Regulation of Financial Markets - an Islamic Ethical Perspective
This paper contributes to the literature on financial regulation and Islamic economics by providing an Islamic ethical perspective on the recent evolution of financial regulation. By relying on the primary sources of Islamic ethics, we show that an Islamic approach to the regulation of financial markets would consist of three dimensions: (1) social norms, (2) institutional structures, and (3) legal constraints. Using evidence from nearly a century of banking regulation, we argue that conventional attempts at regulating financial institutions have largely failed because they have ignored social norms as a dimension of regulation. We contend that social norms are the most important dimension of regulation and—if ignored—the regulation of finance would inevitably lead to failure.
The Islamic ethical framework may help shed light on why conventional financial regulation has failed. We do not suggest that this Islamic ethical perspective is a panacea to all regulatory problems in finance, but it does offer useful insights that may have been overlooked in global debates on financial regulation. We outline the implications of this Islamic approach to the regulation of the financial industry and suggest avenues for further research.
What follows below is a tentative table of contents based on a draft manuscript. The full paper will be submitted before the deadline of 30 May 2016.
Contents
1 Introduction.
In the wake of the global financial crisis, it has become apparent that there is a dire need for the regulation of financial markets. Many efforts are being made along these lines, but few consider them to be sufficient for the needs of the times. In order to get a better understanding of why current approaches are not working very well, this paper is devoted to the analysis of the Islamic approach to regulation. When compared and contrasted with this, we will see why current efforts are inadequate, and also the ways that they can be changed to improve them and to make them effective for our current needs.
2 Three Dimensions of an Islamic Approach to the Regulation of Finance.
3 First Dimension: Social Norms.
3.1 Cooperation.
3.2 Generosity.
3.3 Service.
3.4 Justice.
4 Second Dimension: Institutional Structures.
Institutions are embodiments of human purpose. The "spirit" is reflected in the shape of institutions. The Islamic Spirit (the four social norms of behaviour discussed above) is radically different from the Capitalist Spirit. The institutional structures must reflect this difference. This section discusses what these institutional structures would look like.
5 Third Dimension: Regulations and Laws.
5.1 Halal (Earned) Earnings.
5.2 Prohibition of Interest.
5.3 Trading of Debt.
5.4 Gharar & Gambling.
6 Historical Experience With Financial Regulation.
Regulations in isolation, without modifying the spirit (social norms) and body (institutional structure) cannot work. This section provides historical examples to illustrate this. A key insight here is that conventional financial regulations have been borne out of the spirit. The gradual de-regulation which occurred was in line with the spirit of unleashing greed, legitimization of greed and free competition, with cut-throat competition being considered as a good thing, instead of being regarded as barbaric behavior suitable for the "jungle". This change in spirit led to de-regulation. Regulation was done in form only, making regulatory capture simple and inevitable. So conventional thinking that we can allow greed free reign and regulate greed to avoid harmful effects (what we tentatively call "the dual model of regulation") is fundamentally flawed. We must change the spirit from competition and greed to service, cooperation, generosity and justice to take people out of the "jungle". This is the only way that regulations can work in the long-run. Historical experience bears this out.
6.1 The Great Depression of 1929.
6.1.1 Successful Regulation Following the Great Depression.
6.1.2 Gradual De-Regulation.
6.2 European Experiment on Greed and Dual Model of Regulation.
6.2.1 The Experiment of Using Greed as an Engine of Growth.
6.2.2 Failure of the Experiment.
6.2.3 Savings & Loan Crisis.
6.2.4 Global Financial Crisis of 2007-2008.
6.3 Regulatory Capture.
7 Implications of the Islamic Approach to Regulation.
8 Conclusions and Suggestions for Further Research.
* Zaman is Vice Chancellor of the Pakistan Institute of Development Economics. Tariq is a Researcher at the Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Hamad Bin Khalifa University in Qatar. Corresponding author of this paper submission to the SASE Conference on ‘Moral Economies, Economic Moralities’ is Wijdan Tariq: wtariq@qfis.edu.qa, M: +974-33550058.