SOLUTION: University of Nairobi Banking System in the Islamic Setting Discussion

HOW ETHICAL IS ISLAMIC BANKING IN
THE LIGHT OF THE OBJECTIVES OF
ISLAMIC LAW?
Walid Mansour, Khoutem Ben Jedidia, and
Jihed Majdoub
ABSTRACT
Islamic banking is based on moral foundations that make it distinct from
conventional banking. Some argue that because of its foundation in Islam,
Islamic banking may represent a more morally appealing alternative. Yet,
evidence shows that this is not the case. Indeed, the current practice of
Islamic banking has not been able to achieve its goals which are based on
Islam’s moral values: to enhance justice, equitability, and social well-being.
This essay examines the extent to which Islamic banking is ethical and
concludes that the practice of the industry does not seem to be de facto
ethical from the Islamic perspective of ethical values. It only consists in
trading the same instruments of conventional banks without genuinely
enforcing Islam’s ethical vision. The practice of Islamic banking misrepre­
sents Islam and does not contribute to solving social problems. The inter­
action between maqasid al-sharVa (objectives of Islamic law) and qiyas
(deductive analogy) provides a supplementary tool for interpreting the
failure of the prior in terms of the practical misuse of the latter by Islamic
banks. This essay provides an interpretive approach to the current debate
about why Islamic banking has failed and suggests ways to move cautiously
in the future.
KEY WORDS:
Islamic banking, ethics, maqasid al-sharVa, Islam, qiyas
This paper is financially sponsored by Prince Naif Bin Abdulaziz’s Chair for Ethical Values
at King Abdulaziz University in Jeddah, Kingdom of Saudi Arabia. The authors would like
to thank the Director of the Chair and the members of the Chair’s Scientific Committee for
their support.
Walid Mansour is a research affiliate at the Islamic Economics Institute, King Abdulaziz
University. He spent over eight years in teaching and research in different educational
settings in the United States, North Africa, and the Middle East. He completed a postdoc­
toral teaching and research fellowship at Kansas University. He is particularly interested in
the interplay between Islam and finance and the consequences in terms of ethics, informa­
tion asymmetry, and Islamic financial product development. Walid Mansour, Islamic Eco­
nomics Institute, King Abdulaziz University, PO Box 80214, Jeddah 21589, Kingdom of
Saudi Arabia, wmmansour@kau.edu.sa.
Khoutem Ben Jedidia is an Assistant Professor at Institut Superieur de Comptabilite et
d’Administration des Entreprises (ISCAE, University of La Manouba) and a research
affiliate at URED Research Lab (Faculty of Economics and Management of Sfax, Tunisia).
She received a Master’s degree and a Ph.D. from Universite Lumiere Lyon II (France). Her
research interests cover financial intermediation, monetary economics, and Islamic finance.
JRE 43.1:51-77. © 2015 Journal of Religious Ethics, Inc.
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Journal of Religious Ethics
1. Introduction
The claim that Islamic banking has an ethical foundation—that it is
based in Islamic principles of equity, cooperation, and social justice—has
contributed to its appeal in the wake of the 2008 subprime mortgage
crisis. Indeed, Puzetto argues that the unethical practice of risk manage­
ment by U.S. banks and speculation*1 are among the explanations of the
last financial crisis (Ivo Puzetto 2008). As a result, there has been a great
deal of interest in the place of ethics in financial services. Many studies
turned to shari’a-compliant finance as one way to address the lack of
ethical oversight in the financial sector. The collapse of Enron2 and other
accounting frauds showed that business standards need to be raised and
brought in line with ethical considerations.
Islamic economics is considered by its practitioners to be ethical
(iakhlaqi), godly (rabhani), humane (insani), and balanced (wasati)
(Al-Qaradawi 1995). According to Syed Naqvi (1981), ethics ought to
dominate economics and not the opposite. However, it is possible to
consider many definitions of ethics without agreeing on only one (Vesilind
1988). The meaning and scope of ethics in Islam is a complex matter that
defies easy explanation (Baker 2011). Islamic banking ethics presents us
with unique difficulties since its ethical norms and standards are drawn
both from conventional banking as well as the additional requirements of
Islam. Thus, an accurate definition needs to take both into account.
Islamic banks emerged in the early 1970s as a result of 1973 oil crisis,
which allowed all member countries of OPEC to raise large amounts of
capital. The Islamic Development Bank in Jeddah was established in 1975
Ben Jedidia Khoutem, ISCAE, Camus Universitaire de la Manouba, 2010, Tunisia,
khoutembj@yahoo.fr.
Jihed Majdoub is an Assistant Professor of finance at the Institut Superieur de Gestion de
Tunis (University of Tunis) since September 2011. He is a Research Fellow at LAREQUAD
research lab at the Faculty of Economics and Management of Tunis. Dr. Majdoub received
his Ph.D. in Finance from the University of Cergy-Pontoise in France in 2010. He published
several papers in international journals and collective books such as the North American
Journal of Economics and Finance, Journal of Computations & Modeling, Journal of
Business Studies Quarterly, and Cambridge Scholars publishing. Jihed Majdoub, Institut
Superieur de Gestion de Tunis, 41, Avenue de la Liberte, Cite Bouchoucha, Le Bardo 2000,
Tunisia, jihed.majdoub@isg.mu.tn.
1 Speculation is considered to be a salient aspect of unethical practices in the financial
industry. It is prohibited by Muslim scholars because it does not lead to a win-win game and
cannot be beneficial to a wide spectrum of market players.
2 The collapse of Enron in December 2001 was due to several mismanagement practices
that led to audit failure. Indeed, top officials put their own interests over those of Enron’s
stakeholders. They implemented unusually complex business models and unethical practices
that misrepresented earnings in order to better the performance presentation. This event
spurred the industry to include ethics, credibility, and trust in business and leadership
practices.
How ethical is Islamic banking
53
and followed by the Dubai Islamic Bank (the first Islamic private bank)
and the Arab Bank for Development in Africa. According to Andre Martens
(2001), Islamic banks were developed because a renewed vitality of Islam
beginning in the middle of the twentieth century created a strong demand
for shari’a-compliant financial instruments. In addition, Islamic banks
were able to attract wealthy Muslim investors. As a result, some Western
banks have been motivated to launch Islamic windows or subsidiaries.
The global market of Islamic financial services (shari’a-compliant
assets) was estimated at $1.13 trillion at the end of 2010, up 21.1% from
2009 (The City UK Report 2012). Moreover, the Islamic finance industry
is dominated by Islamic banks. Islamic banking assets represented 83.4%
of Islamic assets overall by the end of 2010 (IFSB, 2011). Shari’a princi­
ples are important pillars of Islamic business ethics (Ayub 2007; Walsh
2007). They provide a set of ethical and legal rules embedded in the
Islamic financial industry. The question we address here is whether
Islamic banks have achieved objectives found in shari’a for a just and
equitable distribution of wealth.
In practice, Islamic banks seem to be more concerned with legal and
mechanistic aspects of adherence to Islamic law rather than with promot­
ing Islamic ethical values (Balz 2010; Nienhaus 2011). The prevailing
general sentiment is that, so far, Islamic banking has de facto failed to
meet the social and ethical goals claimed by shari’a (Ahmed 2011a). From
a theoretical standpoint, Muhammad A. Musa notices that “there is an
apparent lack in the current literature of Islamic finance and Islamic
business ethics of an evaluation of the extent to which the ideal ethical
norms of Islam are implemented by Islamic financial institutions” (2011,
3). The interaction between maqasid al-shari’a and qiyas is not of trivial
importance in this regard since the failure of Islamic banks to adhere to
ethical norms is partly due to their misuse of qiyas in trading their
financial instruments.
The aim of this essay is to assess the extent to which Islamic banking
is committed to the ethical goals as proclaimed in shari’a. The second
section presents shari’a and its objectives (that is, maqasid al-sharVa).
The third section explains the de jure ethics and moral foundations of
Islamic banking activity. The degree of commitment to the ethical aims of
Islam will be discussed in the fourth section. The fifth section argues that
the interaction between maqasid al-shari’a and qiyas provides an impor­
tant interpretive key for understanding the proper application of Islamic
norms to banking activity.
2. Shari’a Principles, maqasid al-shari’a, and Ethics
Islamic banks are, at least theoretically, institutions with ethical
responsibilities since they are founded on shari’a. They are expected to
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Journal of Religious Ethics
promote justice and welfare in society (Haniffa and Hudaib 2007). The
Islamic ethico-legal framework spurs banks to respect many principles
and comply with Islamic values.
2.1 Main sharVa axioms
The main axioms related to the financial system in Islam stem from
four main sources, namely (1) the Qur’an, (2) the Prophet Muhammad’s
sunna (practice), (3) ijma’ (consensus), and (4) qiyas (deductive analogy).
Islamic jurists argue that the following are the principles of shari’a that
are applicable to the structure of the financial system.
RIBA PROHIBITION
The major principle is the prohibition of riba (interest) since it is
considered as a profit gained without risk. Rima Ariss claims that “the
prohibition of interest is not exclusive to Islam, but common to all three
Abrahamic faiths. Although the Qur’an does not explicitly justify the
prohibition of dealings based on a pre-determined rate of interest, it is
believed that the primary reason for doing so is to remove any form of
injustice in business transactions” (2010, 102). Islam prohibits both
payment and receipt of interest on the basis of a predetermined rate. In
fact, money itself has no intrinsic value. It can only be a means of
transaction. The following verse from the Qur’an shows why interest
payments are forbidden:
Those who consume interest cannot stand [on the Day of Resurrection]
except as one stands who is being beaten by Satan into insanity. That is
because they say, “Trade is [just] like interest.” But Allah has permitted
trade and has forbidden interest. So whoever has received an admonition
from his Lord and desists may have what is past, and his affair rests with
Allah. But whoever returns to [dealing in interest or usury]—those are the
companions of the Fire; they will abide eternally therein. (Q. 1:275)
While the verses from the Qur’an clearly prohibit the use of interest as an
incentive mechanism in transactions, the riba-free sale is permitted.
PROHIBITION OF MAYSIR AND GHARAR
Shari’a formally forbids contracts and transactions that contain or are
based on maysir and/or gharar. Gharar is related to uncertainty. It
literally means exposing one’s wealth to a situation of hazard in a
contract. Natalie Schoon (2009) maintains that there are two ways to
interpret gharar. First, it applies exclusively to situations of doubtfulness
or uncertainty, as in the case of knowing whether something will take a
How ethical is Islamic banking
55
place or not. Second, it applies to the unknown. The combination of these
two cases is always taken as gharar. Maysir is associated with games of
gambling. It occurs when one loses a fraction or all of one’s wealth. Maysir
is one example of gharar. However, the latter is more general.
PROHIBITION OF INVESTMENT IN ILLICIT SECTORS
According to shari’a principles, it is illicit to earn money by investing in
activities that are socially harmful such as alcohol, pork, drugs, and
pornography. Islamic banks screen for such activities to ensure compliance
with halal (permissible) sectors and international standards (Belabes
2010).
ASSET BACKING PRINCIPLE
This axiom holds that all financial transactions should systematically
be linked to tangible assets. Islamic banking is accordingly in the service
of the real economy, while money is only an instrument of financing. Lease
contracts (asset-based) are a representative example in this context. They
consist in a sale-leaseback agreement (operating lease) according to which
the financier provides credit in return for rental payments over the term
of the temporary use of an (existing) asset, conditional on the future
re-purchase of the assets by the borrower (Jobst 2007). This principle
affirms a close association between the financial sphere and real economic
activity.
PROFITS-AND-LOSSES SHARING
(PLS) principle
Islam recommends sharing profits and losses equitably3 between
lender and borrower instead of being concentrated on one side. There­
fore, Islamic banks are not permitted to charge predetermined interest
rates on loanable funds. Depositors are rewarded by sharing the bank’s
profits.
2.2 Maqasid al-sharVa
Maqasid al-sharVa could be translated literally as “the objectives of
Islamic law.” By pursuing the aforementioned axioms, Islamic banking
activity tries to realize maqasid al-sharVa since they reflect the perspec­
3 The profits and losses are shared on the basis of a predetermined formula that is agreed
upon by the contracting parties at the beginning of the project. In the main, this formula is
the ratio of the respective contributions of the contracting parties in the capital for the
project.
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Journal of Religious Ethics
tive of Islam as a global, integrated set of moral norms for individuals and
society. Such norms aim at realizing justice and social welfare by indi­
viduals and organizations in a society where its members cooperate to
reach falah (happiness). The ultimate aim of maqasid al-sharVa is the
protection and preservation of life on earth. Abu Hamed al-Ghazali argues
that “the objectives of the sharVah is to promote the well-being of
mankind, which lies in safeguarding their faith {din), human self {nafs),
their intellect {aql), their posterity (nasi) and their wealth. Whatever
ensures the safeguard of these five serves public interest and is desirable”
(1937, 139).4 Dusuki claims that “the uppermost objectives of sharVah rest
within the concept of compassion and guidance, that seeks to establish
justice, eliminate prejudice and alleviate hardship. It promotes coopera­
tion and mutual supports within the family and society at large” (2010, 5).
Al-Ghazali emphasizes the crucial role of maqasid al-sharVa in bringing
about benefits and preventing harms (1937, 140). Such benefits are
classified into three groups, namely (1) the essentials (daruriyyat); (2) the
complementary (hajiyydt); and (3) the embellishments (tahslniyyat).
Umer M. Chapra (2007) claims that the essentials are the most important
group to the ethical conduct of financial transactions.
Maqasid al-sharVa are dynamic inasmuch as they may change over
time. After the Prophet Muhammad’s death, the geographical expansion
of Muslim territories in the East and West integrated people of different
cultures and traditions. Such diversity led to the emergence of major
schools of Islamic thought, commonly known as madhahib. The most
influential are the Hanafi, Maliki, Shafi’i, and Hanbali schools. Scholars
belonging to these schools of thought established deductive methodol­
ogies based on injunctions that stem from the Qur’an and the sunna.
The deduction process for interpreting injunctions varies according to
the socio-economic and cultural contexts. The process is also influenced
by the approach taken by scholars for understanding and applying
injunctions to the particular cases studied.
Maqasid al-sharVa do not neatly fit the vision of profit maximization by
individuals and organizations. By contrast, they cover a wider perspective
that aims at combining profit maximization with efforts directed at
ensuring spiritual health, justice, and fairness at all levels of human
interaction, which fulfills the core of maqasid al-sharVa (Chapra 2000).
The ethical goals of Islamic economics are a sharp contrast to modem
capitalism which limits the possibilities for Islamic ideas to affect the
international debates on the deep crisis of capitalism (Moisseron 2012).
The ethical dimension of maqasid al-sharVa offers a strong ethical
response to the crisis of capitalism. Indeed, Jean-Yves Moisseron claims
4 Cited by Chapra (2000, 118).
How ethical is Islamic banking
57
that by means of re-interpretation of Islamic principles of economy,
“Islamic thoughts could become an Islamic wisdom useful for the whole
mankind and the Islamic economy could be more active player in the
debates about ethical finance” (2012, 1).
Islamic economics, especially as regards the interaction between ethics
and Islamic banking is viewed through the prism of maqasid al-shari9a.
Indeed, Islamic banking, is ethical if its objectives are compliant with
those of maqasid al-shari’a. Although the notions and norms of ethics are
sometimes used interchangeably, they do not necessarily have the same
meanings. Indeed, the notion of ethics is associated with principles,
values, and moral sentiments like human brotherhood and well-being for
all (Chapra 2009).
2.3 Islamic ethics
Unity (one’s life is related entirely and eternally to God), equilibrium,
and responsibility are among the ethical axioms in Islam covering all
aspects of life (Naqvi 1981).5 In Islam, ethics in business cannot be
separated from the whole life of Muslims (Wilson 2001; Beekun and
Badawi 2005; Hasanuzzaman 2003). Shari’a principles present wideranging implications across a range of business activities. The three
important criteria of Islamic ethics are adl (justice), amanah (trust), and
ihsan (benevolence) (Beekun and Badawi 2005). According to A.S. al-Misri
(1986), mercy, trustworthiness, honesty, tolerance, and justice constitute
the main values in Islamic ethics in business. Several authors suggest
that the concept of tawhid (oneness and sovereignty of God) constitutes
the core of Islamic ethics (see Faruqi 1992; Naqvi 1981; Beekun 1997; and
Kamali 2008).
Abderrazak Belabes (2013) argues that the interaction between ethics
and finance can lead to three variants. First, some moral aspects, such as
the prohibition of interest, could be integrated into the input without
affecting the output, that is, the human, social, or environmental dimen­
sions. For instance, a financial contract could be enforced between two
parties without taking into account such dimensions prior to its enforce­
ment. Second, the same moral aspects are not embedded at the input level
and the goal is at the output level in terms of human, social, and
environmental norms. Third, the interaction between finance and ethics
could also lead to the development of a method of financial intermediation
that cares about both the input and output. In other words, this method
of financial intermediation is not restricted to the pure ethical approach
that is indifferent to the consequences and to the consequentialist
5 Rafik Beekun (1997) adds benevolence to the axioms enumerated by Naqvi 1981.
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Journal of Religious Ethics
approach for which the implications of a given action should constitute the
basis of ethical judgment.
According to Usman Hayat (2010), there are differences between
ethics in Islamic finance and ethics in the secular view. Islamic finance
is interested in the structure of financing, whereas it is not an ethical
concern in the secular view in which ethics are based on human fac­
ulties only ( …
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