Challenges in Islamic finance

By TERENCE TAN

MANY books have been written on Islamic financial markets but Introduction to Islamic Finance: Theory and Practice by Zamir Iqbal, Abbas Mirakhor (John Wiley) is the first book to introduce all of the essential topics in one volume. 

Zamir Iqbal, a principal financial officer with the World Bank, and Abbas Mirakhor, an executive director at the International Monetary Fund, sketch an outline of that compromise economy in their book. 

Though Islamic finance may be a niche market in the West, elsewhere it is widespread and growing. The General Council of Islamic Banks and Financial Institutions estimated that in 2005, the industry spanned 38 countries, with nearly 300 entities managing about US$200bil. In Iran and Sudan, finance is almost entirely Islamic. Other countries, like the Gulf states, Pakistan, Malaysia and Indonesia, operate under more mixed systems in which Islamic and conventional finance compete. 

How is it they satisfy both their God and themselves? A reader seeking answers to this intricate question can understand Iqbal and Mirakhor's book in several ways: as a believer, a skeptic, a businessperson, or some combination of the three. 

There is a broad consensus nowadays that a cornerstone of Islamic finance is the prohibition of interest, or riba. In a perfect Islamic economy, Iqbal and Mirakhor argue, lenders could not receive fixed interest on a loan, but they could profit from financial instruments, like equity partnerships, cost-plus sale contracts and leases, that do not guarantee a certain kind of return. To avoid usury, creditors must risk loss of their capital - just as any borrower does when he or she converts funds into equipment and starts a business, knowing it may fail. And perhaps, as the authors argue, that is right and just. 

Islamic finance has a clientele that runs from Saudi princes to paupers. 

Market demand was enough to prompt Standard Chartered Bank to pay US$487mil in August for Union Bank, which offers Islamic financial services in Pakistan. 

The Regulatory Challenge (John Wiley), Simon Archer and Rifaat Ahmed Abdel Karim have brought together 21 essays by a variety of experts on the key regulatory issues currently facing Islamic financial systems. 

This approach has several distinct advantages for the reader. It helps to give broader coverage and also presents the information in self-consistent, bitesized chunks. However, it can also raise issues of overlap or even conflict between the different contributors. 

Editors Archer and Rifaat have handled these potential issues well, avoiding duplication by giving the writers well-separated topics to cover. Overall, the reader is left with a sense that the contributors are well aligned and give a consensus view on the way forward. 

As you would expect, some of the regulatory issues facing Islamic finance arise directly from the unique aspects of its financial systems. These include the need to be syariah compliant, the prohibition on interest, and the different risk sharing characteristics versus conventional banking. The world’s conventional banking regulations were not developed with these concepts in mind, so Islamic banking systems do present some interesting regulatory issues. 

But the surprising aspect of the regulatory challenges is that they often sound remarkably familiar. In fact, many are not unique to Islamic finance at all – they are the same challenges that conventional banking systems have been dealing with during recent decades. At the risk of over-simplifying, you could suggest that since Islamic banking only started about 30 years ago, it is still catching up with conventional banking in areas like risk management, transparency and corporate governance. That is very good news, since there are ready-made ways to deal with most of those issues. So in many respects, Islamic finance does not have to develop new solutions at all. It just has to tweak and implement existing, proven solutions. Islamic Finance: The Regulatory Challenge explores how these solutions can be implemented, but it mainly calls for evolutionary rather than revolutionary change. 

As Islamic banking systems continue their dramatic expansion into global financial markets, this book is useful reading for regulators, supervisors, governments and scholars who have to deal with the regulatory implications. It shows that while the challenges may seem daunting, they are certainly manageable.