----------------- HES POSTING -----------------
You might be interested in the following review by a Hindu (myself) in the
Journal of the Christian Economists (UK) of the book referred to by Elias
Khalil in an earlier posting.
Perhaps this may provide at least something of a cross-cultural perspective on
the subject.
Prabhu Guptara, Switzerland
(Review Article for The ACE Journal (U.K.), no. 27, 2000, pages 32-43)
[NOTE: THE ACE Journal permits further publication of articles published there, and this
article is distributed here without violating any copyright laws. - RBE]
Islamic Finance: Theory and Practice
by
Paul S Mills and John R Presley
Macmillan Press, UK, 1999, hardback, 171 pages, £45.00
Why should members of ACE be interested in a book on Islamic finance? Because
the Islamic financial system is at present the only reasonably well-articulated
major contender against the current materialist economic system (capitalism),
and because Islamic finance is based on tenets curiously parallel to those in
the Old Testaments. Examining the case for and against an Islamic financial
system may also help us to consider the case for and against developing a
genuinely Biblical economics. Further, one might wish to consider that, as the
failure of the Church adequately to address its prophetic duty on the issue of
social justice in the nineteenth century led to the creation of Marxism, and as
the failure of the Church adequately to tackle the desire for peace and a new
world after World War II led to the birth of 'flower power' and the New Age in
the Sixties, so the failure of the Church adequately to tackle the challenges
of capitalism is leading at the moment certainly to individual conversions to
religions or philosophies which are perceived as offering some hope regarding
the key issues of global capitalism such as social justice, animal rights and
environmental care ('sustainability'); if the Church continues to fail in its
prophetic duty to address such issues, we may well see the development of
another soul-less and therefore ultimately destructive mass alternative to
global capitalism.
Mills and Presley observe that "the financial headlines continually bear
testimony to the recurring problems of our current approach to banking and
finance, (so) it is right to consider whether a more fundamental response than
the usual palliatives of more bailouts and regulation is needed" (p. viii,
parenthesis mine - here and throughout this article). Islamic Finance is
therefore "motivated by the suspicion that there is another way. In particular
that the critique of interest-bearing debt finance has more economic cogency
than is assumed by mainstream economics. The book begins by setting the Islamic
critique of interest and proposals for a non-interest banking system in the
context of the Islamic approach to economic analysis. It then develops the
theoretical properties of the non-interest model and assesses the recent
experience of Islamic banking in practice, before outlining the economic
benefits (and costs) of a non-interest financial system....". (p. viii)
The salient feature of Islamic finance is its rejection of usury (which, being
interpreted into modern English, is the rejection of all interest). Mills and
Presley conclude their book with a consideration of the prohibition of interest
in the West but, for people who accept the authority of the Qu'ran or of the
Bible, this is probably the best point at which to begin. The authors remind
us of facts we conveniently choose to forget, if indeed we have ever come
across them in the course of our indoctrination into materialist economics.
For example, "the Western belief in the benign results of interest-based
financial operations is historically relatively novel. More typical has been
the attitude of the English Puritan(s) ... to the effect that lending at
interest is inherently exploitative" (p 101). Why has the consistent Western
tradition of opposition to usury been lost? Due "to the divorce of ethical
debate from economic theorizing" (p. 101). When was the historic opposition to
usury dropped in the West? The authors date this to the period after Calvin,
though this is in my reading historically mistaken, and ought to be traced to
the introduction of the distinction between usury and interest by the Roman
Catholic Church in the thirteenth century.
In any case, the authors argue, "there was far more economic sense in the
...opposition to interest than is currently assumed." (p 101). This case the
last chapter sets out to explore. The chapter starts by clarifying that the
distinction between 'legitimate' interest payments and 'unjust' usury was
originally intended only to indemnify the lender rather than to provide a
financial return. (It is worth noting, however, that in the Bible, standing
surety is roundly condemned too, from which one might draw the principle that
indemnifying the lender is as unsound as is usury). "The number of instances
when such payments were deemed legal was gradually increased until most loan
charges were legitimized under the guise of 'compensation'. Lenders persisted
with the euphemism 'interest' in order to avoid the unwelcome associations of
'usury'". (p. 102)
Mills and Presley's summary of the Western opposition to interest begins with
the well-known Deuteronomic prohibition of interest, reinforced elsewhere in
the Old Testament. The authors seem to think that there is "no explicit
rationale for the prohibition given in the texts themselves" (p. 103) - a
belief which appears to me to be sustainable only if one confines oneself to
the specific verses in question. However, the context of these verses makes it
clear that the prohibition of interest was part of a larger
spirituo-socio-politico-economic system in which there would be 'long life',
'none of the diseases' which plagued the Egyptians, 'peace and plenty' and 'no
poor' people (because, though there would always be some income differences,
poorer people would be taken care of by the generosity of those who were
richer, by the system of tithes and offerings, by the restriction on
collateral, by the prohibition of usury, by the generous provision for freed
slaves, times of festival, the cancellation of debt, and so on; see Deut. 4.49;
5.29 & 33; 6.2; 7.14 & 15; 14.22-28; 15.1-18; 16.9-17; 24.8, 12, 14, 17, 19-21;
26.12; 28.11-12 et al). So the creation of a society based on interest, inter
alia, militates against these promised benefits. That is the rationale for the
prohibition of interest - though of course there is no 'economic' rationale
provided in the texts which makes sense in modern economic terms; in other
words, the question here is: 'logic' or 'rationale' by whose definition?
The authors are right, however, in pointing out that post-prophetic rabbinical
teaching explained the prohibition "largely in terms of encouraging charity
and community feeling, rather than declaring interest to be inherently unjust.
Jewish communities have tended to observe the prohibition of interest amongst
themselves but charged interest on loans made to Gentiles (following the
brother / foreigner distinction of Deuteronomy)" (p. 103). Among the Greeks,
"only Plato and Aristotle voiced outright opposition to the very existence of
interest within Greek thought....interest free lending to family and friends
was greatly esteemed within ancient Greek societies, (but) interest was
regarded as legitimate if charged on an impersonal or business loan - echoing
the Old Testament injunction" (p. 103). Roman authorities were "far more
interventionist, however, as the perpetual indebtedness of peasant farmers, and
the severe penalties for default, resulted in periodic debtor revolts. The
maximum interest rate was set at 10 per cent in 450 BC but eventually lowered
to zero in 342 BC. This outright prohibition quickly became obsolete in
practice, but was periodically revived during debt crises. Sulla eventually
adopted the customary rate of 12 per cent as the legal maximum in 88 BC, which
continued until the fall of the Western Empire" (p. 103).
However, the authors are again on tendentious ground when they declare that the
New Testament makes "only passing reference to interest..... Most relevant is
Jesus' teaching to his disciples on lending ('If you lend to those from whom
you hope to receive, what credit is that to you? Even sinners lend to sinners
in order that they may receive in return the equal amount. But love your
enemies, and do good and lend, despairing of nobody'). An idiomatic rendering
of the final phrase would be 'lend, without hoping for any return'. Whilst
Jesus is clearly advocating a radically liberal approach to lending, it is not
clear what is to be forgone - interest, principal or the hope of reciprocal
favours" (p. 103). The authors' commentary is weak because the text clearly
contrasts the usual practice among 'sinners' of lending to others in hope of
getting back 'the equal amount' (no expectation of interest, even among
sinners!) with the practice, commended by Jesus, of not lending only to those
from whom we might hope to receive anything (no reciprocal favours!) - rather
of lending even to those from whom we despair of receiving the principal.
'Lending', in other words, is to be done simply as a 'good' in its own right.
The believer is to give freely and liberally, expecting back neither interest
nor principal - nor indeed reciprocal favours - in contrast to the calculating
attitude of unbelievers. (In a similar vein, see also Jesus' teaching on
luncheons and dinner parties, Lk 14: 12-14; and on the otherwise
easily-declinable appeals of beggars for one's cloak; as well as on the unjust
but legal demands by Roman soldiers requiring one to carry their luggage for a
mile).
Other explicit references to interest, point out the authors, come in the
parables of the ten talents or minas. "By implication, these references
describe interest as 'reaping where one has not sown'". (pp 103-104).
In any case, as a result of the Biblical teachings, interest was formally
proscribed within the Church by the Council of Elvira (306 AD) and the Church
Fathers were unanimous in condemning usury for greed and uncharitableness. St
Augustine went further and declared usury to be a variant of theft and so
inherently immoral, though interest was first proscribed for all citizens by a
Western legislature under Charlemagne in 789. Until approximately 1050,
interest-taking was considered to be a sin of greed and lack of charity.
However, the commercial revival of the late eleventh century and the ensuing
increase in demand for business loans tempted theologians to reclassify usury
as a sin of injustice. This was also the time when the distinction between
interest and usury came to be accepted though the harshest anti-usury Church
legislation was passed by the Council of Vienna (1317), which called for the
excommunication of usurers as well as the excommunication of any ruler who
sanctioned usury. In other words, usury was classed along with heresy. The
theoretical ban on usury continued till the late eighteenth century in Roman
Catholic Europe (Mills and Presley claim that the Vatican formally recognised
the legitimacy of interest only in 1917 though this is debatable) and it would
be useful to know to what extent it applied in practice in Roman Catholic
Europe. In Protestant Europe, the ban on usury continued only till the
sixteenth century, when Calvin's grudging acceptance of it when applied to
borrowings by rich people opened the door to the legitimisation of interest.
>From 1600 onwards, the debate in fact shifted from whether to proscribe
interest altogether to which rate was most expedient to have as the legal
maximum. Ultimately, the debate shifted to whether a legal maximum could be
justified at all, for instance in the writings of Jeremy Bentham, which carried
the day, resulting in the 1854 Moneylender's Act that abolished the 5% usury
law and allowed lenders to charge at any rate. A limit of 48% was reimposed in
1927 in an attempt to protect vulnerable borrowers. However, since the passage
of the Consumer Credit Act (1974), even that restriction was removed -
borrowers must instead demonstrate exploitation to a court given their
circumstances. There is no definition of exploitation in the legislation, and
I understand that there is no case law on the subject.
Briefly, we may say that there is a strong case against the taking of interest
through the centuries of Western thought and that the theoretical and spiritual
grounds for the ban on interest have never been countered. These grounds focus
on the Biblical attitude to charity, justice, social divisions and societal
health, to relationships, to work, to risk, to money and to time: "Eventually,
the whole usury debate turns on our attitude towards time. The justification
of interest entails the claim that, quite literally, 'time is money'. Since
the mere passage of time supposedly alters the value of assets, money and
satisfaction automatically, their forfeiture over time (through a loan)
automatically justifies interest as compensation. The opponents of interest
would dissent. Since nothing is certain in time, we ought not to act as though
it is. Contingent profit-share and rental contracts allow for positive returns
to be made, and the services of durables to be enjoyed, over time. But they do
not presume that the mere passage of time necessarily affects anything.
Hence, it is unwarranted to justify discounting through positive time
preference" (p 110-111). I am not sure that rental contracts are Biblical
either, but let that pass, for the moment.
After piling up the case against interest on ethical, legal and economic
grounds, the authors conclude lamely: "While this accumulation of evidence
against interest might seem compelling to some, unfortunately the case for the
prosecution has one major flaw. Most of its arguments are predicated upon
initial premises - be they religious, ethical or legal - that are not
unanimously held. If usury could easily be equated with an obviously immoral
act, such as theft, then the case for prohibition would be clear" (p. 112).
The problem with this position is that, in our pluralistic world, there is no
act which is "obviously immoral" - or at least there is no act whose immorality
is obvious to everyone. Robin Hood did not consider theft immoral. Nor is
theft necessarily considered immoral by certain socialists on the one hand, or
on the other by muggers and street louts. In fact, the prohibition of theft
has no adequate moral basis outside the Semitic religions, since it is
sanctioned at best by tradition, rather than being rooted in the character of
God and of the universe as it is in the case of the Bible.
Internationally-accepted moral standards in relation to murder, monogamy, work
and most other matters originate within the Semitic religions and certainly
have no unarguable validity in materialist humanism. So I do not understand why
the authors abandon for perceived political correctness the case which they
develop with such intellectual rigour.
The authors go on to argue that "the practical drawbacks to interest ....must
be weighed against the pragmatic disadvantages of its prohibition. In
particular, the proscription of interest in a society uncommitted to the
underlying requisite religious or ethical ethos will merely result in a
thriving black-market for loans - with suitably adjusted risk premie - and the
proliferation of contractual devices that disguise interest as profit, rent or
unconnected favours. ...While compelling grounds can be given for the
rationalization of the Biblical prohibition of interest, their acceptance
depends on prior commitment to particular religious or ethical norms....Without
moral pre-commitments, the usury debate becomes a pragmatic one. Whilst there
are many practical disadvantages to a free market in interest-bearing
loans....Western countries have been stripped of the religious and ethical
presuppositions conducive to the proscription of interest. (p 112-113). This
is surely going too far. While it is true that there appear to be fewer and
fewer people in the West with an a priori commitment to particular religious
practices, it is also true that there are more and more people with an a priori
commitment to ethical norms which are coming to be seen as universal, such as
human rights, honesty, transparency, and so on - though it probably ought to
be added that such commitment in many instances may be much weaker than among
those with specifically religious beliefs.
In any case, the authors conclude that "if the legitimacy of interest is to be
seriously questioned again, the debate must hinge on the feasibility and
practical benefits of a non-interest financial system, which have been examined
in the preceding chapters" (pp 112-113). There is much merit in such an
approach, though in our day one ought to add the consideration that any
usurious economic system is also a high-growth system since it minimises risk
for the lender, guaranteeing returns and making capital accumulation possible.
In a non-usurious economic system, the only way of accumulating wealth is by
hard work (which has its limits), by risk-sharing methods of wealth-generation,
or by looting, theft and other immoral means (all of which also have their
limits). In historic or traditional non-usurious economic systems, group
cultures generally further militated against high growth rates by encouraging
conspicuous consumption usually of a public sort (monuments, feasts) while
conspicuous consumption of a personal sort was not discouraged. The Protestant
contribution to reversing these cultural attitudes is well perceived
historically, a la Weber and Tawney, though its precise role in so doing is
hotly contested academically (was it the sole cause? was it the sufficient
cause? did or do such reversals happen elsewhere? and so on). The merit of a
usurious high-growth economy is progress in the supply of material goods. The
demerits of a usurious high-growth economy are that it inevitably increases the
gap between the poor and the rich, does not necessarily or by itself contribute
to the alleviation of poverty (and can in fact increase poverty), and has in
any case since the eighteenth century contributed to global environmental
degradation (even though it has contributed also to "local" environmental
improvement). There is an open question about whether a high-growth economy by
its very nature grows faster and faster and whether, when it becomes a global
high-growth economy (as it has since more or less the last ten years), it
becomes cancerously uncontrollable from an environmental point of view. There
are "believers" and "sceptics" on both sides of this debate but I mention it
here only to place it on the table as the authors do not seem to me to take
sufficient cognisance of this issue, which must also be placed in the balance
when one considers whether to press or to abandon the case against usury.
We come now to the rest of the book. As the chequered history of usury in the
West shows that there was a gulf fixed between theory and practice for most of
the time that usury was banned, so the experience of the Islamic opposition to
usury too reveals that the theory and the practice of Islamic finance have a
large gulf fixed between them. What is the reason for these gaps? The general
impression is that this is because the idea of Islamic finance is inherently
unsound, just as the idea of an Islamic society is backward-looking. (Compare
the fact that if the notion of "a Christian society" still appeals to some
people, the notion of "a Biblical financial system" usually seems strange -
even though there is general agreement that neither capitalism nor socialism
are inherently Biblical.) The authors structure their work as follows:
Chapter 1: The Background to Islamic Economics and Banking (and a brief
discussion of its guiding principles)
Chapter 2: the Islamic Critique of Interest (with the relevant textual
evidence and subsequent casuistry, as well as Islam's legal, ethical and
economic critique of interest, examining especially Islamic definitions of
money and capital)
Chapter 3: The Interest-Free Financial System (elaborated by Islamic
theoreticians)
Chapter 4: Modelling Profit-and-Loss Sharing
Chapter 5: Non-interest Banking in Practice
Chapter 6: Non-interest Finance and Macroeconomic Stability
Chapter 7: Key Issues in the Islamic Financial System.
It is not possible to describe and discuss each chapter in detail; I will
mention, describe or discuss matters according to the degree to which they
appear to me to be of possible interest to readers of ACE.
1. "The devout Muslim with disposable wealth has always faced a dilemma.
Qu'ranic opposition to interest is clear, but so too is the condemnation of
hoarding and wasteful consumption. The impasse is that of having wealth to
save but few legitimate financial instruments with which to do so" (p 15).
However, the dilemma arises only because of human fear and greed - in the
Qu'ran as well as in the Bible, excess wealth is meant for hospitality, support
for the poor, and so on. An Islamic society (as also a society governed by Old
Testament or New Testament values and beliefs) is a society in which there is
equality of opportunity for everyone to develop and apply their talents to the
fullest possible extent, the rewards of which are not meant to be hoarded or
loaned on interest but are meant to be enjoyed along with others, though not in
a wasteful manner. So what is one to do with excess wealth? It is intended to
be given away. This requires supernatural reliance on God in order to counter
the fear and greed which naturally attends the accumulation of wealth - a
fundamentally different attitude from that of the worldling who is concerned
with the accumulation of wealth for its own sake or as a means of keeping
uncertainty and mortality at bay for as long as possible. If Islamic society
hoards in spite of clear Qu'ranic teaching to the contrary, this is because
there is no supernatural life there, just as evidence of this and other sins in
Christian communities is evidence of lack of experience of God's power there.
2. The problem for "devout Muslims" (with financial hoards estimated to be of
the order of $80 billion in Muslim countries in the early 1980s) therefore
became that of how to devise financial intermediaries that operate without
resorting to interest but which still yield a return to depositors. "The
achievement of Islamic economists and bankers has been the conception and
elaboration of such a structure" (p 15). Undeniably, this is an achievement
but, much as the development may delight economists theoretically, the
achievement is a sort of Pyrrhic victory: Islamic theoreticians have created
what neither the Qu'ran nor the Old Testament nor indeed the New Testament ever
intended to be devised. That is why it leads Islamic scholars into the sorts of
difficulties and disagreements in which they find themselves and it is also why
it leads Islamising societies into the practical difficulties their economic
systems face as a result. Those who find this saying too hard will naturally
commit themselves to something along the lines of current theories of Islamic
finance which are, I agree, an achievement which centres round the elaboration
of the theory of "interest-free banks" or structures for profit- and
loss-sharing (PLS). The authors go on to discuss issues in the theory of
interest-free finance specifically in relation to trade and consumer credit as
well as government borrowing and monetary policy.
3. "The framing of a theoretical Islamic model society (is) relatively easy.
However, like other theocratic ethical systems, Islam can diagnose what is
currently wrong and describe the "perfect" society, but is less certain about
what to do if people refuse to conform to Islamic moral standards....Islamic
economics also includes the evaluation of the government initiatives and legal
reforms needed to transform current institutions and modes of behaviour in
Muslim societies into those which conform to Islamic norms....building bridges
between the "is" and the "ought" ....This leaves ample scope for divergence of
opinion because scant guidance is given in Islamic law on such pragmatic
questions" (p. 2). This is not quite true; both Biblical and Qu'ranic guidance
is available: those who do not obey must be appropriately punished and,
depending on the severity of their disobedience, even killed - but our times do
not cope with the logic or the necessity of this, regarding this sort of thing
as primitive and barbarian when the problem may be our own social and spiritual
blindness.
4. The debate regarding interest-free banking "has remained entirely
theoretical, however, primarily because the existing private Islamic banks
which have to hold 100 per cent demand deposit reserves are enormously
disadvantaged in free market competition against conventional banks" today (p
18) which can leverage their deposits with international legitimation by 850%
and indeed by more than this in some parts of the world. "The jury is still
out on PLS banking because ... countries (which) have abolished "interest"
without committing themselves to a full-blown PLS system....remain open to the
charge that non-interest banking has been instituted merely to salve the
consciences of pious depositors rather than to make a radical impact on how the
financial system operates" (p 57)
5. While the authors are right in noting similarities and correspondences
between Islamic, Hebrew and New Testament thinking, they seem to think that
these similarities are fewer than is in fact the case. For example, it is not
only the Qu'ran but also the Old and New Testaments which are primarily
theocratic (other rulers are regarded as being instituted by God and therefore
worthy of respect and even obedience only so long as these rulers act in
consonance with God's revealed ways). Again, it is not only Islamic social
thought, but also Old Testament and New Testament social thought, which is
organised by the principle that "the spiritual and moral takes precedence over
the material and pragmatic, based on the assumption that human happiness is
ultimately to be found in moral obedience rather than material ease" (p.2).
This is also the case, mutatis mutandis, with belief in a life beyond that of
this earth; with the teaching that God rewards and punishes us in that life on
the basis of the principles on which we have acted in this life; with the
rejection of the notion of inalienable property rights in favour of the status
of trusteeship of all that is justly acquired by us; the condemnation of
hoarding, squandering and denying to the poor; the duty and indeed importance
to God of our work; belief in justice, equality of opportunity, and so on.
6. "What distinguishes Islamic thought from Judaism, Christianity and even
Muslim pietism is that the jump from individual obedience to the transformation
of society is automatic" (p.2). This is debatable. Consider that the Mosaic
laws were given before the Hebrews went in to occupy the promised land
specifically in order that an ideal state and an ideal society might be built
there. Their society was to be a righteous one, in contrast to the sinful
societies which at that time occupied the land (the Hebrews had earlier been
told that they could not occupy the land for four generations because the
iniquity of the Amorites had not yet reached the depth which would justify God
bringing them judgement in the form of the entire elimination of those people
by the Hebrews; see Gen. 15.16). In other words, Jewish ethics starts
specifically in the context of the founding of a righteous state, and there is
as little distinction between individual and "national" matters in original
Judaism as there is in Islam. And, insofar as the religion of Jesus is
predicated on the failure of the "gathered" Jews to maintain the Mosaic law,
the new community of the followers of Jesus is intended to be a "scattered"
community, doing its work like yeast in "all the world". Further, insofar as
the instructions for the followers of Jesus are a stronger version of the
instructions given to the Hebrews, it is clear that the followers of Jesus were
meant to influence the world as yeast influences the rising of bread-dough
rather than be a national model to the world as in the case of the Hebrews. In
whichever part of the world the followers of Jesus were in greater
concentrations, it is clear that their influence would go beyond the merely
individual to the structural, creating relatively more model societies
everywhere rather than an absolutely model society in the promised land - till,
that is, the perfect society is directly introduced by God through the radical
structural transformation of the heavens and the earth at the completion of the
"end times" which were inaugurated by Jesus the Lord.
7. "At the outset there appears to be no fundamental difference between the
accepted economic objectives in the West and those of a truly Islamic economy.
The underlying feature of any economy must be the desire to achieve social and
economic justice." (p. 3). This is an astonishing statement, unlikely to
command agreement from Friedmanians and others who are much more concerned
about having instead a high-growth economy and who believe that minor matters
such as social and economic justice look after themselves by the operation of
Adam Smith's invisible hand.
8. "Islamic opposition to interest is primarily inspired by religious
adherence to the teachings of the Qu'ran. However, this has not prevented the
theoretical analysis and justification of a PLS (profit- and loss-sharing)
financial system in order to convince sceptics of the efficacy of Shari'ah
(God's laws). In their turn, the sceptics have countered with various
theoretical objections that are believed to render a non-interest system
impractical or inefficient." (pp 21-22). The authors present both sides of
the argument by outlining the theoretical implications of a PLS financial
system and assessing its feasibility in the light of conventional economic
theory and historical experience - coming out broadly in favour of a PLS
system.
9. Mills and Presley present a highly concise discussion (less than six pages)
regarding the principal agent problems in financial contracting, covering the
background, the case for debt finance with asymmetric information (and its
limitations), and the implications thereof for interest-free banking and
finance. The case for the defence of non-interest banking is similarly concise
(just over 4 pages), before the authors move to their assessment: they
acknowledge that financial contract theory poses a prima facie case against
non-interest banking. "However, the case against a non-interest financial
system is far from overwhelming. In practice, debt finance copes inadequately
with risk-sharing in an uncertain world and imposes its own significant agency
costs. Also, the practical difficulties associated with non-interest finance
are not insuperable. Monitoring costs can be reduced by randomized checking
and the handling of borrowers' transactions, whilst their incentive to cheat
can be restrained by intertemporal contracts which tie lower PLS ratios in the
future to satisfactory performance in the present. In particular, financial
contract theory and conventional banking experience suggest that PLS finance
will be far more feasible if placed within the context of long-term banking
relationships. " (p 32)
Having mentioned some ways in which a non-interest banking system might indeed
be superior, their overall conclusion is: "By stressing the intertemporal
nature of the financial terms on offer, a non-interest banking system should at least
prove workable" (p 33).
10. "The theoretical benefits and limitations of a non-interest financial
system bear a close resemblance to those of (M.L.) Weitzman's proposal to
replace flat-rate wages with profit- or revenue-sharing labour remuneration
arrangements....Weitzman predicts a robust economy with a cycle of diminished
amplitude and a tendency to full employment (because of) the stabilizing
consequences of introducing flexibility into the labour remuneration mechanism"
(p 34).
11. In a non-interest contractual system "the manager is left free to choose
the individually optimal level of investment in each state contingent on his
contractually specified level of effort. Such a contract permits a
mean-variance improvement in capital investment - average investment is
increased whilst inefficiently large fluctuations around this level are
reduced." (p 45)
12. "Conventional economics has neglected the role interest plays in fostering
wealth inequalities (and a) non-interest financial system would retain
substantial scope for inegalitarian flows of property income, but these should
be lessened by the absence of compound interest and the widespread sharing of
profits and losses with savers" (pp. 45-46).
13. "The quest to find workable (and beneficial) alternatives to interest has
strong implications for agricultural finance, particularly in developing
economies. The potential for rural moneylenders to exploit and enslave
smallholders through high rates of interest and input prices is
well-documented. Consequently, there is great scope for PLS development banks
specializing in agricultural finance and input supply" (p. 46)
14. "Rulers came to see Shari'ah as applicable to individual conscience but
not to social legislation" (p 49) - paralleling what happened in the West.
15. "The most frequently posited advantage of profit-and-loss sharing (PLS) is
its contribution to (economic) stability. Whereas conventional finance
supposedly amplifies the business cycle, PLS finance is predicted to dampen it"
(p 58). The case is examined by setting out the supporting monetary and
financial theories of the cycle and the ways in which non-interest banking
could alter matters. Wicksell, Hayek, Fisher, Minsky, as well as financial
cycle theories dependent on asymmetric information (the equity-rationing
approach and the agency cost approach) are all examined to consider
non-interest contributions to cyclical dampening (including the destabilizing
movements in the cost of capital, fractional reserve banks and credit
volatility, bank failures in depressions, speculative lending and borrowing,
non-contingent liabilities and debt deflation). The authors conclude: "Debt
finance has long been accused of contributing to cyclical
instability....However, this is one of the commonsense propositions that
economics has delighted in contradicting. (These theoretical rebuttals of the
impact of debt finance have been undermined by) the application of asymmetric
information considerations to financial relationships (which) has shown ways in
which financial structure can have an effect on the real economy. Secondly,
the increase in private sector indebtedness in the 1980s resulted in financial
fragility ... (which) contributed to the length and depth of the subsequent
recession. Two implications can be drawn...(First, it) is illogical that the
corporate tax systems of developed economies invariably favour debt over equity
finance. Interest payments are tax deductible whilst dividends and retentions
are considered as taxable profit. This reduces the cost of debt finance,
relative to the equity equivalent, by a company's marginal tax rate. This bias
needs to be eliminated not only on efficiency grounds, but also to encourage
greater resilience to financial shocks. Indeed, the externality costs of debt
financing indicate that the tax incentive should be reversed rather than
eliminated. (Second, the) growth in aggregate demand in Anglo-Saxon economies
is now closely tied to the private sector's willingness and ability to borrow.
That such debts are rarely indexed introduces an inflationary bias to the
output:inflation trade-off facing the monetary policy-maker, particularly on
the downswing of the cycle". (pp 70-72).
16. Clearly, interest-based finance may not be the only cause of instability
within capitalist economies. Equally clearly, a non-interest economy may not
be without cycles. But, the authors conclude: "a non-interest economy would be
more stable than its debt-financed counterpart. The benefits, in terms of a
lower cost of capital and a more advantageous output:inflation trade-off would
be considerable" (p 72).
17. In chapter 7 ("Key Issues in the Islamic Financial System"), though the
authors acknowledge that the issue of equity deserves full consideration
because it is in some ways an even more significant, they choose to focus on
only four issues: savings behaviour, the allocation of loanable funds, bank
stability and public finance, and government borrowing. "A potential
theoretical weakness of proposals for a non-interest financial system that is
often alleged is their possible impact upon savings behaviour" but, on the
basis of considering the insignificance of return-related savings, the reaction
of savers to greater return variance and the riskiness of PLS deposits, they
conclude: "careful weighing of the arguments suggests that the introduction of
a PLS banking system would have an indeterminate effect on aggregate savings
behaviour and might even raise the average propensity to save and the
bank-intermediated supply of loanable funds" (p 73). They then discuss one
"fundamental concern of critics of a PLS financial system (which) is that the
elimination of interest removes the one price signal that efficiently allocates
loanable funds between competing demands, and the equilibration of planned
saving and investment. An inefficient allocation of loanable funds and lower
productivity are predicted. This outcome relies on the assumption that there
is no alternative to the rate of interest as an allocator of loanable funds,
and that it does the job efficiently at present. Both assumptions are open to
dispute" (p 77). "Intermediating finance through interest-bearing contracts
biases the supply to borrowers and projects with collateral and secure
cash-flow. There can be no presumption that these projects have the highest
net present value of those on offer. The resulting allocation of credit
discriminates against small firms with little capital, entrenches the status
quo and increases the amplitude of the lending cycle. (While interest-based)
finance circumscribes short-term agency and monitoring costs, leading to a
lower cost of capital, (these) advantages are offset by longer-term
inefficiencies in project selection and inappropriate risk-taking (resulting in
insufficient) monitoring of borrowers....Few non-interest proponents claim that
their system would achieve the "first-best" allocation of investible resources,
and macroeconomic equilibrium at a high level of activity in theory, let alone
in practice. However, there are sufficient grounds for questioning the
allocative efficiency of the rate of interest as a price signal, and for
claiming that a profit-related allocator may do better" (p 85). Regarding bank
stability, the authors argue that, in effect, banks gamble on the "law of large
numbers" and on depositor confidence in order to remain solvent and liquid.
Banking history is "littered with occasions" when the gamble did not pay off.
"Hence governmental regulation and under-writing of banks is a universal
phenomenon.... the safety net provided to private sector banks goes
unchallenged...and yet bank collapses and runs are still with us. The
fundamental problem cannot be solved by treating its symptoms with better
regulatory medicine because the ultimate cause of bank instability lies in
contracting on an interest basis": "Banks and other deposit-taking financial
intermediaries exist to transform the maturity and liquidity of financial
assets. Yet. by issuing interest-bearing liabilities, whose nominal (par)
value is guaranteed and potentially recallable on demand, conventional banks
pretend that they are not transforming asset maturity and liquidity"
(p85)...."Thus far, state intervention has largely succeeded in preventing
system-wide bank collapses at the expense of subsidising banks to take risks;
favouring large banks over small, and banks in general over other financial
intermediaries; incurring high costs to taxpayers through bank rescues and
nationalisations; adding to the inflationary bias of capitalist economies; and
perpetuating a banking system that amplifies the economic cycle.
Interest-based banking has survived thus far by persuading the monetary
authorities to underwrite many of its liabilities. The options facing monetary
authorities are either to "paper over the cracks" (e.g. by tinkering with DI
liabilities) and risk the costly support or collapse of the edifice in the
future; or to rebuild the financial structure on firmer foundations, rendering
external support unnecessary. If some preconditions are met, a non-interest
banking system should not only be feasible, but also more stable and less
costly to the rest of the economy" (p 98). Finally, on government borrowing,
the authors argue that while the elimination of interest-bearing government
debt has serious welfare disadvantages, the long-term economic and moral
advantages should outweigh these costs: "The most widely-felt impact of a
non-interest financial system would be the elimination of interest-bearing
mortgage and consumer debt ....high levels of household indebtedness can prove
economically divisive - as the well-off enjoy better terms and access to credit
- and socially destructive. Further detrimental consequences can include
depressed aggregate savings propensities and more volatile consumer durables
demand. High levels of household leverage yield a more fragile macroeconomy,
vulnerable to rises in real interest rates. These effects are amplified by a
housing sector dependent on mortgage finance to fund house
purchases....Clearly, the current reliance upon interest-bearing mortgage and
consumer credit is one without its costs. Consequently, there are practical
reasons for advocating its replacement ....(and though there are difficulties
in a non-interest financial system such as) the provision of credit needed for
immediate consumption or liquidity (there are feasible substitutes such as)
charitable or state-run interest-free loans funds...non-interest mutual credit
arrangements and time-multiple overdraft facilities" (pp 99-100).
Conclusion
Our authors are cautious and systematic, making little reference
to Jubilee, to tithing and wider gift-giving, to the economic value of living a
sober life and to "Protestant ethics" generally, or to the contemporary need
for a "slow-growth economy". It is interesting that Abraham and his
descendants were withdrawn from "high-growth economies" or at least "high"
economies in Ur, Egypt, Babylon and Persia and sent to build the "low-growth
economic system" outlined in the Old Testament. However, as the Hebrews and
the Christians are, at the same time, promised "prosperity" it may be worth
drawing a contrast between "pagan" prosperity and "Godly" prosperity. "Magical"
sacrifices and unjust systems were replaced with a "rational" system of tithes,
rest for the land every seventh year, sabbath rest for people every seventh
day, numerous festival seasons and feast days, and so on.
While Mills and Presley have some reservations about Islamic finance itself,
the book more or less thoroughly endorses the Islamic (and Biblical) case
against the ungodly usurious system which pervades the world as a result of the
current domination of universities and senates by materialist humanism.
It is delightful to have this serious evaluation of the contribution of Islamic
finance. What is needed now is similar evaluations of contemporary Jewish
economic thinking as well as of the radical alternatives represented by The
Other Economic Summit. Similar evaluations of the "relatively high-growth
economies" of Egypt, for example in the Early Dynastic Period (3100-2686BC), of
China, for example during the Zhou dynasty (1066-221BC), of the Mayans from
325-925AD, of the Incas say from 1200-1530AD, of the Aztecs under Montezuma I
and II (1440-1519AD), of the Songhai Empire between 1464 and 1591AD, and of
India during the Gupta period (300-500AD) as well as during the Mughal period
(specifically 1527-1605AD) would be fascinating as well as useful.
Prabhu Guptara
------------ FOOTER TO HES POSTING ------------
For information, send the message "info HES" to [log in to unmask]
|
