Islamic Finance

The Basics of Islamic Finance

Religion and money are joined in many ways. Discussing these issues can educate and improve understanding among followers and non-followers alike.

Introduction

One in five people in the world is Muslim. There are anywhere between twenty and fifty Muslim countries depending on the definition you use. Clearly Muslims represent a significant demographic in the global economy. In this post, I will discuss how Muslims view wealth, restrictions Islam places on how Muslims use their money, and ways in which Muslims use their wealth to serve the common good.

 

Islam does not see wealth as inherently evil or inherently good. The status of wealth in Islam is inherently neutral. A hadith, a saying of Prophet Muhammad (peace be upon him), tells us that while envy is usually a sin, it is permissible to envy a man who has wealth and strives to spend it for good causes. However, another hadith says, “Avoid cruelty and injustice…and guard yourselves against miserliness, for this has ruined nations who lived before youRiyadh-us-Salaheen, (Lives of the Righteous) 203. From this text, one can see three injunctions connected to the use of wealth. Muslims should not use their money to promote cruelty. Also, they should not use their wealth to promote injustice. In addition, they should not be misers that hoard their wealth like the infamous character “Scrooge.”

 

The language of the Quran and the language of Prophet Muhammad (pbuh) was Arabic so a lot of important terms in Islam are in Arabic. I will do my best to define Arabic terms clearly and consistently.

 

Riba (interest, as in the interest one pays on a loan)

Riba is the Arabic term for interest, especially usury, an exorbitant amount of interest that makes it difficult for a debtor to get out of debt.

-Muslims try their best to avoid paying or receiving interest. Some situations make it very difficult to avoid, such as getting a mortgage for one’s home. However, by saving wisely, one can pay the mortgage off quickly and minimize the interest that one pays.

-The ban on interest has led to different responses. Some Muslims have argued that Islamic law only prohibits excessive interest and that the interest used in the modern global economy is permissible. Others have resorted to complex legal devices to avoid interest. Neither of these options have appealed to devout Muslims who think it disingenuous to argue that interest is not really interest and dishonest to try to exploit legal loopholes in Islamic law.

-Many Muslims have avoided using banks and formal financial institutions. This has proved perilous both for individuals and nations. It puts the assets of individuals at risk for major loss. Also, the distrust of institutions has prevented Muslim nations from accumulating capital.

-When a Muslim loans money to a friend, he or she should only ask for the principal in return. Asking for interest on top of the principal is not permissible in most cases. If the loan has not been repaid for a long time or the local economy is in such a mess that significant inflation has occurred, some scholars say that the lender has the right to ask for additional money to offset the loss due to inflation.

 

Islamic Banking

-In the past thirty-five years, Islamic banks have emerged around the world. Islamic banks act much like mutual funds in that there are shared risks and shared returns for individuals and institutions. Individuals put their money in these institutions which use the money to invest in a variety of enterprises that are in accordance with Islamic law. When the enterprises make profits, the institutions pass the profits on to the investors. When the enterprises lose money, the investors lose money.

-According to Urrooj Rehman, an economics scholar, “Many Islamic economists tout the superiority of Islamic banking over traditional, interest-based banking in that 1) it is not exploitative 2) it will allocate resources more efficiently than conventional banking and 3) it does not distort the ‘real’ economy, and thus will save the world from painful ‘boom and bust’ business cycles.”

 

Zakat (alms or poor-due)

Zakat is a portion of a Muslim’s wealth that he or she is obligated to give to the needy.

-The typical value for Zakat is 2.5% of one’s annual income. The value varies slightly on different kinds of property such as real estate and precious metals.

-Zakat is seen as a means of purifying wealth. By setting aside a small portion of one’s assets for the sake of Allah, a person protects his or her wealth.

-It can be used to feed the hungry, clothe the poor, provide shelter for travelers, heal the sick, and many other worthy causes.

-Zakat is more than a tax; it is a fundamental aspect of Islam. It is as important as daily prayer and fasting in the month of Ramadan

 

Nisab (minimum taxable level of wealth)

– Not every Muslim must pay zakat. Some Muslims are not obligated to pay zakat because they do not meet nisab.

-Nisab is a threshold of wealth owned by an individual, any excess over which is subject to zakat. The American tax code has a similar threshold so that anyone who earns income exceeding that value (set at $2000 in 1989 and adjusted for inflation since then) must pay taxes.

-The most recent data for nisab says that as of March, 2007, it is equivalent to $1990 or three oz. of pure gold.

-Pre-pubescent children and the mentally insane are also free from the obligation of zakat.

 

Sadaqah (charity)

Sadaqah means non-obligatory charitable contributions that serve the communal good.

-According to Hadith, “Wealth does not decrease because of charity.” This means that when a person spends money in charity, God responds by either blessing his or her remaining wealth or by increasing his or her wealth.

    

-Among the causes that Muslims see as especially noble are supporting orphans and building masajid (places of Islamic worship). One reason why Muslims are devoted to orphans is because Prophet Muhammad (pbuh) was an orphan from the age of six (His father died before he was born and his mother died later.) Also, in most societies orphans are particularly vulnerable to poverty and abuse as they lack parents to protect them. Masajid have importance both as places where God is worshipped five times a day and as cultural centers. Historically they have served as universities and sanctuaries.

 

Accountability

-Islamic economic philosophy is based on the absolute sovereignty of God, brotherhood/sisterhood, and social justice. Muslims believe that God will hold them responsible for their duties to Him, their duties to other Muslims, their duties to other humans, and their duties to every living organism.

-In the Hadith narrated by Mu`adh ibn Jabal, the Prophet (p) said: “No human will move from his station of accounting until he is asked about four things: (1) his lifetime, how did he consume it, (2) his body, how did he wear it out, (3) his knowledge, how did he use it, and (4) his wealth, how did he earn it and how did he spend it.”

 

-Muslims believe that God will hold them responsible for every resource that He gave them. This includes one’s life, one’s body, one’s knowledge and one’s wealth. Also, while each person is only accountable for his or her own actions, a parent has the responsibility of teaching his or her children about Islam. Even spending money on something as trivial as shoes has a religious dimension to it since God is the ultimate source of wealth so one should be neither extravagant nor stingy in spending. It may seem odd to think of God as the source of one’s wealth but if one believes that one is created by God, sustained by God, taught by God, and healed by God, it makes sense to believe that whatever wealth one has, it is due to the benevolence of God.

 

Conclusion

-In some ways, Muslims face a unique set of financial challenges. They must avoid interest. They are not permitted to support injustice, nor can they be miserly. They eschew dealings with businesses that deal in things that Islam forbids. Some investment opportunities which would be perfectly acceptable to non-Muslims are abhorrent to Muslims. For instance, many people would have no qualms about investing in Anheuser Busch, the manufacturer of Budweiser. Muslims would find this to be morally repugnant since Islam prohibits the consumption of alcohol.

-In other ways, Muslims face the same financial issues as non-Muslims. They have assets which they want to grow. They take financial risks and reap financial rewards. Their motives in transactions can range from selfish to altruistic.

 

Cross-Posted on www.mindyourdecisions.com

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  1. #1 by Susan Kishner on June 2, 2008 - 4:30 am

    Nice writing style. I will come back to read more posts from you.

    Susan Kishner

  2. #2 by Allen Taylor on June 2, 2008 - 4:34 am

    Nice writing. You are on my RSS reader now so I can read more from you down the road.

    Allen Taylor

  3. #3 by Mike Harmon on June 2, 2008 - 5:00 am

    Hello.

    I like your site and wanted to know if you would be interested in exchanging blogroll links.

    Thanks in advance

  4. #4 by William Cullinan on June 3, 2008 - 6:28 am

    This article is on Islamic Banking.

  5. #5 by William Cullinan on June 3, 2008 - 6:29 am

    This article is good research material.

  6. #6 by Bill on June 3, 2008 - 6:42 am

    This is a very interesting article. I encourage more people to connect religious teachings with economic and financial matters. This can be good dialog for people in business, finance, economics, as well as theologians and religious scholars. Seeing connections like this not only help individuals understand another religion and culture, but this also leads to a better understanding of one’s own religion, culture, and economic system.

  7. #7 by Junaid Bhatti on June 3, 2008 - 10:29 pm

    Jazakum’Allah Khairan.

    Thank you for this article. It is very enlightening and well-written.

    Wassalaam.

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