Fourth UC Berkeley Islamic Finance Forum Ethics & Regulation: Critical Approaches to Islamic Banking 09 April 2011

1. Fourth UC Berkeley Islamic Finance ForumEthics & Regulation: Critical Approaches to Islamic Banking09 April 2011 “Concentration of Wealth as A Threat to A Wise and Stable Economy: Overhauling Ownership, Liability and Labor Employment Structures” MaghsoudImaniMarkid PhD Researcher, King’s College London LLM Candidate, UC Berkeley

2. Islam vs. Socialism vs. Capitalism Socialism/Communism: - Means of production are owned and controlled collectively by the people - All people should get an equal share of the wealth - No private property rights - Goods produced in society would be distributed among the citizens "from each according to their ability, to each according to their need." Capitalism: • Means of production are privately owned and individuals operate them based on self interest • Income takes usually three forms: profit, wages and rent. • Profitis what is received by virtue of control of the tools of production, by those who provide the capital • Wages are received by those who sell their labor with those tools. • Rent is an income from the control of natural resources. • Government does not have control over markets, and on property rights.

3. Islam vs. Socialism vs. Capitalism Islamic Economic Order - Not only includes the system of production and management of material wealth indices but also concerns about the development and improvement of intellectuality and spirituality conditions and spirits of cooperation in a society - Allah (God) is considered the only absolute owner of everything. All other individual ownerships in the world are subordinated to Allah’s ownership. - Natural resources such as minerals, forests and lakes cannot be owned privately. They belong to society as a whole and should be utilized for the benefit of all. - All individuals should have an equal opportunity and access to production facilities in society - Owning (privately) the means of production are allowed, but they should be operated not just based on self interest but also in a way that contribute to welfare & prosperity in society as a whole. - Sharing incomes and rewards proportionally among all production forces (capital, labor and any other possible factors of production) based on their amount of effort and effectiveness - Government intervention in marketplace is somehow allowed subject to certain conditions (to meet its supervisory and policy making roles)

4. Overhauling Ownership Structure (The Prevalent Banking Practices) Functions: • Accept deposits maintained in Demand and Time deposits accounts • Legally/practically, deposits owned by the bank • A debtor & creditor relationship established between depositors and bank (even in trust and custody accounts and payment systems) • Lending by using usually a loan structure • repaid with interest usually in equal periodic payments on or before a fixed date and secured by a borrower’s asset • charging borrowers with exorbitant interest, passing on a small percentage to depositors Major problems: • Concentration of wealth mainly because of taking ownership of deposits • Taking ownership implies the right to control property, including determining how it is used, who uses it, whether to sell or rent or do another transaction on it, and the right to the revenue generated by the property • Maintaining capital adequacy requirements • Bank runs and panics (financial instability and bankruptcy threats) • “Too Big to Fail” (systemic risk)

5. Overhauling Ownership Structure (Islamic Bank As A Financial Facilitator/FF) “Spending whatever is surplus to reasonable needs, ensuring circulation of wealth rather than hoarding “ • For profit making purposes: • Mutharaba(Capital & Labor Providers Partnership) • Musharaka (Capital Providers Partnership) • Mu’awatha (Exchange Contract) • Bay’(Contract of Sale including Murabaha) • Ijara (Leasing Contract) • Hybrids (e.g. combination of Musharaka and Mutharaba) • For non-profit making purposes: • Zakat (an obligatory payment if your wealth reaches above a certain threshold) • Sadagha (voluntary donation to the poor and needy) • Hiba (gratuitous) • Waqf (Endowment) • A’riya(granting permission to derive profit free of charge from his/her property) • Gharth (interest-free financing) • Islamic Banking (FF) functions: facilitating circulation of wealth and provision of services: • Making profit in circulation of wealth by using Mutharaba, Musharaka or hybrid structures • Receiving a feein return for provision of preservation by using Wadi’a (entrusting an asset for preservation by FF) and payment services by using Hiwala (assignment) or Wakala (agency) and other services like provision of security via Dhaman (contract of guarantee) or Kifala (suretyship/bail out)

6. Overhauling Liability Structure Liability Rules • “Anybody benefits from, shall bear all associated costs and losses” (Man-lahol-ghonm-alayhel-gohrm) • “No damaging action to others [even in exercising his/her own rights] is allowed. Any losses and damages incurred by the injured due to the wrongdoing of injurer should be remedied fully”(La-tharara-wa-la-therar-fil-Islam) • Standard of liability in Islam is proportionate/commensurate liability. • Inconsistency: limited liability is inconsistent with above Sharia rules. It is indeed a way of avoiding actual liability. • Creation of negative externalities: corporations/banks do not take the effects of externalities into their own calculations and they mainly concerned about increasing their profits at the cost of their counterparties, third parties and society as a whole. This is a kind of unjust enrichment, as well. • The more the activity, the more the level of precaution needed to reduce the probability of risk. Therefore, the liability standards should be aligned with the level of activity in the market. That is why I would argue for proportionate liability!

7. Overhauling Labor Employment Structure Labor employment for profit making purposes • Mudharabais a partnership between the provider of capital and manager/worker; both agree to share profits on an agreed basis while the loss is borne by the former as the worker/manager loses his/her labor. • Musharkais a combination of the rights of several proprietors/partners in a partnership by way of undivided shares. They share profits and losses. The managers /workers employed for running the partnership, share in profit while the loss is borne by the partners, with the managers /workers losing their labor. Labor employment for non-profit making purposes • Ijara(Leasing Contract): is a contract whereby the lessor becomes the owner of the profits resulting from the thing leased. Inanimate things, animals, or persons may all be the subject of Ijara. • Payment/remuneration for labor or services to a worker would be usually on an hourly, daily, weekly, or monthly basis. • Ji’ala(Contract of reward): is the engagement of a person to pay a known recompense to the other party, in return for an act by him/her. The agent/rewardee will become entitled to the reward when s/he has done the undertaken work or delivered the requested subject. • In Ji’ala, the specification of the recompense in all particulars is not necessary; it can be a fixed amount or a specified undivided share in the value of subject of Ji’ala Labor employment for doing legal actions • Wakala(Agency): is a contract whereby one of the parties appoints the other as his/her representative for the accomplishment of a specified legal action • The fee of the wakil/agent will be according to the agreement between the two parties

8. Conclusion • Islamic Economic Order is neither Socialism/Communism nor Capitalism, but a system in between • keeping depositors as owner of their deposits with banks rather than banks taking ownership of their deposits • Removing limited liability and implementing proportionate liability as a liability rule • Applying proportionate sharing of income instead of current salary-based compensation scheme

9. UC Berkeley School of Law Thank You For Your Attention