How is Islamic finance ethical?

Sultan Choudhury is chairman of Offa

To understand the ethical nature of Islamic Finance, it is vital to understand what Shariah is. Linguistically, Shariah means the path to a source of water. Technically, it is the system of God which He has revealed to mankind. This system encompasses belief, practice and character.

The connection between the linguistic and technical meeting is that just as water is a source of life, the code of conduct and system is a means of sustainable development. Being a source of life means that its very principles do not jeopardise life, hinder sustainability or exploit. Instead, the Shariah principles are there to foster growth, establish justice and promote opportunities. This will become clearer from the following principles:

Interest

Interest is absolutely prohibited in Islamic finance. Paying interest, receiving interest and facilitating interest are all non-compliant and explicitly prohibited.

Interest is an injustice to the needy and creates disparity between the rich and the poor. Interest is unjust, because the lender gets no reward for lending to a successful business and (generally) suffers no harm from lending to an unsuccessful business.

Interest is destabilising, because lending with interest encourages further borrowing and investment during a growth period and places high burdens (causing bankruptcies) when profits are low. These realities exhibit the unethical nature of interest payments and why Islamic finance is ethical.

Uncertainty in contracts

Another prohibition is major uncertainty in contracts. This may arise in the form of uncertainty in the contract and anything that is related, such as uncertainty in the value of the subject matter; the time of payment on deferred sale; the quality and the quantity of the subject matter; existence, or ownership; deliverability; and availability or nature of the object of the contract.

It is on this basis that a number of financial instruments are prohibited due to their contingent outcomes such as options trading. With such uncertainty, a counterparty can be unethically disadvantaged, or made to suffer harm.

Gambling

The Qur’anic guidance regarding gambling tells us that gambling creates discord and friction in societies. Many people unfortunately suffer from gambling addiction. A gambling addiction occurs when a person continues to gamble despite negative effects that may impact their finances, relationships, or wellbeing.

Research has shown how long-term gambling addictions impact individual’s health, relationships and mental wellbeing.

No investment in harmful activities

The Islamic paradigm has highlighted several activities which are considered harmful from the Islamic ethical framework. As such, investing in any such activity is not permitted.

Businesses involved with alcohol, tobacco production, gambling, non-Halal meat, pornographic material are examples of businesses which are negatively screened from an Islamic perspective.

Social welfare as a pillar of faith

One of the hallmarks of the Islamic system is that it embodies social welfare within its main pillars of faith. Zakat is a human capital fund formed from alms (compulsory giving for Muslims that can afford it) which seeks to empower individuals. Zakat guarantees every struggling person a baseline provision and support to give them more opportunities to break out of the cycle of poverty.

Zakat creates liquidity injections to the market and acts as an economic stimulus by activating consumer spending. Zakat is a social contract between communities to look after one another and to grow together. Beyond Zakat, Islamic Finance has the institution of Sadaqah (charity) and Waqf (endowment) which further power growth for those struggling.

Islamic Finance is not just another ‘alternative finance’.  It truly has principles which can resolve many of the disparities we are witnessing across economies.

Read Sultan Choudhury's introduction to Islamic finance here.