Islamic Banking and Finance – Shariah Based Solutions – Research Paper

This research paper was read by IBA Karachi students at the IQRA’s International Islamic Conference.

Finance has proved to be the life nerve of all economic activities, with all economic transactions culminating into financial results.  Financial markets are there to serve a unique function of efficient allocation of the scarce resources.  The prevalent financial system works with interest as the determinant cost of funds varying with the risk, however, with little or no relation to the real output of the assets. This dichotomy of the operational results of the businesses and their cost of funds results in the exploitation of one or the other stakeholder. This inherently flawed financial system has proved to widen the development gap and decelerate, and in some cases even reverse the real transfer of development.

This severance of the natural link between the enterprise’s profits and the return to the lenders has led to the unwise resource allocation, placing these markets in a self-perpetuating vicious cycle, so that even the best practitioners have felt the pinch of the situation. This has resulted into destabilization of markets resulting in economic slowdowns across the globe.

Islamic Shariah has bestowed upon us a prudent mechanism of allocation of the economic resources, based on equitable sharing of the rewards. The Islamic banking is based on different principles than the conventional banking, therefore the result of their operations are not necessarily the same in terms of profitability as other banks. The concept of Islamic banking is based on an economic philosophy underlying the rules and principles of Shariah.  This philosophy aims at establishing distributive justice free from all sort of exploitation.

It is a big challenge to reform the financial institutions to bring them in harmony with the dictates of Shariah. Especially in an environment where the entire financial system is based on interest, it is a formidable task to structure the financial institutions on an interest free basis.  The foundering efforts by Islamic banks are commendable.  New Islamic banks with huge amount of capital are being established. Conventional banks are opening Islamic windows or Islamic subsidiaries for the operations of Islamic banking.  It seems that the Shariah based financing will cover a large area of financial transactions of the world.

While working in isolation and with little support of the governments, despite all its benefits there are practical problems in using the Islamic modes of financing. The Islamic banks should have moved towards the ideal modes of financing given by Shariah in gradual phases.  However, these banks have overlooked the basic requirements and resulted into practicing financing techniques that are not Shariah compliant at the very least and indistinguishable from the contemporary banking transactions.

Thus, there is a need for Islamic financial institutions to improve their operations and adhere to Shariah principles in their transactions.  To work towards the attainment of this objective they must work closely with their Shariah advisory boards and Fiqh scholars towards the evolution of Islamic legal system to facilitate the swift shift to the Islamic system of financial management.  It also presents a strong case for the governments of the Islamic countries to provide the requisite support and encouragement to these institutions.

IQRA (IBA’s Quranic and Religious Association) is organizing a two-day conference with a focus of addressing the issues and providing solutions in the light of Shariah.  The conference will provide a forum for distinguished scholars, researchers, and policy makers from around the world to discuss the need, potential, and challenges towards this purpose. The time is, therefore, ripe for the Islamic world to realize the importance of taking material steps towards this long due initiative.