Need for a Well-Directed Muslim Response

Salman Ahmed Shaikh

Some of the non-Muslim contemporaries of Prophet Muhammad (PBUH) used to tease Him (PBUH) during His life. Qur’an mentions that people who did not believe in Prophet Muhammad (PBUH) called upon Prophet (PBUH) in words which had dual meanings and their hearts implied the meanings which tease (2:104). God forbid, they used to call Prophet (PBUH) a poet, fore-teller and magician (69:41-42). God forbid, they even called Him (PBUH) as mad (15:6) and Muftari, i.e. forger or liar (16:101).

Qur’an denies these claims and mentions that Prophet Muhammad (PBUH) was on a exalted standard of character (68:4) and sent as blessing for all worlds (21: 107). Qur’an also guides towards the right response. “God knows all that is in their hearts; so ignore what they say, admonish them and speak to them in such terms as will address their minds.”(4:63). Quran says: “Invite to the Way of your Lord with wisdom and fair preaching.” (16:125). Qur’an says: “So remind them, you are only a one who reminds. You are not a warden over them.” (88:21-22). Qur’an also says: “Don’t insult those whom they worship besides Allah… (6:108).”

Few years back, Muslims shared some information on Prophet Muhammad (PBUH) using #WhoIsMuhammad hash tag. Many hundreds of non-Muslims also shared the messages on social media platforms and they were amazed to know such information. We must recognize that their most often instance of engagement with Islam is not through Qur’an, but through meeting Muslims. We need to educate ourselves on the right mindset required from us. Qur’an says that there is no compulsion in religion (2:256), preach with wisdom (16:125), be just even with enemies (5:8) and know that killing a human is like killing humanity (5:32). Tolerance will come in our society if right education is received.

Qur’an mentions that capital punishment can be given in the case of murder or in the case of Fasad-e-fil-Ard (5:54). Fasad-e-Fil-Ard refers to mischievous activities which harm people’s lives, wealth, honour and rule of law in society. The punishments pronounced by Prophet Muhammad (PBUH) as head of state to some individuals belonged to one of these categories. Kab ibn Ashraf was punished not instantly when he started blasphemy, but when he indulged in high treason against the state. Likewise, Abdullah ibn Khatal killed his sub-ordinate. Islamic laws prescribe capital punishment for murder of a human being. Abdullah Bin Ubai, who was a hypocrite, but who did not indulge in murder or Fasad-e-Fil-Ard, was never prosecuted and punished and he died and buried as a Muslim in this world.

Maulana Zahid Ur Rashidi in Al-Shariah journal (Oct, 2011) explains how Abdullah Ibn-e-Abbas (rta) and Hanafi jurists like Imam Abu Yousuf, Imam Tahawi and Ibn-e-Abidin viewed blasphemy. As per them, capital punishment does not apply to non-Muslims and even when it is applied to Muslims, it is pardonable upon repentance.

Qur’an credits Prophet Muhammad (PBUH) as having best morals. His (PBUH) life explains that. He (PBUH) pardoned and forgave those who plotted plans to harm and kill Him [God Forbid], those who tortured Him (PBUH) emotionally, physically and financially, those who banished Him (PBUH) and those who misbehaved and harmed His (PBUH) family members including wife (rta) and daughters (rta).

Prophet Muhammad (PBUH) said: “A Muslim should speak the truth when he says anything, and fulfil his trust when he is in position of trust.” He (PBUH) said: “He is not one of us who dies without having shown kindness to our young ones and respect to our older ones.” He (PBUH) defined a Muslim as: “One from whose tongue and hands, others are safe”. Prophet Muhammad (PBUH) looked at Ka’aba and said: “You are sacred, but the life of a human being is more sacred than you”.

Silence is also a conscious stance. We will be judged for our actions, intentions, mindset and conscious efforts in understanding the true message. As per Qur’an, on Judgement Day, not even blood relations will share each others’ burden, let alone any thought leaders. The contemporaries who did not believe in Prophet Muhammad (PBUH) practiced political correctness. Their fate and Qur’an’s verdict on them shows us that there is no benefit in political correctness when the need is to be clear and decisive. Spare a thought to understand what it means to be a Muslim in the words of Prophet Muhammad (PBUH). He said: “A Muslim is one from whose tongue and hands, others are safe”.

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A Dialogue with Atheists

Salman Ahmed Shaikh

A lot of people these days present themselves as ‘Realists’ and ‘Atheists’. Often, they do not understand the basic premise of religion. Religion concerns itself first and foremost with the question of ‘Why’ rather than ‘What is’ and ‘How it is’. In answering the question of ‘Why’, Islam’s basic demand is ‘tazkiyah-e-nafs’ (ethical purification of actions) and ‘ibaadat-e-ilahi’ (submission to Allah and worship only Him) in a person’s life.

Allah asks in Quran, ‘Were they created by nothing, or were they themselves the creators?’ (At-Tur: verse 35). If we have been created, then the intellect with which we discover knowledge about matter in physical sciences to answer the question of ‘What is’ and ‘How it is’ and the conscience with which we differentiate between right and wrong, both are  bestowed by Allah.

Inner conscience, intellect and external guidance through Prophets are all given by Allah. Atheists deny Prophets and commonly shared history of more than three-fourths of human beings belonging to Abrahamic religions, but do not answer where the conscience and intellect come from?

Some Atheists refer to their doctrine as Secular Humanism. The basic source of knowledge and guidance then becomes conscience alone. That still begs the question that who created conscience and why it does not go through a biologically evolving process. Another problem with conscience only approach is that it cannot settle conflicting moral axioms and it also does not answer at all the purpose of existence and why exactly one should follow the righteous path if one can avoid material law, especially if there is no life after death.

Animals wake up, find food, eat, sleep and wake up again. As per Atheism, humans are also supposed to have only that same purpose. If I believe in this life only, then as long as I can avoid conflict with material law, control legislation by funding political cronies and muster military and diplomatic strength, I can commit genocide, kill, steal, rob for 50 years of my life and the victims and society cannot do anything unless they gain same power and make me powerless and define a different standard of justice and ethics.

According to this belief, a murderer who died before punishment or who committed more than single murder cannot be given absolute justice and victims cannot be given life again since this life is the only life. Belief in afterlife accountability promises absolute justice for any tiny act of evil or kindness in this life.

Conscience may not err in helping to differentiate between right and wrong, but the right ethical choice may not be chosen by a person if it conflicts with self interest. If I believe that this life is the only life, then why shall I use my limited time, income, abilities and resources to help others? Altruism and sacrifice shall be nonsense. Belief in Atheism entails evading responsibility and encourages pursuit of absolute freedom.

Atheists sometimes argue that science and its advancements have dispelled the need to use religious explanations to events and how things work. First, it must be understood that religion concerns with the moral conscience and strengthening it to elicit positive actions and behavior. Belief in the Creator without seeing Him personally does not mean that one can believe in all types of magic, superstitions, miracles and dogma.

Science concerns with the question of ‘What is’ and ‘How it is’. Any physical explanation of matter, either correct or incorrect, complete or incomplete, does not answer ‘Why it is’. Religion answers the question about purpose of existence and that can help humans to use matter in ways that can result in societal well-being. Else, the same technology bestowed by scientific advancement can be used to kill millions and millions of people instantly with the latest weaponry. Every civilized society with law accepts freedom with responsibility. When that responsibility is determined and guided by the Creator Himself, belief in Tawheed enables a person to be free from being subservient to anyone else except the Creator. Belief in Tawheed ensures equality since every human being is the creature of Allah like everyone else.

Religion has a distinct worldview. It does not have to borrow it from any other doctrine. Science is not a worldview since science is just a way to simplify the understanding of matter in a way to be able to make use of it. The intellect with which we discover nature’s wonders is created by Allah. If religion is not used to suggest lawmaking, then we will be using collective conscience of human beings which is again created by Allah. The Creator of conscience and the Creator of intellect has also provided a third source of guidance through the pious Prophets. Religion does not argue for ‘Creation’ doctrine alone. It gives a worldview which explains the meaning and purpose of life which is ‘aboodiyat’ (submission to Allah) and ‘tazkiyah-e-nafs’ (ethical purification of actions) and which will bring deterministic rewards with absolute justice in afterlife. The alternate worldview to religion is emptiness and anarchy of mind, soul and action.

It is correct that conscience is a powerful source to guide towards the straight path. Conscience is created by Allah. The important thing is that having knowledge of the right path, what will encourage righteous action. When someone believes that there is no Creator and that there is no afterlife and one musters diplomatic, media and military strength, then even if genocide is committed, how shall absolute justice be ensured in this world? What makes the conscience functioning? Religion is not just a source of information to know right and wrong. Religion gives a worldview that explains the purpose of life. Belief in afterlife accountability promises absolute justice which is not possible in this world for crimes like genocide or crimes for which criminals could not be convicted or punished in proportion to their nature of crime because of informational, legal, time and other natural constraints. The promise that every action and even intention will be given full justice by the Creator makes the ‘static conscience’ created by Allah a ‘self-regulated functioning conscience’.

The objective of religious guidance is submission to Allah alone and ethical purification of one’s actions and it should be reflected in one’s duties to the Creator and the environment (which includes other humans and animals of present and future generations).

Atheists often argue that why would Atheists doing good acts not get anything in afterlife from Allah. If a person does not believe in Allah and afterlife, then, it is important to understand what will have been the motive of that person for good actions. Among other reasons, it may be one of these things: 1) helping others and to see their lives improve IN THIS WORLD, 2) getting a good name and die in good records TILL THIS WORLD ENDS and 3) gain self-satisfaction TILL THE LIFE ENDS. These can be some of the broad objectives for a person who does good act and who knowingly does not believe in Allah and afterlife. As far as this world can provide justice, all of these objectives will be achieved to a certain extent. If not achieved or if a person anticipates that the world will not be just enough to reward good actions and right intentions; then, one has to explore as to how the ‘aspiration of absolute justice’ can be fulfilled. Religion promises absolute justice for every willful action and intention in afterlife for everyone. To expect any gain from Allah in afterlife, one already believes that there is Allah and that there is afterlife.

Human mind wants absolute justice, but it is not possible for natural reasons like an army general cannot be given equivalent punishment for committing genocide and in cases where the oppressed are in weak position legally, diplomatically, politically and militarily. Human conscience wants justice for oppressed and for all events where there is injustice. But, this aspiration is not possible to be realized in totality in this world for natural, informational, political and legal constraints. Belief in afterlife accountability gives meaning to the life and what we and others do in it. Else, in an Atheist paradigm, it is just the game of survival of the fittest. Animals play it as well as humans with no difference between the two.

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Some Misconceptions about Jihad in Islam

Salman Ahmed Shaikh

Jihad is a broad term and besides armed struggle against injustice, it encompasses academic, diplomatic and moral support to the righteous cause. In the specific meaning of armed struggle, Holy Quran says that Jihad in the meaning of armed struggle can only be undertaken for the sake of eliminating injustice [Surah Al Hajj: 39].

It is not a fight against non-Muslims. It is a fight against injustice. It can only be undertaken as a last resort to eliminate injustice. It can only be undertaken by the government and cannot be done privately. Jihad cannot be undertaken for the expansion of the state, against innocents, against non-combatants and against any contract of peace.

According to Islamic worldview, Allah sent His messengers who invited mankind towards Tawheed (belief in no Creator except One), belief in afterlife accountability and to engage in righteous conduct in all spheres of life. Some of these messengers were sent as ‘Rasool’. According to the Sunan-e-Elahi (law of Allah) of divine appraisal of chosen nations, several Rasool came in this world and established this Sunan-e-Elahi based on the will of Allah.

The struggle of any Rasool goes through these steps: 1) Dawat (initial stages of preaching), 2) Dawat-e-Aam (preaching publicly on a large scale) and 3) Itmam-e-Hujjat. Itmam-e-Hujjat refers to the situation where truth is explained in its complete form and where subsequent denial remains only due to prejudice, pride or communal interests.

After Itmam-e-Hujjat, the direct recipients had to accept the message received or if they refused the truth, then they had to face punishment in this world. According to the Islamic worldview, this world is a place for test where the objective of creation of man is obedience to Allah. Those direct recipients of the Rasool who disbelieved without any reason and remained disobedient and thankless to their Creator were punished by their Creator. Those who were obedient, steadfast and morally upright were rewarded by their Creator. This divine appraisal concerns all human beings. But, the direct recipients of Rasool who denied the message of Rasool without any reason were punished in this very world as well.

Since the direct recipients got the message of truth firsthand, so if they denied the truth after Itmam-e-Hujjat, they were punished in this world. Establishment of this Sunan-e-Elahi becomes a way of remembering divine appraisal in Qiyamat (judgement day) for all human beings to come. This is Sunan-e-Ilahi and this was commonly and consistently applied to Qaum-e-Noah, Qaum-e-Aad, Qaum-e-Samoud, Qaum-e-Lot, Qaum-e-Shuaib, Qaum-e-Younus, Qaum-e Musa and Qaum-e-Isa before Prophet Muhammad (pbuh).

Non-believers of Prophet Muhammad (pbuh), a Rasool, were also dealt in the same way by Allah. The only difference is that in the case of Prophet Muhammad (pbuh), this divine punishment to the non-believers who fought against Muslims came in the form of defeat of non-believers in the armed struggles with believers. It is because in the case of Prophet Muhammad (pbuh), there were enough followers and these armed battles also became a way to distinguish between true believers and munafiqeen (hypocrites).

In verse 17 of Al-Anfal, Allah says:

“You killed them not, but Allah killed them. And you [Muhammad (pbuh)] threw not when you did throw but Allah threw, so that He might test the believers by a fair trial from Him. Verily, Allah is All-Hearer, All-Knower.”

In various time periods, Rasool of Allah came with undeniable signs to their nations and when their nation decided to not accept the message received directly and clearly with undeniable signs, then the non-believers were punished by Allah in the form of natural calamities if the believers were fewer in number or through the triumph of believers over non-believers who fought against them as in the case of Prophet Muhammad (pbuh). The specific verses in Holy Quran describing jihad in the meaning of armed struggle against non-believers of those times are clear from the context that they refer to this Sunan-e-Elahi we explained above. When Rasool come with clear signs, they establish this Sunan-e-Elahi which is a divine appraisal of their nation the way it will happen for all people on the Judgement day.

This history is common heritage of all Abrahamic religions which represents almost three-fourths of all human population. Quranic verses about Jihad specifically with non-believers are often misunderstood by West and also misunderstood by some minority Muslims as well when they generalize these verses out of context.

From a community of 1.5 billion people spreading in 7 continents of the world, individual instances from a small minority of deviants are picked in an effort to embarrass and tease peaceful mainstream Muslims. Close to 100 million Muslims live in developed regions alone. There has to be acknowledgement and understanding of this fact that Islam and Muslims are two different things.

There can be difference of opinion, but selectively picking particular types of arguments, peoples and actions and generalizing them over 1.5 billion people is unjustified. The objective of religion of Islam is not its political enforcement. The basic thesis of religion is to inform people about their role and relation with Creator and what attitudes, behavior and actions can lead them to success in life hereafter.

A faith must never be studied from the followers’ actions. Christianity is not to be studied in the light of holocaust, colonization, slavery in Africa and crusades. In the light of teachings of Jesus (pbuh), these events were wrong as per the true teachings of Christianity.

Likewise, we shall not judge liberal democracy or secular humanism based on two World Wars, invasions, transnational wars, undue sanctions, embargoes, political interference to topple democratic governments, advancement in race to produce ever more destructive weapons of mass destruction, and paying lip service to thousands and thousands of people suffering genocide in Bosnia, Kosovo, Burma, Gaza, Kashmir and at other places. Indeed, these actions by the authorities do not represent the aspirations, values and views of common man in west.

Quran says in verse 256 of Al-Baqara ‘There is no compulsion in religion”. Indeed, as per Islamic worldview, people are created and for the specific purpose of testing their thankfulness to their Creator and would be judged on merit by their Creator when they return towards Him after death in this world. However, this test period has granted freedom to people in this world and hence Islam does not direct Muslims to make everyone else Muslim in this world by force. Allah says to Prophet Muhammad (pbuh) in verse 21-22 of Chapter Ghasiya “So remind them, you are only a one who reminds. You are not a dictator over them.” In verse 125 of Chapter Nahl, Allah says “Invite (mankind, O Muhammad ) to the Way of your Lord (i.e. Islam) with wisdom and fair preaching, and argue with them in a way that is better.”

Islam does not teach hate and violence. It is a source of spiritual contentment and fulfillment for a quarter of world’s population. It teaches a believer in Islam to never tease, hurt or inflict any harm with hands or tongue to humans, animals and environment and no matter whether there is any law about it and whether it is being enforced because all people for all their intentions and willful actions shall be accountable on the Day of Judgment.

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How Did Islam Abolish Slavery?

Salman Ahmed Shaikh

Islam grants equal human rights to all people. In verse 13 of Chapter Al-Hujurat, Allah says:

“O mankind! We have created you from a male and a female, and made you into nations and tribes, so that you may know one another. Verily, the most honorable of you with Allah is the most pious. Verily, Allah is All-Knowing, All-Aware.”

It is to be understood that 15 centuries ago, the institution of slavery was common in Arabs and when Islam spread, Islam took measures to get rid of the institution of slavery in a gradual process. Quran is very clear on freeing slaves in the later revealed verses. In verse 12 and 13 of Chapter Balad, Allah says:

“And what can make you know what is [breaking through] the difficult pass? It is the freeing of a slave.”

In Zakat rules, there was a fiscal head allocation for freeing slaves. Also, as an alternate to pecuniary punishments, freeing slaves was encouraged. In verse 33 of Chapter Nur, the final verdict comes like this:

“And such of your slaves as seek a writing (of emancipation), give them such writing, if you know that they are good and trustworthy. And give them something yourselves out of the wealth of Allah which He has bestowed upon you.”

Not only this verse points towards freeing slaves if they so desire, but also to help them with resources so that they can afford their livelihood independently.

Meanwhile, in the transition period, several verses and Ahadith ensured that slaves were dealt humanely. A Hadith says that while fasting, Muslims should work with their subordinates and reduce their working hours.

William Muir (a non-Muslim) in his biography about Prophet Muhammad (pbuh) writes:

“Zaid, the freedman, was so strongly attached by the kindness of the Prophet, that he preferred to remain at Makkah rather than return home with his own father. ‘I will not leave thee,’ he said, clinging to his patron, ‘for thou hast been a father and mother to me.”

In Muslim world later on, the institution of slavery was abolished quite late. However, the sources of Islam, i.e. Quran and Hadith are very clear in their principle stand on slavery and Islam took steps to get rid of slavery in a gradual process. The gradual process was adopted as an economic need of transition so that an abrupt change must not bring about massive levels of economic hardships for the slaves.

But, even in the transition period, imbued with the spirit of kindness, compassion and submissiveness, people treated slaves humanely which resulted in their acceptance of Islam. In fact, one of the arguments of non-believers was that how can Islam give such generous rights to slaves. Prophet Muhammad (pbuh) describing how to treat slaves once said: “feed them with food you eat yourself, clothe them with clothes that you wear yourself.” [Bukhari]

It must be understood in the light of history that it was during the colonization and post colonization period when Western powers treated slaves like animals with brutal torture and adopting un-human ways.

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Risk Management Tools in Islamic Banking

Salman Ahmed Shaikh

In this article, we discuss the major risks that Islamic banks face in their commercial operations and the tools with which they mitigate these risks.

Credit Risk

Credit risk is generally defined as the risk that the counterparty fails to meet its obligations in accordance with agreed terms. Credit risk includes the risk arising in the settlement and clearing of transactions.

But, since clean borrowing is not possible in Islamic banking, Islamic financing is asset backed and adequately collateralized. Furthermore, the title of ownership rests with the bank in Ijarah and Murabaha until the actual sale transaction is made. Therefore, an Islamic bank can foreclose the asset in the case of default.

Tools to Manage Credit Risks

  • Pledge of Assets as Collateral

Any asset owned by the client could be taken as collateral. The client may not be able to sell that asset without bank’s permission. However, the ownership of the asset will remain with the client.

  • Third Party Guarantee

If the client’s own guarantee is not completely reliable, then the bank can ask for third party guarantee, especially when the client is an associated company or a subsidiary company or when the majority owner is a conglomerate.

  • First and Second Charge on Assets

First and second charge rank the order in which the proceeds of the liquidated asset(s) are used to pay off liabilities. If a financier has a secondary charge, then his turn to be paid back from the client’s liquidation of asset(s) will come second or later than the first. All else equal, financiers will prefer to have first charge.

  • Takaful

Takaful can be used to insure a tangible movable or immovable asset. The insurance cost can also be added back in sale price or rentals.

  • Hamish Jiddiyah

As an alternative to down payment or security deposit, some advance rental could be taken which may be adjusted for future rental payments. It could also be used as partial settlement price for the sale of asset. However, any amount received in this case at the beginning of the contract cannot be taken as income for that period.

Market Risk

It refers to the risk arising from adverse movements in interest rates, commodity prices and FX rates. Commodity risk is also present in Murabaha, Ijarah and Salam.

Tools to Manage Market Risks

  • Parallel Contract (if permissible)

To mitigate the storage risk and avoid inventory cost, parallel contract can be done for the same date in the case of Salam.

  • Binding Promise

Binding promise which is unilateral (one-sided) can be taken to ensure contract enforcement and to guarantee seriousness of purpose on client’s end before the bank invests depositors’ funds to provide financing to the clients.

  • Takaful for Asset Risk

Takaful can be used to insure a tangible movable or immovable asset. The insurance cost can also be added back in the sale price or rentals.

Equity Risk

It refers to adverse changes in market value (and liquidity) of equity held for investment purposes. It covers all equity instruments including Mudarabah and Musharakah.

Tools to Manage Equity Risks

  • Seek diversification of capital contribution.
  • Use restricted Mudarabah.
  • Use Musharakah than Mudarabah together where possible.
  • Limiting period of contract.
  • Plan exit strategies.

Liquidity Risk

Liquidity risk is the potential loss to the Islamic banks arising from their inability to meet their obligations as they fall due without incurring unacceptable costs or losses.

Tools to Manage Liquidity Risks

  • Diversify Sources of Funds

Increase in non-remunerative deposits can reduce the cost of raising funds from the public. Reliance on few big deposits is risky. It is better to have a widespread deposit base.

  • Reduce Concentration of Funding Base

It is better to have efficient liability mix with adequate availability of short term and long term deposits. Maturity matching on both sides of balance sheet can solve much of the problem systematically.

  • Rely on Marketable Assets

It is better to finance those assets on priority basis that have secondary market and that are somewhat standardized and widely used in the real sector of the economy.

Legal Risk

It refers to inadequate legal framework, conflict of conventional and Islamic laws and conflict between Shariah rulings and legal decisions.

Tools to Manage Legal Risks

  • Documenting agreements to make them enforceable.
  • Binding undertakings.
  • Covering contingencies in design of agreements.
  • Documenting the details of rights/duties in agreements.
  • Strong internal compliance, due diligence and audit.

Displaced Commercial Risk

It refers to the risk that the Islamic banks may confront commercial pressure to pay returns that exceed the rate that has been earned on its assets.

Tools to Manage Displaced Comercial Risks

  • Floating rentals so that increase in benchmark rate is absorbed effectively on both sides of the balance sheet.
  • Using profit equalization reserves.
  • Using Hibah.
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Islam and Institution of Interest Based Lending

Danial Pirani

In modern times, the institution of interest is regarded as critical for the stability of an economy. Nearly all the economic and financial institutions are, in one way or the other, connected to the interest based transactions. Interest is considered as an incentive to save money. Secular economic theory claims that the whole interest mechanism guarantees an efficient allocation of available funds. It keeps the flow of credit stable in the economy.

Today, nearly all financial institutions work on interest based transactions. They all share a common belief that interest based systems provide good incentives to invest and simultaneously earn as per the standard requirements, the result of which ultimately leads towards capital formation and economic growth.

But in practical world, this is not the case every time. What if a person bears a loss? Or what if he cannot afford to pay above the principal amount he borrowed? In both the cases, one becomes a permanent slave of the creditor. He loses his identity and becomes bound to obey what the creditor commands. Today, Pakistan has to pay half of its tax revenues in paying interest alone.

In the earliest times in recorded history, Aristotle – who is considered as a pioneer figure in secular philosophy – criticized the institution of interest. Thomas Acquinas also stated that the just price of money lent is nothing more than the principal amount lent itself. All Abrahamic religions denounced the institution of interest in clear terms. Even great thinkers like Martin Luther said: You cannot make money just with money.” Making money with money is referred to as earning something in trade by selling what does not exist.

Thomas Aquinas said: “To take usury for money lent is unjust in itself, because this is to sell what does not exist and this evidently leads to inequality which is contrary to justice.”

In the interest based lending, the lender bears no risk in the enterprise of borrower and yet demand and is guaranteed a fixed return. Hence, it leads to an inequitable distribution of income.  This can be seen by taking an example.  Suppose there are three people who consume all of their income in a given year. One of them starts with $1,000 in savings, a second with $100 and a third with zero.  At 10% interest per annum, by the end of the year, the first person has $1,100, the second has $110 while the third person has zero in his account.  If the same scenario follows in the next year, the first person will have $1,210, the second will have $121 and the third will have zero.  One can see how the wealth distribution between them gets unequal every year.  This scenario ultimately leads to an autonomous inequality in society generated by no one, but suffered by everyone. Note that those in debt paying interest that grows every year have not been added to the picture.  In their case, as interest rate continues to grow, more and more of their overall income will be consumed by interest and therefore, further exacerbating the skewed distribution of income.

On the behavioral side, the one receiving interest indirectly tags money as risk-free and work-free. This leads to a lifestyle mainly based on consumption. But more importantly, it leads to a very irresponsible attitude towards one own self and the society.

On the social equality front, the one paying interest becomes a slave of those who lent him money since the burden gets bigger over time. This leads to dependency and leaves self-empowerment as mere fantasy and ultimately leads towards loss of self-identity, self-honor and destruction of humanity.

John Maynard Keynes, a well-known economist of the west, who unveiled the mysteries behind the greatest economic crisis on earth (Great Depression on 1930s), also argued that the best way to revive the economy is to increase the money supply so that the rate of interest falls. A fall in the rate of interest would lead to higher investment, employment and output. In fact, Keynes held that ultimately an ideal economy is one wherein interest does not exist.

Economists like Milton Friedman, Kindle Berger and H.C. Simon regard fixed interest rates to be responsible for economic instability. Friedman contends that changes in rate of interest bring about either inflation or deflation and both are harmful to the society. He therefore argues “Our final rule for the optimum quantity of money is that it will be attained by a rate of price deflation that makes the nominal rate of interest equal to zero”. This proposition is known as Friedman’s Rule, and it is one of the most celebrated propositions in modern monetary theory.

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Limitations of Mainstream Consumer Theory in Economics

Salman Ahmed Shaikh

Mathematical tractability has restricted economic analysis of consumer behavior within a confined boundary of certain axioms. Often, these axioms are found to be empirically false. Even more importantly, these axioms and the analytical framework based on them is incapable of explaining economic choices in environment goods, public goods and social sphere. Studies in behavioral finance have also documented information processing incapacities and biases that challenge some of the rationality assumptions.

In traditional mainstream neoclassical consumer theory, the consumer is supposed to maximize a utility function subject to some budget constraint. To conduct maximization analysis, certain axioms are imposed on the consumer choice set that enable mathematical tractability and optimization analysis. These axioms can be summarized into the following: completeness, transitivity, invariance of preferences, convexity, continuity of the utility function and monotonicity or local non-satiation.

Apart from Economics, other social sciences are not always thrilled to restrict consumer behavior analysis within such a framework which is only used for mathematical tractability in economics. Lehtinen & Kuorikoski (2007) defend the neoclassical methods for analyzing consumer behavior by arguing that the false assumptions are not potent reasons to abandon the mainstream methods and analysis. It is the empirical validity of predictions with observed behavior which gives the mainstream tools and methodology the credibility and wide acceptability.

However, the relevance and validity of these axioms are not trivial to Gowdy & Mayumi (2001). They opine that if consumer behavior does not conform to the set of axioms adopted in neoclassical theory, then one cannot make the leap from maximizing utility to constructing welfare measures of consumer surplus using Hicksian or Marshallian demand curves.

Thaler (1980) explains that since mainstream consumer behavior theory is based on a rational maximizing model, it describes how consumers should choose given the model and its assumptions; however, not necessarily describing how they do choose. Mainstream consumer behavior theory is normatively based and it only claims that it is also a descriptive theory.

But, in many cases, the mainstream consumer theory fails to predict the economic choices either because of rigid axioms or simplistic preference structure.

Sen (1977) explaining the shortcomings in the structure in neoclassical approach comments as follows:

“A person is given one preference ordering, and as and when the need arises this is supposed to reflect his interests, represent his welfare, summarize his idea of what should be done, and describe his actual choices and behavior. Can one preference ordering do all these things? A person thus described may be “rational” in the limited sense of revealing no inconsistencies in his choice behavior, but if he has no use for these distinctions between quite different concepts, he must be a bit of a fool.”

Gowdy & Mayumi (2001) correctly argue that monotonicity axiom is irrelevant in environment goods where the balance and coherence matters more than abundance. Health goods also require a balance for their effectiveness. Same is true when consumption is analyzed with respect to health effects. Moreover, just like the consumer choice implicitly maintains or should maintain a balance with regards to health effects of consumption, the mainstream consumer theory will be much better off by giving due importance to the balance with regards to ecology, biodiversity and intergenerational equity. This may require incorporating the attribute of ‘commitment’ in consumer theory (Sen, 1977).

Using an example from social choice, Sen (1977) states that even when individual voters have limited probability of affecting actions and when the costs of casting votes could be substantial in particular circumstances, people still take the pain to cast votes to document their true preferences. Sen argues that if this desire reflects a sense of commitment, then the behavior in question would be at variance with the view of man in traditional economic theory.

Furthermore, ‘Ultimatum Game’ reflects the fact that people tend to look at their choice outcomes relatively. Prisoner’s Dilemma highlights the fact that choices by each player in a self-centric way are not necessarily going to be best for them either individually or collectively.

On the other hand, there is another critique on the rational consumer theory that it is overly optimistic about the information processing capability of the consumer. On this, Simon (1957, p. 198) wrote:

“The capacity of the human mind for formulating and solving complex problems is very small compared with the size of the problems whose solution is required for objectively rational behavior in the real world — or even for a reasonable approximation to such objective rationality.”   

Furthermore, recent evidence in behavioral finance and consumer psychology points to the fact that consumer information processing capabilities are limited and prone to error. Alias paradox (1953) and Ellsberg paradox (1961) are good examples of this phenomenon.


Gowdy, John M. & Mayumi, Kozo (2001), “Reformulating the foundations of consumer choice theory and environmental valuation”, Ecological Economics, 39, pp. 223–237.

Lehtinen, Aki & Kuorikoski, Jaakko (2007), “Unrealistic Assumptions in Rational Choice Theory”, Philosophy of the Social Sciences, 37, pp. 115 -137.

Sen, Amartya K. (1977), “A Critique of the Behavioral Foundations of Economic Theory”, Philosophy and Public Affairs, 6(4), pp. 317 – 344.

Simon, Herbert (1957), “Models of Man”, Wiley: New York

Thaler, Richard (1980), “Toward a Positive Theory of Consumer Choice”, Journal of Economic Behavior and Organization, l, pp. 39 – 60.

Allais, M. (1953), “Le comportement de l’homme rationnel devant le risque: critique des postulats et axiomes de l’école Américaine”. Econometrica, 21 (4), pp. 503 – 546.

Ellsberg, Daniel (1961), “Risk, Ambiguity, and the Savage Axioms”, Quarterly Journal of Economics, 75 (4), pp. 643–669.

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Potential of Islamic Finance to Lead New Financial Architecture

Salman Ahmed Shaikh

The financial crisis of 2007-2009 and ongoing sovereign debt crisis in Europe has challenged the conventional wisdom. Massive levels of debt and consumption beyond means and speedy financial innovation with lax regulation has put major economies in a deep crisis.

In the US, the share of total corporate profits generated in the financial sector grew from 10% in the early 1980s to 40% in 2006. These earnings are transaction costs for the productive sector. Financial institutions that were just supposed to be playing a supportive role to the productive economy got much bigger and unregulated through shadow banking practices. Recently, Piketty in his book “Capital in the 21st Century” explains that the tendency of returns on capital to exceed the rate of economic growth today threatens to generate extreme inequalities.

Nevertheless, financial intermediation has a useful function to facilitate intertemporal consumption decision by households and investment decisions by firms to encourage capital formation. What is needed is a new paradigm that can put the focus back on productive enterprise, brings recovery with job creation, limit and regulate speculative financial instruments and improve corporate governance by influencing the incentives more deeply and proactively. Below, we analyze how Islamic finance principles and institutions can provide basis of new financial intermediation architecture.

During the last decade and half, the Islamic financial industry has seen tremendous growth even when the conventional financial institutions went into a deep crisis. Islamic finance is a fast growing industry all across the globe. Islamic banking assets with commercial banks globally crossed $1.7 trillion in 2013, suggesting an annual growth of 17.6% over the last four years.

The two most important problems identified in a post-financial crisis look back are perverse incentives and de-linking of financial sector growth and activities with the real sector of the economy. Islamic finance principles by basing all financial products with real assets fill the gap and this feature alone is a very important risk management tool inbuilt into the system.

In Islamic banking, there is inherent risk management technology. Floating rate rentals substitute the use of interest rate swaps. Credit Default Swaps (CDS) are not needed in most cases since almost all financial assets credit creation is backed by real assets and the bank has recourse to them. Delivery based trade contracts ensure that the transaction is not for speculative purposes only. Price hedging can be ensured through Salam and Murabaha already which are used for short term financing. In long term financing, the rentals are mostly floating.

However, to lead and sustain the growth momentum, Islamic banking has to overcome several challenges.

Islamic banks do not have complete product alternatives for all kinds of conventional finance solutions. According to the World Islamic Banking Competitiveness Report 2013, there are 38 million customers globally with Islamic banks with an average product holding of 2.1 which is significantly lower than the class leading average of 4.9. This represents untapped cross selling potential in Islamic banking with existing and growing customer base.

While it is indeed appreciable that not all conventional practices are replicated as is by Islamic banks, but such lacking in solutions and alternatives cannot completely be attributed to this factor alone. Distress financing, educational financing, health financing and micro finance are areas where if Islamic product alternatives can be developed and adequately marketed, it will increase the size and scope of Islamic banking. Furthermore, it will validate the position of Islamic banks as having solutions for all classes and stratum in economy and not just for the big corporations looking to expand.

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Challenges for Islamic Banking in Pakistan

Salman Ahmed Shaikh

Islamic banking in Pakistan is an established industry with 12% market share achieved in just over a decade. There are 5 full fledged Islamic banks and more than 15 other commercial banks that operate Islamic banking windows alongside conventional banking in Pakistan.

One of the challenges faced by Islamic banking industry in Pakistan is that deposit mobilization had been much easier as compared to using the deposits to provide finance. Islamic banks with asset-backed financial products rely much more on formal documented manufacturing based industries where finance is required for plant and machinery, raw material and industrial equipment.

On the other hand, the financing operations that are overly dependent on asset backed debt based modes of financing create several issues.

First, in times of recession, Islamic banks in Pakistan have limited product range for firms that require finance in already ongoing projects in which big investments had already been made, but financing is required to meet rising costs of energy and utilities.

Secondly, in recession, purchasing new assets for expansion is not the first things most firms would do or can afford to do. Hence, if Islamic banks remain stuck in debt based modes of financing, they will have to start offering buyback or sale and leaseback type of products which are not preferable or ideal from the Maqasid-e-Shari’ah perspective.

Third, over-reliance on debt based modes of financing requires firms to take initiative and increase their demand for such products from Islamic banking. Hence, the supply side response by Islamic banks is hindered and they may remain ineffective in bringing an economy out of recession by providing less restricted and flexible modes of financing like Mudarabah and Musharakah.

But, Islamic banks in Pakistan seem to be content with surplus liquidity. Instead of using the deposits to provide finance to private sector, they had increased investments. This has resulted in a finance to deposit ratio of as low as 34% in recent months. This undermines their function of financial intermediation between firms and households.

It is surprising that we do not look at development towards Islamic economics ideals by looking at the size of equity markets, number of new IPOs and self-employed professionals. They are all avoiding payment and receipt of interest directly. We need to get out of this mentality of only assessing progress towards Islamic economics ideals in the commercial practice of Islamic banks.

The path dependency is followed more rigorously in product design for commercial viability, but not when another institutional structure appears to conform to basic Quranic injunctions, but not to the directly Fiqh defined parameters. For instance, the modern day venture capital funds, private equity, public and private corporations are time tested structures which avoid direct involvement of interest and for which sufficient covenants had been developed by way of experience and legislation which render these structures highly usable in current times.

Banking penetration is 11% in Pakistan, then, 89% of the population is already interest free by not being directly involved in interest based banking. The number of firms using their own equity, family funds, partnership or capital markets for finance maybe much more in number than those opting for bank finance alone.

If commercial viability is a valid excuse when 89% of Pakistanis not use banking services in the first place, then, Islamic banking penetration in future will become an obstacle against itself when there will be an academic call to change the structure for Maqasid-e-Shari’ah compatibility.

Banks usually serve risk averse clientele. The equity investors are also in financial markets and are willing to take part in equity investments with no guarantee of either capital gains or dividends. In fact, they participate despite there being capital value tax and capital gains tax in Pakistan’s stock trade.

Banks hide behind the depositors who in the first place, are only placing funds with banks as a secure way to park liquidity rather than as a means of investment. It is confirmed by the very low deposit rates in Pakistan which do not even makeup half of Pakistan’s inflation rate during the last 10 years.

Karachi Stock Exchange, the premier equity market of Pakistan has market capitalization of about $70 billion which is roughly one-third of Pakistan’s GDP. While corporate bonds have very little penetration and banking services are utilized by only 11% of population. Most savers with adequate risk apatite look to invest in secondary market for equities. Karachi Stock Exchange had provided return of 48% and 49% in 2012 and 2013 respectively. Hence, the less risk averse investors favor equity investments in liquid stocks for parking their surplus money.

Still, no Islamic bank has seriously ventured in micro finance sector in Pakistan and not even in investment banking. Helping IPOs by investment banking operations is closer to fulfilling Maqasid-e-Shari’ah than getting trapped in path dependency and debt based product structures in commercial and retail banking.

Islamic banks are in search of a distinct identity for themselves and to showcase their significant and unique impact on the economy that can legitimize their economic merit over and above the conventional banks. Facilitating IPOs through investment banking can make them play an effective role and also pave the way towards increased use of equity based financing over debt based financing in Pakistan.

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Sukuk Market in Pakistan Set for Take-Off

Salman Ahmed Shaikh

Sukuk is an alternative Islamic finance instrument for conventional bonds. Sukuk is a certificate that represents ownership in underlying real asset(s). Islamic law does not permit interest and hence conventional coupon paying bonds are impermissible as per Islamic law. However, Islamic law allows sale and lease of real assets and the resulting income in the form of profit on sale or rental income stream on lease of assets. Holders of Sukuk share in the lease or profit income generated from the ownership of real assets that the Sukuk certificate represents.

A typical Ijarah Sukuk would work like this. For instance, if a manufacturer requires industrial equipment, it will issue Sukuk that can be purchased by institutional and/or retail investors. From the proceeds of Sukuk, the industrial equipment is purchased and is leased to the manufacturer. During the period of lease, the manufacturer will pay rent and that will generate income stream for the Sukuk holders who had invested in Sukuk. After the lease period is over, the manufacturer will purchase the asset in a separate contract and this will enable the Sukuk holders to be able to redeem their investment.

Sukuk could turn out to be an instrument of choice after the current financial crisis. Not only Muslim countries, but non-Muslim majority countries are also taking interest in it. UK treasury is issuing a Sukuk worth £200 million. It will become the first sovereign state outside the Muslim world to issue an Islamic bond.

In Pakistan, capital markets are not as developed and most of the formal sector financing takes place through banks. Savings rate is very low (12%-14%) and the inflation rate on average had remained above 10% during the last 10 years or so.

Capital market instruments require long term investment horizon and liquidity. Due to political instability and policy inconsistency, usually, the long term investments are not very popular among the investors. In the last few years, only a handful of IPOs had taken place. The bond market is also very small and dominated by sovereign issues than corporate bonds.

While risk averse investors had found comfort with bank investments even though banks do not offer inflation beating returns, most savers with adequate risk apatite look to invest in secondary market for equities. Karachi Stock Exchange had provided return of 48% and 49% in 2012 and 2013 respectively. Hence, the less risk averse investors favor equity investments in liquid stocks for parking their surplus funds.

There are many reasons why corporate bond market did not develop as per expectations in Pakistan. The national savings scheme instruments issued by the government of Pakistan are offering very attractive yields and they are default free. Some national saving scheme instruments are also tax-free and hence after-tax yield on such instruments are even higher as compared to the corporate bonds.

Moreover, the corporate sector itself has lost confidence and interest for long term big investments in the country ever since the episode of nationalization in the 70s. Afterwards, indirect taxation and removing import barriers had also made corporate investment more challenging in the 80s and 90s. Then, the rise of industrializing countries on the external front together with energy and security crisis in the domestic front had resulted in even more challenging times for formal corporate sector businesses, especially in the manufacturing sector. As a result, neither new IPOs nor corporate bonds had much of a success during the last 6-7 years in the country.

In Pakistan, 78 Sukuk had been issued so far for an amount of Rs 637.43 billion. Out of the total 78 issues, 32 Sukuk issued for an amount of Rs 100.10 billion had been fully redeemed.

Government of Pakistan (GoP) had issued Ijarah Sukuk on numerous occasions in past to meet its escalating borrowing requirements. Government sector companies like Water & Power Development Authority (WAPDA) and Sui Southern Gas Company Limited (SSGC) had also issued Sukuk in past. Karachi Shipyard has also issued an Ijarah Sukuk in 2007.

Sovereign Ijarah Sukuk issued by the Government of Pakistan (GoP) have been structured in such a way that it allows the government to mobilize funds. The Sukuk holders are also able to earn Shari’ah compliant income. It also facilitates Islamic banks to manage their liquidity as well as meet statutory liquidity requirement stipulated by the central bank of Pakistan.

In the corporate sector, Sitara Chemical Industries Limited, Wateen Telecom, Engro Chemicals, Dawood Hercules, Century Papers & Boards, Attock Generation Limited, Arzoo Textile, Lieberty Power, Amreli Steels, Eden Builders, Quetta Textile, Pakistan American Fertilizers, PEL and Kohat Cement are some of the companies that had issued Sukuk in past. One private sector entity Maple Leaf defaulted on Rs 8 billion Sukuk in 2009. Maple Leaf default on its Sukuk liabilities had demoralized already minimal investor confidence. But, capital markets – especially led by a buoyant stock market – are experiencing resurgence in investor participation and interest.

Recently, K-electric (formerly KESC) issued Rs 6 billion Sukuk which is also listed on the Karachi Stock Exchange (KSE) and Lahore Stock Exchange (LSE). There was no Pre-IPO placement and the entire amount of Sukuk issue was offered to retail investors and it was fully subscribed in a matter of few hours.

In recent times, Meezan Bank also arranged the country’s first airtime-based Sukuk. These Sukuk use intangible assets such as minutes of mobile telephone use. The structure of these Sukuk is based on Ijarah and sub-Ijarah of services. Assets are airtime (minutes) represented by prepaid calling cards and identified by the serial number of each card.

On the regulatory front, Securities and Exchange Commission of Pakistan (SECP) had issued guidelines for the issuance of Sukuk. According to SECP, the issuer must not have over-due loan and the issuer’s as well as the instrument rating should not be lower than triple B minus (BBB-).

SECP has decided that Sukuk would be offered in three types, that is Sukuk-1 of up to Rs 750 million for a tenor of thirteen months, Sukuk-2 of up to Rs 3,750 million for a tenor of three years and Sukuk-3 of Rs 1,500 million for a tenor of five years.

The SECP explained that the subscription period would be for three months. The rate of return on Sukuk-1 will be one month KIBOR plus 100 bps, Sukuk-2 will be three month KIBOR plus 225 bps and Sukuk-3 will be three month KIBOR plus 275 bps. KIBOR is Karachi Interbank Offered Rate and used as a benchmark in pricing time based intertemporal financial products just like the use of LIBOR in the international markets.

Through issuance of more Sukuk, the investment class assets universe will expand and it will enable the Islamic-conscious individual and institutional investors to effectively diversify their portfolios. Treasuries of Islamic banks will also have an expanded set of investment avenues. It will increase liquidity of these Sukuk and generate wider interest among all investors in the economy to consider investing in these investment vehicles.

In most developing countries, the governments pay more than 50% of their tax revenues in servicing debt and spend very little on development. Often, these governments trim development spending to cover other non-discretionary current expenditures. Going forward, Sukuk can be used to finance the purchase of infrastructure that can be used in development projects.

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