BY: DR MARJAN MUHAMMAD
There is no doubt that the Islamic finance industry has grown tremendously over the past decade. Even though Islamic finance represents only 1 percent of global financial assets, The Banker reported that global Islamic financial assets grew 21.4 percent from 2010 to 2011. A report by The CityUK estimated that total Islamic financial assets worldwide have increased by 150 percent over five years. Sukuk issuance, for instance, increased 62 percent to USD84 billion in 2011, with Malaysia, the largest issuer, issuing two-thirds of that. Meanwhile, Islamic management funds reached a new high of USD58 billion in 2010.
In achieving this market growth, Islamic finance has seen the emergence of various innovative instruments. On the one hand, they have helped the Islamic financial services industry to prosper, yet they have been criticized for converging with the conventional sphere. Most of the time, when new Islamic financial products are developed, they are modeled after, and strongly resemble, conventional products.
The principle of unilateral promise (wa‘d), for example, has become a major tool to replicate various conventional products so that they share the same economic substance. This includes the use of wa‘d in Shari‘ah-compliant hedging instruments such as Islamic FX forward and Islamic profit rate swap to mimic the effect of conventional forward contracts, and in sukuk structuring to have similar economic outcomes as conventional bonds. An empirical study by Shabnam Mokhtar shows that unconditional purchase undertakings in musharakah and mudarabah sukuk structures create an element of indebtedness by acting to guarantee both principal and profit.
Apart from that, Islamic financial innovation has witnessed an increasing reliance on debt-based financing, ranging from small-scale personal financing to large quantum syndicated financing. Although these products may differ legally and technically from conventional products, their essence and substance are similar. IMF Working Paper (June 2012) suggests that the gap between Islamic and conventional financial practices, particularly in Malaysia, is shrinking, with Malaysian sukuk and conventional bonds having similar economic functions and comparable returns. Humayon Dar, in his article “Identity Crisis: Islamic Bank – In Search of a Lost Soul” pointed out that Islamic banking has become capitalistic in its approach and operations. Most Islamic financial offerings nowadays are meant for profit maximization for shareholders, thus competing with their conventional counterparts via a replication of economic effects.
Due to this inherent trend, a question arises: should Islamic finance search for an alternative to this Shari‘ah-compliant approach? Which is better for the future direction of Islamic finance? Many believe that Islamic finance should move towards a Shari‘ah-based approach focusing on risk sharing as its essence. In fact, much of the theoretical literature on Islamic finance proposes profit and loss sharing (PLS) as the philosophical origin of Islamic finance. Munawar Iqbal and Philip Molyneux noted “the most important feature of Islamic banking is that it promotes risk sharing between the provider of funds (investor) and the user of the funds (entrepreneur)”. As such, Islamic finance should base its deals on underlying assets and not gain profit from “fictitious” contracts that require no risk (when the risk is pertinent).
The advocates of this idea also urge that while adherence to the requirements of Islamic jurisprudence remains central in developing any Islamic financial products, observance of the principles of social justice, favouring the weaker party, cooperation, mutuality and ethical dealings should prevail.
However, is the industry ready to shift? I believe, after passing thirty years of its inception, Islamic finance is still at a crossroad between abiding to the true practice of Islam by fulfilling both Islamic jurisprudence requirements and ethical spirit and meeting market demands by creating innovative Shari‘ah-compliant instruments that are applied within a conventional ethos.