Editor's Note:  What follows is the text of a paper read at the Ninth Annual Conference of the Society held at the University of Lancaster, 11-14 July, 1982.  

 i.

In recent years, as we all know, there has been much discussion of the Islamic revival, especially since the Iranian revolution. Its political and social implications have been widely debated although admittedly often in somewhat vague terms. The economic and financial implications however have been little discussed, and what discussion there has been has been even less precise.

I would like at the outset to emphasize my own position and background. I come to this topic not as an Islamic scholar, and I Know that many of you are much more qualified to talk about Islam and Islamic ideas than I am. Rather my training is in economics, essentially. Western economics and the approach I must take when examining Islamic economic ideas and their implications is basically from a Western perspective.  At its core there are-several assumptions in all Western neo-classical economics which are certainly applicable in Western societies, but the extent to which they have universal, applicability must be debatable. I would like to focus on just three of them. I will then go on to illustrate their relevance or irrelevance in an Islamic context.

These assumptions are:-

1. PRICES ARE THE MAJOR MEANS OF ALLOCATING RESOURCES.  It is prices which bring demand and supply into equilibrium, not just in markets for final goods, but also in markets for land, labor and capital.

2.  PRESENT CONSUMPTION IS PREFERRED TO FUTURE CONSUMPTION. Individuals will naturally prefer to obtain goods now than at some future date, and if they are to defer their consumption by waiting, then they will have to be compensated in some way.  Put crudely, TIME IS MONEY.

3.INDIVIDUALS ARE RISK ADVERSE.  This means they seek to avoid taking risks in financial dealings, although they may be prepared to take some risks if the prospects for personal gain are enhanced.  Without some possibility of financial compensation, individuals will naturally avoid risk whenever possible.

Rather than discuss the applicability of these neo-classical economic premises in Islamic societies in general terms, I would like to look at their applicability in relation to certain specific issues about which there has been some debate over the years.

     ii.  Financial Implications of Islamic Teaching

Firstly, I wish to consider the implications for business finance, which is clearly important for all economies, whether Islamic or non-Islamic.  Much business finance, of course, comes from ploughed-back profits, and on this there is no conflict with Islamic teaching. Share issues are also an important source of business finance in the West, but in Islamic societies these are generally less significant due to the under development of the financial infrastructure. Only Kuwait has a significant stock market in the Islamic world, and even it accounts for less than 1 per cent of all world stock market dealings.  Kuwaiti investors are in fact more active in Western stock markets than they are in their own market[1].

The underdevelopment of stock markets means there is even more reliance on banks for business finance in the Islamic world than in the West -- but it is this that presents problems. Banks usually reward some of their depositors with interest, at least those with savings or time deposit accounts.  At the same time interest is charged on funds borrowed from the banks, partly to compensate depositors, but also partly to cover bank overheads.

Now according to neo-classical economic theory interest has two functions:

(1)  It represents the price of capital or borrowed funds. It has to be paid to depositors to compensate them for the savings they are making — as there is a sacrifice in saving in terms of deferred consumption.

(2)  Interest serves as a market--equilibrating mechanism by milking sure that the supply of savings is brought into line with the demand for credit. If there is an increase in demand for bank loans, then interest will rise. This will reduce demand for credit, while   at the same time it will increase the supply of savings.         

Therefore interest is seen as necessary to ensure an adequate supply of savings, and to   ensure the efficient working of financial markets. It is viewed as the price of capital, and a way of rewarding those who defer consumption.

     iii.    Quranic Views of Usury

In the Quran, the practice of living on interest earnings is explicitly condemned:       “Those that live on usury shall rise up before Allah like men whom Satan had   demented by his touch; for they claim that usury is like trading. But Allah has permitted trading and forbidden usury[2]”. The unfavorable contrast of living on usury with trading activity makes it clear that usury is seen as unproductive, whereas trading is viewed as a useful activity.  The deferment of consumption is not to be encouraged, and certainly not rewarded for its own sake. Time is not seen as money. Another pronouncement from the Quran illustrates the objection to hoarding: 'Proclaim a woeful punishment to those that hoard up gold and silver and do not spend it in Allah’s' cause.  The day will surely come when their treasure shall be heated in the fires of Hell, and their foreheads, sides and backs branded with them. Their tormentors will say to them ''These are the riches which you hoarded. Taste then the punishment which is your due[3]".

The objection to interest is also because of its adverse redistributive effects - not only does if make the more productive indebted to the less productive – but it can also result in the poor being indebted to the rich. Where a debtor gets into difficulty with repayments, the Quran urges leniency with debt rescheduling: 'If your debtor be in straits, grant, him a delay until he can discharge his debt; but if you can waive the sum as alms it will be better for you, if you but knew it.[4]'

 iv. The Application of these Views in Modern Islamic States

These Islamic strictures on usury are interpreted in different ways in the Muslim world today.  One response has been the rise of Islamic banking.

  Islamic Banking

Although they remain insignificant in aggregate terms, Islamic Banking institutions operate in most Gulf States, the Dubai Islamic Bank being the largest. The Islamic banking movement first started in Pakistan as far back as the 1950s, but spread to Egypt in the early 1960s.  In Egypt its main strength was in the provincial, towns of the Delta-rather than in Cairo or Alexandria, where the secular nationalized banks did most of their business. Today Islamic banking has even spread to Europe, with an international Islamic bank operating out of Geneva[5], which is controlled through a Cayman Islands-based holding company. 

Islamic banks do not pay their depositors interest, but rather they provide for profit sharing. I will describe briefly the operation of the Dubai Islamic Bank, as this typifies the others[6].  Two types of account are provided for depositors by the Dubai Islam bank, savings accounts and investment accounts. No interest is earned on savings accounts, but depositors qualify for interest- free loans, and many depositors who have not made use of this loan facility nevertheless regard it as worthwhile to maintain funds in such an account as it offers them security. Those who open investment accounts are entitled to share in the profits from the bank's investments, but funds have to be maintained in such accounts for a certain minimum period to qualify, normally a year.  Funds cannot be withdrawn from investment accounts on demand, as notice must be given in advance, but the bank is fairly flexible about this, and usually one month is the notice stipulated for small amounts, and three months for larger sums. If a client needs funds urgently and is in financial difficulties, the bank always understands, especially as it is aware of its religious obligations. Debtors will never be squeezed under any circumstances; the bank will instead offer advice about how their financial affairs should be reorganized.  Obviously the record and moral standing of the client is taken into account when help is offered, and this will play a part in determining the conditions attached to the help given.

Those who receive money from the bank for business purposes have to pay the bank a share of the profits of their businesses. The bank is really investing money rather than lending, and the bank is sharing the risks with the client.  If there are no profits, the bank will not get a return on its investment. This means sound investment, appraisal is necessary before funds are advanced. A bank such as the Dubai Islamic Bank has to function as a merchant bank in assessing risk, although this fits in well with the merchant traditions of that part of the Gulf.

         Prohibition of Interest -- the Saudi Experience

Another response to Islamic strictures has been to allow conventional banks to operate, but to prohibit interest payments and receipts by law. This is the practice in Saudi Arabia, where banks levy service charges on borrowing, but do not charge interest[7]. This is no matter of mere semantics. Interest is not permitted to be paid as a reward to those depositors who have time or savings accounts. Most deposits in Saudi Arabia in any case are current accounts which earn no return. There is, however, a growing volume of savings accounts, especially with the former foreign-owned banks which were recently Saudi-ized[8]. Returns are payable to compensate for inflation —in other words nominal interest is permitted, but not real interest -- to compensate for deferring consumption.  The distinction between nominal and real payments is seen as critical in Saudi Arabia. Similarly, the service charges levied on borrowers are partly to cover the administrative overheads of the banks, but a margin is also allowed for inflation.  The banks should not charge their clients real interest, but neither should they subsidize their borrowers by charging zero nominal interest.

As all banks function according to Islamic principles and the Shariah law in Saudi Arabia, there is no need for special Islamic banking institutions to serve believers. The only specifically Islamic financial institution is the Jeddah– based Islamic Development Bank, but it is an external development aid agency and does not finance internal development in Saudi Arabia[9]. The low returns on bank deposits (4 per cent) in Saudi Arabia have, however, made many reluctant to deposit funds within the country. In the absence of controls on outward capital movements many depositors have placed money overseas, especially given the high return available in international financial markets.  This has caused problems for the Saudi financial system, with borrowers often forced to go outside the Kingdom for loans which local banks are unable to supply. Hence, although funds can be borrowed at present from the National Commercial Bank or the Riyadh Bank at 8 per cent in line with inflation (zero real interest); many have to borrow from the Bahrain offshore banks at 15 per cent and more. Clearly this is a worry for the authorities.

 v.  Islam and Insurance

I have already referred to risk aversion as one of the fundamental premises of neo-classical economics. One way of avoiding risks is by taking insurance cover, which comes in many forms. In Islam, however, there are two objections to insurance, one fundamental, and one regarding the operation of insurance companies themselves. The fundamental objection concerns trying to cover against future events, which are seen to be the will of Allah. This fatalistic interpretation of Quranic teaching is mainly adhered to in Saudi Arabia, where all insurance companies are prohibited from registering within the country. Foreign-registered insurance companies give cover in the kingdom, but there are no local Saudi Arab inn insurance companies.  There are however, some foreign insurance companies under part-Saudi ownership, mainly in the Far East.

The second objection concerning the way insurance companies operate is to their asset holdings. Often insurance companies invest their client’s funds in long-term interest yielding securities. In Dubai the Islamic Bank has established an insurance subsidiary, however; the Arab Islamic Insurance Company.  This is organized as a kind of mutual society. Premium income is invested in accordance with Shariah principles, and a small cash reserve is held for contingencies. Participants agree to help other members by increasing their subscriptions if there are a large number of clients putting in claims at the same time, but they are reimbursed by the company eventual1y. Those receiving assistance are expected to repay at least, some of the compensation they obtain, unlike the practice with conventional insurance companies. This last proviso is justified, partly in order to keep down premium levels, but also so that all participants feel a sense of solidarity one with another in line with Islamic teaching. The identification and the commitment are with the other members rather than an impersonal. corporate entity and the emphasis is on mutual sharing.

There is no doubt that further new types of financial institution will be developed to serve the Islamic world. Quranic principles, far from being a constraint, are being interpreted in an innovative fashion in the Gulf and elsewhere. This emphasis on the positive rather than the negative contrasts with the view of Islam sometimes held in Western financial circles. Indeed it may well be that by studying the workings of the new Islamic instituti- ons Western financial specialists can gain a greater insight into the defects and merits of their own institutions.

 vi.  An Islamic Economic System?

Finally, 1 would like to address myself briefly to some wider issues outside the narrower financial field. 1 am somewhat reluctant to ask that question whether a specifically Islamic economic system can be identified or delineated — an appealing alternative to capitalism or communism for the Islamic world. My reluctance stems partly from, the fact that I am not so sure that a specifically capitalist or communist system can be identified either — there, are so many variations between nations, and within nations over time.  However if we look at the leftist writer Maxime Rodinson, who had fewer of these doubts, and his work on Islam and Capitalism[10], we find little enlightenment. His main finding is that, 'The correlation between Islam and any particular economic system has emerged as being very largely inconclusive . . .  The leaders of the Muslim expansion were traders even before their conversion and they conquered societies in which trade was very highly developed already before the conquest.  The precepts of Islam have not seriously hindered the capitalist orientation, taken by the Muslim world during the last hundred years, and nothing in them is really opposed to a socialist orientation either.  . . . Similarly the precepts [of Islam] have nowhere created a social or economic structure that, was radically new[11]'. Gerard Destanne de Bernis, with fewer ideological axes to grind than Rodinson, reached a similar conclusion in his work on Islam and Economic Development[12].

Turning to the recent economic writings of Muslim authors we can find no universal Islamic economic system defined. Rather we find that some have tried to apply Islamic ideas to particular areas. Most notable is the effort of the Pakistani writer Hakim Mohammed Said, to apply Islamic teaching to the field of labor relations and empl- oyment contracts[13]. Siddiqi's work Public Finance in Islam with particular reference to the Zakat is also worthy of mention[14]. I would suggest, however, that it would be too great a task for any one writer to define a complete Islamic economic system in any case.  Islamic economists like their Western counterparts have specialized in particular areas.  There are facets of Islamic teaching which have, and are having, an impact on economic practice as I have pointed out. To try to reach a conclusion with respect to a  whole system, as Rodinson attempted, is certainly an over-ambitious task, and one which in my view is doomed to failure.                                                                                   

NOTES

1.  Rodney Wilson, Recent Financial Trends in the Gulf (University of: Durham Centre: for Middle Eastern and Islamic Studies, Economic Research Paper No, 9), 1981 (Part 1 deals with Kuwait).

2.  The Koran. Translation by N.J.Dawood.  London, Penguin Books, 1936, p. 352.

3.  Ibid., p. 314.

4.  Ibid., p. 353.

5.  Known as Dar al-Mal al-Islami (DMI) 'The House of Islamic Funds'.

6. A paper presented by Bakri A. Bashir (Lancaster University) to the postgraduate session of the Ninth Annual BRISMES Conference and to be published later in this Bulletin, provides details of the working of the Faisal Islamic Bank of the Sudan.

7. For a detailed background of the Saudi banking system see Rodney Wilson, 'The Evolution of the Saudi Banking System and its Relationship with Bahrain'  in T. Niblock (ed.) State, Society and Economy in Saudi Arabia, London, Croom Helm, 1981, pp.278-300.

8. Such as the Saudi British Bank (formerly British Bank of the Middle East), Saudi American Bank (formerly Citibank), etc.

9. A critique of this bank is provided in Rodney Wilson, Banking and Finance in the Arab Middle East, London, Macmillan, 1983 (forthcoming), Chapter 4.

10. London, Penguin Books, 1974.

11. Islam and Capitalism, p.186.

12.  'Islam et development economique' in Cahiers de 1'Institut de Science Economique. Appliquee (Paris), No. 106 (October I960), pp.105-146.                                                  

13.  Hakim Mohammed Said, The Employer and the Employee — Islamic Concept, Dar al Fikr al Islami, Karachi, 1972.

14.  S.A.Siddiqi, Public Finance in Islam, Lahore, Shaikh Muhammad Ashraf, 1948.