The Stability of Islamic Finance Creating a Resilient Financial Environment for a Secure Future The Stability of Islamic Finance Creating a Resilient Financial Environment for a Secure Future HOSSEIN ASKARI, ZAMIR IQBAL, NOUREDDINE KRICHENE AND ABBAS MIRAKHOR John Wiley & Sons (Asia) Pte Ltd Copyright © 2010 John Wiley & Sons (Asia) Pte Ltd Published in 2010 by John Wiley &Sons (Asia) Pte Ltd Clementi Loop, #02-01, Singapore 129809 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as expressly permitted by law, without either the prior written permission of the Publisher, or authorization through payment of the appropriate photocopy fee to the Copyright Clearance Center Requests for permission should be addressed to the Publisher, John Wiley & Sons (Asia) Pte Ltd., Clementi Loop, #02-01, Singapore 129809, tel: 65-6463-2400, fax: 65-6463-4605, e-mail: enquiry@wiley.com This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering professional services If professional advice or other expert assistance is required, the services of a competent professional person should be sought Neither the authors nor the publisher are liable for any actions prompted or caused by the information presented in this book Any views expressed herein are those of the authors and not represent the views of the organizations they work for Other Wiley Editorial Offices John Wiley & Sons, 111 River Street, Hoboken, NJ07030, USA John Wiley &Sons, The Atrium, Southern Gate, Chichester, West Sussex, P019 8SQ, United Kingdom John Wiley &Sons (Canada) Ltd., 5353 Dundas Street West, Suite 400, Toronto, Ontario, M9B 6HB, Canada John Wiley &Sons Australia Ltd, 42 McDougall Street, Milton, Queensland 4064, Australia Wiley-VCH, Boschstrasse 12, D-69469 Weinheim, Germany Library of Congress Cataloging-in-Publication Data ISBN 978-0-470-82519-8 Typeset in 10/12pt Sabon by MPS Limited, A Macmillan Company, Chennai, India Printed in Singapore by Toppan Security Printing Pte Ltd 10 In the Name of Allah, the All Merciful, the All Beneficent Contents Foreword ix Acknowledgments xiii Glossary of Arabic Terms xv Introduction CHAPTER The Nature of Capital and the Rate of Return 11 CHAPTER The Origins of Financial Panics and Recessions 23 CHAPTER Monetary Policy and Financial Crises 37 CHAPTER The Internationalization of Financial Crises 45 CHAPTER The Role of the Credit Multiplier in Financial Crises 61 CHAPTER The Inherent Stability of Islamic Finance 75 CHAPTER A Theoretical Model of the Inherent Stability of Islamic Finance 83 CHAPTER Asset Pricing and Risk in Islamic Finance 93 vii viii Contents CHAPTER Islamic Financial Intermediation and Markets 113 CHAPTER 10 Risk Profile of Islamic Financial Intermediaries 131 CHAPTER 11 Financial Engineering, Derivatives and Financial Stability 141 CHAPTER 12 Corporate Governance and Financial Crises 163 CHAPTER 13 The Performance of Islamic Financial Intermediaries and Products 183 Conclusion 209 Bibliography 217 Index 225 Foreword Over the past 25 years or so, Islamic (Shari’ah-compliant) finance has made impressive strides As of 2007, some $600 billion of assets were managed in Shari’ah-compliant accounts around the world An additional substantial sum is represented by sukuk, or Islamic bonds Notably too, the development of Islamic finance is not limited to Islamic countries Global institutions such as HSBC, JPMorgan, and others, have begun to offer Shari’ah-compliant financial services through their worldwide networks Moreover, the phenomenon of Islamic finance seems likely to continue to increase in importance Over recent years, Islamic financial accounts and instruments have been growing twice as fast as conventional finance Given the size of the untapped market, and the growing wealth of Islamic countries, especially those that are major oil exporters, this trend seems set to continue Amid this ferment of practical activity, rigorous studies by well-trained economists have been relatively rare In this sense, this new book by a group of four Western-trained Islamic economists is greatly to be welcomed It builds on and extends their earlier work on the topic and will become essential reading for all those with an interest in the economic implications of Islamic finance The book develops themes that link Islamic finance to existing traditions in economics; that assess the stability properties of Islamic financial instruments, and that explain some of the key Islamic concepts in economists’ terms It will be an invaluable source for those who want to know more about the nature of the financial instruments that go to make up an Islamic financial system, and to understand how an Islamic financial system might work in a twenty-first century context Everyone knows that a key concept of Islamic teaching is the avoidance of interest payments that are fixed in advance (Interestingly, this prohibition is not different from that of other faiths at certain stages of their development.) But much less well-known to non-Muslims are the social teachings that lie behind the prohibition, and the variety of concepts that are permissible in economic transactions among Muslims Islamic finance has its roots in the teachings of the Prophet Muhammad (himself a merchant) and is grounded in the social, moral and cultural precepts of the Qur’an Much has been written about the relationship of Islamic finance to Qur’anic teachings; but much less, until very recently, about how Islamic finance is related to traditional economic doctrines, and how Islamic ix x Foreword finance might perform in a turbulent and unstable time like the present This volume therefore fills an important gap The book begins with an overview of classical capital theory, pointing out its consistency with many of the concepts and limitations of Islamic finance, once interest (the return to capital) and profit (the return to entrepreneurship) are seen as a combined return to the provision of capital resources Pursuing this theme, the authors analyze capital theory from Adam Smith and David Ricardo through William Stanley Jevons, Karl Marx, Eugen von Böhm-Bawerk, Knut Wicksell and others This sets the scene for developing the central thesis of the book, namely that Islamic finance is potentially a more stable means of financing capital accumulation than one that attempts to separate the functions of providing capital and bearing risk Since Islamic finance requires a much greater relative role for equity capital, it is, the authors contend, better protected against the instability that can come from excess leverage The authors seek to demonstrate how conventional finance can generate cyclical instability in credit creation which in turn leads to economic booms and busts They describe the process we would now call “procyclicality” in the financial system and relate it to the Minsky hypothesis of endogenous financial instability During a bubble, many assets become effectively monetized and add to demand, while in a bust, liquidity evaporates and credit shrivels Central banks, while trying to offset these tendencies, have often added to them Focusing on the management of interest rates to manage the real economy, the authors argue, has in practice fuelled speculative booms, and the ensuing busts have proved impossible to prevent Central to all this is the process of credit creation generated by ability of banks to create money substitutes through issuing interest-bearing liabilities An interesting chapter deals with the current financial crisis The book blames the internationalization of the crisis on excess money creation in reserve centers, and self regarding policies by individual countries Although not directly related to the theme of Islamic finance, the authors implicitly support the idea of a common reserve currency as the basis of a more stable international financial system Since Islamic finance avoids interest and interest-based assets, it is, the authors argue, inherently more stable than conventional finance, and need not inhibit the mobilization of savings and the efficient allocation of investment Islamic financial instruments are more directly linked to the productivity of the real investments they finance, and therefore not only promote the social objective of “sharing” risks and rewards, but cushion financial intermediation against the inherent risks of excess, both in booms and slumps Foreword xi Doubtless, defenders of conventional financial systems will say that better regulation and risk management can also protect financial stability, and that a wider range of permitted financial contracts can better achieve the completeness of markets It is not my purpose here to defend the specific claims made by the authors of the book Overall, however, it is a provocative and insightful assessment of the economic properties of Islamic finance that deserves to be read and reflected on by Islamic and non-Islamic economists alike Andrew Crockett President, JPMorgan Chase International Former General Manager, The Bank for International Settlements (BIS) Acknowledgments We are grateful to Sir Andrew Crockett for taking the time from his busy schedule to write the Foreword to this book Sir Andrew is, without a doubt, among a handful of the most respected and experienced international bankers of the last quarter of a century—senior official of the International Monetary Fund, executive director of the Bank of England, head of the Bank for International Settlements (BIS), member of the Group of Thirty, and the president of JPMorgan Chase International We are thrilled and honored by his contribution We are indebted to our editor, John Owen, for improving the manuscript We also acknowledge the hard work of our production editor, Joel Balbin The support of John Wiley & Sons (Asia) for Islamic economics and finance is greatly appreciated Finally, none of this would have been possible without the love and support of our families; to them we will always remain grateful xiii 214 THE STABILITY OF ISLAMIC FINANCE financial failure of one counterparty reverberates around the world In short, cross-border equity financing does not reinforce instability and panic in the way that debt does Financial instability, in turn, has significant economic and social costs First and foremost, it leads directly to an economic contraction as financing becomes unavailable The loss in national economic output can be significant and prolonged Next, governments invariably resort to bailouts as the way to rescue their faltering financial system Bailouts impose a burden on current and future taxpayers Moreover, when the central bank tries to socialize losses from a speculative boom through large bailouts, it could set in motion an inflationary process This penalizes the public for policy mismanagement, and causes large wealth redistribution from fixed income wage earners and creditors in favor of banks and debtors Moreover, high inflation causes a deflation of real output and may degenerate into stagflation if inflationary expectations become fully embedded in the price and wage system These separate costs, even if we had good estimates for each, cannot be simply added up to come up with a single cost estimate That would be akin to adding up oranges and apples How can one simply add the drop in output, the purchase of toxic assets by the government, increased unemployment payments, government financial guarantees and the direct infusion of cash into financial institutions? But all of these are real costs of financial turmoil In the financial crisis that started in the US in 2007, the components of the cost are disparate and impossible to quantify, at least in 2009 For instance, in an article on April 29, 2009, The Financial Times reported that according to the IMF “Efforts to stabilize the financial system could end up costing US taxpayers about 13.3 percent of annual output, or $1,900 billion per year over the next five years.” This, the paper calculated, equates to about $6,200 per head of the population.1 This only covers efforts to stabilize the financial system While the figure of $9.5 trillion (that is $1,900 billion per year for five years) may seem large, it does not include all financial guarantees and purchases of toxic assets by various branches of the US government (especially the Federal Reserve) By our estimates, as of April 2009, this figure was close to $15 trillion, and rising When all the other potential costs listed above are added to this, the true cost of financial stabilization would appear to be simply staggering Last resort bailouts are tantamount to a validation of the uncontrolled money creation by financial institutions An Islamic system avoids such an outcome: in the absence of last resort lending there can be no uncontrolled liquidity creation or, therefore, inflation based on monetary policy As the current financial crisis and previous episodes of financial instability were initiated, and in large part caused, by overly expansionary monetary Conclusion 215 and credit policies in many industrial and developing countries there may well be a need for a Basel III agreement to regulate the regulators—the central banks—and set guidelines for safe central banking aimed at financial stability, rather than at full employment In the absence of such a regulatory framework, the existing arrangements under Basel I and II—even if fully implemented—cannot prevent future episodes of severe international financial instability Finally, we should note that the social and human costs of financial instability and financial crises, though impossible to quantify, might even dwarf the economic costs The human cost of prolonged unemployment—its impact on the individual psyche and on families—cannot be overestimated The impacts on individual regions are much more extreme than the average effects The unfair redistribution of wealth, at the expense of individuals on fixed incomes and creditors, is simply immoral Islamic finance avoids these and other pitfalls of a financial system based on credit and leveraging We cannot keep repeating the cycles of boom and bust and pretending that the next time the results will be different We are living out the adage that defines stupidity as repeating the same act and expecting a different result the next time! It is time for the world community to lift its head out of the sand, to shed its reliance on debt, interest and leveraging, to totally revamp the financial system to rely on equity ENDNOTE http://www.ft.com/cms/s/0/be8041b6-34fa-11de-940a-00144feabdc0.html? nclick_check=1 The Stability of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future by Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor Copyright © 2010 John Wiley & Sons (Asia) Pte Ltd BIBLIOGRAPHY Akitoby, Bernardin and Stratmann, Thomas 2009, “The Value of Institutions for Financial Markets: Evidence from Emerging Markets,” IMF Working Paper No 09/27, IMF, Washington, D.C USA Al-Hassani, B and Mirakhor, Abbas (eds) 2003, Essays on Iqtisad: The Islamic Approach to Economic Problems, Global Scholarly Publications, New York Al-Jarahi, Mobid Ali 2000, “Issues Of Corporate Governance In Islamic Financial Institutions,” a presentation for the Conference on Corporate Governance and Risk 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From Diagnosis to Possible Remedies,” available at SSRN: http://ssrn.com/abstract=1410455 van Greuning, Hennie and Iqbal, Zamir 2007, Risk Analysis for Islamic Banks, Washington, DC: The World Bank Wicksell, Knut 1898, Interest and Prices, translated by R F Kahn London: Macmillan, 1936 Reprinted New York: A M Kelley, 1965 Yudistira, D 2004, “Efficiency in Islamic Banking: An Empirical Analysis of Eighteen Banks,”Islamic Economic Studies 12(1), August The Stability of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future by Hossein Askari, Zamir Iqbal, Noureddine Krichene and Abbas Mirakhor Copyright © 2010 John Wiley & Sons (Asia) Pte Ltd Index A agency 115, 129, 143, 178, 204 al-mal 176 amanah 115, 117, 118, 133, 135, 184 Asian Crisis 193, 194 asset-backed security/securities 61, 65, 66, 122, 142, 144 asset–liability management (ALM) risk 7, 89, 94, 134–136 asset–liability mismatch 84, 86, 89, 134 asset-linked 118, 120, 121, 122, 123, 124, 126, 148, 152, 187 asset prices 5, 6, 12, 24, 26, 27, 28, 32, 37, 67, 68, 69, 93–94, 99, 101, 102, 103, 106, 108, 109, 110, 111, 212 asset pricing 93–111 B bailouts 1, 2, 30, 39, 43, 45, 64, 79, 84, 91, 92, 211, 214 balance sheet 2, 12, 28, 39, 55, 67, 68, 69, 70, 78–80, 83, 84, 86, 89, 116, 117, 119, 120, 123, 124, 126, 127, 132, 135, 136, 138, 139, 155, 168 bank runs 66, 80, 91, 199 banking 1–2, 6, 7, 9, 12, 16, 17, 26, 27, 31, 32, 33, 38, 39, 42–44, 52, 55, 58, 59, 61, 62, 63, 64, 66, 71, 72, 77, 78, 80, 87, 92, 94, 111, 116–121, 125–126, 131, 132, 133, 134, 150, 185, 193, 210, 212 Basel accord 38, 43 Basel I 8, 32, 55, 215 Basel II 8, 32, 54, 55, 84, 215 Basel III 8, 215 bay’ al-salam 133, 137 bay’ mua’ajjal 133 board oversight 166–168 Böhm-Bawerk, Eugen von 5, 12, 14, 17, 18 borrowing 2, 16, 24, 25, 28, 29, 39, 52, 57, 76, 93, 110, 125, 136, 147, 211, 212 breach of trust 166, 169, 175, Bretton Woods system 32, 46 bubble(s) 5, 6, 12, 17, 19, 25, 26, 28, 30, 32, 33, 37, 48, 55, 70, 73, 94, 107, 108, 109, 111, 161 budget deficit 51, 212 C capital account deficit 45, 156 capital accounts 2, 8, 45, 156 capital goods 11, 14, 17, 18, 19, 40, 45, 156 capital markets 1, 9, 19, 45, 86, 92, 113, 116, 121–125, 128, 165, 183, 185, 195–197, 199, 205 capital productivity 11, 13, 20, 21 CAPM 93, 95, 96, 97, 99, 100, 108, 109, 110, 111 CDO 29 central bank(s) 1, 2, 6, 7, 8, 9, 16, 19, 23, 24, 25, 26, 27, 29, 30, 31–32, 33, 34, 37, 38, 39, 40, 42, 43, 44, 47, 48, 50, 53, 57, 59, 61, 63, 64, 66, 67, 70–71, 73, 74, 75, 80, 94, 108, 110, 111, 124, 125, 161, 211, 212, 214, 215 Chicago Reform Plan Clark, John Bates 14 codes of conducts 168 complexity 129, 148, 156, 157, 160, 163, 164, 165, 168 225 226 consumer goods 11, 12, 14, 19, 30, 31, 49, 63, 83 consumption 3, 13, 15, 16, 23, 27, 39, 51, 57, 73, 75, 84, 87, 88, 89, 92, 98, 99–100, 111, 114, 117, 210, 211 corporate governance 125, 163–179 corporate social responsibility (CSR) 197–199 correlation 94, 96–97, 100, 108, 109, 111, 171, 202 credit default swaps (CDS) 29, 53, 66, 141, 213 credit expansion 5, 6, 19, 23, 24, 25, 26, 30–32, 34, 38, 39, 40, 43, 49, 51, 61, 62, 65, 66, 69, 70, 80, 84, 89, 92, 141, 209, 211, 212 credit multiplier 6, 58, 61–73, 80, 84, 87, 89, 90, 209, 210 credit rating 29, 129, 147 credit risk 59, 64, 66, 79, 118, 120, 139, 142, 143, 147, 192 cross-border capital flows 32, 57 current account deficit 43, 51, 52, 53, 57, 212, 213 current account imbalances 48–53 current accounts 2, 43, 48–53, 57, 212, 213 customization 128, 148 D debt financing 6, 46, 47, 48, 84, 92, 116 deposits 2, 7, 9, 12, 24, 25, 42, 57, 58, 61, 62, 63, 64, 66, 68, 71, 72, 74, 75, 77, 78, 79, 80, 83, 89, 91, 114, 115, 117, 118, 119, 120, 121, 132, 138 depression 5, 24, 25, 72 derivatives 1, 7, 17, 29, 65, 66, 141, 153–161 discount rate 103 E economic growth 1, 6, 7, 9, 11, 13, 16, 19, 20, 21, 25, 30, 35, 38, 40, Index 43, 48, 70, 72, 73, 75, 84, 87, 91, 92, 113, 125, 152, 158, 179, 210, 211 economic policy 16, 24, 30, 48–53, 94, 131, 213 economic shocks 27, 53–54 employment 1, 6, 8, 15, 21, 23, 24, 27, 31, 32, 33, 34, 37, 38, 38, 41, 43, 47, 84, 85, 87, 90, 92, 110, 210, 211 equity 2, 3, 6, 19, 24, 28, 54, 57, 67, 68, 71, 75, 77, 80, 83, 86, 88, 90, 96, 106–108, 109, 111, 115, 119, 122, 123, 126, 127, 137, 138, 139, 146, 152, 155, 171, 196, 210, 213, 214 equity-based system 46, 57–59, 76, 77, 210 equity financing 28, 119, 184, 214 ethical standards 172–173, 174 ethics 165, 168, 169, 174, 187 excessive credit 6, 25, 38, 43, 49, 62 exchange rate 30, 32–33, 45, 46, 52, 54, 78, 89, 94, 95, 106, 137, 143, 147, 154, 155, 212 expected return 93, 95, 96, 97, 99, 100, 109, 111 F factors of production 13, 18, 21, 84 fatwa 177 Federal Reserve System (FED) 25 fiat money 12, 40 financial crisis 1, 6, 8, 25, 29, 30, 32, 33, 37, 39, 41, 45, 47–48, 49, 55, 62, 65, 66, 136, 141, 147–148, 149, 154–157, 164–168, 175, 179, 188, 199, 209, 212, 214 financial engineering 7, 141, 143–152, 159–161 financial innovations financial instability Financial Instability Hypothesis (FIH) financial intermediary 115, 116, 117, 118, 119, 120–121, 122–123, 125–126, 128, 129, 132, 135, 140 Index financial intermediation 7, 12, 58, 80, 83, 86–91, 113–129, 140, 150 financial panics 23–33 financialization 65 fiscal policy 32, 34, 51 Fisher, Irving 8, 9, 17, 23, 24, 29, 30, 37, 66 fixed exchange regimes 32 floating exchange regimes 6, 33, 45 G gambling 4, 5, 157, 158, 159, 161, 169, 187, 209 gharar 151, 152, 157, 158, 161 globalization 47, 113, 127, 148, 163 government expenditure 34, 51 Great Depression 1, 24, 25, 33, 35, 39, 46, 62, 66 gross domestic product (GDP) 6, 9, 34, 48, 72 H hedge 28, 29, 56, 129, 137, 156, 158, 159 hedge fund 33, 45, 48, 55, 65, 66, 73, 109, 154 hedging 32, 53, 106, 113, 129, 150, 153, 154, 158, 159, 160, 197, 213 hoarding 4, 24, 169 human capital 12, 13, 113 I ijarah 117, 118, 121, 130, 133, 135, 137, 184, 187, 188 income accounts 16 indebtedness 5, 23–27 index performance 196, 197, 204 inflation 8, 12, 16, 17, 21, 23, 27, 33, 34, 39, 40, 41, 42, 43, 44, 47, 48–49, 59, 77, 80, 94, 213, 214 inflationary 1, 6, 8, 16, 17, 23, 30, 31, 37, 38, 39, 40, 42, 43, 48, 52, 64, 73, 80, 91, 94, 212, 214 institutions 1, 7, 8, 9, 25, 27, 28, 29, 32, 33, 39, 43, 44, 45, 48, 53, 54, 55, 56, 57, 58, 62, 65, 66, 67, 70, 227 71, 73, 77, 80, 114, 116, 118–119, 124, 125, 126–127, 128, 129, 130, 131, 136, 137, 138, 149, 161, 163, 166, 167, 168, 172, 174, 175, 176, 177, 178–179, 183–184, 185, 192–195, 199, 204, 205, 214 interest rate(s) 5, 6, 7, 12, 13, 17, 19, 21, 24, 25, 26, 27, 29, 30, 33, 37–38, 39, 40–42, 43, 44, 48, 49, 50–51, 52, 53, 54, 56, 57, 59, 63, 67, 70, 75, 76, 78, 79, 80, 83, 88, 89, 90, 91, 92, 93, 94, 97, 103, 106, 107, 108, 109, 110, 111, 135, 137, 142, 143, 146, 147, 153, 161, 209, 211212, 213 interest vs capital 12, 13, 20, 21 internationalization 6, 32, 45–59 IOUs Islamic banking 7, 9,58, 59, 77–80, 86–87, 92, 100, 115, 120, 126–127, 134, 136137, 138, 183, 185, 186, 187, 189, 192, 193, 194–195, 199, 204, 205, 207, 210 Islamic bond 122, 183, 187, 191 Islamic finance 4, 5, 6, 7, 13, 17, 20, 21, 58, 62, 71–72, 73, 75–80, 83–92, 93–111, 94, 97, 100, 101, 105, 109, 110, 111, 114, 126, 150, 158, 159–161, 177, 183, 184, 185, 187, 197, 198, 209, 210, 211 Islamic financial system 116–126, 174–178 Islamic funds 183, 185, 187, 190, 191, 197 Islamic syndication 138 istisnah’ 59, 79, 80, 117, 118, 121, 133, 135, 188 J Jevons, William Stanley 5, 15 ju’alah 115, 116, 135 justice 3, 4, 5, 13, 19, 20, 75, 76, 80, 123, 150, 158, 160, 161, 170, 172, 173, 174, 179, 194, 197 228 K Keynes, John Maynard 5, 27, 30, 38, 46, 85, 90, 106, 209 Keynesian economics 90 kifala 115, 116, 133, 135 Kindleberger 26, 33, 46, 51 L labor productivity 11 labor theory of value 14 leadership 164, 165, 174–175, 179 lender of last resort 2, 24, 38, 64, 94, 110, 111, 211 leverage 26, 29, 62, 65, 67, 68, 69, 70, 73, 84, 90, 91, 128, 137, 152, 154, 163, 192, 200, 202, 210, 211 leveraging 6, 24, 26, 29, 47, 48, 54, 57, 66, 67–71, 141, 152, 161, 209, 215 levy process 103 liquidity 1, 5, 6, 8, 23, 26, 29, 32, 34, 37, 39, 48, 50, 61, 64, 66, 67, 75, 77, 87, 89, 94, 110, 120, 121, 123– 124, 128, 131, 132, 136, 137, 138, 143, 147, 148–149, 155–156, 161, 192, 199, 204, 205, 209, 211, 214 liquidity risk 120, 128, 136, 148, 153, 155, 192 loan 2, 4, 12, 13, 20, 21, 24, 25, 26, 34, 37, 39, 40, 41, 42, 48, 54, 55, 57, 58, 63, 64, 65–66, 67, 68, 71, 76, 77, 78, 80, 83, 87, 88, 89, 90, 108, 109, 110, 120, 136, 149, 195, 198, 211 LTCM 45, 48, 154 M macroeconomic imbalance 46 macroeconomic policy 16, 48–53, 94, 131, 213 maqasid-al-Shari’ah 150–1 marginal productivity 5, 19, 83, 93, 111 market discipline 131, 134, 164, 165, 179 market risk 25, 57, 59, 64, 81, 96, 97, 120, 137–139 Markowitz portfolio theory 94–95 Index Marx, Karl 5, 19 maslahah 160 materiality 152 maysir 151, 157, 169 Metzler model 84, 86, 87, 88, 92 Middle East 184, 185, 190, 193, 194, 199 Minsky 5, 23, 27–30, 31, 38, 91, 211 Monetarists 30, 39 monetary policy 6, 8, 16, 19, 23, 25, 31, 33, 37–44, 47, 48, 51, 57, 67, 70, 71, 110, 161, 212, 214 money 2, 4, 8, 9, 11, 12, 13, 14, 15, 16, 19, 20, 21, 23, 24, 25, 26, 27, 28, 30–32, 33, 34, 35, 37, 38, 39, 40, 41, 42, 43, 44, 47, 51, 58, 59, 61, 62, 63, 64, 66, 70, 71, 72, 73, 76, 79, 80, 84, 85, 87, 88–92, 94, 109, 110, 111, 113, 116, 118, 124, 158, 158, 161, 209, 210, 211, 212, 213, 214 money capital 11, 12, 13, 14, 16, 17, 19, 20, 21 money circulation 72 money market rate 90, 92, 124, 211 money supply 1, 25, 33, 38, 39, 40, 41, 42, 43, 44, 62, 64, 85, 94 money velocity 24, 72, 85 mortgage-backed security 145 mudarabah 59, 79, 80, 115, 117, 118, 119, 122, 127, 129, 133, 134, 135, 136, 138, 139, 152, 176, 184 mudarib 115 murabahah 118, 127, 133, 135, 152 musharakah 59, 79, 80, 115, 117, 118, 119, 127, 133, 134, 135, 136, 138, 139, 152, 176, 188 N natural resources 11, 12, 13, 16 O operational risk 59, 127, 129, 131, 132, 136, 149 over-the-counter (OTC) markets 141, 142, 143, 149, 155 Index P panic(s) 23, 26, 27, 39, 45, 46, 48, 69, 156, 213, 214 partnership 115, 126, 127, 129, 133, 135, 138, 139, 152, 176, 184 payment system 87, 113, 120, 131 physical capital 19, 41 physical goods 11, 12, 14 Ponzi finance 5, 28 portfolio management 120, 130, 143, 147, 189 price discovery 127, 153, 157 price of capital 17, 42 price stability 7, 41, 43, 210 price stabilization 158 principal/agent 115, 118, 121, 127, 134 productivity 4, 11, 12, 13, 17, 18, 19, 20, 21, 71, 83, 93, 111, 123 profit/loss sharing 4, 9, 58, 78, 80, 83, 86, 91, 124, 126, 132, 134, 135, 138, 139, 210 profit sharing property rights 3, 4, 129, 160, 168, 169–170, 171, 173, 174, 175, 176, 180 purchasing power 20, 24, 34, 47, 58 Q Quantity Theory of Money 40, 41 quasi money 72, 73 R rabbul-mal 115 rate of return 5, 7, 11, 41, 58, 70, 72, 83, 84, 85, 86, 87, 90, 92, 93, 94, 95, 96, 97, 100, 101, 104, 105, 109, 111, 124, 137, 138, 210 real rate of return 83, 85, 86, 92, 93, 105, 111, 209, 211 recession 5, 12, 17, 23, 24, 27, 32, 55, 63, 66, 71, 72, 185, 188, 199 regulation 23, 25, 28, 33, 38, 39, 43, 46, 48, 53, 54–55, 55–57, 62, 73, 84, 89, 113, 147, 161, 165, 209, 212, 213 229 reserve currency 46, 47, 53, 213 reserve requirement(s) 2, 7, 39, 62, 63, 64, 65, 66, 72, 73, 90, 135, 210 resilient riba 4, 75, 151, 158, 161, 198 Ricardo, David 5, 12, 14, 15, 17, 19 risk control(s) 165, 166–168 risk management 113, 119, 121, 125, 128, 139, 141, 143, 148, 154, 157, 164, 167, 179 risk mitigation 127, 150 risk-neutral 93, 99, 101–103, 104, 105, 106, 111 risk-neutral probabilities 93, 101, 102, 103, 111 risk profile 117, 131, 132, 134 risk redistribution 153 risk reduction 153 risk sharing Robinson Crusoe model 14, 83 Russian crisis 32 S savings rate 7, 34, 51, 71, 72, 87, 109, 210 Say’s Law 39, 41, 58 securitization 17, 29, 34, 61, 62, 65–66, 73, 90, 122, 149, 152, 187, 210 shareholders 13, 57, 77, 83, 86, 87, 88, 134, 135, 139, 163, 164, 165, 168, 181 Shari’ah 3, 5, 76, 114, 120, 123, 125, 126, 127, 128, 129, 130, 139, 150–151, 152, 157, 158, 159, 160, 161, 168, 169, 170, 171, 174, 175, 176, 177–178, 179, 183, 184, 185, 187, 188, 190, 196, 197, 198 Shari’ah arbitrage 151–152, 160 Shari’ah governance 179 Sharpe ratio 97, 101, 109, 200, 202, 204 Smith, Adam 5, 13, 14, 17, 90 social cost, 8, 214 230 social justice 3, 4, 5, 75, 150, 160, 174, 179 special purpose vehicle 122, 130 speculation 9, 21, 24, 25, 26, 32, 34, 37, 39, 47, 49, 53, 58, 61, 75, 76, 79, 80, 88, 92, 94, 108, 109, 128, 142, 154, 155, 157, 158, 159, 161, 211, 213 stability 1, 2, 12, 13, 16, 17, 23, 24, 25, 26, 27–30, 31, 32, 38, 41, 43, 47, 59, 75, 83, 84, 85, 86, 87, 88, 89, 90, 91, 92, 93, 122, 126, 130, 131, 134, 141, 148, 149, 154, 161, 164, 179, 195, 209, 210, 211, 215 stakeholders 3, 127, 163, 165, 175–176, 178, 179 stochastic process 101, 103, 104, 106, 110 stock market 1, 25, 26, 48, 64, 95, 106, 107, 108, 122, 123, 127, 128, 138, 139 subprime 47, 48 sukuk 122, 183, 184, 187, 188, 189, 190 supervision 6, 9, 23, 33, 46, 48, 53, 55–57, 113, 124, 125, 131, 134, 138, 161, 164, 179, 213 systemic risk 56, 93, 94, 106, 107, 109, 110, 111, 154, 212 Index T theory of capital 13 too big to fail 1, 33, 56 transparency 48, 127, 136, 138, 149, 152, 156, 160, 174, 175, 178, 179, 184, 198 trust 20, 57, 115, 116, 149, 165, 166, 169, 170, 171, 172, 174, 175, 176, 179 V values 1, 2, 3, 4, 11, 12, 14, 15, 16, 18, 19, 20, 52, 53, 64, 67, 68, 83, 84, 85, 87, 88, 89, 91, 92, 94, 95, 96, 97, 101, 103, 108, 110, 111, 122, 137, 141, 142, 143, 148, 149, 156, 158, 160, 165, 168, 173, 175, 179, 187, 189, 197, 199, 204, 209, 211, 212, 213 W wakalah 115, 117, 118, 130, 188 wealth 3, 4, 8, 12, 14, 17, 18, 20, 21, 27, 30, 31, 38, 42, 43, 45, 59, 66, 71, 75, 76, 80, 88, 95, 119, 124, 140, 153, 160, 169, 171, 176, 209, 214, 215 Wicksell, Knut 5, 17, 19, 25, 37, 41–42, 43 ... Guarantee manafaah al-ikhtiyarat: Variant of al-khiyar manfaa maal/manfa’ ah: Usufruct Benefit flowing from a durable commodity or asset maqasid al-Shari’ah: Basic objectives of the Shari’ah: the protection... discuss the theory of capital as detailed in the Qur’an and the sunnah The notion of capital as a physical asset, whether produced or a natural resource, and the notion of capital as a money fund apply... and profit are necessary for appreciating what lies at the core of financial stability ON THE NATURE OF CAPITAL Factors of production have been classified essentially as a triad: land and natural