Institutional Failures in Islam
There are many reasons that the Muslim world in general has had a hard time developing strong institutions and institutional capacities of any kind, whether they be of governance, civil society or private enterprise. Repression, economic stagnation, persistent reliance on clan and tribal networks to name but a few. For whatever the reason, the preference and tendency has always been to rely on individuals and not institutions to carry on with business. You don't contract with strangers and then rely on the institution of law to protect you, you contract with clan members and rely on the clan, or perhaps some sort of mediator among clans, to help in case of default. You don't report put your money in the bank and expect some sort of financial regulator to ensure its solvency, the regulator probably is crony filled anyway, so you put your money in your cousin's bank, on the expectation (often false) that your cousin is less likely to rob you.
For whatever the reason, this is the way of things in all too much of the Muslim world, and what results is in some cases a rather naive lack of understandings of how institutions and social systems are expected to work. This was brought to my mind just yesterday, after a talk I gave at the New York City Bar on Islamic finance. It was a panel, and all went well, I was my usual contrarian self, pointing out many issues with Islamic finance, but one that I couldn't imagine was going to create the difficulties it did, but which managed to nonetheless, was my pointing out that Shari'a Review Boards, responsible for approving shari'a transactions, were less than neutral because they were paid by the institutions which were seeking their approval to move forward on the deal. At first it seemed like I may have overstated it, obviously you can't just get them to say whatever the hell you want just because you pay them, assumign they have any reputation at all, but equally silly would be the notion that somehow the fact of payment coming from the institution they are supposed to be monitoring (with respect to any single transaction anyway) as being completely unimportant.
But the fellow following me said precisely that. I won't name him, but I'll say he was a late substitute so even looking at the program won't help, but he was an investment banker, which of course meant he was as humble, gentle kind and entirely nondismissive, as all investment bankers tend to be, especially the one years ago who told me ten minutes after meeting me I was a lawyer because I couldn't do math (I had the distinct pleasure of then telling him my degree was in physics from MIT, his was in accounting from a place I had never heard of, and so he didn't even know what math was.) Anyway, the reason apparently I was wrong was twofold. First, that banks, including Citibank, in his 15 years of experience in Islamic finance, never told him he had to hit a profit level, never told him to improve business in that way, but only wanted one thing from him--to adhere to the spirit of Islamic finance. IN such a world, of course there would be no pressure on these people to do anything but adhere to the spirit of Islamic finance. Moreover, there are only twelve or so of these people who approve any of the hundreds and hundreds of major transactins in the field. And they are economists. They have PhD's. They are scholars of religion. They are respected. How can anyone think they'd be biased simply because of money.
Now the first obvious point which is if 12 people are approving hundreds of transactions, they aren't exercising much, if any , supervision. Someone is showing them a chart maybe, they're taking a look, making a few comments, raking in a cool five figures and going away. This is an obvious problem just starting to get the light of day. Even AAOIFI, one of the major issuers of standards in Islamic finance (which everyone then ignores, but anyway . . . ) has in a recent standard asked Sharia Review Boards to read the documents they are approving and make sure they are implemented in the way Islam approves. If that's not indicative of a major problem, I don't know what is. An organization like AAOIFI has to tell these boards to read the documents. Unbelievable, I'm just imagining the American Association of Law Schools asking us to read the books that we publish book reviews for in the future. What is it you people are doing if you aren't reading the contracts?
The solution to that problem of course is institutionalization. The 12 people don't have to be people, they COULD be 12 companies headed by these people, or even fewer if some merge. Their firm's reputations would then stand in the place of the people in question, and more real supervision could be exercised. This is particularly if, as our investment banker friend insisted, it's all "cookie cutter," one deal looks just like the other, you don't need intensive review to know that, it's just the same deal in a different context. Well you might not need the super high expert Grand Poobah dude to read every page of contract 2 if it is based on contract 1 and contract 1 is somehow okay, but if you are doing even minimal supervision, SOMEONE out there under the Grand Poobah, a junior associate perhaps, should be reading every word, every single goddam word, or signing off on the deal is to my mind an act of negligence. I can't imagine our investment banker friend approving of his law firm doing some sort of cut and paste of an earlier document without reading it and just hoping it's more or less going to work because it is cookie cutter. If it didn't, and the client was the investment bank and it was injured, I think they'd allege malpractice. hard to see why you wouldn't hold the Board responsible too. Yet somehow that's not really on the table, beyond rhetoric at least. Somehow the idea that this is really a task for an institution and not an individual is not real. What is important is the person himself, the man speaking, the company doesn't count, even when it's perfectly obvious the man couldn't possibly do the matter justice given other commitments. Even AAOIFI doesn't say let's create institutins, it just says read the documents. as if changing the institutional structure isn't the only way to make sure this happens.
But let's go to the second part of this. Anyone who is anything but incredibly, four year old level naive would probably regard with some sense of amusement the notion of Citibank's Board of Directors telling bankers to go out there and, well, make money or not, who cares, but damn it, adhere to the spirit of Islamic finance! I don't even mean it as an insult to Citibank that they don't think that way (i'll insult them another time), what kind of bank is it that cares about such a thing more than it does its profit margin? Why in the world would they be concerned about "spirit" and not money? I am sure they have a commercial reputation, I'm sure they don't want to make Mickey Mouse transactions that everyone will laugh at in terms of shari'a compliance, so I'm sure they'll say whatever you do, make sure it's a blue chip review board you have reviewing it, in the same way that all reputable companies want a blue chip accounting firm auditing them. That doesn't mean they don't want to make money first and foremost, doesn't mean they won't lean on the auditors to cut things their way, doesn't mean they are more interested in GAAP and its spirit than a profit margin. You can't be serious.
And I think most of us would regard claims of PhD's and scholars and Harvard grads and whatever else as being indicative of a lack of bias as incredibly naive as well. Now let's leave aside our investment banker friend, who has a financial interest in trying to sell the impossible argument that because the man's name has Dr in front of it, he can't be bought. The point is not the banker, it's how can that argument sell? I mean imagine for a moment that as a country we decided that from now on, judges in civil cases will be paid by the plaintiffs. I think there'd be an outcry. I think most people would think that this was viciously ridiculously unfair and bound to lead to unjust verdicts. And I don't think the argument that these people are judges, they have reputations, they graduated top of their class from law school, they are good God fearing men and women would carry an ounce of credibility as an argument. Even if all this is true of them, and I think it is probably mostly right, most of us think institutionally we think to get the right result in a world of imperfect individuals you create an institution with the proper incentive structures that individuals act within, you don't just call people up and pay them by one side and count on that as somehow working because the people are good when we all know judgment will have to be employed and judgment has a funny way of working out to be in the material interests of the person making the judgment when that is applicable.
In the Muslim world we all too often do not think this way. What we think we need to make Islamic finance work is not institutions but better people, superhumans who don't care about money, for whom financial incentives are worthless, who apply sharia neutrally and who have the magic ability to read a shelfload of documents in 15 minutes. And so to fix Islamic finance we figure we need to just get new people. Theproblem is that you don't need new people, you need a system that makes sense, and this isn't it.
This happens in Iraq as well incidentally. I cannot remember how many times I heard lamented that ministers are chosen in Iraq on the basis of politics and party loyalties, not on the basis of their competence. THe selection of a minister should not be political, it is insisted. In Friday prayers, at the Council of Representatives, among senior lawyers within the Council of Ministers, everywhere. Even the Minsiters themselves said it, they just denied being the beneficiaries of politics. This is why these Ministries are so poorly run, the people running them are just too political, the theory goes. Technocrats, everyone just wants technocrats. It's become an Arabic word, tiqnograt.
I am sorry, but I know of no world where a Prime Minister can appoint a Cabinet and get it approved by an elected legislature without politics. It's naive, it's silly, it's deluded to suggest otherwise. If you want to make ministries effective it's not by trying to make Hillary Clinton into a figure with no political loyalties, it's by creating incentives and structures within the institution at a lower level that assure that governance is effective and, yes, political, but still effective and competent within defined political objectives. Civil service is not government largesse, work continues smoothly from one government to the other, and the like. What we in Iraq wanted was some miraculous turnaround at the Minsitries led by superman Ministers who cared nothing of politics and wanted only to run things for love of country (how one does that without a set of political assumptions concerning what is good for the country is hard to know). We were disappointed when the Ministers turned out to be political animals, normal humans and now want them replaced by others. That won't work, any more than replacing these 12 Islamic scholars who review every transaction with another 12 will do anything. It will just be the same thing unless you create institutions and incentives that work better. You can't make them entirely independent admittedly, someone has to pay the Board and it won't be the government, but you can take steps to assure greater independence and competence and review.
That one prefers to sidestep that and instead focus on the need for exceptional honesty of the individuals in question goes to the very heart of the problem.
HAH
For whatever the reason, this is the way of things in all too much of the Muslim world, and what results is in some cases a rather naive lack of understandings of how institutions and social systems are expected to work. This was brought to my mind just yesterday, after a talk I gave at the New York City Bar on Islamic finance. It was a panel, and all went well, I was my usual contrarian self, pointing out many issues with Islamic finance, but one that I couldn't imagine was going to create the difficulties it did, but which managed to nonetheless, was my pointing out that Shari'a Review Boards, responsible for approving shari'a transactions, were less than neutral because they were paid by the institutions which were seeking their approval to move forward on the deal. At first it seemed like I may have overstated it, obviously you can't just get them to say whatever the hell you want just because you pay them, assumign they have any reputation at all, but equally silly would be the notion that somehow the fact of payment coming from the institution they are supposed to be monitoring (with respect to any single transaction anyway) as being completely unimportant.
But the fellow following me said precisely that. I won't name him, but I'll say he was a late substitute so even looking at the program won't help, but he was an investment banker, which of course meant he was as humble, gentle kind and entirely nondismissive, as all investment bankers tend to be, especially the one years ago who told me ten minutes after meeting me I was a lawyer because I couldn't do math (I had the distinct pleasure of then telling him my degree was in physics from MIT, his was in accounting from a place I had never heard of, and so he didn't even know what math was.) Anyway, the reason apparently I was wrong was twofold. First, that banks, including Citibank, in his 15 years of experience in Islamic finance, never told him he had to hit a profit level, never told him to improve business in that way, but only wanted one thing from him--to adhere to the spirit of Islamic finance. IN such a world, of course there would be no pressure on these people to do anything but adhere to the spirit of Islamic finance. Moreover, there are only twelve or so of these people who approve any of the hundreds and hundreds of major transactins in the field. And they are economists. They have PhD's. They are scholars of religion. They are respected. How can anyone think they'd be biased simply because of money.
Now the first obvious point which is if 12 people are approving hundreds of transactions, they aren't exercising much, if any , supervision. Someone is showing them a chart maybe, they're taking a look, making a few comments, raking in a cool five figures and going away. This is an obvious problem just starting to get the light of day. Even AAOIFI, one of the major issuers of standards in Islamic finance (which everyone then ignores, but anyway . . . ) has in a recent standard asked Sharia Review Boards to read the documents they are approving and make sure they are implemented in the way Islam approves. If that's not indicative of a major problem, I don't know what is. An organization like AAOIFI has to tell these boards to read the documents. Unbelievable, I'm just imagining the American Association of Law Schools asking us to read the books that we publish book reviews for in the future. What is it you people are doing if you aren't reading the contracts?
The solution to that problem of course is institutionalization. The 12 people don't have to be people, they COULD be 12 companies headed by these people, or even fewer if some merge. Their firm's reputations would then stand in the place of the people in question, and more real supervision could be exercised. This is particularly if, as our investment banker friend insisted, it's all "cookie cutter," one deal looks just like the other, you don't need intensive review to know that, it's just the same deal in a different context. Well you might not need the super high expert Grand Poobah dude to read every page of contract 2 if it is based on contract 1 and contract 1 is somehow okay, but if you are doing even minimal supervision, SOMEONE out there under the Grand Poobah, a junior associate perhaps, should be reading every word, every single goddam word, or signing off on the deal is to my mind an act of negligence. I can't imagine our investment banker friend approving of his law firm doing some sort of cut and paste of an earlier document without reading it and just hoping it's more or less going to work because it is cookie cutter. If it didn't, and the client was the investment bank and it was injured, I think they'd allege malpractice. hard to see why you wouldn't hold the Board responsible too. Yet somehow that's not really on the table, beyond rhetoric at least. Somehow the idea that this is really a task for an institution and not an individual is not real. What is important is the person himself, the man speaking, the company doesn't count, even when it's perfectly obvious the man couldn't possibly do the matter justice given other commitments. Even AAOIFI doesn't say let's create institutins, it just says read the documents. as if changing the institutional structure isn't the only way to make sure this happens.
But let's go to the second part of this. Anyone who is anything but incredibly, four year old level naive would probably regard with some sense of amusement the notion of Citibank's Board of Directors telling bankers to go out there and, well, make money or not, who cares, but damn it, adhere to the spirit of Islamic finance! I don't even mean it as an insult to Citibank that they don't think that way (i'll insult them another time), what kind of bank is it that cares about such a thing more than it does its profit margin? Why in the world would they be concerned about "spirit" and not money? I am sure they have a commercial reputation, I'm sure they don't want to make Mickey Mouse transactions that everyone will laugh at in terms of shari'a compliance, so I'm sure they'll say whatever you do, make sure it's a blue chip review board you have reviewing it, in the same way that all reputable companies want a blue chip accounting firm auditing them. That doesn't mean they don't want to make money first and foremost, doesn't mean they won't lean on the auditors to cut things their way, doesn't mean they are more interested in GAAP and its spirit than a profit margin. You can't be serious.
And I think most of us would regard claims of PhD's and scholars and Harvard grads and whatever else as being indicative of a lack of bias as incredibly naive as well. Now let's leave aside our investment banker friend, who has a financial interest in trying to sell the impossible argument that because the man's name has Dr in front of it, he can't be bought. The point is not the banker, it's how can that argument sell? I mean imagine for a moment that as a country we decided that from now on, judges in civil cases will be paid by the plaintiffs. I think there'd be an outcry. I think most people would think that this was viciously ridiculously unfair and bound to lead to unjust verdicts. And I don't think the argument that these people are judges, they have reputations, they graduated top of their class from law school, they are good God fearing men and women would carry an ounce of credibility as an argument. Even if all this is true of them, and I think it is probably mostly right, most of us think institutionally we think to get the right result in a world of imperfect individuals you create an institution with the proper incentive structures that individuals act within, you don't just call people up and pay them by one side and count on that as somehow working because the people are good when we all know judgment will have to be employed and judgment has a funny way of working out to be in the material interests of the person making the judgment when that is applicable.
In the Muslim world we all too often do not think this way. What we think we need to make Islamic finance work is not institutions but better people, superhumans who don't care about money, for whom financial incentives are worthless, who apply sharia neutrally and who have the magic ability to read a shelfload of documents in 15 minutes. And so to fix Islamic finance we figure we need to just get new people. Theproblem is that you don't need new people, you need a system that makes sense, and this isn't it.
This happens in Iraq as well incidentally. I cannot remember how many times I heard lamented that ministers are chosen in Iraq on the basis of politics and party loyalties, not on the basis of their competence. THe selection of a minister should not be political, it is insisted. In Friday prayers, at the Council of Representatives, among senior lawyers within the Council of Ministers, everywhere. Even the Minsiters themselves said it, they just denied being the beneficiaries of politics. This is why these Ministries are so poorly run, the people running them are just too political, the theory goes. Technocrats, everyone just wants technocrats. It's become an Arabic word, tiqnograt.
I am sorry, but I know of no world where a Prime Minister can appoint a Cabinet and get it approved by an elected legislature without politics. It's naive, it's silly, it's deluded to suggest otherwise. If you want to make ministries effective it's not by trying to make Hillary Clinton into a figure with no political loyalties, it's by creating incentives and structures within the institution at a lower level that assure that governance is effective and, yes, political, but still effective and competent within defined political objectives. Civil service is not government largesse, work continues smoothly from one government to the other, and the like. What we in Iraq wanted was some miraculous turnaround at the Minsitries led by superman Ministers who cared nothing of politics and wanted only to run things for love of country (how one does that without a set of political assumptions concerning what is good for the country is hard to know). We were disappointed when the Ministers turned out to be political animals, normal humans and now want them replaced by others. That won't work, any more than replacing these 12 Islamic scholars who review every transaction with another 12 will do anything. It will just be the same thing unless you create institutions and incentives that work better. You can't make them entirely independent admittedly, someone has to pay the Board and it won't be the government, but you can take steps to assure greater independence and competence and review.
That one prefers to sidestep that and instead focus on the need for exceptional honesty of the individuals in question goes to the very heart of the problem.
HAH
Professor Hamoudi,
The conflict of issue is approached institutionally in many different ways, but one of the ones that I am most familiar with is the investment advisory role. Investment advisors in the US are required to act in a fiduciary role and disclose any conflict of interests.
Would the fiduciary model work for Shari'ah borads? They clearly have a potential conflict of interest between the investors they are making representations to about Shari'ah-compliance and the institutions they are being paid by.
In a simple system, the Shari'ah scholars (who I think are acting on behalf primarily of the investors who rely on their fatawa to invest in a sukuk or other product) should be required to disclose their conflict of interest (the amount the issuer is paying them) and also be required to act as fiduciaries. Specifically, they should be required to act in the best interest of the investors and to put the investors' interests above their own.
These are financial products we are talking about and so such a high standard would not be out of the question (although that may not necessarily always apply in jurisdictions where Islamic finance operates). However, if Islamic finance wants to try and operate on the moral high ground compared to the way finance is done by conventional financial institutions, it would seem reasonable to meet OR EXCEED the prevailing standards for fairness and ethical behavior.
Blake Goud
Sharing Risk dot Org
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Well said indeed. Precisely the type of measures that one needs to take in order to ensure more neutrality on the part of the shari'a boards, which would be far more effective than just insisting on their purity because the relevant individuals have PhD's and are scholars.
HAH
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