Faith and Finance: The Value Guided Pursuit of Interests
19 May, 2012
This is a 2010 Harvard paper and is reproduced with the kind permission of Professor Siddiqi
Conventional wisdom would keep faith and finance in different boxes never to be mixed with one another. This has not served society well. A holistic view of human personality would like finance to be guided by faith inspired values. Faith impacts finance through motivation and value orientation which, in turn, influence wealth creation as well as the use of wealth for enhancing well being. All wealth is joint production involving both natural and manmade inputs. Natural inputs such as land, air, water, minerals, solar and other forms of energy need to be combined with human resources like ideas, accumulated knowledge, new skills, as well as trust, hope and sympathy. The joint nature of wealth creation necessitates the sharing of wealth among those involved in its creation. Product sharing, profit sharing, renting, wage contracts all involve sharing, but renting and wage contracts are more vulnerable to unfairness. This may take place, for example when a rented piece of agricultural land fails to produce any crop due to draught or flood.
Regulators are called upon to ensure fairness in sharing joint products. Regulation of business practices is a well established tradition going back to the earliest periods of history. Its earliest forms are the obligation to fulfil promises and tell the truth. Not tampering with socially approved weights and measures and not indulging in clipping metal coins soon followed. All these are examples of faith inspired values as they reflect a moral view of human relationships. In the absence of faith moral values have to be anchored into pragmatism, which can easily succumb to relativism depriving morality of the strength needed to prevent predatory practices. To assert that these values reflect the evolutionary necessity to preserve and promote vital interests ensuring survival does not contradict their essentially moral nature. There is no conflict between morality and survival necessitated pursuits. It is faith that provides the trust needed to remove any fear of dissonance between well being enhancing values and survival ensuring interests. By enhancing trust, morality reduces transaction costs and increases efficiency.
Faith answers questions for us beyond the reach of our sensory means of knowing. Who are we? Where to are we headed? Are we accountable for our choices here and now? Faith impacts finance through the answers it provides to question such as why to produce and for whom to produce. The strength of our faith is reflected in the intensity of our efforts to produce. It is also reflected in our decisions on what to do with one's earnings. The nature of our faith determines where we stand in the broad spectrum from the exclusive pursuit of self interest and to reaching out to all of humanity. Faith broadens the scope of and widens the horizon for productive efforts.
The realistic middle ground (to which most of us stick) is avoiding harming others while serving our self interest and aspiring to do good to others if and when circumstances call for it. Faith does this through generating moral obligation towards others, however, all societies have not been the same in this regard. In recent human experience western secularism has pushed back faith and encouraged greed and the pursuit of self interest as a means to social well-being; concern for others has dimmed. The natural tendency of faith to generate morality is ruptured by false notions about the efficacy of amoral behaviour in delivering social good. It is also weakened by man’s proclivity to selfish behaviour in absence of spiritual roots.
The overriding focus on shareholder value maximisation has pushed out other stakeholders such as customers, employees and society at large. A moral approach to finance has the potential to take the stakeholder approach, be long term focused and to address the issue of compensation based on fairness and equity.
Faith has often been replaced by aggressive ideologies justifying cruelty, even brutality, in the name of rapid growth. Faith emphasises inclusive growth even though vested interests care only about impressive growth. The modern scenario of mega cities, divided into luxurious living quarters and shiny suburbs on one side and dark, dilapidated slums lacking basic amenities such as clean drinking water and schools on the other, is largely a product of economics that have purged faith and morality. Despite their claim to be guided by reason, modern economic ideologies have resulted in the most unreasonable scenario in what is aptly called the global village. The same division between the rich and poor that afflicts our mega cities afflicts the global village too. Modern economics has no answer to the question.
The cause lies in a moral deficit in the contemporary structure of the social, political and economic edifice. This moral deficit lies in a lack of concern on the part of individuals for the good of others, which sometimes degenerates further into exploiting others in pursuit of one’s own gain. The moral deficit itself is caused by the absence of faith; sometime a weak faith or faith diluted by confusing world views produces the same result impotent faith incapable of moral uplift. A robust faith brings into focus the essential oneness of mankind owing its existence to the same Creator. The brotherhood of man, equality in dignity and identical rights to God given resources in the environment, as well as in human relations; all belong to this focus and are sustained by it. Regaining this focus should be high on agenda of all concerned.
Ground Reality and Desired State of the World
Going forward we need to explore two parallel concepts: the actual conditions pertaining to faith finance relations in contemporary society and the potential of faith in correcting finance's current course. I begin with the latter, the potential of faith for ameliorating the contemporary economic crisis. The nature of finance is too complex to issue a simple list of dos and do nots in the name of faith. Its ever changing nature defies any list of prohibitions and obligations to suffice for all places and all times. However, the crucial values that promise to help in securing fairness in changing conditions are: the concern for others’ well-being; the will to abstain from harming others even at the cost of personal sacrifice and the willingness to submit to democratically enacted social regulations. Most of the recent adverse developments in financial markets responsible for widespread sufferings are rooted in the absence of these values. Current economic theories do not embody or promote these values. For example, the Friedman school that has been influential from early nineteen eighties through today openly warns against firms and individuals trying to care for others. The ruling dogma is that one best serves society by serving oneself. No wonder the other two values, the will to abstain from harming others and a willingness to abide by rules also evaporated under the encouragement of the unlimited pursuit of self interest. Given this environment, who would not twist the rules to make them serve one’s own interest?
The answer necessitates pondering over what the quest for fairness in the financial system entails. In the absence of hard and fast regulations capable of ensuring fairness it is not structures but perspectives, understandings and morals that matter. People who want to behave will find ways to do so, if not straightaway then haltingly, by experimentation. They may even find ways to constrain deviants and minimise the loss of social weal due to individual perfidy. Much has been made of the lack of full information to economic decision makers in debunking the idea of caring for social good. The reality is there is no way to have full information about future values. The falsity of the assumption of market mechanisms somehow magically solving this human predicament has been exposed by a succession of crises. Man must try to make up for the inevitable information deficit by experimentation, pooling available information and sharing the consequences of ill informed decisions. They can do so at the individual level as they have been doing at the societal level. Faith is a positive aid insofar as it creates an incentive to cooperate for the social good.
People of faith have learnt some lessons during the quest for fairness in the past. These deserve to be our starting point in a similar quest today. As I proceed to summarise them, I beseech you not to get stuck with them, quibbling over the variety of interpretations and controversies surrounding the circumstances in which they are applicable. I also underline the fact that these form the first steps to be taken in man’s search for a just and fair financial system. By no means would they be sufficient on their own to usher in a just society.
Pillars of Fair Finance
The prerequisites of fairness in finance include the prohibition of interest, fraud (in its myriad forms), gambling and transactions involving excessive uncertainty (gharar in Arabic). These prohibitions are to be seen in the perspective of private ownership, freedom of enterprise and the supervisory role of the state as the guardian of the poor and the weak. Faith encourages charitable giving, which includes lending to the needy and expecting to receive no more than what was given. Regarding business loans, shifting all the risk onto the borrower is repugnant to faith while encouraging partnership and profit-sharing instead suits faith. This follows from the nature of the environment in which business is done, as future value/productivity is surrounded by risk and uncertainty. Gambling is creating risks to play with chance. Financial speculation that thrives by trade in other people’s risk is a contemporary example of gambling. Some activities are surrounded by uncertainties to such an extent that contractual relationships built around them become problematic. The contracts through which these activities are carried on are not transparent, affording the same information to all concerned. The means of just sharing is missing; it is better to avoid them. That sums up the Islamic thinker’s attitude towards excessive uncertainty (gharar).
In Islam the jurists have worked hard to translate the three principles listed above prohibition of interest, prohibition of gambling and minimisation of gharar, into rules governing business relationships. The ever changing nature of these relations, however, in itself largely shaped by changing technologies, defies being captured in a net of rules framed at a particular time and place. Innovation in ways of doing business necessitates making new rules, so the process of rule making must go on!
Protecting the weak from the strong, the knowing from the unknowing and the poor from the rich necessitates some socially imposed restraints to human freedom, including the freedom of enterprise. Securing fairness would, however, need more than imposing restraints. That is where the values mentioned above concern for others, readiness to limit one’s potential gains in that context and following democratically enacted laws become relevant. We need to harness human ingenuity in positively enhancing justice and equity, not only in preventing injustice. Faith is capable of doing so. The nature of a competitive economy is often cited as the reason for the inability of an individual firm to promote social good. It is a challenge to our ingenuity to harness the forces of cooperation to counteract this.
Faith versus Cult
Faith knows no land, race, language, nor culture, but people of faith sometimes develop strong attachments to one or more of these to the extent of identifying their religion with a particular land, race, language or culture. Worse still, sometimes religion is made to serve national, racial and other narrow goals. As a result faith loses its power to generate a universal morality overriding narrower interests. In today’s world faith has had little influence on finance since faith has been made a tool of national, racial and other social ambitions. Religion is the expression of faith in particular people, translating faith’s demands into rules of conduct. Over time these rules have often been turned and twisted to suit particular interests.
The rejuvenation of faith necessary to transform the current financial system would first involve the disentangling of faith from other narrower loyalties such as religion or citizenship. Faith in its purest form, i.e. faith detached from religion, citizenship, etc. has the capability to cut across all ideologies and promote morality. By creating positive sympathetic relationships with the faith of others would make men accountable and responsible to each other, but faith in its current state, faith that is made subservient to nationalism or imperialism, fails to do so. Impure faith creates an artificial distinction between morality and faith. Loyalty to a nation or race, for example, dictates certain ethics and priorities that are generally in conflict with those of another nation or race. In combination with the first and major barrier to moral behaviour in finance, human greed, faith cannot impact finance unless and until these barriers are removed.
Islam’s contribution to universalising faith generated morality lies in pushing back these barriers to their proper secondary positions. The best periods of Islamic history have been when tribal or racial loyalties were kept in check and universal morality reigned supreme, as was the case in the early decades of Islamic history. Conversely, the worst period occurred when tribal and racial identities surpassed universal morality in the creation and sharing of wealth. The resilience of Islamic morality necessitates calling for a review of the financial system in the light of Islamic ideals of justice and equity (Adl and Ihsan). The fifty year old movement of Islamic banking and finance is a recent example.
Diluting Faith’s Mandate
Originally the position of people of faith regarding interest on loans was that the charging interest on loans to the needy was immoral; charging interest on commercial loans was considered unfair as it amounted to shifting the risk to the borrower. As is well known this position was later modified by many faith groups to allow moderate rates of interest on commercial loans. We need to take notice of this development.
The distinction made between loans to alleviate need (which do not result in anything marketable) and loans for productive purposes has no basis in the texts to which these faith groups swear allegiance. They did it supposedly on pragmatic grounds to facilitate financial transactions between owners of money capital and users of money capital for creating additional wealth. It was argued that interest payments were needed to compensate for the loss of the opportunity for profitable employment of that capital on the part of the lender, ignoring the fact that no opportunity for guaranteed profit existed in the real world. Man’s environment is characterised by uncertainty about the future value productivity of capital as Frank Knight demonstrated in his 1921 book Risk, Uncertainty and Profit. Furthermore, as the author of the article on usury in the Encyclopaedia of Religion and Ethics (1967) points out, any legitimacy accorded to interest in one sector permeates throughout the economy with the passage of time. Islam eliminated that possibility by declaring excess payment above the initial amount lent as prohibited riba. As the Quran says:
Believers! Have fear of Allah and give up all outstanding interest if you do truly believe. But if you fail to do so then be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your capital; neither will you do wrong nor will you be wronged. [II:278-80].
The distinction between low and high rates of interest or between loans for business and loans for need-fulfillment is not recognised by the Quran. As regards the presumption that commercial loans were not prevalent at that time, it has no basis in history. On the contrary riba in seventh century Arabia was overwhelmingly common in commerce. This is underlined by the declaration made by the Prophet, peace be upon him, in his last Hajj sermon cancelling all interest owed to his uncle, Abbas bin Abdul Muttalib. Abbas advanced money capital to the growers of dates in Medina as well as to the growers of grapes in Taif. Failure to pay at the time the loan was due then justified an increase in the amount to be repaid.
Some have tried to grant legitimacy to interest arguing that it is analogous with rent. Unlike money capital, which must first be spent to acquire real goods and services, rented goods like machines and real estate are usable right away. Islam, like all other religions allowed charging rent as a price for usufruct. Jurists often absolve the lessee from the obligation to pay rent should the rented property lose its ability to provide the expected usufruct.
The legitimacy of profit and rent is hedged with the provisions directed against monopoly and hoarding in order to maintain fair competition. The rest is largely left to the market functioning under the watchful eyes of the social authority. Abu Bakr, the first ruler succeeding the Prophet Muhammad, peace be upon him, described the ruler's duty as protecting the weak from the strong.
Speculation in financial markets often takes the form of betting on the uncertainty of the outcome of future events. Regulators must realise that such trading in risk is no more than gambling and serves no legitimate financial purpose. As such, regulators should prohibit such trades and they should examine all associated financial instruments, such as derivatives, for such characteristics.
Faith has the potential to influence financial markets by moulding human behaviour in accordance with moral values conducive to social weal. The essential universality of moral values has to be protected from being made subservient to hegemonic ambitions rooted in racial, national or religious identities. People of faith have devised institutions to realise the ideal of a just society. Within the framework of private ownership, freedom of enterprise and state supervision, prohibition of fraud, gambling and interest form necessary parts of these arrangements. Rapid technological changes necessitate adapting these institutions to new circumstances and making new arrangements in order to realise social goals. Continuing innovations in financial markets present new challenges for regulators. The quest for fairness in finance becomes a continuous process. The recent resurgence of Islamic finance should be looked upon as part of that process.
Mohammad Nejatullah Siddiqi is a noted Indian economist and winner of the King Faisal International Prize for Islamic Studies. He was educated at the Aligarh Muslim University, where he became Associate Professor of Economics and Professor of Islamic Studies. He has also served as Professor of Economics at King Abdul Aziz University in Jeddah, Saudi Arabia and was also a Fellow at the Centre of Near Eastern Studies at the University of California, Los Angeles and Visiting Scholar at the Islamic Research and Training Institute of the Islamic Development Bank. He is a prolific author on the subject of Islamic economics and has appeared on conference platforms around the world.