Paper Title: Beyond Prohibitions: Unveiling the Hidden Dynamics of Islamic Economics and Finance

Author:        Prof. Dr. Burhan Uluyol

Publisher:    Journal of Islamic Monetary Economics and Finance. Vol 12(1), 81–106.

This research paper provides a theoretical reframing of the objectives underlying Islamic economics and finance. While Islamic finance is largely known for avoiding specific prohibitions—such as Riba (interest), Gharar (excessive ambiguity), and Maysir (gambling)—critics argue that it has become operationally identical to conventional finance. The author argues against this phenomenon of ‘Shariah arbitrage’, where the outward form is Islamic but the substance remains conventional.

The study identifies specific dynamics that anchor Islamic finance to real-world socio-economic equity:

1. The Role of Money: Conventional systems treat money as a tradable commodity designed to generate predetermined interest. In contrast, Islamic finance views money strictly as a medium of exchange to facilitate real economic activity. The author argues that this dynamic prevents wealth hoarding, speculative bubbles, and systemic economic imbalances.

2. The Limit of Debt Securitization: Conventional finance transforms illiquid debt into tradable securities, which increases systemic vulnerabilities, as seen in the 2008 Global Financial Crisis. Islamic finance deliberately discourages the securitization and sale of debt. By keeping financial transactions linked to physical assets, the system avoids excessive leverage and cascading market failures.

3. Bridging Financial Asset Growth and the Real Sector: Conventional banks primarily seek to expand financial assets and act as creators of endogenous money. Islamic banks prioritize real sector development, tying financial growth directly to productive goods like agriculture and manufacturing. This inherently limits the dangerous expansion of unregulated shadow money and speculative claims.

4. Financing Development Infrastructure: Developing nations typically rely on heavily leveraged government borrowing to fund infrastructure, exposing them to macroeconomic instability. The author argues that Islamic finance offers Sukuk which can be used to direct private capital toward public infrastructure through asset-backed risk-sharing. The author also cites the historical institution of Waqf (voluntary permanent donation) as an advanced moral incentive model for funding public goods without capitalist debt.

5. Shariah Screening in the Stock Market: Islamic equities avoid high-leveraged firms, complex derivatives, and toxic assets, making them relatively stable during market downturns. Nonetheless, the paper is comparing the ideals and theory of Islamic economics with practice of conventional finance. What the author identifies as hidden dynamics are not really areas where Islamic finance practice has a distinction.

For instance, Islamic banks also operate under the fractional reserve system where the money is created by the banking institutions through their asset and liability operations. While the outright sale of debt is avoided, but contracts like Bai Inah, Tawarruq and asset light transactions and instruments achieve the end-result in a Shari’ah compliant way through legal stratagems. 

Furthermore, it is not correct to say that Islamic finance instruments use risk-sharing principle rather than risk-shifting instruments. The predominantly used debt-based modes of finance transfer risk almost immediately or cover it through covenants and insurance whose cost is borne by the client. The cost of finance in Islamic finance is generally higher or at best at par with conventional finance.

It has been documented in studies that profit rates on deposits are generally lower in Islamic banks than conventional. By having greater inefficiency and larger spreads, small-size Islamic banks are more focused towards financing large corporate sector than conventional. Islamic banks neglect SMEs and agriculture more blatantly than conventional, such as in countries like Pakistan. Hence, Islamic finance is yet to have a distinctive edge when it comes to inclusive financing to the important real sectors like agriculture, SMEs, microenterprise finance, start-up finance etc.  

Finally, the stock screening principles are operational limits imposed without a definite basis in Shari’ah about the specific threshold values. They discourage conventional interest-based investments and leverage. But, if the same leveraged financing is obtained at even a higher cost from Islamic finance, then the threshold values do not apply. Hence, deriving any dynamic of economic distinction from the stock screening criteria is unwarranted.

The paper also touches on the distinction of Sukuk and Waqf instruments to foster link with real economy and provide development finance. However, in practice, many Sukuk are asset-light. Many of the Ijarah Sukuk are based on the conventional sale and leaseback structure in essence through minor modifications for legal compliance that does not change the economic substance. That is why, Islamic financial institutions plead for tax neutrality by presenting the case that Islamic finance instruments are similar in economic substance as their conventional counterparts.

Finally, Waqf is largely a dormant institution due to the rigidity in jurisprudential understanding around how to use Waqf. Trusts are more common even in Muslim majority countries in the third sector. When it comes to Zakat, the actual collection is less than 1% of the potential in many Muslim majority countries. Hence, there is a gap between Islamic economic theory and potential versus the actual practice. 

While Islamic finance literature, especially from the first generation, indeed had visionary insights and expectations for Islamic finance, those expectations, principles, and benchmarks cannot be assumed to be fully translated into the Islamic finance practice of today. Despite adopting terms like profit-sharing, Islamic banks frequently replicate conventional amortization structures that maintain asymmetric risk. True risk-sharing cannot survive on contractual vocabulary alone.