Islamic finance and economic developmen

  • 09 Pages
  • Published On: 28-11-2023
Islamic finance and economic development/Concept of profitability in Islamic VS Conventional banking

Aims and Objectives

The aim of this essay is to explore the concepts of Islamic Finance. While doing so, it will examine the Islamic economic thought along with the ethics and practice of Islamic Finance. It will examine concepts of profitability, interest free finance, Riba, Gharar, Qimar and other prohibited activities under Islamic Law. This essay will explore the legalistic view of Islamic Finance concepts, principles and practice and will review them against those of conventional banking that is not faith based. This will be done to explore the comparative efficiency between the two sets of finance frameworks. The objective of this essay is to attain basic knowledge of Islamic banking and finance. This essay will help understand the basic principles and the components or elements of Islamic Finance as compared with those of conventional banking and finance. The main objective will be to understand the efficiency of Islamic banking and finance in providing banking services based on Islamic faith.

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Literature review

This segment will present literature review of Islamic finance and economic development. It will review literature on the concepts in Islamic finance including concept of profitability. It will conduct a comparative review with concepts of conventional banking. Usman Hayat of the CFA Institute Research Foundation, a not-for-profit organisation provides that Islamic finance is widely considered a fastest-growing segment of global finance. Islamic finance is based on faith and Hayat states that the literature on Islamic finance is legalistic in that it discusses the reason behind a prohibition or a permitted action in the context of Islamic commercial jurisprudence (Hayat, 2014). The system of Islamic finance comprises permitted and prohibited actions based on Islamic faith. Concepts such as Riba, Gharar and Maysir are examples. Visser (2019) observes that the system is based on these concepts. To elaborate, the interest on a loan is considered Riba. So, in case a financier wants its capital to give return, the financial transaction must be combined with real transaction where the financer will receive a share in profit, fees or rental income (Visser, 2019). The principles of Islamic ethics hold the ground basis for Islamic economic thought and finance. Their means and ideals may not be exclusive to Islam as could be seen that Islamic finance principles focus on market-based risk sharing of financing, as seen in above. The principles aim to promote asset and enterprise. They deploy finance in real economy and stress on redistribution of wealth and opportunity. CFA Institute Research Foundation (2015) conducted a review of literature published since 2000. They observed that the modern Islamic finance practices are not only rooted to Islam. They are also source from non-Islamic participants. Islamic economic thought is core basis for the Islamic finance theory and practice. There are moral checks on the economic behaviour. The concepts of market economy and capitalism are not inconsistent with Islamic economic thought. Islamic economic thought stresses on social justice. This seems to be the reason why there is a strong preference on risk and profit sharing (CFA Institute Research Foundation, 2015). The emphasis on social justice could be found reflected in commercial banking where Islamic commercial banks offer different types of accounts, including afekeeping accounts without the prospect of returns on deposits (CFA Institute Research Foundation, 2015). Al-Jarhi (2017) observes that there is not much rational provided in Islamic jurisprudence behind Islamic finance other than the concept of justice. Islamic finance is based on the underlying concept of prohibition of interest. There is higher contractual and transactions costs due to lack of one standardised contract but the use of numerous product-based contracts. Al-Jarhi states that Islamic finance follows one simple rule of avoiding trading present for future money at the payment of a premium. Such finance model removes financing through debt (Al-Jarhi, 2017), The elimination of profit or interest indicates a risk sharing characteristic of the Islamic economic system. For example, the participatory nature of Islamic model could be found in the financial sector where households provide funds to the financial intermediaries on a PLS basis (Al-Jarhi, 2004). The intermediaries supply such funds to the users based partly on PLS and partly on sale-finance. This is unlike the conventional finance where the risk is imposed on a minority of players and the majority are spectators that risk nothing (Al-Jarhi, 2004).

Methodology

The methodology is straightforward. It starts with reviewing the basic concepts and principles of Islamic finance and understanding of importance of faith in such concepts and principles. The methodology focuses on capturing the essence of Islamic finance, which is the Islamic faith. Concepts and principles based on social justice such as Riba, Gharar and Maysir are discussed and cited in order to understand the influence of the faith in Islamic finance. The methodology will compare the difference and commonality of Islamic finance and conventional banking and finance. It identifies the main rationale for Islamic finance. This method is to identify an ideal model for Islamic finance to be accepted and operational in global finance framework.

Conclusion

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Essay 2 - Islamic finance and Africa’s economic opportunities and challenges

Aims and objectives

This essay will explore Islamic finance in African context in regard to the economic opportunities and challenges. It will consider the role of Islamic financial in terms of its potential and realised potential in fostering foster financial inclusion. This essay will explore whether or not Islamic finance has adopted an adaptive system to African finance practices and regulations. It will explore the capability of Islamic finance’s capability to harmonise classical religious precepts, traditionalism and social responsibility with the modern demands of global banking. The objective of the essay is to achieve basic understanding of the applicable principles of Islamic finance in context of the structural economic issues in regard to the macroeconomic opportunity that Africa presets. This essay will deliver an understanding of Islamic finance market in Africa by mapping Islamic finance principles and practices against the existing Africa’s economic opportunities and challenges.

Literature review

There are apparent reasons of why Islamic finance could succeed in Africa. One of the reasons is the presence of unbanked financial systems that demand Shariah compliance. Islamic finance is considered as a major facilitator to the increasing support across the African continent for more trade with Muslim world. For example, in the Northern part of the content, which comprises Egypt, Morocco, Alegeria, Libya, Tunisia and Mauritania, the governments see Islamic finance as the opportunity to create capital and foster economic development (Amine, 2016). Irrespective of the potential growth, it seems that the Islamic financial system is not inclusive. Amine (2016) observed that there is limited political support. Unless there is a change to capitalised on FDI inflows and formally governing the unbanked sector under the banking sector, the lack of political support would not make Islamic financial institutions open up to other non-Islamic finance system. For example, the institutions do not consider having real interest in the alternative asset classes as potential investment for new clients. Further, there is higher tax on Islamic finance products coupled with the problem of less information on Islamic finance (Amine, 2016). The potential lies in Islamic finance through the means of sukuk and other finance products to meet the need of financing sources in North Africa. This potential could be unlocked through political intervention. For example Egypt is the sixth biggest Muslim nation; however, Islamic finance is Egypt faces many obstacles, one namely tax obstacles. Islamic finance is not mere trading. It is a real economic transaction, where sale, purchase or lease incurs additional tax on the capital gains. The Egyptian tax code does not support Islamic finance. The banking regulations also do the same (Amine, 2016). It seems the basis of social justice and prohibition of interest or profit are the reason for non-adaptation of Islamic finance. The system of cash flow (in the form of taxes) back to the central government that could use the money for a fair wealth distribution may increase the cost of Islamic finance products. As Amine (2016) observed, Islamic finance products are more expensive than those of conventional banking that make them less attractive. Africa has deficit in vast infrastructure development. This calls for financing needs, which could take help from Islamic finance. The examples could be seen countries such as South Africa, Kenya, Nigeria, Senegal, Uganda, Djibouti and Morocco (White & Case, 2018). They have introduced legal and regulatory frameworks promoting the development of Islamic finance products. For instance, Kenya has introduced stamp duty and VAT regulation creating a harmony between Shariah-compliant products and conventional products. There are traditional banks that have started offering Shariah-compliant banking products as well (White & Case, 2018). The opportunities of implementing Islamic compliant could be capitalised only when there are changes in the institutional structures. For example, even where local currency treasury instruments that correspond to conventional interest-bearing instruments, there must be changes to make such instruments acceptable to Islamic institutions (White & Case, 2018). The challenge lies in bringing a balance accommodating domestic tax rules and traditional treasury instruments. This is because the most of the existing laws are not designed to cater to interest-free financings. As such, they may not be complaint with the Islamic concept of economic risks and rewards sharing. This represents a gap in regulation and knowledge and lower accessibility of formal banking services to the existing banking and financing system that is mostly informal (White & Case, 2018). Issa Faye, Thouraya Triki and Thierry Kangoye (2013) explored the Africa-based Islamic finance providers. They attempted to quantify the amount of foreign Islamic funding and compared performance between that of African Islamic with conventional banks. They cited the annual growth of Islamic financial institutions fostered by innovative Islamic finance, its regulatory reforms and new taxation frameworks. The changes brought about accommodating Islamic financial activities. However, they also found that Islamic finance in Africa remained underdeveloped (Faye et al., 2013). Islamic financial institutions account for only 116 providers from 21 countries. The 2013 study found significant cross country variations in the development of Islamic banking and type of services offered. However, they have the view that Islamic banks are superior in efficiency as compared to the conventional banking (Faye et al., 2013). For instance, flexible approach is adopted in East Africa to foster innovation and facilitate development of Islamic banking. Also, there is stability of Islamic banks as they have lower insolvency risk, but higher return on average assets. Such banks have lower non-performing loans as they are asset backed. Their higher loan loss provisioning ratio is a reflection of a conservative approach towards provisioning for Islamic banks (Faye et al., 2013).

Methodology

The methodology will comprise a study of the economic opportunities and challenges. This will include the potential as well as the realised potential of opportunities and challenges connected with the financial and economic position of Africa. The methodology will involve a review of the literature and empirical evidence of the opportunities and challenges in the African countries. A comparative analysis will be conducted of what model is adopted and which model has worked in specific jurisdictions. By doing so, the uniformity or variation could be gauged in order to determine whether or not the existing framework positively works or which principles of Islamic finance may found helpful in filing any gaps either in regulation, practices, or knowledge distribution and implementation.

Methodology

The methodology will comprise a study of the economic opportunities and challenges. This will include the potential as well as the realised potential of opportunities and challenges connected with the financial and economic position of Africa. The methodology will involve a review of the literature and empirical evidence of the opportunities and challenges in the African countries. A comparative analysis will be conducted of what model is adopted and which model has worked in specific jurisdictions. By doing so, the uniformity or variation could be gauged in order to determine whether or not the existing framework positively works or which principles of Islamic finance may found helpful in filing any gaps either in regulation, practices, or knowledge distribution and implementation.

Essay 3 - Implications of Islamic Finance in Africa's Socio-Economic Developmenty

Aims and Objectivesy

This essay will explore the applicable principles of Islamic finance in relation to Africa’s socio-economic development position. It will identify the particular area of development that Africa requires and map corresponding principles and concepts of Islamic finance that could be deployed to fill the gap. This essay will cite for example sukuk instrument as a principle of the Islamic finance and determine whether or not they confirm to the Shariah principle of human wellbeing and communal good-life. The objective of this essay is to attain basic understanding of particular gaps in the social-economic development plan and how applicable Islamic finance would fill those gaps

Literature review

Shariah objective is to promote social welfare. In order to do so, Islamic financial institutions must align their actions and decision to that effect. The social welfare aspect projects ethical credentials of the Islamic institutions. It makes them attractive to both Islamic and non-Islamic consumers. As such, mainstream Western financial institutions, such as HSBC (UK), UBS (Switzerland), and Citibank (USA) have adopted the Islamic finance principles and also offer Islamic finance products (Islamic Research and Training Institute, 2007). This represents that Islamic economics and finance has become more popular. This is evident in the ICD-Thomson Reuters Islamic Finance Development Indicator (IFDI), which reported that the 2015 global Islamic finance assets were US$2 trillion. Worldwide, there has been compound annual growth rate of the Islamic finance assets at 4% since 2012. Sukuk occupies the second position in terms of asset class at 17% of total asset (Thomson Reuters, 2017). Irrespective of the global growth of Islamic finance, there is little corresponding effect in the development of Africa. There are issues of poverty, inequality and unemployment. In such circumstance, it is a matter of concern to determine whether or not Islamic finance has contributed or could contribute to addressing the issues (Oshodi, 2016). Dogarawa (2012) explored whether or not Islamic finance be the alternative financial system to address financial crisis. Dogaraw proposes that the concept of profit-risk sharing of Islamic finance with the characteristic of socio-economic function along with an effective regulation and supervision can attain the objective. This proposed solution may substantially reduce any financial instability with faster development (Dogarawa, 2012). Chapra (2011) argued that the global financial crisis of 2007 through 2008 did not impact the Islamic financial institutions much. The reason is based on the basic Islamic finance principle of prohibition of payment or prohibiting interest in financial transactions. Such principle helped the institutions from getting affected by malicious assets (Chapra, 2011). Hassan (2009) also affirmed to this view. They stated that if the Islamic finance was in full force the impact of the 2007-2008 economic crisis would have been minimal (Hassan & Kayed, 2010). Karwowski (2009) states that the Islamic financial system is superior to the conventional system. Karwowski refers to the former as the morality of the “homo Islamicus”. It prevails over the moral hazard and the adverse selection problems. It has the socio-economic and developmental characteristics that promote growth and wealth redistribution. Islamic financial system offers inherent stability in economic fluctuations (Karwowski, 2009). It has, however, been observed that there is a problem of infrastructure deficit as is found in the Sub-Sahara African (SSA) region. A major portion of the African continent faces such infrastructure deficit due to the existence of vast funding gap. This gap constrains socio-economic development. The region relies heavily on traditional sources of funding. However, it is not able to keep pace with the increasing demands for infrastructural development (Abdurraheem & Naim, 2018). Abdurraheem and Naim (2018) state that the potentials offered by Islamic finance have not been exploited by the African countries. They cited the example of Sukuk instruments that could be used for funding in order to fill the funding gap. They observed that Sukuk is at the initial stage in respect to its deployment as a long-term financing instrument. However, they could be used for rapid rapid and large scale infrastructure developments. They could remove sovereign debt (Abdurraheem & Naim, 2018). However, Oshodi (2016) observed a different aspect as given below. Oshodi (2016) assessed the viability of Islamic finance by citing the example of sovereign sukuk. He observed that the sukuks do not provide for guarantees from multilateral institutions. This poses more difficulties for such sukuks to attract foreign inflow. The problem is aggravated by risks of foreign exchange and rapid currency devaluation of African markets (Oshodi, 2016). There is no consideration given to preferences of foreign investors and foreign Islamic investments of short portfolio investment. In absence of guarantees, such short term preference would permit foreign investors exit the African market quickly, which has the potential of destabilising African economic system (Oshodi, 2016). The existing practice, as Oshod (2016) further observed, does not adhere to principles of the Islamic finance and Shariah, which seeks for human wellbeing and communal good-life and for promoting and safeguarding the prosperity and wealth. This highlights a lack of a suitable development model, which allows more autonomy, access to required trade and industrialisation funds, and establishing defined market (Oshodi, 2016).

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Methodology

The methodology employed in this essay will comprise of identifying the gaps in socio-economic development plans and map them with identifiable, applicable and suitable Islamic finance principles and practice that could address those gaps. The methodology will, thus, require understanding the basic and core elements of the existing socio-economic development plans. It will identify the most apt Islamic finance principle in terms of understanding the overall delivery that it could make against the gaps identified. For example, the deployment of sukuk instruments is identified as an alternative source of funding that could complement the traditional informal form of funding to develop infrastructure. The methodology will thus require identifying the gaps in socio-economic development plans and their implications. It will then choose the appropriate Islamic finance product or principle to address the gaps with providing empirical evidence of its success.

Bibliography

Abdurraheem, A. & Naim, A.M., 2018. Sub-Sahara Africa’s infrastructure funding gap: potentials from Sukuk financing. Indian-Pacific Journal of Accounting and Finance , 2(4), pp.26-34.

Al-Jarhi, M.A., 2004. Remedy for banking crisis: what Chicago and Islam have in common: a comment. Islamic Economic Studies, 11(2).

Al-Jarhi, M.A., 2017. An economic theory of Islamic finance. ISRA International Journal of Islamic Finance.

Amine, M.A.B.M.A., 2016. Islamic Finance and Africa's Economic Resurgence: Promoting Diverse and Localized Investment. Springer International Publishing.

CFA Institute Research Foundation, 2015. Research Foundation Year in Review 2014. CFA Institute Research Foundation.

Chapra, M.U., 2011. The global financial crisis: Some suggestions for reform of the global financial architecture in the light of Islamic finance. Thunderbird International Business Review , 53(5), pp.565-79.

Dogarawa, A.B., 2012. Global financial crisis and the search for new financial architecture: can Islamic finance provide alternative? Journal of Islamic Economics, Banking and Finance , 113(470), pp.1-16.

Faye, I., Triki, T. & Kangoye, T., 2013. The Islamic finance promises: evidence from Africa. Review of Development Finance , 3(3), pp.136-51.

Hassan, M.K. & Kayed, R.N., 2010. The global financial crisis and the Islamic finance solution. In Durham University: Durham Islamic Finance Conference., 2010.

Hayat, U., 2014. ISLAMIC FINANCE: ETHICS, CONCEPTS, PRACTICE. [Online] Available at: Providing banking services of the highest standards according to Islamic Shariah without dealing in Riba (Interest on money) and by using the sate of art technology in computer, telecommunication and information system. [Accessed 11 February 2021].

Islamic Research and Training Institute, 2007. Advances in Islamic Economics and Finance. Proceedings of 6th International Conference on Islamic Economics and Finance. Islamic Research and Training Institute.

Karwowski, E., 2009. Financial Stability: The Significance and Distinctiveness of Islamic Banking in Malaysia. The Levy Economics Institute Working Paper, 555.

Oshodi, B., 2016. Africa: Implications of Islamic Finance in Africa’s Socio-Economic Development. [Online] Available at: https://d1wqtxts1xzle7.cloudfront.net/52309566/TWFR_Sep-Oct_2016_-_Implications_of_Islamic_Finance_in_Africa%CE%93COs_Socio-Economic_Development-1.pdf?1490522053=&response-content-disposition=inline%3B+filename%3DTWFR_Sep_Oct_2016_Implications_of_Islami.p [Accessed 11 February 2021].

Thomson Reuters, 2017. SUKUK PERCEPTIONS & FORECAST STUDY 2017. [Online] Available at: https://ceif.iba.edu.pk/pdf/ThomsonReuters-SukukPerceptionsForecastStudy2017.pdf [Accessed 11 February 2021].

Visser, H., 2019. Islamic Finance: Principles and Practice, Third Edition. Edward Elgar Publishing.

White & Case, 2018. Africa Focus: Autumn 2018. [Online] Available at: https://www.whitecase.com/publications/insight/islamic-finance-africa-opportunities-and-challenges [Accessed 11 February 2021].

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