Does Islamic finance provide salvation for the financial sector?

Business Contributor
Islamic finance
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Islamic finance has expanded very fast in recent years. It was announced in the year 2012 that Germany will have its first Islamic bank soon. And after some time Germany got its first Islamic bank named KT Bank Ag. It is the first bank to introduce comprehensive services according to ethical and sustainable Islamic banking principles.

This is kind of ironic if you consider the antisemitic history of this country. At the same time, it gives us a positive ray of hope, that Islamic finance can actually provide salvation to the banking systems. The global growth of Islamic finance is actually mitigating the demand for an ethical system. But can it be a more tangible solution beyond the Islamic community?

What is Islamic finance?

Like any ethical investment in the conventional financial sector, Islamic finance prohibits the use of funds for definite purposes. For example, investing in activities like alcohol, pornography, and gambling is forbidden (haraam) in Islam.

The foundation for Islamic finance’s ethical codes initiates from the Holy Qur’an. It is less arbitrary than secular ethical investments. In comparison to the standard ethical investments, the texts in Qur’an gives a more permanent anchor to guide our finance.

Islamic finance bans transactions where people share risks and uncertainty. This is the reason the use of interest or riba is prohibited.

The policy of no speculation:

The standard financial system allows speculative activities. It is induced to keep the market efficient and active. But these speculations can also induce uncertainty and financial bubbles. Here is how Islamic finance is different.

It prohibits financial transactions related to speculations. According to Holy Qur’an, the transactions must be related to some real activities. Therefore, you can buy and sell properties if you are interested in the underlying value. If not, if you want to gamble on changes in its price, Islamic finance is not for you.

Therefore, Islamic finance limits the amount of debt in the system. It creates fewer opportunities for speculation. As a result, minimizes the chances of the financial system being unstable. By banning riba and inducing the share of profit and loss, the approach which Islamic finance takes must shift risks of the clients onto banks. It actually offers a safer and more equitable pathway to the bank or financial organization than the conventional system.

Islamic finance: Is it a way to the equitable financial system?

Though if you look into the practice, this system has so far not been able to perfectly perform what it preaches. Yes, riba is prohibited and banks should share in profits and losses. Still, the banks tend to structure some products in the shadow of some interest-based products. As a result, Islamic banks get more outcomes without bearing the risks of profit and loss sharing arrangements.

But, these choices are actually necessary. This is to compete with the conventional sector. Once Islamic finance becomes sure-footed and established, these habits will be abandoned. Despite the criticisms, Islamic finance can actually reframe the debate about the role of the financial sector in present society. Amidst the global financial crises, the pathway of Islamic finance provides salvation for the banking and financial sector.