Islamic Finance: Protects Humanity and Preserves its Morals

Islamic Finance: Protects Humanity and Preserves its Morals

May 11, 2023 0 By Michel Santi

The first “Sharia-compliant” obligation dates back to the Ottoman Empire in 1775. In 2004, Germans were the first Europeans to issue a “sukuk,” an Islamic bond that attracted investors from the Gulf, Saudi Arabia, Malaysia, the United States, Japan, and Hong Kong. This instrument was specifically an “ijarah,” a vehicle that aimed to collect rents and income from assets, mainly of an immovable nature. As interest payments are prohibited according to Sharia, sukuk holders receive a return proportional to the rents, knowing that the entire contract is resold at maturity to return investors’ initial investment.

The great specificity of a sukuk is that it must be imperatively correlated to an underlying income-generating asset. These have been used to finance numerous projects related to real estate, infrastructure, and renewable energy. For example, in 2014, Saudi company ACWA Power issued a $814 million sukuk to finance the construction of a solar thermal power plant in Morocco. In 2018, the Islamic Development Bank launched a program to finance projects related to the United Nations’ Sustainable Development Goals (SDGs). This program aims to encourage investment in sectors such as renewable energy, health, education, and infrastructure to contribute to the SDGs and promote sustainable and responsible development.

Another concrete application of Islamic finance is musharakah, a partnership contract that allows for project financing by sharing profits and losses. Thus, investors share the risk with the company, thereby encouraging prudent and responsible management of funded projects. This financing method is often used for SMEs that need funds to grow but cannot bear the high financial risks of traditional loans.

In Malaysia, a pioneer country in the development of Islamic finance, the concept of takaful was put in place, which is a Sharia-compliant insurance system based on the principle of cooperation and solidarity among members. Unlike traditional insurance, where premiums are considered payment for a service, members pay contributions within the framework of takaful to contribute to a common fund to help those affiliated who suffer financial losses. This system allows for risk-sharing and encourages responsibility and solidarity among members.

Therefore, Islamic bonds are essential to financial stability. In the presence of such rules, it is impossible to contract debts that are not linked, amortized, or at least partially balanced by future income. Would respecting this principle alone not have prevented the excessive indebtedness of many of our Western nations? Additionally, would not morality have been saved with products like “musharakah” or “mudarabah,” which allow for the collection of profits while at the same time requiring participants to share any potential losses? We immediately think of Western banks and their shareholders who were rescued by taxpayers’ money without suffering any adverse consequences. This socialization of losses that we experience daily does not exist in Islamic finance, where the only potential losers are always those who have accepted the risk.

We also think of our peripheral European states – such as Spain and Ireland – who, having spent without counting to save their financial institutions, subjected their youth to a unemployment rate exceeding 50% at the height of the sovereign debt crisis, thanks to austerity imposed by financial markets, too happy to regularly call on taxpayers to absorb their losses. Finally, to countries like Greece, which had to sell off its strategic assets for having succumbed to predators like Goldman Sachs, which cleverly manipulated its public accounts.

In this world of Islamic finance, as money is considered for what it really is – a simple means of payment – the degree of risk that investors are willing to assume is significantly reduced. Assets and goods that do not exist at the time of contract initiation simply cannot be sold in anticipation! Money is therefore always and in all circumstances linked to the real economy. This simple principle fundamentally discourages speculation, ruling out any derivative product whose very essence is to deal with phantom assets. It is the subprime crisis and the European sovereign debt crisis that could have been spared, and the exacerbated volatility of financial markets, commodities, and foodstuffs that would have been significantly reduced if our West had drawn some inspiration from the spirit of Islamic finance.

Although it currently accounts for only about 5% of assets traded globally, Islamic finance is nonetheless developing at a pace 50% faster than other traditional banking products. Sharia-compliant instruments – currently worth $3 trillion – are beginning to attract non-Muslim investors attracted by the security and low volatility provided by these investments. Non-Muslim investors even hold 85% of Islamic bonds in a country like Malaysia! Finance accessible to all and products whose understanding is within everyone’s reach: that is what Islamic finance can bring today to a decadent and self-important Western finance.

Because money and finance are just a means, not the ultimate goal.