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Conference
April 2000 / New York |
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College
of Insurance |
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Evolution of Islamic Banking and Insurance
as Systems Rooted in Ethics. Authored by Dr.Nejatallah Siddiqi. |
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Mr. President, Brothers and Sisters
It is heartening indeed to see that the subject of insurance has at last
started getting the attention it deserves. Your Forum and the presence
of distinguished scholars as well as practitioners in the field of Islamic
Insurance and banking is reassuring. I have come to learn and refresh
myself on the subject. But in compliance with the wishes of the organizers,
especially my friend Omar Fisher, I venture to make some observations
which could provide a perspective to the other presentations and deliberations.
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1.Economic Progress |
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Man has needs which he seeks to fulfil
in ways available. One such need is exchange as no one can survive, much
less live efficiently, on what he himself can produce. In the beginning
there was barter but it was problematic and inefficient. Soon some objects
came to be used as means of payment. These could be carried over time, so
we had 'money' serving as medium of exchange as well as store of value.
Providing for future needs led man to invest in order to enlarge the scope
of what could be done - that was money as 'finance'. As trade developed
within and between regions and communities the role of finance increased
and financial intermediation became a possibility with new promises. Modern
banking spread with the social acceptance of bank credit, fractional reserve
and paper currency, enabling an increasing population to cope with larger
and larger volumes of trade and investment in a fast expanding world. |
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With each new development new risks
appeared. The farther into future man looked, the more uncertainty he encountered.
Handing risk and uncertainty became an increasingly prominent aspect of
economic life even for ordinary men and women. Early ways and means of handling
risks and uncertainty took simple forms of cooperation between the near
and the dear. Pooling, sharing, diversification all occurred within the
framework of trust, reciprocity and mutuality. That was insurance / takaful.
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As uncertainties increased and risk
became more complex shifting risks to those willing to take them (in expectation
of gain, or course) and unbundling them into manageable parts took new forms.
The earlier simple stratagem of insurance and coinsurance among people brought
together by kinship or vocation or trade, yielded to more sophisticated
arrangements open to wider groups of people. Sometime along this bumpy road
man hit upon the Law of Large Numbers and the Law of Averages. This discovery
reinforced a lesson learnt in antiquity. By coming together men could face
risks and uncertainties they could hardly cope with individually. That I
believe is the core idea behind insurance and takaful just as financial
intermediation is the core idea behind banking. Both have had revolutionary
impacts on economic progress, each in its own way. |
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2.Ethics |
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Running parallel to the saga of economic
progress is another thread, the ethical imperative of doing things in a
manner that does not harm others or violate social interests. Even though
morality is a human need in the sense that man's felicity and ultimately
his survival depends on ethical conduct, in reality ethical conduct does
not always obtain. Men misbehave. They act in immoral ways, one harming
other. Some violate public interest. Ultimately these end up harming themselves
too. This necessitated reminders and warnings and a reaffirmation of ethical
conduct. It also necessitated arrangements for information, its acquisition
and dissemination as well as preventing its withholding where due. Prophets
and saints, philosophers and statesmen, and many ordinary men and women
of strong commonsense kept reminding and warning that economic activity
must be informed by public purpose and a care for the interest of others
along with serving the interests of the actor himself. They also emphasized
truthfulness, the key to information. |
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Islam has legislated the minimum of
morality necessary for human felicity, leaving for persuasion and voluntary
compliance higher standard of morality which could make life better, more
decent. Prohibition of Riba (interest) and maysir (gambling) along with
the strictures against telling lies, fraud and deception and breach of contract
are the most relevant provisions of Shariah, insofar as economic activity
is concerned. Given these, helping behavior and regard for public interest
could ensure good society so far as the economic aspect is concerned. |
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It is in this perspective that one
should see how modern banking and insurance were handled by the Muslim peoples.
When they came out from under colonial rule they scrutinized these arrangements
in the light of Islamic laws and ethics. This was necessary as these artifacts
had evolved into an alien ethos and planted in Muslim societies by rulers
with little regard to the interest of these societies or their norms and
values. Let us first see what the Muslim mind did to banking. |
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3. Islamic Banking |
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Beginning the middle of
the twentieth century projects were launched to establish banking companies
which would neither pay interest nor earn interest. Bank-depositor relation
would be based on the depositor sharing the profit accruing as a result
of the bank's profitable use of the deposits pooled together. On the asset
side a number of ways were tried to earn profits including partnerships
and profit-sharing (mudharaba) with businessmen. Many Islamic banks entered
into business directly, buying and selling commodities, land or real estate.
Experimentation soon led to what is currently the predominant form of Islamic
finance, i.e. murabaha. In this mode of finance the bank buys something
on the specific request of a client and sells it to that client at a price
higher than the purchase price, to be paid after a period of time. Leasing
and prepaid orders (salam/istisna) were also used as profitable employment
of the pool of deposits. |
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In a nutshell, the core idea behind
commercial and investment banking, that of financial interemediation was
retained but the ethically repugnant practice of interest on loans was discarded.
Within a short period of fifty years, the first half of which was devoted
mainly to theory and model building, Islamic banking established itself
as an alternative, claiming ethical superiority over conventional banking.
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What is unethical about riba/interest
to revoke such a response to interest-based banking from the Islamic civilization?
The Quran (2:279) characterises it as unfair, as implied by the world Zulm
(oppression), exploitation, opposite of adl i.e. justice). Man's environment
does not guarantee positive return to productive use of money capital as
value productivities lie in the future surrounded by uncertainty and risk.
Some risk is involved in the productive use of money capital which, in fairness,
the supplier of money capital must share if he wants a share in the profit
of productive enterprise. A loan seeking positive return must share the
risk involved in its use, otherwise it is to be returned without increase.
As argued by Islamic economists this unfairness at the root of conventional
banking is bound to affect its efficiency also as money capital would tend
to be allocated on the basis of credit-worthiness of the borrowers rather
than expected productivity of the projects being financed. They have also
demonstrated how interest contributes to the instability of the capitalist
system. All this refers to loans to business enterprises. When it comes
to consumption loans the unfairness of interest and its negative impact
on society become more obvious. Whether for business or for consumption,
interest on loans violates the cooperative nature of man's life requiring
fairness add care for others. |
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4. Islamic Insurance |
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The story of Islamic insurance
is no different. One issue was to avoid interest in the investment of the
contributions / savings / premia deposited by those taking insurance. That
was easily done as the establishment of Islamic banks preceded the establishment
of Islamic insurance companies. As a matter of fact the first Islamic insurance
company was established towards the end of 1978 at the behest of the Faisal
Islamic Bank of Sudan. Now Islamic insurance companies have a whole range
of Islamic financial instruments in which to invest. |
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The other ethical imperative was to
prevent insurance from degenerating into gambling. Gambling inheres into
games of chance played for a gain. The activity is created or voluntary
entered into. It is not like the chances one has to take in the ordinary
business of life, i.e. the risks and uncertainties attending upon sale,
purchase, investment and production, even upon travel, choosing a career
or choosing your doctor. The unambiguous examples of gambling are bets in
horse race, in games of cards or on spinning a roulette wheel. The financial
risk involved in gambling could have been avoided if the gambler wanted
to do so, by not playing the game. Not so in the case of risks in productive
enterprise, investment or travelling, for to avoid financial risks in these
cases one has to give up not a game but the ordinary business of life'. |
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Like interest, gambling also violates
the spirit of cooperation and fairness on which civilization is based. The
appropriation of existing wealth already owned by some one by mere chance
is unethical. Wealth is either appropriate directly from the (yet un-owned)
pool of nature, or transferred to the new owner by the old owner as a gift,
against a price or by inheritance. As the gains of the gambler do not belong
to the first category we have to examine its legitimacy as a transfer from
the old owner. The unethical nature of this transfer reveals itself if we
look at the way the old owner must have come upon it. It is largely a product
of work. As explained elsewhere ownership rights on the bases of work, inheritance
or gift are ethically justifiable.* They have a rationale, serve a social
purpose and do not violate fairness or the spirit of cooperation. Allowing
wealth to be transferred by pure chance would make a mockery of that rationale
and the social function of ownership. It would be unfair to transfer wealth
acquired on the above mentioned grounds to one who does not qualify on any
one of those grounds |
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Shah Wali Allah of Delhi (1703 - 1762)
saw the above clearly. As Bajlon noted: |
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"The requirement of mutual aid is,
in the opinion of Shah Wali Allah the main ground for the prohibition of
maysir (gambling) and riba (interest)" . |
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One need read the whole passage to
appreciate Wali Allah's conclusion that both ways of gain (i.e. maysir and
riba) are tantamount to inebriation, as they are in flagrant contradiction
with the principles God has laid down for earning a livelihood. " |
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5. The Core Idea Behind Insurance |
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Modern insurance (Takaful)
is based on the idea that what is uncertain with respect to an individual
may cease to be uncertain with respect to a very large number of similar
individuals. 'Insurance by combining the risks of many people enables each
individual to enjoy the advantage provided by the Law of Large Numbers.
Of course the numbers are not usually 'large enough' so that actual values
deviate from the expected values. The theory of risk seeks to analyze these
deviations. Theories seldom reach perfection, yet practice fumbles on as
life in the modern metropolis is hardly possible without insurance, especially
in societies with shrinking nuclear families and neighborhoods of diverse
ethnic groups. |
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Insurance, however, is only one form
of handling risk by pooling or unbundling and/or shifting it to those who
are willing to take it in expectation of a gain. One other form is the market
for common stock. As explained by Kenneth Arrow, 'By this means, the owner
of a business could divest himself of some of the risks, permitting others
to share in the benefits and the losses. Since each individual could now
own a diversified portfolio of common stocks, each with different set of
risks attached, he could derive the benefits of a reduces aggregate risk
through pooling: thus, the stock market permits a reduction in the social
amount of risk bearing. "Arrow has also pointed out that 'insurance is a
very subtle kind of contract, it is an exchange of money now for money payable
contingent on the occurrence of certain events. |
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It is this subtlety that has been
causing problems for contemporary Islamic jurisprudence which failed to
take a macro view of the matter. In order to avoid endorsing 'contingent'
payments which obviously involve gharar, under pressure from the necessity
of insurance, some have tried to model it on altruistic giving (tabarru)
or charity. But the notion of charity can hardly survive the explicit reciprocity
involved in takaful. The gharar / uncertainty involved in the contract between
one individual and the insurance company, because of the contingent nature
of the payment, tends to disappear when large numbers are involved. What
is still contingent for the individual becomes routine for the group as
a whole as well as for the company. |
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6.Commercial Vs. Cooperative
Insurance |
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Since the core idea on
which mutual insurance or takaful is based is the same as behind all insurance,
the distinction between mutual and commercial forms of insurance is a matter
of organization, not a matter of substance. When the give and take involve
large number of people some coordination would be necessary. Such coordination
has to be paid for. The manager may receive his salary from a mutual or
a commercial, the activity remains the same. The choice between the two
forms of organization should be guided by considerations such as efficiency,
transparency etc, in short, on maslaha, good of the people. The form of
the organization does not affect the legitimacy of the activity itself.
It is not good reasoning to characterize mutual insurance as cooperation
and commercial insurance as illegitimate profiteering |
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As Ibn Khaldun remarked, trade itself
is a form of cooperation: "Man cannot survive as an individual in isolation,
by his very nature he needs cooperation to get what he requires. This cooperation
inevitably involves, first quid pro quo (mu awada) then sharing (musharaka)
and other forms". In fact for - profit activities often prove to be better
coordinated than those done in charity - the lesson so succinctly taught
by Adam Smith. That these same require regulation and overseeing by Social
Authority is not to be denied. |
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Having said that, I have no intention
to wish away the problems surrounding insurance. Regulators worked hard
to purge insurance from elements of gambling in its early days. But the
task is hardly complete as newer more subtle opportunities of speculation
present themselves. Nor has the battle against fraud and deception ended.
We have only to remember the breaking story of the Lloyd's of London to
convince ourselves to the contrary. Then there is the perennial issue of
moral hazard; of insurance changing the behavior of the insured in an undesirable
way. There is no doubt a dark side to insurance. Neither the regulators
nor the preachers can leave things as they are. Public intervention would
always be called for to ensure fairness, eliminate fraud and protect the
consumer. Insurance is too important for modern living to be prohibited
as a preventive measure (saddan liz zariah) No doubt it is vulnerable to
fraud and deception, even gambling, but so are the activities in the share
market, currency market, even in commodity markets. Rather, the correct
approach would be for the social authority as well as consumer groups to
exercise vigilance and introduce needed regulations. |
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7. The Future |
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Islamic insurance is there
to stay, whatever the organizational setup and whatever the juristic rationale.
The question before forums like the present one is how to take it to Muslim
homes and how to do this ethically i.e. carefully protecting the interests
of the people concerned. As Islamic bank and Islamic funds proliferate,
it should not be difficult for Islamic insurance institutions to tag on,
entering into strategic alliance with these banks and funds. Also the Ulama
owe it to the community to endorse Islamic insurance as vehemently as they
have endorsed Islamic banking so that the community can forge ahead with
a clear conscience. |
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Having efficient banking and insurance
would still leave the larger issues of social justice and equity in need
of attention. It is time we start doing that. |
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-end-
April 2000, New York
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