DeFi, we should. Disrupt, we must.
The positive contribution of Islamic microfinance to Islamic finance in general was the dichotomy it presented. There were the Grameen-type Islamic replications. There were also the indigenously born Baitul Maals and Qard Funds. Islamic microfinance was also practiced by Islamic non-profit organizations and cooperatives that were mobilizing zakat and sadaqa funds. The blended nature of Islamic microfinance and sustainable nature of Islamic charity funds kept the issue of “affordability” in the front burner. Islamic microfinance could be offered at much lower rates than their conventional counterparts. Notwithstanding the earlier conventional microfinance best practices that emphasized “access to and not cost of” microfinance as the key issue, the “smart” principles of microfinance that appeared later, did emphasize “affordability”. The positive impact of zakat and sadaqah funded Islamic microfinance was palpable, at least for us.
The apparent success of these experiments led to the birth of a new discipline – Islamic social finance. And these new developments were a source of hope for Islamic scholars who would come up with a new paradigm – building a financial system to achieve Maqasid al-Shariah (MaS) and the sustainable development goals (SDGs), given a high degree of alignment between the two. Many found in this a second opportunity (apparently the 2007-08 crisis presented the first opportunity that was wasted) to present before a global audience the strengths of an ethical MaS-driven Islamic economy over its conventional counterpart in achieving the SDGs.
Bad Actors or Bad Habits?
Notwithstanding these welcome developments, the so-called mainstream Islamic financial services industry continued in its trajectory for which all the Shariah concerns were apparently settled for ever. And I was one of those who had started seeing mainstream Islamic finance as grossly un-Islamic. We were fast learning to focus on Islamic social finance and avoid any dealings with the tawarruq-based banking, or profit-seeking insurance or investments fetching guaranteed returns. But there were questions that kept bothering me. They do even now.
Have I been witness to some mega frauds perpetrated on global Muslims in the name of Islamic banking and finance by “bad actors”? If so, aren’t we obligated to expose them? Who are these bad actors? How did they manage to undo the years of hard work and intellectual achievements of an entire generation of Islamic scholars and economists, destroying the soul of Islamic finance? Do we know them? Who are these guys who created an entire breed of Islamic banks, insurance companies, investment companies to serve Islam and Muslims, and yet went back on every single ethical norm prescribed by Shariah? They outpaced and outsmarted most of our scholars, always introducing a new product, a new structure, a new game that would allow them to sell money/debt and risk and earn profit while marketing the same as Islamic (free from riba and gharar). And before the scholars and the researcher community would sense the presence of riba (through back-door) they would bring in yet newer products and structures confounding all actors.
Perhaps, the game began by underlining the need to “adapt” the classical contracts found in books of fiqh
Perhaps, the game began by underlining the need to “adapt” the classical contracts found in books of fiqh. This would be justified by pointing at the nascent nature of Islamic financial services industry and highlighting this as “necessary” to move towards a much “purer” way of doing business in future. Some believed in this. Some learnt to parrot this in good faith.
When I was introduced to Islamic finance in the 1990s, the “adaptations” had already occurred and were kind of accepted by the Islamic finance fraternity. And when I started bringing together the pieces to author my first book on Islamic Financial Services, I assumed this had to be the right way of doing business Islamically. Islamic finance to accommodate the intermediaries had permanently transformed the classical contracts into something very different. Trade had become inah and tawarruq. Mudarabah had lost its feature of pre-determined sharing ratio, acquiring new features, such as “notional liquidation” and others, seeking a similarity with common equity. In some places, it had become a revenue-sharing contract with no down-side for the financier. Ijarah (simple operating lease) had become ijarah-muntahiyya-bit-tamleek (financial lease). Salam had become back-to-back Salam. Istisna had become back-to-back istisna. Sukuk had moved on from being ijarah-based (with clear ownership of assets by sukuk holder) to all different hybrids offering “assured” returns with no effective ownership of assets. The list of adaptations was getting longer and longer.
When I drew the structure of bai-muajjal (a simple credit sale) as an Islamic banking product, while authoring the manuscript for my book, I was startled to realize that I have to bring in an agent in between, who would first take possession of asset on behalf of the seller and would then resell the asset to itself. S/he would just be wearing different hats at different stages of the transaction. Well, for other contracts as well, I was going to do the same, why? Because, our Islamic Bank was just not interested in being the owner of the car or truck it was buying to resell. It was not interested in retaining the crops it was buying by paying advance price (salam). And as a project or construction company or manufacturer (in istisna), it was just not in the business of manufacturing. After all, it was an intermediary and was in the business of making money by trading money. Yet, it was an Islamic institution.
Light at the End of Tunnel?
So why am I excited now, over one and half decades after authoring my first book? Because now, I can expand the title of the book by adding a term “decentralized” to Islamic financial services. And I won’t have to talk about the proverbial middlemen – the commercial and investment banks or the financial institutions. I can do this because times have changed. Denounced by some as anarchists or perceived as a bunch of angry guys dissatisfied with the existing financial system and its players and regulators, a few technology-savvy individuals have given us hope. Using technology, we can revert back to the basics. We do not need the legal tricks in the name of adaptations that create enormous fees, underwriting surpluses and spreads for the intermediaries.
The classical Islamic contracts will deliver as they did through all ages. We just need to be “smart”.
The classical Islamic contracts will deliver as they did through all ages. We just need to be “smart”
It has happened before. Bad actors have tried and failed, sometimes due to alertness and vigilance of the scholars. I am witness to at least one such attempt – to offer zakat investment services – as if zakat is meant to be invested. It failed to get any traction, perhaps because this was an area considered too conservative to make profit from. Sometimes, technology has helped. For example, in the field of zakat, it did help in ensuring that bad agents do not corrupt the game. It helped by ensuring person-to-person or person-to-project flow of zakat. In microfinance, the exorbitantly high financing rates justified on grounds of high operational costs were challenged by platforms, such as Kiva that brought down the rates to zero or at least, to affordable levels.
So, when I author my next piece on Islamic DeFi, it is going to be a lot easier in the beginning, at least. I plan to simply strike off the bad practices, the bad structures, the adapted ones and stick to the classical structures that are individual-to-individual or individual-to-market. And groups on the platform can come together to participate in a project, share the output, the profits and risks in a way they chose to; and to offer mutual protection against probable loss without partaking in any underwriting surplus. The application of technology (blockchain and smart contracts) is going to create a whole new Islamic DeFi space with products and services that address the needs of all economic units in terms of liquidity, risk, returns, maturity and what-have-you. And they can ensure that a close link is maintained at all times between the financial sector and the real sector of the economy. This is the essence of Islamic finance. And this is why we must bring in the disruptors to fight the corruptors.
Vultures in the Sky?
At the same time, let us not assume for a moment that the Islamic DeFi space will all be populated by the holy and the noble. As with any new game in town, there would be vultures looking for easy prey (any takers for yield harvesting?). The issue of cryptos must be discussed and deliberated a lot more. After all, isn’t it a lucrative idea to make your own money; and get a few gullible and greedy minds to believe that this is the money of the future? Where does that leave us, the protagonists of Islamic DeFi? The DeFi space must be subjected to rigorous Shariah scrutiny. The possibilities of easy money and rampant speculation must be plugged.
As with any new game in town, there would be vultures looking for easy prey
There would always appear the complex ones, the exotics on the scene. There would be new possibilities of riba through the backdoor.
It is our responsibility not to let it go. This is one great opportunity of ushering in “true” Islamic finance. This is indeed the biggest promise of Islamic DeFi. That it will enhance financial inclusion is another. We must not allow it to be ruined by lack of vigilance and timely action. We must also be ready to answer some tough questions now. Can the benefits of DeFi and technology outweigh the economies of scale and scope associated with the institutional provision of financial services? What additional risks, DeFi entails. Why the idea of DeFi does not clash with the role of government as the ultimate manager of the economy. We must offer good answers.
DeFi, we should. Disrupt, we must.
(To be continued)