First of several parts
Islamic finance is one of the fastest growing financial industries, with its total assets placed in excess of US$ 1 trillion.
The total number of Islamic financial institutions is approaching 600 around the globe.
Nevertheless, Islamic finance is facing various challenges, which may impede its growth.
Some of these challenges are of legal nature, like not allowing Islamic banks, according to some jurisdictions, to trade in assets.
Selling and buying assets is indispensable for Islamic banking activities since it comes as a core solution to financing with interest.
Other laws allow Islamic banks to own assets but impose some taxes upon every transfer of asset title, which makes some banks tend to avoid payment of taxes by reducing some necessary contractual steps.
This in turn may raise some Sharia concerns.
Laws may also prohibit banks from leasing assets to clients and therefore Islamic banks are left with no choice but to dodge and execute Ijarah (lease) in the form of sale.
Besides, the market of a vital Islamic Capital Market tool such as ‘Sukuk’ is not yet regularised fully due to various legal constraints.
Furthermore, many courts do not recognise Sharia Law while dealing with disputes relating to Islamic finance.
Apart from the seriousness of these legal challenges, Islamic Finance is also facing internal challenges that may put at stake its credibility and pose a more serious threat to its long-term success and its very survival.
These challenges come from inside the industry.
They include a lack of enforceable robust Sharia governance, creating an avenue for fatwa (Sharia opinions given by Sharia scholars) shopping and invasion of controversial products endorsed by Sharia scholars starred based on their ‘convenient’ fatwas.
In addition, they relate to the methodology used in Islamic Banks in structuring their finance products.
This methodology has yielded a number of products borrowing their legitimacy from the mere adherence to certain useless and perplexing technicalities, only to make them look different from their conventional counterparts. Such challenges, until addressed on organisational level, necessitate a diligent approach to Sharia endorsement of products and transactions, especially with the growing Sharia awareness of the average client and the existence of unprecedented court cases of Sharia-compliance nature.
This Paper addresses these internal challenges by highlighting the deficiencies in the existing Sharia supervisory work as well as in the product development methodology followed in Islamic Banks.
Endorsement of a controversial product is eventually the result of defects in these two works. Through the intended analysis, this Paper attempts to outline the prospectus of a sound Islamic banking product in terms of both Sharia control and development methodology.
It is no secret that Islamic Finance is facing challenges related to a lack of proper and effective Sharia governance. Further, the Islamic Banking & Finance industry has been regulating itself since its inception, without the supervision or intervention of indisputably independent authorities.
The Bahrain based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is a regulatory authority from within the industry.
It has introduced a standard for ‘Tawarruq,’ though this product has been ruled as ‘categorically unlawful’ by the Fiqh Academy, the largest representative of the cotemporary Sharia scholars!
The Islamic Financial Services Board (based in Kuala Lumpur, Malaysia), another regulatory authority from within the industry, has dodged the issue of setting governance rules for Sharia boards to weed out the unqualified Sharia supervisory board members (Mabid Ali Aljarhi, Professor of Islamic Banking & Finance, Hamad bin Khalifa University, Qatar, 2009).
This shows self-regulation of this industry has proved to be impractical and unreliable. The intervention of central banks has also proved unsuccessful, because the core problem faced by Islamic banking is the credibility of its products and their resemblance to the conventional banking products.
Central Banks will not be pleased with Islamic Banks offering genuinely Islamic products, because these products will then inherently carry different business risks.
Therefore, a balanced Sharia regulation is required, and the full independence of any potential Sharia regulatory authorities from the Islamic financial institutions is a prerequisite.
Abdulazeem Abozaid is Associate Professor of Islamic Finance Programme at Qatar Foundation, Qatar. The above is the abstract and opening paragraph of the Paper that he presented at the 11th Conference of Western Economic Association International hosted by Victoria University and Massey University at Te Papa Museum, Wellington from January 8 to 11, 2015. His Paper will appear as a series of articles in our ensuing issues.
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