Zamir Iqbal

Risk analysis for Islamic banks

This publication provides a comprehensive overview of topics related to the assessment, analysis, and management of various types of risks in the field of Islamic banking. It is an attempt to provide a high-level framework (aimed at non-specialist executives) attuned to the current realities of changing economies and Islamic financial markets. The Islamic financial system is not limited to banking; it also covers capital formation, capital markets, and all types of financial intermediation and risk transfer. Islamic finance was practiced predominantly in the Muslim world throughout the middle ages, fostering trade and business activities with the development of credit. The growth of Islamic finance coincided with the current account surpluses of oil-exporting Islamic countries. The Middle East saw a mushrooming of small commercial banks competing for surplus funds. The Islamic Republics of Iran, Pakistan, and Sudan announced their intention to make their financial systems compliant with Shariah.

Regulating Islamic Financial Institutions: The Nature of the Regulated

More than 200 Islamic financial institutions (IFIs) operate in 48 countries. Their combined assets exceed

The Role of Islamic Finance in Enhancing Financial Inclusion in Organization of Islamic Cooperation (Oic) Countries

200 billion, with an annual growth rate between 12 percent and 15 percent. The regulatory regime governing IFIs varies significantly across countries. A number of international organizations have been established with the mandate to set standards that would strengthen and harmonize prudential regulations as they apply to IFIs. The authors contribute to the discussion on the nature of prudential standards to be developed. They clarify the risks that IFIs are exposed to and the type of regulations that are needed to systematically manage them. They consider that the industry is still in a development process whose eventual outcome is the convergence of the practice of Islamic financial intermediation with its conceptual foundations. The authors contrast the risks and regulations needed in the case of Islamic financial intermediation operating according to core principles and current practice. They outline implications for approaches to capital adequacy, licensing requirements, and reliance on market discipline. They then propose an organization of the industry that would allow it to develop in compliance with its principles and prudent risk management, and facilitate its regulation.

Economic development and Islamic finance

The core principles of Islam lay great emphasis on social justice, inclusion, and sharing of resources between the haves and the have nots. Islamic finance addresses the issue of “financial inclusion” or “access to finance” from two directions — one through promoting risk-sharing contracts that provide a viable alternative to conventional debt-based financing, and the other through specific instruments of redistribution of the wealth among the society. Use of risk-sharing financing instruments can offer Shar ahcompliant microfinance, financing for small and medium enterprises, and micro-insurance to enhance access to finance. And redistributive instruments such as Zak h, adaqat, Waqf, and Qar -al- asan complement risk-sharing instruments to target the poor sector of society to offer a comprehensive approach to eradicating poverty and to build a healthy and vibrant economy. Instruments offered by Islam have strong historical roots and have been applied throughout history in various Muslim communities. The paper identifies gaps currently existing in Organization of Islamic Cooperation (OIC) countries on each front, that is, Shar ah-compliant micro-finance and financing for small and medium enterprises and the state of traditional redistributive instruments. The paper concludes that Islam offers a rich set of instruments and unconventional approaches, which, if implemented in true spirit, can lead to reduced poverty and inequality in Muslim countries plagued by massive poverty. Therefore, policy makers in Muslim countries who are serious about enhancing access to finance or “financial inclusion” should exploit the potential of Islamic instruments to achieve this goal and focus on improving the regulatory and financial infrastructure to promote an enabling environment

Financial Inclusion : Islamic Finance Perspective

Islamic finance has been practiced in some form since the inception of Islam, its practice in modern financial markets became recognized only in the 1980s, and began to represent a meaningful share of global financial activity only around the beginning of this century. In recent years, significant interest in Islamic finance has emerged in the worlds leading conventional financial centers, including London, New York, and Hong Kong, and Western investors are increasingly considering investment in Islamic financial products. The organizing principle of Islamic finance in an Islamic economy is transaction based on exchange, where real asset is exchanged for real asset. By focusing on trade and exchange in commodities and assets, Islam encourages risk sharing, which promotes social solidarity. The features of an Islamic economy will change the behavior of society. There will be greater consultation; hence there will be no impulsive-compulsive reaction in financial dealings. At the same time, the labor force in an Islamic economy will work under a rule of trust and full understanding of contracts and obligations. Workers also share in the gains achieved through the risk, based on productive efforts, which is a better incentive system than a fixed wage. Workers will be treated with respect, which reflects the importance of human dignity in Islam. This paper is organized as follows: chapter one discusses the epistemological roots of conventional and Islamic finance. Chapter two provide a perspective of conventional modern economists. Chapter three provides a brief taxonomy of the foundational Islamic market principles and evaluates them in the context of institutional and behavioral economics in the context of Knightian uncertainty. Chapter four accounts for finance and development in Islam from a historical perspective. Chapter five discusses the evolution of the concept of economic development. Chapter six provide an Islamic perspective on financial inclusion and argue that the core principles of Islam place great emphasis on social justice, inclusion, and sharing of resources between the haves and the have-nots. Chapter seven addresses financial inclusion. Chapter eight provide insight into Islams perspective on social safety sets and social insurance. Chapter nine examines Islamic capital markets in a global context. Chapters ten examines the problems of primary and secondary aspects of the conventional stock markets and their critiques of corporate governance. Chapter eleven give a realistic view of the current state of affairs in Organization of Islamic Conference (OIC) countries. Chapter twelve addresses key economic policy challenges in the context of the Islamic economic and financial system.

Understanding Development in an Islamic Framework

Enhancing financial inclusion or access to finance can make critical contributions to the economic development. Conventional mechanisms such as micro-finance, small-medium-enterprises (SME), and micro-insurance to enhance financial inclusion have been partially successful in enhancing the access and are not without challenges. Islamic finance, based on the concept of risk-sharing offers set of financial instruments promoting risk-sharing rather than risk-transfer in the financial system. In addition, Islam advocates redistributive risk-sharing instruments such as Zakah, Sadaqat, Qard-al Hassan, etc, through which the economically more able segment of the society shares the risks facing the less able segment of the population. These are not instruments of charity, altruism or beneficence but are instruments of redemption of rights and repayment of obligations. In addition, the inheritance rules specify how the wealth of a person is distributed among present and future generations of inheritors. This paper argues that conventional modes of enhancing financial inclusion can be replicated through instruments of Islamic finance allowing risk sharing and risk diversification. However, even after availability of micro-finance and SME financing, financial exclusion may not be fully overcome. Therefore, one needs to utilize, Islam’s instruments of redistribution where mandated levies and recommended avenue of spending may play their role. They help reduce the poor’s income – consumption correlation. The paper concludes that Islamic finance provides a comprehensive framework to enhance financial inclusion through the principle of risk-sharing and through Islam’s redistributive channels which are grossly under-utilized in Muslim countries. The redistributive instruments may be developed as proper institutions to optimize the function of such instruments. Applications of financial engineering can device innovative ways to develop hybrids of risk-sharing and redistributive instruments to enhance access to finance to promote economic development.

Ethical Dimensions of Islamic Economics and Finance

In this paper, the foundational rules governing human, economic and financial development in Islam, as understood from the Qur’ān and from the life and traditions of the Prophet Muhammad (pbuh), are summarized. These rules pave the path to development as the basis of institutional structure, which in turn, underpin the path of economic and social progress. The essential elements in the life of a Muslim—the unity of creation, freedom and freedom of choice, economic and human development, economic system and financial practice—are developed.

Economic and Social Justice: The Policy Objective in Islam

Having developed a framework of virtues and business ethics in previous chapters, this chapter discusses the application of the ethical framework to Islamic economics and finance. An in-depth analysis of risk sharing, materiality, social and economic justice, and governance aspects of Islamic economics and finance are provided, arguing that such a framework provides rich ethical standards and ensures finance that is responsible and good for the society. Ethics are embedded in the core principles of Islam and each rule prescribed has explicit or implicit ethical dimensions reflecting its adherence to core values and virtues. The chapter discusses the ethical dimensions of risk-sharing finance and highlights various features of Islamic finance such as materiality, anti-fragility, stability, economic justice, and redistributive justice. These features address several ethical issues prevailing in global financial systems.

Developing Social Capital

Throughout the ages, one of the most important questions confronting mankind has been, “on what basis should economic resources be distributed?” The answer depends on the underlying concept of justice and fairness, which, in turn, depends on the belief system. In Islam, the concept of justice for humans is simple and unambiguous: justice is obtained when all things are placed where intended by the Creator and when everyone is given their rightful due.1 How are humans to know where the right (just) places is for everything and what is the rightful due for everyone? The answer: follow the rules prescribed by the Creator.2 By the instrumentality of His Walayah, the Loving Creator has provided all that is necessary for humans to achieve perfection of the human state. He has also clearly designated the path-to-perfection and has marked it with rules of behavior in all facets of human life. Rule-compliance assures justice, which assures balance for individuals and for society. Compliance with rules guarantees that humans draw closer to their ultimate objective, namely, their Creator. Morality is a result of just behavior, that is, rule-compliant behavior. Undoubtedly, justice is seen as a supreme virtue: “O you who believe, be upright for Allah, and (be) bearers of witness with justice!…” (Quran 5:8) And “…the Word of your Lord has been fulfilled in truth and in justice. None can change His Words.”

Risk-Sharing Finance and the Role of Public Policy

The concept of social capital is multidisciplinary and is not easily defined or understood. The concept has been used to explain phenomena from the growth tragedy in Africa associated with high ethnic fragmentation (Easterly and Levine, 1997) and group-based programs for environmental improvements including microfinance (Pretty and Ward, 2001) to the role of trust in underdevelopment (Banfield, 1958; Guiso, Sapienza, and Zingales, 2004) and the limited stock market participation puzzle (Guiso, Sapienza, and Zingales, 2008).