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Islamic finance values hold key to innovation

Islamic finance like any other industry must create a distinctive value proposition that meets the needs of its customers.

By Mushtak Parker | Arab News | 26 Dec 2011

In the aftermath of the global financial crisis which was precipitated inter alia by the conduct and perceived greed of bankers chasing profits and bonuses seemingly at any cost, there has been a revisiting of the philosophy of banking and finance especially its relationship to the public good and the real economy.

In Islamic economics and finance, the concept of the Public Good (Maslaha) is well established. Islamic finance in essence should also pursue Maqasid Al-Shariah - the objectives of the Shariah relating especially to financial transactions, relationships and contracts.

Islamic finance, stress academics such as Professor Hashim Kamali, has provided sufficient evidence that the Shariah has enormous potential to contribute to the Public Good. One manifestation is the proscription on investments in speculative derivatives and transactions such as CDOs which were the bane of market capitalism in the recent financial crisis. The concept of Maslaha is not confined to Islamic finance per se, but also to wider governance, governments and public life, although the application of Maslaha must be genuine, all inclusive and have no conflicts with Shariah injunctions.

Indeed, at a recent 5th International Islamic Capital Markets Forum which was held at Lanai Kijang in Kuala Lumpur, Zarinah Anwar, chairman of the Securities Commission Malaysia, urged that the virtues of Islamic finance - public good, ethics, shared values, governance, real and tangible contributions to the economy - need to be unlocked further, and they hold the key to innovation and growth of the industry.

Pertinent to this year's forum theme, “Risk-sharing — A Way Forward to Public Good”, Zarinah emphasized that "the pursuit of profits guided by a higher social purpose will create not just economic returns but also comply with universal values shared by all of mankind. Indeed it is possible to derive profits from doing good. Putting this in place will strengthen the universality and acceptability of Islamic finance, enabling it to offer a distinctive value proposition."

Islamic finance like any other industry must create a distinctive value proposition that meets the needs of its customers. To a certain extent, Islamic Finance has managed to transcend religious, political and geographical boundaries and today serves not only the needs of the Muslims but it is also gaining the interest and acceptance of non-Muslims.

But, she warned that there are challenges that could pose threats to the entire value chain. Islamic finance products have had universal appeal due to its ability to replicate its conventional counterparts. But replication has its dangers. "Replicating the conventional banking products means that the industry is importing the same issues and concerns faced by conventional finance. Conventional finance recognizes debt as the basis of all financing structures whilst Islamic Finance has risk participation as its cornerstone. Blending the two, which has been the popular practice, has to some extent diminished the value and the spirit of the Shariah. And as a consequence we see increasing legal uncertainties and concerns over investor protection. But there is also a school of thought that says a close resemblance is permissible," she explained.

The forum covered concepts such as Maslaha (the public good); Tayyib (wholesome, the best); risk-sharing and public policy; a legal perspective of risk-sharing contracts; corporate governance and corporate social responsibility; an inter-disciplinary approach to Islamic finance; and linking Maqasid Al-Shariah (the objectives of Shariah) to the economy.

Zarinah emphasized three important propositions - the early development of Islamic finance which saw largely the Shariah-compliant replication of conventional products; the emergence of risk sharing in Islamic finance which integrates risk management with value creation; and the importance of achieving Maqasid Al-Shariah to offer a distinctive value proposition to the global financial system and society per se.

The industry has achieved double-digit growth rates; there has been increasing acceptance of Islamic finance not only in the Muslim-majority countries but also in non-Muslim jurisdictions; and the market has seen increasing participation of multinational corporations, multilaterals and conventional institutions in sukuk issuances.

Adapting conventional products to make them Shariah-compliant with the hope that these would eventually evolve and become more closely aligned with the principles of the Shariah was necessary in the early development of the industry, and has facilitated acceptance of these products and has been instrumental in getting Islamic finance to where it is today.

However, according to the SC, the emphasis on Shariah-compliant products has also meant that there has been less urgency to develop Shariah-based products. Furthermore, adaptation has resulted in direct comparisons being made between conventional and Islamic products in terms of risk-return profiles, cost structures and legal, tax as well as regulatory considerations. Often and not unexpectedly, such comparison would result in Islamic products being seen as less attractive.

The SC Chairman contended that for Islamic finance to flourish and sustain its long-term growth, it must be able to offer a more distinctive value proposition that is universal and all-encompassing. In this regard, risk-sharing is one of the cornerstones of the Shariah.

Risk-sharing contributes to fairness and collaboration, both of which are universal values. More concerted efforts to facilitate the expansion of Islamic finance toward risk-sharing structures will  therefore provide Islamic finance with a distinctive value proposition which will not only broaden its customer base to include investors seeking risk-participatory instruments, but also offers innovative product structures to provide diversification benefits.

But although the form of contracts for conventional and Shariah compliant financial transactions differ, the problems and challenges are not dissimilar. "Continued reliance on debt-based structures perpetuates the element of inequitable risk sharing by virtue of the risks in debt based transactions being largely transferred to the client or investor. The subprime crisis serves to remind us of the fragility of a debt-based system," she added.

Risk-sharing integrates risk management with value creation. The Islamic concepts of Musharakah and Mudarabah, for example, target value creation and are good ways of managing risk. Risk-sharing also encourages entrepreneurship.

While risk-sharing fosters strong commitments, it must have deterrent features that can effectively address any violation of the applicable principles or arrangements. "Only in this way," emphasized the SC chairman, "can we have a system that is competitive and allows for profit-maximization. Risk-sharing structures by their very nature will foster greater self and market discipline, thus allowing the regulators to focus on their core business of investor protection, ensuring fair and orderly markets and minimizing systemic risks. The risk-sharing concept, therefore, leads to the attainment of public good and promotes ethical and responsible corporate conduct."

Modern finance, agreed Chairman Zarinah, has contributed immensely toward global economic and social development. New ethical dimensions have been introduced into the financial services industry, such as CSR programs, socially responsible investing, green-financing, application of the equator principles which ensure the commitment of conventional institutions to the pursuit of public good.

Ethics and public good are inherent in the Islamic concept of risk-sharing. The ultimate objective of Islamic finance must be to fulfill the objectives of the Shariah. Indeed, the prohibition of Riba, leverage, speculative risk-taking and Gharar are meant to realize the ideals of social justice and to prevent exploitation. Thus the motivation for partaking in Islamic finance should therefore also include considerations beyond just the rationale that funds are from permissible sources, transactions are asset-backed, forms are Shariah-compliant and greater transparency are apparent in the structures.

Malaysia, said Zarinah, is well-poised to take Islamic finance to the next level given its success as an established Islamic financial centre where the government, regulators and industry all work hand-in-hand to support Islamic finance initiatives.

"Under our Capital Market Masterplan 2, the widening of the international base of the Islamic capital market has been identified as a key growth driver. In this respect, successful implementation of initiatives and strategies to facilitate and expand the Shariah-based approach, with its underlying qualities of promoting ethical and equitable economic and social developments that have universal appeal, will be crucial in supporting the sustainable growth of the Islamic capital market," she concluded.


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