Intermediate Islamic Finance. Mirakhor Abbas
institutional framework for an ideal Islamic financial system is to some extent consistent with the fundamental principles of institutional economics, but it is also inclusive of rules of conduct and enforcement, which are derived from the morality and justice system embedded in Islamic teachings. Consistent with the objectives of Sharīa'h, the principal purpose of this institutional framework is to achieve social welfare through the internalization of ethical and moral rules of behavior. Three main features of the institutional structure are addressed below (1) ownership and property rights, (2) contracts and markets, and (3) trust and mutuality. It remains, however, true of any society that trust remains its permanent lubricant.
Ownership and Property Rights
The central argument is that economic justice demands that wealth is created only through labor and enterprise and that there are no restrictions that curtail the rights of people to work or that prevent equal access to resources. It is in the abolition of legal and institutional hurdles against equal opportunities that socioeconomic justice can be better served. Thus, ownership is recognized over the resources thus created from the application of labor, and only then can property rights be subject to free transfer through exchange, inheritance, contract, gift, or redemption of rights. This redemption of rights allows for an equitable sharing of wealth with the less able. There is a clear emphasis on social justice and harmony where the insatiable desire for wealth is consistent with an insatiable desire for charity. There is reference in al-Qur'an to righteousness, birr, as the state of active participation in deeds of benevolence. Thus, an insatiable desire to increase wealth may be explained by an equally insatiable desire to contribute toward philanthropy and may not constitute a sign of unfettered self-interest.
An important implication of the principle that property rights are created through labor and enterprise is that there is no room for sources of instantaneous creation of property rights, such as theft, interest (ribā), or gambling (maysir). Also, the principle of ultimate divine ownership in Islam implies that the owner's freedom to dispose of property rights is not absolute. There are, for instance, restrictions against the use of property rights in prohibited transactions, and against waste and destruction. The injunctions against excessive accumulation of wealth are injunctions against the amassing of property rights that are conducive to a monopoly over opportunities, intrusion upon the rights of others, and privileged access to resources. Given these restrictions about absolute ownership, wealth circulation is allowed to play an essential role in economic development and social justice.
Another corollary to the principle that wealth is created through labor and enterprise is that it can only be shared through either a redistributive mechanism or risk-sharing mechanism. As noted above, redistribution through zakah constitutes a form of redemption of property rights to the poor. The risk-sharing mechanism provides an opportunity to increase wealth, but only under the conditions of appropriate exposure to risk. Thus, wealth-increasing arrangements such as al-ribā, which do not take into consideration the trade-off between risk and reward, are deemed impermissible. Thus, restrictions imposed on the scope of individual freedom with respect to property rights are essential to achieve the right balance between individual rights and social interests. They are also consistent with the office of gerency and conducive to capital formation, which is required for economic development, and social justice through poverty alleviation. Thus, this institutional setting differs from the conventional property rights system not only in the restricted freedom of disposal through impermissible transactions, but also in the consideration of property rights as a means of inclusion of the less able, because of idiosyncratic factors such as illness and disability, in the wealth of the more able. It is through risk-sharing mechanisms, in addition to inheritance rules, that wealth is necessarily shared with the society to provide new opportunities for property rights through labor and entrepreneurship.
Contracts and Markets
The second facet of the ideal Islamic financial system is represented by the rules of behavior in the domain of property rights transfer through contract and organized exchange. Since the concept of “property” represents a set of usufruct rights, powers, duties, and liabilities defined with respect to an underlying asset, it is possible to appropriate rights through the combination of one's labor with the resources, but the concomitant duty of sharing remains. Property is therefore associated with rights and obligations in the use of resources: (a) the right not to be excluded and (b) the obligation not to exclude others. In principle, the property rights and obligations cannot be dissociated from each other, but as argued by Askari, Iqbal, and Mirakhor (2015), it is the advent of the market system in Western economies that led to a revision of the concept of property, which eliminated the right not to be excluded from the use of assets owned by third parties. The rationale behind this exclusion is that this right is not consistent with market economy because it was deemed not marketable. Thus, the Western conception of property rights is presently centered on the right to exclude others. But the right not to be excluded by others remains intact, as it does not undermine the functions of markets in the allocation of resources based on the risk-sharing principle.
From the economic perspective, contracts provide a legal institutional framework for the transfer of property rights, but also for the allocation of risk. Because of the uncertainty about the future outcome of labor and enterprise, contracts are useful in facilitating the allocation of risks. The Islamic jurisprudence includes an entire class of classical nominate contracts, including participatory arrangements such as mudhārabah (principal-agent partnership), mushārakah (equity partnership), and mushārakah mutanāqisah (diminishing equity partnership). In particular, mudhārabah partnership contracts provide the basis for an essential part of the business of Islamic banking institutions. The full spectrum of permissible contracts also includes ijarah (leasing contract), istisnā' (consignment to manufacture), among other things. All these contracts have a basis in the Islamic law of muā'malāt, which implies that their purpose is congruent with the fundamental objectives of Sharīa'h, and consistent with the principle of risk sharing.
There is also an essential place for the market system in an Islamic economy because private enterprise, freedom of contract, property rights, and pricing mechanisms are consistent with the promotion of social welfare and economic efficiency. In conventional economics, the market system constitutes, after the retreat of socialism, the raison d'être of capitalism and its defining ideology. In an Islamic economy however, this market system is also a necessary mechanism for the allocation of risk, but the mere existence of markets may not be sufficient to ensure social justice. The need for competitive markets arises because of their ability to allocate risk efficiently and provide an effective system of price discovery. But it is only in a world of perfect markets with no transactions costs, and perfect information about financial assets that this function becomes effective. It is understood that there were, for instance, no taxes imposed on market access, no barriers to entry or exit, and no transaction taxes, no restrictions on international and interregional trade, no import or export taxes in the free-market system designed under the Noble Messenger (saws). But there were prohibitions on price controls and against hoarding of commodities. There was also free movement of goods across markets, as well as free and transparent sharing of market information. The guarantee of contract enforcement was also associated with the obligation of clear specification of the terms of contract, including the conditions of delivery and settlement, and property rights and obligations of all contractual parties. There was also the institution of market supervisors to ensure the compliance of market participants to the rules prescribed for the proper operations of markets.
The supervisory bodies similarly established in the conventional system to guarantee compliance to market regulation are deemed to be not only necessary but also sufficient for the proper functioning of markets. This is not the case of the institutional market conditions in an Islamic economy, which requires also a morality and justice system. There is indeed an additional requirement to the enforcement of a code of morality that is internalized by all market participants. Thus, the institutional structure of markets in an Islamic economy depends on the free flow of information, protection of property rights, and legal contract enforcement system, but also, as argued by Askari, Iqbal, and Mirakhor (2015), on trust as well as the right not to be harmed and obligation not to harm others.
Trust