Financialised ethics,economic security and the promise of Islamic finance

Abstract

The character and state of a financial system are important contributing factors to the performance, stability and security of any economy, something which has been repeatedly demonstrated during times of financial crisis. While assessments of earlier financial crises tended to focus on shortcomings in the governance of financial sectors, not least when crises occurred in the developing world, many have noted issues with the moral character of the industry, and the attendant processes of securitisation and financialisation, in the wake of the transatlantic financial crisis of 2007–2008. Against these recent criticisms, Islamic finance was pitched as a more ethical, stable and secure alternative. Although the ideas that inform the development of Islamic finance might hold the promise of a more ethical alternative to conventional finance, the industry itself has not been immune to processes of financialisation and securitisation, which have arguably undermined the market's initial promise.

Keywords

economic security ethics finance Islamic finance

The importance of the financial sector to the economic development and well-being of East Asian economies, in fact any economy, is well-established. The ability to mobilise financial resources to economic ends is a key feature of the literature on state-led developmental models in which East and Southeast Asian economies have featured prominently.¹ Economic development, growth and, by extension, security would be impaired without a well-functioning financial system. From this perspective, the financial sector has historically been viewed as a ‘handmaiden’ to the ‘real’ sector of the economy, where tangible goods are produced. Indeed, it is the production of manufactured goods and the primacy of the ‘real’ sector that have underpinned the export-led growth that has characterised East and Southeast Asian economies in the second half of the 20th century.

Over time, the financial sector has however increasingly become a source of economic value in its own right and has consequently become a target of policy reforms to unlock its economic potential (Lai, 2015a). Policy actions to liberalise the sector, led by the United States and the United Kingdom and followed by many others since the 1980s, have led to a rise in the relative importance of the financial sector in the economy (Financial Crisis Inquiry Commission, 2011; Helleiner, 1994). The East and Southeast Asian economies are no exception (Carroll and Jarvis, 2015; Rethel, 2018). Alas, the liberalisation and expansion of the financial sector since the 1980s have been accompanied by a series of financial crises afflicting a variety of countries (Reinhart and Rogoff, 2009).

Many researchers and policy-makers have unsurprisingly attempted to understand the causes of these crises. History has vividly demonstrated the devastating consequences of financial instability on not just the financial sector but also the economy more widely, a matter with which Southeast Asia became deeply familiar in 1997. Financial stability is clearly critical to economic security, if the latter is understood as ‘safeguarding the structural integrity and prosperity-generating capabilities and interests of a politico-economic entity in the context of various externalised risks and threats that confront it’ (Dent, 2001: 6). Events such as the Asian Financial Crisis in the late 1990s have demonstrated time and again that turmoil in the financial system can threaten the structural integrity of not just national but also global economies, thus undermining the ability of both to generate welfare-enhancing goods and services. How, then, can we ensure financial stability, and by extension economic security?

Earlier assessments, when financial crises were largely phenomena of the developing world, have tended to highlight issues with the liberalisation of those markets (see for example Goldstein, 1998; Woo et al., 2000). Crises emerged because the financial sector was liberalised too quickly, in a poorly sequenced manner or without proper governance frameworks, as Singh (1998) has argued with reference to East and Southeast Asian economies in the context of the Asian Financial Crisis. Regulators’ inability to control the emergence and growth of asset price bubbles was often a source of weakness in developing markets. Issues were also identified with the management of capital accounts and international debt, which created vulnerabilities such as mismatches in either currency or tenure of financial obligations. For the most part, the dominant prescriptions that emerged out of these earlier crises focused on shortcomings with the management and regulation of financial sectors, and effectively with the actions, or inactions, of their respective national governments and regulators.

Criticisms of systemic features of the financial sector became more vociferous and forceful in the wake of the financial crisis that struck advanced economies in 2007–2008, when analysts focused on the role of professionals in the financial sector in addition to, and in combination with, their interaction with the regulatory system in creating conditions that undermined the stability of the financial system as a whole. Of particular note is the critique that practices in the financial sector were ethically questionable. In a report published by a 10-member commission established in 2009 by the United States’ Congress to investigate the causes of the financial and economic crises of 2007 in the United States, the Commission found ‘systemic breakdown in accountability and ethics’ in the US financial sector, as well as ‘an erosion of standards of responsibility and ethics that exacerbated the financial crisis’, which ‘stretched from the ground level to the corporate suites’ (Financial Crisis Inquiry Commission, 2011: xxii).

The Commission's report offered an impressively detailed account of the unfolding of the financial crisis and is filled with compelling examples narrated in an engaging manner. According to the report, the main driver of vulnerability in the financial system was the proliferation and subsequent securitisation of sub-prime mortgages, and the growing use of collateralised debt obligations (CDOs) and credit default swaps (CDSs). These financial instruments interacted extensively to form a pipeline of activity that generated considerable economic opportunities and risks. At its worst, it was found that:

mortgages were knowingly, and sometimes predatorily, offered to borrowers who had little ability to repay;

individuals and firms that were securitising mortgages did not perform adequate due diligence on the mortgages used to underpin the security and at times knowingly waived compliance with underwriting standards;

CDOs were sold to investors with incomplete, if not misleading information;

in practice, CDSs were no more than simple bets on outcomes in the market instead of sophisticated financial instruments to hedge risks as they were purportedly meant to be;

the nature of the bets embedded in CDSs created conditions that favoured market failure (from which counterparties benefitted) and thus reduced incentives for markets actors to exercise more diligence; and

market regulators failed to enforce existing regulations, let alone identify newly emerging vulnerabilities in the system.

The Commission damningly concluded that ‘there was a significant failure of accountability and responsibility throughout each level of the lending system’ (Financial Crisis Inquiry Commission, 2011: 125). Looking back in 2015, the Managing Director of the IMF stated that:

actions that precipitated the crisis were – mostly – not so much fraudulent as driven by short-term profit motivation. This suggests to me that we need to build a financial system that is both more ethical and oriented more to the needs of the real economy – a financial system that serves society and not the other way round. (Lagarde, 2015)

How then can a more ethical financial system that is oriented more towards the real economy be achieved, if indeed that is the solution to insecurity wrought by contemporary financial practices? To what extent can more ethical finance succeed in challenging less ethical financial practices?

Against the background of this debate, proponents have presented Islamic finance – a niche but ‘really existing’ example of ethical finance – as a more stable and ethically preferable alternative to conventional finance by emphasising practices in the former that contrasted with those that contributed to financial instability in the latter. The Assistant Governor of the Central Bank of Malaysia, the country which is home to the third highest share of global Islamic banking assets and the world's largest outstanding volume of Islamic securities (sukuk) (Islamic Financial Services Board, 2019), claimed in a speech in 2019 that:

Islamic finance has always been subjected to higher overarching objectives that place ethical and moral conduct at its centre. … putting in place features of an embedded governance that support the highest level of integrity and good conduct … Islamic finance therefore naturally has the potential to take the lead striving towards an ethical, moral and also sustainable model for finance in the global financial system. (Adnan Zaylani, 2019)

In Indonesia, home to the world's largest population of Muslims, the masterplan introduced in 2019 to develop the country's nascent Islamic economy envisages Islamic finance as a tool to achieve the goals of empowering ‘individuals and communities, promoting entrepreneurial culture, investing in a real and sustainable economy, hence benefitting the wider society and the country's economy’ (Ministry of National Development Planning, 2016: 1). In other words, Islamic finance is intended to facilitate a capitalist economy that is inclusive and productive.

According to at least a couple of readings, Islamic finance could, from this perspective, be seen as ‘anti-Western’ and a reaction against the process of neoliberalisation emanating from the West that has tended to emphasise market over societal outcomes (Hoggarth, 2016; Mohamad and Saravanamuttu, 2015).² Differentiation from practices and behaviour in conventional finance that could be understood and classed under the labels of securitisation and financialisation were specifically highlighted (see for instance Kamil et al., 2010). For example, under the rules of Islamic finance, financing should, in principle, only be provided when there are clear and explicit links to underlying ‘real’ (as opposed to intangible) economic activity, echoing the comments made by Lagarde in 2015. The securitisation of mortgages and the creation of CDOs and CDSs that were identified as a key source of vulnerability in the lead up to the Transatlantic crisis in 2007 are contrary to generally understood practices in Islamic finance because the link between financial instruments and underlying real economic activity is usually several times removed, and sometimes rather ambiguous. Given the requirement to tie financial instruments to ‘real’ economic activity, Islamic finance should, a priori, be less prone to processes of securitisation, less vulnerable to opaque distribution and transmission of risks, and less vulnerable to dynamics of financialisation arising from product innovation.

Given these claims of offering more ethical and stable finance, how successful has the Islamic financial industry been in avoiding and contesting processes of securitisation and financialisation? Although the ideas that inform products and practices in Islamic finance might hold the promise of a more ethical alternative to conventional finance, and despite the adoption of practices and institutional mechanisms that should, in principle, restrain perceived excesses in the financial sector and confer greater economic security, I argue in the remainder of this article that the industry itself has not been immune to processes of financialisation and securitisation. The discussion is informed largely, but not exclusively, from observations and fieldwork on the Islamic finance industry in Malaysia.

Ethics in Islamic finance

The features of Islamic finance and its ethical claims are, in the first instance, derived from a set of religious sources, the chief of which is the Quran. Although these sources outline characteristics that financial products must possess, contemporary religious scholars play a critical role in interpreting historic texts to identify their practical implications in contemporary times. This interpretive role is a source of a number of contentious issues, some of which are discussed in this article.

Islamic finance's claim to ethical superiority comes from analysing the a priori effects of practices that are derived from religious sources. For instance, usury, which arises when interest is charged on the lending of money, is forbidden in Islamic finance and can be avoided if financing take the form of equity-like arrangements as opposed to credit-like arrangements. With the former, returns to those who provide finance will come in the form of dividends or share of profits, whereas with the latter, returns will come in the form of interest payments. Credit-like forms of financing offer lenders greater certainty in outcomes as their returns (interest payments) are predetermined and known. The returns on equity-like forms of financing are less certain to investors since they are dependent on the outcome of the project or purpose of financing. As a result, it is often argued that investors and financial institutions would exercise less care when extending credit-like forms of financing because there is less at stake than when equity-like financing is involved. These dynamics have potential implications for the amount of financing extended and the level of risk in the economy. They would also result in different outcomes when an economic or financial crisis hits since we would, in principle, expect investors who offered equity-like financing to absorb a greater share of the consequences of their financial participation than lenders who offered credit-like financing.³

Another aspect of Islamic finance that is relevant to our discussion is the religious injunction that money be employed for productive purposes, which is often interpreted as a prescription that money be used to finance only ‘real’ economic activities, as opposed to, for example, using finance for speculative purposes. Consequently, the growth of CDOs, characterised by the repackaging and on-sale of debt instruments, and a key process of financialisation and structural weakness in the conventional financial sector, would not be consistent with Islamic financial principles. Without going into the technical nature of these products, suffice to say that CDOs have been described by the aforementioned congressional inquiry as not just ‘merely bets’ on the performance of real mortgage-related securities, but also ‘multiple bets on the same securities’, thus raising questions about the material bases of these instruments (Financial Crisis Inquiry Commission, 2011: xxiv).

One might conclude from these two features of Islamic finance, as did an IMF Staff Discussion Note, that ‘its risk-sharing features and prohibition of speculation suggest that Islamic finance may, in principle, pose less systemic risk than conventional finance’ (Kammer et al., 2015). This is one of the key bases for the industry's self-promotion, as illustrated by the following quotation from a flagship report published by the Islamic Financial Services Board (IFSB), an international standard-setting organisation for the global Islamic finance industry:

Islamic financial institutions, which are subject to Shari’ah regulations,⁴ are forbidden from investing in such derivative instruments [referring to CDOs and CDSs] and therefore did not have exposure to such derivatives. Also the holding of shares or the investment in conventional financial institutions which are involved in usury or riba’ are not permitted. The combination of these factors minimised the impact of the financial crisis on Islamic financial institutions. (Islamic Financial Services Board, 2010: 26)

In assessing the success of Islamic finance in offering a more ethical alternative, I focus my analysis on sukuk, often characterised as the Islamic equivalent of financial bonds even though it is more accurately described as Islamic investment trust certificates. Sukuk has a particularly high profile in the industry in part because transactions in this market frequently have high financial value and count large corporations and governments as its main participants; and in part because the development of these financial instruments has been more complex and contentious. It also shares some similarity with CDOs and CDSs, in that they are all forms of structured financial products and involve a process of securitisation. Securitisation in sukuk, however, is employed to facilitate compliance with religious injunctions, whereas in contemporary conventional finance, securitisation appears to be driven largely by a desire to transfer risks (Jobst, 2008).

Although there are variations in how sukuk is operationalised and structured, the following offers a brief example as context for the discussion that follows.⁵ Typically, financiers or investors would invest in a Special Purpose Vehicle (SPV) that will use the funds invested to purchase and take ownership of a tangible asset, which is usually an asset required in a project for which financing is sought. The SPV would then enter into an agreement with the borrower to compensate the SPV for use of the asset.⁶ Ideally, compensation would take the form of a share of the profit (or loss) generated from the use of the asset. Since returns to investors would be uncertain, investors would effectively be sharing risks of the project with the borrower. At the end of the project or period of financing, there would be an option for the borrower to acquire the asset from the SPV. The acquisition would ideally be transacted at the market price for that asset, prevailing at the time of the acquisition, rather than at a price that was pre-agreed when the financing agreement was first made. There would be less certainty to the preservation of the value of investors’ capital with the former arrangement. As before, this is intended to reflect the principle or philosophy that the provision of financing is not to merely offer funding but rather to jointly undertake risks on a project, and in effect to enter into an economic partnership.

Securitisation in Islamic finance

This complex set-up for sukuk addresses the materiality requirement of Islamic finance. As the funds raised are used to acquire a tangible asset, a clear link between the source of finance and the productive economic use of that funding can be demonstrated. A claim could be made that usury is avoided since returns to investors come in the form of dividends or share of profits, which is made possible through the intermediation of an SPV.⁷ This structured financial product should also bring about equity-like forms of financing and higher incidences of risk-sharing, both of which are expected to encourage normatively preferable practices and outcomes.

However, in practice, only a small proportion of sukuk that have been issued have a risk-sharing criteria or equity-like structure. Instead, most sukuk have financial structures that are equivalent to debt as they had been structured to deliver standard and certain periodic payments to investors that are independent of the performance of the project; and contain legal provisions that require the borrower to acquire the asset at a pre-agreed price at the end of the period of financing. According to Al-Harran (1995; cited in Ibrahim and Alam, 2018: 669), murabaha sukuk – a ‘flavour’ of sukuk that most closely resembles a fixed-interest debt instrument – made up roughly 80 to 90 per cent of Islamic banking assets from the 1970s to the 1990s.⁸ In late 2007, Sheikh Muhammad Taqi Usmani, a highly respected Islamic scholar with an international reputation, famously claimed that up to 85 per cent of all sukuk issued may not have been fully shariah-compliant (Arabian Business, 2007), which rattled the financial market and industry (Wigglesworth, 2010). This observation does not seem to have changed materially in recent years, as according to the IFSB (2015: 121), an ‘analysis of developments in Islamic banking and sukuk markets revealed some trends that are at odds with the view that risk-sharing should be a distinctive feature of Islamic finance’ and believed that there was ‘a creeping movement of [profit-sharing investment accounts] being replaced by deposits with capital guarantees and predetermined returns’. Mudarabah and musharakah structures – ways of structuring Islamic financial instruments that embody more risk-sharing and equity-like features – had persistently fallen in the years leading up to 2014, when they accounted for less than 10 per cent of new sukuk issuances. This implies that sukuk structures that resemble conventional bonds, which leave issuers to assume the bulk of the risks instead of sharing it with investors, dominated the market. More recent data suggested that only 15 to 20 per cent of outstanding sukuk embody contracts that are truly risk-sharing, with the majority being debt-based (Bacha, 2019). Tellingly, in the midst of the COVID-19 pandemic, the two standard-setting bodies of the global Islamic finance industry, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the IFSB, issued statements in May and July 2020 respectively with technical advice to financial institutions on managing payment moratoriums that have been announced by various governments.⁹ Such advice might not have been needed had financing been provided on the basis of profit-and-loss sharing, and thus stayed true to the ideals of Islamic finance, rather than on credit.

Such shortcomings in the operationalisation of the ideals of Islamic finance have led Professor Bacha (2019) at the International Centre for Education in Islamic finance (INCEIF) in Kuala Lumpur, among others, to opine that ‘the basis of Islamic finance and its true value-added, risk sharing philosophy has been relegated to insignificance. [Islamic finance] today is little more than another purveyor of debt’, which implies dealing in usury and is therefore anathema to the foundations of Islamic finance. More importantly, it raises questions about Islamic finance's claims to more prudent financial decisions and improved market stability that would come from its risk-sharing characteristics.

Aside from widespread use of credit-like financial instruments, the increasing dilution of the quality of assets and the growing use of ‘blended portfolios’ for the purpose of securitising the instrument are also ringing bells of concern. Haneef (2009) first characterised this change as an evolution from ‘asset-backed’ instruments, where sukuk-holders have ownership rights over the underlying asset and which is captured in the literature as a ‘true sale’; to ‘asset-based’ instruments, where sukuk-holders have only beneficial rights over the underlying asset and rank pari passu with unsecured creditors; and subsequently to ‘asset-light’ instruments that are securitised with minimal tangible assets. More generally, even when tangible assets are employed in securitising sukuk, there have been doubts about the materiality of these assets to the sukuk as legal provisions are often employed to subvert investors’ recourse to the underlying asset in the event of a default (Khan, 2010). The import of these developments and practices become clear in the event of a default. Investors in asset-backed sukuk would be insulated from the originator should the latter default since investors retain ownership rights of the securitised asset via the SPV. Investors in an asset-based sukuk, however, would be relatively unprotected and would have to recourse to the originator for restitution given that they have only beneficial rights to the asset in the security. In other words, the second group of investors would be treated like unsecured creditors. The shift from asset-backed to asset-based sukuk therefore has implications for the underlying risk-return profile of the financial instrument and the assertion that these Islamic securities are equity-like or embody greater sharing of risks than their conventional counterparts.

In addition to the move towards asset-based sukuk, the use of ‘blended assets’ has also emerged, giving rise to the appearance of ‘hybrid sukuk’ or ‘mixed-assets sukuk’. As the names imply, these instruments are securitised with different kinds of assets including debt, which is usually viewed as intangible and against the normative view of usury in Islamic finance, as well as other intangible assets like financial receivables (Radzi, 2018: 22–23). In other words, the object of securitisation has shifted from ‘real’ to ‘intangible’ assets. This change in the kinds of assets used to securitise sukuk has nudged sukuk progressively closer towards looking more like the kind of securitisation observed in conventional finance, where in addition to intangible assets, assets that are riskier with less certain returns are employed. Thus, instead of offering investors greater security, elements of risk transfer are now in play.

These changes in the securitisation of sukuk are driven by a combination of factors (Radzi, 2018). There is limited availability of tangible assets suitable for the purposes of securitisation. For instance, tangible assets might already be encumbered through previous fund-raising efforts, or there might be political and cultural sensitivities surrounding assets like nationally significant buildings. Another factor is the preferences of investors for familiar structures or specific risk-return profiles in financial instruments, thus influencing the types of financial instruments that are produced and marketable. Third, the ‘cooperation’ of religious advisors and scholars with accommodating liberal interpretations of religious edicts (sometimes defended as being ‘pragmatic’) is also critical to the development of the market (Ariff et al., 2012). Since religious actors are also handsomely remunerated by the very same financial institutions seeking their certification of financial products (Abbas, 2008; Liau, 2014; McBain, 2012), it is arguable that there are conflicts of interest at play. Broadly, one might conclude that the general underlying driver of the progressive dilution of the quality of assets and changes to approaches used in the securitisation of Islamic financial instruments is the pecuniary interest, rather than ethical concerns, of key actors in the market. The quality of assets and ethical ideals are sacrificed at the altar of market development from which individual financial interests can be satisfied.

Financialisation and Islamic finance

The other key ‘selling point’ of Islamic finance is that forms of finance must be used productively, which is usually interpreted as having material links to the ‘real’ economy. This is often read in contrast to an ‘ephemerality’ that has emerged in the evolution of contemporary finance in recent years, which can be articulated and understood under the notion of ‘financialisation’.

Although the word ‘financialisation’ has probably been in use since the 1990s, there is no consensus on a definition of the concept. One that is often cited takes a broad understanding of the phenomenon by defining financialisation as ‘the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operation of the economy and its governing institutions, both at the national and international levels’ (Epstein, 2005: 3). While agreeing that financialisation represented an expansion in the space of activity, many saw it as a mass social phenomenon that extended beyond finance and economics into other realms of social life (see variously Aitken, 2005; Harmes, 2001; Langley, 2008; Seabrooke, 2006; van der Zwan, 2014). However, for some observers, financialisation signifies not just a change in space but also a change in kind where financialisation can be understood as a shift from productive to ﬁnancial forms of capital accumulation (Carroll and Jarvis, 2014), or towards speculation (Langley, 2002; Soederberg, 2004). While Dore's (2008: 1097) observation that financialisation is ‘a bit like “globalisation” – a convenient word for a bundle of more or less discrete structural changes in the economies of the industrialised world’ – will resonate, there is nevertheless a consensus that the concept of financialisation encompasses a substantive change that could be identified by paying attention to spatial and qualitative effects. If we take ‘financialisation’ as referring to both the spatial expansion of finance and the ascendance of financial forms of economic accumulation, then it is arguable that processes of financialisation have taken root in Islamic finance.

One phenomenon that speaks to this is ‘fatwa shopping’ (Oseni, 2017), a practice that is similar to ‘forum shopping’. This practice arises because of the inherent subjectivity of the interpretation of religious texts combined with the need to obtain certification from religious scholars before a financial product can be offered in the market.¹⁰ Financial professionals who are wedded to selling a specific financial instrument would go from one religious scholar to another to solicit the requisite approval, hence ‘fatwa shopping’ where fatwa refers to the certification granted by a religious authority on Islamic aspects of financial products. This phenomenon is vividly illustrated by the following account from a professional who had worked in the industry (cited in Foster, 2009):

We create the same type of products that we do for the conventional markets. We then phone up a Sharia scholar for a Fatwa [seal of approval, confirming the product is Shari'ah compliant]. If he doesn’t give it to us, we phone up another scholar, offer him a sum of money for his services and ask him for a Fatwa. We do this until we get Sharia compliance.

The progressive dilution of the quality of assets employed in the securitisation of sukuk (discussed in the previous section) also reflects a financialising dynamic in Islamic finance. For instance, the hybrid sukuk introduced the ability to ‘blend’ tangible with other kinds of assets, and consequently enabled issuers to raise more funds than they might otherwise have been able to do if they had to rely solely on the amount of tangible assets to which they had recourse. This sleight of financial structure enables the issuer to convert non-marketable and illiquid assets (that would otherwise be deemed non-shariah compliant) into negotiable instruments that can be traded (Radzi, 2018: 22). Sukuk with a ‘blended’ portfolio of assets effectively enable leveraging, that is the multiplication of financial value through the creation of credit, thus financialisation. At a rhetorical level, these changes to standards and practices are pitched as ‘financial innovation’. However, it is innovation in the service of expanding the market, and arguably also enhancing the financial situation of individual institutions, rather than improving on ethical aspects of the industry, since ‘blending’ results in a ‘distance’ between underlying real economic activity and the source of funding, and in turn a hollowing of ethical substance in Islamic financial instruments.

A third development that points to processes of financialisation within Islamic finance could be identified as the increasing ‘metrification of ethics’ in Islamic finance. Although Islamic financial instruments are, in principle, proscribed from being involved with a number of types of activities such as gambling, alcohol, pork-related products among others, it is in practice not always possible given the complexity of the contemporary global economy. For instance, an investor might want to invest in the parent company of a conglomerate whose main source of income is the running of hotels, however the conglomerate might derive some of its income from the sale of alcohol. In order to address these complex, ‘real world’ situations in a ‘pragmatic’ manner, the approach adopted by the industry is to identify and set a threshold between permissible and impermissible activity. For example, as long as activities that are non-compliant do not contribute more than X per cent towards the revenue or profit of the financial instrument, then it would be reasonable to deem the financial instrument as being compliant with Islamic principles as long as other criteria for Islamic finance are also met.

However, the determination of the threshold, that is the X per cent, is highly contested and political since no value for this figure can be found in Islamic texts. While a low value might be uncontentious, many Muslims would probably object to a high value of X. Since there are differing points of view in the interpretation of Islamic ideas and principles in the operationalisation of Islamic finance, there are, in practice, a wide range of possible values for X. At the extreme, it is possible to find a wakalah sukuk, a type of sukuk structure, containing as much as 70 per cent intangible assets in its portfolio, which Radzi (2018: 25–26) believed explains its popularity among financial professionals selling the sukuk.

Variation in X does not only have import for individual practice of religious faith, but also the market performance of the financial instrument. One, the use of a numeric threshold serves as a useful tool to enable the development and marketing of Islamic financial products. By creating a measure that quantifies the ratio between permissible and impermissible activities, industry professionals also created a means to make decisions about characteristics of a financial instrument. This enables individuals to make judgments and discriminate between types of Islamic financial products to serve individual religious beliefs and needs. It can also help to improve investors’ confidence in the product. The measure is ipso facto a measure of the ethical dimension of the financial instrument and is therefore a constitutive element that enables the market to exist and expand. Two, the value of X directly affects the potential growth of the market. A high value of X would widen the range of financial instruments that could be sold as being compliant with Islamic finance, thus contributing to the expansion of the market and growth in financial returns to market insiders.

This managerial technique – the ‘metrification of ethics’ – can be employed to strengthen the ethical dimension of Islamic financial products, and consequently further the development and marketisation of Islamic finance. Thus, a tool that was conceived to strengthen ethical considerations in financial instruments also paradoxically pushes the industry further down the path of financialisation in that metrification represents the employment of financial calculus in the realm of ethics which in turn encourages the expansion of the industry. Moreover, since the value of X is not independently determined but is rather intricately bound up with the market objectives of those working in the sector, it is also open to abuse.

Securitisation and financialisation and the promise of Islamic finance

According to the IFSB (2010: 14), ‘the inherent features of Islamic finance have the potential to serve as a basis to address several of the issues and challenges that have surfaced in the conventional financial system during the [2007] crisis’. Indeed, over time, the industry developed a complex system of governance to ensure that the features of Islamic finance are preserved. Malaysia was a pioneer in this regard (Lai, 2015b). However, as identified in this article, market practices in recent years might have undermined the promise of Islamic finance. Instead of offering investors more security, practitioners have over the years resisted offering financial instruments that stay truer to the ideals of Islamic finance. They have also introduced changes in the securitisation of sukuk that result in less and less security through a dilution in the quality of assets employed. Furthermore, by expanding the types of assets that can be used in securitisation, sukuk may also have ended up mimicking those very same financial instruments (CDOs) that were deemed to have been toxic and contributed to the 2007 transatlantic financial crisis, the very ones from which it sought to set itself apart. The industry can also be characterised as having been driven by dynamics of financialisation since the early 2000s. This is reflected in the practice of ‘fatwa shopping’, enabling financial leveraging by diluting the quality of assets employed in securitising sukuk and the metrification of ethics, all of which are arguably symptoms of prioritising an inward-regarding ambition to develop the industry, where success is measured through growth in market size over adherence to ideals found in its religious origins.

The sacrifice of religious ideals in favour of market development should perhaps not be surprising given institutional dynamics and incentive structures in the industry. Much like its conventional counterpart, the processes of product and market development in Islamic finance increasingly seem to serve the industry itself as opposed to the broader ethical ideals that the industry espouses, reflecting what we might call ‘financialised ethics’. As an industry professional recently observed, ‘Islamic finance is based on Shariah but on the ground there is not enough proof or practical manifestations of Islamic finance [sic] ethical orientation’ (Aaminou, 2019: 34). This ultimately undermines the industry's claim to offering a more ethical, stable and secure alternative to conventional finance, which in turn raises questions about the industry's ability to ‘[safeguard] the structural integrity and prosperity-generating capabilities and interests’ (Dent, 2001: 6) of its host economies, of which Malaysia and Indonesia in Southeast Asia are but two. If true, Malaysia is particularly vulnerable given its historically more liberal approach to developing the market (see for instance Brown, 2010). Have securitisation and financialisation in Islamic finance undermined the promised economic security and stability of what might have been more ethical finance?

Footnotes

Declaration of conflicting interests

The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author received no financial support for the research, authorship and/or publication of this article.

ORCID iD

Jikon Lai

Notes

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