The Social Benefits of Islamic Finance

Despite deriving its foundational principles from the Quran, the Hadith and the traditional schools of scholarship, Islamic finance is not distantly different from conventional finance. Like conventional finance, Islamic finance includes banking, insurance, asset management, capital market and advisory services. And like conventional finance, it fosters trading, profit making, promotion of shareholder’s value and encourages corporate social responsibility. The major differences been the absence of debt and the prohibition of all forms of interest. Another distinctive feature is the concomitant social consequences of Islamic finance. This frequently ignored aspect of Islamic finance is briefly discussed by this article in the context of events happening home and abroad.

It is incontestable that innocent victims and some of the greedy culprits are still paying the price for the recent global financial crisis. The world is also still discovering the depth of the putridness caused by greed and unbridled thirstiness for debt. We may privately acknowledge that greed is gross and debt is debilitating, we may even believe that these are impetus for the sustained disconnect threatening the world social cohesion, but we still worship the system promoting these vices. This is why in our debt-based society and interest-based lending, the lender is not concern about whether the debtor business is earning profit or making loss, for irrespective of the outcome his interest income is always almost guaranteed. This may be excused as consensual transaction but it is still the protection of private benefits at the expense of social benefits.

For example, in an article, The Independent reported how RBS, a bank in the UK, is being investigated for allegations of deliberately distressing debtor businesses for profit. Even the LIBOR-rigging scandal, the London Whale affair and other similar financial scandals are fuelled by greed and self-interest. The antithesis to all these may be the adoption of the codes and ethics of Islamic finance and key injunctions relating to aspects of business transactions. One selected verse in this regard is: Eat not up each other’s property by unfair and dishonest means. (Al-Quran 4:29). This is strictly enshrined in Islamic finance.

The poor, who are supposed to get greater protection, are left vulnerable to insensate exploitation by the so-called social microfinanciers who are more driven by quest for growth and profits than alleviating poverty, their ambition screened behind the ‘social mission’ façade. There are instances where the toxic combination of hyper-competition, uncurbed chase for market share, liberalized regulation, over-lending, over-indebtedness and extortionate interest rates had created virulent and unwholesome environment where the ultimate losers have always been the poor, especially farmers who, in some parts of the world, have taken to committing suicide as ‘a way out’ of the predatory pressure of debt repayment.

With Islamic finance however, where microfinance loans can be provided using a Mudarabah contract, farmers may not be obligated to pay back loans if they can’t afford it especially when there are poor harvests due to droughts or natural disasters. The logic is that since loss and inability to pay is neither caused by the negligence of the farmer nor by his violation of the contract agreement, it is only moral and ethical for the financier/banker to bear the loss instead of adding pressure of loan repayment to the psychological and economical strains already on the farmer brought by the poor harvest. Moreover, money given is not a loan but an interest-free, equity investment in the farmer. And like all equity investment, the value of investment can fall as well as rise and you may not get back what was originally invested. This is how Islamic Microfinance works. This way, for the poor and the weak, social justice is guaranteed. It should be made clear that microcredit isn’t exactly the enemy, but an Islamic microfinance system, compared to interest-based conventional microfinance, could be the more socially responsible way of alleviating poverty.

The Prophet Muhammad (PBUH) said, “He who sleeps on a full stomach whilst his neighbour goes hungry is not one of us“. Applying this principle to all economic relationships would mean invoking the spirits of fairness and social justice. But we rarely do that. As a result, economic inequality is not relenting the world over, even in countries with higher access to financial services. Income gap between the rich and poor is increasing, households are burdened with huge debt and compounded interest, and wealth is continuing to be concentrated in few hands. The IMF published a report where it confirmed the growing inequality across many regions of the world and how this is threatening to undermine global economic growth. Also, according to a report cited in The Economist, in the US 95% of the gains from the economic recovery after the recession is reported to have gone to just 1% of the population. This is not only inequitable but certainly a symptom of system inefficiency. An unjust system where the poor with lower income must earn lower returns on savings and forced to pay higher interest on borrowings while the rich exchanges lower interest expenses for higher profit earned from equity investments. An inefficient system that glorifies inequality and stagnates social mobility.

Even though Islamic economic, and by extension Islamic finance, isn’t exactly socialistic, it does promote distribution of wealth in the attempt to achieve the tripodal objectives of establishing a natural, fair and practicable system of economy, empowering everyone to get what is rightfully due to him and eradicating the concentration of wealth. The prohibition of interest, the prohibition of selling what you don’t own (short selling), the motivation for both lender and borrower to cooperate because of shared business risk, the fostering of lending to real sector to promote economic prosperity for the community, the ingenuity of institutions of zakat and awqaf, and the benignity of qard al-hasana are all some of the features of Islamic finance that promote social justice, social equity and social inclusion.

For developing countries like Nigeria, achieving social cohesion where all citizens would, without discrimination, have equal access to fundamental social and economic rights, is as important as getting into the coveted league of developed economies. But greed, heavy indebtedness and excessive risk taking are inherent weaknesses in conventional financial system that accentuates its frangibleness and frailty. These features are inimical to socioeconomic justice and equitable distribution of wealth. However, these weaknesses are rare in Islamic financial system because debt is not part of its make-up and greed is greatly controlled.

Although Islamic finance may not be the ultimate silver-bullet to put an end to the huge problems of poverty and income inequality but because of the ethical nature of this financial system it is certainly a good start to redistributing wealth, alleviating poverty, easing income inequality and abolishing class differentiation. As might be expected, absolute equality in distribution of economic resources is not feasible, nevertheless, few of the perquisites of pure-play Islamic finance are limiting unchecked pursuit of self-interest, building of social capital, strengthening of people’s sense of belonging, creating opportunities for social mobility and engendering social inclusion.

NB: This is an article I wrote for a blog few years ago.