The Way Forward for Islamic Finance

Research posted on July 8th, 2015

By Prof Dr Mansor Ibrahim, Dean, School of Graduate Studies

The fast-growing Islamic finance amidst the global financial uncertainties has captivated much

interest especially as to whether it can serve as a viable alternative system. Facilitated by increasing

data availability, Islamic banking and Islamic capital markets become subjects of increasing empirical

inquiries. Over the years, many scholarly works have emerged to assess various dimensions of Islamic

banking and finance. However, they are predominantly confined to empirical verifications of the

performance of Islamic banks and Islamic capital markets. While there is much to be done due to

contradictory findings from existing empirical studies, there are two critical avenues of research that

need to be undertaken such that the viability of the Islamic financial system can be based on a sound

and concrete ground. The first avenue relates to the micro-foundations of Islamic finance while the

second is the extension of empirical studies on the bearings Islamic finance has on socio-economic

aspects as embedded in the Maqasid al Shariah (Objectives of Shariah) of its establishment.

With few exceptions, existing Islamic finance studies can be viewed as empirical extensions of

prevailing mainstream works on banking and finance, backed mainly by an argument that Islamic

finance is different. Little attempt, however, has been made to place Islamic-specific characteristics

in theoretical settings.

Theoretically, it would be insightful to explicitly derive the implications of banks’ or firms’ adherence

to Islamic principles. Empirical analyses using existing data can be deceptive in demonstrating the

distinct nature of Islamic finance since it has been well noted that, in practice, Islamic finance

particularly Islamic banking has yet reached its ideal business model or has not departed substantially

from conventional practices.

Moreover, in the case of Islamic stocks, taking firms that pass Shariah screening to be Islamic may not

be fully accurate since the Maqasid al Shariah goes beyond the used screening criteria. As such,

Shariah-compliant firms as classified may share a similar bottom line as any other firm, i.e. profit

maximization, and hence no difference in their behaviour. Meanwhile, Islamic firms have Maqasid al

Shariah governing their behaviour and, thus, they have more than profit maximization to

achieve. Accordingly, the theoretical behaviour of the latter would be more relevant for understanding

Islamic banking and finance.

Despite the need of theoretical foundations, we also believe that a fruitful avenue to pursue is to assess

the bearings the present Islamic banking and finance have on the economy at large. The key question

is: has Islamic finance fulfilled the objectives of Shariah?

These questions mean that assessments need to be made on the roles played by Islamic finance in, for

examples, poverty alleviation, income distribution, equal and widened access to finance, and economic

productivity and efficiency. Moreover, how the significant presence of Islamic finance would affect

monetary policy instruments and the conduct of monetary policy or even whether monetary policy has

any role would be important especially to monetary authorities in countries spearheading the

development of Islamic finance. At present, our understanding on the relations between Islamic

finance on one hand and socio-economic outcomes and macroeconomic policies on the other hand

remains limited.

http://www.inceif.org/blog/the-way-forward-for-islamic-finance-research/

LACUNA IN ISLAMIC FINANCE posted on August 3rd, 2015

(Part 1)

By Prof Dr Mansor Ibrahim, Dean, School of Graduate Studies

The Islamic Finance (IF) industry has emerged to be an integral part of the global financial scene,

landmarked not only by its significant presence in many Muslim countries but also its increasing

acceptance in non-Muslim world. Its growth over recent years, estimated to be around 17% per annum

over 2010-2014, is nothing short of being spectacular. The robust and resilient performance of IF

amidst global financial uncertainties has added further to its praise and potential as a viable alternative

system to the existing so-called conventional financial system. Indeed, anecdotal evidence of the IF

successes is proliferating and scholarly empirical evidence supportive of the Islamic-based model of

finance is increasingly forthcoming.

While one can join in praising the successes of Islamic Finance, one also cannot help but to ponder on

three noteworthy observations:

Theoretically, Islamic Finance differs from conventional finance. In practice, however, there

seems to be no discernible difference between them.

Islamic Finance prospers only in some Muslim countries. Indeed, many Muslim countries have

not embraced the Islamic-based finance model.

Despite its rapid growth, the Islamic Finance size is still marginal as compared to the conventional

finance.

The first observation has long been the focus not only of popular discussion but also of scholarly

debates under the heading: Is Islamic finance Islamic? It is admitted that Islamic finance particularly

Islamic banking is far from achieving its ideal. However, a verdict that it is non-Islamic would be a

sheer mistake since transactions in Islamic finance and their underlying contracts are in conformance

with the Shariah.

While the issue of Islamic finance being Islamic is important, there are several queries emanating from

the above observations: Why has Islamic Finance not progressed to its ideal model and spread

throughout all Muslim countries? Why has it remained small relative to conventional finance? Of

course, the answers to these questions can be direct and obvious: the Islamic finance industry is still

young and finding its way towards its ideal model. However, given the much hype and praises, more

is expected from Islamic Finance.

A key question is: Has Islamic finance reached its plateau or is there a lacuna to be filled for the

industry to leapfrog forward?

Fundamentally, the progress of the Islamic Finance industry, or any other industry, depends on its

products (P), governing institutions (I) and people (P). Dissecting these PIP factors of success can

potentially bring light on the lacuna to be filled. Benefiting from conventional counterparts, the

Islamic finance is not short of product innovations. Although certain Muslim countries still have issues

with their institutional quality and framework to facilitate the progresses of Islamic finance, Malaysia

is exemplary in the developments of Islamic regulatory framework and infrastructure. Indeed,

Malaysia’s institutional structure for Islamic finance can be adapted by many other countries provided

that they have political will to do so. Thus, the real lacuna lies in the workforce of Islamic finance. Yes,

it is a cliché to say that education is central to producing Islamic finance talent. But, it is more than

the cliché as it relates to the requirements of Islamic finance education. And existing providers of

Islamic finance education seem to fall short of providing all essential and necessary parts that construe

the Islamic finance education. This lacuna, at present, remains unfilled.

Islamic finance is deep-rooted in Islamic principles or the Shari’ah. Hence, the knowledge of the

Shari’ah is crucial in the Islamic finance education. At the same time, given that Islamic finance

necessarily faces various sorts of risk and operates competitively in an increasingly integrated financial

markets, having analytical ability to manage financial assets and perform and assess financial risk is

also critical. This means the Islamic finance education must be the symbiosis of the Shariah knowledge

and finance-related analytical skills. It can be further stressed that to leapfrog forward, the Islamic

finance industry cannot afford to simply imitate the conventional finance. In this respect, thought

leadership is needed. This means that Islamic finance education must encapsulate economic/finance

theories and research capability. In short, the ideal Islamic finance education must comprise the

Shariah, Quantitative Skills, and Economic and Finance theories equally strongly in depth and

coverages without diluting any one of them.

In parallel to the fast-growing Islamic finance industry, more and more institutions of higher learning

are offering undergraduate and post-graduate programs in Islamic banking and finance. The existing

program structure of IF degrees do comprise these three core fields of knowledge. However, they are

not stressed equally strongly in almost all degree programs. Thus, the IF education cannot fill the void

of having graduates that are well versed with Shariah, technical knowledge of finance, and theoretical

knowledge of economics and finance. Hence, the long-noted problem of “inadequate expertise in IF”

continues.

(Look out for Part 2 of Prof Mansor’s blog later this week.)

http://www.inceif.org/blog/lacuna-in-islamic-finance/

LACUNA IN ISLAMIC FINANCE posted on August 7th, 2015

(Part 2)

By Prof Dr Mansor Ibrahim, Dean, School of Graduate Studies

While the present IF education may have a long way to go, various issues must be addressed first for

it to even move forward.

First: Theoretical Foundations of Islamic Finance.

The theoretical constructs of Islamic finance at present remain descriptive and the understanding of

Islamic banking and finance is normally viewed from the lens of conventional finance. A scrutiny of

existing IF studies reveals that, with few exceptions, they are predominantly confined to applications

of conventional theories to Islamic finance motivated merely by an argument that IF is different. No

serious theoretical works have been undertaken except at the early stage of IF in 1980s.

Theories are core foundations of any body of knowledge. Unfortunately, the lack of the theoretical

foundations underlying the Islamic finance system has not resulted in increasing emphasis on

theoretical IF research and studies. Instead, the focus has been on adapting curriculum content and

research focus to the current need of finance industries under the widely-acclaimed motto: “industry

relevant”. It is no doubt that being industry relevant is important. However, IF is more in need of

finding directions to depart away from the conventional benchmarks and hence the thought

leadership. This requires the IF education program to be intensively theoretical and analytical. None

of the institutions of higher learning at present can claim that they have theoretical and analytical

rigor.

While being industry relevant is important, the absorptive capacity of practitioners in the industry

must be raised to the level that they can appreciate the research content of the academia. The priority

of the academic is on propelling the IF industry to the next level through cutting-edge research and

forward-looking curriculum content. “Practicality” of the research output and education depends on

the “knowledge” level of those who want to apply them. Accordingly, there is no such thing as theory

– practice divide. Instead, there is KNOWLEDGE divide between the academia and industry. By

persistently harping on the words that the works in the academia are too “academic” and hence “not

practical” will only mean opportunity lost for the industry. Both must play their respective roles in this

KNOWLEDGE divide. It is expected that the academic should be able to articulate issues and provide

prescriptions at the level understandable by the industry. The industry must also upgrade its

knowledge content too.

A predominant focus on being industry relevant, which is viewed as worthy by some, will only put IF

education at tracksides. No progress in its fundamental knowledge content would be forthcoming.

Second: Low Common Denominators.

Ideally, as noted above, the IF curriculum education comprises three bodies of knowledge – Shari’ah,

Economics and Finance, and Quantitative Methods. Unfortunately, student intakes to the IF programs

are rarely equipped with necessary foundations of all three. In most likelihood, they have pre-

requisites in at most two areas.

Further, due to the attraction of Islamic Finance, IF programs have attracted applicants from diverse

areas. Thus, it is not surprising that the gaps among students are so wide. In a quantitative class, one

may find students with good foundations in mathematics and statistics and students with have

minimal knowledge of both. The latter are normally from religious-oriented schools or institutions,

which give less emphasis on mathematics and statistics. Then, in Shari’ah courses, one may find those

who have no ideas of the Shari’ah and those who are far ahead.

This situation makes teaching extremely difficult. Worse, it creates the temptation for the schools to

lower their education levels to the common denominators and, accordingly, the lack of rigor in Islamic

finance education. The industry still laments on the lack of IF talent against, ironically, the backdrop

of increasing IF graduates produced by universities. The best guess is: the lack of rigor in the IF

program make them unfit to the need of the industry.

Third: It is not a Business.

Education is NOT a business. However, in parallel to the fast development and rapid growth of the IF

industry, increasing number of especially private institutions of higher learning are introducing

Islamic finance degree programs with the back of their mind the business bottom line. Thus, it is not

an exaggeration to state that education is now a profit-making business.

It is not wrong to do so since education has the characteristics of both private and public goods.

However, it would be unfitting to run education institution in the same way as running a business firm.

For one thing, the target horizon of educational institutions cannot be on a yearly basis as in the case

of business firms. For another, students are not client and graduates are not products in the business

senses.

The positive externalities of education mean that “clients are always right” must not be at the centre.

Instead, in the eyesight of the IF education providers should be the assurance that the positive

externalities of education are fully realized by the society at large and education should not be carved

to cater the need of clients, which at most times, meaning the sacrifice of quality in favour of

maintaining “clients”. The quality drop in Australian education is recently attributed to the fact that

education has become a business. Education is not a business.

http://www.inceif.org/blog/lacuna-in-islamic-finance-2/