A Problem of Overselling: Realistic Expectations and Islamic Finance

I realize I have been derelict in my posts and that nearly two months have passed since my previous post. Incredible personal and professional obligations elsewhere have kept me occupied, unfortunately. (None bad, most quite good--all very time consuming). I should be a little better positioned now.

Last week I was at an Islamic Finance Conference in Sarajevo where I heard a very interesting comment from my friend, colleague and waterpipe smoking buddy Mehmet Asutay (you have drinking buddies, we have shisha buddies . . . .)  Professor Asutay is really a leading voice on some of the failures of Islamic finance to develop what he describes as a "moral economy" in his persuasive writing on the subject (see his SSRN page with his substantial scholarship here). 

One of the most interesting comments from him arose from recent findings from a study he led regarded expectations of the Muslim community on the conduct of Islamic banks.  When you ask them how they want the banks to behave, they say the bank should forgive more loans, it should foreclose less often, it should bear some of the losses when the borrower must bear them, it must be, overall, more concerned with the community, with morality and distributive justice and less obsessed with profit over all else.  Homo Islamicus, as Professor Asutay would describe it.  Then ask the consumer the return they want on their deposits from that Islamic bank, and it's perfectly clear--the same thing as conventional banks, and they'll pull their money if the returns are noticeably lower.  Homo economicus.

Now when he presented this really interesting finding, there were noticeable chuckles in the audience, from many, including myself.  It's easy to see why, the whole notion is preposterous.  Precisely where is the bank supposed to get the money from to pay those competitive rates if it's off forgiving loans and sharing losses?  The math clearly won't add up, the Muslim consumer is running a politician's budget--I'll you give you all this stuff and cut your taxes.  And then I'll yell and scream about how bad deficits are later.  All true, all salient if one wants to figure out how to fix an industry so many of us regard as flawed.

But on another level, just like the American voter, it's not clear that the Muslim consumer is herself the sole source of blame, as it's not like she's ever really been levelled with, talked to with some level of maturity.  If one looks at the early works on Islamic economics--MB Sadr, Maududi, Qutb--infected throughout the work is an insistence that Islamic economics is not only more socially just, but also that it is more efficient.  In an interest based economy, the theory goes, capital goes to enterprises that won't reap the best returns, because the lender doesn't care how successful the enterprise is given their fixed return.  Interest based economies, the theory runs, lead to vast disparities of wealth and thus result in productivity losses as the owners of the capital grow fat and lazy, and the workers surivive on subsistence and hardly develop entrepeneurial skills. And so on.  You read this, and it seems reasonable to think you can have it all--social justice and higher returns all at once.

Now of course before someone starts shouting at their computer screen I will admit that it would be absurd to suggest that any Islamic bank in the world actually buys into everything the earliest thinkers on the subject were saying, and in particular this quasi Marxist stuff on owners of capital and the like. (And to be clear, I'm not criticizing the early folks either they did not have the benefit of our hindsight).  But proponents and leaders in Islamic finance from Usmani to Chapra do make the simultaneous claim that Islamic finance can be more productive than conventional finance and at the same time that it is fairer, with obvious deviations on the fairness principle often being dismissed as compromises to necessity in an interest based world.  Hence both the self congratulation on avoiding the financial crisis, and the insistence that doing so was driven out of concerns for fairness (avoiding exploitative gain) and prudence (avoiding gambling).  (Completely wrong, as I've posted before). The conventional bank is thus not only riskier, but also less fair.  You can still have it all or would be able to if only our methods became more broadly accepted.  So goes the claim.

So is it a surprise to me when the Muslim consumer wants the same returns as a conventional bank, but a practice grounded in a moral economy and less obsessed with profit?  Not at all, it's what's been sold by the industry all too often.  A more honest approach would be to inform the Muslim consumer that at some level and to some extent, there is a zero sum game at work here.  Some methods of financings might prove more efficient than others, who knows, but at the end of the day, there's a tradeoff to be made.  Either the industry mimics conventional finance, as it does now, and offers the same return and subjects itself to the same risk exposure in the process, using only differences in form to achieve the result, or it actually does do something different, something actually concerned with social justice, or the development of a moral economy, or the redistribution of wealth. But if it does that, then the money has to come from somewhere, and that somewhere are going to be the depositors, who will have to live with lower returns.  That's the choice, it's the choice now, it was the choice when the practice started to bloom about 3-4 decades ago, and it will be the choice 3-4 decades hence given the economic realities of the globe.  So pick your poison, as the shisha guy tells us.  Rather sad when the guy selling me apple tobacco seems more direct and forthright than the guy trying to sell me an Islamic mortgage.



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  • 11/23/2012 7:22 PM Arshad Ahmed wrote:
    Love the comparison between US voters and Islamic finance consumers -- makes the point well.
    I'm wondering whether there have been any serious studies comparing the "fairness" (based on the metrics you cited) of an equity-based model versus an interest-based model. Silicon Valley (SV) comes to mind, with its geographic area that's a mere subset of the SF Bay Area as a whole. SV is where, between 2001 and 2011, approx. $600 billion of new value (equity) was created by venture-backed companies going public, while all of continental Europe in an apples-to-apples comparison created approx. $60 billion over the same period. SV is the epicenter of an equity-based (i.e., non-interest based) economy that really, truly works in supporting new job and wealth creation.
    Although SV venture capital (VC) has been unfairly criticized as "vulture capital" the truth of the methodology is that VC's do business by partnering with entrepreneurs and management in true partnerships, they take shares and they take real risk. SV has been called a "culture of failure" because realistically it's expected that most businesses will fail -- and that's fine, because that's the nature of high-risk entrepreneurial start-up activity. When VC-backed start-ups fail, each of the VCs, managers, founders, etc., walk away with only their respective share, if any, and they don't go grabbing the other's shares. For business owners, that's better much better than being saddled with loans they'd need to beg banks to forgive.
    Lenders manage risk by shifting the risk over to the borrower in the form of the guarantee implicit in a loan, and recourse and security interests where the law allows it. In contrast, VCs manage risk at the macro-level by distributing, pooling and counting on the law of large numbers: that a small handful of portfolio companies will do so well that they will make up for the losses resultant from failed investments.
    It can be said in this way VCs are concerned with the community (SV being "the community" par excellence), with certain qualities of morality and distributive justice. Believe it or not, VCs are willing to give up on incremental profit for the sake of generating or maintaining good-will. SV success has been predicated on a partnership model, one that seems more amenable for the (re)emergence of a Homo Islamicus, as Prof. Asutay and Prof. Waleed El-Ansary would say.
    Reply to this
    1. 12/21/2012 2:27 PM Haider Ala Hamoudi wrote:
      Thanks very much Arshad, and my apologies for not posting this sooner, as I should have.  I've been in the midst of the end of semester crunch. . . .
      Reply to this
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