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Future of Islamic Finance as an Islamcompliant and not just a Shari’a- Compliant Phenomenon


This year’s theme of Developing a Distinct and Independent Value Proposition for Islamic Finance (DIVPIF) is GIFR’s boldest yet. Almost half a century since the formal inception of the industry through the first full-fledged Islamic bank, it might be somewhat disconcerting that we are still in search of a distinct and independent value proposition, but it is nonetheless a highly worthy theme to explore so that our next fifty years can indeed move the industry towards a more refined vision-based future.

An excellent book1 was written over a decade ago, aimed to illuminate the grip of legalism on Islam in general and on Islamic law and understanding and applications of Shari’a principals in particular. Although this challenge of legalism is not widely recognised from a traditional perspective, Muslims need to take a closer look, because legalism often boxes them into a thinking mode that lacks goal orientation, problem-solving orientation and impact orientation from a broader perspective.

Legalism also influences a Shari’a-centered approach, because the way Shari’a is understood is often connected with the lack of that three orientations.

This chapter refers to a number of works by Professor Mohammad Omar Farooq. The ideas presented in these works are relevant because while Islamic finance has emerged as a Shari’a-compliant enterprise, it has essentially been reduced to merely prohibition-avoidance and these works are geared toward a more robust transformation. Currently, the Islamic finance industry is focused on avoiding some key prohibitions, including riba (commonly equated with interest in a blanket manner), gharar (avoidable, consequential uncertainties in contracts or transactions) and maysir (gambling and gambling-like speculations). What is haram is of serious importance in Islam, and riba is one of the most important prohibitions, as emphasised in the Quran with the sternest warning. However, Islam is more than just avoiding prohibitions. This is where a current framework of Shari’a compliance based on a narrow, legalistic understanding of Shari’a can have profound implications.

If we assess the contribution of Islamic finance in contemporary times, one cannot help but be impressed with the way it has grown, received support from at least a segment of the Muslim population, and is continuously recognised by and integrated into the mosaic of the mainstream finance. We have indeed come a long way. If we can call this journey of Islamic finance to date as its first wave, what would be its next wave? Would it be a continuation of the same or would there be some serious qualitative change? To delineate a vision for the future, especially the next wave, we need to embrace goal, problem-solving and impact orientation from a wider perspective. The benchmark of assessing Islamic finance is not (or it should not be) about:

  • How many trillion dollars the size of the Islamic finance industry is?
  • In how many countries there is a presence of Islamic finance?
  • The growth rate of the Islamic finance industry, however impressive it is.
  • How many different types of products the industry offers?
  • Whether the rate of return matches or even beats the industry’s conventional counterpart?
  • Gala events in big hotels and facilities.

In all these areas, the industry has proven to be a notable success and, in all likelihood, such success will continue in the foreseeable future. While there are many who would be ecstatic to see progress based on the abovementioned benchmarks, as a Shari’a-compliant or prohibition-driven enterprise, a success based on these benchmarks cannot be deemed entirely adequate from an Islamic perspective.

Islamic Finance and the Next Wave

The first wave of Islamic finance has provided a strong momentum for the industry to build its institutions and infrastructure. The second wave, if a qualitative change is desired, would require a new vision that goes beyond the current narrow framework of Shari’a compliance.

Since Islam is more than prohibitions, which has its imperatives as well as the aspirational goals for society, and since Islam is relevant and applicable to the entire spectrum of life – there is a need to think in terms of Islamic compliance–a substantively different framework that is proposed and articulated in a paper.

This proposed framework of Islamic compliance shifts the attention away from any unfair critique of Islamic finance, because Islamic finance (IsF) can deliver its true potential only in a compatible Islamic economy.

Having a broader or expansive expectation from the IsF industry beyond mere Shari’a- compliance is neither warranted nor realistic

One reality for IsF industry is that it emerged and evolved as a stand-alone enterprise. Financial institutions are part of a financial system, but IsFIs do not function in a conducive Islamic financial system. Rather, these institutions exist in a dual banking system while also being interfaced with the global financial system that does not reflect Islamic principles, values or parameters.

Furthermore, a financial system is not a stand-alone enterprise either; it is a part of an economic system. The reality is that economic systems of Muslim-majority countries do not reflect the principles, values and parameters of Islam. Thus, Islamic activities primarily occur at the level of institutions, without being duly embedded in a conducive financial system, in an economic system or in a society that broadly reflects Islamic norms.

Thus, having a broader or expansive expectation from the IsF industry beyond mere Shari’a- compliance is neither warranted nor realistic. If we cherish the achievement of the broader socioeconomic goals and leverage Islamic finance, then we need to rethink the framework, first by putting the horse before the cart.

Islamic finance emerged in the backdrop of century-long Islamic revivalist aspirations that sought a systemic change in Muslim societies, which included the transformation of the economy. However, due to the dynamics of the Muslim world during the post-colonial period, none of the Muslim-majority country was willing to undertake such a systemic change.

Gradually, the interest shifted from economy to a much narrower goal of establishing Islamic financial institutions. That historical background is beyond the scope of this chapter 4.

We are still searching for a suitable “value proposition”, but it is unlikely that a DIVPIF is possible without embracing “Islam-compliance,” and pursuing it with the horse before the cart. Some essential aspects of it are presented here.

The Islamic way of life does not begin with prohibitions. Rather, it begins with presenting the broad scope of what is permissible and then delimiting with specific prohibitions. This Islamic principle is important to understand. We find this principle illustrated in the example of the story of creation of humanity. When created and placed in Paradise, Adam and Eve were told that the Heaven in its entirety with all its blessings and amenities were theirs to enjoy, except for a single prohibition:

And We said, ‘O Adam! You and your wife dwell in this Garden, and eat freely from it wherever you please – but do not approach this tree for you will become of those who transgress.’ (Quran: 2:35)

This Quranic principle and approach, delineating the scope of halal first and then specifying the prohibition, is also exemplified in case of riba. Before broaching the subject of riba and its categorical prohibition, the Quran specifically draws attention to qard hasan, loaning in the name of God, with multiplied reward promised in the hereafter for such act.

Who is the one who would give Allah a good loan [qard hasan] so that Allah multiplies it for him many times? Allah withholds and extends, and to Him you are to be returned (Quran: 2: 245).

Then the Quran covers several verses (2: 270-274) discussing infaq (spending), a pursuit not necessarily synonymous with charity or donations. The Quran dwells on what is needed for people’s ability to run their life with facility and dignity and only then it invokes the relevant prohibitions (e.g., riba in this case). It follows that, even on the basis of riba, human life cannot be restricted leading to financial hardship without first ensuring a halal (permissible) and abundantly available recourse. This is again compatible with having the horse before the cart. Notably, this is not just placing the permission and prohibition in the context of the Quran, but is also illustrated in the transformation experience under the leadership of the Prophet Muhammad (P.B.U.H), as a society emerged and evolved based on the divine guidance of the Quran and illustrious example of the Prophet (P.B.U.H). During this gradual process of change, there were no imperatives (obligations or prohibitions) during the first thirteen years in Makkah. Then, the nascent society began to take its structural shape in Madina, the above-mentioned principle or approach was applied.

The Islamic society did not begin with the introduction and implementation of the prohibitions, but the transformation continued with laying out the spiritual and moral foundation, and then introducing the imperatives (prayer, fasting, zakat, etc.), presenting a society that embraces a caring and reliable leadership and institution (good governance), and then relevant prohibitions were introduced only gradually.

These days, those who want to implement Shari’a try to begin with the prohibitions, and even that not gradually but in one go, without allowing necessary transitional stages for a society to grow. Also, these prohibitions were introduced as part of an evolving system (social and economic). This does not mean that individual-level obligations or imperatives have to wait until systematic changes have taken place or the conducive environment has been created; rather, it means that both from Islamic and practical viewpoint, the true and robust solutions to broader problems do require systemic vision and approach, and transaction or institutional level activities cannot be delinked from the relevant system and the pursuit for it. The contemporary narrow framework of Shari’a-compliance begins with what is prohibited and then on top of it, limits itself to prohibition avoidance. In contrast, Islam compliance begins with delineating what are the collective, broader goals, mapping out the solution to achieving these goals systemically, subject to the specific prohibitions.

Islam-compliance and National Development Framework

How a country develops and solves the basic socioeconomic problems of the people is not a mystery. Also, irrespective of a country’s orientation, there are some common worldly aspirations or imperatives:

  1. Elimination of poverty and fulfillment of basic needs (another word, shared prosperity);
  2. Maximum sustainable employment, supported by functional and productive education system;
  3. Elimination of economic exploitation and injustice;
  4. Reducing inequality and concentration of wealth, while spreading ownership of capital and wealth;
  5. Addressing destructive ecological and embracing sustainable development and balanced consumption habits; and
  6. Elimination or significant reduction of corruption and bad governance.

When a country commits to pursue Islam compliance at the national level, it would focus on achieving human-centric development for sustainable shared prosperity, while avoiding what is haram, and such pursuit is possible only when such aspirations and priorities are integrated into a country’s national development framework. In such a framework, the burden of achieving these aspirations is not expected to be put on the shoulders of IsF industry. Rather, while IsF industry also has relevant roles to play, for Islam compliance all the sectors, including the financial sector, must be effectively aligned. Such a national development framework will provide the desired ecosystem where sectors, institutions and various stakeholders can synergistically pursue to move beyond the narrow Shari’a-compliance and contribute to Islam-compliant development. An Islam-compliant national development framework and ecosystem would facilitate IsFIs’ positive contribution, where they can gain profit as commercial institutions but also are incentivised to take relevant initiatives and risks beyond what they do now. Some of the key dimensions of such a framework under Islam compliance are delineated below.

Islam-compliance and Mapping Out to Reach Specific, Impact-oriented Goals As Islam-compliance must begin with setting aspirations and goals at the macro level, the desired outcomes are not accidental or matters of chance. To achieve the goals, the role of the financial sector must be mapped out to those goals, along with performance benchmarks to assess the impact and progress over the long run. Consider for example the case of zakat. Zakat remains one of the key acts of worship by Muslims and so many Muslims pay zakat to fulfill their religious duties. But because zakat is not approached in a problem-solving manner to systematically solve the problem of poverty, Muslims have been paying zakat throughout history, but poverty also remains an integral part of these societies.

Muslims treat zakat as an act of worship only, not as a problem-solving tool in a goal-oriented manner. The outcome is predictable. Similarly, when Shari’a compliance is meant essentially to avoid some key prohibitions, any positive socioeconomic outcome becomes incidental, not planned or mapped out. That’s why a national development framework, aligned with Islam compliance, is not an approach where the positive outcomes happen accidentally; rather, the desired outcomes would be achieved in a systematic, predictable, benchmarked manner.

When Shari’a-compliance is meant essentially to avoid some key prohibitions, any positive socioeconomic outcome becomes incidental, not planned Islam-compliance and Reconceptualisation of the Real Economy

It is commonly argued that one of the key positive features of the Islamic economy (and by extension, Islamic finance) is its real-economy orientation. Unfortunately, this argument or claim is essentially hollow. This argument is generally based on the notion that Islamic financial transactions are asset-backed or asset-based (to generalise, asset-linked).

However, let alone asset-based, even asset-backed transactions do not amount to what is broadly expected of the real economy that can be conceptualised at the simplest level in terms of the dynamics of at least six components: production, consumption, trade, technology, institution, and human capital. Islamic finance activities cannot be merely focused on the transaction and institutional level, while concentrating on trade and cash financing to be able to claim real-economy orientation.

This is a rather intricate topic that goes beyond the scope of this chapter. A proper reconceptualisation of a real economy needs to go far and fundamentally beyond any asset-level transaction.

Islam-compliance and Structural Changes in the Current Islamic Banking Structure

Shari’a-compliant finance is generally on contract level with a micro-juristic focus. Thus, Shari’a standards, as developed and adopted by IsFIs, broadly relate to various modes of contracts and transactions. While the current Islamic finance is designed to offer alternatives to conventional products in a Shari’a-compliant manner and there is a serious effort to distinguish Islamic finance products from its conventional counterparts in a legalistic way, there is hardly any consideration given to the institutional structure of banking, as in commercial banking where the depositors are no more than clients.

When the Islamic finance industry was launched almost half a century earlier, various options or novel ideas and solutions available as alternative financial structures were not conducted, resulting in the adoption of the structure of conventional commercial banking. As Islamic finance is micro-juristic, focused at the contractual level, there is no concern whatsoever as far as the structural and institutional issues are concerned. There is a systemic problem in this regard, as the compendium of Islamic fiqh, especially as rooted in the classical period, is not based on relevant or adequate empirical foundation6.

This is not merely a polemical issue, because dominated by the global financial powerhouses, there are some fundamental problems associated with the conventional financial superstructure, which is significantly associated with the ever-increasing concentration of wealth and resultant widening inequality. The IsF industry has built its foundation and hoisted itself on this problematic institutional structure7. Indeed, the Quranic imperative and call for ta’awun (cooperation) has been broadly ignored. Such ta’awun or cooperative framework is more consistent with spreading ownership among broader population and achieving the anti-concentration [“… Let the wealth not circulated among a few…”, Quran: 55:7]. The importance of ta’awun cannot be overemphasised, but the industry has reduced cooperation to merely takaful or Islamic insurance8. The narrow Shari’a-compliance framework focused on the transactional level is neutral in regard to the Quranic value of anti-concentration. From an Islam-compliant perspective, the institutional and structural issues are equally, if not more, important for our broader socioeconomic transformation and mapping out the solutions in a problem-solving manner should start from designing the institutional, structural and systemic level than transactional level.

Broader Sector Coverage and More Diversified Risk-Taking

In explaining the merits of Islamic finance vis-à-vis its conventional counterparts, it is commonly argued that Islamic finance, i.e., Shari’a-compliant finance, is based on fair risk-sharing. For the same reason, common equity-based products are generally idealised. However, the reality is that commercial banking as institutions of financial intermediation is by nature risk averse, and it is no surprise that Islamic banks based on Shari’a-compliance have shunned or marginalised profit-loss sharing (PLS) type products and services as part of their activities.

Unfortunately, contrary to its claim of fair risk-sharing, the current Islamic finance is predominantly characterised by risk-shifting/transferring or risk avoidance. The current IsF’s propensity toward risk-shifting is exemplified by its disproportionate emphasis on contracts that essentially replicate debt-based products, the types of conventional transactions that generate fixed, guaranteed (or indicative but predictable) return.

Thus, quite predictably exchange-based, debt-creating products, such as murabaha, salam, istisna’, tawarruq, bai al-ina, and service-based products like ijara, fees, etc. are predominant in banks offering Shari’a-compliant finance. Furthermore, while critiquing that conventional banking is fundamentally based on interest (where return and the principle are fixed and guaranteed), which is broadly debt-creating, Shari’a-compliant Islamic finance is also patronising and encouraging the debt culture. That the debt culture has been devastating for the conventional economies, leading to recurring crises, is well documented.

Interestingly, current Islamic banks usually structure their investment deposits based on mudaraba (a PLS product), but it marginalises, if not shuns, mudaraba on the financing side, due to high degree of information asymmetry.

Shari’a-compliant finance is characterised not just by risk-shifting (or heavily preferring the debt-based products with predictable return), but also risk avoidance. Much of the Islamic banks’ activities are geared toward trade or cash financing. Modern economies are based on a combination of sectoral activities covering agriculture, industrial/manufacturing and other sectors requiring entrepreneurial activities and impetus. However, these sectors are riskier. Examining Shari’a-compliant Islamic banks’ portfolios, one observes the pattern that these IsFIs prefer to engage in trade or cash financing activities, while as far as the riskier sectors they usually adopt the risk-avoidance mode.

There are rational explanations for current Islamic banks to avoid those risky sectors, but in Islam-compliant finance, their roles will be mapped out as part of a national development framework, where the government can incentivize such broader risk-taking within regulated, but patronized collaborations.

Rising Above Legalism and Embracing “Value Orientation”

Societies need laws and legal frameworks. Laws to ensure safety and protection of the rights of human beings in general and citizens in particular from potential abuses by others, whether individuals, organisations or even governments, are indispensable. Laws and the legal system enable a society to set standards, maintain stability, minimise conflict and resolve disputes, and uphold fundamental rights of the people. However, having laws and falling victim to legalism are not the same things, as the latter can easily undermine the underlying purpose of law: justice, stability and prosperity.

While this is not very commonly understood and recognised, like many other societies of the past, Muslim societies have also fallen victim to legalism. Due to the influence of literalism on the one hand and a jurisprudence-centred understanding of Islam, the gap between form and substance has considerably widened and become pronounced. Part of the problem is the notion that since Islamic laws (often, labeled as Shari’a) are God-given, and therefore it must be just and merely implementing these laws ensures justice or the relevant OS.

O believers! Stand firm for justice as witnesses for Allah even if it is against yourselves, your parents, or close relatives. Be they rich or poor, Allah is best to ensure their interests. So do not let your desires cause you to deviate from justice. If you distort the testimony or refuse to give it, then know that Allah is certainly All-Aware of what you do. (Quran: 4: 135)

Notably, in verses like this one, Allah unconditionally requires the believers to stand for justice. While justice is not defined, it is implied that everyone knows and recognises what justice is. Taking the cue from this understanding, it is commonly assumed that not just what is explicitly mentioned or specified in the Quran and Sunna, but also what is derived as laws, rules or codes by human beings based on the Quran and Sunna also reflect the divine will and thus the pursuit of justice is axiomatically assumed to be fulfilled.

Unfortunately, while in case of something we know that something is from the Quran and incontrovertibly from the Prophetic narrations cannot but embody justice, the same cannot be said or assumed about much of fiqh that is based on human interpretation. As human interpretation is fallible by nature, the possibility exists that the laws and codes so derived may not necessarily reflect justice, when the contexts and circumstances are in flux. It is in this context the centrality of values like justice in Islamic discourses in general and legal discourse in particular, as explained by Imam Ibn Qayyim (d. 1350 AD), is highly relevant.

The principles and fundamentals of the Shari’a concerning the injunctions and the good of humankind in this life and the next are all based on justice, mercy, the good of man, and wisdom. Every situation in which justice succumbs to tyranny, mercy to cruelty, goodness to corruption, wisdom to foolishness, has nothing in common with the Shari’a, even if it is the result of an allegorical interpretation [ta‘wil]. For the Shari’a is the justice of God among His servants, the mercy of God among His creatures, His shadow upon His earth, and His wisdom, which is both the proof of His own existence and the best witness to the authenticity of His Prophet.

Anything based on fallible human interpretation warrants extra circumspection in derivation and, especially, the enactment of laws. If we are genuinely concerned about justice and welfare, then without explicit consideration of the impact on society and individuals, the desired result may not be guaranteed. Currently, in regard to the idea of Shari’a, Muslims suffer from a form of myopic reductionism, where Islam is reduced to rules, codes, and laws, and as a consequence the balance, beauty, wholesomeness and efficacy of Islam in human life is broadly compromised. The concern about form often dominates the concern about substance. When Shari’a compliance is reduced merely to the avoidance of prohibition, then the imperatives and aspirations of Islam in regard to human society are ignored or undermined. This can help us understand why the prevalent concept and framework of Shari’a compliance falls short in achieving the broader imperatives of Islam, and why we need to make transition to Islam compliance.

The Vision of a Prosperity-sharing, Injustice-free World, Beyond just a Riba-free World

As Muslims, our life should be free from anything haram or prohibited, and riba is definitely most sternly prohibited. While riba is rightly understood to be equivalent to interest, the scope of prohibition is beyond prohibition of the narrow practices involving interest. The issue of riba is integrally related to the issue of injustice and exploitation, and the scope of injustice is much broader than just riba.

Therefore, it is important to envision a world that is free of injustice, which necessarily will entail being riba-free. However, when riba is understood inappropriately or narrowly and the concern about riba does not start from the fundamental concern about injustice, then we may very well end up with a riba-free world, but not necessarily a world free of injustice. Islamic vision as laid out in the Quran and in the legacy of the Prophet Muhammad (P.B.U.H) is to work for a world free of injustice. Nevertheless, the key impetus behind the emergence of the Islamic finance industry is to provide financial services without any riba (read, interest). If the preoccupation with riba (and thus, interest) is because riba is prohibited, that’s understandable and it should be that way.

However, if the concern is about injustice and exploitation, then we need to be a little more empirically oriented and open our eyes to explore the role and consequence of the unbridled pursuit of profit by corporations around the world, especially the multinationals. Furthermore, in our complex, dynamic, globally interconnected world, the role and consequence of rent-seeking behaviour (extracting wealth without contributing to the economy) might be much greater than interest at the transaction level.

Conceptualisation and Operationalisation of Islam-compliance

While focusing on what Islamic finance ought to be in its next 50 years, it is proposed to envision a broader future that is injustice-free, reflecting shared prosperity. The main thought in this chapter is to make the case that while Shari’a compliance is reduced to certain prohibition avoidance, from Islamic perspective our focus should be on the positive imperatives and aspirations of Islam in a comprehensive way.

As long as Shari’a-compliance is synonymous with prohibition avoidance, it should be noted that Shari’a-compliance is a necessary condition for being halal, but not sufficient for being “Islamic” because Islam encompasses more than prohibitions. Recognising this aspect is the first step toward addressing the gap between what “Islamic” finance normatively should be and what Shari’a-compliant finance is.

This will lead toward addressing the broader socioeconomic challenges facing societies from the Islamic perspective. To become “Islam-compliant”, warrants that we should not have the misunderstanding that solving or addressing the broader socioeconomic challenges rests on the shoulders of IsFIs. As Islamic banking and finance is currently constrained in a self-imposed manner with the narrow framework of Shari’a-compliance, under Islam-compliance the industry will have a more refined role as part of a broader, national undertaking.

Operationalising Islam compliance involves engagement of the public sector, the private sector as well as public-private collaboration in key areas, identifying potential ways of designing suitable interventions. Many ideas herein are not necessarily novel, as some of them might already be separately in practice throughout various parts of the world. The challenge for the Muslim world is to harness and apply its own energy and creativity to synthesise a coherent and robust pathway for Muslim societies to deal with their problems as part of their own learning curve. The main purpose of the chapter, however, is to provoke a discourse on thinking about how the current conceptualisation of “Shari’a-compliance” is constraining the industry’s potential, and how it has become pivotal to engage all stakeholders to think in terms of “Islam-compliance” and identify their respective roles to achieve the desired impact.

The vision for changes delineated here may not be expected to come from the IsF sectors or its constituent institutions. The status quo of the Shari’a-compliant industry might not feel comfortable regarding any fundamental or robust change.

The desired change largely has to be demand-driven. The people, the users of finance, in particular need to have their role in demanding that as Islam is not merely for avoiding prohibitions, they want their representatives, their regulators, their religious leaders and so on need to synergize their efforts to address their broader socioeconomic challenges in a problem-solving manner. Thus, they should insist on purposive, impact-oriented “Islam-compliance”. This is, by no means a modest proposition, but bigger aspirations often require immodest vision and propositions.


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