Money Market – a Shariah Anomaly

Conventional wisdom states that money must generate returns all the time, even when it is idle. Hence the creation of the money market, a place for trading idle money. When there is a trade, there will be a price; and the price of money is the interest rate. What determines the interest rate? Other than the forces of demand and supply; monetary policy, expectation of changes in the base rate and inflation also influences the price of money.

The money market is also a place where mismatches in banks’ assets and liabilities are rectified. Banks with excess funds (liabilities > assets) will sell (lend) the excess cash in the money market and banks facing a shortage of funds (assets > liability) will buy (borrow) money from the market.

The money market ensures liquidity is managed and is therefore crucial to ensure the banking system and the economy works smoothly.

Why then do I say that the money market is an anomaly in Shariah based finance?

Firstly, my understanding is Shariah prohibits the trading of money because money is not a commodity; it is merely a tool to facilitate trade. Money is potential capital, useful only when put into productive economic use.

Secondly, money is a ribawi item, one which cannot be exchanged unless it is equal in value and transacted spot. The following hadith is the basis of this ruling.

The Prophet s.a.w. said “gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt should be exchanged like for like, equal for equal and hand to hand [on the spot]. If the types of the exchanged commodities are different, then sell them as you wish, if they are exchanged on the basis of a hand-to-hand transaction. (Sahih Muslim)

Therefore, the act of lending overnight money at 3%, contravenes the above hadith because (1) the exchanged value differs and (2) it is not exchanged on spot basis.

Then Tawarruq came along. Liquidity management in a Shariah compliant manner is now possible via the buying and selling of commodities (which does not leave the warehouse and is reused again and again for subsequent transactions). The route is longer but the objective is met nonetheless, money is exchanged in different amounts at different times, made “permissible” due to the presence of the trade. It sounds like a hilah to me because the whole transaction is undertaken merely to circumvent Shariah ruling on riba. It also does not entail any direct economic activity. The biggest beneficiary is the commodity brokers, getting paid for facilitating a seemingly pointless transaction.

No doubt, there will be times of excess liquidity and it does not make economic sense to keep the potential capital idle without generating any income.

This excess liquidity can be channelled towards financing short term projects or providing short term funding. Trade financing would be a good place to start. Retailers/traders usually buy from suppliers or wholesalers or manufacturers on credit terms. Banks could offer a short term murabahah facility to finance this type of transactions in the form of a 3 day, 1 week, 2 week or 30 day murabahah financing. This would channel the excess liquidity towards funding real economic activity.

Another way to absorb the excess liquidity is by way of a short term lease. A clearing house needs to be set up. The clearing house shall own a pool of tenanted properties. When a bank (or anyone for that matter) has excess liquidity, they will purchase property from the clearing house and the rental will be paid to them. When they need the cash, the property will be sold back to the clearing house at market value. In most cases, the purchase and sale price would be the same as it is quite unlikely for real estate values to fluctuate very much in the span of a few weeks.

Both methods entails actual economic activity and the returns from the investment are generated from actual economic activity.

There is always a Shariah based solution to every financial need. If there isn’t, the financial transaction is probably not in tandem with Shariah in the first place.

Will There be a New World Financial Order? by Pankaj Kumar (The Star, Business section, 21 January 2009)

Copy of the email I sent to the Editor of The Star, commenting on the need for an alternative financial model.

Dear Editor,

Quoted from Pankaj Kumar's article in The Star 21 January 2009:

"The simple argument is that asset managers or hedge fund managers do not need crude oil or other commodities for that matter or even currencies in their books.They have no business to be in these markets if they are purely speculating on price movements.They should stick to basic investment in asset classes, that is, genuine companies that use these commodities for real markets, real products and real profits. And yes, we do need a new world financial order to get rid of speculative activities which have time and again created asset bubbles and financial manias."

I cannot agree more with Pankaj's observation and would like to point out that an alternative financial order is already in place – Shariah (Islamic) based Finance.

The principles of Shariah disapprove of uncertain contract terms, prohibit gambling and abhor speculative practices. Unfortunately, these elements are prevalent in most financial instruments of late which ultimately caused the fallout in the financial markets that we are experiencing now. If undertaken in its true form, Shariah based financing can eliminate most of the problems associated with conventional financing as laid out by Pankaj in his article.

The key is however, to practice Shariah based financing as it should be, according to the principles of Shariah and not as a conventional product with an Arabic name. Shariah based finance is totally different in all respects from the conventional finance and banking the world has seen and grown to love for the past 100 years. It would be disastrous and detrimental to the development and growth of Shariah based finance if practitioners (and regulators) continue to develop so-called Shariah products based on the conventional platforms and norms.

What is needed is a paradigm shift in the way we approach and view Shariah based finance. We need to accept that although the objectives of Shariah based financing are similar to that of conventional finance, the means of achieving it is drastically different. Different here does not mean changing the product name or adding a few clauses in the transaction documents. The difference is in the mechanics, determination of profits (pricing), contractual obligations and relationship of all parties, the risk analysis and management, recovery methods, source of funds, utilisation of proceeds and remedies in the event of default.

In order for Shariah based finance to prosper, practitioners must not only be well versed in the laws of Shariah but more importantly understand the objectives of Shariah. The market also needs to be made aware of the uniqueness of Shariah based finance. Only then can we see the emergence of the true form of Shariah (Islamic) finance.

Regards,