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James Simon Watkins

Islamic Finance and

Global Capitalism
An Alternative to
the Market Economy
Islamic Finance and Global Capitalism
 James Simon Watkins

Islamic Finance
and Global Capitalism
An Alternative to the Market Economy
James Simon Watkins
Regent’s University London
London, UK

ISBN 978-3-030-59839-6 ISBN 978-3-030-59840-2 (eBook)

https://doi.org/10.1007/978-3-030-59840-2

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer
Nature Switzerland AG 2020
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Publisher, whether the whole or part of the material is concerned, specifically the rights
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tion in this book are believed to be true and accurate at the date of publication. Neither
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Dedicated to Rachelle Delarosa—my wonderful mother, singer, poet and
thinker who did so much to inspire me, who did so much to support others
and who was so happy for me that I was writing this book—Thank you
 Preface

As I write, the global economy is in lockdown—as am I.

Typing this preface at home under UK Government restrictions, this
book was being prepared at a special time in global history—when the
power of Governments trumped the dominance of the ‘titans’ of global
markets by responding to a series of public health emergencies roiling
across the world.
I am confident that by the time you have picked up this book, we will
be in the recovery room for the global economy.
But what has the early months of the 2020s taught us about political
economy?
Is it really the case that laissez-faire markets are essential for peoples’
well-being or does the COVID-19 outbreak tell us that, when it comes to
the crunch, free trade and market economics are footloose and ephemeral
without the bulwark of nation states?
It could be argued that either of these statements is not contradictory—
that free markets combined with the steadying influence of Governments
conforms with the thinking of Adam Smith and successive economists.
However, the 2020 COVID-19 crisis has led to a debate as to whether
the traditional economic model has led to short-term decision-making
which is against the public good. For example, although we could not
have predicted when the pandemic would occur, the coronavirus threat
had been known for many years. The SARS (2002) and MERS (2012)

vii
viii PREFACE

outbreaks meant public funds were used to help develop a potential coro-
navirus vaccine but this was abandoned by pharmaceutical companies due
to a lack of a guaranteed financial return in the short term.
One of the most striking comments at the start of the decade was from
the Allianz Chief Economic Adviser, Mohamed El-Erian who spoke of the
discord between “Wall Street and Main Street ”:
With markets focusing on the improvement in the “second derivative”,
that is a reduction in the rate of labour force dislocation, U.S. stocks rose.
This widens an already considerable decoupling from the real economy and
will fuel the debates on Wall Street versus Main Street, companies versus
people and the well-off versus the marginalised.1
Advocates of Islamic finance argue that the risk sharing nature of this
model would mean that the disconnect between markets and the real
economy that can occur in conventional finance, cannot practically happen
in Islamic finance.
It is not just COVID-19 that has led to the reappraisal of assumptions
that has belied the Washington Consensus for the workings of the global
economy.
When Margaret Thatcher declared that “there is no alternative” to free
market economics, most commentators in the 1980s and 1990s accepted
this comment as a statement of the obvious.
For the then UK Prime Minister was speaking at a time when commu-
nism was collapsing and free markets were seen not just as an economic
system but as a guarantor of liberty against the collectivist demands of the
State.
However, in the first few decades of the twenty-first century, following
the 2008 global financial crisis and the 2020 coronavirus outbreak, ques-
tions were being asked as to whether there is an alternative to business as
usual.
Consequently, the proponents of a stronger role for nation states
in national economies cite the 2008 financial crisis to argue for a
more enhanced economic role for the State whilst laissez-faire advo-
cates can revert to Adam Smith’s infamous ‘invisible hand’ to rebut such
arguments.
But is there an economic system that enables a market economy to
be effective whilst protecting the long-term interests of Governments,
regulators and consumers?
Could Islamic finance really be seen as that alternative?
 PREFACE ix

Islamic finance has a rich structure and robust set of values which,
at first glance, seems almost utopian. It embraces the profit motive but
prohibits investment in sectors that are deemed unethical such as selling
arms and gambling.
It encourages long-term investment but prohibits short selling
(borrowing shares of a company from an existing owner through her/his
brokerage, selling those borrowed shares at the current market price and
pocketing the cash).
It focuses on returns to investors from the success of the business but
rules out returns that are based on interest.
In short, Islamic finance is a fundamental challenge to business as usual.
It embraces the positive nature of investing for long-term growth whilst
stopping businesses being obliged to pay interest-based loans that may
have no bearing on the current performance of the company.
There is also no conflict between ethics and enhancing profits as can be
seen with conventional finance. In addition, Islamic finance is structured
in such a way that it encourages long-term investment rather than making
money at the potential strategic expense of a company or a nation.
On the surface, this utopian system of ethical capitalism also seems to
be highly profitable. The industry’s total worth was estimated to be US$
2.05 trillion in 2017. Global Sukuk (Islamic finance bonds) surged by a
record 25.6% to close at US$399.9 billion as of 2017.2
Islamic finance is now visible across the world. From the Persian Gulf
to Malaysia and from London to New York to Tokyo, Islamic finance is
now a key feature of the global economy.
However, is Islamic finance as utopian in practice as it is in theory?
This book will examine the highs and lows of Islamic finance. Whilst
this model can be structured for long-term investment, in a number of
markets the sector is largely focused on short-term financing. Why is this
and are there inherent weaknesses in broadening the scope of Islamic
finance to meet all of a nation’s needs?
The richness of Islamic finance with its differences in contract struc-
tures is seen by its critics as a complex maze that could lead, eventually, to
an Islamic finance bust. Other critics argue that Islamic finance is based
on a false premise and is a ruse to pursue an ideological agenda.
Whilst this book takes cognisance of the critics, the structured nature of
Islamic finance—preserving the profit motive whilst avoiding the depreda-
tions of interest-based loans—is a unique form that offers a route through
x PREFACE

the boom and bust economics that all of us have got used to—often with
tragic results for left behind communities.
Islamic finance—as a model of capitalism—has proven to be prof-
itable for investors. There is hardly a bank or a consultancy which is not
involved—in one way or the other—in the sector.
But as the industry grows, can it really offer an alternative to conven-
tional finance?
The answers may surprise you—for by the time you finish reading this
book—you may question whether Margaret Thatcher’s dictum that “there
is no alternative” really does hold true for the 2020s.

Birmingham, UK James Simon Watkins

May 2020

Notes
1. Mohamed Al-Erin (7 May 2020), The Market Keeps Distancing Itself from
the Economy, Bloomberg website.
2. Global Islamic Finance Market—Growth, Trends, and Forecast (2018–
2024), (July 2019) Mordor Intelligence.
 Contents

1 Introduction: Is There an Alternative? 1

2 The Emergence of Islamic Finance 11

Formation of the Faith 12
The Prophet and the Emergence of Islamic Economics 13
The Emergence of Tax Policy 17
Risk Sharing and the Concept of Interest Rates 19
Sunni/Shi’a Divide 21
Schools of Islamic Jurisprudence 24

3 In the Beginning … 33
The Role of Money 35
Religion and Interest Rates 38
Interest Rates: The Economic Arguments 40
Islam and Riba 42
Avoiding Detriment 45
Avoidance of Gharar (Unnecessary Uncertainty
or Ambiguity) 46
Prohibition of Gambling (Qimar) 49
Prohibition on Speculation (Maysir) 50

4 The Beauty of Islamic Finance Contracts 55

Liquidity Financing and Conventional Banking 60

xi
xii CONTENTS

Murabaha and Tawarruq Explained 62

Ijara: The Islamic Mortgages Market 68
Salam 71
The Forex Dilemma 72
Istisn’a: Long-Term Project Financing 74
Profit Sharing and Patient Finance: The Islamic Finance
Offer 80
Mudaraba 82
Musharaka 87
Diminishing Musharaka 89
Bai Bithaman Ajil 90
Sukuks and Conventional Bonds 91
Mudaraba Sukuk 94
Musharaka Sukuk 94
Ijara Sukuk 94
Salam Sukuk 95
Istisn’a Sukuk 96
The Scope of the Global Sukuk Market 97
Islamic Derivatives 99
Contentious Developments During the 2000s 101
Shari’a Compliant Derivative Products
and the International Islamic Financial Market 102
Personal Finance 105
Service Ijarah 106
Murabaha Line of Credit 107
Murabaha/Service Ijarah Credit Card 107
Shari’a Compliant Pawnbroking and Conventional
Pawnbroking: Is There a Difference? 108

5 Compliance 115
Is Interest Really Banned in Practice? 116
Bank of Credit and Commerce International (BCCI)
and Egyptian Islamic Finance Scandals 121
Role of Religious Scholars 123
Usmani and Sukuks 124
Religious Scholars: Will There Need to Be Greater
Accountability? 129
Multilateral Institutions 136
OIC’s Fiqh Academy 137
 CONTENTS xiii

Accounting and Auditing Organisation for Islamic

Financial Organisations (AAOIFI) 138
Islamic Financial Services Board (IFSB) 139
The Future of the Multilateral Organisations 140
Dow Jones Islamic Markets Index 141
From CSR to ESG: The Challenge for Islamic Finance 145

6 Faith and Capitalism 157

The Role of Faith in Economic Thought 157
Vice-Regency (khalifah): The Islamic Perspective
of the Position of Humanity 164
Islamic Finance: Faith and Its Critics 169
Faith and Conventional Finance 177
Arguments Against Faith 181
Religion and the Economy 189
Religion, Party Politics and the Economy 193
Maqasid al-Shari’a 197
Maqasid al-Shari’a and Maslaha 199
Maqasid al-Shari’a and the Future of the Islamic Finance
Industry 201

7 Ethical and Business Finance 207

Venture Capital and Islamic Finance 207
Comparative Analysis: Strengths of the Venture Capital
Market 210
Comparative Analysis: Deficiencies of the Venture Capital
Market 213
Healthcare and the Potential Role of Islamic Finance 214
Climate Change: Potential Opportunities for Islamic
Finance 218
The Potential for Shari’a Compliant Emissions Trading 222
Environmental Goals 224
Islamic Microfinance: Models for Growth 227
Indonesia: Baitul Maal Wat Tamwil 231
Microfinance: The Role of the Islamic Development Bank 235
Microfinance and Self-Sufficiency 238
Microfinance and Developed Countries 240
Social Impact Bonds 242
xiv CONTENTS

Mezzanine Finance and Islamic Finance: A Comparative

Analysis 243
Crowdfunding and Islamic Finance 244
Impact Investing: Is Islamic Finance Being Ignored? 245
Family Offices and Islamic Finance 247
CSR Law in India: What Are the Implications for Islamic
Economics? 247
Islamic Finance: What Is Holding the Industry Back? 249

8 Can There Be an Islamic Monetary Policy? 257

Speculation and Interest Rates 257
Do Interest Rates Reflect the Real Economy? 262
Islamic Economics: Lessons from the Wall Street Crash 266
Karl Marx and Interest Rates 269
Milton Friedman 272
Arthur Pigou 274
John Maynard Keynes 275
Gold Standard—Can It Really Work? 276
Gold: Early Islamic History 278
Gold: The Lessons from the 1930s 281
Gold Dinar: Can It Work? 283
Mahathir, Keynes and the Gold Standard: Could It Work? 288
Is There a Role for an Islamic Cryptocurrency? 291
Is There a Future for an Islamic Monetary Policy? 295
Indonesia: An Islamic Trade Policy? 296

9 Varieties of Capitalism and Islamic Finance:

A Comparative Study 305
Islamic Finance, Socialism and the Profit Motive 305
Nineteenth-Century British Capitalism and the Work
Ethic in Islamic Finance 312
Varieties of Capitalism 317
Islamic Finance and East Asian Developmental Capitalism 322
1997Asian Financial Crisis and Its Implications
for Islamic Finance 327
Varieties of Capitalism Case Study: Kazakhstan
and Islamic Finance 332
Utopian Visions and Mutualism 335
 CONTENTS xv

Takaful: Islamic Insurance and the Principle

of Cooperative Economics 338
Cooperative Economics: Lessons for the Islamic Finance
Industry? 343
Doughnut Economics, the Circular Economy and Islamic
Finance 349

10 Islamic Economics and Political Economy 361

The Emergence of the Islamic Finance Industry
in the Twentieth Century 361
From Partition to the Political Economy of Pakistan 364
Saudi Arabia and the Religious Drive for Islamic Finance 372
United Arab Emirates and the Gulf States: Crossing
the Finishing Line 393
Iran 403
Malaysia and the Heart of the Global Economy 426
Sudan 438
The Russian Orthodox Church and Islamic Finance 445
Egypt 449
Lebanon 453
Republic of Ireland and the United Kingdom 457
Political Economy and Islamic Finance 462

11 Branding and Islamophobia 473

1990s and 9/11: Islamophobia 473
Islamophobia and the Islamic Finance Industry 478
European Court of Human Rights: Has the Court
Misunderstood Shari’a Law? 482
Turkey: Branding and domestic politics 486
France—Is Prejudice Hindering the Growth of the Domestic
Islamic Finance Industry? 489
Qatar Central Bank and the Islamic Finance Industry 494
Branding and the Future of the Islamic Finance Industry 496

12 The Future of Islamic Finance 501

xvi CONTENTS

A Brief Literature Review 513

Index 517
 List of Arabic Terms and List of
Acronyms

Common era (CE) chronology will be used throughout this book instead
of Anno Hegirae (in the year of the Hijra—AH) chronology unless
otherwise stated.
There are some Arabic terms that are used repeatedly throughout the
book.
For ease of reference these terms are:
Allah—God
Fatwa—Ruling or judgement
Fiqh—Islamic jurisprudence
Gharar—Uncertainty
Hadith—Sayings of the Prophet
Hajj—One of the five pillars of Islam with the pilgrimage to Mecca and
its environs
Halal—Allowed
Haram—Forbidden
Istisn’a—Long-term project finance contract
Ijara—Financial and operational lease contract
Ijtihad—Reasoning
Ijma—Consensus
Maqasid al shari’a—Objectives of shari’a law
Maysir—Speculation
Mudaraba—Direct equity investment contract. Losses borne by one party
to the contract

xvii
xviii LIST OF ARABIC TERMS AND LIST OF ACRONYMS

Musharaka—Direct equity investment contract. Losses borne by all parties

to the contract
Sunnah—Customs and practices of the Muslim community which has
been codified
Qimar—Gambling
Qiyas—Analogy
Qur’ran—Holy Book of Islam; revelation as communicated from God to
the Prophet
Riba—This term primarily relates to interest payments
Salam—Short-term finance forward (non-tradeable)
Shari’a—Framework of Islamic law
Sukuk—Islamic finance bond
Takaful—Islamic insurance
Ulama—Muslim scholars who have specialist knowledge of shari’a law and
theology
Ummah—Muslim community
Wakala—Agency (as in an agency contract)
Zakat—One of the five pillars of Islam with part of an individual Muslim’s
discretionary spend being allocated for charitable purposes
Some acronyms are also used repeatedly. These are:
AAOIFI—Accounting and Auditing Organisation for Islamic Financial
Institutions
ASEAN—Association of South East Asian Nations
GCC—Gulf Cooperation Council
IFIs—Islamic Financial Institutions
IFSB—Islamic Financial Standards Board
IRTI—Islamic Research and Training Institute (part of the IsDB)
IsDB—Islamic Development Bank
OIC—Organisation for Islamic Co-operation
UAE—United Arab Emirates
 List of Figures

Fig. 4.1 Islamic finance contracts 60

Fig. 4.2 Murabaha 64
Fig. 4.3 Ijara 70
Fig. 4.4 Parallel Istisn’a 78
Fig. 4.5 Two Tier Mudaraba 84
Fig. 7.1 Wakaful microfinance model 231
Fig. 8.1 Business cycle 263
Fig. 8.2 Business cycles as shifts in aggregate demand: Recession 263
Fig. 8.3 Business cycles as shifts in AD: Economic boom 264

xix
 CHAPTER 1

Introduction: Is There an Alternative?

There is no alternative.

As the shock of the 2008 global financial crisis reverberated across conti-
nents, pundits stubbornly argued that the excesses of capitalism were
something we all had to grin and bear.
Whether it was the seventeenth-century craze for tulip bulbs or the
2001 dot com bubble, finance ministers through to brokers patiently
explained to shocked consumers that capitalism’s many upsides do come
with occasional downside risks.
Even respected observers of the global markets—years after the 2008
financial crisis—felt that it was all too complicated to change how global
capitalism works, including in the world’s number one economy:

Does the United States really know how to build a financial system that is
the servant, not the master, of the economy? Sadly, the answer is probably
no; at present it is hard to imagine what this would even look like.1

The immediate responses, during the 2020 coronavirus crisis, as to the

future of capitalism was far more mixed. Mariana Mazzucato argued that
the 2020 crisis meant capitalism as we know it had to change:

We desperately need entrepreneurial states that will invest more in inno-

vation – from artificial intelligence to public health to renewables. But as

© The Author(s), under exclusive license to Springer Nature 1

Switzerland AG 2020
J. S. Watkins, Islamic Finance and Global Capitalism,
https://doi.org/10.1007/978-3-030-59840-2_1
2 J. S. WATKINS

this crisis reminds us, we also need states that know how to negotiate, so
that the benefits of public investment return to the public.2

Other commentators saw the impact on capitalism from the 2020 crisis
very differently. Allister Heath argued, instead, that a more laissez-faire
approach to the economy will have to be adopted once the crisis was
over:

Hurting the rich for populist reasons is something that governments can
afford to do in the good years, not when they are desperate to attract
entrepreneurs, capital and talent.3

The well-rehearsed left/right paradigm as to the future of capitalism is

playing itself out again.
However, there is an economic model that does not fit neatly within
this dynamic and which may contain important lessons for the future of
the global economy.
For there was one financial services sector that continued to grow
through the 2008 financial crisis and beyond—Islamic finance. The sector
had double digit growth during the crisis achieving a compound annual
growth rate of 16.94% between 2009 to 2013.4
How was this possible?
The answer is that the very restrictions which govern the space in which
Islamic finance operates within also help guide the sector’s success.
Monem Salam from the shari’a compliant investment firm, Saturna
Capital, has argued that as it is forbidden to invest in key sectors such as
conventional banking and gambling as well as avoiding investing in over-
leveraged companies, the sector weathered the 2008 economic storm.
Salam has argued that the Islamic finance industry is also performing well,
as compared to conventional finance, during the 2020 COVID-19 crisis,
for the very same reasons.5
But many free market thinkers did not take on board the strength
of Islamic finance. Instead the focus has been on conventional forms of
capitalism. Had not the race to economic and social recovery from the
devastation of the Second World War through the Cold War and up to
the final collapse of the Soviet Union clearly demonstrated the sclerotic
growth of Communist states as compared to the dynamism of Western
capitalist countries?
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