Three Dimensions of Islamic Finance

 By Prof.Dr.Saiful Azhar Rosly

Islamic finance needs some definitions. There are more than a dozen books today written on this subject. One thing in common is the diversity of subject matter examined by the authors, which includes the Shariah, Islamic economics, Islamic banking, Islamic capital market and takaful.

So what is Islamic finance actually? At the tertiary level, some suggest it belongs to the finance department by virtue of the tag “finance” after Islamic. Does it now mean Islamic finance is synonymous to corporate finance, managerial finance etc? But what about public finance or entrepreneurial finance or even microfinance which more or less offered by many economics and business departments?
I will try answer the above question by looking at Islamic finance from three perspectives. First, I will examine Islamic finance as a field of study and second, Islamic finance as a financial system and thirdly, Islamic finance as a business. Let’s examine them closely.

1. Islamic finance as a field of study as can easily be identified with INCEIF’s flagship programme, namely, the Chartered Islamic Finance Professional (CIFP). The programme offers modules on Shariah, banking,  economics, capital market, accounting, wealth planning and takaful. In similar fashion, post-graduate programmes in Islamic finance offer courses with similar degree of diversities. The core is Shariah as it lays down values ordained by God in the conduct of business. By Shariah it should mean fiqh and comparative fiqh i.e. Islamic jurisprudence and also usulludin (i.e. the study of tawhid and akhlak) and the study of the Quran and Hadith and Islamic history. Islamic thought, which deals with Islam’s response to modernism and western philosophies is critical in Islamic finance in view of the supreme position of the neoclassical-positivist tradition in conventional economics and finance, which in many cases are adopted by Islamic financing practices.
2. Islamic finance as a financial system serves to promote justice in the financial market. A financial system is a set of rules and regulation that governs the flow of funds from the surplus sector to the deficit sector. In Islam, some of these rules are set by God, such as rules on riba, al-bay, gharar, maisir and some are designed by reason and facts as evidenced in financing guidelines, policies and processes of financial institution and regulatory framework set by monetary authorities. I call the first rule hukm shari’ which the most supreme and the second one  hukm tabi’. These rules are meant to control human behaviour in the marketplace as people in their business dealings according to Al-Ghazali, are frequently open to occasions for hatred, envy, jealousy and other maladies of the soul. Risk-behaviour should be driven by the principles al-bay as opposed to riba while the prohibition of gharar and taghrir should prevent the market to profit from asymmetric information.
3. Islamic finance as a business is the application of Shariah principles by financial service providers (IFSP) that carry an Islamic label. IFSPs include the banking and legal firms, unit trust and fund management companies, takaful operators, factoring companies, brokerages and venture capitalists. Corporations intending to raise capital via sukuk and Islamic equities use Islamic investment banking services to do so. While Islamic banks provide deposits and financing products to household and business clients, takaful companies underwrite pure risks via the wakalah system. As a business, Islamic finance’s exposure to Shariah-compliant issues is quite intense. Some financing practices such as tawaruq munazam, bay al-enah, commodity murabaha and some sukuk structures received considerable criticisms from Shariah scholars, especially from the Fiqh Academy and AAOIFI. Practitioners are caught in the middle at meeting corporate targets and observing Shariah rules.

To date the Islamic finance industry is estimated at US$3 trillion. As a business, performance of IFSPs is critical and thus, risk management is crucial in determining their ability to minimize losses from systemic events. For example, the downgrading of US government debt from AAA to AA+ by Standard & Poors, will raise the global interest rate since cost of funds are benchmark against the US treasury bill rate.  How will the Islamic finance business response to this event is interesting to see.
To define what is Islamic finance is quite a challenging task. This is true since the phrase has been use rather loosely. Back in the early sixties, Islamic economics received the limelight with relatively little industry applications. Focus was mainly made on riba, zakat and poverty eradication.  In the late seventies onwards, Islamic banking came into the picture with the establishment of modern Islamic banks in Dubai, Bahrain and Malaysia. Islamic finance seemed to emerge after the Asian financial crises as corporations began to source funds from the capital markets. The supply of Islamic bonds and sukuk is critical to Islamic banks, Islamic funds and takaful companies as it help absorb excess liquidity faced by them.