Islamic Economics Research Centre King Abdul-Aziz University, 10 June, 2009 Assets Managements from An Islamic Perspective and the Current Financial Crisis NAGAOKA Shinsuke PhD, Islamic Economic Studies & Islamic Finance JSPS Research Fellow, Center for Southeast Asian Studies (CSEAS), Kyoto University, JAPAN (permanent) & (official) Website:

Objective of this Presentation Distinguishing the features of the Islamic Economic System (IES) Presenting the common ground between the IES and Modern Capitalism (MC) Providing a theoretical framework for understanding relationship between Islamic finance and the current financial crisis

Methodology Clarifying the legitimacy of Islamic financial products Reviewing the legal resolutions (Fatawa) issued by Sharia scholars Presenting two Case Studies 1. Murabaha 2. Tawarruq

Case 1: Murabaha (1) Basic Scheme of Murabaha The most popular product of asset side

Case 1: Murabaha (2) Resolution by Sharia Scholars Fatwa of the first Al-Baraka Seminar in 1983 [ABS 1983] A: In Murabaha … is conducted in the form of exchange … real goods for money. The specific feature of Murabaha, as compared to Riba- based loans, is that even if the mark-up amount is predetermined the seller’s profit will be influenced by the market price of the relevant real good. Therefore, any profits in Murabaha are expressed as a function of supply and demand in the real goods market rather than the monetary market.

Case 2: Tawarruq (1) Basic Scheme of Tawarruq Alternative method of securing consumption loans

Case 2: Tawarruq (2) Critique against Tawarruq Munazzam in the Resolution by MWL [2004] Against the possibility of overlooking the actual transfers of real goods Against fictitious forms of interest-based loans Against the involvement of the Islamic bank in resale transactions

Features of IES (1) Actual transfers of real goods are required as an essential condition of Murabaha and Tawarruq. Murabaha and Tawarruq are legitimized not because of the “loan” but because of the “buying and selling of goods.”

Features of IES (2) Profits from Murabaha are expressed as a function of supply and demand in the real goods market. The mark-up in Murabaha is considered as opportunity costs of the real goods Involvement of Islamic banks in resale transactions and is prohibited in Tawarruq. Scheme of Murabaha and Tawarruq must bear the market risk of the relevant real good.

Features of IES (3) Strong link with the real domain of the economy Market mechanism in the real domain affects the performance of the monetary domain. “Embeddedness” (Karl Polanyi) of the monetary domain of the economy into the real domain

Common Ground of IES and MC (1) Economic Fluctuation and Islamic Finance Considering the response of Islamic finance to the impacts of economic fluctuation Are there specific devices for mitigating economic shocks?

Common Ground of IES and MC (2) Case 1: Price Fluctuation Caused by Monetary Factors (e.g., Inflation) Islamic finance allows price indexation in Ijara (lease contracts) and Qard Hasan (interest-free loan). Islamic Economic System equips devices for mitigating economic shocks from the monetary domain.

Common Ground of IES and MC (3) Case 2: Price Fluctuation Caused by Real Factors (e.g., supply-demand imbalance) Islamic finance does not allow price indexation in case of price fluctuation caused by real factors. Any profits from Islamic financial products must bear the market risk of the relevant real goods. Islamic Economic System does not equip devices for mitigating economic shocks from the real domain.

Common Ground of IES and MC (4) Economic Fluctuation and Islamic Finance No specific devices for mitigating economic shocks in the real domain of the economy Common Ground between IES and MC Common theoretical platform as far as the real domain of the economy is considered. Similarity between partnership finance in Islamic finance and equity finance in modern capitalist finance

Implication to the Financial Crisis (1) Try to providing the theoretical framework for understanding relationship between Islamic finance and the current financial crisis “IES and Islamic finance” is robust & stable compared with “MC and conventional finance”?

Implication to the Financial Crisis (2) What does the notion of “Embeddedness” imply? Instability arising from the Islamic financial system itself (i.e. monetary domain) does not tend to occur No autonomous mechanisms to prevent the economic crisis arising from outside the IES and Islamic financial system

Implication to the Financial Crisis (3) Important theoretical implication Islamic finance itself does not have possibility to be a starting point of the economics crisis Instability of the Islamic financial system is necessarily accompanied by the depression caused by the other sectors (real sectors or conventional financial sectors) “IES and Islamic finance” is not necessarily robust & stable compared with “MC and conventional finance”?

Implication to the Financial Crisis (4) How to understand the relationship between Islamic finance and the current financial crisis (theoretical framework) Conventional Financial System As a Starting Point of the Current Financial Crisis Islamic Financial System As an “Embedded” System into the Real Economy No Direct Negative Impact, rather Positive

Implication to the Financial Crisis (5) How to understand the relationship between Islamic finance and the current financial crisis (theoretical framework, contd.) Conventional Financial System As a Starting Point of the Current Financial Crisis Islamic Financial System As an “Embedded” System into the Real Economy No Direct Negative Impact, rather Positive Indirect Negative Impact via the depreciation Real Economy caused by the Financial Crisis

Implication to the Financial Crisis (6) Impact of the current financial crisis to Islamic finance (theoretical insight) Direct positive impact > Indirect negative impact via real economy Impact of the financial crisis is positive Direct positive impact < Indirect negative impact via real economy Impact of the financial crisis is negative As a matter of fact…?????

Islamic Asset Management role (1) What is roles of “Islamic Asset Management” in this framework? Two edged roles: Positive role: excluding the autonomous causes of the financial crisis Negative role: increasing the possibility to come under the influence of the shocks in the real economy

Islamic Asset Management role (2) The more growth of Islamic Asset management, the more impacts (whether positive or negative) from the financial crisis Policy Proposal Need to set buffers for preventing the negative impact via the real economy E.g. more prudential selection, more engagement by Islamic finance to the business

Conclusion Distinguishing feature of the IES “Embeddedness” Common theoretical platform Real domain of the economy Financial crisis & Islamic finance Instability is necessarily accompanied by the depression caused by the other sectors Impact of the current financial crisis depends on which direct or indirect is larger

Thank you for your kind attention. Golden Temple in Winter Kyoto, JAPAN (since 14th century)