Islamic finance and speculative risk: absolute immunity or relative exposure?
The Islamic economic system has existed for fourteen centuries and the question of its viability does not arise. This is an obvious fact that post-modern civilization has evaded. And yet from the Far East to Morocco, Muslims have indeed monetized goods and services, minted coins, collected taxes, invested privately or collectively, without interruption in space or time, from the early days of Islam until the beginning of the twentieth century with the sole reference being the application of jurisprudential rules of Islamic essence.
In this respect, and according to a classical perspective; the first sources of Islamic economic sciences are the Koran which answers the question of Whythe Sunnah which translates into the deeds and actions of the prophet the how ; and finally Ijtihad which, through consensus (Ijmaa) and then reasoning by analogy (Qiyas), opens the door to unlimited horizons. In this respect, men took over very early, particularly with regard to taxation, investment and economic cycles. From the second century of the Hegira, we will remember the writings of Abu Yusuf on tax as an expression of central power through a market economy with a social character, or El Shaybani on the proper use of savings, and much later, the mechanisms of inflation resulting from excessive monetary creation, developed by Al Maqrizi. A leap of twelve centuries will bring us retrospectively with Ibn Achour to the principles of transaction jurisprudence which are non-hoarding, transparency, protection of private property, and finally the fair use and freedom to dispose of one’s wealth. These transactions are framed to this day by three main prohibitions: interest – Riba, major uncertainty – Gharar, and absolute uncertainty – Maysir.
The Islamic economic system also includes charitable institutions, starting with Zakat or the purifying solidarity tax whose effect is limited in time, Waqf which implements a generosity inherited by the community, and Takaful which involves the mutualization of risk management through solidarity and not within the framework of a commercial transaction.
Islamic finance, a branch of the Islamic economic system, is ethical in essence. It involves sharing losses and profits between all parties through equity and solidarity. The time factor and risk cannot be monetized in absolute terms and they are necessarily backed by tangible production factors (land, labor, money, etc.) and a lawful object. Islamic finance relies on financial institutions that offer participatory contracts such as Musharaka and Mudaraba or commercial contracts such as Salam (immediate payment, delivery at term), and other Murabaha, Istisnaa, Ijara. Islamic financial markets aim to facilitate liquidity management through Sukuks, which are securities relating to actual transactions and which are halfway, according to the criteria of the conventional stock market, between stocks and bonds.
Mirroring this long history and secular tradition, speculation is a phenomenon no less ancient and above all polymorphic, adopting as many definitions as authors and periods combined. However, whatever the perspective, speculation has an intrinsic character that is antinomic with the benefits expected by Islam through the management of the commercial thing. Indeed, the speculator is fundamentally short-termist. He has no purpose of consumption, transformation, or physical transfer from one market to another of the object of the transaction. He is remunerated on his sole capacity to expose himself to a high risk, by a commitment of capital and an unbalanced dispersion of the probabilities of gains and losses. He profits above all from price fluctuations that occur all the more frequently as they do not generate transaction and/or storage costs. He cannot therefore be part of any mechanism of the Islamic economy. As an illustration, we can consider two tools: short selling (selling a product before having bought it) and future sales (liquidation not by delivery but by compensation, in particular on the commodities market); which, although relevant and effective on an individual scale, are a source of instability on a collective scale and, above all, likely to create a gap with the real economy.
On the stock market, a meeting point for speculators of all kinds, the valuation of an asset always differs from one trader to another due to their necessary divergence in the interpretation of current events in order to anticipate a necessarily contingent and increasingly turbulent future. The whole challenge is to identify, before other operators, an overvalued or undervalued asset. This would be an unintentional mechanism for preventing speculative bubbles, stabilizing markets, providing liquidity, and trading on securities at an appropriate price.
The reality seems to be quite different: insiders monopolizing information, carelessness in decision-making; frenzy of transactions, recurring crises, are the rule. This is explained firstly by the difference between the speculator and the investor in the perception of securities: monetizable (and therefore to be sold as soon as possible), or sources of dividends (and therefore to be perpetuated). Added to this is a feedback loop in the form of a majority opinion itself becoming the norm at the origin of speculative frenzies. Like the populist politician who would systematically align himself with the expectations, legitimate or not, of his potential voters; speculation would create income by adopting the predominant trends independently of economic fundamentals. The psychology of crowd movements then becomes the skill to be mastered by any trader with a view to success.
In parallel with these endogenous factors, speculation is also driven by exogenous factors, mainly legal and macroeconomic.
Regulation, first of all, although under the authority of the legislator, it often allows parallel accounting operations (shadow banking), in addition to the existence of transnational levers that escape legislation. In fact, the laws are permissive to the extreme, including; the creation of money delegated to private actors, the mutualization of losses and the privatization of institutionalized profits, as well as continuous (day trading) and automated high-frequency trading.
On the macroeconomic level, we find a coherent but flawed system, due to omnipresent factors such as the indebtedness of actors with little solvency and bearing an unfair risk, a leverage effect made available to speculators which allows them to invest money that they do not have; and also the monetization of promises of repayment by securitization authorizing unlimited monetary creation (circumvention of prudential rules by banks).
The dichotomy is therefore very structural between speculation, the “vanishing point” of triumphant liberalism, and Islamic finance. The latter therefore seems to be sheltered from a deeply insidious phenomenon. However, on closer inspection, the devil conveniently hides in the details. First of all, in terms of benchmarks, two normative frameworks coexist. On the one hand, the AAOIFI (Accounting & Auditing Organization for Islamic Financial Institutions) allows for a high tolerance for risk-taking, the frequency of transactions, monetary creation, and the abundance of liquidity. On the other hand, the IFSB (Islamic Financial Service Board) adopts a stricter prudential framework emphasizing risk management, governance, ethics, sufficient capitalization, and efficient control tools. Beyond these bodies and their differentiated approaches, it is above all at the level of contemporary behaviors and economic foundations that the problem lies. Indeed, both operators and operations emanate directly from conventional finance today and fundamentally obey its challenges. Finally, on a more global level, the Islamic economic system has already been implemented in two nation states, Sudan and Malaysia, with very different choices in terms of Islamic financial orthodoxy. If in Sudan an acceptable resilience had been noted with the exception of excessive risk-taking, Malaysia, for its part, has implemented an economic system largely exposed to speculative risk with the exception of a restriction on the number of operations (one per day).
In conclusion, we can add that experts in Islamic finance from different backgrounds are unanimous: Islamic financial markets are not immune to any speculative, transactional and behavioral risk factor. The facts are qualified regardless of the point of view adopted, academic or empirical. These factors are widely manifested for some of them, despite a certain theoretical resilience, at the level of the fundamentals which, more or less, face widespread lax practices. Only the magnitude of the phenomenon can be the subject of discussions. On the scale of the Islamic economic system, given the presence of all the factors, it can therefore only be qualified according to its degree of protection against speculation. To date, the duplication of tools and behaviors from the non-Islamic economic system implies a certain paradigmatic challenge. The diagnosis is clear, the solutions have already been tested, there remains the hope of seeing the emergence of a new, truly alternative and proactive finance capable of ensuring the protection of our economic systems from speculative risk.
Bibliography:
Islamic financial markets and speculation risk
Lahlou, 2018 – Mohamed V University of Rabat
https://www.researchgate.net/profile/Mohamed-Talal-Lahlou/publication/340174275_Marches_financiers_islamiques_et_risk_de_speculation/links/5e7c61c1299bf1a91b7a9b01/Marches-financiers-islamiques-et-risk-de-speculation.pdf
