With Islamic finance and banking emerging as one of the fastest growing sectors within global financial services, and financial centres in both the developed and developing worlds competiing hard for supremacy, questions of regulation are gaining rapidly in importance.

In May, the Islamic Financial Services Board (IFSB), the standards setter for the Islamic financial services industry, will publish its framework for the development of the industry over the next decade. Few details were available as GRR went to press, but the framework is expected to reinforce the IFSB’s mandate to develop international prudential and regulatory standards for Islamic financial institutions and to help integrate the industry into the international financial system.

It will set out a number of initiatives including developing the appropriate legal, regulatory and supervisory frameworks to cater for the Islamic market and ensure tax neutrality between Islamic and conventional financial products. The Kuala Lumpur-based IFSB, headed by secretary-general, Rifaat Ahmed Abdel Karim, also aims to build an efficient Islamic inter-bank liquidity market, develop the necessary specialised human capital to research and monitor the industry and encourage closer collaboration among international Islamic financial institutions.

The precise size of the Islamic finance market is still a matter of guesswork. Zeti Akhtar Aziz, governor of Bank Negara, central bank of Malaysia, one of several countries keen to become a major Islamic finance centre, estimates that the industry’s assets are now worth more than $1 trillion, with annual growth estimated at between 15% and 20%.

A series of regulatory initiatives is underway to establish principles for the supervision of this market, and a number of multilateral institutions, including the IFSB, are seeking to establish global principles for its regulation. Regulators in the Middle East and Asia, notably Bahrain, Dubai and Malaysia, are also working hard to establish ground rules for the supervision of Islamic banks and capital markets within their own countries. This can be very challenging for the regulators who operate in countries where a dual banking system, including conventional and Islamic banks, operates. Indeed even within Islamic finance and banking there is a lack or harmonisation over definitions and standards making cross-border comparisons of different financial institutions very challenging for regulators. The need for more uniform principles is urgent, say proponents of a more harmonised global Islamic finance industry.

“There is a general market desire to move towards standard market practices and to generate as much consensus as possible for the Shariah supervision of Islamic financial services,” says London-based Ruari Ewing, primary markets advisor at the International Capital Markets Association, the self-regulatory organisation and trade association representing the financial institutions active in the international capital markets worldwide. “This seems to be filtering down,” he adds, “to the national level where we are beginning to see some regulators working to establish a level playing field between Islamic and conventional products within national law.”

In addition, responding to the growing involvement of international banks and investors in Islamic finance, regulators in non-Islamic countries are looking at ways to shoehorn the supervision of this market into their existing regulatory frameworks. Since 2004, Britain’s Financial Services Authority (FSA) has had oversight of the first Islamic bank in Europe, the Islamic Bank of Britain. Authorisation of this bank was followed by the establishment in Britain of the first standalone Islamic wholesale bank in Europe, the European Islamic Investment Bank, in 2006.

Defining Sharia law

The distinguishing feature of Shariah (Islamic) law is that risk in trade and business must be shared. The law bans speculative activity meaning that interest, or riba, is prohibited. Business deals are also, usually backed by assets. For example murabaha, salam and istisna contracts are based on the sale or purchase of an asset, while ijara (leasing) contracts are based on selling the benefits of such an asset. Musharakah and mudaraba are profit-sharing transactions (see box).

Investment in certain business activities, such as alcohol, tobacco, pornography, armaments and gambling is also forbidden on ethical grounds. “Ultimately Shariah is part law and part ethics,” says Michael McMillen, partner at Dechert law firm in New York and an internationally recognised expert in Islamic finance. “A lot of this is a matter of personal belief and religious principles and it is debatable how much you can standardise this.”

This is not stopping the regulators trying to do so. To police this growing market a number of multilateral regulatory institutions have sprung-up, of which the leader is the IFSB. Created in 2002 the IFSB’s key objective is maintaining the stability of the Islamic financial services industry, including banking and capital markets. It works in conjunction with other regulatory bodies to provide guidance on Islamic investment products and is the multilateral body charged with addressing the issue of Basel II – the new capital standard for banks that is now starting to be implemented around the world – and Islamic banking.

The IFSB is emphasising to both banks and regulators worldwide that Basel II compliance is possible for Islamic banks. “We do not attempt to reinvent the wheel for Islamic finance as a niche system, rather, we complement the work of the Basel Committee, architect of Basel II, by catering for the specificities of Islamic banks,” the IFSB’s Rifaat told a seminar on Islam and the global economy, held last June in Wellington.

Philip Smith, senior director in Fitch Rating’s financial institutions group in London, agrees that despite the differences in approach between Islamic and conventional banking there is enough common ground for Islamic banks to fulfil Basel II capital adequacy standards. “For our own part we can’t see any reason why Islamic banks and financial products cannot be accommodated into our existing rating scale and methodology,” he says. “Islamic finance is certainly more asset-based but essentially the risks are the same although there are certain differences in product structures and risk profile, and you must be sensitive to this.”

In a bid for further clarity and standardisation, at the end of last year the IFSB published a document setting out seven guiding principles of prudential requirements in the area of corporate governance for institutions offering Islamic financial services, excluding insurance. These principles offer guidance for the general governance of these institutions, the rights of investment account holders, compliance with Shariah rules and principles and transparency in the reporting of investment accounts.

No single model

That IFSB report says: “We share the opinion of the OECD [the Paris-based policy body for developed nations] and the Basel Committee that there is no ‘single model’ of corporate governance that can work well in every country. Each country or even each organisation should develop its own model that can cater for its specific needs and objectives.”

It continues: “Despite undergoing a very rapid development in recent decades it should not be forgotten that the Islamic financial services industry is still in its infancy. Any rigid, rule-based approach adopted in haste may jeopardise the potential and healthy growth of this market.”

So, the IFSB has been cautious in setting down basic principles for governing Islamic banks. In December 2005 the Board adopted two standards; (1) the Guiding Principles of Risk Management and (2) Capital Adequacy Standard for Institutions (Other Than Insurance Institutions) Offering Only Islamic Financial Services. These guidelines outline how Shariah financial risks should be defined and measured and have been designed to closely adhere to the basic principles of the Basel Committee.

However, these guidelines have their limitations. “What cannot be overlooked is the fact that Basel II, despite its principle-based approach, was not designed for Islamic institutions or institutions offering Islamic products. It does not recognise the different risks emanating at various stages of an Islamic financial transaction’s lifecycle,” says John Tattersall, head of financial services regulatory practices at the professional services firm PriceWaterhouseCoopers, in London.

The Board, Tattersall says, has drawn up principles based on the standardised approaches to Basel II for both credit and operational risk. “What we must now see is more thinking about how these practices can be expanded to include the more advanced approaches to measuring risk under Basel II, in particular, the internal ratings-based approach for credit risk and the advanced measurement approach for operational risk. This is the next challenge for the IFSB,” he says.

Specificially, more work is needed to clarify the types of risks faced by Islamic banks and fit them into the Basel context. This includes rate of return, withdrawal, liquidity, transparency and Shariah risk. The latter fits under the operational risk umbrella and refers to the risk that a product is not Shariah-compliant and will not be approved by Shariah-scholars. The IFSB is also working to produce more detailed guidelines on pillars 2 and 3 of Basel, namely the supervisory review function and information disclosure to enhance market discipline.

Another regulatory institution seeking to establish global principles for Islamic finance is the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), (see box, page 18). This organisation has taken the lead in establishing accounting, auditing and banking practices appropriate for Islamic financial institutions. AAOIFI standards for accounting and reporting are processed in a manner similar to international accounting standards, except that they are modified to comply with Shariah principles.

Farmida Bi, partner at law firm DentonWildeSapte in London, says the Organisation is playing a key role in the harmonisation of Islamic financial services. “AAOIFI is a member of the standards advisory council of the IASB and maintains close links with the International Monetary Fund, the Washington agency, and other global bodies to ensure that its standards are comparable. Increasingly in the market you hear people refer to AAOIFI standards and there is no doubt they are expanding their ambit in Islamic financial services supervision.”

According to Bi, the countries already following or basing their regulation on AAOIFI standards are Bahrain, Sudan, Jordan, Malaysia, Qatar, Saudi Arabia, the UAE (specifically Dubai), Lebanon and most recently Syria.

It is hoped that the work of the IFSB and the AAOIFI will complement each other and that closer collaboration will establish firm international standards that represent both the Asian and Gulf face of Islamic finance, although this remains a tricky and controversial area. “Make no mistake about it there is rivalry between the Far East and the Middle East over who owns the Islamic principles and rules for governing Islamic financial services,” says PWC’s Tattersall.

Bi agrees: “We would like to see national Shariah boards established which could meet international needs to create global standards. However this is a tall order when you consider the philosophical differences of the main four schools of Shariah thought.” These four main schools of Sunni Islam – Hanafi, Maliki, Shafi’I and Hanbali – share most of their rulings although some take a more literal approach to the texts while others allow for looser interpretations. The other major school of thought is Jaafari, followed by most Shia Muslims.

The Bahrain banking regulator has been very proactive in promoting itself as a key supervisor of Islamic finance and has set a deadline for all banks under its jurisdiction to be Basel II compliant by the end of 2008. The Central Bank of Bahrain (formerly known as the Bahrain Monetary Agency) was the first central bank and financial services regulator to develop a comprehensive regulatory framework for Islamic banks back in 2001. The CBB claims that Bahraini Islamic financial institutions are subject to a regulatory standard that is comparable to that in the conventional sector and is accepted as such by the major international regulatory bodies. Meanwhile, both Dubai and Malaysia, which have a well-established framework for supervising both Islamic and conventional banks, are also confident that their banking sectors will meet Basel II requirements in a timely fashion.

FSA’s steep learning curve

In Europe, Britain’s FSA has been busy trying to overcome a number of issues specific to the supervision of Islamic banks. “It has been a steep learning curve for us as regulators and we are still running to keep up with developments in the Islamic market. However in each instance we have found a way to work with Islamic banks on a ‘no obstacles but no special favours’ basis,” says David Holt, manager of wholesale banks and investment firms, Middle East, at the FSA in London.

This includes establishing the treatment of deposits in Islamic banks. Under British law a bank must offer a guarantee to repay the total sum of the deposit, whereas under Shariah law the bank and depositor agree to share profits and losses. The solution that the FSA put in place is that depositors are legally entitled to ask for their money back but if they wish to follow Shariah principles they can just ask for a share of the profit/loss.

The FSA also had to decide on its supervisory stance towards an Islamic banks’ Shariah supervisory board. It decided that the Shariah board did not have a sufficiently managerial role to require personnel to be approved by the regulator.

Sharia-compliant home finance in Britain provides a good illustration of how regulation has been adapted to level the playing field between conventional and Islamic products. Salem Patel, specialist in the financial services division at consultancy firm Accenture in London, says that when the Bank of Kuwait first launched the Manzil Home Finance Product in Britain in 1996, consumer take-up was slow as the product was very expensive compared with a conventional mortgage. “This was because stamp duty had to be paid twice, once when the bank bought the home from the vendor, and then again when the bank sold the house to its customer. This anomaly was removed by government legislation in 2003, and more providers such as Lloyds TSB and HSBC quickly entered the market. Consequently, Sharia-compliant mortgages have become far more competitive and sales have rapidly increased,” he explains.

Britain’s regulators are also looking at ways to boost participation in the Sukuk (Islamic bond) market, says Patel. The International Islamic Financial Market (IIFM) has estimated that $150bn worth of Sukuk will be issued by 2010, with the overwhelming majority of issuance coming from the Middle East and South East Asia. “The growth and popularity of Sukuk in other parts of the world has forced regulators to examine whether existing regulation has hindered companies from issuing Sukuk in Britain,” he says. Obstacles caused by the country’s tax legislation were addressed in the March budget when Britain’s finance ministerr Gordon Brown confirmed that Sukuk would receive the same tax relief as conventional bonds.

Focus on capital markets

Attention is also being given by the IFSB to the development and regulation of Islamic capital markets. “The [Board] has done a phenomenal job in developing core principles for the world’s regulators to use as guidance for the supervision of Islamic banking and more work is being done in this area. However, as that process matures we are seeing them add capital markets to the agenda. This will be a focus area for this year,” says Dechert’s McMillen. Items under consideration include how to develop and use existing legal frameworks for Islamic finance, securities regulation, trust law, insolvency laws, and the role of the shariah boards across jurisdictions.

McMillen, who is working with the IFSB and the Madrid-based International Organisation of Securities Commissions (an umbrella body for over 100 national regulators) on this topic, says they are initially focusing their research on five countries all operating with different securities laws for Islamic products. These are Saudi Arabia, United Arab Emirates, Singapore, Malaysia and Pakistan. “You have five different jurisdictions each with different securities laws governing Islamic and conventional capital market products. Every individual country has different methodologies and different degrees of specificity for regulating their market,” he says. “Each of these illustrates issues that need to be addressed in the formulation of an effective legal framework for Islamic finance.”

He says that the plan, as with banking regulation, is to try and establish some core principles and definitions for Islamic finance that can then be interpreted and applied by national regulators.

Islamic finance institutions

• Islamic Financial Services Board (IFSB)

Set-up in 2002 in Kuala-Lumpur, the IFSB’s key objective is maintaining the stability of the Islamic financial services industry, including banking and capital markets. The IFSB is the multilateral body charged with addressing the issue of Basel II and Islamic banking.

• Accounting and Auditing Organisation for Islamic Financial Institutions

Set-up in 1990, the Bahrain-based AAOIFI is a regulatory institution seeking to establish global principles for Islamic finance. It has taken the lead in establishing accounting, auditing and banking practices appropriate to Islamic financial institutions.

•International Islamic Financial Market

The IIFM is a Bahrain-based body established in 2002. It aims to develop primary and secondary market for Islamic financial instruments.

• International Islamic Rating Agency

This Bahrain-based agency also operates at an international level establishing credit, Shariah-compliant and corporate governance ratings for Islamic financial institutions. • Liquidity Management Centre

The Bahrain-based Centre has been set up to develop an active secondary market for short-term Shariah-compliant treasury products.

Islamic finance products

• Murabahah (cost plus) – a contract for purchase and resale that allows the customer to make purchases without having to take out a loan and pay interest. A bank purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over instalments, effectively obtaining credit without paying interest.

• Salam (deferred delivery sale) – a purchase contract with deferred delivery of goods(opposite to Murabaha), usually used for commodity finance. It is similar to a forward contract where delivery is in the future in exchange for spot payment.

• Istisna (predelivery financing and leasing) – an instrument used to finance long-term projects. It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment, and future delivery. Often used for financing the manufacture or construction of houses, plants, projects, and building of bridges, roads, and highways.

• Mudarabah (profit/loss sharing) – a contract between two parties, one who provides the funds and the other who provides the expertise and who agree to the division of any profits made in advanceThe profit-sharing continues until the loan is repaid.

• Musharakah (joint venture) – where parties agree to the sharing of profits and losses in the joint business. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions.

• Sukuk (Islamic bond) Fixed-income, interest-bearing bonds are not permissible in Islam so Sukuk are securities that comply with the Islamic law and its investment principles, which prohibit the charging or paying of interest.

• Ijarah (leasing) – involves a contract where the bank buys and then leases an item – perhaps a consumer durable – to a customer for a specified rental over a specific period. The duration of the lease, as well as the basis for rental, are set and agreed in advance.

The Need for Tangible Assets

Shari’ah requires that financing should only be raised for trading in, or construction of, specific and identifiable assets. Trading in ‘indebtedness’ is prohibited and so the issuance of conventional bonds would not be compliant. Thus all Sukuk returns and cashflows will be linked to assets purchased or those generated from an asset once constructed and not simply be income that is interest based. For borrowers to raise compliant financing they will need to utilise assets in the structure (which could be equity in a ‘tangible’ company). It’s worth noting that Equity financing is Shari’ah compliant and fits well with the risk/return precepts of Islam.

The Problem with Interest or ‘Riba’

As Shari’ah considers money to be a measuring tool for value and not an ‘asset’ in itself, it requires that one should not be able to receive income from money (or anything that has the genus of money) alone. This generation of money from money (simplistically interest) is ‘Riba’, and is forbidden. The implications for Islamic financial institutions is that the trading/selling of debts, receivables (for anything other than par), conventional loan lending and credit cards are not permissible.

The Problem of Uncertainty or ‘Gharar’

This principle is widely understood to mean uncertainty in the contractual terms and/or the uncertainty in the existence of an underlying asset in a contract and this causes issues for Islamic scholars when considering the application of derivatives. Shari’ah also incorporates the concept of ‘Maslahah’ or ‘Public benefit’, denoting that, if something is overwhelmingly in the public good, it may yet be transacted – and so hedging or mitigation of avoidable business risks, may fall into this category but there is still much discussion yet to come.

Controversy

Sukuks are widely regarded as controversial due to their perceived purpose of evading the restrictions on Riba. Conservative scholars do not believe that this is effective, citing the fact that a Sukuk effectively requires payment for the time-value of money. This can be regarded as the fundamental test of interest.

Summary

With its Arabic terminology and unusual prohibitions, Sukuk financing can be quite mystifying for the outsider. A good analogy is one of ethical or ‘Green’ investing. Here the universe of investable securities is limited by certain criteria based on moral and ethical considerations. Islamic Finance is also a subset of the global market and there is nothing that prevents the ‘conventional’ investor from participating in the Islamic market.

Further reading:

Managing Financial Risks of Sukuk Structures

Explanation of the mechanics behind a Sukuk

I contend that as increasing numbers of people in the West become dissatisfied or skeptical about the banking services they receive, and see them as exploitative or even unethical, the emergence of Islamic banking with its own distinctive morality could help project a much more positive face to Islam. Islamic banking and finance can help foster dialog between Westerners and Muslims.

Islamic retail financial institutions, including the Islamic Bank of Britain, the European Islamic Investment Bank and Lariba Bank in California, are now well established in a number of Western countries. Furthermore, the leading international banks, including Citibank, HSBC Amanah, Deutsche Bank and UBS of Switzerland, all offer Islamic deposits and shari’a-compliant financing facilities.

There has been much dialog between the Western bankers working in these institutions and the shari’a scholars who advise what is, and what is not, permissible. This dialog extends to insurance, where Islamic companies have become increasingly active, their distinguishing feature being that they do not hold conventional interest-yielding bonds, and that shareholder funds and premiums paid by policy holders cannot be co-mingled.

As shari’a is about universal, divinely inspired principles rather than national laws, leading international law firms have also become involved in Islamic banking and finance, as contracts need to be drafted under English or American law in a way that is consistent with shari’a. Indeed, the main job of the shari’a committee members who serve on the boards of Islamic banks and conventional banks offering Islamic products is to ensure that new contracts are compatible with shari’a principles and, if they are not, to pursue a dialog with the lawyers concerning amendments and redrafting.

The aspiration of many Islamists is to have divinely inspired shari’a replacing man-made laws, perhaps even the establishment of a universal caliphate under which everyone, Muslim and non-Muslim, should live. Not surprisingly, such an aspiration is unacceptable for most non-Muslims, and indeed for many Muslims, as it denies choice.

Islamic banking and finance can point the way forward: it is about extending choice, not restricting options. As each institution has its own shari’a board, shari’a compliance is effectively privatized, rather than being a matter of national law. Indeed, each shari’a board passes its own fatwas, or religious rulings, which further extends choice in the marketplace for religious ideas. Religion, of course, flourishes under competitive conditions and Islam is no exception, whereas when it is nationalized, its adherents soon become alienated.

The Islamic Republic of Iran can be regarded as an example of how not to encourage the development of Islamic banking and finance. There, all banking has been shari’a- compliant since the Law on Interest Free Banking was passed in 1983. Bank clients have therefore no choice but to use the shari’a system. The banks, however, are state-owned and have little autonomy, even in determining what deposit and financing products to offer. They also do not have shari’a committees, the argument being that this is unnecessary as the law ensures shari’a compliance in any case.

The result has been that banking development has been slow, there is little financial innovation, and most Iranians do not have bank accounts. In contrast, on the Arab side of the Gulf and in Malaysia, where Islamic and conventional banks compete, Islamic banks have attractive products on offer and a growing client base. Al Rajhi Bank of Saudi Arabia has become the world’s largest Islamic retail bank, and its range of services and delivery channels compares favorably with the best that Western banks can offer.

Islamic banking is here to stay, is an opportunity rather than a threat, and has an exciting future. Gaps remain — there is no Islamic bank in Israel for example to serve its Muslim population. But if the Central Bank of Israel licensed such an entity it could create much goodwill. It might also encourage the Jewish population living there to question whether the operations of their own banks are compatible with religious teaching in Leviticus and Deuteronomy.

Ultimately, Islamic banking and finance is about the emergence of a distinctively Islamic form of capitalism that may co-exist and interact with Western, Chinese, Russian or any other capitalism. Such a development should be welcomed and facilitated, and not hindered or suppressed.

Rodney Wilson is Director of Postgraduate Studies at Durham University’s Institute for Middle Eastern and Islamic Studies. He is co-editor of The Politics of Islamic Finance and co-author of Islamic Economics: A Short History. This article is part of a series on economics and Muslim-Western relations distributed by the Common Ground News Service (CGNews), and can be accessed at www.commongroundnews.org. Special thanks to Leena El-Ali.

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by Alexandra Dubsky

Latest figures show that 134 companies in the Gulf are preparing for stock market listings. But is it the best way to raise cash? And just how big can the rewards be? Alexandra Dubsky finds out.Sir Richard Branson did it. The British computer tycoon Sir Alan Sugar did it twice. And Google founders Larry Page and Sergey Brin did it large.

Now though, the trend for IPOs is sweeping the Gulf. Cashing in on big ideas, and the potential for big profits on stock markets that are otherwise indifferent, is the latest craze - just 17 IPOs have raised over US$6.2bn in the first nine months of this year alone.

In the GCC, markets have seen an increase of 45% compared to the same period the previous year, and are forecast to reach US$8bn until December, according to figures released by Gulf Capital, a UAE-based investment firm.

Meanwhile, some 134 companies are preparing to launch an IPO - and 57 of those have appointed managers to oversee the sale of shares. Another 77 have announced plans to go public, but they have yet to meet the legal requirements.

“Now is the perfect time for firms to go public - there is a strong investor demand for IPOs, and the market is very liquid and offers large buy-outs,” says Aabed Al Zeera, CEO, International Investment Bank in Bahrain.

Al Zeera is merely promoting what companies in the West have been promoting for decades, particularly during the dot.com boom of the late nineties. With financial centres in Dubai, Bahrain and Qatar attempting to outdo each other for the title of “financial capital of the Middle East,” businesses of all shapes and sizes are preparing themselves for flotation.

“It’s something we have been working towards since the day I took over two years ago,” says Alex Andarakis, CEO of drinks giant Aujan. His company has seen sales double to US$360m in the past two years, and its debut on the Saudi stock market next year should put a billion-dollar valuation on the company.

Other firms are just as eager to join the rush, even with likely valuations of no more than US$200m.

Yet more and more gulf companies are keen to go public - the accumulated value of all IPO launches is expected to reach a staggering US$31bn within the next three years, and so outperform the highly volatile equity market. All this despite the region’s stock markets falling by an average of 35% since the turn of the year.

Regional firms are moreover valued at a very strong Price Earning (PE) figure of 25 and more, since most of them show convincing financial results and a profound company history.

“Due to the regional high liquidity in the gulf, the governments increased funding and pumped lots of money into the economy, and therefore helped to push up financial results. Also, investors are relocating their assets from the West and have two options: real estate or equity. The latter has proved to be shaky, and IPOs are an ideal alternative,” says Al Zeera.

“The PE varies according to the specific industry of the company, and often firms have hidden values such as a good reputation or an excellent management team,” he says. “The success of an IPO however purely depends on the individual company, those with an established name and promising track record will probably go public successfully,” he adds.

Going public also offers great exit opportunities for regional firms, since most of the larger companies in the Gulf are 2nd or 3rd generation family businesses. Via IPOs owners can cash out and balance family interests without giving up control completely.

“For many of these businesses that were started by two brothers some generations ago it makes sense to sell out now. They know its time to let go, and this is the best way to do it. The owners get a new managing director but keep the majority stake, and they of course get a nice chunk of money as a cash-out. This reduces the conflict between the brothers, but they can still oversee the operations on board level,” says Al Zeera.

Aujan is a prime example of this, having been family run for over 100 years. Alex Andarakis explains: “Basically the owner has decided he wants to take the company to the next phase of growth. That means he becomes an investor rather than an owner, but the rewards are that we can raise considerable amounts of money for expansion.”

Saudi Arabia, the largest economy in the region, is also the biggest IPO market in the gulf, followed by the UAE and Qatar, which are the most competitive and attract the largest share of investments.

Saudi Arabia topped the markets with US$2.3bn raised in the first nine months of 2006, followed by the UAE with US$1.4bn and Qatar with US$1.3bn, respectively.

The Bahrain market raised a surprising US$1bn, compared to US$6m in the previous year, due to the IPOs of three Islamic Banks that focus on the Saudi Arabian market.

Abe Saad, Managing Director at Shuaa Partners, says: “The number of publicly listed companies is still relatively small compared to more developed markets. When companies, especially in the finance and telecom sector, go public the response is usually high. All sectors are interesting, but the most successful IPOs are of firms that lead within their segment, and of course brands.”

The largest launch this year was the Al Rayan Bank in Qatar with a total of US$1.2bn, followed by Emaar’s Economic City (EEC) with US$680m and Sipchen with US$660m. The EEC and Sipchen together with Gulf Navigation of the UAE and the Saudi Red Housing Services raised US$1.7bn in the third quarter of this year.

The public offerings also gained in size, – with an average of US$363m, up 27.8%, in the first month of this year, compared to US$284m in 2005; a figure that might rise to US$515m in December, doubling last year’s average of US$262m.

“People rush to new IPOs, and demand still outstands supply by far. The trend could backfire sometime, however, like in Europe and the US in the 1990s when everybody invested in IPOs and then eventually lost money,” Saad adds.

“Most IPOs have done well here, and most of the family businesses want to go public now. Companies are keener to launch an IPO than to go into private equity since they get a higher and instant cash out,” he explains.

Although the successful launch of an IPO is more company than industry specific some sectors are still outperforming others. “Manufacturing, retail, real estate and oil and gas are usually strong, less so is, for example, technology in the Gulf region. One can generally say that the more traditional sectors are more popular in the region. Islamic banking is also at an all-time high,” he says.

Al Zeera views the real estate and the banking sectors as especially promising. “Contrary to common belief you can still make money left and right with property in the Gulf. For many years now I heard the bubble theory, and it theoretically makes sense but in reality the demand continues to rise throughout the region. Hot spots such as projects on Sheikh Zayed Road in Dubai or commercial spaces will always sell, no matter how much you build. Also in Sharjah and Abu Dhabi there is still much potential,” he says.

“In the financial sector institutes that offer Islamic finance are also booming,” according to Al Zeera. “Banks have been doing well for some time now, but Islamic banking is really taking off these days. Since they entered the scene 10 years ago they have conquered the market, and demand for them continues to grow. The same applies for Islamic insurers, actually anyone offering Islamic finance.”

He adds “Most of these Islamic financers however need to get more established. If they have a track record of just three years or so they are still very young and have less market credibility.”

Companies that seek to go public usually consult an investment banker to support them. They then seek the approval of the local authorities, release a memo about the managerial and financial structure and the company history, and finally launch the IPO with strong publicity to spark investors’ interest.

Saad says, however, that some governments in the Middle East are now limiting the approvals for new IPO launches, since the new IPOs and their massive oversubscriptions were partly responsible for this spring’s stock market crash. “Many investors sold their shares to raise money for new IPOs, which naturally reflected on the equities. The ministry now regulates this more tightly,” he says. “The oversubscription will however continue, especially in Saudi Arabia and the UAE, but not to the same extent as last year.”

In 2005 the market witnessed both overvalued stocks and IPOs, with firms often being oversubscribed by many hundred times. “This trend is unlikely to continue”, says Head of Research and Strategy at Gulf Capital, Imad Ghandor. “An IPO today might be ten or twenty times oversubscribed - and it will probably stay at this rate. This is still more than the global average, but yet not as exorbitant as last year,” he says. “Investors used to put their money into anything available, equity and public offerings. I guess investors will act more wisely and less emotionally in coming years.”

“Additionally, banks were offering very convenient credit facilities - often too convenient,” Al Zeera argues. “The banks gave credit to everyone. The central banks should put a leash on that, but I think they have already tightened the requirements. Yet some commercial banks stick to their credit policies.”

So what should investors finally consider when joining the IPO euphoria?

“People must not rush into any investment, but carefully study the track record of the company in question. Most importantly, they should familiarize themselves with the management of the firm, since this can make or break an organisation,” Al Zeera says.

Saad agrees, saying: “The most important thing is the firm’s market fundamentals. And, of course, the management team. Investors need to look at every company individually and must not follow rumours, and must avoid being misled by a famous name. The big companies in Saudi Arabia will be interesting, but investors will again need to do their homework.”

IPOs aren’t, of course, always plane sailing. In the eighties, airline tycoon Sir Richard Branson decided to put his group on the London Stock Exchange, and at one stage saw it hit a US$1bn valuation. But it was a bitter experience, with Branson eventually being forced to buy back his own company and take it private again.

He tells Arabian Business: “It was a long time ago and at the time it seemed a great way to raise money and put a strong value on the business. But what some people forget is that once you do that, you lose control of the company. You are accountable to people in the City, and to your shareholders. They call the shots. So what you might know and think is a very good idea is actually, as far as they are concerned, a very bad idea.”

He adds: “There are some great things to be said about doing an IPO and I would guess in the Arab world right now there are many positive reasons. Certainly there seems to be no problem raising funds. But the key aspect is what kind of business you run. If it is something that depends on creativity, then an IPO may not turn out to be the best idea.”

Three months ago, fashion guru Tommy Hilfiger admitted to Arabian Business that floating his own company on the US stock market was a mistake. He said: “When I look back it just wasn’t the right thing to do. I was being controlled by people who looked at the share price every day, and all they wanted was short-term growth and short-term profits. They couldn’t see the bigger picture. The impact on my company was very negative.”

In Britain, one of the most successful “floaters” has been computer tycoon Sir Alan Sugar. He turned Amstrad into a billion dollar company, years later doing the same with Viglen Technology.

He says: “There is absolutely no question that the greatest way to realise the wealth in your company is to take it to the stock market. Whatever issues there are about answering to other people, it is not only the most sensible thing to do but the only thing to do.”

Which, it would seem, is now what just about every company in the Arab world wants to do. With the likes of Damac Securities now actively pursuing venture-capital investments, with flotation as the exit strategy, the trend can only continue.

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Economy occupies a large part of our life. We cannot pass even a day without undertaking any economic activity, whatever it is. Even eating three times a day or sleeping for a while comes within the purview of economics. As for example- why do we eat? We eat to survive. Why do we survive? We survive for work. Why should we work? We work just to earn our bread. How do we get bread? We get it either for money or by producing.

Therefore, both money and production are the two most important parts of economy. Today’s economy is unthinkable without the help of banking system. We are so much dependent on the banks that those are now literally at our doorsteps and it is true not only in the town but also in the village. In all big markets in the village there is more than one branch of banks.

There is no secret that among all banks in Bangladesh, Islamic Bank Bangladesh Limited is the best performing bank according to international rating.

The performance of the Islamic Bank Bangladesh Limited is so excellent that even the non-Muslims are rushing to this bank. Several years ago, it is either Reuters or AFP reported that Islamic Banks all over the world had been among the top profit making banks for their excellent services and transparency. Islamic banking system, which is the reflection of Islamic economics, is so successful all over the world that according to the latest information available to us, Japan, the second largest economy in the world, next to the USA, is contemplating to introduce Islamic banking system.

What’s the magic behind the success of the Islamic Banking all over the world? Actually, there is no magic. If there is at all any magic, it is because; the system comes from none other than the Almighty Allah, who created everything including men and the universe. Manmade theory may be wrong. But, there is no slightest degree of doubt that Allah’s theory is perfect and beneficial for all irrespective of caste, creed, religion and time. Had this notion been incorrect, Islamic Banking would not enjoy such a prestigious position in the world.

Zakat is an indispensable part of Islamic economy. Zakat is a kind of tax paid to the poor at a certain rate (Taka 2.50 for every one hundred taka) by the affluent people of the society. It is a unique system given by the Almighty to prevent concentration of wealth into the hands of a few.

It is that system which narrows gap between the haves and the have-nots, for which the socialists had been relentlessly fighting during the bygone century, but failed. It is not a fiction but a part of the recorded history that during the rule of Hazrat Omar (Ra.), the Second Caliph of Islam, there was not a single man to accept Zakat. All men became rich enough to be able to give Zakat within 5 years of the introduction of the Zakat system. Why was the system proved to be so successful?

The answer is simple. Because, it came from Allah, the Almighty, who is the creator of everything. Allah, who created men, knows very well how to solve the economic problems.

If Hazrat Omar (Ra.) is successful in solving the economic problems, than why should we not be able to solve our economic problems by introducing the same system? One may very well say that there is a gulf of difference between the age of Hazrat Omar (Ra.) and that of ours. In reply we may also say that had this notion been true then the Islamic Banking system would not be so wonderfully successful.

The experts in Islamic economy say that in Bangladesh every year ten thousand crore of Taka, which is almost one fifth of our national budget of the current fiscal, can be realised as Zakat. And by proper distribution of this Zakat money through the state machinery, poverty, which is at the root of our lingering backwardness, can be eradicated in ten years only. Moreover, we can reduce substantially, our dependence on the IMF and the World Bank.

To draw Taka ten thousand crores from a single sector is not a matter of a joke. Employment opportunity for at least a million half-educated youths can be created every year with this amount. Or, the same number of youths can be provided with unemployment allowance every year at a rate of Taka ten thousand per annum.

Or, about two millions destitute men and women will be able to find out better way of life with the amount if they are provided with Taka 5 thousand each for rearing poultry birds and goats, etc. In a word, it is a very big amount, the proper use of which may bring about a revolutionary change in our economy.

But, we shall not be able to reap the real and optimum benefit of Zakat system until and unless the government comes forward to realise the same compulsorily from the affluent people of the society. Actually, very few people will be willing to give Zakat considering it as a religious binding. Even during the time of Hazrat Omar (Ra.) a group of people, after the death of the Prophet Mohammad (SA.), expressed unwillingness to give the same.

But, Hazrat Omar (Ra.) was bold enough to declare, “I shall declare war against those, who, during the lifetime of Prophet Mohammad (Sa.), used to give even a rope of camel as Zakat, are not willing to give the same.” So, it is no wonder that even today there is no dearth of such people among the Muslims as will be unwilling to give Zakat. It is human nature that unless compelled, they do not easily like to part with their wealth. If the government can compel its citizens to pay taxes for all kinds of commodities and services they use, than it can easily compel them to give Zakat also.

Until and unless the government comes forward in this regard, the role of Zakat in eradicating poverty will not be as pervasive as it was during the rule of Hazrat Omar (Ra.).

In conclusion, we must hope that the government which can allow the Islamic banks to function for economic development of the country can also introduce Zakat system to reduce its dependence on the IMF, World Bank and other foreign donors that give us money on condition and ultimately, keep no role in our economic development.

Besides, the so-called NGOs, which have actually opened up business centres in the country in the guise of lending money to the poorest of the poor on high rate of interest, will gradually find themselves irrelevant if Zakat system is fully geared up. There is hardly any example that any poor nation was able to become self-dependent with the prescriptions of the IMF and the WB. If there is any at all, it is by accident. The earlier government realises it and takes step in that direction, the better.

© Copyright 2003 by The New Nation

In his Prolegomena (The Muqaddimah), ‘Abd al-Rahman Ibn Muhammad Ibn Khaldun al-Hadrami of Tunis (A.D. 1332-1406), commonly known as Ibn Khaldun, laid down the foundations of different fields of knowledge, in particular the science of civilization (al-’umran). His significant contributions to economics, however, should place him in the history of economic thought as a major forerunner, if not the “father,” of economics, a title which has been given to Adam Smith, whose great works were published some three hundred and seventy years after Ibn Khaldun’s death. Not only did Ibn Khaldun plant the germinating seeds of classical economics, whether in production, supply, or cost, but he also pioneered in consumption, demand, and utility, the cornerstones of modern economic theory.

Before Ibn Khaldun, Plato and his contemporary Xenophon presented, probably for the first time in writing, a crude account of the specialization and division of labor. On a non-theoretical level, the ancient Egyptians used the techniques of specialization, particularly in the era of the Eighteenth Dynasty, in order to save time and to produce more work per hour. Following Plato, Aristotle proposed a definition of economics and considered the use of money in his analysis of exchange. His example of the use of a shoe for wear and for its use in exchange was later presented by Adam Smith as the value in use and the value in exchange. Another aspect of economic thought before Ibn Khaldun was that of the Scholastics and of the Canonites, who proposed placing economics within the framework of laws based on religious and moral perceptions for the good of all human beings. Therefore all economic activities were to be undertaken in accordance with such laws.

Ibn Khaldun was cognizant of these ideas, including the one relating to religious and moral perceptions. The relationship between moral and religious principles on one hand and good government on the other is effectively expounded in his citation and discussion of Tahir Ibn al-Husayn’s (A.D. 775-822) famous letter to his son ‘Abdallah, who ruled Khurasan with his descendants until A.D. 872. From the rudimentary thoughts of Tahir he developed a theory of taxation which has affected modern economic thought and even economic policies in the United States and elsewhere.

This paper attempts to give Ibn Khaldun his forgotten and long overdue credit and to place him properly within the history of economic thought. He was preceded by a variety of economic but elemental ideas to which he gave substance and depth. Centuries later these same ideas were developed by the Mercantilists, the commercial capitalists of the seventeenth century-Sir William Petty (A.D. 1623-1687), Adam Smith (A.D. 1723-1790), David Ricardo (A.D. 1772-1823), Thomas R. Malthus (A.D. 1766-1834), Karl Marx (A.D. 1818-1883), and John Maynard Keynes (A.D. 1883-1946), to name only a few-and finally by contemporary economic theorists.

Labor Theory of Value, Economics of Labor, Labor as the Source of Growth and Capital Accumulation

With the exception of Joseph A. Schumpeter, who discovered Ibn Khaldun’s writings only a few months before his death, Joseph J. Spengler, and Charles Issawi, major Western economists trace the theory of value to Adam Smith and David Ricardo because they attempted to find a reasonable explanation for the paradox of value. According to Adam Smith and as further developed by David Ricardo, the exchange value of objects is to be equal to the labor time used in its production. On the basis of this concept, Karl Marx concluded that “wages of labour must equal the production of labour” and introduced his revolutionary term surplus value signifying the unjustifiable reward given to capitalists, who exploit the efforts of the labor class, or the proletariat. Yet it was Ibn Khaldun, a believer in the free market economy, who first introduced the labor theory of value without the extensions of Karl Marx.

According to Ibn Khaldun, labor is the source of value. He gave a detailed account of his labor theory of value, presenting it for the first time in history. It is worth noting that Ibn Khaldun never called it a “theory,” but had skillfully presented it (in volume 2 of Rosenthal translation) in his analysis of labor and its efforts. Ibn Khaldun’s contribution was later picked up by David Hume in his Political Discourses, published in 1752: “Everything in the world is purchased by labour.”7 This quotation was even used by Adam Smith as a footnote. “What is bought with money or with goods is purchased by labour, as much as what we acquire by the toil of our body. That money or those goods indeed save us this toil. They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities.” If this passage which was published in A.D. 1776 in Adam Smith’s major work, is carefully analyzed, one can find its seeds in Ibn Khaldun’s Prolegomena (The Muqaddimah). According to Ibn Khaldun, labor is the source of value. It is necessary for all earnings and capital accumulation. This is obvious in the case of craft. Even if earning “results from something other than a craft, the value of the resulting profit and acquired (capital) must (also) include the value of the labor by which it was obtained. Without labor, it would not have been acquired.”

Ibn Khaldun divided all earnings into two categories, ribh (gross earning) and kasb (earning a living). Ribh is earned when a man works for himself and sells his objects to others; here the value must include the cost of raw material and natural resources. Kasb is earned when a man works for himself. Most translators of Ibn Khaldun have made a common mistake in their understanding of ribh. Ribh may either mean a profit or a gross earning, depending upon the context. In this instance, ribh means gross earning because the cost of raw material and natural resources are included in the sale price of an object.

Whether ribh or kasb, all earnings are value realized from human labor, that is, obtained through human effort. Even though the value of objects includes the cost of other inputs of raw material and natural resources, it is through labor and its efforts that value increases and wealth expands, according to Ibn Khaldun. With less human effort, a reversal to an opposite direction may occur. Ibn Khaldun placed a great emphasis on the role of “extra effort,” which later became known as “marginal productivity,” in the prosperity of a society. His labor effort theory gave a reason for the rise of cities, which, as his insightful analysis of history indicated, were the focal points of civilizations.

Whereas labor may be interpreted from Ibn Khaldun’s ideas as both necessary and sufficient conditions for earnings and profit, natural resources are only necessary. Labor and its effort lead to production, which is in turn used for an exchange through barter or through the use of money, that is, gold and silver. The process therefore creates incomes and profits which a man derives from a craft as the value of his labor after having deducted the cost of raw material. Long before David Ricardo published his significant contribution to the field of economics in 1817, The Principles of Political Economy and Taxation, Ibn Khaldun gave the original explanation for the reasons behind the differences in labor earnings. They may be attributed to differences in skills, size of markets, location, craftsmanship or occupation, and the extent to which the ruler and his governors purchase the final product. As a certain type of labor becomes more precious, that is, if the demand for it exceeds its available supply, its earnings must rise.

High earnings in one craft attract others to it, a dynamic phenomenon which will eventually lead to an increase in its available supply and consequently lower profits. This principle explains Ibn Khaldun’s original and insightful analysis of long-term adjustments within occupations and between one occupation and another. However, this point of view was attacked by John Maynard Keynes in his famous statement that in the long run we are all dead. Nevertheless, Ibn Khaldun’s analysis has not only proved to be historically correct but has also constituted the core thinking of classical economists.

Ibn Khaldun succinctly observed, explained, and analyzed how earnings in one place may be different from another, even for the same profession. Earnings of judges, craftsmen, and even beggars, for example, are directly related to each town’s degree of affluence and standard of living, which in themselves are to be achieved through the fruits of labor and the crystallization of productive communities. Adam Smith explained differences in labor earnings by comparing them in England and in Bengal along the same lines of reasoning given by Ibn Khaldun four centuries earlier as he compared earnings in Fez with those of Tlemcen. It was Ibn Khaldun, not Adam Smith, who first presented the contribution of labor as a means of building up the wealth of a nation, stating that labor effort, increase in productivity, and exchange of products in large markets are the main reasons behind a country’s wealth and prosperity. Inversely, a decline in productivity could lead to the deterioration of an economy and the earnings of its people. “A large civilization yields large profits [earnings] because of’ the large amount of [available] labor which is the cause of [profit].”

It was also Ibn Khaldun, long before Adam Smith, who made a strong case for a free economy and for freedom of choice.

Among the most oppressive measures, and the ones most deeply harming society, is the compelling of subjects to perform forced work unjustly. For labour is a commodity, as we shall show later, in as much as incomes and profits represent value of labour of their recipients…nay most men have no source of income other than their labour. If, therefore, they should be forced to do work other than that for which they have been trained, or made to do forced work in their own occupation, they would lose the fruit of their labour and be deprived of the greater part, nay of the whole, of their income.

To maximize both earnings and levels of satisfaction, a man should be free to perform whatever his gifted talents and skilled abilities dictate. Through natural talents and acquired skills, man can freely produce objects of’ high quality, and, often, more units of labor per hour.

Demand, Supply, Prices, and Profits

In addition to his original contribution to the economics of labor, Ibn Khaldun introduced and ingeniously analyzed the interplay of several tools of economic analysis; such is demand, supply, prices, and profits.

Demand for an object is based on the utility of acquiring it and not necessarily the need for it. Utility is therefore the motive force behind demand. It creates the incentives for consumer spending in the marketplace. Ibn Khaldun had therefore planted the first seed of modern demand theory, which since been developed and expanded by Thomas Robert Malthus, Alfred Marshall, John Hicks, and others. As a commodity in demand attracts increased consumer spending, both the price and the quantity sold are increased. Similarly, if the demand for certain crafts decreases, its sales fall and consequently its price is reduced.

Demand for a certain commodity also depends upon the extent to which it will be purchased by the state. The king and his ruling class purchase much larger quantities than any single private individual is capable of purchasing. A craft flourishes when the state buys its product. With his ingenious analytical mind, Ibn Khaldun had further discovered the concept known in modern economic literature as “derived demand.” “Crafts improve and increase when the demand for their products increases.” Demand for a craftsman is therefore derived from the demand for his product in the marketplace.

As is commonly known, modern price theory states that cost is the backbone of supply theory. It was Ibn Khaldun who first examined analytically the role of the cost of production on supply and prices. In observing the differences between the prices of foodstuffs produced in fertile land and of that produced in poor soils, he traced them mainly to the disparity in the cost of production.

[In] the coastal and hilly regions, whose soil is unfit for agriculture, (inhabitants) were forced to apply themselves to improving the conditions of those fields and plantations. This they did by applying valuable work and manure and other costly materials. All this raised the cost of agricultural production, which costs they took into account when fixing their price for selling. And ever since that time Andalusia has been noted for its high prices ….The position is just the reverse in the land of the Berbers. Their land is so rich and fertile that they do not have to incur any expenses in agriculture; hence in that country foodstuffs are cheap.

Besides individual and state demand and cost of production, Ibn Khaldun introduced other factors which affect the price of goods or services, namely, the degree of affluence and the prosperity of districts, the degree of concentration of the wealthy, and the degree of customs duties being levied on middlemen and traders. The direct functional relationship between income and consumption as presented by Ibn Khaldun paved the road to the theory of consumption function as a cornerstone of Keynesian economics.

Ibn Khaldun also made an original contribution in his concept of profits. In economic literature, a theory of profit as a reward for undertaking risk in a future of uncertainties is generally attributed to Frank Knight, who published his ideas in 1921. There is no doubt that Frank Knight substantially advanced a well-established theory of profit. Nevertheless, it was Ibn Khaldun, not Frank Knight, who originally planted the seed of this theory: “Commerce means the buying of merchandise and goods, storing them, and waiting until fluctuation of the market brings about an increase in the prices of (these goods). This is called profit (ribh).” In another context, Ibn Khaldun stated again the same idea: “Intelligent and experienced people in the cities know that it is inauspicious to hoard grain and to wait for high prices, and that the profit (expected) may be spoiled or lost through (hoarding).” Profit is therefore a reward for undertaking a risk. In the face of future uncertainties, a risk-bearer may very well lose instead of gain. Similarly, profits or losses may accrue as a result of speculation which is carried out by profit-seekers in the marketplace. To maximize profits, Ibn Khaldun introduced a gospel for traders, “Buy cheap and sell dear,” which has been widely quoted ever since. In his translation of the Muqaddimah of Ibn Khaldun, Franz Rosenthal stated in a footnote, “In 1952 a book by Frank V. Fischer appeared, entitled Buy LowSell High: Guidance for the General Reader in Sound Investment Methods and Wise Trade Techniques.“

If Ibn Khaldun’s gospel is applied to cost analysis, it becomes obvious that profit may be increased, even for a given price of a final product, when one reduces the cost of raw material and other inputs used in production by buying them at a discount or, in general, at a low price even from distant markets, as he indicated in his account of benefits of foreign trade. Nevertheless, Ibn Khaldun concluded that both excessively low prices and excessively high prices are disruptive to markets. It is therefore advisable that states not hold prices artificially low through subsidies or other methods of market intervention. Such policies are economically disastrous because the low-priced goods will disappear from the market and there will be no incentive for suppliers to produce and sell whenever their profits are adversely affected. Ibn Khaldun also concluded that excessively high prices will not be compatible with market expansion. As the high-priced goods sell less in the market, the policy of excessively high pricing becomes counterproductive and disrupts the flow of goods in markets. Ibn Khaldun had thus laid down the foundations of ideas which later led to the formulation of disequilibrium analysis. He also cited several factors affecting the upward general price level, such as increase in demand, restrictions of supply, and increase in the cost of production, which includes a sales tax as one of the components of a total cost. After his analysis of what stimulates overall demand in it growing economy, Ibn Khaldun stated the following:

Because of the demand for (luxury articles), they become customary, and thus come to be necessities. In addition, all labor becomes precious in the city, and the conveniences become expensive, because there are many purposes for which then, are in demand in view of the prevailing luxury and because the government makes levies on market and business transactions. This is reflected in the sales prices. Conveniences, foodstuffs, and labor thus become very expensive. As a result, the expenditures of the inhabitants increase tremendously in proportion to the civilization of (the city). A great deal of money is spent. Under these circumstances, (people) need a great deal of money for expenditures, to procure the necessities of life for themselves and their families, as well as all other requirements.

As to the impact of restricted supply on the price level, Ibn Khaldun summed it up thus: “When goods are few and rare, their prices go up.”

By carefully reading the above two passages, it becomes obvious that Ibn Khaldun discovered what is now known as cost-push and demand-pull causes of inflationary pressures. In fact, he was the first philosopher in history who systematically identified factors affecting either the price of a good or the general price level.

Macroeconomics, Growth, Taxes, Role of Governments, and Money

In macroeconomics, Ibn Khaldun laid the foundations of what John Maynard Keynes called “aggregate effective demand,” the multiplier effect and the equality of income and expenditure.25 When there is more total demand as population increases, there is more production, profits, customs, and taxes. The upward cycle of growth continues as civilization flourishes and a new wave of total demand is created for the crafts and luxury products. “The value realized from them increases, and, as a result, profits are again multiplied in the town. Production there is thriving even more than before. And so it goes with the second and third increase.” People’s “wealth, therefore, increases and their riches grow, the customs and ways of luxury multiply, and all the various kinds of crafts are firmly established among them.” The concept of the multiplier was later developed and expanded by several economists, in particular by John Maynard Keynes. However, it was discovered for the first time in history by Ibn Khaldun.

Modern national income accounts were also developed and expanded using the equality of income and expenditures. Expenditures of one citizen are income to others; therefore total expenditures are equal to total incomes. This equality was first discovered by Ibn Khaldun. In fact, he used both terms as synonymous to one another after having established the equality between them. “Income and expenditure balance each other in every city. If the income is large, the expenditure is large, and vice versa. And if both income and expenditure are large, the inhabitants become more favourably situated, and the city grows.”

Ibn Khaldun introduced the pioneering theory of growth based on capital accumulation through man’s efforts.

(Man) obtains (some profits) through no efforts of his own, as, for instance, through rain that makes the fields thrive, and similar things. However, these things are only contributory. His own efforts must be combined with them, as will be mentioned. (His) profits will constitute his livelihood, if they correspond to his necessities and needs. They will be capital accumulation it they are greater than (his needs).”

Ibn Khaldun gave his account of the stages of economic development, from nomadic to agricultural to more “cooperation in economic matters” which occur through an expansion of a town to a city, where demand increases and skilled labor congregates and expands production both ill quantity and in “refinement.” Economic growth continues so long as there is an extra effort which creates capital accumulation, which in turn, combined with effort, leads to more production and the development of crafts in the cities. As was presented earlier, wealth expands through labor and its efforts, whereas with less human effort there may occur a reversal to stagnation, followed by a downward trend in people’s standard of living.

Governments play an important role in growth and in the country’s economy in general through their purchases of goods and services and through their fiscal policy of taxation and expenditures. Governments may also provide an environment of incentives for work and prosperity or, inversely, a system of oppression which is ultimately self-defeating. Even though Ibn Khaldun regards governments as inefficient, “not so much calculation” is carried out by them of what is contemporarily known as cost and benefit; they still play an important role in the country’s economy through their big purchases. Government expenditures stimulate the economy by increasing incomes, which are further hiked through a multiplier effect. However, if the king hoards the amount he collects in taxes, business slackens and the economic activities of the state are adversely affected through the multiplier effect. In addition to its welfare program for the poor, the widows, the orphans, and the blind, provided there is no overburden for the treasury, the government should spend its tax revenue wisely to improve conditions of its “subjects, to safeguard their rights and to preserve them from harm.”

Ibn Khaldun was the first major contributor to tax theory in history. He is the philosopher who shaped the minds of several rulers throughout history. More recently his impact was evident on John F. Kennedy and later on Ronald Reagan. “Our true choice is not between tax reduction on the one hand and avoidance of large federal deficits on the other. An economy stilled by restrictive tax rates will never produce enough revenue to balance the budget, just as it will never produce enough jobs or enough profits.” John F. Kennedy said that back in 1962, when he was asking for a tax decrease, a cut in tax rates across the board. But when John Kennedy said those words, he was echoing the words of Ibn Khaldun, a Muslim philosopher back in the fourteenth century, who said the following: “At the beginning of the dynasty taxation yields large revenues from small assessments. At the end of the dynasty taxation yields small revenue from large assessments….This is why we had to have the tax program as well as the budget cuts, because budget cuts, yes, would reduce government spending.”

According to Ibn Khaldun, tax revenues of the ruling dynasty increase because of business prosperity, which flourishes with easy, not excessive taxes. He was therefore the first in history to lay the foundation of a theory for the optimum rate of taxation, a theory which has even affected contemporary leading advocates of supply-side economics such as Arthur Laffer and others. The well-known Laffer curve is nothing but a graphical presentation of the theory of taxation developed by Ibn Khaldun in the fourteenth century.

“When tax assessments and imposts upon the subjects are low, the latter have the energy and desire to do things. Cultural enterprises grow and increase, because the low taxes bring satisfaction. When cultural enterprises grow, the number of individual imposts and assessments mount. In consequence, the tax revenue, which is the sum total of the individual assessments, increases”; whereas with large tax assessments, incomes and profits are adversely affected, resulting, in the final analysis, in a decline in tax revenue. Ibn Khaldun made a strong case against any government attempt to confiscate or otherwise affect private property. Governments’ arbitrary interferences in man’s property result in loss of incentives, which could eventually lead to a weakening of the state. Expropriation is self-defeating for any government because it is a form of oppression, and oppression ruins society.

In macroeconomics Ibn Khaldun also contributed to the theory of money. According to him, money is not a real form of wealth but a vehicle through which it can be acquired. He was the first to present the major functions of money as a measure of value, a store of value and a “numeraire.” “The two mineral ’stones,’ gold and silver as the (measure of) value for all capital accumulations … [are] considered treasure and property. Even if under certain circumstances, other things are acquired, it only for the purpose of ultimately obtaining [them]. All other things are subject to market fluctuations from which (gold and silver) are exempt. They are the basis of profit, property and treasure.” The real form of wealth is not money, however; wealth is rather created or otherwise transformed through labor in the form of capital accumulation in real terms. It was, therefore, Ibn Khaldun who first distinguished between money and real wealth, even though he realized that the latter may he acquired by the former. Yet money plays a much more efficient role than barter in business transactions in a society where man exchanges the fruits of his labor, whether in the form of goods or of services, with another to satisfy the needs which he cannot fulfill alone on his own. Money also facilitates the flow of goods from one market to another, even across the border of countries.

Foreign Trade

Ibn Khaldun also contributed to the field of international economics. Through his perceptive observations and his analytical mind, he undoubtedly shed light on the advantages of trade among nations. Through foreign trade, according to Ibn Khaldun, people’s satisfaction, merchants’ profits, and countries’ wealth are all increased.

The merchant who knows his business will travel only with such goods as are generally needed by rich and poor, rulers and commoners alike. (General need) makes for a large demand for his goods…it is more advantageous and more profitable for the merchants’ enterprise… (that he will be able to take advantage of) market fluctuations, if he brings goods from a country that is far away…merchandise becomes more valuable when merchants transport it from one country to another.

The italicized word, valuable, indicates Ibn Khaldun’s perception of the gains of trade. If a good becomes more valuable by being transported from country A to country B and still sells at a profit in B after the cost of transportation and all other costs are taken into account, then it is (1) cheaper than the same good produced internally, (2) of better quality, or (3) a totally new product. If the foreign good is cheaper than that produced internally, foreign trade will serve to economize labor and other resources by having them diverted from the high-cost good which cannot face competition to other low-cost products. The resources which are saved from this process of diversion may be used to produce other goods or may add another layer of capital accumulation. Foreign trade may therefore contribute positively to the country’s level of income as well as to its level of growth and prosperity. If the foreign good is of a better quality than that produced internally, the imported good will add to the level of satisfaction of those who purchase it. In the meantime, internal producers facing the competitive high-quality product must attempt to improve their production or accept a reduction in their sales and revenues. There will be a welfare gain in either case: a rise in the quality of internal products or a diversion of resources from the production of a high-cost good to a low-cost good, as in the first case. In the last case, when the imported good is a totally new product, the welfare gain from foreign trade may be expressed in terms of an increase in the level of satisfaction of those who purchase it or in terms of an increase in quantity or quality of production of other goods if the imported item is a new tool or a modification of an existing one. Furthermore, an introduction of a totally new product through foreign trade may attract internal producers, if it is feasible, to produce it once they are capable to compete with the foreign product.

Ibn Khaldun was conscious of what was later termed the “opportunity cost.” Applying valuable labor to improving poor soils means that the labor could have been better used in the production of other goods. Resources in general should be put to the best possible use. Otherwise there will be a cost which will surface in a loss in value. Foreign trade provides further incentives in the attempts to optimize the use of labor and other natural resources.

Ibn Khaldun’s originality in his perceptive observations and analysis of foreign trade deserves proper recognition in the field of international economics. The subject of gains from trade has been substantially developed and expanded, in particular, since the publication of Political Discourses by David Hume in 1752. But the first original seed of the subject was planted by Ibn Khaldun four centuries earlier.

Ibn Khaldun and Adam Smith

In spite of Ibn Khaldun’s overall contribution to the field of economics, it is Adam Smith who has been widely called the “father of economics.” Schumpeter’s view of Smith’s economics is more critical than admiring. “Personally, I do not share such a view, for I still consider Adam Smith one of the great philosophers who has significantly contributed to the field of economics even by having been a mere collector of previous economic thoughts. He eloquently presented these ideas in detail in an excellent new form and style. Nevertheless, by comparison, Ibn Khaldun was far more original than Adam Smith, in spite of the fact that the former had also restructured and built upon foundations laid down before him, such as Plato’s account of specialization, Aristotle’s analysis of money, and Tahir Ibn al-Husayn’s treatment of government’s role. Still, it was Ibn Khaldun who founded the original ideas in numerous areas of economic thought.

Despite Ibn Khaldun’s contributions, some economic ideas as well as some economic philosophy of the freedom of choice, as presented above, were later attributed to Adam Smith without giving due credit to the original thinker Ibn Khaldun. “Smith’s great economic treatise contains both his ‘preaching’ of the ‘gospel’ of economic liberalism, i.e., economic freedom for all individuals.”39 Since there is such a striking similarity in the economic thought of Ibn Khaldun and of Adam Smith, it must be left to the economic historian to ascertain direct or indirect links between these two great thinkers who were four centuries apart. However, I would like to suggest some possible and likely points of contact. Even though Adam Smith did not explicitly refer to Ibn Khaldun’s contributions, it may well be argued that there were several channels through which he may have encountered the latter’s pioneering and original economic thought.

Adam Smith graduated from Glasgow University, where he was influenced by his teacher Francis Hutcheson, who was in turn affected by Antony Ashley Cooper, known as Lord Shaftesbury in the late seventeenth century and early eighteenth century, and other philosophers who were concerned with “liberal enlightenment,” all of whom may have been directly or indirectly affected by Ibn Khaldun’s thought. After his graduation, Adam Smith devoted six years to research at Oxford University’s library, where he may have been exposed to Ibn Khaldun’s contributions even without having been aware of the author’s name. It was not uncommon in early times that ideas were circulated, discussed, and delivered from one generation to another without the name of an author. Furthermore, ever since the Crusades, which lasted from the eleventh to the thirteenth centuries, most Western philosophers attempted to discount the impact of Muslim scholars through a multiplicity of approaches, which included using Muslim ideas without mentioning the name of a Muslim author. The protracted war waged by the Crusaders to capture the Holy Land from the Muslims created a strong antagonistic feeling, well embedded in the Western mind, from which Western scholars were not immune and which lasted for centuries, probably until modern times. Another possible channel through which Adam Smith may have been directly or indirectly exposed to Ibn Khaldun’s economic thought was through his tour of Europe. During this tour he encountered Quesnsay, other Physiocrats in Paris, and other European intellectuals who may have been influenced by Ibn Khaldun in one way or another.

Adam Smith could also have been exposed to the economic contributions of Ibn Khaldun through the dominant influence of the Ottoman Empire. Ever since the Ottoman Empire rose in the fourteenth century-and vastly extended its boundaries at its peak in the sixteenth century to include much of southeast Europe, southwest Asia, and northern Africa-a new bridge was erected linking intellectuals in the Continent with their counterparts in the vast territories of the empire, of which Egypt became a part in 1517. It was in Egypt that Ibn Khaldun spent the latter part of his life revising manuscripts of his works which he had originally completed in Tunis in November of 1377. His thoughts were then transmitted from one generation to another, from one century to another, and from one country to another. Influenced by Ibn Khaldun’s idea that craftsmen and industrialists play a significant role in a country’s growth, prosperity, and power, Sultan Selim 1, after having successfully extended his domain of influence over Egypt in 1517, took back with him from Cairo to Constantinople the best-known artisans at that time. In modern terminology, this was a case of a “transfer of technology.”

The impact of Ibn Khaldun was extensive and profound, not only in the minds of some rulers and statesmen, but also among intellectuals and educators long before his books were even translated into other languages, In response to great interest in his works, his books were finally translated to the Turkish language in 1730, exactly forty-six years before the publication of Adam Smith’s The Wealth of Nations.

Concluding Remarks

Even if Adam Smith was not directly exposed to Ibn Khaldun’s economic thoughts, the fact remains that they were the original seeds of classical economics and even modern economic theory. Ibn Khaldun had not only been well established as the father of the field of sociology, but he had also been well recognized in the field of history, as the following passage from Arnold Toynbee indicates:

In his chosen field of intellectual activity [Ibn Khaldun] appears to have been inspired by no predecessors … and yet, in the Prolegomena … to his Universal History he has conceived and formulated a philosophy of history which is undoubtedly the greatest work of its kind that has yet been created by any mind in any time or place.

Through his great sense and knowledge of history, together with his microscopic observations of men, times, and places, Ibn Khaldun used an insightful empirical investigation to analyze and produce original economic thought. He left a wealth of contributions for the first time in history in the field of economics. He clearly demonstrated breadth and depth in his coverage of value and its relationship to labor; his analysis of his theory of capital accumulation and its relationship to the rise and fall of dynasties; his perceptions of the dynamics of demand, supply, prices, and profits; his treatment of the subjects of money and the role of governments; his remarkable theory of taxation, and other economic subjects. His unprecedented contributions to the overall field of economics should make him, Ibn Khaldun, the father of economics.

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Islamic Banking is not a Utopia anymore as was thought to be. When scholars first talked about this idea in the 1940’s, people in the West laughed at the idea of Banking without Interest. It was inconceivable at that time since most of the Muslim countries were reeling under colonial rule; as such there were no takers for this idea. It was only in the later part of the 20th century that scholars attempted at giving a practical shape to the idea of interest-free financial mechanism.
The first successful attempt at establishment of an Islamic Bank was made way back in the year 1963 in Mit Ghamr, Egypt. The bank proved to be a huge success with accounts and deposits swelling within a short period of its existence. The success of the bank gave a much needed impetus to the growth of this nascent banking sector in other parts of the world. The emergence of affluent petro-economy in the Gulf region was another God-sent impulsion in creating interest-free financial institutions catering to the financial needs of vast Muslim population having newly acquired capital wealth. Such capital was not coming into the conventional financial markets for the reason that interest was not welcome. Thus came into existence institutions like Islamic Development Bank (IDB), and the chain of Dar-al-Maal-al Islami (DMI) Trust Group, KSA, which mostly catered to the financial needs of the member countries at governmental level. This was immediately followed by the establishment of Islamic banks all over the Globe. Thereafter the Islamic Banks have shown a rapid growth in the Muslim countries as well as the West.
The Islamic Banks have now carved out a definite space for themselves in the Banking sector of the world. These are now an integral part of the banking system in the Muslim countries as well as the West including the United Kingdom, Germany and the USA. There are about 150 Islamic banks and institutions functioning and catering to the needs of the Muslim population all over the world at present. Besides this a number of major banks of the world like Citibank, HSBC, ABN Amro and ANZ Grindlays have converted part of their financial portfolio into the Islamic mode and opened an Islamic window for operating the equity based banking. Countries like Malaysia, Saudi Arabia, Iran, Pakistan, Sudan, UK and many other countries are leading in patronizing the emergence and establishment of these banks having recognized the role such banks are playing in handling a vast capital resource willing to be invested in risk-bearing instruments and growing with the economies of the region wherever they operate.

Areas of Co-operation between Islamic & Conventional Banks
Since Islamic banks are handling a substantial amount of business in the banking sector, it is inconceivable to think that these can function in isolation. Similarly the conventional banks cannot ignore the Islamic banks given the sheer size of the Muslim population and the quantity of capital that is available for investment with the Muslim population of the world.
The other major reason for cooperation between the Islamic Banks and the conventional banks is the fact that huge trade is going on between the Islamic countries and the rest of the world, particularly with the Europe, USA and Japan. Therefore the Islamic banks and the conventional banks are forced by the circumstances to establish relationships. These relationships include Correspondence Services, Documentary Credit and Exchange of Funds.
The areas in which the Islamic banks and the conventional banks cooperate are all sorts of international and domestic bank transfers. This may include collection of bills except for discounting which involves interest. The customers can also be serviced by purchase and sale of traveler’s cheque, issuing and acceptance of drafts, cheques and remittance to and from abroad.
In order to make this system functional so that the Islamic Banks do not compromise their principles, Islamic banks are required to open interest-free operating accounts with the corresponding conventional banks. Overdrafts are to be kept within agreed limits and to be replenished immediately so as to avoid bearing interest on them.
The Islamic banks can also facilitate customers of such banks which do not have branches in areas where the Islamic bank is operating or where no other bank exists. This can be done by opening operating accounts in either bank without interest. However there could be mutual payment of agreed commission on each collection of bill, transfer of drafts, cheques and remittances.
It is a fact that the Islamic banks do not enjoy a wide network in every country of the world as of today. As such situations arise when an Islamic bank intends to import commodities from a country where no Islamic bank exists. Or else the supplier wants to open an account at a certain bank of his choice. In that case the Islamic bank can open a credit account with that bank in the specific area.
The Islamic bank may ask the correspondent bank to add its confirmation to letters of credit opened on behalf of the supplier to importers. The Islamic bank would keep a surplus in the credit account to cover its expected obligation to the supplier. Thus facilities for documentary credit can be extended. The Islamic bank however should not delay the transfer of the value of the documentary credit so that the correspondent bank is saved from being charged interest for the delay in payments. Furthermore agreements with foreign banks may be made on the basis of simple exchange of letters while extending the facility to the Foreign bank to an agreed ceiling without charging interest should the account go into red. In return the Islamic bank agrees to keep a reasonable amount of cash in their accounts and to cover any debits as soon as possible. There should be no facility for payment on the part of the supplier in return for interest.
The foreign banks usually agree to participate in the documentary credit by securing a partial security by debiting the Islamic bank with a certain cash margin. The Islamic bank is also required to keep cash balance of just the amount which is sufficient to cover up the cash margin and not the whole value of the letters of credit. It has already been pointed out that the conventional banks are recognizing the huge business potential that lies in the untapped capital available in the Muslim world. As such there have arisen possibilities for exchange of funds in many ways that are beneficial to both the Islamic and the conventional banks. The following forms may be possible for this exchange between the two types of banks that exist in almost all the major cities of the world.

• The Islamic Banks may accept funds from the conventional banks on the basis of Mudaraba contracts in the form of investment accounts. The return may be calculated on the yield from the investment pool. The return shall be in the manner as is payable to the customers of the Islamic bank who have invested in the investment account of the bank.
• Islamic banks can also indulge in exchange of different types of currency on a barter system with a conventional bank. Both banks can make a deposit of the surplus currency in exchange for the deficient currency over a period of time. At the end of the agreed period the banks restore the original funds.
• In case the conventional banks are interested in joint finance with the Islamic banks, this is possible through the permissible instruments like Musharaka, leasing, hire purchase etc. However the Islamic banks are hindered in taking up such joint financial cooperation with the conventional banks because those banks use such money which is derived by interest-based methods. For this reason the OIC Fiqh Academy has not approved the taking up of the equity of interest-based institutions.

In the ever-changing scenario of the free-market economy, Islamic banking has opened up new vistas for the existing banking sector to reach out to the hitherto untapped capital and utilizing the same for the collective growth of the economies of the countries in which such an activity takes place and the growth of banking sector itself. This new trend is sure going to set in a new phase of financial cooperation between the Islamic banks and the conventional banks.

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