Soul Searching and Profit Seeking: Reconciling the Competing Goals of Islamic Finance*

Summary

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The worldwide growth of the Islamic financial industry over the past decade has been steady. Increasingly, the ethical principles that underlie the Islamic financial system have been a popular topic of debate. While Islamic finance has much to offer with regard to financial management, ethical investing, and project finance, there are fundamental tensions within the system that may work to stifle its growth and foreclose opportunities to reach a broader investor group. This note provides a brief overview of the Islamic financial system's development, its current status, and its primary methods for financing and investing in compliance with Shari'a law. The author outlines several of the problems and issues that have prevented more widespread acceptance of Islamic finance as an alternative to conventional, Western financing techniques. Lastly, the author employs case studies of a recently developed and somewhat controversial Islamic financial product, the tawarruq, to illustrate the identified problems that have been associated with the Islamic financial system.

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Extract

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Soul Searching and Profit Seeking: Reconciling the Competing Goals of Islamic Finance*

I. Introduction

The worldwide growth of the Islamic financial industry over the past decade has been steady.1 Increasingly, the ethical principles that underlie the Islamic financial system have been a popular topic of debate.2 While Islamic finance has much to offer with regard to financial management, ethical investing, and project finance, there are fundamental tensions within the system that may work to stifle its growth and foreclose opportunities to reach a broader and more diverse investor group.

Chief among these difficulties is the fact that the Islamic financial industry lacks what some consider a necessary cohesive and overarching governance structure. Different countries, and the various sects of Islam within those countries, each have their own interpretations of both the religious and financial teachings of Islam. This has caused the related problems of inconsistent enforcement, inaccurate risk estimation, and the generalized hesitancy among even Muslim investors to pursue Islamic financing options.

This Note, in Part II, provides a brief overview of the Islamic financial system's development, its current status, and its primary methods for financing and investing in compliance with Shari'a law. Part III then outlines several of the problems and issues that have prevented more widespread acceptance of Islamic finance as an alternative to conventional, Western financing techniques. These central issues are (1) a fragmented regulatory structure; (2) the regional differences among Muslim countries' interpretations of Shari'a law; (3) the heightened level of risk involved in anticipating future trends in the Shari'a compliance requirements; and (4) the lack of scholars specializing in Islamic finance.

In Part IV, I outline three general proposals aimed to address these problems. The proposals seek to prevent and manage the risks these problems create for the Islamic financial system. The proposals include (1) streamlining the educational system for Islamic financial experts; (2) creating new methods for avoiding conflicts of interests among the field's influential scholars; and (3) changing how Shari'a compliance ratings are computed for Islamic financial institutions and companies.

Lastly, in Part V, I employ case studies of a recently developed and somewhat controversial Islamic financial product, the tawarruq, to illustrate the identified problems that have been associated with the Islamic financial system. Additionally, this study of tawarruq demonstrates how the implementation of even limited versions of the proposed modifications may help popularize the Islamic approach to investing and finance. Addressing this issue and e...

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