In this podcast edition of Foreign Affairs Unedited author Harris Irfan discusses Islamic finance and conscious capitalism with Foreign Affairs Deputy Web Editor Brian O'Connor.  This interview has been edited and condensed. A rush transcript is below.

Brian O'Connor: So you've had quite an interesting career so far, I was wondering if you could describe how you first became involved in Islamic finance?

Harris Irfan: Well, I was a banker with Deutsche Bank and they transferred me to their newly opened Dubai office in 2001. And when I arrived there, I was the first Deutsche banker on the ground. A lot of clients came up to us and said, "Well, it's great that you're here now, Deutsche Bank, but actually we wanna do these deals on a Shariah-compliant basis," and being investment bankers, I guess we blagged our way and said, "Yeah, sure no problem." But actually it was a very nascent industry and a lot of the complex products that the investment banks were manufacturing had not yet been introduced into the Islamic finance space, and we found ourselves learning at the feet of these people called Shariah scholars,

Brian O'Connor: In terms of reliance on Shariah scholars, what was their role within the bank and how did they end up coming across these scholars that would help them make products that were compliant?

Harris Irfan: Well, the scholars had never previously worked with the big brand name investment banks, up until that point, most of them had been working with a lot of the domestic and regional banks in places like the Gulf states or the Middle East, and Malaysia. And when investment banks like Deutsche Bank came along, we managed to find a number of these scholars who had the relevant credentials in economic theory and finance, as well as the Islamic jurisprudence of commercial transactions, which is a particular specific discipline within Shariah Law.

Brian O'Connor: Toward that end I was wondering if you could go into, just sort of briefly providing a nutshell on how Islamic finance works?

Harris Irfan: Well, I guess there are probably three levels on the manner in which it differs from conventional finance. The first is, the nature of money itself, how does Islamic finance perceive money? The second is, the nature of the assets, they need to be real assets and they need to be employed in the real economy, and I'll come on to what that means. And finally, the fact that any transaction that you or I or any corporation enters into, mustn't be harmful to society.

So I guess let's deal with those in turn, first of all the nature of money. I guess in modern economics and the modern financial services industry, money is no longer seen as merely a medium of exchange, it's actually seen as a commodity to be traded. So we see investment banks trading debt, trading cash flows. The essence of Islamic finance is about the nature of money, it can't be, money has to be merely a medium of exchange, it cannot be based on intangible concepts.

Secondly, we talk about the real economy. The real economy is essentially what you see, touch and feel. It's about real jobs, real wealth creation, real manufacturing, real services. The financial economy, which is something that we hear about in the press, we've heard about, for example, the fall of Lehman Brothers and Northern Rock and other investment banks and banks around the world during the financial crisis. And many of these failures were as a result of the, I hesitate to use the word "pyramid scheme," but in a sense, the complex derivative contracts that these sorts of banks were dealing with were kind of a house of cards, because there was no tangibility to the underlined assets within those pieces of paper. So the real economy is, as the name suggests, it's about real, hard assets. And Islamic finance is very purposefully dedicated to financing the real economy on a one-to-one basis.

And the third element of how it differs is the fact that, in theory at least, Islamic finance, and finance that is compatible with Shariah principles has to be ethical. In other words, it cannot invest in things that are harmful to society. So in theory that means things like alcohol and tobacco manufacturing and so on. And there are certain therefore excluded industries.

And I guess there's another fourth element that we don't see so much nowadays, and that is something that we're seeing in the conventional financial services industry, something that we call in the conventional industry, ESG, which is Environmental Social Governance. And maybe you've heard about socially responsible investing. I heard a couple of days ago that both Oxford University and Cambridge University have recently made commitments not to invest in, for example, coal and tar sands because they want to have a positive impact on the environment, on society and so on. So they have made a conscious decision to invest in ways that are beneficial to society. And I think that's a fourth strand to Islamic finance, which hasn't currently been implemented, but believe me, I'm working on it.


Brian O'Connor: And rightfully so. There really is a burgeoning market both within countries that might want to adhere to Shariah principles, but then also across the board, and have those ethically-minded investments made available to them.

Harris Irfan: Absolutely. I think people tend to get hung up on the idea of 'Islamic finance,' and 'Shariah-compliant finance,' and actually, we do sometimes find that people are turned off by those references, and they need not be because many of principles enshrined in those are absolutely universal, the universal principles of social justice of equality, of transparency, of ensuring that the weak are protected, the vulnerable are protected. That's the theory, of course. The practice is that Islamic banks and Islamic financial institutions operate in the global financial system. Which means, of course, they are subject to the same rules and regulations as conventional banks. Which is a bit like squeezing a square peg into a round hole.

Brian O'Connor: I would imagine so, and it seems as though these two different types of bankings really do stand at odds with one another. How do you think that they could co-exist in the future?

Harris Irfan: Well, it's a very good point. As you know, conventional banks operate in the system called the 'fractional reserve banking system.' Which, in essence, means that for every dollar that's deposited with a bank, is lent out maybe 20 times. I mean, $20 is lent out. So essentially banks have the power to create money. In theory, Islamic banks are not allowed to do that. There has to be a one-to-one relationship rather than, say, a twenty-to-one relationship. That means for every dollar that's deposited in Islamic bank, they're supposed to be financing $1 worth of asset. In reality, of course, that's not the case, because they operate at the same fractional reserves that are prescribed to them by central banks, and there are no special rules for them

Now, I think there's a more fundamental question here, which is, how does one ensure at a legislative level, at a policy level, that we have a fairer economic system? One doesn't need to say that it's Islamic or Shariah-compliant, but how can it be fairer? And I think one of the ways there's been a divergence in wealth between rich and poor in society today, is because we have this fractional reserve banking system that is predicated on Fiat currency. In other words, currency that is created by government, that is decreed by government, legislatively.

Brian O'Connor: Well, it also seems possible at least to say that if you were to have banks that perhaps were not allowed to get too big to fail, banks that couldn't over-leverage themselves to the point where they are giving out loans that are anywhere from two to three to five times what they actually have within their reserve. That, perhaps, maybe Islamic banking, just by very nature of not being able to be that over-leveraged, you wouldn't create banks that would be too big to fail, in that case.

Harris Irfan: Well, it's very true to say that, during the financial crises, they probably faired a little bit better than conventional banks. Largely, because they weren't exposed to many of the complex structured derivative instruments that conventional banks were exposed to. And also, perhaps, because they, in some cases, would have been less leveraged than conventional banks. Although I don't think that's always true.

I think that the current Islamic banking system, in its current incarnation, is essentially a duplication of the conventional banking system. And Islamic banking has tried to replicate the debt-based products that conventional banks produce, and as a result the general public tends not to see a huge difference between the two, which is a huge shame. So, again, one of the things that I am working on, is trying to create a recognizable difference that is truly ethical in nature, but that's a tough challenge.

Brian O'Connor: And I think that brings up a really great point with what you're doing with Cordova Capital. And my question there is, after having the experience that you had at large banks, what led you to go it alone? What led you to start your own house?

Harris Irfan: Well, Cordova Capital was born out of a desire to advise institutions and governments and the private sector on creating truly Shariah-compliant instruments with a strong emphasis on the ethics of those instruments, and the implications of those instruments. Ultimately what happened was that Cordova Capital was absorbed into a small British Islamic bank called European Islamic Investment Bank and therefore, the manner in which products that come out of these boutique specialist Islamic institution is quite different to the manner in which they're produced in large conventional institutions like Deutsche Bank and Barclays where I worked formerly.

Obviously, there is a tendency within the larger organizations towards acquiescence so those individuals who are happy to acquiesce to the needs of management, to ensure profit above all else.  I think within the smaller, specialist boutiques that focus specifically on Islamic finance and don't work in conventional finance, there's the opportunity to have your voice heard. There's the opportunity to shape the culture of these organizations, to ensure that people do good, that they behave in an ethical manner.

Brian O'Connor: I'm curious actually to see what sort of challenges did you come up against representing larger banks when you were first getting into Islamic finance?

Harris Irfan: Actually, funnily enough, investors are much more comfortable with the large brand names, particularly governments, who are issuing these large Islamic bonds, you know, billion dollars at a time. They would rather appoint a global investment bank, almost irrespective of their Islamic credentials, because what they're after is a network of a 100 offices around the world that can sell bonds in a matter of minutes.

Brian O'Connor: What I'm curious to learn about after reading your book is what you see the future of Islamic finance becoming in the next few years.

Harris Irfan: Well, I'm very concerned that my industry, that I care very deeply about, is being hijacked by conventional bankers and by that conventional banking culture. It's very important to me personally to ensure that that doesn't happen. I think that Islamic finance is a force for good. I think it has universal ethical values that appeal to cultures, to people of different faiths, people of no faith. These are universal human values, and so, I think it's good for society in general. So I am very focused personally on changing the culture of the organizations and the clients and the instruments that I work with to ensure that they are genuinely good and beneficial. I think that there is a tendency in my industry to focus on the lowest common denominator so people will tend to look for waivers from Shariah scholars, who are meant to uphold these standards. They will tend to cut corners, find loopholes, but that's nothing new.

Brian O'Connor:I think within western media there is this propensity toward saying that anything that is Shariah Law could be at odds with western values, with western philosophy of governance. So, how do you see Islamic finance as being able to bridge that gap?

Harris Irfan: I think Islamic finance has the power and the potential to unite two different cultures. I think it's a bridge between them because it has common values and I think it can help to demystify and break down the barriers between two cultures. During the financial crisis, for example, a number of governments around the world introduced legislation that would prevent what is called 'shorting' of certain stocks of financial institutions. In other words, traders were not allowed to sell the stock of some financial institutions without actually having legal possession, actually owning them and this type of trading is known as 'shorting.'

It's not allowed in Shariah Law because one cannot sell something that one does not own and have legal title to. And it's very interesting that these are the standards of commercial behavior that are inherent.  I see Shariah Law, for example, as an organic and progressive and evolving body of law, whereas kind of close colonial identity searching by rulers in Muslim countries has led the rest of the world to believe that Shariah is actually something intolerant, dogmatic and exclusive. Which I think is absolutely wrong when the first 1,300 years of Islamic development will prove otherwise. But unfortunately that's a history that's been lost to Europe and the West, and that's something that we should return to.

Islamic finance is only barely scratching the surface. There are 1.6 billion Muslims in the world, very under-penetrating in terms of financial services. Look at countries like Indonesia, for example, with massive Muslim populations that have probably a single-digit penetration rate of financial services. And then look at the ESG industry. Look at how big it is globally, look at how big it is in the US alone. That's probably a $45 trillion industry. And the Islamic finance industry is probably 1/20th of that in size.


So the opportunity for Islamic finance to grow and merge with the ESG industry I think is massive. And one not need be afraid of that in the same way as Islamic legislative frameworks were merely tools to ensure a balanced harmonious society in days gone by, in the Middle Ages, when many cultures lived side by side in harmony. I've seen a reason why Islamic finance cannot be a bridge to cultures today.

Brian O'Connor: That's exciting to hear and it's exciting to see how the sector develops. Thanks so much.

Harris Irfan: Thank you Brian.