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Is Islamic Finance a failure?
More often than you think, people think Islamic finance is a sham, says Oliver Agha, founding partner of a shari'ah-compliant law firm. But Agha says it's all borne from ignorance.
January 28, 2012 2:16 by Reuters
However, in other products such criticism is warranted. A case in point is the term “Islamic bond” — this oxymoron, used so commonly by practitioners and the media, suggests Islamic finance can offer a debt instrument that generates an interest-based return — a complete absurdity. A study of some market sukuk structures, however, reveals the term “Islamic bond” is correctly applied to such “market” structures (for greater detail on sukuk structures and “defaults”, please see Oliver Agha et al, Sukuk: Default or No Default?, Credit: The Magazine for Bond Investors, Jan. 2010).
Some of the structures relied upon to solve the “problem” of “uncertainty” in an insurance transaction are a prime example of fundamentally unenforceable structures. To obviate the uncertainty (lack of knowledge of the actual date of occurrence of a risk of loss) in an insurance transaction, structures were devised where the premium payer “gifts” the premium (with no expectation of return) to the credit of the takaful fund and then the takaful fund (while having no obligation to pay) “gifts” back the proceeds (assuming enough of a balance remains in the fund) upon the occurrence of an event of loss. This way the parties are just making the gifts and “not really getting into a contract”.
But they are and expect it to serve as an enforceable obligation! However, based on Shari’ah precepts, once a gift is made there can be no expectation of a return. Thus, the entire construct is built on a false premise and the contract is invalid (this excludes those contracts where conditional contributions are made to a pooling arrangement). This sort of circumvention (hila), by making two unilateral “gifts”, effects the seemingly proscribed transaction through a sham arrangement. Ironically, the “uncertainty” inherent in such transactions is not even of the proscribed type (Oliver Agha, Tabarru in Takaful: Helpful Innovation or Unnecessary Complication? 9 UCLA J. Islamic & Near E.L. 101 (2010)).
Such constructs demean the Islamic finance industry and spur the hackneyed adage that “Islamic finance is a sham.” In truth, there is substantive basis for the development of Islamic insurance (which should be based on mutual arrangements and a commitment to refund premia on certain events upon non-occurrence of events of loss).
Legal and regulatory frameworks in countries are generally severely deficient (with some exceptions e.g.Malaysia and Pakistan) and do not provide a framework for the fluidity required for efficacious transactions; nor does the system envisage the requisite Islamic procedures/laws/dispute resolution systems — Islamic finance is not understood and in some instances (and in Islamic jurisdictions) is not even treated on a par with conventional finance.
More needs to be done at the governmental levels, including formulating legal and regulatory frameworks that (i) delineate standards applicable to the products/constructs in the industry (AAOIFI guidelines are helpful though not necessarily dispositive, and in some areas need review and revision to reflect consistency and cogency); (ii) develop substantive laws on property/real estate transactions that detail the rights and obligations of Islamic financier vs. developer vs. customer (clearly mortgage laws have little application in an Islamic ijara financing as the financier/property owner cannot properly be granted a mortgage on property that it owns); (iii) otherwise “level” the playing field between conventional and Islamic banking (e.g. reduce transfer fees in Islamic banking that need to occur twice, where in conventional banking there is just one property transfer); and (iv) simultaneously address the issue of transactions that have Shari’ah Board approval but are in stark contravention of the law of the country (e.g. beneficial ownership is not dispositive while registered ownership is when pursuing a defaulting customer).