More about States and Bankers: Prospects for Islamic Finance

By Clement M. Henry, University of Texas at Austin

* This memo was prepared for “The Arab Uprisings Explained” workshop, October 2-3, 2014. 

In The Arab Uprisings Explained: New Contentious Politics in the Middle East I was trying to explain the successes and failures of Arab uprisings by their underlying financial structures, pointing out key differences between the strong states, Egypt and Tunisia, on the one hand, and the weak bunker states of Libya, Syria, and Yemen, on the other. I also showed how the other strong state in the region, Morocco, was able to manipulate divisions and neutralize its February 20 movement by a combination of constitutional reform and economies of patronage facilitated by the banking system. Now it is time to zero in on key differences between Egypt and Tunisia and try in more general terms to think in game theoretic ways about reversing the polarization of Arab civil societies.[1]

In addition to the obvious differences between the Egyptian and Tunisian military establishments, Tunisian civil society seems key to the different outcomes of political transition. Unlike the Egyptians, the Tunisians were able to pull together a political transition process and keep it afloat. Not only did a self-coopted transitional assembly of “civil society” devise and implement electoral laws, when the Ennahda party and its opposition seemed unable to reconcile their differences, a Quartet of the Tunisian General Labor Union (UGTT); the Tunisian Union of Industry, Commerce, and Handicrafts (UTICA); the Tunisian Bar Association; and the Tunisian League of Human Rights managed eventually to shepherd a working consensus for the new constitution and elections.

Was Tunisia’s civil society really somehow more capable and developed than Egypt’s? Arguably Egypt’s Supreme Council of the Armed Forces (SCAF) never gave civic associations a chance to prove their mettle. Also, Egypt’s second uprising, on June 30, 2013, against the Muslim Brotherhood, followed by the group’s massacre at the hands of the new transitional regime on August 18, perhaps gave Ennahda a decisive push toward giving up power to a transitional government a few months later. It can still be argued that the Tunisian civil society actors – and Ennahda – displayed greater political acumen than their Egyptian counterparts. They also operated under different cultural constraints. Shadi Hamid nicely contrasts the respective historical contexts and former President Habib Bourguiba’s distinctive legacy.[2] Detailed research may uncover illustrative episodes and anecdotes and even tease out political sophistication scales from the Arab Barometer and other surveys that the uprisings facilitated, at least temporarily, in Egypt as well as Tunisia.

To the extent, however, that civil society structurally depends on an active, relatively autonomous private sector, it may, with the possible exceptions of some monarchies, be a dead end, at least temporarily, in other parts of the Middle East and North Africa, where the private sector is still either submerged in the informal economy or orchestrated by ruling families. How across the region may we imagine ways of reversing the polarization between various forms of Islamism, on the one hand, and advocates of liberal polity on the other? Polarization across the region seems to be intensifying, moving some Islamists toward jihadism and some liberals toward fascism, each side calling for the annihilation of the other. How might the momentum be reversed? What Islamist forces might offer incentives for taming jihadists? Under what conditions might liberals prefer illiberal democracy to military dictatorship? I will focus on taming jihadists under the assumption, possibly mistaken, that liberals might then become more tolerant of Islamist identity politics.

Let me review possible banking and financial underpinnings for renovating civil societies. These could, following Marxist theorist Antonio Gramsci, offer more peaceful pastures for ideological contestation. Financial structures obviously do not determine political outcomes but they can offer incentives for bringing informal economies out into the open, thereby offering greater potential for civil society building. I propose to examine Islamic finance as a potential underpinning for a “civil state with Islamic identity,” as Youssef Qaradawi puts it.

This set of financial practices, when officially authorized, can color a civil state with some Islamic identity. Islamic banking has been developing since the mid-1970s in peaceful competition with conventional banking. It represents an alliance between mainstream ulama, co-opted to monitor compliance with Islamic jurisprudence, and conservative Muslim investors.[3] It has made significant progress in the Middle East and North Africa, where Arab Barometer studies indicate widespread disapproval of interest-based lending and conventional banks in general.

I hypothesize that Islamic finance may gradually sap the informal economies underlying bunker states. In societies distrustful of or rejecting conventional interest-based banking Islamic finance can lure the informal economy out into the open by financing small and medium enterprises and even engaging in microfinance, which is much neglected in the region.[4] Identity-based economics can complement and tone down identity politics by giving more economic actors a stake in the system.

As political philosopher Montesquieu proposed in 1751, “gentle commerce” may undermine arbitrary exercises of violence. For Montesquieu the spirit of commerce inculcates “a certain sense of exact justice, opposed to brigandage on the one hand and to those moral virtues, on the other hand, that might distract one from the rigorous pursuit of one’s interests….”[5] Might it be a stretch to imagine a commercial mentality opposed to jihadism and favoring an instrumentalist ethic or wasatiyya (balance or moderation)? Arab Barometer surveys not only suggest that Islamic finance has a potentially receptive audience. The majorities of Muslims who reject interest and conventional banking tend also to be relatively apolitical religious conservatives. Among the elite, too, Islamic finance may represent an alliance between wealth and conservative ulama.[6]

Driven by wealthy Gulf investors, Islamic finance has steadily gained market share in many Arab countries, including Syria. Led by Malaysia, it is also gaining traction in Indonesia and other countries with Muslim majorities. Even states with Muslim minorities, such as Britain, have Islamic banks catering to them. The grand total in the world of sharia-compliant financial assets, to be sure, while approaching $2 trillion still does not add up to those of a major U.S. or Chinese bank. And although Islamic banking continues to grow more rapidly than conventional banks in most Arab countries, the skeptic may still ask whether it really mobilizes new clienteles or simply diversifies the portfolios, as in the Gulf, among wealthy investors.

In Syria of all places, some Central Bank data are available to test such a hypothesis until 2012.[7] After 2006, when Syria permitted three Islamic banks to begin operations, they quickly penetrated Syria’s rudimentary financial markets. By the end of 2011 they held 16.5 percent of the total assets of Syria’s burgeoning private sector, which now held 27.2 percent of Syria’s total commercial bank assets. During the period currency in circulation as a percentage of the money supply steadily declined until 2011, when it dramatically increased under the pressures of political events, terminating chances to test whether Islamic finance was attracting new clienteles. Had violent jihadist factions not hijacked the opposition, both sides could have shared an interest in continuing experimentation with Islamic finance, a source of legitimation for the regime yet also, apart from dress codes and family status laws, one of the very few “Islamist” identity markers.

Be that as it may, can we identify any of the moderating political effects that Montesquieu hypothesized? “Gentle,” instrumentally minded bankers invariably at least pretend to shy away from politics. Yet there can be synergies between political parties or factions and Islamic financiers. There can be incentives for them to cooperate, say, in a venture capital enterprise. A logic of tit for tat will work as long as the players accept modest but steady rates of return.[8] Robert Axelrod’s model of the iterated prisoners’ dilemma assumes that the players are “rational” and share Montesquieu’s instrumentalist ethic.[9] May partisan entrepreneurs and financiers share the necessary discipline to obey the model?

How might one test such a proposition? Might Islamic finance somehow contribute to strengthening an Islamist mainstream to isolate the jihadis? If history is any guide, al-Qaeda tended to avoid the banks after 9/11. After some initial confusion in Washington about Islamic finance the U.S. Treasury Office of Foreign Assets Control (OFAC) targeted only one small Sudanese “Islamic” bank in its financial “Global War on Terror.”

In theory Islamic finance could assist in regulating regional cash flows more effectively than the standard anti-terrorism regulation of conventional banks. Heavy-handed regulation of the (very conventional and highly respected) Arab Bank, indeed, may drive more regional finance into Dar El-Islam’s new banking system. For fear of unnecessarily offending mainstream Muslim opinion and having learned from past errors, international regulatory authorities (such as U.S.-led Financial Action Task Force) might be less heavy handed than in the recent case of the Arab Bank, when the U.S. Treasury Department trumped State Department concerns about suppressing critical evidence for the defense.[10]

In retrospect the private Gulf Cooperation Council supporters of Islamist oppositions in Syria and Libya might have been more consistent and less “pernicious” in their support of Syrian factions, had they operated through Islamic financial vehicles.[11] As Wendy Pearlman suggests, “Unity is likely to remain elusive unless external actors cooperate in instituting a transparent, accountable centralization of financial support.”[12]

Islamic banks at least in theory have an even greater stake in transparency and accountability than conventional banks. Their distinctive form of financing is equity rather than debt based, and consequently the investors require more extensive information about their entrepreneurs than the standard credit checklist for conventional borrowers. These theoretical considerations may be quite irrelevant to war zones but in the long run Islamic finance, by sapping the foundations of the Middle East and North Africa’s informal economies and responding to popular desires for interest-free banking, may build up civil societies supporting civil states. Even if viewed as illiberal, such states may be more liberal and inclusive than military dictatorships.

Clement Henry is professor emeritus in the department of government at the University of Texas at Austin and former chair of the department of political science at the American University in Cairo.



[1] Building on Marc Lynch, ed., “The Political Science of Syria’s War,”Project on Middle East Political Science, Dec. 18, 2013.

[2] Shadi Hamid, Temptations of Power: Islamists and Illiberal Democracy in a New Middle East, Oxford University Press, 2014.

[3] Monzer Kahf, “Islamic Banks: The Rise of a New Power Alliance of Wealth and Shari’a Schlarship” in Clement M. Henry and Rodney Wilson, eds., The Politics of Islamic Finance, University of Edinburgh Press, 2004.

[4] El-Gamal, M. A., El-Komi, M., Karlan, D., & Osman, A. (2011). “Bank-Insured RoSCA for Microfinance: Experimental Evidence in Poor Egyptian Villages” Accessed at See also Mohammed El-Komi and Rachel Croson, “Experiments in Islamic Microfinance,” Journal of Economic Behavior and Organization, 95 (2013): 252-269.

[5] Montesquieu, Esprit des lois, XX: 2.

[6] Monzer Kahf, “Islamic Banks: The Rise of a New Power Alliance of Wealth and Shari’a Schlarship”

[7] Central Bank of Syria: (retrieved October 5, 2014). Excel spreadsheet “Money and Banking Statistics” can be downloaded from “Statistics” lefthand tab.

[8] Clement Henry Moore. “Prisoners’ Financial Dilemmas: A Consociational Future for Lebanon?” American  Political Science Review, 81:201-218 (March, 1987).

[9] Robert Axelrod, The Evolution of Cooperation, Basic Books, 1984, 2006.

[10] Stephanie Clifford, “Arab Bank Liable for Supporting Terrorist Efforts, Jury Finds,” New York Times, Sept 22, 2014.

[11] See Lynch “The Political Science of Syria’s War,” 3.

[12] Wendy Pearlman, “Understanding Fragmentation in the Syrian Revolt” in “The Political Science of Syria’s War,” 41.

Leave a Reply

Your email address will not be published. Required fields are marked *