Managing My Finance the Islamic Way
Managing my finance the conventional way has been my main, or perhaps the only method to handle my money. But as I grow up and start to be concerned about the global economy, I have found out that Islamic finance is likely to be my main financing tool in upcoming future. Before I voice out my future financial planning in Islamic way, let’s look at the big picture of the present financial world first. With that, we may be able to get a glimpse on how and why Islamic finance may reign supreme in future.
The most powerful destabilising factor of all in modern markets is the activity of money creation by the banking system. By creating money out of nothing and lending it into circulation, central banks and commercial banks have together caused a succession of speculative bubbles that can be traced back more than three hundred years in the western world. When newly created money is spent on assets such as property and shares, their prices naturally tend to rise. Conversely, when banks reduce the rate of money creation, buyers disappear from markets and prices begin to fall. The ability to create money is therefore a hugely powerful political and economic tool, and one that is almost always abused in due course.[1] Most of these disordered and unstable economic scenarios occur due to the fragile and unsustainable model of conventional interest-based banking system.
Interest-based banking system is in fact the born child of capitalism. The capitalist system has allowed a free hand to the capitalist countries and within them the firms and individuals to maximize their profits with minimal consideration of the human aspects, norms and ethics. Capitalism does not monopolize all resources directly but through several diversified media with different levels and distribution controls, like a master-slave set up. Due to strong political and institutional support at international level, effectively giving veto to big powers over the activities of the IMF and the World Bank, capitalism has taken a longer time cycle, but as all limits have been crossed, it could at any time lead to collapse, inflicting heavy loss on the global economy. Current financial crisis has been one of the big signs regarding that.
The way the interest-based banking system operates has led to great financial instability. This interest-based banking system which creates conventional debt is a major hurdle in achieving distributive justice. It is creating unrepayable debt, which in return making a class of people richer and leaving others poorer and oppressed. Excessive debt and its servicing are the striking features of the interest-based mechanism: yesterday’s debt can be repaid by taking out more debt today. It is stifling, and even crippling the efforts made by the World Bank, IMF and other donors to reduce poverty in poor countries. It also distorts the payment systems, on account of which just and fair incomes are given the least consideration. No one cares who is going to pay the debt: which future generations and from where? This kind of behaviour to avoid current debt is not acceptable under any divine religion.
Due to this conventional banking system, many countries around the world including both underdeveloped and developed countries have encountered excessive debt accumulation. Even United States of America is incapable of escaping from this problem. On account of the continued and repeated current account deficits of the United States, it has been transformed from a significant international investor in the 1970s to the world’s largest debtor country. As of today, only US nationals are apparently immune from the devastation of debt and that is by dint of the US dollar being the major reserve currency, despite the fact that it has become a zero-saving nation with unparalleled individual, institutional and national debt. Presently, American national debt has passed $9 trillion so far. It would be an unimaginable out-of-control scene if any of the US major creditors like Japan or China decide to call in their debts.
And hereby Islamic finance has come into the picture as an alternative for financing or banking purpose since approximately thirty years ago. The main difference between an Islamic or interest-free banking system and the conventional interest-based banking system is that, under the latter, the interest rate is either fixed in advance or is a simple linear function of some other benchmark rate, whereas, in the former, the profits and losses on a physical investment are shared between the creditor and the borrower according to a formula that reflects their respective levels of participation. Hence, in contrast to the interest-based system which puts the emphasis on receiving the interest payments, the Islamic bank has to focus on the return on the physical investment, because its own profitability is directly linked to the real rate of return. From Islamic perspective, the institution of interest, on the basis of which governments and the public and private sector corporations borrow funds, actually creates parasites in society and thereby the gap between the rich and the poor keeps on widening.
According to the late Yusuf Ali who is the eminent translator of the Holy Quran into English, “whereas legitimate trade or industry increases the prosperity and stability of men and nations, dependence over usury would merely encourage a race of idlers, cruel bloodsuckers and worthless fellows who do not know their own good and therefore are akin to madmen.”[2] It is a ground reality that the interest-based system, irrespective of the rate, is creating ‘idlers’ and ‘cruel bloodsuckers’. In Islamic worldview, justice is the raison d’etre of any economic system that is to be sustainable in the long run, and the major element creating injustice currently is “interest”. Replacing this with risk-related capital and investment mechanism could help solve many socio-economic ills.
The state of affairs in today global economy and glaring inequalities both at inter and intra national levels necessitate the evolution of a system that could lead to a balanced, sustainable and equitable economic order in the world at large. Islamic banking system seems to be an appropriate solution to it though there are still many aspects desired to be improved.
Now let’s proceed to understand the nature of Islamic finance and see how it works generally. An Islamic banking and financial system exists to provide a variety of religiously acceptable financial services to the Muslim communities. Perhaps the religious dimension should be presented as a further explicit goal, in the sense that the opportunity to conduct religiously legitimate financial operations has a value far beyond that of the mode of the financial operation itself. The ultimate goal of this interest-free system is to achieve economic well-being with full employment and a high rate of economic growth, socioeconomic justice and an equitable distribution of wealth, stability in the value of money, and the mobilization of savings for economic development in such a way that a just return is ensured to all parties involved. Then a question is usually posed by laymen including me whose understanding on banking operation has been deeply influenced by conventional banks: if the paying and receiving of interest is prohibited, how do Islamic banks work?
Here profit-and-loss sharing comes in as a method of resource allocation in Islamic banking. Although a large number of different contracts feature in Islamic financing, certain types of transaction which apply the profit-and-loss sharing principle are central, such as trustee finance (mudaraba), equity participation (musharaka) and ‘mark-up’ methods like murabaha, ijara, salam, bai bi-thamin ajil and istisnaa, along with the newly developed sukuk. Besides the injunction against riba (interest), there is also prohibition in Islam of maysir (gambling, speculation) and gharar (unreasonable uncertainty), the need to ensure that investment be undertaken on the basis of halal (permitted) activities, and the requirement to benefit society through the collection of zakat (almsgiving) overseen by a special religious supervisory board.
To make the elaboration of my Islamic financial planning easier and smoother, firstly I have to note that all the financial contracts which I mention later are applicable in this country for being in compliance with the principles of Islamic finance, and the word ‘bank’ would be impliedly understood as Islamic bank in particular. Let’s start from the basic. I would open a Saadiq savings account first at Standard Chartered Bank. It is a very innovative financial product, as it combines two accounts in one: Savings Account-i and Current Account-i. Conceptually, Saadiq Account-i is based on a combination of Islamic concept of al-Wadiah Yad Dhamanah (Safe Custody) and Mudharabah (Profit Sharing). Its special two-way sweep feature automatically transfers funds between our Savings Account-i and Current Account-i, making sure that there are sufficient funds in either account. Briefly, Savings Account-i is based on the Mudharabah principle of profit-sharing that pays dividends while Current Account-i is based on the Al-Wadiah Yad Dhamanah that allows the bank to grant us a discretionary hibah or gift. I also will enjoy up to General Investment Account-i dividend rates on my savings, and cheque-issuing facilities.[3] With this type of flexible savings account in hand, I can let qualified professionals in Islamic finance to manage my money with a hope to expand its value through the principle of Mudharabah, while having no worry to jump into the investment area which knowledge I am not so well-equipped with.
If I have gained sufficient capital, I may consider opening a General Investment Account-i. General Investment Account-i is an investment account based on the Islamic contract of Mudharabah that works on a profit sharing basis. Mudharabah refers to a contract between us and the bank for the investment of our funds where the profit is divided according to a mutually agreed profit sharing ratio. Based on Mudharabah, the bank will invest our money in profitable ventures that are in line with Syariah principles. Whatever profit that is earned will be shared with us, and the best part is, we will always earn the bigger share of the profits with the bank. Furthermore, there is a range of flexible tenure of investment for us to choose, covering from 1 month to 12 months, whichever suit our needs.[4] Hence I do not have to fear that my money may be stuck in an annoyingly longer-term investment, because most of the investment products available in conventional banks require us to devote our money in a period of at least 3 years generally. It suits me better in that sense.
Coming this far, the principle of Mudharabah has been mentioned for quite a few times and a clearer explanation should be provided on that. In both types of the financial tools above, we the investors (rabb al-mal) will deposit an amount of money with the bank, which acts as the entrepreneur (mudarib). This investment is utilized as business capital by the bank. In this contract investors have no authority to interfere in the management of their investment. On the other hand, the bank will have the right to manage their investments as it thinks fit by placing it into businesses that are permissible in Islam, and which it thinks are profitable. Depending on the tenure of our investment, we will be offered a profit sharing ratio which will form the basis of the agreement made between us and the bank. On the date that our investments mature, the bank will distribute our share of accumulated profit into our investment account.
However, the contract of Mudharabah can be interpreted in another way if we intend to apply for Mudharabah financing to pump in capital to our business. As in this type of financing, Mudharabah financing is a form of partnership where the bank will provide the capital and the customer will provide the expertise. Both will agree on a profit sharing ratio. The customer will be solely responsible for running the business, project or contract without interference from the bank. All forms of capital loss, if any, will be borne by the bank and all forms of labour loss, if any, will be borne by the customer. In this context, the bank becomes the rabb al-mal while the customer becomes the mudarib. I plan to utilize this Islamic principle to raise capital to set up a business or even to expand my business in future, particularly if my business exists in the form of Small and Medium Enterprise (SME).
There is another very lucrative option available for entrepreneurs to gain both capital and expertise from the bank at the same time. I will choose Musyarakah financing as my financing tool if I intend to be involved in the financial service sector in future, in order to obtain the bank’s assistance in my operation of business. Musyarakah financing is often perceived to be the preferred Islamic mode of financing, because it adheres most closely to the principle of profit and loss sharing. In a Musyarakah financing arrangement, the bank and the customer will both contribute their capital as well as expertise in a project. Profit and loss will be shared normally based on the capital contribution. In addition, it gives greater flexibility in the allocation of profit, as all partners have the right but not the obligation to participate in the management of the project, which explains why the profit sharing ratio is mutually agreed upon and may be different from the investment in the total capital.
In Islamic finance, there is an ideal way of financing to purchase goods or assets, which is Murabaha financing. In a Murabaha contract, the bank agrees to buy an asset or goods from a third party, and then resells the goods to its client with a mark-up. The client purchases the goods against either immediate or deferred payment. Some observers see this mode of Islamic finance to be very close to a conventional interest-based lending operation. However, a major difference between Murabaha and interest-based lending is that the mark-up in Murabaha is for the services the bank provides (for example, seeking and purchasing the required goods at the best price) and the mark-up is not stipulated in terms of a time period. Thus, if the client fails to make a deferred payment on time, the mark-up does not increase from the agreed price owing to delay. Also the bank owns the goods between the two sales, which means that it carries the associated risks. For me, it is definitely a good choice to purchase goods or assets, especially for young entrepreneurs as they may occasionally face financial stringency that may cause their delay in payment to banks.
Besides, the Biz Current Account-i provided by the Standard Chartered Bank is a Islamic financial tool created to enhance the value of money in one’s company account, along with its flexibility for business purpose. Unlike conventional current accounts which are not allowed to offer any types of returns, SME's Biz Current Account-i offers a unique advantage - a Syariah-compliant way of banking in which the bank is allowed to pay a discretionary 'hibah' or gift (which is the return). It is based on the Islamic law of guaranteed safe-keeping or 'Al Wadiah Yad Dhamanah', whereby the bank acts as the custodian of our funds and guarantees its safekeeping. This arrangement will allow the Bank to place our money in prudent Syariah-compliant investments that are approved by Bank Negara. The returns gained from the investment will then be used to pay us a discretionary 'hibah' or gift.[5] Its main advantage is to give potentially significant returns on our cash where our normal current account doesn't. This type of company account would certainly give me an edge over others in terms of maximizing financial returns.
When I reach the life stage necessary for me to purchase a dream home for my family, I would probably choose Standard Chartered Bank’s JustHome-i package. JustHome-i is designed to remove the concerns of unexpected increases in the Base Lending Rate (BLR).[6] With this home financing, I can enjoy the peace of mind knowing that the fixed ceiling rate ensures my commitments being easily met, because I will be protected from potential rising financial cost in home financing. Again, this Islamic financing facility is based on Syariah principles. Basically, it is founded on the buy-and-sell concept which includes a profit margin agreed by both parties. It would be notable, though rather redundant to emphasize that this is an interest-free home financing. Subprime mortgage crisis would not have occurred if this sort of interest-free financing is implemented widely.
At the end of the day, I may follow Warren Buffett’s footstep to set up an investment company if rare chances as such do come by in my life. And I would probably make it an Islamic venture capital company, which is still a form of investment entity unfamiliar to public at this juncture. A relationship between a venture capital company and its investors can be mainly that of Mudharabah or Musyarakah or wakalah bij-ujrah (agency contract with fee) or combination of these three contracts. The relationship is determined by conditions and regulations stipulated between the company and investors and the nature of the venture capital company itself. In the case of the relationship between a venture capital company and its investee, the main Islamic contract between them is Musyarakah (al-‘inan), involving the partnership in capital (al-amwal), labour or skill (al-abdan/al-a’mal) and credit-worthiness (al-wujuh). It is due to the active participation and contribution of the venture capital company in the business venture in addition to the investee’s capital outlay. This type of investment activity usually helps creating value chain in national economy at large. Hereby I would like to note that this idea is still a conceptual plan at this stage. It is an idealistic yet practical approach to operate an investment company based on profit-and-loss sharing.
Before I end my essay, I would like to justify my potential Islamic financial management based on its healthy contribution to global banking system as a whole. Islamic finance requires that all financial transactions and the instruments must be represented by genuine assets and business transactions as per their respective rules and norms relating to fair play, transparency and justice. In short, there must be some foolproof criteria for the creation of money. Real-asset based financing and the Islamic principle that the time factor in business transactions has value only through the pricing of goods and their usufructs, provide the best such criteria. This could provide a paradigm shift for financial services by seeking a moral compass for the system based on market forces by linking them with the real economy. And this is exactly the most desirable big picture to be achieved.
[1] Haitham al-Haddad and Tarek el-Diwany, “Boom, Bust, Crunch: Is There An Islamic Solution?” , 29/10/2008, London, Islamic-Finance.com, 15 February 2009
[2] Translation of verse 2:275
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