Friday, July 23, 2010

Elementary Financial Instruments in Classical Islam

Dr. Abdul Ghafar Ismail

Monetization came early, and the ban on unequal exchange of similar fungibles seems to have facilitated the process. Muslims started with Byzantine gold dinars and Persian silver dirhams, but early on they began to mint their own coins. The state had a monopoly on coinage, and any tampering with their weight or purity was severely punished.

Trade and commerce over the vast expanse of the world of Islam, which included North Africa, Spain and a large part of Asia, soon produced certain elementary financial  instruments such as the suftaja (bill of exchange) and the shekk (check). 

All these scholars together help enlighten us on the contributions made by these Muslim scholars to a number of economic concepts like the market mechanism, demand, supply, prices and profits, money, counterfeiting and currency debasement, labor supply and population, and the role of the state and justice, peace and stability in economic development.

However, in the 13th and 14th century, several theologians led by notably the Dominican St Thomas Aquinas, set down the dogma of the Catholic Church in light of the resurrection of the Greek philosophy in the hands of 12th Century Islamic Scholars. These views have been propagated and adopted through colonization in several Muslim majority countries. While nationalism tended to focus attention on rapid economic development, religion, the other motivating force in the struggle for freedom, made many turn to Islam for guidance.

During the eighteenth, nineteenth and the first half of the twentieth centuries, nearly the entire Islamic world was colonized by European nations who managed the economies and finances of Muslim countries in their own interests and in their own waysAs their national consciousness grew and movements for independence promised to bear fruit following World War II, a desire to manage their affairs in accordance with their own values and traditions emerged.

Rafiq al-Misri noted that al-Ghazali indicates the functions of money as standard of value, medium of exchange and store of value. Thus, where the function of money is concern, there is not much deviation between contemporary economics and the teachings of Islam. Money exists in the economy as a medium of exchange and store of value.

Contemporary economics value money as an asset by itself.  As an asset, money could be utilized to generate more money and money itself could be traded at its owners’ will. Meanwhile, the Islamic monetary philosophy holds on to the fact that the existence of money is just a means to an end, not an end by itself. Therefore, money, by itself, is not a commodity or an asset. Thus, money as a medium of exchange, cannot be taken as a production good, which yield profit on daily basis, as is presumed by theory of interest. Money becomes capital only when it is invested into business.

Here, money will be channeled through the Islamic financial institutions and at the same time, the Islamic financial system will have to offer their financial services in the form of contract. The contracts may fall under the following categories: trading contracts, participating contracts and supporting contracts.

The Islamic financial system design produces two important types of financing, i.e debt (murabahah - mark-up based scheme)  and equity (mudarabah - Profit loss sharing) financing. 

It is based on our believe that the Islamic financial system would be able to influence the economic growth by: (i) suggesting the new role of money; (ii) amending the law governing the financial transaction; (iii) introducing financial contracts that encourage the enterpreneurship (for higher productivity); and (iv) producing a more efficient allocation of capital.

Abdul Ghafar Ismail is Professor of Banking and Financial Economics, Islamic Economics and Finance Research Group, School of Economics Universiti Kebangsaan Malaysia, Bangi, 43600 Selangor D.E., Malaysia.  email:

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