Malaysia in the Era of Globalization #81

M. Bakri Musa

IFIs thrived in the first few centuries of Islam not because those early Islamic thinkers had found a magic way to dispense with the cost of funds and returns on investments, rather they used different terms (or more crudely said, put a different spin on the issue) to circumvent interests payments and earnings.

Chapter 9: Islam in Malay Life

Reform in Islam

Islamic Financial Intermediaries (Cont’d)


IFIs thrived in the first few centuries of Islam not because those early Islamic thinkers had found a magic way to dispense with the cost of funds and returns on investments, rather they used different terms (or more crudely said, put a different spin on the issue) to circumvent interests payments and earnings.


The modern version of Islamic banks was resurrected only in the last few decades. Despite its recent rebirth, its popularity has soared both in Islamic and non-Islamic countries. This recent history should serve as a ready caution. The system has not been tested. The system of auditing, accounting, and regulating has not been standardized. What I fear most is that should Islamic banks fail in an economic crisis, it would not only aggravate the situation but also set back people’s trust in them. That in turn would severely shake Muslim’s trust in their religion.

A senior official of the Federal Reserve Bank of New York, which supervises the world’s largest and most sophisticated banks, voiced his concern about this in his address to a meeting of Islamic bankers who were eager on introducing the concept to America. Through bitter experience America has wisely separated commercial banking from insurance and investment banking, and also banking from commerce.

A century ago American banks were deeply involved with commercial enterprises much along the lines currently advocated by proponents of Islamic banking. The 1930 depression was blamed in part because banks were deeply involved in speculative share trading activities of companies they owned. Further, such co-mingling of banking and other commercial activities could lead to an unhealthy concentration of economic power. Banks would then cease from becoming an impartial arbiter of credit worthiness.

Modern Western banking has been continuously refined over the past centuries. Banks today (at least in Western countries) are safer and offer better services. They have also contributed immensely to economic development. The challenge for IFIs is not simply to say that Western banks are un-Islamic but to offer comparable services to customers and thus serve the economic needs of society.

Instead of trying to parse non-existent differences between interest and other costs of funds, modern Islamic bankers and economists should more productively focus their intellectual resources to differentiating the various kinds of lending. Islam rightly prohibits “making money on money,” which I interpret as gambling and speculating, but encourages trade, which is taking risks in productive investments.

There are certainly significant differences between my borrowing money to buy a Mercedes limousine to show off to my colleagues and neighbors, or to use it as a taxi. The economic multiplier effect of the purchase, for example in creating jobs at the factory as well as the car repair shops, is the same in both cases – the direct effects of consumer spending. From there the economically meaningful differences emerge.

With the first instance I am using borrowed funds for consumption; the second for production or investment. With the latter I, as a borrower, would actually earn money (passenger revenues) as a consequent of the loan. And if I share my taxi with another driver, that would create yet another job (making a total of two taxi drivers). No such additional incomes or job creations would result with the first type of borrowing. Additionally, my taxi would provide a much-needed transportation service to the community. My private limousine would only create more pollution and envy from my neighbors. But the most important difference is that with the first borrowing, only the lender (bank) makes money out of the borrower; with the second, both lender and borrower make money.

In either case money is being borrowed and interest (cost of funds) incurred. But with the second case the borrowing serves a useful societal purpose; it is in fact a form of trading. I trade my service or expertise as a taxi driver for the bank’s capital. The first borrowing on the other hand, is purely for consumption. One can be easily persuaded that borrowing in the second instance should be encouraged as society as a whole would benefit from such activities. No such societal benefits would accrue from the first borrowing. Thus we could properly differentiate, as many recent scholars have suggested, between the costs of capital in the first type of lending as interest, riba; the costs in the second instance should be more accurately called profit on the trading of capital, which in this case is money instead of the usual assets such as goods and real estate.

Muslims must remind ourselves that current accepted interpretations of terms such as riba and gharar (risky sale, speculation) are just that: interpretations. Indeed there are some scholars who interpret riba to mean excessive interest. Just as excessive profit is bad (and often illegal as they are usually obtained through such means as market manipulation, monopoly, or plain hoarding) so too are excessive interest rates. Likewise there is a conceptual difference between interests on “productive” versus “consumptive” loans. The latter would more likely fit the description of riba while the former as profit on the trading of capital.

There is a comparable controversy on whether insurance, specifically life insurance, is halal or haram. Islam has its own version of managing risks, Takaful. (mutual aid). Again here it is the duty of its proponents to clearly differentiate their product, especially with respect to safety, security, and rate of returns from traditional insurance so consumers could be better informed and be able to “comparison shop” intelligently.

In such important matters we must go beyond simplistic and legalistic changes of specific words but instead concentrate on deciphering the meanings and intent of such terms.

Indeed Muslim shippers in Spain first started the very concept of takaful or insurance. They would collect levies on each shipper so they would have funds to support the unfortunate shipper who would meet untimely calamity along the way. Of course the concept has since developed a long way from there.

When one traces the development of insurance from a mutual aid society, the ulama can easily understand and readily agree to the concept. I once explained to an alim who vehemently opposed life insurance, the concept of risk sharing. I described a community where when someone dies, the rest of the community would contribute some money to take care of the deceased’s family. He readily agreed to the benefits of such deeds and went on to quote eloquently some holy passages to buttress his agreement. Then I suggested that instead of collecting the money only when someone dies, we would collect it regularly and put that cash in a pool ready to be distributed at the time of need, that is, the death of a member. Again, he readily concurred.

Then I moved on and suggested that instead of giving the same amount of money for each family, we use our judgment and give more to those who die leaving behind young children as opposed to those whose children have grown up. Again, he readily agreed to the rationale that the expenses of a family with dependent children would certainly be greater and therefore they should get more. Then I made the leap forward by suggesting that instead of us or the village committee deciding how much money the deceased family would get, we let individual members decide how much to leave to their family when they die. Surely the individual is the best judge on the needs of his or her family. Those who want to leave more would of course have to contribute more; those who want to leave less would contribute less. Again he saw no problem with that. Then I surprised him by saying that is in essence the concept of life insurance. You decide how much your family would get when you die and you make your contributions (that is, pay your premiums) accordingly.

Today, life insurance is much more complex as other risk factors like age and family history are considered. And instead of a village committee we have a team of professional actuaries who assess and price risks as well as invest the premiums. But cut to its core, life insurance is essentially a commercialized mutual aid society. The money contributed (premiums), instead of being left underneath the village headman’s mattress, is being invested and thus further contributes directly to the economy.

The ulama’s prohibition on insurance, specifically life insurance, is simply based on their lack of understanding of the concept of risk sharing. They have this simplistic notion of life insurance as a bounty to invite some mischief on the part of the beneficiary in order to collect the cash. Well, such a scheme is a crime. One would be punished right here in this world for fraud and murder.

Life insurance, like other forms of insurances, is merely a form of mutual sharing of risks. Nothing prevents a community, co-operative, or a “mutual” company from offering such investments. Indeed such co-ops and mutual insurance companies are among the biggest issuers of insurances in America. The Mormon Church has a similar insurance-like scheme by levying charges (tithes) on its members to take care of the sick and disabled amongst them.

Next: Educating Ulamas on Modern Economics