An economic theory of Islamic finance

Pages: 106
Year: 2017

This publication is part of the journal (2017-2)

Purpose – This paper aims to provide an economic rationale for Islamic finance.
Design/methodology/approach – Its methodology is simple. It starts with listing the contributions
to economic analysis relevant to the required rationale in the theories of banking, finance, price, money
and macroeconomics, to identify the main rationale for Islamic finance. A concise description of the
author’s model for an Islamic economic system, within which Islamic finance can be operational, is
Findings – The paper finds distinct advantages of Islamic finance, when properly applied within the
author’s model. Islamic finance can therefore be a candidate as a reform agenda for conventional
finance. It opens the door for significant monetary reform in currently prevalent economic systems.
Research limitations/implications – The first limitation of the paper is that the distinct benefits of
Islamic finance are all of macroeconomic types which are external to Islamic banking and finance institutions.
They are therefore not expected to motivate such institutions to apply Islamic finance to the letter, without
regulators interference to ensure strict application. The second limitation is the necessity to set up enabling
institutional and regulatory arrangements for Islamic finance.
Originality/value – The results are unique as they challenge the received doctrine and provide nonreligious
rationale for Islamic finance.
Keywords Islamic finance, Islamic economics, macroeconomics, economic reform
Paper type Research paper
Conventional finance, based on the classical loan contract, was practiced in the ancient
world for centuries. The origin of modern banking has been traced back to Italy in the
twelfth century (De Roover, 1943, 1954; Orsingher, 1967; Chachi, 2005). Meanwhile, interestfree
Islamic finance started with the dawn of Islam, based on a number of investment and
finance contracts. Yet, despite its continued application, it did not take the form of banking
until 1975 (Chachi, 2005).
Islamic jurisprudence offers little with regard to the rationale of Islamic finance beyond
the concept of justice underlying the prohibition of interest. Islamic finance involves higher
contractual and transactions costs. Instead of using one standardized contract like the
classical loan contract, it uses products based on numerous contracts, involving the
possibility of mixing and matching as well as securitization.



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