Islamic Finance

A surge in Islamic financial services in Sri Lanka has seen a host of companies offering Sharia (or Islamic Law) compliant services to the market.

Recent entrants include LOLC and LB Finance. They seem to have sprung up in response to burgeoning demand for Sharia compliant financial services expected to increase from the North and East.

Amaana, Sri Lanka’s biggest Islamic finance service provider to date offers nine different financial solutions under the segments of leasing, financing, leasing and investment. Other service providers also offer pawn broking services.

A 2005 IMF working paper indicated that the markets targeted by Islamic financial institutions are largely untapped by regular commercial banks; and with a potential market of almost two billion Muslims, this explains to a certain extent the growth in the sector worldwide and why many commercial banks are hurrying to develop Sharia compliant divisions of their own.

Islamic Banking and Finance have to adhere to certain fundamental principles as laid down by Islamic law (or fiqh). It prohibits the use of interest (riba) in monetary transactions and also prohibits dealing in any item considered to be haraam (forbidden) by the word of God and the example of the Prophet (pbuh). These principles formed the basis of a “robust” economy in the Islamic world, but it was not until the late 20th century that entities calling themselves banks were established commercially in Islamic Communities.

The sector since then has seen fast growth.  The IMF paper said that the sector was growing at 10-15% yearly with signs of consistent future growth. CIMB group, Malaysia’s second largest financial service provider recently estimated that Islamic finance was the fastest-growing segment of the global financial system and sales of Islamic bonds may rise by 24% to $25 billion in 2010.

In addition to prohibiting interest, Sharia law also stresses the importance of profit sharing and asset backed financing as cornerstones of Islamic finance. The original modes of financing since ancient times has been Mudarabah and Musharakah; cost plus financing and partnership financing. Other modern forms of financing such as ijarah (leasing) and murabahah (pawn broking) have been recommended by contemporary jurists to apply to areas where conventional methods may not have had been suitable. Whatever the mode, all Sharia based financing have to adhere to certain fundamental principles (Mohammad Taqi Usmani 2008); Profit Sharing-Financing does not take the form of cash advancement. In the case of Mudarabah and Musharakah. It means participating in the business and in the case of the latter, also sharing in the assets.

Profit and loss-Both financier and entrepreneur must share the loss incurred to the extent of his financing.

Ratio Determination-Partners have the right to determine the rations of sharing profits which can exceed the ratio of capital invested except in the case of a sleeping partner. Loss sharing-The loss suffered by each partner must be exactly the proportion of his or her investment.

Together with policies of not using interest and investing in things deemed forbidden by the religion, these basic tenets form the cornerstones of Islamic financing and its proponents have adapted its various forms to meet many modern finance requirements.

The foremost belief around which Islamic concepts revolve is the belief in one God and in his commandments. These commandments both set down by the Quran as well as the life and example of pbuh cover many areas of almost every aspect of a Muslim’s life. They are neither exhaustively restrictive nor are they ambiguous. Rather, it has a balanced approach to govern human life.

Capitalism and Islamic economy

The basic difference here is the exercise of divine injunction. Capitalism’s unrestricted faith in the market system where private ownership and the profit motive is given unbridled power is reigned in to a certain extent. It does not however deny the action of market forces; it only lays down some guidelines with which to regulate them. Interest, speculative transactions and the lack of ethics has undeniably caused a lot of problems and contributed to the increase in income gaps. A statement issued soon after the financial meltdown by the Vatican’s official newspaper Osservatore Romano said that, “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service.”

Regulation is good, but  still causes imbalance in society simply because humans are not capable of knowing all the consequences of their decisions. The fundamental tenet then, is a religious one. This is reflected in the market structures that have emerged after decades of operation of Islamic banks.

The IMF paper cited above also said that “small Islamic banks tend to be financially stronger than small commercial banks and large commercial banks tend to be financially stronger than large Islamic banks. Further, small Islamic banks tend to be financially stronger than large Islamic banks, which may reflect challenges of credit risk management in large Islamic banks. We also find that the market share of Islamic banks does not have a significant impact on the financial strength of other banks.”

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