Islamic finance in perspective

ByUmair Jalali

Teaches in The Royal Colosseum and is an avid sports fan

Dated

November 26, 2022

Islamic finance in perspective

Umair Jalali mentions an important development

The recent Islamic finance in perspective pronouncement of the coalition government that it will not contest the decision of the Federal Shariat Court instructing the banking system of Pakistan to abide by the Islamic injunctions laid down in respect of interest-free financial system. In this context it must be kept in mind that Islamic finance is an emerging genre in the annals of trade and finance. Though the essentials of Islamic finance are generalised but in actual fact its definitions range from the very narrow interest-free banking to the very broad financial operations conducted by Muslims. A useful definition is the following states that Islamic financial institutions are those that are based, in their objectives and operations, on Quranic principles. They are thus set apart from conventional institutions that have no such preoccupations.

This definition goes beyond simply equating Islamic finance with interest-free banking. It allows to take into account operations that may or may not be interest-free but are nonetheless imbued with certain Islamic principles: the avoidance of riba, in the broad sense of unjustified increase and gharar meaning uncertainty, risk, speculation, the focus on halal activities, the quest for justice and other ethical and religious goals. Two aspects of Islamic finance must be singled out. First is the risk-sharing philosophy: the lender must share in the borrower’s risk. Since fixed, predetermined interest rates guarantee a return to the lender and fall disproportionately on the borrower, they are seen as exploitative, socially unproductive and economically wasteful. The preferred mode of financing is profit-and-loss sharing (PLS). Second is the promotion of economic and social development through specific business practices and through zakat.

Most but not all Islamic institutions have a Sharia board – a committee of religious advisers whose opinion is sought on the acceptability of new instruments, and which conduct a religious audit of the bank’s activities – as well as other features reflecting their religious status. In sum, the defining difference is that while conventional finance usually seeks profit maximisation within a given regulatory framework, Islamic finance is also guided by other, religiously-inspired goals.

Islamic finance also involves more than banking. It includes mutual funds, securities firms, insurance companies and other non-banks. Where once – in the mid-seventies – Islamic banks were few in numbers and easily identifiable, the phenomenon has become quite amorphous with the proliferation of Islamic institutions and the blurring of the lines between traditional banking and other forms of finance. Another complicating factor is that a growing number of conventional financial institutions, inside and outside the Islamic world, have in recent years created Islamic subsidiaries or have been offering Islamic windows or products in addition to conventional ones.

The outside observer may query that in the absence of any interest incentive what alternative may be provided for managing a viable financial system and the clear answer to this question is that it can be managed through the development of profit-and-loss sharing mechanisms or through alternatives such as imposing fixed service charges or acting as buying agents for clients. Islamic finance can no longer be dismissed as a passing fad or as an epiphenomenon of Islamic revivalism. The first Islamic banks were created in the 1970s at the time when the aggiornamento of Islamic doctrine on banking matters was taking shape. At the time, Islamic banks were typically commercial banks operating on an interest-free basis. Today, as a consequence of broad changes in the political–economic environment, a new generation of Islamic financial institutions, more diverse and innovative, is emerging as the doctrine is undergoing a new aggiornamento.

Islamic financial institutions now operate in over 70 countries. Islamic banking has been called the most visible practical achievement of Islamic economics and the most visible mark of Islamic revivalism. Perhaps the most important development has been the growing integration of Islamic finance into the global economy. Many foreign institutions have established Islamic banking subsidiaries and many conventional banks both in the Muslim world as well as in the United States and Europe are now offering Islamic products that are sometimes aimed at non-Muslims. It is widely projected that Islamic finance has all the capacity that it could well become suitable to global economy with certain modification. The globalisation of finance has allowed Islamic finance to thrive and that there has been in recent years a fusion of sorts between Islamic and conventional banking.

Whereas the traditional world of finance, dominated by commercial, interest-based banking, could raise potentially troublesome theological issues, the new world of finance, characterised by the blurring of distinctions between commercial banking and other areas of finance, the downgrading of interest income, and financial innovation, has been rife with opportunities for Islamic financial institutions. Indeed, Islamic finance has driven financial modernization in many parts of the Muslim world and it is now an accepted formation of financial practice. TW

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