Articles on Islamic Finance

Towards a Pristine Islamic Finance: Preconditions

Author:        Oluwaseun Sulaiman Saidu

Publisher:    Share Journal of Islamic Economics and Finance, 9(2), 164 -183

This paper discusses the preconditions for the development of a pure form of Islamic finance that is Shari’ah based as well as fulfilling the higher goals of Islamic teachings, i.e. Maqasid-e-Shari’ah.

The author cautions that Islamization of financial instruments not only needs to look at the practicality of the instrument, but also its effects. When an effort is made for change, the most practical system is the prevalent system.

However, the prevalent system of interest based debt finance is inconsistent with Islamic teachings and as well as its higher goals.  In this context, this study aims at marshalling a path towards scripting a pristine and practicable Islamic finance by identifying two salient preconditions for it.

The author states that since its inception, the Islamic financial industry has been plagued with unnecessary imperfections and defects cutting across all aspects of Islamic financial theorizing and applications. The response to these imperfections and defects has been chiefly regulatory and supervisory prescriptions.

A fundamental flaw in response is the tendency to want to ensure the workability of the system without an ideal operational/enabling law. Another flaw is that the approach seems to champion the idea that: “in the absence of morals, we have regulation and supervision”; whereas, the observance of best practices has a lot to do with internal conviction reinforced with correct knowledge and belief.

Therefore, the author gives two prerequisites for a pure and effective form of Islamic financing, i.e. The Islamic law and the Islamic Man. Both are not mutually exclusive. Rather, they are mutually reinforcing. In fact, their inexistence synergistically precludes the workability as well as practicability of a pristine Islamic finance.

In institutionalizing and implementing Islamic finance, the author presents five practical considerations.

First is concerned with the impracticability of Islamic financing without an enabling Islamic law. It foreshadows that Islamic finance cannot exist without an Islamic law and if it does, it will be filled with unforgivable pitfalls which is not befitting of a complete system called Islam on which such financing is purportedly based.

The second consideration is non-implementability of Islamic financing without the Islamic man. It connotes that a necessary but insufficient ingredient for Islamic financial practice is an Islamic man. This man is instrumental to the development of the financial system as everything rests on him as supplier of funds, customer of financial products and as auditor and regulator.

The third possible scenario is that Islamic finance is orchestrated without an Islamic law but with an Islamic man. This will still result in under-supply of financial services in compliance with Islamic law and result in financial exclusion, low rates of savings and low levels of financial development. In many Muslim majority countries, this is nearly the practical scenario. Despite huge Muslim population, there is very small share of Islamic banking and finance.

The fourth possible scenario is a “globalized” Islamic finance that can at best fit into a practicable legal micro framework in today’s world. Even though, this could be a viable way to expedite growth of Islamic finance, but presently, this is not possible given the limited size of Islamic finance in the overall global financial market.

Furthermore, given the non-standardization in some jurisdictions, there are multiple ways in which Islamic finance is evolving in different parts of the world taking the localized context in perspective. For instance, some instruments are practicable in East Asia, but not in other regions.  

The fifth possible scenario is that a non-global Islamic finance is fostered within a practicable legal micro framework. Even though, this scenario may not have scale benefits and will require long time period for achieving Islamization, but this is the practical route adopted in regions for fostering Islamic finance.

However, the author notes that fulfilling the requirements of Islamic law in letter and spirit is necessary. Thus, efforts should be made to induce features of Islamic law in the general regulations so as to allow Islamic finance to prosper in an effective way.

If legal efforts are confined only towards achieving tax neutrality, then such efforts would only help in achieving assimilation of conventional finance within the Islamic ambit. The goal should be to transform the financial architecture through Shari’ah based structures.

Finally, Islamic finance cannot work in isolation. It requires willingness of people who are ready to accept risk sharing as investors and profit sharing as partners. Islamic financial institutions as intermediaries can only work on the preference structures of their funding clients, i.e. depositors and shareholders. If they do not have the wish to avoid Riba and are not willing to share risk and allow participation by equity, then path towards achieving a pristine Islamic finance will face obstacles.

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