Based on the ground realities as stated yesterday, the author wants to briefly propose some areas where interested Muslim thinkers may need to direct their efforts for making equity modes of Islamic finance practically possible. The idea is to give main pointers, on which further detailed work needs to be done. For this to happen, a few major principles of Islamic finance need to be kept in mind, and these are explained briefly in the paragraph below:
Along with riba, or interest on loans, Islam also prohibits gharar (uncertainty and vagueness) and maysir (speculation) in financial transactions and trade deals. This leads one to the conclusion that for a transaction to be genuinely classified as Islamic, in addition to being equity-based and riba-free, it must be also be transparent and fully understood by all concerned parties to the transaction. It must not be needlessly complex and sophisticated so as to be understood only by the financial experts or those who have designed the transaction (as is currently the case with the debt-based IBF transactions). Also, all transactions and financial dealings are to be based on real economic activity and not on speculative activity if they are to be labelled as "Islamic".
Remodeling the stock exchange In the author's view, the first step in making equity finance practicable in a truly Islamic form, is remodelling the stock exchange along Islamic lines, since in the prevalent economic and financial system, stock markets are the main venues of equity investment. That would mean doing away with the practice of speculative secondary trading in stock markets that involves both gharar (uncertainty and vagueness) and maysir (gambling). Unfortunately, speculative secondary trading is the main focus of most investors in the stock market who just want to make quick gains in a very short time. Currently very few companies, especially in Pakistan, pay regular and substantial dividends to their long term investors. Instead of sharing their profit in the form of dividends with their investors, these companies rely on investors getting their investment returns through speculation in the stock market. The provision of speculative secondary trading for investors promotes greed, selfishness and short term thinking in them, and is also detrimental to the real economy when there are stock market booms and crashes for no real reason.
In the absence of speculative secondary trading activity in the proposed stock exchange model, investors would have no choice but to invest in a company for the long term, and seek returns in the form of declared dividends that would be based on real profit made by the company, and not on superficial activity like speculation. Thus, investors would be compelled to more carefully choose where to invest after studying the actual historical as well as potential financial and business performance of the company. As for the companies that would be using equity funds, it is expected that due to the strong competition amongst themselves for investor funds, companies would be obligated not only to perform well, but also to declare regular and substantial dividends, thus partially taking care of the moral hazard problem of understating profit or declaring losses fraudulently. Thus, a partial deterrent to the moral hazard in equity finance would be built into the structure of an Islamic stock exchange itself, as proposed.
Inadequacy of AAOIFI standards necessitate truly Islamic standards As explained above, a significant part of the moral hazard problem in Islamic equity finance would be resolved through redesigning the structure of the stock exchange by incorporating Islamic injunctions on prohibition of gharar and maysir. However, business organisations using equity finance could still engage in various types of unethical behaviour. Their management, directors on the board, employees at any hierarchical level, and / or other stakeholders could collude to deceive the unaware equity investors and make personal gains from business operations at the latter's expense, if the mechanisms of transparency and accountability are weak.
Hence, to further reduce the possibility of wrongdoing by business organisations, the author recommends that Muslim thinkers concentrate on three areas: 1) Corporate Governance 2) Business Ethics and 3) Accounting principles and methods. So far, most of the work in these areas has been originated in the West based on Western philosophy and world view, which is not necessarily the same as Islam's in many respects. Muslims have failed to capitalise on the rich guidance provided by Islamic teachings in these areas, and have borrowed and implemented theories and ideas from the West with only minor modifications, if any at all.
The ulemas and practitioners associated with the IBF industry may disagree with the author's view above, and may opine that work has already been done in these three areas by The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) that was established in 1991 in Bahrain. However, the author would assert that there is much more to be done, and that too using an approach that is different from AAOIFI's approach. A few such major differences in approach are explained below:
The first difference is that, AAOIFI standards of corporate governance, ethics and accounting cater only to the Islamic financial institutions, a view which the author would call the 'macro-aspect' of the economy, while the author is highlighting the 'micro-aspect' of the economy, that is, the business units or business organisations themselves that would be directly utilising equity investor funds. The second difference is that, a new model of stock exchange along Islamic lines, as proposed, would necessitate work in these three areas based on the truly Islamic mode of finance that is equity finance; whereas much of AAOIFI's work is focused on the debt-based modes of finance offered by the current IBF industry.
The third, and perhaps the most significant difference in approach is that AAOIFI standards suitable for the IBF industry are only slightly modified forms of corporate governance, ethics and accounting standards originated in the West that have essentially a non-Islamic spirit. Thus, there is an urgent need to develop original Islamic thought and theory in these three areas, based on the Islamic ideals as given in the Quran and the Sunnah.
Additionally, the research to be generated in these three areas from an Islamic perspective must be cognisant of the research-practice gap in much of the West-based research in business disciplines such as these. This research-practice gap is being lamented today even by many Western scholars themselves. Due to being largely irrelevant for practice, their academic research is missing on its potential to generate practically meaningful and socially beneficial research. Therefore, Muslim scholars working in these three areas must ask intelligent research questions and choose the correct research and analysis methods that enable them to guide practitioners in the field, and thus, directly influence and reform practice; instead of generating research for its own sake.
(To be continued)
(The writer is a former Commonwealth Scholar for UK, and Fulbright Scholar for USA, in the field of Management with special interest in corporate governance, business ethics and sustainable business. The views expressed in this article are not necessarily those of the newspaper)
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