The Financial Times published a special report yesterday on Islamic Finance (subscription required, but you can read bits of the report at FT Alphaville) that left me wondering whether Islamic Finance is anything more than a scheme to line the pockets of lawyers, bankers and self-styled "Islamic Scholars." 

The use of interest in financial transactions apparently being banned under a strict interpretation of the Koran, Islamic Finance industry has concocted ways for people to borrow and lend money without calling it borrowing and lending.  So, for example, a person not religiously bothered by borrowing money (and paying interest thereon) to purchase a car would obtain a loan from a bank not religiously bothered by charging interest, while the Sharia-compliant person would arrange to have the bank purchase the car and then sell it to him at a marked up price on a deferred payment basis or, better yet, lease it to him with an option to purchase.

You need money to expand your business?  You could, of course, borrow money from a bank, but if you want to engage in a transaction that a "scholar" has deemed Sharia-compliant, you would arrange for the bank to purchase copper at the spot price and then sell it to you on a deferred payment basis at the spot price plus a markup.  You would then sell the copper to a third party at the spot price.

Another example: a county not concerned with Shariah compliance might issue bonds to build a school, while the Sharia-compliant county might set up a special purpose vehicle that sells shares to investors to fund the building of the school.  The SPV would hold the title to the school and lease it to the county.  After the lease is up, the SPV would gift or sell the school to the county.

As you can imagine, all of this nominal avoidance of "interest" gets expensive, all to the detriment of the consumer and benefit of bankers, lawyers and "scholars" who structure and declare these transactions Sharia-compliant.

The most interesting article in the Financial Times report is the opinion piece from Mahmoud El-Gamal, chair of Islamic economics, finance and management at Rice University, who had this to say:

So, what is Islamic finance, really? As the name suggests, Islamic finance is first and foremost about religious identity. It first appears in the writings of the intellectual forefathers of political Islam and their students.

The simplistic economic view of these writers - paradoxically echoed to this day, not only by religious figures, but also by Western regulators - is that Islamic scripture forbids all types of interest. As I, and others, have shown in detail in academic publications, traditional religious scholarship does not support application of this simplistic view to modern finance. Indeed, the very practice of Islamic finance today is interest based.