Tuesday 29, May 2018 by Jessica Combes

Islamic wealth management and its relevance in modern times


Professor Shamsher Mohamad & Dr Ziyaad Mahomed (Inceif) write exclusively for Islamic Business & Finance  

Islam has a unique dispensation on the concept of wealth, its ownership and distribution. Wealth is not regarded as an end per se, but a means to an end: the end being the paradise in the hereafter. Essentially, material possessions are considered the primary form of wealth, perceived to be generated, accumulated and/or invested by the one who acquired it. Inclusively, wisdom, knowledge, salvation and even contentment can all be categorised as wealth. From the Islamic perspective, Allah (to Him be Praise) is the true owner of all wealth and He entrusts it to man for beneficial use (Qur'an 20:6).

From the Islamic perspective, wealth is a means to living a beneficial existence and providing societal benefits and welfare to the members of the society. Islam allows for private ownership of wealth except for the three public goods declared by the Prophet (PBUH), namely water, herbage (grazing land, forest, mines) and fire (energy in the modern sense) that belongs to the community. The total assets of Islamic Wealth Management (IWM) is no more than a minute fraction (approximately two per cent) of the world’s conventional assets.

But the steady growth of this unique IWM system has made it on the global stage, practiced in more than 76 countries and adopted by secular governments in sovereign fund-raising. This article briefs on the concept and comparative notes of wealth from conventional and Shari'ah perspective.

From the Islamic perspective, all resources or wealth belong to their Creator (swt) who has provided these resources to mankind (Qur'an 45:13) with the expectation that they would be held in trust (Qur'an 33:72). Humanity is accountable for the manner in which wealth is created, amassed and distributed. This is a fundamental tenet of Islam and Islamic Wealth Management.

Wealth in Islam comprises both tangible and intangible assets, similar to modern meaning of wealth (Jusoh & Muhammad, 2005). The significant difference however, is that tangible (money, real estate, commodities, etc.) and intangible assets (intellectual capital, copyrights, patents, financial rights, etc.) have specific rules in Islamic jurisprudence that limit uncontrolled trade of these assets. For example, same currencies and commodities can only be exchanged at par and at spot, whilst differing currencies and commodities can be traded at agreed prices but at spot.

The concept of ‘spiritual’ wealth is also relevant here. In Islam, the spiritual precept is considered in the context of ‘zuhd’ or ensuring that love of wealth has not entered the heart (simply: greed). Here, specific prohibitions must be avoided to establish ‘zuhd’ or maintain spirituality of wealth in Islam: Al Bukhl or miserliness; Al Israf or wasteful expenditure in extravagance (Qur'an 7:31); Al Tabzeer or spending on prohibited items (Qur'an 17:27); Kanzul Maal or hoarding of wealth for the love of it.

In mainstream economics, wealth is defined by quantitative measurements of one’s material possessions. In the parlance of modern economics, wealth is defined as the owners’ potential capital that is employed to create more wealth. Wealth is “...the value of assets owned minus the value of liabilities owed at a point in time. Wealth can be categorised into three principal categories: personal property, including homes or automobiles; monetary savings, such as the accumulation of past income; and the capital wealth of income producing assets, including real estate, stocks, bonds, and businesses.”  

This definition forms the foundation of modern wealth management practise in the industry. This definition considers wealth as net assets with potential to generate income for the holders. Income, which is merely the periodic addition to wealth is product of the synergic combination of resources and labour-entrepreneur. This mainstream concept of wealth had moved away from the centuries-old Calvinist idea that wealth is a sign of God’s gift to the wealth holder, and that wealth is not an end in itself but a means to fulfil the needs of wealth holders and the community at large. The modern concept of wealth is now practiced in the context of personal wealth maximisation with a very thin-line between morality and ethical restrictions, except as dictated by the secular laws relating to acts of fraud, criminal breach, trust as stipulated in these laws.

Unlike mainstream wealth management practices, IWM is bound by restrictions to ensure it serves its objectives. The first restriction is that no wealth increase is permissible if the wealth is created through illegitimate production and/or investment activities. That is, it is only lawful to earn returns on permissible and risk-sharing based investments. From a Shari'ah perspective, impermissible earnings refer primarily to interest income and proceeds from other impermissible sources of income such as the sale of pork or alcoholic beverages (Elgari, 2000).

Although Shari'ah scholars provide a tolerance level for incidental gains from impermissible activities (less than five per cent), the purification of tainted or impure income cleansed through distribution to charity.   The earning returns from permissible production and investment is expected to improve the well-being of communities and provide financial stability compared to the one-sided no-risk-shared investments under the current modern wealth management practices. The second restriction is on expenditure: the owner may not spend his wealth frivolously (Qur'an 17: 26-27) as he will be questioned on its use. He is however encouraged to spend on himself, his family and those in need. Beyond routine consumption and spending on others, he also has an obligation of alms-giving or Zakat to alleviate the suffering of his fellow beings, starting with the next of kin, then the orphans, those dispossessed of wealth, the poor and the wayfarer, in that order (Qur'an 9:60).

The objective of Islamic wealth management is economic justice through equitable distribution of wealth. This by no means restricts private ownership and entrepreneurship but a wider circulation of wealth (Qur'an 59: 7) and invested in socially beneficial economic activity (Qur'an, 62:10 and 73:20). The insights of these verses also imply that the poor have a rightful share in the wealth of the rich, which mandates annual reduction of the wealth by mandatory charity (Zakat of 2.5 per cent), further necessitating the productivity of wealth. This qualifier is important: the Calvinist idea under a secular concept of wealth enables wealth maximisation but with no requirement to spend other than on one’s needs and wants.

For example, with the advent of modern capitalist ideas in the 1990s, individuals have justified accumulation of huge wealth in households so much so that the inequality of wealth has dramatically increased to a level of the top one per cent of the households owning 49 per cent of all the wealth compared to in 1950 when top 10 per cent of households owned half the global wealth. The wider concentration of wealth in the current period has largely resulted from the revisionist thinking that capital is an important component for development, so capital is increasingly becoming untaxed in the hands of wealth holders. Besides the mandatory alms (Zakat), Islam encourages its followers with wealth entrusted to them to establish voluntary endowment in the form of a charitable trust (Waqf) (Hoexter, Eisenstadt, & Levtzion, 2002).

This is meant to provide for beneficiaries (family and communities) during and after the wealth-holder dies (Maududi, 1960). Historical sources suggest that the government public service in modern times was largely provided by the venerable institutions of these awqaf, which catered to the basic needs of the community in Islamic countries before 1900 AD.

IWM is based on the practice that, whilst there is no objection to wealth creation in permissible ways, wealth should not be used to exploit those without wealth via one-sided contracts. Conventionally, wealth has been generated by undertaking no-risk-sharing ventures to which wealth of an individual or an entity is made available to produce goods useful to society.

Modern banking accepts deposits, ‘increases’ its value using the money multiplier and lends this inflated ‘virtual money’ to entrepreneurs in need of funds. They engage in one-sided contracts requiring an interest (or Riba in Arabic which means an increase over the amount lent) irrespective of whether the entrepreneur achieves profit or loss from the funds. This bank-lending generates passive interest income to capital owners, increasing the concentration of wealth among a few. This aspect of interest-based lending without considering the borrower’s situation is social injustice.

Entrepreneurs with ideas may have to forego their earnings or even lose the enterprise if the venture loses money. Foreclosure laws enable banks to liquidate the venture without considering loss of skill to the society or the loss of wealth of the entrepreneur, protecting the lender and its ‘virtual’ money. Thus, financing through risksharing methods enables a balanced contract that is more equitable and more profitable for both the funder and financing client.

To serve social justice, wealth is not considered legitimately earned unless the risk-and-rewards are both shared in a financial contract: so one-sided no-risk-sharing contracts are not permitted under IWM. IWM allows a socially permissible use of wealth to fund a permitted economic activity based on a balanced contract that provides (i) the fund provider with income (or profit) (increase to the amount funded) only in the years when a profit is made and shared on a pre-agreed basis proportional to the risk of the venture; (ii) it provides for deferment of dividends if no profit is made due to no fault of the entrepreneur; and (iii) the loss of a failed venture may mean loss of wealth of the funder and loss of efforts on part of the entrepreneur.

This is an important ethical foundation of IWM. Unfortunately, this introduces a free-rider problem that could be mitigated through effective supervision and joint participation in decisions relating to the funded venture.

IWM involves wealth generation, accumulation, preservation, purification and distribution. Creation of wealth is defined more broadly than in conventional practice. A set of filters are applied to financial transactions that ensure permissibility and productive activities to promote society’s wellbeing. Such binding ethical restrictions (filters), which could only be exempted under juristic necessity, are absent in modern wealth management practices based on secular laws, despite the fact that secular laws also have societal objectives. The principle of permissible wealth creation places society’s welfare on par with personal welfare. This somewhat limits the unfettered pursuit of personal wealth creation and also the pursuit in the management of wealth practices that are inimical in the long term to the sustainability of a society and the planet (commonly referred to as socially responsible investments or SRIs).

Wealth cannot be earned from activities that are not permitted (weapons of mass destruction; production of intoxicants for personal consumption; production of unhealthy food defined as pork; degrading environment; etc.). Once such wealth is created and filtered, then the wealth is permitted to be cumulated through permissible yields of investments forming additions to wealth over time.

Next is the objective of wealth accumulation. The Islamic belief is that wealth is apportioned according to God’s own discretion, such that no person can envy wealth holders nor should the wealth holder treat the wealth as his own. While wealth accumulation is encouraged, the purpose of the accumulation is first to fulfil one’s personal (the betrothed and the family) needs and wants, then the needs of the broader community. The holder is expected to enjoy his wealth, adorn good clothing, and acquire conveniences, etc., without being miserly (nor be a spendthrift) while at the same time treat the wealth as a trust to improve the lives of others (Qur’an 7: 31).

Wealth protection and wealth cleansing should be considered together. If wealth is appropriately earned from permitted economic activities and then accumulated, there is no need for cleansing. Though the ideal of such high-flouting wealth creation might not always be possible in a community where conventional practices are well established.

For example, people living under a secular system may not have freedom to avoid interest earned on pension fund schemes, compulsory interest on deposits, etc. These impermissible gains are expected to be distributed to the needy as a method of purification or cleansing. The process of cleansing applies in corporate finance and investment as well. IWM also deals with the distribution of wealth in a compliant manner. The mandatory charitable deduction (Zakat) is considered a means of spiritual cleansing of the wealth one has acquired in excess of a minimum threshold referred to as the nisab.

The Zakat operators are to distribute the money to the eight classes of recipients explicitly mentioned in the Qur'an (9:60). The inheritance law is part of the distribution process. The premise of this law is that if the wealth originally belongs to God and man is only entrusted to have it while he is alive. When he dies, the wealth goes back to its original owner i.e. God and it is then re-distributed through inheritance. In brief, Islamic Wealth management is broadly similar to the modern wealth management practises except for the filters at each stage to ensure Shari'ah compliance.

This article started with the capitalist idea of what wealth followed by IWM and its provisos. The Islamic and Christian beliefs are based on the premise that all wealth belongs to God, and that the goal of wealth is to improve the welfare of the society and earn merit through good deeds. The Islamic belief system advocates that wealth is permissible if it is meant to be spending for the sake of pleasing the Creator: it is fair to spend on one’s needs/wants—meaning that fulfilling needs and wants of the created beings are in the radar as pleasing to God. What is pleasing are actions to spend wealth for doing good deeds, including on oneself.

The modern position on how concentration of wealth is not in the best interest of societies is expounded by Amartya Sen (1999). He identifies the incidence of unprecedented opulence in this century along with extreme deprivations as a serious problem for humanity to resolve. The difference between the wealthy and those deprived of wealth is widening especially since the anointment of special positions given to wealth under the current brand of capitalism. Wealth creation, accumulation and distribution have tilted in favour of the wealth-endowed households while production is shifting around the world to take advantage of income disparities to dictate where wealth can be amassed.

In this context, it is perhaps noteworthy to redefine wealth as a means not for fulfilling the needs/wants of the wealthy alone but also those deprived and are in dire need. Hence, IWM has much relevance in this modern world today and the future to help mitigate the inequality gap between the wealthy and the poor and serve social justice.