Home' Trinidad and Tobago Guardian : June 22nd 2017 Contents BG14 | FINANCE
BUSINESS GUARDIAN guardian.co.tt JUNE 22 • 2017
Finance and Islam
This weekend Muslims in
T&T and around the world
celebrate Eid-ul-Fitr. Today
I focus on some aspects of fi-
nance as seen from an Islamic
Start by imagining a world without either
the receipt or payment of interest. The prohi-
bition of receiving and paying interest is well
documented in Islam even if it is not as widely
practiced as it is supposed to be. However, this
is not a construct that is unique to Islamic the-
ology and students of the Old Testament can
cite many references where interest is either
prohibited or limited to some degree.
These prohibitions are no longer widespread
as the entire model of Western finance and,
for all intents and purposes, global finance is
based on the premise that interest is the price
Nobel Prize winner Muhammed Yunus in his
2007 book, Creating a World without Poverty:
Social Business and the Future of Capitalism,
stated that: "Giving the poor access to credit
lets them immediately put into practice the
skills they already have."
Former Governor of the Central Bank of India
Raghuram Rajan in his 2010 book, Fault Lines:
How Hidden Fractures Still Threaten the World
Economy, pointed out that there are dangers
to freely accessible credit in that it can also
facilitate overconsumption, reflecting a lack
of self-control and essentially mortgaging
tomorrow to enjoy today.
Conventional finance argues that it is the rate
of interest that is the arbiter of two credit sce-
narios mentioned above. Implicitly, it means
that the poor person accessing credit should
pay a high interest rate because of their risk
profile and those that seek credit for consump-
tion should be given that opportunity so long
as they are able to repay.
The rate of interest should reflect the risk
associated with the lending, in other words, an
individual's ability to repay should be linked
to the level of available credit. The higher the
demand for credit, the higher the rate of in-
terest and the lower the demand the lower the
rate of interest.
Interest is therefore the compensation paid
by the borrower of capital to the lender, for
permitting him to use his funds.
A typical economic definition puts interest
as the rent paid by the borrower of capital to the
lender, to compensate him for the loss of the
opportunity to use the funds when it is on loan.
It can be likened to the decision not to live
in an apartment or house that you own. One
would, in such circumstances, rent it out to a
tenant. The tenant pays a monthly rental be-
cause as long as he is occupying the property
the owner is deprived of the opportunity to
The same principle is involved in a loan of
funds. The difference is that the compensation
in the case of property is rent, whereas in the
case of capital, it is interest.
The suggestion here is that the rental of an
asset (the house) and the rental of money is
effectively the same type of transaction even
though one involves the rental of money and
the other the rental of a real tangible asset.
Further, there is the assumption that there is
always an opportunity cost for surplus capital.
Finance through the lens of Islam has a
different premise. It starts by focusing on the
surplus as just described.
By definition a surplus suggests no existing
need or use and argues that if there is currently
no existing need or use for the available funds
then there can be no opportunity cost associ-
ated with those funds.
The question then becomes: what is the
justification for charging interest to provide
someone with access to your funds if it was
truly surplus to your needs and there is no
opportunity cost of ownership?
Conventional finance answers this on the
basis that money has a time element to it and
so even funds for which there is no use---lent
at a point in time to be repaid at a future date
---introduces an element of risk as the future is
uncertain. That charge for uncertainty forms
part of the interest charge.
Further, even though the funds are surplus
to the owner, by lending, it confers a benefit
to the borrower and so the owner must be duly
compensated for the use of their funds just
as the property owner is compensated for the
rental of the unused home.
The Islamic perspective counters that argu-
ment through the definition of money.
In Islam, money is seen as a medium of ex-
change, a store of value and a measuring tool. It
is not a commodity to be traded. Based on this
view of money, in a transaction involving two
or more parties money carries a passive role.
Money, itself, cannot be traded for profit and
so it is not possible in the context of Islamic
finance to benefit from the trading in money
as if it were an active part of the transaction
analogous to a commodity.
From an Islamic perspective lending money
is not something that can be done for profit.
A common conclusion is that the Islamic
approach does not recognise the time value of
money but this is not the case. What is pro-
hibited is any claim to the time value of money
as a predetermined quantity calculable at a
predetermined rate, in other words, interest.
The argument is that it is not sufficient to
assume there is an opportunity cost to holding
surplus funds as a justification for charging
someone interest to use these funds.
The onus is put on the owner of these funds
to find the opportunity (or have an agent source
the opportunity) and once this opportunity is
found translate the surplus funds into a real
asset by engaging in a partnership with the
entity in need of the funding.
By translating the funds into a real asset that
has an underlying use, it is no longer surplus. It
is, in fact, now put to use and the compensation
for its use is the charging of an economic rent
which can be accumulated over time as per
the example of the rental of the house above.
The fundamental argument is that interest
is an unjust mechanism for generating a return
as it is in many ways exploitative and can also
lead to an allocation of capital to activities that
The theory of Islamic finance argues that
there should be a more "equitable" distribu-
tion of risk and returns between borrower and
lender and advocates the use of a mechanism
known as profit and loss sharing.
Consider the scenario where interest is
charged in a transaction involving a borrower
and a lender. If the project is a very viable one
then the risk/return dynamic of the transac-
tion is skewed in the direction of the borrower.
In such a scenario, the borrower carries a
small risk of any losses but they also enjoy the
potential for outsized returns if the transaction
funded by the loan is very successful.
On the other hand, the lender is likely to
generate a single return regardless of how the
funds are utilised since the interest rate charged
is irrespective of any other factors.
For a marginal project exploitation may
be the end result from lending on interest. A
borrower is one who is experiencing a deficit
of capital while a lender is one with surplus
Generally speaking, it is the wealthy that
will be the owners of surplus capital and if
that capital is lent based on a predetermined
return in the form of interest which is paya-
ble regardless of the outcome of the use of the
funds then it can be argued that the skewed
risk/return trade-off is directed towards the
party who can ill afford such a dynamic (the
borrower) while the wealthy are faced with a
more stable risk/return dynamic despite the
fact that they may have the capacity to take
on greater variability of outcomes.
One may take a step back from the transac-
tion itself and consider interest in the context
of the broader economy.
Recognise that the issue of fairness is not
unrelated to the issues of productivity and ef-
ficiency. The basic point here is that a more
"equitable" risk /return profile for both bor-
rower and lender allows for a more compre-
hensive evaluation of any venture requiring
third-party funding and, therefore, leads to a
more efficient allocation of resources resulting
in a stronger, more productive and inherently
more stable economy.
The bottom line is that from the perspec-
tive of Islam, finance it is not of the view that
the interest rate or the availability of credit
should be the arbiter on a project but rather
a risk/reward trade off that involves both the
provider and the user of capital via a profit
It's a different concept but one that may
become more relevant as the global debt bur-
Ian Narine is an investment adviser registered
with the SEC and can be contacted at ian.
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