2014년 8월 30일 토요일

[발췌: Mohamed Ariff's] Ethics-based financial transactions: as assessment of Islamic banking (2011)

출처: Mohamed Ariff (2011). "Ethics-based financial transactions: as assessment of Islamic banking", Chapter 2 in ^The Foundations of Islamic Banking: Theory, Practice and Education^. Edward Elgar Publishing. Jan 1, 2011
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※ 발췌 (excerpts): 

Chapter 2. Ethics-based financial transactions: as assessment of Islamic banking


1.0 INTRODUCTION

This is an analytical chapter with the modest aim of assessing a 48-year old experiment commonly termed Islamic finance, which describes the profit sharing and risk-sharing contracting in financial transactions as being ethically consistent with human welfare. Profit-earning after risk-sharing in debt contracts (as has always been the case throughout history in equity contracts) has been practiced in financial dealings in settled societies for over four millennia, before the birth of modern banking practices which are debt-based on no risk-sharing, with pre-agreed fixed interest charges. In just 48 years, the ethics-based Islamic finance has gained a respectable foothold in some 76 countries, including seven major financial centers, as will be supported by evidence in this chapter. Its presence is felt in many countries. With the Bank of Englad's adoption of a landmark liberal regulation in 2002, after careful study over many years, to accept Islamic financial institutions as another niche in banking, the pace of growth of adoption of this experiment has substantially accelerated.

These two facetsㅡfoothold and wider recognitionㅡhave been hard-earned, and deservedl so, if one were to examine Islamic finance as an alternative ethics-based financial practice, which is claimed to be. As we will observe later in the chapter the ethical moral-based financial principles, along with the human princple of equitable dealings in financial transactions, reconnects these financial activities of Islamic finance to the long-practiced wider belief in human history that financial transactions should be based on risk-sharing, and thus, also by the sharing of the ^ex-post^ outcome of the risk, that leads to profit-sharing as morally correct in finance.

If, for acceptable reasons, profits do not materialize in a risk-sharing venture during the term of a debt contract, then the most a lender gets is the principal put at risk. Despite widespread practice of safeguarding the principal borrowed in guaranteed contracts in this new finance, some authors(Iqbal, 2007) claim that guaranteeing the principal is also strictly not kosher in Islamic finance, but, in practice, is allowed. In publicly-traded debt contracts this is always the norm,as traded prices of bonds decline if the risk does materialize, leading to losses because of declining bond prices. [n.1]

In this sense, modern banking practice of exacting a pre-fixed interest charge in debt contracts, albeit not high enough to reach the legal limit of usury rate, introduces a one-sided contract with no equitable recourse for borrowings at risk. Some claim that this makes the moneyed, wealth-owing, capitalist class introduce an element of oppression of the borrowing class. Throughout history it is the entrepreneur without the money wealth who predominantly created inventions to improve society's progress. Indebtedness, due to non-risk-sharing, dents entrepreneurial benefits to society, which is a limiting factor for human welfare, despite the protection of limited liability laws available to a small sliver of entrepreneurs in large formal organizations.

This new form of ethics-based finance has been offered as a new financial invention, replacing the much older, very entrenched, financial transactions based on lender-favored pre-fixed interest payments with no risk-sharing, in debt contracts of conventional finance. While this much older modern finance [n.2] finds no strictures against lending on these bases to promote economic activities such as gaming, production of intoxicants for non-medical consumption, prostitution, etc., the new ethics-based Islamic lending prohibits such lending activities as being anti-social. Islamic financial institutions do not lend based on interest, nor receive interest (as it is considered non-risk-shared reward, and for reasons of canon law) nor lend to promote anti-social activities. Historical writings (Goetzmann and Rouwenhorst, 2005) suggest that Muslim communities in the 10th-13th centuries, and throughout Muslim communities thereafter, engaged in both formal and especially the more dominant informal lending via profit-sharing debt (and equity) contracts. Pre-fixed interest-based debt contracts also thried at the formal end in Muslim, as well as in other societies. Even today much informal lending on a profit-shared basis is very prevalent, but is unrecorded based on zero interest or profit share. That is not to deny that in the over 15 centuries of Islam, there was no interest rate-based financing. Nor is it easy to argue that all interest charges are forbidden (El-Gamal, 2006).

The research questions addressed in this chapter are aimed at making a modest contribution to the ethics literature on a number of directions. What are the essential ethical principles, and how do these compare over historical time and against current modern practices? How successful is the penetration of this new form of profit-making with ethics-based financial practices? How is the ethical dimension overseen? What is the comparative assessment of Islamic finance and modern finance?

The following sections elaborate the contributions of the chapter. Section 2 provides a quick discussion and an important review of what this author considers as the seven ethical-moral principles of financial transactions as evolved over 5,000 years in many belief systems that are embodies in Islamic finance. We also discuss the contributions of the debate in the Islamic finance literature. In Section 3, the reader will find a discussion based on summary statistics on the incidence of Islamic financial institutions(IFIs) and modern banks, as at 2007. That leads to Section 4, which contains a quick review of the meaning of money, basic regulatory structure and performance of IFIs, mainly Islamic banks in comparison with modern banks. There is little known about the performance of Islamic investment and insurance entities, so we discuss these items only tangentially in the same section. An assessment as to whether this new idea will further spread speedily is made in Section 5 as a conclusion of this study.

2.0 EVOLUTION OF FINANCIAL TRANSACTION PRINCIPLES: A LONG VIEW OF HISTORY

An examination of historical writings found in historical, finance and religious literature around the world suggests that pure financial transactions (meaning banking, finance and insurance that are to do with exchange of money wealth to be defined in a later section) may be surmised as being based on seven fundamental principles, as a summary of the many principles found in Islamic jurisprudence(fiqh mualamat) about the financial transactions.[n.3] Financial transactions in historical times were carried out mostly by savings of individuals (the modern day capitalists) who lent it directly to borrowers. These individuals had the power to dominate, and extract economic rent, even the labor of the borrowers, by lawfully taking the wives and children of the defaulting indebted into slavery. There were no formal organizations for intermediation, such as exist in the banking environment of our modern times, [n.4] which was only established in its modern form with fractional banking in the 18th century. The Catholic Church undertook some custodial functions of banking as far back as the 11th century, but these were not equivalent to fractional banking.

Three ethical principles of a total of seven that evolved over several millennia in borrowing-lending activities are discussed first.

1. For a participation in a contract to rightfully demand a return in a financial transaction when one party makes her savings available as a loan to another party to carry out entrepreneurial economic activity by lending (or share ownership in the activity as part or full owner), the lending part first shares in the risk of the activity for which the money is lent(or a share ownership is taken if owned), and then take a profit share from the ^ex post^ outcome. So, the sharing of profits is ^ex post^ the sharing of risk. An historical example is the 2/3 share of profits taken by wealthy lenders financing voyages of the Dutch East India Company in the 16th century, or a '2 and 20' term (meaning 2 per cent of capital provided as fees, and 20 per cent of profit share) venture capitalists require to fund a business today. If the loan is made on a pre-fixed interest basis as agreed upon by a lending party and the borrowing party, then the interest rate charged, as regulated by societies over long historical periods, was limited to be non-excessive, that is not usurious. Usury as a moral compass has been around for nearly 5,000 years in different settled societies, as is discussed later (Nelson, 1969).

2. The return the lender (or part-owner) gets must be commensurate with the amount of risk undertaken. For example, a sleeping patner may get just a small share of the profits, whereas the active partner may get a larger share of the profits. On the other hand, the lender may get less than the sleeping partner, since the lender undertakes the risk only over the short period of lending, unlike the sleeping partner who carries the risk over an undefined period of time. These are consistent with the time-invariant principle of risk-return that has been enshrined as Nobel prize-winning theories in Economics: here reference is made to Markowitz's portfolio theory, and Sharpe's capital asset pricing theory, for example.

3. Where a return is demanded and agreed upon ahead of the financial transaction─this is the case of what modern banks practice as pre-fixed rate of return─the rate of charge could not be usurious. Usurious return is excessive return, and such contracts are proscribed by law and also by religious laws.[n5] For an exhaustive treatment of how Christian and Jewish scriptures prohibit usury, see ( ... ).

( ... ... )
( ... ... )
( ... ... )

Islamic scholars have generally tended─there are many exceptions to this statement─to consider any return that is pre-fixed in a financial transaction, and is not based on profit-sharing, meaning the reward is earned before sharing the risk of the enterprise (as discussed in Note 1), as not ethical earning. No scholars has said all pre-fixed interest charges are usurious, at least in the serious literature. Some scholars have also suggested─as in Egypt, and also under Iranian laws in practice─that the bank deposit interest rate is considered not usurious, perhaps because bank interest rates are much smaller, and are mostly a shade higher than the inflation in countries, so it is risk-free, thus deposits are not to be considered risky lending. Indeed, bank rates charged to borrowers do have risk, but rates applied to deposits in banks can be shown to be just about equal to the inflation rate in the long run. Certainly, depositors' earnings are not big enough to constitute a return that doubles and quadruples, a necessary condition to make a return usurious in Islamic finance. The debate on interest versus usury continues.

( ... ... )

4. Now we discuss the fourth ethical principle in another banking activity, namely mortgage finance. In addition to purely making available an amount of savings to fund economic activities in mostly debt contracts, banks also buy and sell 'things' such as cars, houses, ships, airplanes. These transactions are not purely wealth-producing economic activities, although capital gains may accrue as increases over what was paid in the purchase value of an asset. These are activities to enable purchase of costly items, be they cars, motocycles, aircraft, houses, commercial properties, or even a cow in micro-finance and so forth. This creates a financial transaction where the bank is the provider of the money as an agent to enable purchase (loan for entrepreneurship does not involve merely buying chattels). It is a buy-and-sell or buy-and-rent arrangement. Here too, the Islamic principle of honest brokerage comes in to ensure ethical dealing. After a mortgage purchase id done, the lender is required to build equity ownership in the asset bought right from the start, as the mortgage is being paid off. Modern banks collect initial payments entirely as interest charges, with insufficient equity being built for the owner of the asset in the early period of loan.[n.9]
[n.9] In the case of lease financing, the rent paid to the owner of the lease by the borrower of the 'leased asset' is unequivocally a payment for the services of the leased asset that belongs to the owner of the item. It is not interest, and the charges for debt contract for leasing often uses the prevailing interest rates.
Modern banks can start deducting the interest portion of the deal much faster. The principle of ownership protection and proportional or equal equity from day one of purchase is an equitable financial principle, though it is not at all widely promoted even by Islamic banks because they have opted to use the exact amortization tables of the modern banks without serious consideration of the details of this principle. [n.10] This may be termed the fourth ethical principle applied strictly to Islamic mortgage transactions in buy─resale contracts. This is the private property ownership preservation principle ensuring the lender is not reneging on ownership of the borrower solely because a lender has the exploitative power in an unequal transaction.
[n.10] It is interesting to note that mortgage financing practices vary across countries. Brazilians used to buy houses with cash savings until a few years ago! Some financiers of mortgage do not reveal the exact details of ownership in assets, and continue to deduct interest first and let owners build equity after several years, even in case of part cash purchases!
5. Turning to investment companies [n.11] to discuss how ethically acceptable returns should be earned on invested capital, we find a fifth sound ethical financial principle developed in historical times. ( ... ... )

6. ( ... ... )

7. ( ... ... )

( ... ... )

p. 34.

( ... ) Islamic finance is a contemporary challenge to modern finance. Interest on interest is opposed by this new experiment; equity in mortgage finance is promoted in proportion to the payment ratios; pre-fixed interest is replaced with after-risk-sharing reward, which makes possible a symmetric lending contract to earn risk-return beyond inflation; ( ... ... )

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