Understanding Islamic Finance - Doha Academy of Tertiary Studies

92 Understanding Islamic Financefrom B for Rs.1000/= he can pay any Note(s) of Rupee amounting to Rs.1000 ”. Thisreal nature of money, which should have been appreciated as a fundamental principle of thefinancial system, remained neglected for centuries, but it is now increasingly recognized bymodern economists. Professor John Gray (of Oxford University), in his recent work FalseDawn, has remarked:“Most significantly perhaps, transactions on foreign exchange markets have now reached theastonishing sum of around $1.2 trillion a day, over fifty times the level of world trade. Around95 percent of these transactions are speculative in nature, many using complex new derivatives,financial instruments based on futures and options. This virtual financial economy has a terriblepotential for disrupting the underlying real economy, as seen in the collapse in 1995 of Barings,Britain’s oldest bank.”The evil results of such an unnatural trade were pointed out by Imam Al-Ghazali 900years ago in the following words:“Riba (interest) is prohibited because it prevents people from undertaking real economic activities.This is because when a person having money is allowed to earn more money on the basis of interest,either in spot or in deferred transactions, it becomes easy for him to earn without bothering himselfto take pains in real economic activities. This leads to hampering the real interests of humanity,because the interests of humanity cannot be safeguarded without real trade skills, industry andconstruction.” 174.7.3 Creation of Money from the Islamic PerspectiveThe monetary and credit policies in any economy have a great impact on the functioning of itsfinancial system through their impact on the quantity and value of money. As against bullionmoney, paper or fiduciary money can be created simply by ledger entries or the issuing ofpaper securities and without regard to a corresponding increase in goods and services in aneconomy. This leads to distortions and exploitation of a segment in society by others. Inthe Islamic financial system, where exploitation of one by another is strictly prohibited, thesupply or growth of money/credit should match the supply of goods and services. Theremight be some minor mismatches, but persistent mismatches are not consistent with theprinciple of Islamic finance, as they generate distortions in the payments system and injusticeto any of the parties to the contracts.Of all the features of Islamic financial instruments, one stands out distinctly – that theseinstruments must be real asset-based. This means that Islamic banks are not able to createmoney out of nothing or without the backing of real assets, as is the case in the conventionalsystem today. They can only securitize their asset-based operations for the purpose ofgenerating liquid funds, transferring thereby their ownership to the security holders alongwith their risk and reward. The financing of government budget deficits by Islamic banksand financial institutions will not be possible until the governments have sufficient realassets to raise funds in a Sharī´ah-compliant manner or for the conversion of debt stock intoSharī´ah-compliant securities.To ensure this, it is important for the regulators to monitor the three sources of monetaryexpansion namely, financing of government budgetary deficits by borrowing from thecentral bank – the major source of expansion, the secondary credit creation by commercial17 Shariat Appellate Bench, 2000, Taqi Usmani’s part of Judgement, paras 135–152.