Building Genuine Islamic Financial Institutions

55m Video Talk at PIDE on 2 Jan 2017. Post provides a short 330 word Abstract, a detailed outline of 3300 words, and links to original paper as well as Urdu Version of Talk (67m YouTube). Homepage for paper ( with links to related material, including Turkish translation.


330 Word ABSTRACT: Today’s talk, is about building genuine Islamic Financial Institutions. The Islamic Financial Institutions, we see today, are copies of western institutions and are not genuine Islamic Financial Institutions. The essential difference lies in the spirit behind the institution, which is not directly visible in the body of the institution. Many historians – for example Karl Polanyi in The Great Transformation of Polanyi and RH Tawney in the Protestant Ethic and the Spirit of Capitalism by RH Tawney – have documented the dramatic change in the values of Europe from the 16th to th 18th Century. Christian society was based on the idea that “love of wealth is the root of all evil”. After the transformation, George Bernard Shaw said that “lack of money is the root of all evil”. Modern Banks came into existence only AFTER it became socially acceptable to accumulate, hoard, and pursue increases in surplus wealth. Benjamin Nelson astutely describes the effects of social acceptance of banks and usury in his “The Idea of Usury: From Tribal Brotherhood to Universal Otherhood”. In contrast to this, Islam strongly encourages giving excess wealth to others, and thereby storing it up for use in the Akhira. This spirit was implemented in Islamic society by an institution which the opposite of a bank, namely a WAQF. For more than a thousand years, most wealthy Muslims followed the spirit of the Quran (which has more than 200 verses about giving to others for the sake of Allah) and gave generously to set up institution to provide for education, health, social welfare, and provide for the poor, orphans, widows, and the oppressed. The surplus wealth was used for social welfare in Islamic societies, according to the spirit of Islam, while it was used to create concentrations of wealth in power in capitalist societies, according to the spirit of capitalism, which is the accumulation and hoarding of wealth. Today, instead trying to adapt capitalist institutions designed for hoarding to Islam, we need to create radically different types of Institutions, based on the Islamic spirit.

1 Goals of Social Institutions

Institutions are organization of people, who have a purpose. For example, if I want to educate the children of Pakistan, then for this purpose, I need to build schools. To evaluate Islamic Financial Institutions we must ask: What is the PURPOSE of building this institution? As the Hadeeth says: The value of an action is in accordance with the intentions.

Two arguments which are given in order to justify creation of an Islamic Financial Institution are:

  • Muslims have been left behind in the race for worldly wealth and power. We need to catch-up with the west. West has banks, so, we must have banks.
  • Muslims are engaging in Haram activities: So, we need to provide the Halal alternatives.

These two arguments are not satisfactory, for reasons that are explained in this lecture.

1.1        Spirit of Capitalism

Max Weber (1930) said that the spirit of capitalism is the pursuit of wealth (the making of money). The purpose of a bank is to enable people to store money and to grow their money and this purpose is condemned in Quran(9:34 . 104:1,2). Accumulation of money  is not a valid purpose in an Islamic society. If the purpose of an institution is not Islamic, then it cannot be made Islamic, until you change the purpose.

These institutions (banks) are built on the basis of exploitation and injustice. In Pakistan and India, we had a well-organized system of “Waqf”, funded by “Auqaf”, for providing education, health and social services, to all of the population, for free. This whole network was replaced by British with the current modern system, in which one has to pay for food, education etc. Today, we have 8 people in the world who own more money than 3.5 Billion of the bottom population. Banks have a very important role in making this happen. The Quran tells us not to allow the concentration of wealth into a few hands, while this is exactly one of the functions of the banks: these institutions create concentration of wealth in the hands of the already wealthy.

1.2        Social Institutions

The goal of an Islamic society is to provide justice on all fronts (social, economic, political). We should ensure the provision of food, clothing, housing, education, training and jobs skills, microfinance (that is, loans to the poor and needy, as well as loans to enable poor entrepreneurs to start their business) etc. The idea of Grameen bank and similar proposals for microfinance, is not compatible with Islamic ideas. Islam says if somebody is poor, I should not be concerned about earning money from him, I should be concerned about providing them with Qarz-e-Hasna. Money should be used for Tazkiya (purification of heart). These are permissible goal in an Islamic economy. They should lead to cooperation, building of community, creating love and togetherness among the members of society. This is something, “Waqf” can do because, “Waqf” gives to others. Actually, it is the act of giving which creates love.

The question is, do Islamic Financial Institutions achieve any of these goals? Students of Islamic banking and finance, while analyzing the efficiency of Islamic banks are looking for answers of the questions like, how profitable are these institutions? How much money they provide to shareholder? What is the market share? How much stability it has in a financial crisis? Large numbers of articles in the literature analyze the efficiency of Islamic Banks in terms of these criteria, and compare them to conventional banks. But these criteria are not relevant, from an Islamic point of view. Instead the questions should be, if they are providing social justice or not? Are they feeding the hungry? Are they preventing the concentration of wealth? So, IFIs should be judged according to goals that are considered desirable by Islamic criteria.

2         Trap of Capitalistic Economy and Its Ramifications

2.1        Riba or Interest

Banks use interest and ensure that the wealthy can make money without taking any risk. Whereas the key principle of Islamic Finance is that you must participate in the risk of doing business in order to earn money. Ownership of money is not a productive activity. Whereas according to west and modern economic theory, ownership of money is a productive function. You are entitled to earn money because you own money.

2.2        The Debt Trap

So, the interest rate has been used to tie up the whole world in debt. The Nigerian president, Obasanjo, said that we borrowed $5 billion up to 1985. Since then we have paid $16 billion, but $28 billion still remains in interest on the original debt.

Up until world war 1, the Europe ruled the world by force. They had colonies all over the world. However, in the Post World War 1 era, they are using a different trick and a trap. Basically, they give us loans. They sell these loans on false grounds, using false economic theory, to deceive us, as elaborated by John Perkins in “Confessions of an Economic Hitman”, where he would do econometric analysis and show that it is in your benefit to take this loan and of course it was not, just like the Nigerian president Obasanjo, elaborated. So, today, loan and interest help in achieving the goal of extracting wealth from poor countries. As is evident to all, Pakistan, Turkey, and many other countries all over the world are trapped by the burden of foreign debt.

2.3        Global Financial Crisis

The global financial crisis of 2008 was caused by greed of western financial institutions, who got a return because of the existence of interest contract, even though they were not entitled to return. In fact, a book by Atif Mian and Amir Sufi titled, “House of Debt”, explains that if the contracts were done in some Islamic Finance form like Musharika, the global financial crisis would not have happened.

Bank made use of two haram instruments that lead to global financial crisis. First, the banks lent money to people for purchasing houses, knowing full well that they will not be able to repay and housing market would collapse. The banks did that because the return was not tied to the performance of loan. Secondly, the banks took the mortgage loan and created a new financial asset based on this loan. The person who took the loan has to pay the bank $100 per month for 30 years (for example) for a total of $72,000. The bank “sells” this stream of payments to Financier F, saying that you give me cash of $30,000 now, and you (F) can collect $72,000 from this borrower. Of course, the bank knows that the borrower may not be able to make the payments, but the financier F does not know this, and he might think this is a good deal.  Now this is haram according to Islamic principles: the bank cannot sell debt.  Because of a lot of such fraudulent transactions took place, the end result was a global financial crisis when the housing market collapsed.

The underlying spirit of capitalism is to make profits regardless of consequences to others. I am selling you a mortgage loan and I know that you will default but it’s not my job to tell you to protect yourself. You should lookout your interest and I am looking after mine. This is called the jungle of cut throat competition. This is how efficiency is achieved.

3         Dramatic Contrast in Functions of Banks and Islam

So, the banks breed concentration of wealth – the wealthy have many different techniques they use to safely create a lot more money. These financial techniques which involve trickery and manipulation of millions of dollars are not available to the poor, who can only earn a small return on their money and labor. This is in conflict with Islamic principles. Islam encourages the circulation of wealth. So, how can we make a bank Islamic, when the objectives, it is designed to accomplish are not Islamic? After Khyber, people went to the Prophet (PBUH) and said we have lots of money, what should we do with it? The Prophet (PBUH) said, “Put this into Waqf”. If you have more than what you need then you should spend on other people. This is the exact opposite of the capitalist idea, that if you have excess money you should use it make even more money, even if the process causes lots of losses to others.

4         Paradox of Islamization

In 2002 Dr Muhammad Sayyid Tantawi, Shaykh-ul-Azhar  in Egypt gave a fatwa which said the interest is permissible. When asked to explain, he said that look if you shut down interest, people would starve. And actually, it is a technically correct statement. In a sense that if today, a law is passed banning interest in Pakistan the economy would collapse. The banks are necessary within a capitalist system. So, Shaykhul Azhar said that interest is permissible, because this is the position of Islam: that if something is necessary for survival then it is permissible. You can even eat pork if you are hungry and there is no alternative food. So, the banks are necessary in capitalist system. If you say that the whole system will remain capitalistic then there is need to Islamize the banks and this is the position that has been taken by Ulema. If you change the whole system then there is no need of a bank.

Actually, first generation of scholars, strongly rejected the capitalist models of finance. In order to get to genuine Islamic models, you need to make revolution, you cannot make evolution. Small changes in capitalist system cannot lead us to an Islamic system. You have to make big changes. Unfortunately, even big changes may not succeed: Revolutions which were successful like in Iran and Afghanistan, were unable to create an Islamic system. This is because a society run on basis of Islamic institutions has been lost and forgotten, and nobody knows HOW to create genuine Islamic society and institutions – social and financial. In Pakistan, Islamic economists were asked, if we give up interest then what is the non-interest-based system and there was no answer to this question. We didn’t have anything other than 2nd rate copies of western models.

5         Humans: False Assumptions and Islamic Understanding

The reason for our difficulties in creating a genuine Islamic Institution have to do with our absorption of false ideas and theories from the West.

5.1        False Assumptions About Humans

There are certain assumptions that are made about human beings in economic theory. Assumptions like, human beings are naturally selfish and their goal is to maximize consumption. If we are selfish and we accumulate wealth, this will create paradise on earth because we will have lots of goods and that’s what paradise is. All of these are false assumptions but are widely believed, even by Muslims.

So, first thing that we need to do is Tazkiya. We have to clean our hearts of the poison that we all have absorbed and certain ways of thinking that have been developed because of living in market society.

5.2        Islamic Understanding of Humans: Sophisticated and Complex

Now the Islamic understanding of human beings is very sophisticated and complex, not easily understood even by Muslims unfortunately. Islam says that the heart of every Muslim is a battle ground between good and evil. Muslims are free to choose the evil or the good. So, the problem is how to make people prefer the good and reject the evil.

Actually, lots of evidence exist for showing that actually human beings are very generous and charitable. They give even though they are not compelled to. According to Islamic understanding, every human being has the tendency for selfishness and for being generous at the same time. So, the question is how can we intervene? How can we arrange things, so that people act nicely, so that they are encouraged to do good and prevented from doing evil? This idea of Amr-bil-Maaroof and Nahi-Anil-Munkir is at the heart of Islamic Teachings.

6         Bank versus Waqf

The banks express the spirit of hoarding, accumulation and they encourage the tendency towards greed, selfishness and not caring about others. This is the central institution of the capitalist society.

For a thousand years, Islamic society dominated the world and they didn’t have banks. The spirit of Islam is not of hoarding, it is of giving and Waqf is the institution that expresses this spirit. If a person had excess money in capitalist society he wants to earn interest but in Islamic society excess should be spent on others. In the Ottoman empire, 1/3rd of the land was registered for Waqf. Historians have documented that, everybody could eat, everybody who wanted education, could get education. There was no concept of tuition fee and every body was provided health service for free by the state.

7         Replacing Banks

There are two different objects that have been combined in banks. One of the object is, if somebody has money, he wants to keep it safe, this is called “Amanah”. This comes from the time of Prophet (PBUH) and such an institution can be built in an Islamic society. Second thing is that one would want to invest the excess money. This is also possible in an Islamic society. The Prophet (PBUH) before his prophethood took money from Meccan Traders and did business and gave them return. This use of money for joint business ventures with profit sharing is also possible. But these two are SEPARATE institutions and they cannot be combined. Interestingly, even secular economists have understood the harm that results from combining these two functions of keeping money safe, and of investing money in risky ventures – ultimately, banks end up using and losing depositors money. This happened in the Great Depression, when banks lost huge amount of money, and millions of people lost their life savings. The Glass-Steagall Act was passed in 1934, after the Great Depression to prevent banks from investing in stocks and risky assets. As a result there were no banking crises in the USA for more than fifty years. Then in 1999, the Glass-Steagall Act was repealed. Only a few years later, the Global Financial Crisis of 2007 occurred for precisely the same reasons – the banks started gambling with the depositors money. See Completing the Circle: From the Great Depression 1929 to the Global Financial Crisis of 2007

8         Bold Steps Needed by Muslims:

So, today we need to make many bold steps. The Prophet (PBUH) created a revolution in history. He took the backward and ignorant Arabs and made them, leaders of the world. Today, Muslims have parliaments/ democracy not Khilafa/ Shoora. Western laws/ courts, not Sharia/ Qazi. Today, we pay for schools, which provide a Western education, and there is no universal education, and no genuine Islamic education. Today, we don’t follow Islamic laws in trade and business rather follow Jews/ Christian. So, in order to arrive at Islamic model, we need to make very radical changes, not minor modifications. All institutions, social, political, economic must be changed. The first thing needing change is the mindset which evaluates everything in terms of money because of living in the market society.

We need to be one community. The Ummah is like one body. If one part is in pain, then all parts, feel the pain. These are all revolutionary ideas that Islam brought and implemented. But today these ideas are so far away from our lives that we think of these ideas as foolish. But, actually the Prophet (PBUH) did it and showed that it is possible.

One of the requirement of the shariah is to feed yourself and your family. If you do that with the intension of obeying Allah then earning money for yourself and family is also worship. It is not selfish and greedy.

In my paper titled “Building Genuine Islamic Financial Institutions”, I have described many different things that Muslims can do which other people cannot do, which will create very new and very different types of financial institutions which cannot be replicated in the west.

1400 years ago, Islam took ignorant and backward Arabs and made them leaders of the world. Today, Islam has exactly the same potential. Unfortunately, today, we think that our path to salvation lies in following the west not in understanding, reading and implementing the Quran and Hadeeth in our lives. Today, we think that Quran and Hadeeth are obsolete. These were good, 14 centuries ago, but these are no longer useful for us in our modern lives. So, if I say that today if you want to solve the economic problems of Muslims, you will get more guidance from Quran and Hadeeth than you will, from a PHD at Harvard, people don’t believe this. The opportunity to embrace the golden gifts of God, and lead the world out of its current darkness awaits the awakening of the Muslims to the light of the Message, which shines as brightly today as it did 1400 years ago.

This entry was posted in islamic economics by Asad Zaman. Bookmark the permalink.

About Asad Zaman

BS Math MIT (1974), Ph.D. Econ Stanford (1978)] has taught at leading universities like Columbia, U. Penn., Johns Hopkins and Cal. Tech. Currently he is Vice Chancellor of Pakistan Institute of Development Economics. His textbook Statistical Foundations of Econometric Techniques (Academic Press, NY, 1996) is widely used in advanced graduate courses. His research on Islamic economics is widely cited, and has been highly influential in shaping the field. His publications in top ranked journals like Annals of Statistics, Journal of Econometrics, Econometric Theory, Journal of Labor Economics, etc. have more than a thousand citations as per Google Scholar.

10 thoughts on “Building Genuine Islamic Financial Institutions

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  6. Assalamu alaikum prof. may i translate your article to Indonesia language? this is not for profit, only for more knowledge sharing and to be more understood by Ummah. jazakallahu khaeran

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  8. This article, by Asad Zaman, shows that from the time of Abraham mankind has invented two economic philosophies, which have driven Christians and Muslims apart–the opposite of what should have happened.

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