concept, which tends to give an assurance to big banks that the central bank will definitely come to their rescue and not allow them to fail.

The false sense of immunity from losses that all these factors together provide, has introduced a fault line in the financial system. Banks have not, therefore, undertaken a careful evaluation of the loan applications. This has led to an unhealthy expansion in the overall volume of credit, to excessive leverage, and to an unsustainable rise in asset prices, living beyond means, and speculative investment. Unwinding later on gives rise to a steep decline in asset prices, and to financial frangibility and debt crises, particularly if there is over-indulgence in short sales. Jean Claude Trichet, president of the European Central Bank, has rightly pointed out that ‘a bubble is more likely to develop when investors can leverage their positions by investing borrowed funds’.

The subprime mortgage crisis

The subprime mortgage crisis, in the grip of which the US finds itself at present, is a classical example of excessive and imprudent lending. Securitisation or the ‘originate-to-distribute’ model of financing has played a crucial role in this. The creation of collateralised debt obligations (CDOs) by mixing prime and subprime debt made it possible for mortgage originators to pass the entire risk of default of even subprime debt to the ultimate purchasers who would have normally been reluctant to bear such a risk. Mortgage originators had, therefore, less incentive to undertake careful underwriting.

Consequently, loan volume gained greater priority over loan quality and the amount of lending to subprime borrowers and speculators increased steeply. According to Ben Bernanke, chairman of the board of governors of the US Federal Reserve System, ‘far too much of the lending in recent years was neither responsible nor prudent… In addition, abusive, unfair, or deceptive lending practices led some borrowers into mortgages that they would not have chosen knowingly.’ The check that market discipline could have exercised on the serving of self-interest did not come into play. Even the supervisors failed to perform their task effectively by not taking serious notice of the unfair practices at an early stage and nipping them in the bud.

The result is that a number of banks have either failed or have had to be bailed out or nationalised by the governments in the US, the UK, Europe and a number of other places. This has created uncertainty in the market and prolonged the credit crunch, which made it hard for even healthy banks to find financing. There is a lurking fear that this might be only the tip of the iceberg and a lot more may follow if the crisis causes a prolonged recession and leads to defaults on the part of credit card institutions, corporations and derivatives dealers.

When there is excessive and imprudent lending and lenders are not confident of repayment, there is an excessive resort to derivatives like CDSs to seek protection against default. The buyer of the swap (creditor) pays a premium to the seller (a hedge fund) for the compensation he will receive in case the debtor defaults. If this protection had been confined to the actual creditor, there may not have been any problem. What happened, however, was that hedge funds sold the swaps not to just the actual lending bank but also to a large number of others who were willing to bet on the default of the debtor. These swap holders, in turn, resold the swaps to others. The whole process continued several times.

While a genuine insurance contract indemnifies only the actually insured party, in the case of CDSs there were several swap holders who had to be compensated. This accentuated the risk and made it difficult for the hedge funds and banks to honour their commitments. The notional amount of all outstanding derivatives (including CDSs of $54.6 trillion) is currently estimated by the BIS to be over $600 trillion, more than ten times the size of the world economy. No wonder George Soros described derivatives as ‘hydrogen bombs’, and Warren Buffett called them ‘financial weapons of mass destruction’.

The Islamic financial system

One of the most important objectives of Islam is to realise greater justice in human society. According to the Quran, a society where there is no justice will ultimately head towards decline and destruction (Quran, 57:25). Justice requires a set of rules or moral values, which everyone accepts and faithfully complies with. The financial system may be able to promote justice if, in addition to being strong and stable, it satisfies at least two conditions based on moral values. One of these is that the financier should also share in the risk so as not to shift the entire burden of losses to the entrepreneur, and the other is that an equitable share of financial resources mobilised by financial institutions should become available to the poor to help eliminate poverty, expand employment and self-employment opportunities and, thus, help reduce inequalities of income and wealth.

To fulfill the first condition of justice, Islam requires both the financier and the entrepreneur to equitably share the profit as well as the loss. For this purpose, one of the basic principles of Islamic finance is ‘no risk, no gain’. This should help introduce greater discipline into the financial system by motivating financial institutions to assess the risks more carefully and to effectively monitor the use of funds by the borrowers. The double assessment of risks by both the financier and the entrepreneur should help inject greater discipline into the system, and go a long way in reducing excessive lending.

Islamic finance should, in its ideal form, help raise substantially the share of equity and PLS in businesses. Greater reliance on equity financing has supporters even in mainstream economics. Professor Kenneth Rogoff of Harvard University states that in an ideal world equity lending and direct investment would play a much bigger role.

Greater reliance on equity does not necessarily mean that debt financing is ruled out. This is because all the financial needs of individuals, firms, or governments cannot be made amenable to equity and PLS. Debt is, therefore, indispensable, but should not be promoted for nonessential and wasteful consumption and unproductive speculation.
For this purpose, the Islamic financial system does not allow the creation of debt through direct lending and borrowing. It rather requires the creation of debt through the sale or lease of real assets by means of its sales- and lease-based modes of financing (murabaha, ijara, salam, istisna and sukuk). The purpose is to enable an individual or firm to buy now the urgently needed real goods and services in conformity with his/her ability to make the payment later. It has, however, laid down a number of conditions, some of which are:

* The asset which is being sold or leased must be real, and not imaginary or notional.
* The seller or lessor must own and possess the goods being sold or leased.
* The transaction must be a genuine trade transaction with full intention of giving and taking delivery.
* The debt cannot be sold and thus the risk associated with it must be borne by the lender himself.

The first condition will help eliminate a large number of derivatives transactions which involve nothing more than gambling by third parties who aspire to claim compensation for losses which have been actually suffered only by the principal party and not by them.

The second condition will help ensure that the seller (or lessor) also shares a part of the risk to be able to get a share in the return. Once the seller (financier) acquires ownership and possession of the goods for sale or lease, he/she bears the risk. This condition also puts a constraint on short sales, thereby removing the possibility of a steep decline in asset prices during a downtown. The Shari’ah has, however, made an exception to this rule in the case of salam and istisna where the goods are not already available in the market and need to be produced or manufactured before delivery. Financing extended through the Islamic modes can thus expand only in step with the rise of the real economy and thereby help curb excessive credit expansion.

The third and the fourth conditions will not only motivate the creditor to be more cautious in evaluating the credit risk but also prevent an unnecessary explosion in the volume and value of transactions. This will prevent the debt from rising far above the size of the real economy and also release a substantial volume of financial resources for the real sector, thereby helping expand employment and self-employment opportunities and the production of need-fulfilling goods and services. The discipline that Islam wishes to introduce in the financial system may not, however, materialise unless governments reduce their borrowing from the central bank to a level that is in harmony with the goal of price and financial stability.

One may raise an objection here that all these conditions will perhaps end up shrink-ing the size of the economy by reducing the number and volume of transactions. This is not likely to happen because a number of the speculative and derivatives transactions are generally known to be zero-sum games and have rarely contributed positively to total real output. Hence a decline in them is also not likely to hurt the real economy.

While a restriction on such transactions will cut the commissions earned by the speculators during an artificially generated boom, it will help them avert losses and bankruptcy that become unavoidable during the decline and lead to a financial crisis.

The injection of a greater discipline into the financial system may tend to deprive the subprime borrowers from access to credit. Therefore, justice demands that some suitable innovation be introduced in the system to ensure that even small borrowers are also able to get adequate credit. Such borrowers are generally considered to be subprime and their inability to get credit will deprive them from realising their dream of owning their own homes and establishing their own microenterprises.

There is no doubt that a number of countries have established special institutions to grant credit to the poor and lower middle class entrepreneurs. Even though these have been extremely useful, there are two major problems that need to be resolved. One of these is the high cost of finance, ranging from 30 to 84 per cent in the interest-oriented microfinance system. This causes serious hardship to the borrowers in servicing their debt. No wonder the minister of finance for Bangladesh described microcredit interest rates in that country as extortionate in an address he delivered at a microcredit summit in Dhaka in 2004. It is, therefore, important that microcredit is provided to the very poor on a humane, interest-free basis (qard hasan). This may be possible if the microfinance system is integrated with zakat and waqf institutions. For those who can afford to bear the cost of microfinance, it would be better to popularise the Islamic modes of PLS and sales- and lease-based modes of finance, not only to avoid interest but also to prevent the misuse of credit for personal consumption.

Another problem faced by microfinance is that the resources at the disposal of microfinance institutions are inadequate. This problem may be difficult to solve unless the microfinance sector is scaled up by integrating it with the commercial banks. Commercial banks do not generally lend to small borrowers because of the higher risk and expense involved in such financing. It is, therefore, important to reduce their risk and expense. This may be done partly by a subsidy from zakat and waqf funds for those borrowers who are eligible for zakat.

Thus we can see that the Islamic financial system is capable of minimising the severity and frequency of financial crises by getting rid of the major weaknesses of the conventional system. It introduces greater discipline into the financial system by requiring the financier to share in the risk. It links credit expansion to the growth of the real economy by allowing credit primarily for the purchase of real goods and services which the seller owns and possesses, and the buyer wishes to take delivery. It also requires the creditor to bear the risk of default by prohibiting the sale of debt, thereby ensuring that he evaluates the risk more carefully. In addition, Islamic finance can also reduce the problem of subprime borrowers by providing credit to them at affordable terms. This will save the billions that are spent after the crisis to bail out the rich bankers. These do not, however, help the poor because their home may have already become subject to foreclosure and auctioned at a give-away price.

The problem is that the Islamic finance is still in its infancy and shares a very small proportion of international finance. In addition, it does not genuinely reflect the ethos of Islamic teachings. The use of equity and PLS is still very small while that of debt-creating modes is preponderant. Moreover, even in the case of debt-creating modes, all the conditions laid down by the Shari’ah are not being faithfully observed by the use of legal stratagems (hiyal). This is partly due to a lack of proper understanding of the ultimate objectives of Islamic finance, the non-availability of trained personnel, and the absence of a number of shared or support institutions that are needed to minimise the risks associated with anonymity, moral hazard, principal/agent conflict of interest, and late settlement of financial obligations. The system is, thus, not fully prepared at present to play a significant role in ensuring the health and stability of the international financial system. It is, however, expected that the system will gradually gain momentum with the passage of time and complement the efforts now being made internationally for
promoting the health and stability of the global financial system.

Concluding remarks

Since the current architecture of the conventional financial system has existed for a long time, it may perhaps be too much to expect the international community to undertake a radical structural reform of the kind that the Islamic financial system envisages. However, the adoption of some of the elements of the Islamic system, which are also a part of the western heritage, is indispensable for ensuring the health and stability of the global financial system. These are:

* The proportion of equity in total financing needs to be increased and that of debt reduced.
* Credit needs to be confined primarily to transactions that are related to the real sector so as to ensure that credit expansion moves more or less in step with the growth of the real economy and does not promote destabilising speculation and gambling.
* Leverage needs to be controlled to ensure that credit does not exceed beyond the ability of the borrower to repay.
* If the debt instruments, and in particular CDOs, are to be sold, then there should be full transparency about their quality so that the purchaser knows exactly what he is getting into. It would also be desirable to have the right of recourse for the ultimate purchaser of the CDOs so as to ensure that the lender has
incentive to underwrite the debt carefully.
* While there may be no harm in the use of CDSs to provide protection to the lender against default, it needs to be ensured that the swaps do not be come instruments for wagering. Their protective role should be confined to the original lender only and should not cover the other purchasers of swaps who wish to wager on the debtor’s default. For this purpose the derivatives market needs to be
properly regulated to remove the element of gambling in it.
* All financial institutions, and not just the commercial banks, need to be properly regulated and supervised so that they remain healthy and do not become a source of systemic risk.
* Some arrangement needs to be made to make credit available to subprime borrowers at affordable terms to enable them to buy a home and to establish their own microenterprises. This will help save the financial system from crises resulting from widespread defaults by such borrowers.

*A distinguished 14th century polymath and the forerunner of classical economics and social sciences, Ibn Khaldun broke new ground in many fields and anticipated the later findings of Western social scientists. Some hundreds of years ago, he presented a comprehensive theory arguing that the development and decline of societies does not depend on any single factor, but rather the combination of factors, including moral, social, economic, political and historical.

However, the example of Ansar is of questionable value to Haddad’s argument. Having started in 1994, the model has yet to catch on, or to grow significantly...


Sheikh Haitham Al Haddad is a director of the Muslim Research and Development Foundation (MRDF). The MRDF, which was awarded charity status in 2007, and is a co-operative research based venture, run by scholars, imams and other professionals, with the aim of articulating Islam in a modern context, as well as addressing the unique situation faced by Muslims in the West. He is also involved with the Islamic Shari’ah Council, a body which deals chiefly with the issue of Shari’ah-compliant marriage and divorce in the UK. The council also provides advice and guidance to British Muslims on financial, business and other matters. He is currently working on a PhD in Islamic jurisprudence at the School of Oriental and African Studies (SOAS), a major part of which is about mortgages. He also sits as an advisory scholar for Ansar Finance, an Islamic initiative in Manchester, which was founded in 1994. Here, he explains to NewHorizon his views on the problems with Islamic finance in the UK.

Al Haddad believes that, while Muslims living in non-Islamic countries deserve ‘special consideration’ within the Ummah (worldwide community of Muslims), ‘there are some aspects of their daily lives that cannot be changed because they live in the West’. Finance is not the only aspect which Al Haddad believes this applies to, another example being marriage. However, the ‘interest based system is one of the most dangerous systems in the world’, so ‘the gravity of the problem’ for Western Muslims is huge. Al Haddad quotes the late American president Thomas Jefferson, that ‘if the people wanted to be enslaved, they should allow the banks to create money’, and he goes on to say that the creation of money and the creation of interest-based systems are of course linked.

The bulk of Al Haddad’s work concerns Islamic mortgages in the UK. However he states that his criticism is ‘equally applicable to other product classes’ in the space. The reason that he focuses on mortgages in particular is that they represent most of the Islamic finance industry in the UK. Only recently has the first independent takaful (Islamic insurance) operator, Salaam Halal Insurance, been launched in the country (NewHorizon, October–December 2008). ‘More or less the main products here are the Islamic mortgages.’

‘We Muslims should hold firmly onto the value that the interest-based system is prohibited.’ However, Al Haddad is also a prominent critic of supposedly Shari’ah-compliant finance in the UK and elsewhere. His main criticism is the way in which riba is interpreted in a literal, semantic way by equating it to the word ‘interest’. What this allows is for a system to be devised in which the flow of money and the share of risk between agents is completely equivalent in a supposedly halal transaction to a conventional transaction based on interest. ‘My problem with Shari’ah-compliant finance is that the whole process is more or less the same’ as conventional banking, he explains. The effect of this is that the prohibition of riba makes no noticeable difference to finance.

‘In all the schemes for Islamic mortgages, the bank buys the property and sells it to you. This will be now, or later, according to murabaha, and may be just with part of the property. The bank buys the property and sells it to you. The big problem is that the bank buys it in order to sell it to you’. Thus the bank buys the property with the intention of selling the property. Moreover, ‘when the bank buys it, the bank knows that you are obliged to buy it’. This means, to Al Haddad, that since the bank is guaranteed to sell the property, the concept of the bank’s ownership of the property during the mortgage is phoney.

‘The bank is paying X money to buy the property, and by contract is obliging you to pay the bank X amount plus Y. So in a nutshell, the bank pays money, and gets more money for it, which is the interest-based system’. This is achieved by combining contracts which, on their own, are halal, but looked at as a whole, clearly include the equivalent of interest. A bank might buy a property and sell it in instalments to a homebuyer at a profit, and this will only be possible if the homebuyer promises to buy the property from the bank, as soon as the bank has purchased it. From the banks perspective, in this murabaha model, the bank avoids a situation where it owns the property for any length of time. This can be added to the fact that the rate and amount of repayment from the homebuyer to the bank is likely to be strongly linked to interest rates.

For Al Haddad, the key for considering this as riba is the fact that the transaction will be carried out in this way is explicitly stipulated in a contract. This is because of his second major criticism of Islamic finance in the UK, that it allows banks to minimise their own exposure to risk. ‘If the agreement is done on a handshake, it means if the homebuyer ends up breaking the agreement, the bank has no obligation against him, and cannot sue him. This is the principle of loss-sharing. The bank should not secure itself against any risk of loss. It is as simple as that.’

Instead, Al Haddad promotes the model of Ansar Finance Group, where, as mentioned, he sits on the advisory board. Ansar’s stated mission is ‘to provide and promote awareness of halal financial borrowings and investments among the Muslim community of the UK’. A membership-based organisation (membership is open to anyone), it provides interest-free finance based on the qard hasan model. Qard hasan is usually associated with charitable giving, either for welfare purposes or for fulfilling short term funding requirements. The borrower is expected only to pay back the original sum. Al Haddad describes Ansar as a ‘community project’, and transactions are done on a handshake. A moral, rather than a binding, agreement, must be based on the goodwill and trust engendered amongst the members. ‘The bank buys the property, an agreement with the client is made, and if the client can’t continue paying, then the risk on the property is with the bank.’

However, the example of Ansar is of questionable value to Haddad’s argument. Having started in 1994, the model has yet to catch on, or to grow significantly (its website claims 800 members). Haddad does provide a reason for this which is that it is difficult to build sufficient funds for mortgage lending from scratch. Secondly, he says, ‘I am often disappointed by the lack of support for Ansar from the community and also businesses’. Yet he is sure that Ansar’s model is commercially viable, and believes that larger Islamic banks in Britain have not copied Ansar’s example, or developed a similar framework, because ‘they want to eliminate any possible risk’. The larger banks’ Shari’ah boards adopt a lenient approach, for example, by arguing that it is unfair for a bank to suffer a loss since it is responding to a client’s expressed need for a home.

Meanwhile, the mainstream of Islamic finance would most likely make the criticism that, while qard hasan is suitable for microfinance, it is not so suitable for attracting huge funds with high volumes of investments. To do so, there would need to be a profit motive. And neither the Holy Quran nor Prophet Muhammad prohibit entrepreneurship and possible subsequent wealth (provided that both are confined to permissible activities, sharing in the risk and reward without involving usury and interest). The Quran clearly states, ‘God hath permitted trade and prohibited riba’ (2:275).

Al Haddad’s criticisms of Islamic banks’ approach to risk are compounded by the difficulties he sees in regulating the industry in the non-Islamic West. He is particularly critical of the auditing processes. Scholars at most Islamic banks in Britain, who as Al Haddad has already made clear take a lenient approach, ‘are not auditing the implementation of whatever opinion they give’. ‘What they should say is “here is what we suggest is halal. Then let us see examples of your transactions. Are you implementing what we are saying?” but they don’t do so.’ Al Haddad states that there is currently no legal requirement for scholars to do so. However, ‘in order to ensure an organisation has received a certificate that its products are of a certain standard of quality, we need to audit it regularly’.

But who can perform such a task in the UK? The Financial Services Authority (FSA) would be ideally placed, thinks Al Haddad, except that it represents a secular government. ‘We can discuss whether the UK government should play a role, in ensuring that the audits are real, and making sure that the interpretation is accepted by the vast majority of Muslims.’ However, Al Haddad does not see this as realistic. ‘It doesn’t fit. For example, if I don’t believe in halal meat, how can I monitor it? Maybe technically it can be done but it would not bring confidence’ to Muslims.

The alternative, as Al Haddad has suggested to his peers, is to form an independent body of scholars in the UK to perform the functions that the FSA ideally would. There are some examples of this throughout the world. The AAOIFI (the Accounting and Auditing Organisation for Islamic Financial Institutions) is one. And there are only a few institutions which work on a similar model to Ansar Finance Group. In the meantime, Al Haddad believes, ‘we need Muslim governments to play a role. Then it would be easier for non-Muslim governments such as in the UK to get help from Muslim governments, and to establish their own Shari’ah board’.

As Al Haddad accepts, however, his views are in a minority. This means that any new organisation would most likely back up the stats quo view of the majority of scholars. So, he acknowledges, ‘the system would remain the same. At the end of the day, that is their view. We have a different view’. In the meantime, therefore, Al Haddad works to spread his message, though the internet, and through his involvement in Ansar Finance. ‘On a frequent basis I receive emails from people who have read my arguments and are convinced.’

The big question for Al Haddad, though, is whether there is a realistic, alternative way of persuading people to provide their money for the use of others, whether this is done conventionally, for interest, or through the West’s established Islamic banks, for profit. It is very difficult to believe that the Ansar model provides an alternative to mainstream Islamic finance for the mass market, since it does not involve profit. But a large part of Islam’s problem with interest is that it favours the person who has money to start with. Al Haddad’s problem with Shari’ah-compliant finance in the West is that it does also. ‘I should not have any privilege because I have loaned money to someone else,’ he says. But is there another way? ‘Yes, qard hasan is viable.’ But it depends on goodwill and trust. Is it going to happen? ‘Yes, because Ansar Finance started on a goodwill basis. It started with people lending and not expecting anything. With education, people can change.'


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Source: www.islam21c.com; written by New Horizon as a feature and posted at http://www.newhorizon-islamicbanking.com/index.cfm?section=features&action=view&id=10741