Issue #51
Last Update May 5, 2007
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Finance Shariah Compliant Investments by David Katz November 30, 2006 The Moslem world is playing a larger and larger part in world affairs. Even without Islamic fundamentalism disturbing the peace of the West and Islamic countries alike, and even without the importance of the Arabian peninsula, Iran and Iraq to the world oil economy, Islamic countries from Singapore to Indonesia to much of Northern and Central Africa, not to mention the enormous Moslem population of India are participating in the global economy in significant ways. Such a participation requires access to capital and to other forms of financing if growth is to continue. Shariah law, the religious law of Islam which shapes the form of daily life in Moslem countries, also shapes the forms in which economic life is conducted.
There are two fundamental rules of Islamic business: interest is forbidden (whether giving or taking), and investment in businesses involved with prohibited activities (usury, pornography, tobacco and alcohol related ventures, to name a few) must be avoided. It should be noted that businesses with a debt to equity ratio of greater than 1 to 3 are also to be avoided, perhaps on the grounds that lending at interest must be involved. On the other hand, money beyond what is needed for living expenses and charity must be put to use, lest the individual be accused by Allah of hoarding resources that could benefit the community. The tension among these principles has given rise to the forms of investment particular to the Moslem world.
Mortgages, the lending of money at interest for the purchase of property, and secured by the purchased property, are, of course, improper investments and an improper way of financing a real estate purchase. Two methods do exist, however, for achieving these purposes:
1. The “lender” can purchase the property, and then resell it to the “borrower” at a profit, with payments extended over a period of time. This conforms to the traditional “middle-man” trading structure, which is permitted by the Koran.
2. The “lender” can purchase the property and resell it to the “borrower” at cost, with payments made over a period of time. During the payout period, the “borrower” pays rent on the property. This conforms to the traditional “leasing” structure, also permitted.Other types of Shariah-compliant investment also exist.
Since Islamic banks can't pay interest, Islamic bank accounts are often credited with a share of profits in some aggregate investment by the bank. For example, in a commodity-type account, the bank will use the pooled assets of depositors to buy some commodity at wholesale prices, and resell the commodity at retail. The bank then takes a share of the profit and distributes the rest among participating depositors. Unlike non-Islamic interest-bearing accounts, depositors share in losses as well as gains. Savings accounts, retirement funds and commercial banking can be successfully implemented using these structures.
Venture financing is also organized on a shared ownership, shared risk basis, with investors receiving a pre-determined percentage of profits of the ventures invested in; the entrepreneurs receiving the investment are able to repurchase the investors' shares after some fixed period (often five years), and the investment is concluded. Again, in this schema, the investors share in losses as well as gains.
Subject to the Shariah constraints on permissible corporate activity, stocks may be purchased, just as by non-Moslem investors. Dow Jones publishes a family of over 60 Dow Jones Islamic Indexes, a compendium of Shariah-compliant equities. These include global indexes, global industry indexes, US indexes, Euro and Euro Zone indexes, Asia/Pacific indexes, other country indexes and specialty indexes. A fund based on these indexes is marketed by Dow Jones. Since interest situations are avoided, this fund may have idle cash at times when other funds might park some of their holding in interest-bearing accounts.
Exchanges in Dubai, Singapore, Malaysia, Frankfurt and other places trade Shariah-compliant indexes, equities and funds. Within the Shariah framework, all of the normal borrowing, investment, capital placement and hedging operations facilitated by American and European banking and financial institutions can be duplicated in a manner that does not transgress Koranic law, albeit in a format that may appear strange to Western sensibilities.
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