Transcript Video Conference with IEG IFC A Short Introduction to IF

Introduction
to Islamic Finance
Sami Al-Suwailem
IRTI, IDB
Thul-Qida 1430H –November 2009
Pillars of Islamic Finance
Non-profit Domain
For-profit Domain
 For-profit domain
 Non-profit domain
 A balanced approach
For-profit
Non-profit
Motives
Self-interest
Altruism
Objective
Productivity
Fairness
Creation
Distribution
Relationship
Competition
Cooperation
Regulation
Prohibitions
Obligations
Wealth impact
Like a bird, an economy needs the two
sectors to fly
 Brotherhood replaces both individualism
and communism
 Brothers are similar enough to promote
sympathy and cooperation
 But they are different enough to allow for
specialization and trade
 Brotherhood encompasses both domains
 Zakat
 Nafaqat
 Inheritance law
 Sharing in times of necessity, starvation, or
hardship
 Obligatory donation
 Applies to idle money (not used for one
year)
 Measure against hoarding
 Hoarding and the current financial crisis?
 Obligatory spending for designated relatives
 Parents, family, close relatives
 Subject to need
 Coordination
 Civil standards
 “Tragedy of the commons”
 “The whole is greater than the sum”
 Safety net
 Less moral hazard than government net
 Preservation of wealth
 Happiness cannot be achieved by one
domain
 Balance allows both to flourish and thrive
 Prohibition of israf
 Prohibition of usury or riba
 Prohibition of gharar or wagering
 Over-spending or over-utilization of
resources
 In consumption:
 extravagant spending
 Conspicuous consumption and status games
 In investment:
 Greed—“Irrational exuberance”
 Bubbles => crashes
 Wealth preservation is an essential objective
of Shari’ah
 Israf violates preservation of wealth
 Results: pollution, global warming,
depletion of resources
 Essence of economics is to avoid israf
 Riba or usury: any stipulated addition over a
loan
 Includes both simple and compound
interest
 Prohibited by all divine religions as well as
Buddhism
 Two-thirds of world population subscribe to
this belief
 Debt grows faster than wealth
 Debt cannot be paid except with new debt
 Debt burden destroys the economy
1000
1,546,318,920,731,950,000,000
1500
60,806,303,788,323,700,000,000,000,000,000
2000
2,391,102,204,613,620,000,000,000,000,000,000,000,000,000
1 pence borrowed
at 4% in 1 AD
In 1750 debt equals weight
of the globe of gold
In 1990 it equals 8190 globes!
 Average growth annual rate:
 Debt: 39%,
 GDP: 21%,
 M2: 19%
 Debt-GDP ratio: 1.3 to 2.2
 Debt-M2 ratio: 2.2 to 4.2
Debt
Wealth
 Inverted pyramid is not sustainable
 Crashes needed to “clean up” the system
 Then debts start to accumulate again faster
than wealth
 Recurrent crashes
 Very costly to maintain the system
 Theory: Intertemporal Budget Constraint:
 The present value of debt go to zero
 Prevents Ponzi financing
 Reality: E.U. requirements:
 Deficit < 3% of GDP
 Debt < 60% of GDP
 Problem: Need to govern debt from the
ground-up
 Debt creation is integrated with wealth
creation
 For-profit debt must be contractually
embedded in real transactions
 Islamic modes of finance:
 Deferred sale; salam; leasing;
 Sale of a good for a deferred price
 Price includes markup
 Time value is paired with real value
 Murabaha: Financing deferred sale
 Opposite of deferred sale
 Price is spot; good is deferred
 Time-value is reflected in lower price
Trade
Loan
Exchange different items
Exchange identical items
Gains from trade
No gains from trade
Creates wealth
Cannot create wealth
 Similarity negates gain from trade
 Variety allows mutual benefit
 Diversity is essential for prosperity
 Stronger similarity imposes stronger
restrictions of exchange
 Riba: imbalanced exchange of similars
Loan
Trade
Low
High value
Low restrictions
Similarity
High
Low value
High restrictions
Debt
Wealth
 Creditor must forbear if debtor is in
difficulty
 Why forbearance is important for stability?
 Foreclosure causes prices to fall
 Which leads to additional defaults
 Which leads to more foreclosures
 Which makes prices go even lower
 And so forth
Unregulated
credit expansion
Regulated credit
expansion
Forbearance enacted
No forbearance
 Universal principles
 Sound economic reasoning
 Balanced approach