Islamic Perspective on the Financial Crisis


An economy geared towards meeting the needs of the people, not faceless banking corporations

The Financial crisis can be characterised by unrestrained credit creation on the back of an out of control financial system that not only allows the creation of money and interest from nothing, but gambling on a mind-boggling scale. Wealth has been extracted out of the system in never before seen amounts, and will not be easily replaced. From an Islamic perspective this is entirely predictable and preventable. Yet the cure is requiring of the complete application of Islam within the governance structures set down within the Caliphate ruling system. A ruling system in which the economy is geared towards meeting the needs of the people, not faceless banking corporations.

The following principles of economy in Islam are presented, not as reactionary points of debate to be part of the patchwork of crisis and flawed response, but as an ideological alternative which has enjoyed many centuries of success for Muslims and non-Muslims alike.

The Human Crisis

Perhaps the most startling aspect of the crisis is that it is in fact a human rather than financial crisis. It is real people that are losing their homes, jobs and savings, yet the headlines focus upon the mechanics, the companies and the dollars.

The first principle of economics in Islam is to meet the basic needs of ALL the people in society. The economic problem is described as one of distribution, not production. We do not lack for resources and wealth in the world, yet the drive for constantly increasing production which has been unequally accumulated has led to massive levels of poverty even in the most developed countries. The difference lies in the responsibility of both the state and the individual to ensure that all in society have at the least their basic needs of food, accommodation, clothing, health and education. Muhammad (saw) said: “The son of Adam has no better right than that he would have a house wherein he may live and a piece of cloth whereby he may hide his nakedness and a piece of bread and some water” (Tirmidhi).

Where the extended family unit is unable to, and only when it is unable to, the state will act to ensure that the basic needs are met. The poor and indebted are included in those that are eligible for zakat payments (an enormous pool that the wealthy contribute 2.5% of unused wealth to). Islamic Shariah dictates that the State has no responsibility to bailout public companies at the expense of the State and public. Nationalisation of public banks is also against the Shariah which clearly distinguishes between state, public and private ownership.

Credit Creation or Misery Creation

“Neither a borrower, nor a lender be; For loan oft loses both itself and friend” [Hamlet, William Shakespeare]

The categoric prohibition of interest in Islam is well known, less well known is that lending is very strongly encouraged in Islamic society. The Prophet (pbuh) said: “No Muslim would give another Muslim a loan twice, except that one would be written for him as charity.” Which means that to loan to someone twice carries the same high reward of giving charity.

The making of loans and leniency in demand for repayment are highly encouraged in Islam. Similarly the non-repayment of loans is treated harshly with the Prophet (pbuh) refusing to lead the funeral prayer over such individuals. The most important point to note however, is that the taking and giving of loans in Islam is without compensation (interest) which means that it is impossible to inflate lending assets beyond what is actually available of real assets in the society.

The incentive to invest and ensure a consistent circulation of wealth that all economists desire, stems from two distinct features of the Islamic economy both fiscal and legislative. Faced with non interest bearing bank accounts and the levying of zakat at 2.5% per annum against unutilised (according to various criteria) wealth there is simply no incentive to take money out of circulation. If it lay fallow in a bank account it will be subject to the zakat charge. The other great stimulus in Islamic economy for investment is via the effective nil rate of company income and dividend tax. Although certain stocks and inventories of companies are subject to the annual 2.5% zakat levy, punitive corporation tax and the dis-incentive of being taxed on the dividend payouts of company activity, which is also absent in the Islamic economy acts as a strong incentive to invest.

The Islamic taxation system does not tax income, but taxes wealth (although modestly). With greater disposable income available for goods and services, and tax liable on unspent wealth, there is a strong fiscal boost to demand for goods and services right across the economy which will generate an increase in trade and in turn an increase in wealth for businesses. All of this will create a dynamic economy which creates more jobs. As more jobs are created, then more money is spent in the economy or re-invested in the economy, which creates more jobs in turn.

The key legislative factor in high and consistent investment levels stem from the prohibition of hoarding money. Which is the practice of taking money out of circulation for no purpose (saving for a purpose such as a large asset purchase is not considered as hoarding). The Quran clearly sets out:

“And let those who hoard gold and silver and do not spend them in the way of Allah know that a severe and painful punishment is awaiting them” [9:34]

In a hadith Qudsi (Imam Nawawi) the Prophet (pbuh) narrated: “Spend oh son of Adam, and I will spend on you”.

The combination of prohibiting banks from trading with interest, or acting as the sole middle man in effectively controlling the money markets, together with the incentive for investment (zakat on unused assets and prohibition of hoarding) has meant that the Islamic society benefited from high and consistent investment. These disincentives to take wealth out of circulation have consistently been applied over hundreds of years and massively softened the impact of business downturns, which usually resulted from natural shocks such as climactic disasters. The current liquidity crisis is as much about those that are taking their cash and wealth out of circulation as the incredible levels of losses that banks are experiencing which have caused massive retrenchment.

Not only are governments bailing out banks for their gambling debts, but stimulus packages are now on offer to try and put money into the economy as billions have been spirited away by those on the winning side of derivative “bets”, and have purely selfish reasons and no disincentive to now hoard cash. With stock markets plummeting and bond yields at historic lows this money will sit on the sidelines, possibly for years at a time when its circulation is most needed.

“In order that it does not merely make a circuit amongst the wealthy” [Quran Al-Hashr 59: 7]

The Islamic system provides a compelling investment model, and there is no basis to suggest that the Islamic economic system does not promote investment. The truth is that Islam encourages business and investment, but does not encourage interest based investments which ultimately restricts the flow of wealth around the economy. Allah (swt) distinguished between this when He said:

“… they say, “trade is like usury” but Allah has permitted trade and has forbidden usury” [Al Baqarah: 275]

Stability in the economy is built upon investments only being permitted in real products or business which makes wealth generation a result of work and profits, not debt.

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