Friday, December 08, 2006

Commodity financing & the role of social justice in Islamic finance

Commodity trading in Islamic finance

"Commodities and Islam, the start of something big", Reuters UK, December 8, 2006

One of the ways in which the Islamic financial industry has structured financial deals to avoid violating the scholars' interpretation of what is Shari'ah-compliant is by substituting trade in commodities (e.g. metals, palm oil) as a financing mechanism. Essentially, every transaction is a murabaha (cost-plus) sale between a financial institution and its customer where the bank purchases an item for the customer and sells it to the customer at a fixed markup, often in installations. The areas in which this type of trading has become particularly controversial is by using multiple halal transactions to approximate derivatives, currency swaps or personal loans (through tawarruq, for example, which literally means 'monetization'). In tawarruq, a commodity is described well by Mahmoud El-Gamal in his new book Islamic Finance: Law, Economics & Practice:
"If a customer wishes to borrow $10,000 and pay 5 percent interest, and the bank wishes to lend him the money at that rate, the bank needs only to buy $10,000 worth of platinum from a dealer, sell to the customer on a credit basis for $10,500 to be paid later, and then sell the platinum on behalf of the customer back to the dealer, thus generating the desired result (p. 69)

This article describes how a currency swap is designed to become Shari'ah-compliant:
"Under the swap, if the ringgit falls against the dollar, the bank makes a payment to [...] offset the drop in the dollar value of the group's investment. The bank does this by selling the group some metal at a discount to market value. The group then sells the metal and treats the gain as profit."

These types of transactions meet the literal interpretation of how Islamic finance should be conducted, but where does the Islamic conception of social justice enter into the transactions? That is an area in which I believe Islamic finance should work on improving.

Islamic finance: book review

"Book Report: An Introduction to Islamic Finance", International Herald Tribune, December 8, 2006

A review of a book on Islamic finance written by two professionals, Zamir Iqbal & Abbas Mirakhor, one at the World Bank and one at the International Monetary Fund (IMF). The review is a fairly standard description of Islamic finance, but the beginning describes the authors description of the ideal role of Islamic finance:
"In Islam, such subjects [finance & economics] are not profane, but form part of a sacred totality in which profit-seeking, if it is done right, can also be a holy endeavor. And that rings true: After all, entrepreneurship creates wealth, and under the right conditions, wealth spreads, allowing humans to rise above just trying to make ends meet."

An interesting description of the role Islamic finance plays in the interaction between religion, economics and social justice.

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