This Post Really Suk-kuks: Examining Islamic Finance

By Jabulani Leffall on 11 May 2008 24 comments

Before you read on, know that this one of those listen-to-me-now-believe-me-later on posts.

Enter the Sukuk: the interest-free loan, based on Muslim principals and before you laugh, understand this: Citigroup, Morgan Stanley, HSBC, Standard Chartered and others are getting into the Sukuk issuance business in force.

Moreover, while we grunt and grimace at the fact that it took 50 bucks to "fill-er up" or that 40 bucks only got us to three quarters of a tank or in some cases, only half a tank -- the sheer quantity of cash from petrodollars is creating a financial boom in the Middle East as well as Asian Tiger economies such as Malaysia and Indonesia -- all seats of Islam, the dominant religion among that region's populations.

Mohammed Mahmud Awan, a scholar at Malaysia-based International Center for Education in Islamic Finance, said recently in a speech that the mortgage crisis is "unthinkable" under Islamic principles regarding debt. Awan said that it was "time" for the Islamic banking industry to present solutions to the global economic community in the wake of the crisis.


Well, Islamic finance assets are growing at an annual pace of 20% and are set to hit $2 trillion in 2010 from the current $900 billion, literally fuelled by us who create flood in the desert of petrodollars, which by extension folks, means the import -- forced through business conditions or voluntarily - of some of these principles and philosophies to western banking circles.

In the Gulf and Asia, Standard & Poor's estimates that 2 out of every 10 banking customers would without thinking about it, choose an Islamic loan package for housing and business financing over a conventional one even if it had a similar risk-return profile.

Yeah, Yeah, Yeah you say, "what does this have to do with me?"

Nothing much right now. However, there is a coorelation between the growth of Islamic finance and high oil prices. Where do you think they get their money? Date farming? Sand? Manufacturing? I think not. 

And you should know that Oil-rich Middle Eastern and Central Asian sovereign wealth funds are large shareholders of many foundering Western banks who are in dire need of capital because of exposure to the interest-bearing and complex loan packages that created the subprime meltdown. This could mean that one day soon, some of these large shareholders will demand an entry into profitable and growing markets. Again enter the Sukuk.

Not withstanding events that are beyond our control, at present, the equation is simple -- albeit with many variables.

Oil Prices = High Gas Prices = Mega Petrodollars = Expansion X More Petrodollars + More Money in Islamic Banks = Growth of Islamic Finance + Stakes Acquired in Non-Islamic Banks+Islamic-Style Banks Having a Say in the Expansion of Western Banks which will one day offer yes: Islamic Sukuks.


An "Interest-ing" History

Charging a vig on a loan (interest on credit) has its roots in the Roman Empire's coin-based economy that was backed by vast amounts of resources in the treasury. The concept of interest became a staple during the rise of mercantilism during the Italian and European renaissance. Merchant of Venice anyone?

And before any xenophobia sets in, it's important to note that speaking out against the concept of interest-based financing is not solely a Muslim thing. In fact, St. Thomas Aquinas of Catholic fame was said to have espoused that the charging of interest was morally wrong because it amounts to usury, i.e., charging for both the amount and the use of the amount. But the concept still took shape during the industrial revolution and has been trucking along ever since and remains a matter of life and debt for our country.

So now the equation is this: Our paper money, for their black gold, means we have to borrow more paper money from them to buy more black gold, while they use the proceeds of our black gold purchases to build their own infrastructure, capitalize their own banks, buy shares in our banks and the rest is history or our potential future at the very least.

Hence it's not inconceivable that some of us -- especially of the international traveler persuasion -- will be taking out interest-free loans sometime in the future and on a larger level this is a subset of the clash of civilizations. Credit isn't going anywhere mind you, as it goes so do we but the thing question is: Will we some day be at an economic disadvantage because of credit-tinged opulence when other white-hot economies are playing it straight up? Or is it straight up? Is the concept as it is with the sukuk, of renting your loan amount instead of essentially paying down a principal amount plus interest more viable? 

One Islamic finance scholar, a Rice University Prof. Mahmoud El-Gamal ,has famously suggested that there has been no major test case for the sukuk yet to ensure that Shariah-compliant loans can work, or for that matter be deemed as anything other than a way to market to religious sensibilities.

In an August 2007 blog posting, he wrote:

"Unless and until we have a high-visibilty case of bankruptcy, we will not know with any certainty who owns what in the maze of SPVs that lawyers and structured financiers love to use. Until then, many will continue to line their pockets with legal, structuring, and advisory fees, as they congratulate themselves on "innovative Islamic products." What a shame!"

Given that, what are your thoughts on a world where you have to buy what you can buy with legal tender and not be able to get by on credit? Do we have a moral obligation to fix our financial system and change our attitudes about spending and consumption while recognizing the bubbling competition?

 What do you think?

Interest or no interest?

What do you believe in?

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Guest's picture

Why do you link the principle of interest free loans to Gas prices. it's two different things. The Islamic finance principle of sharing the risk in any investment has nothing to do with the Oil.

Jabulani Leffall's picture

@ Guest. 


Oil Prices = High Gas Prices = Mega Petrodollars = Expansion X More Petrodollars + More Money in Islamic Banks = Growth of Islamic Finance + Stakes Acquired in Non-Islamic Banks+Islamic-Style Banks Having a Say in the Expansion of Western Banks.

 It may seem like a stretch but it isn't. Once upon a time, the Oil boom in Odessa-Midland Texas spurred the creation of several millionaires, which spurred the creation of local regional and state banks, who leant to businesses based on Good Ol' Texas principles. It's the same thing in Dubai except it's an Islamic

Islamic finance assets are growing at an annual pace of 20% and are set to hit $2 trillion in 2010 from the current $900 billion, literally fuelled by us who create flood in the desert of petrodollars, which by extension folks, means the import -- forced through business conditions or voluntarily - of some of these principles and philosophies to western banking circles.




Jabulani Leffall

Monetary Gadfly, Common Currency

00000 Broke Blvd. Kitchenette #68 & 1/2

Lowcash, CA 90000-0000

Guest's picture

As a student of Religion, specifically Islam, I am particularly sensitive to topics such as these. Please remember that Islamic banking and finance has existed since its inception and is NOT primarily propagated by the oil-rich nations. Also, it's important to remember that ARAB or Middle Eastern oil nations are NOT the same thing as Islamic oil nations.

At the same time, I appreciate your broaching the topic and reminding the readers that not just Muslims believe in the interest-free loan (and that being said, many Muslims believe in the traditional loans we're accustomed to as well).

Sorry for not responding to your original prompt; I just thought I'd stick my nose in an interesting issue.

Guest's picture

Am I the only one who thinks this is a bit of a cop out?

Sharia forbids charging interest, so an Islamic mortgage would work like this (for example): Instead of the customer obtaining a loan to buy the house, the bank purchases the house. The customer then pays the bank back in monthly 'installment fees', plus various 'administration costs' along the way, until they own the house outright.

Granted, this isn't literally charging interest, but it might as well be.

Guest's picture

As a muslim, this post is kind of offensive to me. Not all dollars in Islamic finance vehicles are funded by the oil industry. Some of us folks have regular jobs where we do regular things (gasp!)

Not all muslims are Arabs either, nor are we all living in the Middle East. We live in all parts of the world, okay? This includes Asia, where I happen to be. Sigh.

I think you might have a point or two there worth elaborating on, but you did it in a manner that tells me you don't know what you're talking about.

Guest's picture

I can see his point but in a more roundabout way. More companies that have Islamic owners or boards of directors can have an influence on the way businesses they acquire or invest heavily in are run.

An investment conglomerate held financial ownership over a coffee chain. Since they now had a say how this business was run they asked that ham sandwiches and something else I can't remember be removed from the offerings.

I can see how more financial ownership and investment from large companies with people running said company that hold the Islamic concept on loans could influence traditionally western run banks.

We used to have usury laws, most of them have been removed so companies can make even more money off of people. When you look at the mired mess people can get into with credit cards and interest it is pretty obvious why there are old rules, laws and customs against it.

The only thing I have not been able to figure out is how no interest finance makes it's money back? If cost of living erodes the value of said sum of money and no fees or interest come back to the lender how does the lender not operate in the negative?

Guest's picture

Sorry I have to agree with other posters, this is totally xenophobic. Just because there are countries who use interest free banking does not mean that there is something horribly wrong. We got ourselves into the place we are, with credit debt up to our noses. It makes me so angry that we sit here whining over the high price of gas, and that other countries are making money off of the wealth they have fair and square. We've had our place in the sun for a loooong time, with the rest of the world looking longingly at what we have. There are Islamic run banks in the US, as well as Islamic mutual funds that invest only in halal businesses. I don't get what your problem is?

Guest's picture

Not sure what your point is?

No Western Bank is having any gun to its head to take in Islamic shareholders. At least that is what I last heard.

And all corporations do owe some responsibility to their shareholders.

You seem to suggest that soon the entire world will be overrun by Islamic banking. Actually it should be good since we'll have more choices.

Guest's picture

This is a product cleverly guised as not having interest, but basically the companies but large amounts of gold at discounted prices, give it to people as a loan, and they are required to pay back the dollar amount at the retail amount of the gold. Call it what you want, but in my mind, that is a loan with interest. I'm sure there will be plenty of risk involved somewhere down the line. When the middle east gets as spend-happy as the US (See-Dubai), people will start living outside their means and then boom, there will be a war/natural disaster/collapse of a local government, and people will stop paying the money back (see housing boom - US).

Call it what you want, but this is a loan with interest.

Guest's picture

Either one of two things will happen: the Islamic financial system will find loopholes (like Jonathan said above) in order to cover the opportunity cost of lending out money, or else they are effectively crippling themselves against secular banks. Citizens have no reason to leave their money with an Islamic bank. If the bank cannot lend out money at interest, it cannot give interest on savings accounts, and therefore its only clients are those whose religious beliefs trump their drive for profit. This would suggest that secular people would not have any interaction with the bank. It has no advantage. Furthermore, even if they do find loopholes, it is fundamentally changed. For instance, buying stock in a company and slowly selling it off is not the same as buying a bond form that company. If the company goes bankrupt, it pays its bondholders first, and its stockholders receive what is left over, if there is anything.

On a side note, it would be nice if readers of the blog could possibly try and look at the spirit of the post, rather than read into it looking for possible ways to be offended. Claiming most of the monetary interaction that Westerners and Muslims is that of the oil trade is not a far-off claim. Sure, most Muslims are from Southeast Asia. That is not what this post is about, and Muslims in Southeast Asia are not buying hefty shares in Western investment firms. Arab Muslims with oil money are.

Guest's picture

Thank you Ix. Thank you so much. I'm Jabulani Leffall, the guy who wrote this. I appreciate all the comments and I'm glad this has sparked a spirited debate about money philosophies, which is the purpose of this blog. First off, I have great respect for Islam and my uncle is Muslim and dillentante of theology I may be, I would never want to offend anybody's faith. I think the contrast of this philosophy what the scholar from Malaysia said and the credit curnch America finds itself in, because of a dropping dollar and soaring oil is rather ironic. I also chose this subject because of the stunning growth of Islamic finance and the sudden interest that many "Western" banks have taken in it. I think the Sukuk (Bond, Loan) and the Takaful (insurance) are both novel and fascinating concepts in our modern world and a concept of interest to those of us in the Western world who study finance, economics and money flow. Aside from being an international journalist and content developer, I"m also a History major. So yes I'm aware that most Muslims aren't Arab. Yes I'm aware that a larger part of the islamic finance market is in places such as Indonesia and Malaysia and not the Arab middle east and that not just Shieks, Sultans and Emirs use this form of finance. That said, I also agree that with this post, some may be looking for bits and pieces and ways to be offended.

I presented the facts, the market is growing, in part but not all, because of oil revenue. That's fact, I didn't speak for or against the sukuk, I didn't predict doomsday for oil guzzling consumption crazy americans at the hands of Sukuks and Islamic finance either. I just meant to say it's a brave new world, one that is getting smaller, one we must prepare for and learn from in some form or another. Keep the comments coming though. Love 'em!

Guest's picture

I was expecting a description of how "Islamic" financial instruments work, particularly how they make money despite not charging interest. This post doesn't seem to contain very much information- the comments are more informative.

Guest's picture

Why the 'us vs. them' tone? There is only one Earth. All of us are children of Adam, and he was created from dirt.

Guest's picture

"Why the 'us vs. them' tone? There is only one Earth. All of us are children of Adam, and he was created from dirt."


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Guest's picture

Could you write another post on how these loans work and how they differ from the conventional loans with interest we are used to?

Guest's picture

I'm interested in how the lack of interest as an output affects economies that have large numbers of Islamic constituents. I read an article at [is this a reliable source?] that appeared to say that, whereas in capitalist countries, land, labor, and capital generate fixed returns (rent, wages, and interest respectively) but entrepreneurial ability generates an uncertain return (profit), in Islamic-based economies, only land and labor may generate fixed returns (rent and wages), and capital and entrepreneurial ability generate uncertain returns (profit).

The sources I read stated that this makes for more socially responsible lending in that a capital provider has more of a stake in the success of a business because he only makes money if the business is successful. In other words, you wouldn't see any companies making a loan with the idea that the borrower would pay them enough interest to make it profitable but then default/fail.

On the surface, this system appears to provide for much greater stability. It certainly makes lenders more accountable. But personally, I don't see how this system retains the flexibility necessary to create enough equity for everyone in an economy to experience an increase in their standard of living. The system essentially requires that its investors understand the business, which, while a good idea, isn't always true. Can you imagine Bill Gates having to explain the feasibility of a GUI to investment moguls of the DOS age who had never owned a computer? Fedex wouldn't even exist after a college professor gave the idea an 'F'. Brilliant people who know enough to create but not communicate, or smart investers that aren't brilliant enough to understand the next big thing wouldn't have much of a chance to succeed in that type of economy, IMO. And what about households? How would the average household contribute to the economy in ways beyond spending their wages without the ease of mutual funds or other interest-based investments?

I guess what I'm trying to say is that, if there is no interest in an Islamic-based economy, then wealth can only be created through equity. That makes for a lot of stability and good investments. However, I think that by tying capital to entrepreneurial ability, it deprives people [and therefore the economy] of the ability to create wealth through entrepreneurial ability alone. This is in addition to depriving the economy of the enormous wealth created by interest. How can this type of economy grow quickly enough to improve the lives of all of its people? Are there some other methods of wealth creation in an Islamic-based economy that I am ignorant of (this is very probable)?

Guest's picture

I think we are getting there as far as understanding the implications of an interest free capitalist system. Sek you were largely correct, except to say that without loans, entrepreneurs like Bill Gates et. al. wouldn't have the means to obtain capital. Often, only the very first loan a start-up takes is from the bank. Sometimes none at all. Very soon into the process they begin looking at venture capital. These vc firms do not buy bonds in the company, they buy a vested interest, or equity. So to say that equity doesn't have the flexibility to support growing businesses is an error: the banks would need specialists in industry and business, just like vc firms do now, but they could effectively measure likelyhood of success this way, in order to determine who would be 'lent' money.

What interests me most is whether or not banks in the Islamic Financial world pay interest on the capital they hold to their clients. For instance, what incentive would I have to leave my money in the bank instead on under my bed- security aside? I may write a nice long post about the effective differences between Islamic and Western financial systems, and see if I can come up with parallel pay and risk structures for all Western investments in the Muslim world, and vice versa. I don't write for Wise Bread, but I can link to it here when I finish it.

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This sounds silly, but not knowing much about venture capital other than what's available via mass media, I didn't stop to think that banks hire experts to evaluate some business loans [I figured that unless it's a very large bank, the institution would just reject any unlikely-looking loan application]. However, I didn't mean to imply that equity isn't enough support to grow a business. I wanted to say that lending money based on likelihood of equity alone makes the riskier, and therefore also the most profitable ventures (with the most potential to grow an economy), more likely to be overlooked.

Interest is used by banks not only as a return on capital, but also as a hedge against risk. When a bank charges 15% interest [criminal!], it's not because it believes the time value of money is worth that much right now- it's because it's risking the chance that the customer won't pay it back. So, even if the customer doesn't pay up in the end, the bank is protected against part of the loss through the money it collected in form of interest. Without interest, I don't believe banks would be eager to invest in riskier ventures. Thus, some of the riskiest -and therefore most profitable- businesses would not be able to form in an economy without interest. I'd be interested in comparing a risk analysis for an investment in an Islamic economy vs an interest-bearing loan in America.

lx- Have you studied the banking industry in Japan at all? Japan's banking system, when you get right down to it, does not pay interest to the average consumer for a bank account (although there are plenty of interest-bearing instruments in the economy). The attitude towards savings is much different than in America. After all, Japanese banks charge you money to make a deposit at an ATM! Maybe I should find out how Japanese people choose their banks?

Throughout Japanese history, businesses have given one another shares or other things. You could see financial officers of companies holding significant shares of other companies, in a kind of circular pattern that had a tendency to hold onto control: .
However, this behavior was always in the presence of interest, as interest is accepted in Japan. The problem with this method is, again, that it is easy for a small group of people to control a giant share of business, become set in their ways and not take risks on anything they personally can't understand (no matter what the "experts" say). Collusion to keep smaller companies out can be rampant, if it doesn't become a "too many cooks spoil the broth" situation. In Japan, the power of this sort of company was eventually upset by the market due to the presence of interest itself. But without the presence of interest, would a state eventually be dominated by businesses with shares in one another? How frequently to Islamic businesses sell their shares?

I'm essentially arguing that I think an economy with interest is more flexible (if more unstable) than one without.

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