A critique on “Real Islamic Logic”

Jan Aldert Bergstra

Utrecht, March 2011

Recently I have posted a paper [1] titled “Real Islamic Logic” (Hereafter RIL) on the open access repository www.arXiv.org. Rather than to repeat the gist of that work here, which adds nothing to what can be obtained by downloading and reading the mentioned work, I will formulate some critique that I was unable or rather unwilling to include in the paper. Given its speculative nature, many weaknesses can be spotted in [1], but in several cases a weakness can be removed simply by removing the section in which it occurs, thus shortening and also simplifying the work, which may even be considered an improvement. I will call this the drastic removal strategy, because a problem is eliminated together with the entire context in which it appears. This strategy for instance applies to the range of arguments used in the discussion of the existence of God, and to the limited substantiation made of the claim that the Islamic Court Legal Proposition Process (ICLPP) is computationally intractable.

The drastic removal strategy is not applicable if it comes to the portrayal of logic as being important for organized and methodical human reasoning. Although a complex logical setting is suggested, RIL is based on the assumption that a well-worked out and formalized reasoning methodology is helpful for humans deliberating alone or in groups about moral issues. It should be noticed that RIL is supposed to be instrumental for reasoning processes outside formalized courts. Efficiency is important in real time applications (where court referral is practically impossible) and for limiting the case load of courts (which is a necessity if their judgments are to be valuable).

That very assumption is hardly supported by experimental work in cognitive psychology. I mention the PhD thesis of Marian Counihan [2] and the vast bibliography contained in that work as a recent and convincing meta-study of the problems one encounters when logic is supposed to be of an explanatory (or normative) value for human thinking.

Four different perceptions of logic come to mind in the context of RIL;

A) RIL supports those humans who became logical experts through detailed personal studies. It is no more than a tool for those who like it, assessments of its use are private. No one can (will or ought) to be forced Into “logic”. (Question: can a useful tool be effectively designed.)

B) RIL explains how reasoning by citizen contemplating whether or not to have the issue  rerouted toward a formalized court. The evidence, gained in a wealth of investigations thoroughly discussed in [2] strongly suggests that this hope is vacuous unless

C) RIL (once developed) will obtain normative status: only by consciously and explicitly reasoning according to patterns confirmed by RIL, citizens can be sure not to make reasoning errors for which the may subsequently be held accountable.

D) RIL is useful for developing an overall picture of appropriate decision making, thus leading to a data base of past judgments which can be used by decision makers via association based search engines.

If RIL ever reaches the maturity sketched in the paper, it should work like the following combined scenario:

- Systematic attempts to support persons in different circumstances with extra-court reasoning lead to a toolkit that may support at least those who had an appropriate training, thus validating scenario (A), and

- support may in part be delivered by means of the tools mentioned in (D).

- Then scenario (B) is ignored because focus is on a methodical training of all citizens intending to apply RIL based reasoning effectively and for its intended purposes.

- The resulting state complies with (C) and RIL, once mature, has obtained a normative status.

This description does not depend on a realization of scenario (B) which has almost been ruled out by past research as reported in [2]. Nevertheless the combined scenario may be considered speculative to such an extent that this renders the RIL idea fruitless.

I am optimistic about the future of applied logic so I don’t think that working towards RIL is necessarily a fruitless endeavor. If, however, one intends to modify the RIL project so as to be made independent of an optimistic view of the future of applied logic, the project can be renamed into RIR (Real Islamic Reasoning), where Reasoning builds on a far larger body of  psychological knowledge than logic traditionally does. Statistical methods, extensive data mining, pattern matching, results from neuro-imaging, and applications of social computing, can all be brought together to constitute a package of techniques which may replace the bundle of methods which I have listed in order to specify what RIL might take on board. In this way a hypothetical transformation of the RIL paper into an (equally hypothetical) RIR paper can be undertaken, while leaving most of its embedding in a context concerning the Islamic Legal Process invariant.

[1] Jan Aldert Bergstra, Real Islamic Logic, arXiv:1103.4515v1 [cs.LO] (2011), (http://www.arXiv.org/abs/1103.4515).

[2] Marian Counihan, Looking for logic in all the wrong places: an investigation of language, literacy and logic in reasoning. Ph D Thesis, University of Amsterdam, ILLC Dissertation Series DS-2008-10 (2008)

Must money and goods be distinguished?

Jan Aldert Bergstra

Informatics Institute, Faculty of Science, University of Amsterdam, The Netherlands

It seems obvious at first sight that the principles of Islamic finance imply a dichotomy between money and other goods. While buying goods for money is free, buying money for money in any non-trivial way is forbidden. Buying goods for goods is not buying but if the good is gold then spot sales must be trivial in the sense that equal amounts are traded. This suggests that the quantities traded may only differ in their composition: 10 blocks gold of 1 kilogram may rightfully be traded for 5 blocks of gold of 2 kilogram and so on.

In our paper on "Reduced Product Set Finance" (http://arXiv.org/abs/1012.4291) we analyze the consequences of an asymmetry between money and goods which can be thought of as a limitation of the class of admissible financial products. Very different viewpoints on these matters are possible, however.

In several contributions posted on NewHorizon Azeemudin Subhani challenges this view. (See http://www.newhorizon-islamicbanking.com July-September 2008, "Interview: a new take on riba" and January 2011 "Whither Islamic finance"). Professor Subhani asserts that the forbidden phenomenon is creation of a good (be it money or not) from itself. This is a matter of theology, completely unrelated to any justification derived from an unfairness that may result from requiring interest or imposing usury to borrowing persons. Professor Subhani provides quite a number of arguments for his proposition and his arguments can be split in two groups:

A) (Im)plausibility arguments indicating the inconsistency or implausibility of common viewpoints depending on an asymmetry between money and other goods.

B) Text analysis arguments regarding the occurrence of riba and bay in Qu'ran and Hadith which are supposed to imply that self-generation is always at stake when the prohibition is argued which has been massively construed against interests in Islamic finance.  

I will further reflect on the issue of self-creation or self-reproduction as it has been termed in computing

In computing a computer virus is a program that can generate multiple copies of itself. Can one infer that the "use" of a computer virus is forbidden for this very reason, also in cases where it does no intended or unintended harm to somebody else. In biotechnology certain powerful cells can be made to self-reproduce to good use. If the entire community is viewed as an entity it seems to be amenable to growth. So it seems that self-reproduction is acceptable from some level of complexity onwards. In that case is the basic commodity nature of money which induces the prohibition of its autonomous growth. A clear discrepancy between classical commodity money (gold coins) and modern fiat money emerges: unlike commodity money fiat money utterly fails to feature basic commodity nature as its value primarily derives from macroscopic (that is macro-economic) events.

Nevertheless the anti-selfreproduction argument is definitely meaningful and it can be adequately formulated in terms of gold. Here is an extended version of it:

- assume that P lends a weight W of gold to Q with the agreement that Q will return W+w in one year,
- assume that there is no risk at all that Q cannot comply with this promise,
- then Q must be planning to create gold by means of alchemy, or theft,

- alchemy is unethical (representing an impersonation of God), 

- theft is forbidden,

- if P borrows Q his gold P must know what Q plans to do with this "capital" (as P takes on some       responsibility for Q's actions for some time).

For these reasons P must not engage in a contract that formalizes the agreement mentioned in the first line. Interestingly this argument fails if Q possess a gold mine or if Q avails of a very non-trivial (and thus far quite uneconomic) nuclear technology capability. 

Indeed at closer inspection there seems to be a weakness in the argument against self-reproduction for gold because we may assume that gold mines exist. Let us assume that:

- P knows that Q is in the possession of a gold mine, 

- but Q cannot pay the work force to exploit it,

- and Q knows of the presence of the gold, 

- Q has informed P about the presence of gold in the mine (and P believes Q), 

- Q cannot exploit the mine without support by a well-trained work-force,

- none of those who Q will engage for exploiting the mine believe his claim about the gold in the mine,

- the members of the prospective work force don't want to gamble that the mine will reveal gold,

- by initially working without being paid workers are making a gamble,

- thus Q needs to pay the members of his prospective workforce in advance,

- and P can borrow Q the golden coins for doing so,

then why would it be wrong for P to lend his gold coins to Q and to ask a larger value in return after the mine has been successfully brought to exploitation, knowing that all agents involved (including members of the very sceptic workforce) will profit from this. If Q has no mine then Q might know R who is in the situation just specified about Q and Q could act as an intermediate agent which borrows P's coins and then lends them to R and so on.

One might hold that the gold is not really self-creating in the mining example, thus allowing this contract by way of exception. What can be concluded is that in the absence of gold mines a contract which asks an agent to return more gold than initially received at a latter moment in time may be considered problematic by anyone, not merely by muslims, while in the presence of gold mines the rule against self-reproduction cannot simply be formulated in contractual terms.

Although these arguments about P and Q and their transactions as mentioned above may be deeply flawed from the perspective of the Islamic philosophical tradition at large, as it stands the arguments put forward by professor Subhani against the legality of self-reproduction in defense of some fundamental principles of Islamic finance seem to have the peculiar property of being valid for non-Islamic finance just as well. After the extension to the prohibition of self-reproduction in general (as proposed by professor Subhani), these principles are simply not about restrictions on financial transactions but are reflecting universally valid economic boundaries, which only seemingly impact on the financial system due to a confusion between money and the mechanics of its underlying commodity. 

I conclude that Islamic finance is best seen in political terms (that is in terms of Jihad understood as a fundamentally non-violent endeavor) which is compatible with the perspective of RPSF (Reduced Product Set Finance). Using the arguments presented above I hold that the RPSF perspective is not critically undermined by professor Subhani's critique against prohibition of interest as an asymmetric (money only) prohibition of self-reproduction.

On some viewpoints of Tarek El Diwany about Islamic Finance

Jan Aldert Bergstra

Utrecht, The Netherlands,

A most useful site on Islamic finance is being maintained by Tarek El Diwany from London on http://islamic-finance.com. Tarek El Diwany is also heading Zest advisory LLP (http://zestadvisory.com), which provides consultancy on matters of Islamic economics to a wide range of institutional clients.

Without making any attempt to provide a full survey of Tarek El Diwany's viewpoints regarding Islamic finance, which have been laid down in several books written for the international market, I will reproduce a number of intruiging positions, taken from his contributions on http://islamic-finance.com. These positions are definitely relevant for the RPSF line of investigation (see "Preliminaries to an Investigation of Reduced Product Set Finance, http://arxiv.org/abs/1012.4291). Of course the responsibility for mistakes that may perhaps be perceived in the interpretation of Tarek El Diwany's texts below is entirely mine.

In a previous post on this blog, Bergstra & Middelburg http://introductiontorpsf.blogspot.com/2011/01/product-instance-assessment-for-rpsf.html

we have assumed that writing about Islamic finance from a non-Islamic position constitutes an additional difficulty, in comparison to writing from an 'inside' Islamic position, and for that reason requires additional scrutiny. Tarek El Diwany, however, provides arguments for an opposite point of view by means of the following six observations.

Observations made by Tarek El Diwany

1) Christianity opposed interest payment successfully until the contractus trinus was introduced in the 13th century. Contractus trinus (a description can for instance be found in http://arxiv.org/abs/1012.4291 based on a paper by Wolters) provides a synthetic financial product composed from permissible base products (from a medieval Christian viewpoint) which for all practical purposes can be equated with an interest bearing loan. According toTarek El Diwany the Church was unable to prevent the use of contractus trinus by legal means, although it initially had an intention to do so. As a consequence "Christian" financial engineering (in particular financial product synthesis compliant with Christian regulations as issued by the Church in those days) during the 13th century, put an end to the resistance of the Church against the use of interests. Since that time Islam is the only remaining force against interest based finance.

2) In the first half of the 20th century Islamic economics and its subtheme Islamic finance (IF) emerged. By now that has led to an activity which may be referred to as mainstream Islamic finance (mainstream IF). According to Tarek El Diwany mainstream IF's greatest strength, however, lies in sophisticated financial engineering leading to synthetic products that simulate 'unethical' products by making clever and combined use of ethical financial products only. He then proceeds with the observation (without supporting proof or documentation) that mainstream IF methods play a role comparable to the role played by contractus trinus. Due to mainstream IF many inhabitants of originally Islamic countries (that is countries with Islamic majorities) now are in debt (possess negative equity) with obligations imposed upon them that are hard to distinguish from the hardship of interest payment. Thus rather than to keep interest prohibition in tact, mainstream IF has had the opposite effect of exposing the Islamic population of a number of countries to new and seductive financial arrangements of which the disadvantages will become manifest only much later.

3)Tarek El Diwany leaves no doubt about his viewpoint that the relevance of interest prohibition needs to be understood from the problems that will creep into any system without interest prohibition. This is a fundamentalist approach as it is grounded on a perspective concerning the original motives that led to interest prohibition. Stated differently, rather than demanding formalistic Shari'ah compliance, he demands the awareness that interest based finance brought, brings and will bring many citizens into deep trouble by exposing them to the risk of negative equity from which they may not be able to escape. These problems are linked with the practice of fractional reserve banking. Formalistic adherence to the tenets of mainstream IF need not guarantee the disappearance of such problems. According to Tarek El Diwany fractional reserve banking must be considered inadmissible from an Islamic point of view because it features gharrar. In this case gharrar refers to the downside risk of a bank run which may terminate the bank's existence. Expecting the non-occurrence of the bank run may be considered a matter of maisir (a gamble).

4) Taking a closer look at fractional reserve banking, suppose that bank B obtains 1 M Euro additional reserve by client deposits, and according to the regulations it may now lend k M Euro to its clients (thereby creating (k-1) M Euro), who annually need to pay i.k M Euro interest to B, of which i.(k-1) M Euro for newly created money. First of all B leaves it to external parties to produce i.(k-1) M Euro and secondly these (k-1) M Euro which have been created are probably deposited after certain transactions from B's clients with third parties on other banks for which these third parties are clients thus triggering the additional creation of (k-1).(k-1) M Euro and so on. Banks create additional money because they can lend it with interest to their clients. This whole mechanism may lead to a perverse feedback cycle on a real estate property market where the newly created money triggers in increase in property value which may become a self-fulfilling prophecy thus leading to an overvaluation and a consequent collapse of property values that finally leaves many property owners in negative equity. Fractional reserve banking plus interest based finance can lead to a financial chain reaction within an overheated financial multi-processor (the rational banking system) with a subsequent and very detrimental melt-down. Such difficulties, which are not hypothetical, can and must be prevented by Islamic based interest prohibition. 

But analyzing from the perspective of rational finance Tarek El Diwany concludes (already in a 2004 contribution) that it would be most useful to include home prices in the calculations that determine inflation so that a boom in property values can lead to either increased interest rates or to higher reserve requirements for banks. This is very convincing, recent history having amply confirmed this position, and one might add that even the stock marked must be taken into account when determining inflation because most people buy stock (themselves or indirectly via pension funds) in order to guarantee an appropriate income after retirement. They have no other option than to make such investments.

5) Having thus reiterated the problematic character of money creation by banks in combination with an interest based system of financial circulation, Tarek El Diwany comes to the drastic and unexpected conclusion that mainstream IF has imported these problems and the consequences thereof in a number of countries where such problems were far less prominent before mainstream IF came into existence via Islamic windows of mainly internationally operating western banks. Here one notices a point that makes the understanding of Islamic finance much harder from an Islamic point of view, than from a non-Islamic point of view. As an outsider one need not really be worried about the Halal status of mainstream IF. But from inside Islam that issue cannot be avoided and positions like that of Tarek El Diwany need to be taken into account. 

The PPSF paradox

Implicity Tarek El Diwany points to a paradox. I will call this paradox the RPSF Paradox: limitation to a reduced product set can trigger exactly the consequences (here widespread negative equity with highly adverse consequences for its holders) that this very limitation is supposed to prevent.

6) Tarek El Diwany further notices that mainstream IF providers make use of small teams of Islamic scholars as consultants who can judge positively about the Shari'ah compliance of their new financial products even if these scholars know that a majority of their colleagues would oppose a positive judgement. He notices, however, that Islamic jurisprudence asks these providers to be autonomously convinced about the Halal status of their products and that the legal process is primarily needed to establish a Haram status once the Halal status of a product comes under attack. This attack can take place in spite of the provider's conviction that the product is Halal, which in any case is assumed to have been arrived at in good faith. Opponents to a product need to prove their point, and that is the other way around compared to what mainstream IF providers seem to be doing. According to Tarek El Diwany this mechanism for positive evaluation tolerates ignorance concerning deeper Islamic objectives and the usage made of the mechanism results from a lack of commitment by the management of mainstream IF service providers to the intrinsic objectives of "true" islamic finance.

A paradox of fundamentalism

A most remarkable corollary of Tarek El Diwany's position is this: he advocates a stricter application of some Shari'ah based constraints (no gharrar for banks, avoiding negative equity for citizens) than mainstream IF's advocates and that makes him a hard-liner from a non-Islamic perspective. But at the same time he is less formalistic or dogmatic in his approach to the application of Shari'ah principles than mainstream IF providers who (according to Tarek El Diwany) use their strict and uncompromising attitudes as a marketing strategy towards a naive Islamic customer base that is likely to mistake these strict attitudes for an intrinsic compliance with Islamic principles. By having essentially social objectives, for which Islamic finance serves as a means to an end rather than as an end in itself, Tarek El Diwany is more inclined to take rational finance (that is "conventional finance") solutions seriously into account and to remedy the problems created by such solutions by means that may not fully but at least partially be in compliance with his understanding of Shari'ah constraints. Summing up: his drastic orientation towards some Islamic virtues induces a more compromising attitude towards some aspects of rational finance. At first sight this is paradoxical and the paradox results from taking an inside Islamic position. This second paradox (counting the RPSF paradox as the first) is absent for observers from outside Islam. Extrapolating perhaps beyond Tarek El Diwany's own position I obtain the paradox of fundamentalism in Islamic finance which consists of these two rules:

(i)  a more fundamentalistic approach to Islamic Finance is likely to be more compromising towards rational finance,

(ii) a more dogmatic (and for that reason less fundamentalistic) approach to Islamic finance tends to be less compromising towards the achievements of rational finance.

Conclusions and further remarks

Each of the above 6 observations impacts on the research questions that were put forward in previous contributions to this blog. At the same time the line of argument need not be accepted as compelling by a non-Islamic researcher of Islamic finance who at least initially can study mainstream IF as if its claims to Halal status have been established beyond reasonable doubt. For a non-Islamic observer both paradoxes (RPSF Paradox and Fundamentalism Paradox) are mere curiosities. A non-Islamic observer only needs to take into account that Islamic finance includes a range of subtly disparate judgements about the relative and absolute ethical status of the same financial products, where some approaches claim "true IF" status in opposition to mainstream IF status which is then considered less "true".

Following Tarek El Diwany's line of argument no instance of RPSF is the right way to go because probably no approach to it can guarantee that its application on a large and complex scale will prevent the negative consequences of interest based finance.  


Some arguments can be put forward against these opinions. Islamic finance may be considered a very successful and imaginative exploitation of a far from trivial insight (probably due to Maulana Mawdudi and his coworkers around 1930): simply by imposing the prohibition of interest payment in a rather strict way an entirely new financial industry can be launched. This industry will bring modernity (imperatively needed according to Mawdudi) to Islamic states but it will do so in an Islamic fashion. "Islamization of modernity" has been coined as a label for this perspective. Islamization of modernity might be contrasted with modernization of Islam which Mawdudi considered less promising. Eighty years later Islamic finance proves vividly that Islamization of modernity can make sense. Tarek El Diwany, however, puts forward that he is not a fan of the particular form of modernity (modern banking) which has now been imported on a grand scale in Islamic countries as a consequence of the emergence of Islamic finance. Where he considers Islamic finance a tricky detour for moving barriers out of the way that were previously successfully imposed, Mawdudi's  successors are more likely to be surprised by the remarkable Islamic identity which their new banking system has acquired and which it seems to maintain without any problem. These matters are the more confusing because Mawdudi is sometimes considered to have been an intellectual forerunner of Islamic extremism. At the same time his heritage can be blamed for importing more western methods and techniques into the operations of Islamic countries. My conclusion is that Islamic finance represents the impact of a striking achievement of visionary clear thinking given the objective of Islamization of modernity, on which Tarek El Diwany's critique has no bearing. Tarek El Diwany's critique, however, goes at the heart of the rationale of Islamization of modernity as an objective, because he hopes instead that the Islamic world can learn from "western mistakes" and that known design errors in societal engineering can be avoided by means of a more principled approach.

Product instance assessment for RPSF

Jan Aldert Bergstra and Kees Middelburg

(The Netherlands 2011)

Islamic finance: beyond technical product analysis

In [BM2010] we have outlined RPSF (reduced product set finance) as a paradigm that can help to understand ethical finance, and in particular Islamic finance,  from the perspective of rational finance (often referred to as conventional finance, see also [BM2011a]). The technical contribution of [BM2010] is to put forward a line of research which can help to understand that exactly are the features of a financial product that make it unwanted from a certain ethical point of view. It is demonstrated that already in the simplest case of a savings account it is far from obvious what precisely triggers the application of anti-interest rulings to that particular case. Technical work as suggested in [BM2010] needs to be performed for all financial products that are considered unwanted in some world view based financial system (see [BM2011a] for that notion), in order to understand precisely what constitutes the offense and to what extent the same objectives can be reached by synthesizing the unwanted product from acceptable products by acceptable means of composition.

Now one might claim, as many authors on Islamic finance seem to be doing implicitly, that it is more or less clear which financial products are in violation of Islamic principles. Based on the work reported in [BM2010] we have doubts about such claims in the first place, but more importantly we believe that such claims render the theme of Islamic finance far more problematic, as a topic of investigation, than it would be, were no such bold claims be made. A simpler view arises if one takes the governance structure of a system of Islamic finance as a point of departure. The theme is simplified if at least in principle the existence and even the co-existence of different systems of Islamic finance can be imagined. In that case one may consider the design of a system of Islamic finance and suggest minor modifications to it without entirely leaving the class of Shariah compliant financial systems. The situation can be compared to someone who investigates a specific programming language say Ada. Even if Ada is his sole subject of investigation, it may be very useful for this researcher to have the notion of a programming language available because that allows him to understand Ada as a particular design existing in the context of a multitude of similar possible (and sometimes actual) design alternatives.

A two tier governance system for Islamic finance

Below we suggest a simple two tier governance system for an system of finance which allows sufficient freedom for tailor made design and which at the same time reflects the stated objectives of Islamic finance to a reasonable degree.

            A managed system of Islamic finance (MIF) provides local Shariah councils as well as a general Shariah council. The task of the general council is to set rules that each of the local councils will comply with. Such general rules will explain which financial products are at all available (that is permitted) and which ones (taken from the offerings of a system of rational finance) are not.

            Local Shariah councils produce advice on the actual use of available financial products by parties involved. So rather than making assessments at the abstraction level of financial products they deliver assessments at the level of product instances. In practice that means that, if two or more partners intend to make use of a financial product which has not been categorically ruled out by the general council, and they are in any doubt of the ethical validity (in this case Shariah compliance according to the local Shariah council), they ask the local council for an assessment of their joint plan of use of the product. Typically if a poor family plans to bet all of their precious savings on a lottery in order to buy a new home when winning, the downside risk (gharrar) involved may induce the local council to advice negatively against this plan, even if the lottery by itself has not been forbidden by the general Shariah council. If, however, a rich family plans to participate in that same lottery for the same amount of money, but now with the plan to buy the poor family their home when winning, this may be (but need not be) considered permissible because the downside risk is marginal for the rich family.

This two tier arrangement has the remarkable property that it contains rational finance as an extreme case. To see this we assume a MIF where the general council departs from a managed system of rational finance (MRF) and then decides for each of its financial products if the product is unproblematic (all uses are always to be considered ethically correct), forbidden (no usage is ever to be permitted), or problematic. Each instance of the use of a problematic product needs to be assessed by a local Shariah council. If we now assume that no products are declared forbidden at the general level and all local Shariah councils allow for each instance of the use of each problematic product, a system is obtained that differs little from the underlying system of managed rational finance.

This reconstruction of the underlying system of rational finance in the two tier governance model suggest that, unless all problematic products (as ruled by the general council) are always disallowed by al local councils,  Shariah compliance of a financial system with this governance model needs to be assessed at a system level. In any case one may allow for local variation in the assessments made by the local councils.  Moreover a continuum of possible though hypothetical financial systems emerges in which the most  restrictive orthodox system is placed at one extreme and the underlying system of rational finance is positioned at the other extreme. Three degrees of freedom, mainly to be used by the local Shariah councils determine an MIF in this setting: (i) which product instances of problematic  products are nevertheless considered ethically valid, (ii) what is to be done if parties engage in a product about  which a negative advice has been issued, (ii) what to do if after a transaction (all or part of the progression that constitutes the use of a particular financial product) has taken place, a delayed assessment suggests that the parties involved should not have done so at all.

The advantage of this two tier governance model for a conceptual investigation of Islamic finance are enormous. Although asking for, receiving or paying interest is considered problematic, the local council may allow for it in some cases, and although gharrar must be avoided the determination of gharrar may involve all knowledge of the facts at hand to the  local council's satisfaction. Similarly, the local council may decide in which cases inappropriate force is applied to make someone pay or in which cases seller and buyer in a spot sale have failed to exchange sufficient information about the sold item. It is also left to the council to decide if an item at sale is sufficiently real to be appropriately sold. The  local council can make up its mind about the impact of the obligation to distribute zakat (gifts for those in need) on the permission of other transactions. It can also assess whether or not an action leads to the exposure of excessive luxury. Finally employer-employee relationships can be assessed concerning the way in which employees are facilitated to fulfill their ritual religious obligations.

            The degree of freedom that arises for a Shariah council by being able to permit specific plans of usage of problematic financial products supports the viewpoint that the financial system is providing a means to an end rather than that it constitutes an end in itself. The deeper end to which the financial system is to be tuned relates to the justness of society and the fulfillment of religious duties by all local Muslims in such a way that jihad in the sense of living in an exemplary style which proves the universal value of Islam to others, notably to local non-Muslims, comes to fruition.

Local Shariah council assessment benchmark suite

Viewed from the perspective of the underlying system of managed rational finance these explanations are still vague. One cannot imagine on the basis of this brief explanation how life in the MIF at hand will actually be like. That can be done, however, by developing an extensive benchmark of test cases. This benchmark consists of a listing of plans for the use (or the continued use) of a problematic product together with an explanation of what it is that each of the prospective participants intend to achieve. Now rather than merely responding with yes or with no, the council is asked in each of these cases to respond to the following question: given the intention of the parties as stated what is your advice? There may be the following options: (i) go ahead, the plan is ok, (ii) at least one of the participants has ethically invalid intentions, so don't go ahead, (iii) the intentions of the participants are ethically valid but their plan is not, in the case of these intentions they are suggested another plan that is considered ethically unobjectionable.

            Considering the case of interest prohibition this point of view opens up new possibilities. In rational finance the payment of interest combines the compensation for an insurance policy taken by the lender against the failure of the borrower to return the principal amount at the end of the period of lending with a compensation for the opportunity cost incurred by the lender of not having the principal sum available during the period of the loan. One may contend that only the latter amount constitutes an unethical transfer of money, as it provides a certain increase of the principal amount for which no further investment or activity from the side of the borrower is required. A local council may now allow for some instances of loans with interest payment which compensate the lender for the risk of borrower failure only. In this way it scrutinizes the inherited usage of the term interest as well as its payment, thus avoiding an overly restrictive policy which may lead to adverse consequences that jeopardize the whole endeavor of this particular form of ethical finance by inadvertently ruling out what was not meant to be ruled out in original sources in the first place.

            It is a meaningful research plan to develop conceptually consistent Shariah council benchmark suites. Such work can be done empirically by inspecting the jurisprudence as developed by an existing Shariah court, but it can also be done in a more intellectual fashion on the basis of interviews with Islamic scholars.

[BM2010] J.A. Bergstra, and C.A. Middelburg, source paper on RPSF posted on http://arxiv.org/abs/1012.4291

[BM2011a] is the previous item in this blog

Some methodological aspects of comparative financial paradigm research

Jan Aldert Bergstra & Kees Middelburg

In our recent paper [BM2010] on Reduced Product Set Finance (RPSF, Twitter hashtag #rpsfi), we have outlined a plan for technical research on the foundations of interest prohibition. Interest prohibition has a very long history and is nowadays strongly advocated by proponents of Islamic finance. In [BM2010] we have coined RPSF as a container concept which includes Islamic finance and variations thereof. In doing so RSPF can be positioned as a subtheory of conventional finance and by inheritance (the theory of) Islamic finance becomes a subtheory of conventional finance. For setting up technical work on specific issues, which is the objective of [BM2010], this viewpoint is satisfactory, but for motivating work on disparate financial systems it may not suffice.

Here we discuss the question how to understand the ideological basis of work on Islamic finance as seen from a Northern EU country and performed by researchers who have not been exposed to Islam in any systematic fashion. The discussion has several parts:

a) We consider the naming of financial systems at large first. This is a matter of terminology. Many papers make mention of the contrast between Islamic finance and other ways of organizing financial systems. Different indications for 'other finance' are used, for instance conventional finance. The contrast between Islamic Finance and conventional finance (also referred to as mainstream finance and sometimes as western finance) is problematic and places Islamic Finance in an exotic position which is a disadvantage for its students and proponents. Non-Islamic finance is an adequate name for mainstream finance, but its connotation is curious. Something better is needed, and we propose managed rational finance as an alternative. We must admit at once that 'rational' has potentially problematic connotations as well, but alternatives such as pragmatic finance, liberal finance or democratic finance are worse in that respect. We will use rational finance and acknowledge that rationality rather refers to the absence of certain exogenous influences than to the presence of a compelling design logic.

b) We discuss the unavoidable plurality of financial systems both in theory and in practice. We emphasize that neither Islamic Finance nor managed rational finance should be understood as monolithic and coherent financial paradigms. Both allow for diversity.

c) We discuss why limitations such as the prohibition of interest may be interesting for managed rational finance.

d) We argue why and how the investigation of RPSF and of Islamic finance might be useful from an EU perspective.

TERMINOLOGY. Rational finance versus World View Based Finance Rational finance (RF) refers to a financial system where all design decisions have been made on rational grounds. No other authority except
rational thinking from first principles is allowed in its conceptual construction. In particular old religious sources have no role in the design of RF. Managed rational finance (MRF) refers to a financial system which in principle has been based upon the results of rational thinking, but which also has been influenced by decisions made by governing bodies. A typical example of management influence on a financial system is the emergence of fractional reserve banking (FRB). FRB does not immediately follow from a principled analysis, but governing bodies may allow it when constrained by some regulation. Such regulations may be maintained (modified, redesigned) once circumstances change. A formidable spectrum of different ways to manage an RF system exists. Currently EU-MRF, USA-MRF and PRoC-MRF are not the same, though differences may seem small to non-specialist observers. Opposed to MRF, we see World View Based Finance (WVBF). A world view based finance need not be based on rational design decisions only. It can in addition make use of principles inherited from some world view, for instance a religion. Now Islamic Finance or more specifically each coherent approach to Islamic Finance might be considered an instance of a world view based system system of finance. One might criticize the proposed terminology because what is termed rational finance might also be called a WVBF with capitalism as the world view. Against this objection one may state that capitalism is just as well imaginable in a system of Islamic Finance and that the connection between rational finance and capitalism is a superficial one only. Clearly a WVBF must be managed just as well as an RF. Thus a multitude of MWVBF systems can be imagined, including variations of Islamic finance and per variation different approaches to its management.

In a system of rational finance, a financial product exists because some users like it. Only if the product's existence presents a risk to the system as a whole it will be ruled out by its managing bodies, often only after such risks have materialized in unacceptable ways. There are, however, limits to financial product development within rational finance that one hardly notices. For instance if we pack 10.000 Euro in  anknotes in a bag, which itself has a worth of 150 Euro, and sell that bag subsequently for 1000 Euro to a dear friend this is not a permissible spot sale in EU-MRF, because it constitutes a gift of 8850 Euro, which for that reason may involve a special form of taxation according to local (that is national) regulations. The classical and widely mentioned Islamic rule that gold may only be exchanged for equal amounts turns out to hold for Euros within Europe today.

PLURALITY. The viewpoint that Islamic finance is an exotic extremity peripheral to a monolithic and coherent mainstream financial system is erroneous. MRF's are all influenced by regulation and systems of regulation diverge. Today the EU-MRF has more faith in the validity of policies for keeping the amount of money in circulation limited than the USA government seems to have. Today's EU-MRF is less Keynesean than USA-MRF and that leads to different rules of behavior. Differences between regional RF's do not primarily reflect ideological positions, but rather they reflect differences in economic circumstances. Anyhow these differences may be enormous. Similarly it is implausible to view Islamic finance as one single coherent design. There are many conceivable variations on the theme of Islamic Finance, including theoretical versions that emerge from imposing grand simplifications. It should be noticed that Shariah compliance itself is not a universal concept. What is Shariah compliant needs to be found out time and again by local or regional scholars. One might even try to understand the universal prohibition of interest differently: whenever interest is paid, promised, received or expected it is possible (but not necessary) that a council of Islamic Scholars scrutinizing a specific event concludes that it was not Halal. The logic of Islamic finance is a matter that requires further investigation. Besides listing principles derived from various Islamic sources and traditions, one may consider the more dynamic aspect of Shariah Councils taking decisions in real time into account. It is not obvious from outside which considerations are taken into account when such decisions are taken.
That may range from an interpretation of pre-existing sources and traditions together with logical conflict resolution when these sources and traditions are or seem to be contradictory to the development of an expectation of the effect of some ruling which may be taken into account when deciding about that ruling.

RELEVANCE. Relevance of systems of world view based finance for approaches to rational finance. We focus in the prohibition of interest as a principle that is included in some systems of WVBF (in particular Islamic finance) and which is hardly visible in any MRF known at present. Consider EU-MRF. IT seems to be the case that the increasing spread in interest rates for government bonds for different EU countries creates problems of a magnitude that had not been foreseen when the Euro was created. Market forces create discrepancies that can be remedied only temporally by means of policies that cannot make use of the political union which some authors had always stated to be a precondition for a stable Eurozone. Some national citizens feel trapped in a EU that preaches an independence of states which is not sufficiently powerful to prevent monetary dissociation and at the same time preaches the virtues of an extending Eurozone.

One might guess that the UK's disinclination to join the Euro may be be connected to its dislike of further political unification within the EU in combination with an understanding of the market forces just mentioned. Increased interest rates constitute the main signal sent by these market forces. Another issue that makes interest free systems intriguing is that monetary policies tend to move interests towards zero in times of stagnation and when it matters most no further step can be taken because handling negative interest is a technical problem for the financial system at large. So it seems that, in order to have interest rate setting available as a weapon for managing the economy, it needs to be
significantly higher than zero 'naturally', just like a ship that needs speed for it to be controlled by its rudder. Now this is an asymmetric matter, in theory working with steady deflation might also work. Anyhow the double role of interest as a market price for credit and as a handle for managing the economy is not always comfortable.

In [Lewison1999] one finds other arguments against the free setting of interest rates, in
particular the fact that those in need of credit are likely to pay the highest interests because of the higher risk of default at the borrowers side. Lewison also explains that upper limits to interests asked by lenders and imposed by financial authorities may lead to adverse results because some potential borrowers may not be able to find any credit. One notices that interest rates reflect a mix of insurance against default and compensation for opportunity cost which might preferably be disentangled. From these considerations it may be concluded that principled investigations about the design of interest free WVBF's can be meaningful from the perspective of e.g. EU-MRF.

PERSPECTIVE. Potential gains from studying Islamic Finance from within the EU can be pointed out. It is conceivable that systematic work on RPSF, while taking the current EU-MRF into account, leads to the development of a viable EU-MWVBF based on principles of Islamic finance. This system, one might refer to it as an EU based managed Islamic finance (EU-MIF), may even become visible throughout the world, and instead of constituting a threat to the core EU identity it is an opportunity waiting to being exploited.

Reference: [BM2010], Preliminaries to an investigation of reduced product set finance. Available at http://arXiv.org/abs/1012.4291, submitted for publication to J. KAU. Islamic Economics.

Preface to an introduction

Jan Bergstra
(Utrecht Netherlands 2011)

I have decided to start a blog in order to have a fast way to make my work on the theoretical foundations of ethical finance known to those who share my interetsts in that fascinating topic.

Needless to say Islamic finance is today's paramount example of an approach to ethical finance. RSPF stands for Reduced Product Set Finance (for an extensive rationale of this notion see http://arxiv.org/abs/1012.4291). The Twitter hashtag for RPSF is #rpsfi.

I assume that systems of ethical finance are all subsystems of a large and evolving superstystem called Rational Finance. The adjective rational reflects the absence of explicit underlying ethical principles rather than the presence of any compelling design logic.

For theoretical and conceptual work it is important to think in terms hypothetical systems specified in abstract ways. An abstract (and for that reason stylized and simplified) description of a system of finance will be called an abstract finance framework (AFF). Many different abstract finance frameworks can be imagined.

Existing systems for finance, often denoted as mainstream, conventional, western or common, can in principle be analysed as a parallel and interacting combination of instantiations of different AFF's. Similary Islamic finance is a container concept which may refer to a variety instantiations of different AFF's.

I write from an external position, that is from outside Islam, and if the work reported in this blog may become classified as work on Islamic finance, it would preferably be classified under the heading of secular Islamic finance.

Secular Islamic Finance is an approach for investigating AFF's which incorporates essential tenets taken from known approaches to Islamic finance, not so much because of their origin in classical tradition and writings but because of their conceptual value for the design of alternative financial systems. Thus, at least in principle, an AFF based on an approach to secular Islamic finance might be the system of choice for a Christian community, simply because they applaude the portfolio of design decisions which it comprises.

Thus some systems of RPSF are AFF's which, when instantiated would be valid as a system for Islamic finance, and at the same time is meaningful for other potential users. An AFF for secular Islamic finance, preferably specified as an RPSF embedded in some larger system of rational finance can serve as a platform for conceptual and theoretical research. Its instantiations need not comply with all requirements of Islamic finance but perhaps only with some of these requirements. The kernel "Islamic finance" is carried along in this terminology because the product set restrictions imposed will by and large be inspired by the theory and practice of Islamic finance.

The advantage of this way of working, seen from the perspective of rational finance is that design restrictions can be imposed in a modular fashion.

In this blog I will try to set out viewpoints that arise from my own research, including joint work with colleagues, but I will also try to comment on existing work as well as work in progress by other authors and groups in order to combat an isolation which makes these efforts less attractive for prospective blog visitors.