Khatab Alqararah, MUCI1415 University of Deusto, Spain

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Islamic Banking: Objectivity and Subjectivity

Abstract

In this paper, I tried to address Islamic banking industry phenomenon in different dimensions;

Objectivity and Subjectivity. Objectivity dimension by applying the objectivity criteria, I find that

Islamic banking industry need to be examined in different economic environments characterized

by efficiency and less corruption than developing countries. The Subjectivity dimension is mostly

appealing to address the Islamic societies rather than other societies, since it is generated by

religious views and cultural values.

Introduction

Islamic banking industry was officially proposed in Egypt 1963, and since then the phenomenon

has grown slowly but steadily. Islamic banking industry supposed to provide the Muslims society

with financial instruments that compliant with religious beliefs and characteristic. According to

the prevailing interpretations of the Islamic law (Sharia); interest (predetermined amount or

percentage of profit) is prohibited. This interest called in Islam culture riba (usury) and

according to Quran (the holly book of Muslims) riba is prohibited. However; Islamic law

emphasizes that investment must be as profit-and-loss sharing (equity), which seem to exclude

debt contracts. This is in marked contrast with all commercial and conventional banks.

In such context, Islamic banking industry has developed instruments for commercial financing

based on two principles; the profit-and-loss sharing principle PLS and the markup principle. In

the PLS principle the bank may earn a return on investment and at the same time share the risk of

the investment in case the project fails. Driven from this principle, Islamic banks utilized two

instruments:

Mudarabah financing: in this instrument the bank provides capital and the client

contributes effort and exercise a full control over the business venture. In case of loss the

bank earns no return or a negative return on investment and the client receives no

compensation for his/her effort. And in case of profit the bank and the client share it

according to a negotiated equity percentage.

Khatab Alqararah, MUCI1415 University of Deusto, Spain

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Musharaka financing: in this instrument the bank and the client jointly supply the capital

and manage the project. Losses are shared according to the percentage of contribution,

and in case of profit the percentages are freely negotiated.

In the markup principle the bank finances the purchase of assets in exchange for negotiated profit

margin. Driven from this principle there are two instruments widely used in Islamic Banks:

Murabaha financing: in this instrument the bank purchases the asset on behalf of the

client and resells it to the client in a price that covers the cost of the asset and

predetermined margin of profit. Payment is made in the future in lump sum or

installment.

Ijara financing: in this instrument the bank purchases the asset and allows the client to

use it for fixed charge. The ownership of the asset can remains to the bank or gradually

transferred to the client by rent-to-own contract.

Objectivity vs Subjectivity

Here we must markup questions; why Islam developed a different banking system? And why not

conventional banking system? The existence of such kind of banking system must have purpose

or rationality; otherwise it does not make a sense. So far; if this rationality is really exist, Islamic

scholars have to disclose this kind of rationality and purposes, to know if it is subjective or

objective. Afterwards; we can argue and evaluate the necessity for these systems to be existent.

Islamic banking refers to a system of banking or banking activities that is compliant with Islamic

law (Sharia) principles and guided by Islamic economics, Sharia believes that profit should be

based on effort; moneylenders expend little effort, their earnings accruing while they sit idle.

Islamic discourse argues that Sharia principles in terms of banking and financial activities claim

to:

Create welfare to society.

Equal distribution of wealth

Social justice

These three main purposes are addressing universal, stable and repeatable social phenomenon in

some sense. And there is objective truth about welfare, wealth distribution and justice in terms of

economy. In addition; nowadays we can reach universal agreed-upon method that can helps

Khatab Alqararah, MUCI1415 University of Deusto, Spain

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people to determine whether these claims are really true or false, such as Human Development

Index HDI, GDP per Capita or life standards…etc. And in case of disagreement at least

according to these indices we can judge and evaluate Islamic banking industry. Which in general

sense can be considered as Objective.

On other hand, Muslims also claim that they do Islamic banking because of their religious beliefs

and culture. They argue that, who knows the truth? Who knows good and bad for society in

terms of economy and finance in the long run? They do that only because they follow Quran

(words of God) and Allah (God) says “And Allah has permitted trading and prohibited interest.

So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his

matter is up to Allah (to judge). And the ones who revert back, those are the people of Fire.

There they remain (for ever)”. Upon this Muslims claim that Islamic Banking system is better

than conventional banking system for society. At this point it is clear that Muslims rely on their

beliefs and culture to interpret good and bad. Which in general sense can be considered as

Subjective.

Objectivity dimension of Islamic Banking Industry

For a long time Muslims were facing a dilemma, it most likely to be impossible to steer interest

free financial transactions in the modern world, which interest plays the major role in this part of

economy. The fact that conventional banks which work based on interest are dominating the

scene in the financial markets, Muslims societies are unable to keep away from. The Islamic

banking industry pursues to keep the momentum in the last decades. They are doing remarkable

job to charge the situation in both hands; theoretical and practical.

Scholars and academics keep working to improve theory regarding to interest free financing to

be developed as well as interest based ones. Furthermore; to make this theory has the ability to

foster or construct economic theory which claims to create welfare societies and justice. On the

other hand, practical experience is being gained in running interest free banks and financial

institutions. A good deal of interaction is also taking place between the theory and practice of

Islamic banking. The Islamic banking movement is still in its infancy but it has already made a

significant impact on the world financial scene.

As mentioned before the two principles for commercial financing that Islamic banking industry

has developed is profit-and-loss sharing principle PLS and Markup principle. Islamic scholars

claim that these principles are likely to be social welfare improving and good instruments to

Khatab Alqararah, MUCI1415 University of Deusto, Spain

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foster justice in wealth distribution. And no doubt will develop better economy. These claims are

most likely to be objective; due to truth value existence.

In welfare and economy development as a social phenomenon; truth will be what people claims

to be truth, such as emphasizing that opportunities in education, employment, advancement,

benefits and resource distribution, and other areas should be freely available to all citizens

irrespective of their age, race, sex, religion, political association, ethnic origin, or any other

individual or group characteristic.

Agreed-upon methods exist to judge and evaluate these claims. As mentioned before highly

respectful non-governmental international organizations have developed some indicators to

benchmark countries’ development and social welfare. Such as HDI created to emphasize that

people and their capabilities should be the ultimate criteria for assessing the development of a

country, not economic growth alone. The HDI can also be used to question national policy

choices, asking how two countries with the same level of GNI per capita can end up with

different human development outcomes. The Human Development Index (HDI) is a summary

measure of average achievement in key dimensions of human development: a long and healthy

life, being knowledgeable and have a decent standard of living. Published by United Nation

Development Program UNDP.

In terms of economic differentiation and governance assessment, the Global competitiveness

Report GCR which attempts to quantify the impact of a number of key factors which contribute

to create the conditions for competitiveness, with particular focus on the macroeconomic

environment, the quality of the country’s institutions, and the state of the country’s technology

and supporting infrastructure. Published by World Economic Forum. These two instruments can

be considered as methodology to figure out whether Islamic financial system is really helpful to

foster better economic development and social welfare.

Islamic banks operate in about sixty countries around the world. Most of these countries are in

Middle East and Asia. However; conventional banking institutions still dominate the financial

scene there, operating alongside Islamic banks. Except three countries; Iran, Pakistan and Sudan

had converted the whole financial systems to Islamic financial system.

Contrary to the expectations, these countries; Iran, Pakistan and Sudan are not performing very

well in terms of social welfare and economy. According to HDI Iran, Pakistan and Sudan ranked

75,146, 166 respectively in 2013. And according to Global Competitiveness Index (GCI), Iran

and Pakistan ranked 83,129 respectively in 2014 and no information regarding to Sudan. This

might contradict Muslims’ claims or defeat the rationality of proposing new or different financial

system.

Khatab Alqararah, MUCI1415 University of Deusto, Spain

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On the other hand Islamic bank’s advocates argue that Islamic banks mostly are operating in

inefficient economies specially Iran, Pakistan and Sudan. Where these financial markets are

characterized by high degree of imperfect information and rent seeking behavior, bureaucracy

inefficiency and corruption. Iran, Pakistan and Sudan have somewhat inefficient economies in

which there are fairly high levels if rent seeking and corruption.

In such environment, Islamic financing system faces an agency problem. Economies

characterized by agency problem will be biased toward interest based financing. The crucial

assumption is that the cash flow (profit) form the client’s project using PLS instruments is not

verifiable to a court of low. As these problems are exist interest based financing will become the

dominant instruments.

Subjectivity dimension of Islamic Banking Industry

Cultural heritage in addition to prevailing value system in Arabic societies before Islam, was

suffering the confine of wealth in the hands of minority. The practice of lending based on interest

was dedicating this encroachment by minority. Moreover; this easy money reduced wealthy

people’s desire to pursue productive operations to create profits. Also limits the generation of

profits through trade activities. This cultural heritage started to be religious view and beliefs after

Islam, since Islam prohibits riba (any financial activities aim to generate money from money

purely). This prohibition is clear and mentioned in different places in Quran: “Allah forbids riba

and permits trade” and also in other place “And Allah has permitted trading and prohibited

interest. So, whoever receives an advice from his Lord and stops, he is allowed what has passed,

and his matter is up to Allah (to judge). And the ones who revert back, those are the people of

Fire. There they remain (forever)”. Profit generation must come through either trade activities

or PLS investment.

In this argument, the supreme truth value and knowledge generated among Islamic banking

industry are subject to religious views and beliefs which are driven from Quran. Furthermore;

these money transaction rules in Quran is mentioned in general sense. In other words, the way

that we might understand or legalize these rules is subject to the way that we perceive and

interpret Quran.

Khatab Alqararah, MUCI1415 University of Deusto, Spain

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Islamic bank’s advocates argue that Islamic banks have passed the exam. Islamic banks

performed very well during last world’s financial crisis. According to ratings agency Moody's,

the global Islamic finance sector is worth $700 billion and has the potential to be worth $4

trillion. Islamic banks have performed 20 % growth in 2007.

Consequently; people started to look for alternatives to conventional banks services. There are a

lot of non-Muslim countries, including the UK, France, Japan, Hong Kong and Singapore

encouraging Islamic finance. In the West, banks including Lloyds TSB, HSBC, Deutsche Bank

and Citibank all offer Islamic finance products. In the occasion that happened in wider spread

around the world, truth value may be generated; in consideration of truth is what people claims

to be truth in social phenomenon sense. This will entirely turn it to objectivity, since subjectivity

is objective.

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