An Introduction to Islamic Finance

Tarek El Diwany

SOAS

15 November 2013

Purpose and Values

What is our purpose?

What is the correct measure of value?

To whom are we accountable?

What are the implications for business and finance?

Purpose and Values

“In 1987, in the midst of a bitter two-month strike in Mexico, Ford

Motor Company tore up its union contract, fired 3,400 workers, and

cut wages by 45 percent. When the workers rallied around dissident

labour leaders, gunmen hired by the official government-dominated

union shot workers at random in the factory.”

Source: Korten, D., When Corporations Rule the World, 2nd ed.

The Islamic Contractual Framework

Wealth Creation Wealth Transfer

For

personal gain

Trade

Investment partnership

Waged labour

Theft

Usury

Gambling

Not for

personal gain

Community work

Caring

Educating one’s family

Gift

Endowment

Interest-free loan

Some Shariah Rulings on Financial Transactions

Prohibitions based law

Underlying assets not in conflict with objectives of shariah

Theft

Usury (riba)

Uncertainty/deception (gharar)

Double deferment

Manipulation of uninformed market participants

Combination of contracts

Payment of wealth levy (zakah)

DEVELOPER HOME BUYER

£100,000 cash price

A Cash Sale

immediate

transfer of title

DEVELOPER HOME BUYER

£150,000 in instalments over 10 yrs.

Instalment Sale

immediate

transfer of title

DEVELOPER HOME BUYER

£150,000 in instalment

payments over 10 yrs.

Murābahah

immediate

transfer of title

FINANCE

COMPANY

£100,000 initial

promise

to buy

immediate

transfer of title

HOME BUYER

Ijārah

promises

to buy/sell

£50,000 in rentals +

final purchase at £100,000

transfer of title

at end of rental

DEVELOPER

FINANCE

COMPANY

£100,000 immediate

transfer of title

FINANCE

COMPANY

HOME BUYER

PARTNERSHIP

£80,000 £20,000

£100,000

Rent

Diminishing Partnership

DEVELOPER

Economic Perspectives on Interest

Interest as the price of money

Interest as a rent on money

“Interesse”

Damnum emergens, lucrum cessans

Abstinence

Waiting

Opportunity cost

Time preference

100 (invested)

2 (insurance premium)

7 (sale of profit)

100 (repayment)

Financier Businessman

The Triple Contract

A Short History of Commercial Banking

A Short History of Commercial Banking

Cheques and Accounts

BANK

PERSON A PERSON B

cash £10 £ 10 equity

BANK

PERSON A PERSON B

£100 money

cash £10

loan £ 100

£ 10 equity

Cheques and Accounts

BANK

PERSON A PERSON B

£60 money

cash £10

loan £ 60

£ 10 equity

Cheques and Accounts

UK Home Prices and Lending (% annual change)

-20

-10

0

10

20

30

40

50

1971

1975

1979

1983

1987

1991

1995

1999

2003

2007

2011

% annual change

house price change

adjusted net change in lending

Turkey CPI and M2 (% annual change)

0

50

100

150

200

250

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

% annual c

hange

m2 change %

cpi change %

Leverage

1. Start with £100 of your own capital

2. Borrow £900 for one year at 10% interest

3. Buy property for £1000

4. After one year sell property for £1100

5. Repay loan at £990

6. By what % did the property price rise?

7. What was your % rate of profit?

Rokakis on Lending

According to Jim Rokakis, the County Treasurer for Cleveland's

Cuyahoga County, "Wall Street strategies that made the cycle of no-

money-down, no-questions-asked lending possible have sucked the

life out of my city".

BBC, 5 November 2007

(http://newsvote.bbc.co.uk/1/hi/business/7070935.stm)

A “Bradbury” Treasury Note

Edison on Usury

“If our nation can issue a dollar bond, it can issue a dollar bill. The

element that makes the bond good makes the bill good … It is absurd

to say that our country can issue $30,000,000 in bonds and not

$30,000,000 in currency. Both are promises to pay; but one promise

fattens the usurer, and the other helps the people.

Thomas Edison, quoted in The New York Times, December 6, 1921

Sources: a Gold As A Store of Value, World Gold Council,

Research Study No. 22, November 1998; b Economist 1995

Purchasing power index Av. Annual change

Gold a + 0.16%

£ b - 4.06%

Purchasing Power of Gold Versus £ Sterling

Cost of Bank Bail-outs as % of GNP

Sources: B. Lietaer from The Economist 27/9/2008, Working Papers no.1620 World Bank 1996

Country % of initial GNP

Sweden 1992-96 3.6

Spain 1977-85 16.8

Venezuela 1994-5 18

Mexico 1994 19.3

Japan 1997 24

Chile 1981-83 41.2

Thailand 1997-2000 45

Malaysia 1997-2000 45

Argentina 1980-82 55.3

South Korea 1997-2000 60

Global financial crisis 2007 – 2013 ?