Is IB Islamic?

Three Ground of Conflict between claims and aspirations of Islamic Banking and the reality of current Islamic Banking Models

1. Initiators of the movement for IB argued that capitalism has many defects: It concentrates wealth in the hands of the wealthy, and exploits the poor, and leads to highly unjust economic outcomes. The wealthy make excessive money, while the poor must struggle. This is confirmed by Piketty, who shows that the return to savings/wealth for wealthy is HIGHER than the return for the poor, which leads to ever increasing income inequality in capitalism.

Islamic Banks were suppose to overcome this problem. Unfortunately, current Islamic banks perform exactly the same functions as capitalist banks and therefore lead to exactly the same outcomes. This promise of economic justice was not fulfilled and cannot be fulfilled under current models of Islamic Banking

2. The spirit of Capitalism is the pursuit of wealth for its own sake -- a highly un-Islamic concept. In Islam, we can seek wealth, but ONLY for a shari'ah valid purpose -- which have been specified in detail. The spirit of Islam is generosity -- those who have fulfilled their own needs are encouraged to look after others rather than save for their own potential future needs. If this cooperation takes place, then there are many positive externalities which create goodwill cooperation and brotherhood in the society. The BANK is an INSTITUTION which gives a concrete shape to this will to save -- A book called "The idea of usury: From tribal brotherhood to universal otherhood' explains how charging money to give loans to someone in need is a hostile act which disrupts brotherhood and community -- and is also contrary to islamic norms of generosity, and being helpful to thers in need. This Islamic spirit is captured by the institution of WAQF, which was the central financial institution where Muslims placed money in excess of their needs during the thousand plus years of dominance of the Islamic Civilization. This opposition between the spirit of Islam and the spirit of Capitalism is captured in my paper on "Building Genuine Islamic Financial Institutions".

3. Initiators of Islamic Banking recognized that current methodology was a compromise -- Cooperative models based on Musharka would be ideal forms. They argued that let us start with imperfect forms, and we will gradually move towards more Islamic forms. However, after the initial start, most of the movement has been in the reverse direction -- instead of becoming more Islamic, Islamic banking has become more and more westernized and more indistinguishable from Western banking. This point has been made effectively by Volker Nienhaus, among others.

4. The problem of money creation by private banks has not been recognized or understood by those who have introduced Islamic Banking. This is a delicate and difficult and hard to handle problem. Difficulties cause by this private money creation led to the Global Financial Crisis. Benes, J., & Kumhof, M. (2012). The Chicago Plan revisited. International Monetary Fund Working Paper, WP 12/202. have outlined the problems created by private money creation and spelled out a solution in terms of the Chicago Plan. Islamic Banks need to offer an alternative to the Chicago Plan which takes care of these same problems. I have provided an outline of how this might be done in my paper called: An Islamic Version of Iceland Plan for Monetary Reform: (available from SSRN: )

THE SECOND PART OF THE PAPER PROVIDES AN ALTERNATIVE MODEL of Islamic Banking which is radically different from existing forms and RESOLVES the problems and difficulties raised in the first part.

The first main concept of the alternative is that Islamic Banks should be focused on providing services, with money deposits and loans being an intermediate function, and not the primary purpose of the institution. One such institution is Tabang Haji. The main purpose of the institution is to provide services for Hajj -- it also accepts deposits and can provide loans to facilitate Hajj. Similarly, one can think of Housing Cooperatives which would provide housing to general population. They would also accept deposits and could purchase houses on behalf of member and then transfer ownership on easy terms -- alternatively, the housing society could retain ownership, and simply provide long term leases which would take care of housing. This would be a genuine alternative to mortgage based loans for individual ownership, suitable for an individualistic society -- Our model would pormote community and cooperation.

The second main concept is that Islamic banks should be community based cooperative banks -- justs like the FIRST Islamic Bank Mit Ghamr, which took inspiration from German models of community banking, which still exist. Economist Richard Werner has discussed the benefits of community banks as opposed to large corporate banks which are exploitative by their very nature, creating credit and charging interest to prey on consumer temptations.

The third main concept is controlling the private creation of money. The Sovereign Money model of Iceland Plan and Chicago Plan gives the power of money creation to state. This creates the dilemma that polticians may abuse this power and cause huge damage to the economy by de-stablizing the value of money. Genuine Islamic Banking provides a new alternative by providing this power of creation of credit to community banks, which can provide service to their communities under regulation by the State Bank which would be able to provide strict guidlines to ensure that credit creation takes place in the right amount to provide for stable full employment without inflation.

Indeed, this is an excellent outline. I would appreciate some remarks regarding the future directions of Islamic Banking towards or away from the alternative (true to the spirit of Islam)Islamic Banking to be presented in Prof. Zaman's paper.

Haider A. Khan, John Evans Distinguished University Professor

Distinguished Senior Fellow, Policy Research Institute