The Islamic financial system – Part 1

By Ravi Abeysuriya

The Islamic financial system is not much different from the products and services in the traditional financial system but it operations are essentially based on a certain set of moral and ethical principles that determined what is viewed as morally ‘right’ implying actions and transactions that promote public good, and ‘wrong’ implying actions and transactions likely to be against the public good.

Describing the Islamic financial system simply as “interest-free” does not provide a correct picture of the system as a whole and tends to create confusion. While prohibiting the receipt and payment of interest is the nucleus of the system, it is supported by other principles of Islamic teachings advocating individuals’ rights and duties, property rights, equitable distribution of wealth, risk-sharing, fulfillment of obligations and the sanctity of contracts. 

The Islamic financial system is not limited to banking but covers insurance, capital formation, capital markets, and all types of financial intermediation and suggests that moral and ethical aspects in the regulatory framework are also necessary in addition to prudent and sound controls.

Misconceptions about Islamic finance 

With the fast-evolving discipline of Islamic finance from a global perspective, it is important to clear up the misconceptions and debunk myths that may be the source of misunderstanding about the Islamic finance industry. 

This is to ensure that Islamic finance is presented in a fair, balanced manner as a genuine ethical business aimed at serving the needs and demands of the market just like any other financial discipline. 

1 – It is for Muslims only

This is a big misconception, but one that is far easier to address than most, seeing as conventional banking groups such as Citigroup, HSBC and Standard Chartered, among others, are already offering Islamic financial services. This is proof that no prohibition exists in terms of the use of Islamic financial products by non-Muslims, nor are there laws stating that non-Muslims may not own institutions offering such products and services.

As for the prohibition against interest based transactions, that is, investments in unethical or immoral sectors such as alcohol, gambling and pornography, it should be noted that other major world religions including Christianity, Judaism, Buddhism and Hinduism also impose this restriction. Many non-Muslims abstain from investing in such businesses as well, whether as a matter of religious, cultural or personal principle.

Islamic finance shouldn’t be seen as divisive, but instead as an alternative for conducting financial transactions according to a set of defined ethical values and parameters that differ from the commonplace. More importantly, it should make commercial sense, or it would be unlikely that any individual, Muslim or non-Muslim, would willingly engage in it.

As proof of its universal viability, Islamic finance has also been in the Vatican’s official newspaper, Osservatore Romano, which stated that “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.”

2 – It is just an Islamic copy of conventional finance

It’s easy to assume that Islamic finance is a mere replica of conventional finance, seeing as there are many similarities between the two, especially in terms of the economic objectives for end users. Because the distinction between these two forms of finance is not obvious, it’s easy for critics to disregard the differences.

However, the fact remains that at its root, Islamic finance is governed by some fundamental principles that are very different from conventional finance, including prohibitions against interest, gambling and ambiguity, which Islamic finance products are designed to remove. 

Essentially, while profits are as important in Islamic finance as they are in conventional finance, the means by which these profits are earned is doubly important. This is the main philosophical distinction between the two financial systems, and one that truly differentiates Islamic finance from conventional finance.

3 – Islamic finance is based on Shariah (Islamic) law – will it therefore fall outside the jurisdiction of the local court of law?

No, an Islamic finance contract will usually contain exactly the same kind of choice of law and jurisdiction clause that you see in conventional loan documentation. Indeed, it is open for the parties to agree in an Islamic finance contract that any disputes shall be resolved under the laws of a particular country and for the courts of that country to have jurisdiction. Arbitration provisions are also quite common. 

In many ways, Shariah can be considered to play a role only at the outset of an Islamic finance transaction – through ensuring that the structure and the documentation comply with the principles of Islamic finance. 

4 – It is aimed towards Islam’s world domination

If Islamophobists are to be believed, Islamic finance is fifth generation warfare that aims to replace the current financial system and ultimately bring about the domination of the world by Islam. And yet, they don’t explain how this is possible, seeing as the entire Islamic financial industry makes up less than 1% of the global financial system, and, more importantly, how Muslim-majority countries are among the most impoverished and underdeveloped in the world. 

In fact, the collective gross domestic product of the 56-member Organisation of Islamic Conference (OIC) makes up less than 5% of the world’s total, with intra-trade volume of just around 7% of total global trade. 

Many Islamic countries also suffer from prolonged wars, unrest and social strife, and therefore are too bogged down by issues such as economic survival and community well-being to be able to focus on pushing Islamic finance to greater heights.

5 – It finances terrorism

This is by far the most common misconception, and also the easiest excuse to disregard Islamic finance as a legitimate discipline.  The fact is Islamic law (also known as ‘Shariah’) categorically condemns terrorism, as it considers any overt and illegal use of violence a heinous crime, even more so when innocents are involved.  All institutions engaged in Islamic finance are strictly prohibited from knowingly assisting or participating in any acts that constitute terrorism, or may lead to it.

Irrational phobia against Islam and conspiracy theories aside, there has not been real, solid evidence to justify allegations linking Islamic finance to terrorism.

Like any other financial body, Islamic financial institutions are bound by and must adhere to strict laws and regulations of the country, including those pertaining to terrorism and money laundering. Should there ever be any proof that links an Islamic financial institution to a terrorist organisation, the due process of the law of the country should be activated in order to bring the perpetrators to justice.

(The writer is President – Association of Alternate Financial Institutions.)

Sources: 

www.inceif.org

www.diapiper.com

www.islamic-banking.com/explore/islamic-finance