For most people when hearing about Islamic finance for the first time, the new term usually begs the question, “What’s different about Islamic finance compared to regular finance?” I get asked this question quite often, and it’s difficult to know where to begin and how deeply to delve into the details. During our second week of P3 in Abu Dhabi, we had a guest lecturer from the Department of Economic Development for the Government of Dubai, Harun Kapetanovic, deliver a talk that I hoped would help me answer the question more succinctly. What I took away from Kapetanovic’s lecture, however, was not a concise encyclopedic way to explaining the characteristics that delineate Islamic finance from conventional finance. Rather, his talk offered a more compelling way to place Islamic finance in the context of the global financial system by showing how the principles that underpin Islamic finance have been echoed in other schools of economic thought.
For instance, Thomas Piketty, whose book, Capital in the Twenty-First Century, proposes an economic plan to reduce the widening inequality gap, supports a wealth tax. For those with wealth between €1m – €5m, Piketty proposes a 1% tax, and for those with > €5m, a 2% wealth tax.
Piketty’s tax echoes the practice of zakat, often translated as “alms,” which is one of the five pillars of Islam. Zakat is calculated as 2.5% of wealth that goes above one’s basic needs. Kapetanovic was careful to distinguish zakat from tax, pointing out that nobody is checking to make sure that you are paying your zakat annually. In the UAE, there is a national Zakat Fund, and while it is considered mandatory according to Shari’ah, it is paid voluntarily and not legally binding.
An Islamic financial system, in Kapetanovic’s words, should integrate social and economic objectives, and achieving a more equitable distribution of wealth is the principle one of the macro-objectives of zakat. The implication of such a system means that the wealthy classes cannot rest on their wealth. Simply to maintain their wealth, they must grow it by 2.5% every year without interest, which incentivizes them to circulate their wealth back into the economy through profitable, asset-backed investments.
Kapetanovic referred to other figures, such as Michael Porter and Christine Lagarde, who have made statements that align very closely with the principles of Islamic finance. Porter, for example, has highlighted the inherent interdependence of business and society, and decried the common approach to corporate social responsibility, which treats it as an afterthought that pits business and society against one another. Rather, he posits, social responsibility should be more central to corporate missions. This is also consistent with the principles of Islamic finance.
Christine Lagarde has recently stated that, “the international monetary system would benefit from a higher share of equity compared with debt flows,” which is an integral element of Islamic finance and one that shielded Islamic capital from the 2008 financial crisis.
When asked about the differences between Islamic and conventional finance, it’s tempting to simply explain how Islamic finance functions without interest, or what sukuk are. To properly explain the philosophy of Islamic finance, however, Kapetanovic reminded us of the need to zoom out, see the greater picture, and consider the ability of Islamic economic theory to address some of our global economic woes.