The Potential of Islamic Finance

Here, you will learn more about Islamic Finance and how it can contribute to financial services. What do you think the next innovative financial product or service after Islamic financing and cryptocurrencies will be?

Islamic Finance: What Is Different?

The concept of Islamic or Shariah-compliant finance is based on core tenets of Islam concerning property rights, social and economic justice, wealth distribution, and governance. One of the key features of the system is prohibition of riba (interest) and gharar (ambiguous contracts or deals). There is consensus among scholars that the prohibition of interest is not limited to usury but refers to interest on debt in any form. The prohibition of gharar is  to discourage excessive uncertainty in contracts, enhance disclosure, and proscribe all forms of deception. In addition to the  prohibition of riba and gharar, Islamic finance has seven key precepts. Implemented fully, Islamic finance:

  1. Eliminates pure debt securities from the financial system, replacing interest by the rate of return earned ex post on contracts of exchange or risk sharing.
  2. Calls for bank deposits to be collected on a profit/loss-(PLS) sharing basis rather than fixed predetermined liabilities. All profits and/or losses on the asset side are to be passed through to the investors (depositors) on the liabilities side.
  3.  Promotes financing of trade and exchange of goods and services to ensure a close link between the real economy and the financial sector, because all financial contracts should be backed by assets or transactions/activities in the real economic sector.
  4. Upholds property rights for the individual and society, and clarifies the sources of individual ownership.
  5. Mandates fulfillment and sanctity of contracts that deal with trade in goods and services, as well as transfer of ownership and honoring of debt obligations.
  6. Emphasizes principles of morality and ethics in business conduct, proscribing illicit activities according to Shariah, and mandating that all economic activities be governed by rules of fair dealing and justice.
  7. Advocates the sharing of risk and reward between the rich and the poor through specific instruments of re-distribution.

These elements constitute an alternative approach to conventional finance. Since their development in the mid-1970s, Islamic financial institutions have increasingly provided attractive channels for financial intermediation and have grown rapidly, especially in the last decade.

Source: Mahmoud Mohieldin, https://openknowledge.worldbank.org/bitstream/handle/10986/10051/676440BRI0econ00Box367885B00PUBLIC0.pdf?sequence=1&isAllowed=y
Creative Commons License This work is licensed under a Creative Commons Attribution 3.0 IGO License.