Whose legitimacy? Islamic finance and the global financial order

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Islamic finance is a fast growing segment of international financial markets. Deriving its core principles from the Quran and the Sharia, the objective of Islamic finance is to install a more equitable financial and economic order that at the same
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   PLEASE SCROLL DOWN FOR ARTICLE This article was downloaded by: [University of Southampton]  On: 23 November 2010  Access details: Access Details: [subscription number 773565842]  Publisher Routledge  Informa Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK Review of International Political Economy Publication details, including instructions for authors and subscription information:http://www.informaworld.com/smpp/title~content=t713393878 Whose legitimacy? Islamic finance and the global financial order Lena Rethel aa  Department of Politics and International Studies, University of Warwick, Coventry, UKFirst published on: 23 November 2010 To cite this Article  Rethel, Lena(2010) 'Whose legitimacy? Islamic finance and the global financial order', Review of International Political Economy,, First published on: 23 November 2010 (iFirst) To link to this Article DOI 10.1080/09692290902983999 URL http://dx.doi.org/10.1080/09692290902983999 Full terms and conditions of use: http://www.informaworld.com/terms-and-conditions-of-access.pdfThis article may be used for research, teaching and private study purposes. Any substantial orsystematic reproduction, re-distribution, re-selling, loan or sub-licensing, systematic supply ordistribution in any form to anyone is expressly forbidden.The publisher does not give any warranty express or implied or make any representation that the contentswill be complete or accurate or up to date. The accuracy of any instructions, formulae and drug dosesshould be independently verified with primary sources. The publisher shall not be liable for any loss,actions, claims, proceedings, demand or costs or damages whatsoever or howsoever caused arising directlyor indirectly in connection with or arising out of the use of this material.  Review of International Political Economy 2010, iFirst: 1–24 Whose legitimacy? Islamic finance and theglobal financial order Lena Rethel Department of Politics and International Studies, University of Warwick,Coventry CV4 7AL, UK  ABSTRACT Islamic finance is a fast growing segment of international financial markets.Deriving its core principles from the Quran and the Sharia, the objective of Islamic finance is to install a more equitable financial and economic orderthat at the same time is transaction-friendly. Thus, Islam could be seen asa foundation for the inclusion of the ethical and moral dimensions of eco-nomics and markets. This coincides with rising demand for Islamic financialproducts. Indeed, recent years have witnessed increasing efforts to developand to institutionalise Islamic capital markets and above all, to make Islamicfinance acceptable (and thus investable) to the mainstream. In this article, Iuse the question of legitimacy to explore whether Islamic finance offers analternative to the existing international financial order. To this end, I take acloser look at the knowledge base from which Islamic financial products areconstructed and assessed as well as the emerging international regulatoryframework for Islamic financial markets. I conclude that efforts to expandthesocialconstituencyofIslamicfinancetothetransnationalsphereofglobalfinance are overly focused on its epistemic legitimation as normal financialactivity. As a consequence, the currently emerging power, knowledge andgovernance structures for Islamic finance tend to emulate, and thereforelargely reproduce, the existing global financial order. KEYWORDS Islamic finance; financial regulation; Sharia compliance; legitimacy; globalfinance. INTRODUCTION AstheAnglo-America-centeredinternationalfinancialsystemexperiencesits worst crisis since the 1930s, it is only timely to start looking at alter-natives. Global finance is at the crossroads and the question is whether it Review of International Political Economy ISSN 0969-2290 print/ISSN 1466-4526 online  C  2010, iFirst Taylor & Francishttp://www.informaworld.comDOI: 10.1080/09692290902983999  D o w nl o ad ed  B y : [ U ni v e r si t y  of  S o u th a m p t o n]  A t : 14 :16 23  N o v e mb e r 2010  REVIEW OF INTERNATIONAL POLITICAL ECONOMY will be possible to create a new international financial order based on theprinciples of equity (profit-  and loss -sharing), mutuality and sustainability,instead of speculation and the  apotheosis  of short term profit-making. I willexplore these issues by taking a closer look at Islamic finance, one of thefastestgrowingsegmentsofinternationalfinancialmarkets.Atfirstglance,Islamic finance seems to be an appealing alternative to the global finan-cial hegemony. Rooted in the jurisprudential body of knowledge which isknownasthe Sharia andbasedontheprinciplesofthe Quran ,theobjectiveof Islamic finance is to install a more equitable financial and economic or-derthatatthesametimeistransaction-friendly.Thus,Islamicfinancecom- bines both religious principles and consequentialist elements of a widerappeal. Therefore, Islam could be seen as a foundation for the inclusion of the ethical and moral dimensions of economics and markets. At the sametime, it cannot be abstracted from developments in the wider politicaleconomy such as an increasingly affluent Muslim middle class, the explo-sion of oil revenues, and a reorientation towards cultural-religious values.As a consequence, over the last few decades increasing efforts have beenundertaken to structure Sharia-compliant financial products, to developand institutionalize Islamic capital markets and above all, to make Islamicfinance acceptable (and thus investable) to the mainstream.IwillusethequestionoflegitimacytoexploretheextenttowhichIslamicfinanceoffersa–possiblymoreequitable–alternativetotheexistinginter-nationalfinancialorder.Tothispurpose,Itakeacloserlookatthe  genesis of modern Islamic financial practice, the knowledge base from which Islamicfinancial products are constructed and assessed, and the emerging inter-national regulatory framework for Islamic financial markets. In so doing,I will not only trace the development of Islamic finance but also cast lighton the constitution and normalization of what is considered as  legitimateeconomic activity  more generally. My findings suggest that while Islamic fi-nance challenges Western, more specifically Anglo-American dominanceof the international financial system, at the same time it serves to repro-duce, to legitimize and thus to further entrench the knowledge structuresthat underpin contemporary finance.The argument will proceed as follows. The next section discusses theoften neglected ethical and moral character of capital markets. It then goeson to identify the core principles of Islamic finance and how they relateto different notions of legitimacy. Section 2 gives an overview of the riseof Islamic finance over the last decades. It suggests that to the extent thatthesedevelopmentssymbolizetheemergenceofamoremultipolar,andinthis sense possibly more legitimate, international financial system, Islamicfinance certainly challenges the existing global financial order. However,at the same time as Islamic finance more and more engages with theinternational financial system, its knowledge base becomes increasinglydependent on existing structures. This will be discussed in more detail in2  D o w nl o ad ed  B y : [ U ni v e r si t y  of  S o u th a m p t o n]  A t : 14 :16 23  N o v e mb e r 2010  RETHEL: WHOSE LEGITIMACY? Section 3, where I look at the conflicts inherent to attempting to create andregulate a mainstream-capable Islamic financial system. Section 4 summa-rizes key points and concludes with an outlook on the possible futures of Islamic finance and its potential as a site of resistance and change. 1. CAPITAL MARKETS, ISLAM AND THE QUESTIONOF LEGITIMACY Contesting the absence (of an explicit articulation) of the ethical and socialdimensionsofcapitalmarketsisakeythemepervadingthemorecriticallyinclined political economy literature. In this literature, the conceptualiza-tion of capital markets as abstract rational entities that follow objective,scientific principles is contrasted with the social, cultural and even moral embeddedness  of markets (see e.g. De Goede, 2005; Watson, 2007). Theseapproaches see capital markets not as natural phenomena but as the re-sult of historical contingencies, contestation and the emergence of sharedunderstandings which condition, and are conditioned by, financial prac-tices. Yet, despite an acknowledgement of diverging practices, for exam-ple, in pre-capitalist barter economies or in the form of localized exchangesystems, it is often hard to see to what extent these criticisms can, oreven should, be translated into modern financial practice more generally(Kessler, 2007). While these accounts point to the  constitutive legitimation of global capital markets through ‘scientific’ or – given their intersubjec-tive grounding – rather  epistemic  factors such as modern finance theory,calculative technologies, the work of credit rating agencies and their like,littleattentionispaidtowhatthismeansintermsofthelegitimacyofthesemarkets,andmoregenerallyofthefinancialorderofwhichtheyareapart.Indeed, legitimacy in itself is a rather ambiguous notion. There are var-ious ways of how legitimacy can be understood, respectively of how it isseen to operate, and so far surprisingly little work has been done to betterunderstand its relevance for the wider fields of the ethics and politics of finance (but see Sen, 1991; Seabrooke, 2006; Palazzo and Rethel, 2008). Themost frequent distinction being made is that between input and outputlegitimacy (e.g. Kratochwil, 2006; see also M¨ugge, this issue, for a criticaldiscussion).Whiletheformerimpliesthatcertainproceduralstandardsaremet, the latter emphasizes the quality of the outcomes that are produced.However, ultimately legitimacy is contingent on processes of legitimationthat constitute certain practices as legitimate and others as not. Therefore,the construction of legitimacy in itself is a social process, based on theemergence of sets of shared values and beliefs. Importantly for the furtherdevelopmentofmyargument,thesecanemergeonbothepistemicand/ormoral grounds and, as a consequence, processes of legitimation are inher-ently conflictual. In other words, something can be seen as right on moralgrounds or simply because it is thought to work best.3  D o w nl o ad ed  B y : [ U ni v e r si t y  of  S o u th a m p t o n]  A t : 14 :16 23  N o v e mb e r 2010  REVIEW OF INTERNATIONAL POLITICAL ECONOMY Kratochwil (2006) points out that issues of legitimacy are most acutewhenitcomestopracticalmatters.TheriseofIslamicfinanceprovidesonesuch example. As I will discuss in more detail below, Islamic finance laysclaimtobothproceduralandoutcomelegitimacy.Furthermore,Reus-Smit(2007: 164) draws attention to the ‘social constituency’ in which legitimacyis established. He argues that ‘[w]here one needs legitimacy will depend,therefore, upon where one seeks to act, and the relevant constituency will bedeterminedbythatrealmof[...economic]action’.Thus,currenteffortsto expand Islamic finance have to speak both to its traditional Muslimconstituency and to the transnational sphere of global finance in which itseeks to become established. This is underpinned by complex processesof epistemic legitimation, in terms of conventional financial knowledge,as well as religious legitimation. Hence, the question of   whose legitimacy ultimately will prevail is a crucial one.Moreover, Islamic finance is not only an empirical phenomenon thatwarrants scholarly scrutiny, but also an intriguing analytical counterfac-tual. A literature which claims that a different world order is possibleshould become more curious about the potential of existing alternatives.Such an agenda could also support current efforts to expand, indeed,truly ‘globalize International Political Economy [IPE]’ by looking beyondits narrow focus on mainly advanced, mainly Western political economies(Phillips,2005).Insodoing,InternationalPoliticalEconomy(IPE)candrawonaseriesofrecentcontributionsonIslamicfinanceincloselyrelatedfieldssuch as anthropology (Maurer, 2002); business, economics and finance(Warde, 2000; Henry and Wilson, 2004); business ethics (Rice, 1999); eco-nomic geography (Pollard and Samers, 2007); and law (Vogel and Hayes,1998).In contrast to conventional financial practice which seeks its legitima-tioninthetheoreticalconstructsofmodernfinancetheoryandneoclassicaleconomics, Islamic finance is fundamentally concerned with and very ar-ticulate about embedded elements of morality and ethics. It derives its basic principles from the  Quran , Islam’s holy book, and the jurispruden-tial body of knowledge which is referred to as the  Sharia . A fundamentaltenet of Islamic jurisprudence is that everything which is not explicitlyprohibited is permissible (IOSCO, 2004: 6). In Islamic finance, the four ma- jor prohibited elements are  riba  (unjustified increase; narrowly interpretedas the paying or receiving of interest),  maisir  (gambling),  gharar  (makingprofit from uncertainty), and the production and sale of   haram  (forbidden)goods and services.The prohibition of interest is often seen as the  sine qua non  of Islamiceconomic and financial philosophy (Kuran, 1995). It is based on the notionthat‘makingmoneyfrommoney’isnotethicallyacceptableandheightensthe concern of using money for productive purposes. This unease withthe ‘moral legitimacy of effortless fortunes’ is not solely a prerogative of 4  D o w nl o ad ed  B y : [ U ni v e r si t y  of  S o u th a m p t o n]  A t : 14 :16 23  N o v e mb e r 2010
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