A Shariah-Compliant Future

By now most of our readers have heard of “Islamic finance”, also known as “Shariah finance”, or more fully, “Shariah-compliant finance”.

SCF comprises the body of practices adopted by banks and the financial service industry to accord with the legal dictates of Muslim jurisprudence. Since Western financiers stand to make a lot of money practicing SCF, its use is exploding across the West. Many of the larger banks are adopting it, and not just in their Middle Eastern branches.

A recent example was the National Australia Bank, which announced a few days ago that it was floating an Islamic-finance trial balloon. It plans to test the market by offering “interest-free Muslim loans”:

ONE of Australia’s major banks is planning to introduce “Muslim-friendly” loans that do not charge interest to comply with sharia law.

Wow! Interest-free loans! Why would anybody take out any other kind of loan, when they can borrow Islamic-style money interest-free?

Well… The loan is still going to cost you. They may not call it “interest”, but there’s still a catch:

For example, to get round the Islamic ban on usury — or unfair lending — a Muslim mortgage often works by the bank buying the property, then selling it to the customer at a profit. The customer then repays the sum in instalments.

Shariah-compliant loans tend to be more reliably lucrative for the lender, which is why Western banks are jumping all over them. They can make a good profit and still be doing the will of Allah — how could anyone resist?

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David Yerushalmi specializes in the investigation of Shariah-compliant finance and related legal issues. His law office has put together a presentation to familiarize both legal professionals and the informed layman with the details of SCF. Political correctness and the widespread desire to placate Muslims tend to prevent the kind of critical investigation and oversight that one would normally expect in such a large and profitable financial industry.

In his introduction, Mr. Yerushalmi discusses the murkiness of the Shariah-compliant world:

As Shariah-compliant finance continues apace, professionals and policy specialists continue to ignore a fundamental danger: the lack of disclosure of all the material facts relevant to a post-9/11 investor. This presentation is intended as an in-depth analysis of this critical failure in the current regulatory framework.

The Law Offices of David Yerushalmi, P.C., has prepared this online presentation to assist legal professionals, policy specialists, SEC regulators, Treasury officials, and investors to understand that the Black Box of Shariah compliant finance (SCF) presents a real and present danger not just to our Western financial institutions built on disclosure and transparency, but to our very system of governance and our way of life.

This presentation is entitled: Shariah-compliant Finance: Benign? or Belligerent? It is timely and important for two reasons: first, the interest and investment in Shariah-compliant finance in the West continues to grow, and second, the fragile state of our financial system of late is due to the catastrophic impact of toxic financial products designed as highly sophisticated black box solutions to undisclosed market risk.

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The same black box phenomenon now permeates Shariah-compliant finance. Unfortunately, heretofore, none of the professional literature has examined the risks and problems associated with Shariah-compliant finance in any analytical or critical fashion. Instead, it appears more akin to a cheerleader chorus line singing the praises of this year’s new and improved profit center, much as we heard about sub-prime mortgage securitizations and credit default swaps in their heyday. This presentation is an effort to pry open this new and emerging Black Box.

This presentation is 60 minutes in length and has been organized to be accompanied by source materials available as downloadable PDF files linked below.

This presentation has received encomia from no less than Frank Gaffney, Stephen Coughlin, Andrew McCarthy, and Robert Spencer.

Mr. Yerushalmi’s site has links to further materials. For those of you who are interested in the scholarly details, I recommend an article (pdf format) entitled “Shari’ah’s Black Box” from the Utah Law Review, Vol. 2008, No. 3. The full document is lengthy and comprehensive, and contains extensive footnotes. An excerpt from pp. 1024-1035 (minus the footnotes) is below:

A. What Is SCF?

According to the disclosures and representations of the financial institutions currently promoting SCF, Shari’ah compliance means that a particular investment or financial transaction has been conducted or structured in a way that is considered “legal” or “authorized” pursuant to Islamic law. Compliance with Shari’ah is achieved by having a Shari’ah authority — either an individual or group of individuals possessing authoritative status in matters relating to SCF — approve the particular investment or type of transaction. Most financial institutions retain a Shari’ah advisory board, which typically consists of three or more “Shari’ah scholars” who profess to be recognized as authorities in SCF.

According to most financial institutions, SCF is achieved by the avoidance of interest, risk (typically understood as uncertainty or speculation), and certain types of prohibited industries (relating to activities considered haram or “forbidden,” such as the pork and alcohol-beverage industries, pornography, gambling, and interest-based financing). In addition, SCF also includes a focus on “purification,” which has two separate elements. One is a form of obligatory charitable contribution called zakat, where the act of supporting the less fortunate is considered a spiritual purification; the other is the purification of a Shari’ah-compliant investment or financial transaction that has been tainted with forbidden revenue, whether from interest, illicit speculation, or a forbidden commercial enterprise such as the pork industry. In the latter meaning of purification, the forbidden funds must be disgorged by donating the money to an acceptable charity, but this charitable gift will not count towards a Muslim investor’s zakat requirement.

A rudimentary understanding of Shari’ah is required to grasp the implications of SCF relative to U.S. law. To begin, Shari’ah, or the “proper way,” is considered the divine will of Allah as articulated in two canonical sources. The first is the Qur’an, which is considered the perfect expression of Allah’s will for man. Every word is perfect and unalterable except and unless altered by some subsequent word of Allah. While most of the Qur’an‘s 6,236 verses are not considered legal text, there are 80 to 500 verses considered instructional or sources for normative law. However, the Qur’an is only one source of Allah’s instruction for Shari’ah. The Hadith — stories of Mohammed’s life and behavior — are also considered a legal and binding authority for how a Muslim must live. The Hadith were collected by various authors in the early period after Mohammed’s death. Over time, Islamic legal scholars vetted the authors for trustworthiness and their Hadith for authenticity, and there is now a general consensus across all Sunni schools that there are six canonical Hadith. The legal or instructional portions of the Hadith together make up the Sunna. While the Shari’ah authorities from the Shi’a Muslim world also accept the Hadith as authoritative, they do not accept certain authors’ authority — a belief based mostly upon theological grounds. For all Shari’ah authorities, however, the Qur’an is considered the primary and direct revelation of Allah’s will, while the Sunna is the indirect expression of that will and secondary. Both sources are generally considered absolutely infallible and authoritative.

In order to divine the detailed laws, norms, and customs for a Muslim in all matters of life, the Shari’ah authorities over time developed schools of jurisprudence to guide their interpretations of the Qur’an and Sunna. While there is broad agreement among the schools about the jurisprudential rules, important distinctions between the schools result in different legal interpretations and rulings, albeit typically differences of degree, not of principle. The rules of interpretation and their application to finite factual settings in the form of legal rulings are collectively termed al fiqh (literally “understanding”). Usul al fiqh, or the “sources of the law,” is what is normally referred to as jurisprudence. Technically, Shari’ah is the overarching divine law and fiqh is the way Shari’ah authorities have interpreted that divine law in finite ways. It is important to note, however, that the word Shari’ah appears only once in the Qur’an in this context, yet it has gained currency in the Islamic world by virtue of Shari’ah authorities, over a period of more than a millennium, creating a corpus juris (i.e., al fiqh) based upon their interpretative understandings of the Qur’an and Sunna…

Prior to the twentieth century, there was no discipline termed Shari’ah-compliant financing or even a Shari’ah sub-code regarding commercial transactions. There are rulings by Shari’ah authorities permitting certain contract forms dating back hundreds of years, but as late as the 1900s, there was still some debate among Shari’ah authorities as to whether the prohibition against interest was absolute or just against usurious interest…

The development of these [20th-century legal rulings] and the formalization of SCF have matured over the past three decades so that today there are entire university departments in the Middle East, Asia, and even in Western universities dedicated to the study of SCF. Most observers connect this recent development to the emphasis of Shari’ah in the oil-producing Arab states and their wealth-driven influence throughout the Muslim world and the West.

Effectively, SCF is an attempt to embrace modern interest-based commerce and finance, but developed within a framework of Shari’ah-approved structures. For example, while almost all Shari’ah authorities forbid any transaction or investment which provides for interest income, SCF rules allow for interest in two ways. One way is to rule that a Muslim can invest in a permitted business that earns or pays interest but only if the amount is below a maximum level. Any profit earned by the Muslim from that interest component, however, must be purified by contributing that portion to a Shari’ah-approved charity. A second way to accommodate modern commercial transactions is to structure the forbidden transaction within Shari’ah-approved contract forms. These nominate contracts are based upon contract forms found in the classical rulings of the Shari’ah authorities prior to the advent of contemporary finance. Thus, a loan might be structured as a “cost-plus sale” where the lender buys the property and immediately sells it back to the borrower for a “profit.” This profit is the interest component in the typical loan transaction. The purchase price with the profit component included can be paid over time to resemble an amortized loan repayment schedule. Other forms are available to deal with interest and also with unduly speculative transactions, including sale or lease-back contracts, and partnerships with variations and combinations. For the more complex transactions, these Shari’ah-approved nominate contracts are often pieced together and used in combination to arrive at a Shari’ah-compliant modern commercial deal. [emphasis added]

B. Why Is SCF Important?

As a burgeoning industry, SCF is touted as “[o]ne of the fastest growing” sectors in the global financial markets. Total funds committed to SCF investments are estimated to be $800 billion worldwide, with $200 billion of assets under management in Shari’ah-compliant banks. Annual growth in this sector is estimated at 15 percent, based presumably upon current trends fueled mainly by profits in the Muslim oil- and gas-producing countries and by a worldwide Muslim population reported to be growing faster than the population of any other of the world’s major religions.

Within the SCF market, Shari’ah-compliant bonds, known in Arabic as sukuk, are the most explosive segment driven by huge petrodollar profits creating enormous sovereign wealth and liquidity. There is reportedly “$1.3 trillion looking for high-quality Islamic assets” with only $37.3 billion in Shari’ah- compliant bonds issued in the third quarter — double the amount issued during the same period the previous year. These facts lead one to the conclusion that, despite the increase in the amount of Shari’ah-compliant bonds issued, there is still a much greater demand for them waiting to be quenched

All of this growth, underwritten mostly by the mobile, highly liquid capital flowing out of the GCC states, has generated an industry of financial institutions, law firms, accounting firms, financial advisors, and money managers establishing domestic and international links with the key investment figures in the GCC states in an effort to exploit the opportunity for substantial profits. This enthusiasm has spread to domestic U.S. financial industries, and expresses itself in many forms.

For instance, U.S. companies now seek to invest in Shari’ah-compliant bonds domestically and globally; Dow Jones and Company and Standard & Poor’s have both established Shari’ah-compliant indexes that screen equities based upon software filters meant to eliminate Shari’ah-non-compliant businesses; Shari’ah-compliant, U.S.-based managed equity funds and off-shore hedge funds managed or advised by entities related to U.S. financial institutions have been established and can now peg their performances against these indexes; and U.S. banks have begun to offer Shari’ah-compliant home loans and other credit facilities (with federal banking authorities opining about their legality and at least one state tax authority issuing a ruling on the tax implications of a Shari’ah-compliant transaction).

Notice the absurd and excessively legalistic character of Islamic law. A Sharia-compliant Muslim makes an Orthodox rabbinical authority look casual and slack in comparison.

And the end result is the same: customers pay to borrow money, and the lenders make a good profit. Investors can invest in anything, including pork bellies, as long as they go through the prescribed purifying rigmarole and apply the naughty money to charity. There’s no interest, and everything is pure and moral, yet somehow the non-usurers get just as wealthy as the usurers do.

Funny about that.

And Islamic charity — whether fattened by haram profits, or through the more standard contributions from zakat — applies a Koran-mandated portion of its proceeds to the support of jihad.

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For further information about SCF on an ongoing basis, check in regularly with Shariah Finance Watch.

SCF is not just the camel’s nose under the tent of the Western legal system, with the camel of full Shariah to follow close behind. It’s also a vehicle for the financing of worldwide terrorism.

Whenever a rocket is launched from Gaza into Israel or a suicide bomber blows up a market in India, money from Islamic “charities” provides the necessary operational financing.

And Shariah-compliant finance, aided and abetted by the willing assistance of the Western banking industry, is hard at work making the whole process possible.