A connection that might shock you.
Back in 2008, I used to find joy in seeing reports that Islamic finance is weathering the 2008 crisis relatively unharmed. It filled me with pride to support Islamic finance. However, even then, I couldn’t ignore a sense of discomfort about certain aspects. But I comforted myself that as we moved beyond the interim phase, we would transition to more ethical forms of finance.
It didn't happen.
Fast forward to 2019, during my Executive Master’s in Islamic Finance, our professor emphasized that a particular transaction, known as ‘tawarruq’ or ‘commodity murabaha’, had essentially dominated the Malaysian Islamic finance industry, accounting for an overwhelming 95% of the transactions.
NINETY-FIVE PER CENT.
So, what is tawarruq/commodity murabaha?
Imagine Ahmed needs money, 1 million, to expand his business — not car, house, machine or any other tangible asset that he can buy based on equity partnership — but he wants cash. He goes to an Islamic banker.
I need 1 million no-interest loan, brother. qarze hasana.
If I start giving millions in cash, I’ll go bankrupt bro. But i have a solution. I can sell u palm oil so you can sell it to the..
Wait, are u kidding? What does palm oil got to do with this? I need cash.
Let me explain. u need 1 million, right? The current market value of 250 tons of palm oil in the commodity market is 1 million. So, i sell you 250 tons for 1.2 million. You can buy now and pay later.
Hold on! You’re selling me 0.2 million higher than the current market price and expect me to buy from you?!
Yes, this 0.2 m is my profit. Thats what the word murabaha is, reselling at a markup.
But what will i do with 250 tons of palm oil?
You sell it back in the market now of course. And you will get 1 million in cash. You needed 1 million in cash, you will get it. You can pay me my 1.2 million in 5 yrs in installments inshallah.
But I don’t know how to buy or sell in the commodities market.
I’ll help you do everything. Thats what we’re here for.
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So this entire multi-level arrangement of buying a commodity on an increased deferred price and reselling it in the market for lower market value price to get cash is called tawarruq. It's nothing new. Even some companions engaged in similar kind of transaction and other companions were quick to call them out and declare it just another form of riba.
I could delve into the Islamic perspective on tawarruq, exploring the scholarly debates and all the intricacies surrounding it, but that’s not the focus of this blog. Here, I want to highlight just ONE aspect: how products like tawarruq contribute to the food crisis. So even we swallow riba on the basis of need and go with the most lenient scholarly view, we should still avoid it. As mentioned in The Twin Roots of Economic Woes, it’s not exclusively a Muslim problem but a global problem.
So, what’s this tawarruq got to do with food crisis?
Briefly, tawarruq led to the inflation of food commodities that led to food crisis. How? Ok so first lets understand the 2 key reasons behind food crisis.
- Less production, more speculation. So, more people are betting on wheat or palm oil than actually growing it.
- Financialization disrupting the natural balance of supply and demand, causing confusion and unpredictability. Think, how do we determine how much to grow and what? by supply and demand. If more people buy palm oil bcs more ppl buy it, it runs short n producers know they need to grow n produce more of it. But what if the richest people are PRETENDING to buy HUGE quantities of palm oil — not as our good ol distributers who buy in bulk to sell to the retailers who sell to end consumers — but to resell it in the same market and pocket the difference. In this sense, they’re not adding any value along the supply chain, just moving money around within the closed loop of commodities market. In other words, they have nothing to do with palm oil supply, they’re just using it as an underlying asset. The danger of derivatives.
Ok, so you can claim that commodities’ trade as a financial instrument doesn't add any value, but to claim that they’re disrupting supply n demand and creating food crisis is a bit of a stretch. Your evidence?
Michael Masters, an Americal hegde fund titan said in Senate testimony on the issue of market speculation in 2009:
During [2008], the worldwide supply of oil was increasing..and demand ..decreasing. Yet despite this glut of unwanted oil, the price has risen an amazing 85% per barrel.
And as Rana Faroohar put in her book ‘Makers & Takers’, the fact that the prices of all commodities — not just some — have begun rising and falling in sync with one another is a historically unusual trend and shows how finance — not the law of supply and demand — is impacting commodities negatively.
But why are we putting the blame on Islamic finance when conventional finance is just as much or more to blame? They surely bet more than us, don’t they?
Correct, but they’re not claiming to be ethical either. We are. We actually pride ourselves on being asset backed, which is a good principle in essence but not when applied indiscriminately. In fact, it's ONE primary distinguishing criterion of islamic finance. Granted we don’t make empty bets, but asset-backed shenanigans aren’t problem-free either. And for a time we thought that these multi-layered contracts like ‘tawarruq’ just add to the financial costs (additional sales tax, administration fee etc.) that we justified as long as we were not doing pure riba, yet the societal and economic cost are just as significant and must be factored into the equation before developing any Islamic finance product.
So, what do we do then? Islamic finance already has limited options, you’re limiting it even further by prohibiting tawarruq. So, you’re proposing we become charity, and lend people qarze hasana?
No, we should move to more profit n loss-sharing based businesses instead of lending-based, no matter what name you give it to. In the above example, instead of lending the man 1 million — even if on paper it’s not lending but a sale on credit — the Islamic bank should go into a partnership agreement with Ahmed and share both profit n loss.
Naive! Banks aren't even allowed to engage in commerce in many countries. They cannot just enter into a partnership and share profit/loss.
First, the extent to which banks can engage in commerce depends on the regulatory framework and legal restrictions of a particular jurisdiction, some may be more flexible in this regard than others. Second, we need to think out of the ‘banking box’. Innovative models based on true profit/loss sharing such as pfida should be developed and supported, to allow more interaction and flexibility between financiers and entrepreneurs.
So, key takeaways?
1. Islamic finance products should combine all 3 elements: fatwa (permissible), taqwa (ethical) and maslaha (beneficial). Currently, it is relying on fatwa only, and that too of the more lenient kind.
2. Being asset backed may suffice to make a contract permissible fatwa-wise, but not taqwa- or maslaha-wise and may even contribute to problems such as food crisis.
3. We must seek ethical models that avoid nourishing the parasite of financialization or succumbing to it. Examples include different forms of partnerships, both equity-based (musharaka) and non-equity-based (mudaraba).
4. The root cause of most economic problems is financialization, which is not a Muslim problem but a global problem.
Final thought.
If you’ve read this far, you’re not an average person. You have both a thinking brain and a feeling heart. Add Allah to it and you’ve got everything. No matter how rigged the system is against us, we can still try to fix it. (1) Economy fix (@EconomyFix) / X (twitter.com)
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Ref:
Rana Faroohar’s book ‘Makers & Takers’, chapter 6.
