Restructuring The Financial Landscape of Muslim Countries

Quran is our goal and the means to that goal become obligatory. In Islamic law what is needed to fulfill an obligatory act becomes itself obligatory. As I have written elsewhere that today Quranic values of Jihad, Islamic self-determination and Muslim self-governance by Shariah law are all obligatory for the Ummah and we need to use the contemporary tools and techniques from the world of finance, economy, politics, technology and all other beneficial epistemological resources to achieve our Quranic goals. We must do it fast before we lose our Islamic demography to neocolonialism and fascism. Naïve Muslims will say “is it fard ain (obligatory on every Muslim)”? To answer technically it is not fard ain for every Muslim to take part in Islamic revival, but it is Fard Kifayah (collective obligation of political, financial and other relevant establishments) because they are the relevant people to build and solidify pillars of collective human success which have always meant empowerment of politics, culture, economy and military. For Muslims this empowerment must come through Islam due to earthly and other worldly successes. However, if a Muslim love his religion and feels for the suffering of his or her fellow Islamic brethren due to shared faith and Islamic values won’t every Muslim make it their struggle?

Empowering the Islamic financial landscape is part of that achieving the Quranic goal. Islamic finance is older than modern secular finance. While modern finance is an offshoot of accounting Islamic finance is itself embedded in the Islamic texts of Quran and Hadith of Prophet and Ahl Bayt. Islamic finance has been kickstarted through a detailed resource by God and His prophet. Two central themes in Islamic finance are the time factor and debt repayment as they carry spiritual and worldly consequences in Islam. However due to interest bearing financial landscape and increasing inflation due to money created out of nothing by banks and charging interest on them, time is considered an important factor in secular financial system as time decreases money value due to the two reasons cited[1]. This has given rise to the concept of discounted cash flow, risk analysis of investments and market efficiency. An efficient market is a transparent market where information is accurate and readily available. However, this is not true as secular financial industry has a history of fraudulent activities and manipulation of clients. 

Let me briefly discuss what finance is all about. Finance is as old as mankind’s existence on earth. There has been always spending of people’s wealth in return for a profit or other altruistic achievements. Finance has thus been about raising wealth to invest that wealth in order to achieve something such as profit and deciding on how to further spend that profit. However, through evolution of mathematical science financial decisions and strategies have evolved to help achieve those financial goals by analyzing context of risk and uncertainty. This nature of finance is universal. The science of finance and accounting is not an objective science but rather a subjective abductive science. It is up to us to make it work.

Islamic finance consists of financial practices and institutions based on Shariah law under an Islamic jurisdiction. Islamic financial practices and institutions propose objectives and strategies to achieve these objectives. Major objectives should be generating Islamic taxes and achieving collective human welfare for the Islamic state/republic and not selfish, predatory and greedy pursuit of profit. Various options will be faced when strategies are planned and discussed. Managers of Islamic financial institutions must be involved in operational day to day management of their firms. To help them achieve this an efficient and effective public service and Islamic legal system must be implemented. In Islamic governance firms will face various risks and uncertainties specially, given the hostilities Muslim world facing. The duty of Islamic governance is to help them reduce these risks by various diplomatic, national, socio-cultural and economic protocols and laws and initiatives. Firms’ union should be established and thus liaise with the Islamic governance to best implement these. So, these three types of managements: strategic, operational and risk are the working concerns for Islamic firms as well as Islamic governance.  

When performing financial investment appraisals, financing from sources, financial control and dealing with capital markets foreign or local, firms must not only consider risks and profitability but also human and environmental welfare as well as if it is violating any objectives of the constitution of the Islamic republic. For this firms should have a strong grasp of the Islamic constitution. While firms make connections and deals with lenders and suppliers, they need to give adequate security to the lenders and suppliers of their investments and supplies. Islamic law books detail the nature and categories of business transactions and businesses. These should be incorporated, understood and implemented in financial institutions knowledge book and practices, and Islamic governance.

In modern financial system shareholders are given priority in cases of conflicts between shareholders and business managers and stakeholders. This is called the principle-agent problem. Shareholders are given priority because of they being mostly from the upper financial and economic classes. However, in Islamic financial system everything is well defined through Shariah law. The primary source of conflict resolution will be the Islamic constitution and then the Islamic judiciary. Everything in Islam is about morality concerning our existence vis-à-vis human agent. The financial world is not free from this morality and hence should comply by the divine morality Islam proposes. This morality is summarized in the maqasid shariah or the objectives of Islamic law. So, the financial world must fashion their financial relationships with shareholders and stakeholders according to these goals. The role of Islamic jurists is vital in enhancing the bond among various players of the firm because they will explain the law of Quran when firms are established and implement business relationships with various stakeholders and shareholders. Initiatives towards this end need to be planned and implemented by Islamic public officials.  

In Islamic finance when preparing financial statements i.e. records of business transactions and accounting, several variables need to be considered in line with Islamic principles. Some of them are external and some internal. Tax, payment on loan and fluctuation in prices are three such external variables. The firm must know what the entities on which Islamic taxes are are collected. They need to make statement of tax paid with details of what has been paid and why. Generally, a firm needs to pay Islamic tax after a year of business provided Islamic tax conditions are fulfilled. So when calculating cost of capital and investment appraisals depending on the outcome of calculations, Islamic tax may be considered to be incorporated from the very start or after a year if the taxable amount have been reached.

Internal policies are internal business policies and agreements. Policies and agreements must not violate the Islamic constitution and relevant laws of the Islamic state/republic. Firms which affect the society, culture, security, economy and finance of the state must detail their policies and agreements to the government. Such policies may include capital expenditure commitments, inventory policies, financing agreements, credit period allowed to customers, payment policies, sales, accounting and dividend policies. Sales forecast is the most important factor in business growth. It depends on economic conditions, industry conditions and competition from similar businesses. However, in an Islamic governance Muslim firms are encouraged to collaborate with each other instead of competing. The synergistic effect of this will lead to shared and mutual business growth, data sharing, fulfilling clients needs effectively, helping the new businesses enter the market, research & development. Collaborative Islamic business means giving every Muslim business an opportunity to shine in the market. This collaboration can take the form of, among other forms, delimitation of market, distribution of sales quota, data sharing on consumer behavior, technology sharing and risk assessments. Muslim businesses can form unions or institutes on basis of similar products and services, on basis of similar objectives and goals, on basis of similar research and development interests among other similarities. Collaboration will make research and development easy and convenient and will increase overall productivity and growth of business categories.           

Financial ratios are important numerical information to interpret business performance against some benchmarks. In Islamic finance an important aspect is to calculate the Islamic tax ratio. Islamic taxes are detailed in law books and there are multiple types of taxes both Shias and Sunnis have detailed. These need to be imported in financial statements of the Islamic state/republic. End of year ratio may be employed to calculate the taxable amount or item for each taxable business. The three financial statements consider the FIAT currency only. Islamic finance should consider also those taxable items which are not FIAT currency. Separate statements need to be made by businesses who are dealing with such tangible items of Islamic taxation. Such statements should record changes in these items and year-end total stock remaining after transactions and sales. These should also be correlated with the other three financial statements. It is because in Islam you do not only pay for what you earn in FIAT currency if it reaches zakatable/khumus amount but also what you own for trade and business. Islamic law books have detailed these goods and items of Islamic tax.    

An example of this ratio is “Zakat/Khumus given in FIAT currency” to “total capital employed” which could measure how effective the capital was employed in generating Islamic tax. Another example will be “Zakat/Khumus given in FIAT currency” to “accounts receivable” which could measure how fast the Islamic taxable amount is generated in the firm. Several other ratios could be designed by proper identification of business variables and their relationships. The identification process should be based on a purpose of what you are trying to find or answer financially. Firms which purpose its business activities with the aim of generating Islamic taxation is not only aiming for it’s own benefit and profit but also for the benefit of society and it’s welfare.
Financial statements can be manipulated in many ways. One of them is overstating the revenue. There have been several mechanisms with in accounting that have been proposed. However, some external mechanisms could be also implemented. A firm’s banking activities could be checked and analyzed through the banks. A firm’s clients whether the final consumer or the middle consumer such as distributor for example could be questioned and investigated. The lifestyle of the firm’s directors/owners/managers and their families could be observed. With discrepancies rising from both external and internal mechanisms a firm could be held liable for fraud and deception in financial statements.  

Financial statements must record transactions as they happen for decision making purposes. A future achievable should not be recorded at present until it is achieved for example. As an illustration let us assume that the business will lose money in future and this loss must not be recorded until loss is achieved. This also goes for profit. This is to give businesses and stakeholders a level of certainty about the financial position of the firm. If for example a contract extends for years and revenue will not be achieved until after years, then the contract must be restructured so that revenue is recorded yearly or less than that. Achievable which are backed and secured by law can be recorded earlier before they are achieved such as amounts receivable due to goods sold. When implementing the dual aspect convention for accounting all foreign transactions need to be recorded also in the form of descriptive statements. Such descriptions may include nature of transaction, identities of foreign stakeholders and reason of transaction etc. That is to say even the abnormal operations of the business should be recorded in income statement.

In income statement revenue and expenses must not include any activities which violate or transgress on the welfare of society, people, environment and morality. If there is a cap on certain activities, then such cap must be implemented but firms must declare them. All firms must show the charitable works they have done as expense. If they do zero charitable work, then such also should be recorded as zero. The income statement must include all forms of income for the business. If such income was born out beyond the initial investment of the business, then the cost of such revenue should be added to the opening balance or the initial investment. Depreciation does not always make sense. What if you want to discard an asset after some years and do not want to replace it? Depreciation shows expenses for an asset over time, but this same asset is also generating revenue over time. It is thus not proper to always show depreciation in the income statement as it does not do justice to the financial position of a firm. Financial statements should record relevant, consistent business activities, rare events and activities which affect Islamic tax generation and payment.

Secular financial system considers investment to be an element of time which generates economic benefits in future on some initial economic value that has been invested. Islamic investment should not only consider an achievement on economic benefits but also avoidance of social, human and environmental harm as an obligation and reaping social, human and environmental benefits as charitable.  In current financial system there are number of ways to measure investment returns called investment appraisal methods. These methods tell you about the rate of return on investment in relation to time period. How soon your investment will generate a return on capital invested whether such return is the initial investment amount or profit with initial investment or profit and initial investment with a purchasing power of initial investment (due to inflation)? Islamic financial investment appraisal method should consider how much of Islamic tax (currency or items) can be generated after a period of one year? If no tax can be generated after a year then how soon after a year can it be generated?
One important note on Islamic tax should be mentioned here. Islamic tax is levied on human agents whether Muslim or non-Muslim and not on abstract entities such as firms. Also, Islamic tax is levied if taxable amount is reached after necessary living expenses are deducted from the wealth of the individual or joint earners. So, in Islamic republic or state every year the necessary living costs should be published. Although there is a general necessity agreed on by everyone specific necessities should also be considered case by case basis which must be informed to the proper ministry before the tax deduction date. Now as I said that firms are not eligible for Islamic tax as they are abstract entities, but the wealth of the firm are not owned by the firm but by the shareholders/directors. So, these people must be taxed collectively apart from their individual income. It is because a limited company in current financial context has three sources of finance: retained profit, shares and loans. A firm may choose to retain a lot of profit and pay less dividends to owners. Islamic monetary tax should be collected from the retained profit as this wealth belongs to the owners/directors collectively. Islamic tax is thus collected from the collective owners and as part of the individual wealth of the owner.

In modern financial practice there are several financing sources both long term and short term, and external and internal. Islamic finance must ensure that such sources do not violate any established Islamic laws or protocols from initiation of financing to its performance and completion. The nature of these three stages may be different depending on source of finance. These finances are simply a trade or a business deal through a contract between two or more interested parties. Islamic law has detailed many types of business deals and models and discussing whether such models and forms are prohibited or allowed. Such models and forms must be compared with these modern financial practices in the context of the maqasid and the Islamic constitution of the republic/state. Some of these financing models of current financial system comes with conditions and obligations to protect relevant parties. For example, lenders often impose conditions as a security to their loans. Islamic finance must ensure such conditions are not unfair and unjust. There should be a general form of Islamic legislation to protect both lenders and borrowers in this regard. Such legislation must not violate the freedom to practice what is lawful in Islam in regard to trade and business activities. Islamic judiciary and the Shura council must have an understanding of such security conditions that have been imposed by borrowers. The effect of such an agreement between lender and borrower or for that matter any agreement between the financier and its receiver through any of the financing model thus should be seen in the whole context of Islam, Islamic constitution and the future of the Islamic republic and Ummah. However, this purpose has not been achieved by the Muslim world. An example among many will be Eurobond having unfair preference in many countries due to its large market. Due to technological advancements of Europe and geo-political reasons this has been possible. Another reason is due to Gulf states being close allies of America and having large investments for oil, science and practice of Islamic finance have been manipulated by the gulf royals to suit their rule and investments in west and vice-versa.
Long term finance for Islamic geography must be undertaken under some security and welfare concerns for both the Islamic jurisdiction and its businesses. Too much dependence and long-term collaboration through long term finance with parties hostile or indifferent to the Islamic governance and geography are not only a security threat but also an impediment for becoming self-reliant through Islamic stock exchange. Businesses of the Islamic geographies must initiate a market capitalization campaign among the citizens of Islamic jurisdictions and beyond. To achieve this effective marketing strategies need to be undertaken backed by government support and businesses’ willingness to deliver quality, trust and service.  
In current financial system valuation of asset is based on both inflation and the estimates of future earnings. For Islamic finance valuation should also and necessarily include the welfare aspect of the asset. This welfare can be its ability to empower Islamic demography, empower the human capital, effect on the job industry, effect on society and morality, effect on human rights and effect on environment for example.

The concept of limited company in current financial system is biased. Limited because it gives limited liability to the owners so that in case of default on debt or payment to for example suppliers or lenders they can walk away. However, banks are excluded from this as banks can seize the assets of the company which are owned by the owners. Also in limited company even the owners are limited on how much they can withdraw a specific part of their claim. In Islamic law abstract entities have no legal standing and cannot be mukallaf. It is thus the owners and directors who must be liable depending on the proportion of their wealth income and involvement in decision making in the firm. The reason that shareholders are protected from liability is because often most of the shareholders turn out to be rich investors and thus bias is towards their wealth and influence for democratic political reasons as they turn out to be funders of political parties of democratic system.
There are also small businesses unlike the big corporations. These small to medium sized businesses can often be startups. Their funding sources are risky and often difficult to achieve. It is thus the case many governments help them startup when the business idea shows promise. In Islamic governance the government should also help startups kickstarting their businesses. Apart from providing funds the government must also provide data on risks, markets and forecasts as well as logistical, moral and technical supports to initiate the startups. The startups must be made to believe as part of a greater purpose that they are supposed to serve for the Islamic geography.
 


[1] As banks charge more interest borrowers (firms and businesses) charge more for their products and services which causes a domino effect for all businesses related to the borrower’s firm causing them also to increase their products and services prices. This causes inflation in long term. Another reason is changing interest rates cause firms to change policies towards their working capital (less investment in it) which may cause shortage of production and service leading to higher demand and inflation.