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Is Islamic Finance a failure?

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

Islamic finance, a faith-based system of ethical finance, is growing while it continues to struggle for its identity; it is torn between the market success of emulating conventional structures and developing genuinely Islamic structures that reflect its spiritual ethos. This article reveals the struggle and highlights the endemic and extraneous pressures that threaten Islamic finance — and then notes specific remedial actions that must be taken for its redemption.

The Islamic finance industry is reported to be valued at over $1 trillion, with an estimated annual growth rate of 10 percent (Global Islamic Finance Report, 34 (Humayon Dar et al eds., BMB Islamic ed. 2011)). The industry is continuing to grow despite its inherent problems, and some market analysts project it will be valued at anywhere from $3 to $5 trillion by 2016.

Islamic finance should serve as a stabilising force in the global economic order because deposits in Islamic banks (which are not loans but true investment deposits on a mudaraba basis) are reinvested in the real economy for goods/services without any artificial money expansion. In the conventional system, banks increase credit in good times on the fractional reserve banking system principle — for each dollar deposited (loaned) to a bank, the bank may loan out many more. The “choking” of such credit, in a downturn, can wreak havoc as evidenced by the financial crises, and therefore the equity-based constructs inherent in the Islamic system are likely to serve as a stable pillar of the economic system particularly in these times.

While the spiritual precepts behind Islamic finance espouse risk sharing and partnerships, many products in the market reflect risk profiles of conventional structures. As disputes in such products/structures develop, the judgments (if out of line with Shari’ah precepts in the absence of regulatory and legal frameworks) could threaten the future of the industry. From where we sit, stakeholders need reliability and clarity on laws governing the Islamic finance industry and adjudication of their disputes; in the absence of such clarity the industry will suffer from structural problems risking an exodus.

This article is written, while uncompromisingly, with the intention to have the governmental authorities and stakeholders take serious notice of the issues and address them comprehensively through considered and comprehensive legislation while the industry is still in a nascent stage — a stitch in time will save nine. It is also a call to all to push for an alignment for the industry with its spiritual core — not focusing merely on market success. The article ought to be read with this background in mind.

Today, Islamic finance is beset with problems including those relating to credibility, regulatory, enforceability, uniformity (including Shari’ah issues), lack of scholarship/training and being fundamentally out of sync with its spiritual and ethical mandate.

More often than not, people have said to me, “Islamic finance is a sham.” They don’t see the difference between Islamic banking and conventional banking and cannot differentiate between conventional and Islamic products. Some of this criticism is unfair and due to a lack of understanding of the difference in the actual risk profiles between the two (e.g. in an Islamic ijara project/property finance transaction, the financier assumes the risk of loss of the asset, which is markedly different than a conventional mortgage situation where the mortgagee (bank), as lender rather than owner, does not assume such risk of loss).

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