The 0.5 Second

By

M. Fahim Khan (Islamic Society for Institutional Economics)

Dr. Nejatullah Siddiqi, King Faisal Prize Laureate in Islamic Economics,
has prepared a note to examine the relevance of Islamic economics today
and whether it has a message for humanity in so far as its current
financial problems are concerned? It is a very perceptive response from
Dr Siddiqi which I appreciate very much. I am writing this note just to
reiterate the position, taken by this forum of I-SIE, that if we need to
draw lessons from Islamic economics, we need to look into the economics
embodied in the institutional framework of Islam.

No doubt, riba (interest, usuary) and maysir (gambling, speculative
activities similar to gambling) are the major factors leading to the
current financial crisis. Islam's prohibition of Riba and Maysir
along with Islamic values and morals, and recognizing others'
interest in one's economic fortunes, if adhered to, could not have
lead the world to the present day financial crisis. Keeping individuals
and Society free form financial and economic crises can clearly be seen
as one of the objectives of such instiutions.

The question, however, is how to do this now? Where to go from where we
are now? Even if we can declare that taking and charging of interest in
banking operations is prohibited, the question remains; what is the
alternative? Current practice of Islamic banking has not provided any
convincing alternative. With the Tawarruq made Shari'a compatible, the
results can not be expected much different from those of interest based
banking system.

Through this forum, I like to draw the attention of all concerned about
the need to investigate into the institutional framework of financial
system that prevailed in the Islamic societies before they were
colonized by the West. The contemporary financial system came into
existence when the Muslim societies had already been colonized and their
institutions demolished or diluted. The modern financial system
developed without taking any lessons from the Muslim civilization.

It is curious to note that almost all branches of modern knowledge admit
the contributions of Islamic civilization often referred to
"medieval ages" towards their discipline, except science of
Economics and Finance which does not recognize any contribution made by
Islamic civilization in this field. Even Schumpeter, writing history of
economic thought totally ignores the long history of economic successes
in the era of Islamic civilization. It was the period when the poverty
was non existent. Basic needs of every one were met. No one was
"poor" enough to look forward to receive charity. Worldwide
famine type situations were intelligently and successfully dealt with.
There is no evidence of financial and economic crisis in the long
history spread over about 1000 years.

It is now the time that visionary economists and financial gurus look
back and investigate into the institutional set in the economy of
medieval ages to find solution for the current crisis. Those familiar
with the economy of medieval ages do know that its financial system was
not a banking-based system. Its system was either market (of goods and
services) based system or it was based on Qardh Hasan (benevolent loans,
normally understood as charities). Financing needs in the market were
met through trade contracts. Sale contracts with deferred payments and
sale contracts with advance payments met the financing needs through the
market without needing financial intermediation. "Know thy
client" is more relevant for maket based financial system and hence
the issues of adverse selection, moral hazard and transaction cost were
minimized. The financing needs that market could not or did not want to
meet, were met by the institutions of Qardh Hasan, Zakah and Awqaf
promoted by Islamic teachings. The issue of moral hazard, adverse
selection and transaction did not occur even in these institutions. The
need for developing financial intermediaries never arose despite
economic growth and development.

It is not the place to discuss the details of such a system to meet the
financing needs of a modern economy. Once the concept is acceptable, the
details can be worked out. The point is that market itself is a better
place to generate a financial system to suit its own needs. If markets
are functioning well and institutions are in place to give support and
protection for the market to provide financing as part of the contract
of the sale and purchase of goods and services and if there are
institutions to meet the social needs not met by market, there will be
no need to develop banks to provide a financial system on interest
basis. Even now, several businesses large and small, wholesale and
retail, are doing the business by providing financing while
selling/purchasing goods and services, without letting their customers
go through the banking system to get the financing. They do not have to
explicitly refer to interest calcualtions when providing financing for
their sales and purchases. Every thing is built-in within the price.

The concept of Forward Sale as give by Islam (known as Bai' Salam)
is wonderful guide to develop a market of Futures contract without
tempting the traders and producers in the market to go into gamabling or
gambling type "speculation" . (For more detailed discussion on
this, see my paper on "Islamic Futures and their Market"
published by Islamic Research and Training Institute and is downloadable
free from their website). Modern finance, does not recognise the
financial system prevailing in medieval ages because it did not borrow
anything from there. Occasionally, somewhere we may find a reference to
forward contracts of the medieval ages. But there is hardly any attempt
to understand the nature and economics of those forward contracts in
comparison with the forward and future commodity contracts of today. The
financial gurus may find a lot in the economic and financial system that
was in practice when Islamic civilization was on top of the world

For drawing lessons from the Islamic financial system as prevalent in
the so called medieval ages, what is needed to be done is to reform the
market of goods and services in a way that allows the market to develop
its own financial instruments to suit the financing needs of the
society. Infrastructural institutions are required to be developed to
promote and protect the financing provided by the market of goods and
services as part of its sales and purchases, rather than promoting and
protecting the banking institutions to finance gambling and speculation.

A bank-free but market-based financial system is the key to have
crisis-free financial and economic system. The developed world can take
lead in introducing market-based financial system and show the way to
the developing world too, how to get out of the trap of banking based
financial system.

Banking-based financial system has long been losing its credibility in
the eyes of financial gurus. To Frederic Mishikin, it is a puzzle,
"What makes banks so important?" when there are better and less
complicated options available in the market to raise financing
(including loans). See his book The Economics of Money, Banking and
Financial System.

The world bank report on Institutions, 2000 identifies two types of
financial system. Market based financial system and banking based
financial system. Germany has been mentioned to be having a more market
based financial system compared to other countries in the West and now,
probably, it is Germany which is in a better shape among the G-7, in
this time of worst financial crisis.

It is in the interest of both the Islamic economists and conventional
economists to look into the Islamic economic system which has been in
practice for a very very long time. Islamic Civilization gave a lot to
the modern world to develop physical and natural sciences. Let us see if
there is anything for the science of economics and finance to borrow
from there in the interest of the wellbeing of man on earth. I
particularly invite those working in the framework of New Institutional
Economics (NIE) to take it up as a commitment to their own discipline.
Let us think of an economy at least free of commercial banking. To start
with, let us see how an economy would shape up if there were no
commercial banks and there were no short term borrowing and lending on
interest through financial intermediaries.

Note for Dr. Siddiqi: I hope Dr Nejatullah Siddiqi puts his note on
internet soon so that a link is provided on this site for ready
reference.

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