Book: Islamic Finance in the Global Economy

Edition: Second edition, 2010

Author: Ibrahim Warde

Publisher: Edinburgh University Press

The wayang kulit of Islamic finance: Book Review

by Rosana Gulzar Mohd 

This book by Ibrahim Warde, a US academic, is among a few in the genre of political economy of Islamic finance. Although a much needed subject, it is hardly discussed in classrooms apparently due to political sensitivities. That may be the reason why this book stands out in its contribution but it can also very well stand on its own merits. The content is refreshingly intellectual, critical and direct. But even as I find it to be the most enlightening book I have read on the subject, I wish for more.

The question is, what is ‘political economy’? Or what does the subject cover? It is a fascinating field of economics which goes beyond the simple study of processes. Instead of describing production and trade as if they operate in silos or the often used phrase in economics, ceteris parabus (assuming all else stay constant – seriously, which world is that?), the study of ‘political economy’ combines theories from political science and sociology to bring about a fuller and more realistic perspective on how a country is run. A branch of political economics even draws from other academic areas such as culture and history. This definition from Investopedia is to me, the most appealing though it is arguably not the most reliable source: “International political economy is ultimately concerned with how political forces like states, individual actors, and institutions shape systems through global economic interactions and how such actions effect political structures and outcomes”.

The study of political economy is vital, I argue, in Islamic finance because how does one begin to understand a phenomenon without a frank discussion on the forces shaping it. To borrow from the Indonesians, who are the real dalangs (puppeteers) in this wayang kulit (traditional puppet-show)? Who are pulling the strings? As Warde says, “Quantity, not quality, is the defining feature of writings on Islamic finance. The recent boom in Islamic finance has resulted in a flood of writings that add very little to our understanding of a complex and multifaceted phenomenon. Overall, scholarship is marred by four flaws: the ‘authorised’ nature and pre-ordained conclusions of a significant portion of it; narrow geographic focus and lack of comparative analysis; reductionism (religious, financial, and legal); and faulty assumptions about the relation between theory and practice (p. 8).” In short, we have barely scratched the surface.

Understanding the real actors and their game plans is vital for anyone trying to make a difference in an industry that as Warde notes, has had a mixed record. On the one hand, Islamic finance successfully lodging itself into the global financial system is proof of its viability. But it has also not, by most accounts, live up to its original billing. “Rather than being a different financial system, based on partnership finance, which would bring social and economic development to the Islamic world, Islamic banks have generally mirrored conventional finance and concentrated on short-term financial transactions. Islamic institutions thus raise the inevitable question: is Islamic finance necessary? Stated differently, does it add anything of value to the conventional banking system? (p. 247)”.

The study of political economy is also necessary because as Warde reminds, the industry, from the practice in Indonesia to Malaysia and the Middle East, is far from a monolith. Meaning they are not all the same. It pays to understand the differences. “Despite such efforts at harmonization and streamlining there is still a great deal of diversity to the Islamic sector. Perceptions of Islamic finance in the West cannot be separated from general perceptions of Islam as a monolithic, unchanging and somewhat fossilized belief system. In reality, Islamic finance reflects the diversity of a fourteen-hundred-year-old, 1.2 billion strong religion spread over every continent. Islamic financial institutions come in all shapes and forms: banks and non-banks; large and small; specialized and diversified; traditional and innovative; national and multinational; successful and unsuccessful; prudent and reckless; strictly regulated and free-wheeling, etc. Some are virtually identical to their conventional counterparts, while others are markedly different. Some are driven solely by religious considerations, others use religion as a way of side-stepping regulation, as a shield against government interference, as a tool for political change, or simply as a way of attracting customers (p. 4)”.

Even as I celebrated the book, I wish for more. I think it is time for a rewrite. Since the second edition in 2010, the world has changed. A lot. Then we were at the gates of what was to be the worst economic and financial crisis since the 1930s Great Depression. Islamic financial institutions went into the crisis relatively strong as the Shariah scholars banned them from joining the financial innovation frenzy. So they could not sell lucrative products such as debt (unless they were in Malaysia) and derivatives or got involved in short-selling and highly leveraged transactions. The scholars thus felt vindicated when the crisis toppled one bank after another in Wall Street. But when the crisis spilled into the Main Street and started affecting the economy, some Islamic banks suffered. Hasan and Dridi, 2010, found that Islamic banks in the GCC (Gulf Cooperation Council) and Malaysia had larger declines in profitability in 2009 compared to conventional banks because of weak risk management practices which allowed them to bust concentration limits. Islamic banks in the UAE for example, were heavy lenders to the real estate sector. All these are not captured yet in the book.

It would be interesting to understand Warde’s perspective of the new world order and its impact on Islamic finance. For example, although it has been more than five years since the supposed end of the crisis, the world has not really gone back to normal. We are just trudging on with a few percentage points, if not negative, growth. Regulations-wise also, despite all the commotion, I doubt we have figured out the right guards to put in place. As countries struggle to implement Basel III, which seems to be all about tightening standards (is that what we really need?), talk of another crisis is already brewing. To put icing on the cake, oil prices are still in the slump after crashing by more than 50% in 2014. If most Muslims survive on oil, not water, and Islamic finance was buoyed by petrodollars, is the sector all but dried up now?

In Malaysia, Islamic finance is especially looking uncertain with a new central bank governor. The IFSA (Islamic Financial Services Act) 2013, spearheaded by the former and meant to reform the industry, may die a slow death (not that it was without issues in the first place) as the new governor chooses a new song about alternative financing. With no mentions of Islamic finance, one wonders whether there is still willpower to reform the industry? Most bizarre is the recent proclamation by its top Shariah man that profit and loss sharing contracts are not suitable for Islamic banks. (So they should do more fixed rate debt just like conventional banks?) To top all of these off, crony capitalism in Malaysia may just be at an all-time high. Malaysia’s ranking in the Corruption Perceptions Index dropped by one place to 55 in 2016 as the prime minister joyously goes about his ceremonial visits. Indonesia, an acrimonious Islamic finance neighbour, also slipped two rankings to 90 although its score improved by one point (welcome to the ummah).

Lastly, bankers, the world over, are now the fallen devils. If they were swashbuckling in three piece suits just a few years ago when countries were falling over themselves to issue sukuk, many are now watching their backs as banks drop staff like flies. In these times, I wonder whether the narrative has changed for the wayang kulit of Islamic finance? Or has the puppeteer packed up to play to a different audience … Comments Mr Warde?