Wednesday, January 25, 2012

The Social Impact of Islamic Finance

Farooq Sheikh, a student at the Lahore University of Management Sciences, wrote a 2 part series for SocialFinance, a Canadian blog on impact investing ([Part 1] [Part 2]).  In a comment, he clarifies what he meant by 'social impact':

"I am referring to an influence which is beneficial to the society and delivers sustainable social and/or environmental benefits without negatively affecting the social fabric in the area one is operating. It means solving the problems of the society (e.g.  Providing equity financing to a project which would spur employment) and at the same time earning financial return on the capital for those who have provided the capital."

I am hopeful that Islamic finance will become more focused on the social impact of their activities, instead of just creating the easiest products for them to get Shari'ah approval and make a profit (while donating any non-permissible income to charity as their 'social impact').  There is definitely a wide range of Islamic financial institutions, so to some degree, statements about their concern about social impact are generalizations, but I think it is clear that most Islamic financial institutions are pre-occupied with acting as much like banks as they can. 

As much as it may have been the intent of Islamic economists for "money has no intrinsic value and hence cannot be treated as the subject-matter of trade. It is just a medium of exchange. Islamic financing is always based on tangible assets and inventories, unlike its conventional counterparts."  There is a significant question about whether this is the case in most transactions, for example, those based on commodity murabaha or tawarruq.  These transactions involve tangible assets, but the assets are involved to create a debt (through sale with deferred payment). 

For a while I have argued that this use of commodity murabaha is necessary, both to fit within regulatory requirements, but also in areas like liquidity management where other products do not exist.  I think this is the case, but without necessarily disagreeing with the idea for Islamic finance that Sheikh described.  This, I think, is a clear area where one can differentiate between different uses of commodity murabaha.  While I generally support commodity murabaha used for inter-bank money market transactions (though I have critiqued the use of commodity murabaha-based repo transactions collateralized by commodity murabaha-based certificates of deposit), I have been critical of the use of the same structure for deposits.

The difference, I think, is whether there are alternatives that would work as well that are not commodity murabaha.  In the case of Islamic repos collateralized by Islamic CDs, the commodity murabaha structure could be maintained for the repo with the collateral being tradable contracts like ijara.  In the case of deposits, there are a number of other deposit products like wadiah, qard and mudaraba which are widely used by Islamic banks. It doesn't necessarily address the social impact of Islamic finance, but it can help to combat cynicism that Islamic banks always take the path of least resistance in terms of diverging from the way conventional banks do business. 


socially responsible investments said...

Good post. There should be more emphasis in Islamic finance on its social affects. Without that, it just looks like some kind of technical solution to get around Islamic rules.

Blake Goud said...

I would be interested in your thoughts on the social effects that should be bumped up to top priority.

Anonymous said...

Thanks for the sensible critique. Me and my neighbor were just preparing to do some research on this. We got a grab a book from our area library but I think I learned more from this post. I am very glad to see such wonderful information being shared freely out there.
Living Earth Crafts - Serenity Flat Top Table