Principles of Islamic banking and finance/PIBF201/Rationale for Islamic finance/Overview

As mentioned earlier, the financial sector of an economy is supposed to support the underlying economic system, which is in turn based on a particular worldview and political and economic doctrines. Financial institutions developed in the capitalist system often involve elements that are questionable from an Islamic perspective. For example, in conventional banking, guaranteeing the principal amounts as well as interest accrued on them by commercial banks is a fundamental requirement. This necessitates commercial banks to rely mostly on fixed income assets resulting in a particular distribution of income pattern and a possible source of financial instability. Islamic banking on the other hand requires that amount deposited in banks for the purpose of income generation should be treated as investible funds that are prudently invested by banks in Islamically permissible ways and any profits (or loss) accrued are shared fairly. Similarly, the current rules of the game in other capitalist institutions such as markets for shares and bonds, insurance, futures, options, etc. have some elements of mysir and / or gharar that could be questionable from an Islamic perspective.

Financial institutions and practices under an Islamic economic system would either create new institutions or change the rules and practices of existing institutions of the capitalist system to make them compatible with its overall goals. In this regard, Islamic religious scholars, Muslim academics and practitioners are continuously evaluating existing theories and practices and working of different institutions.

One should accept the possibility that two different views on an issue could be equally strong, convincing and even valid. It is, therefore, possible that Islamic economic and financial systems implemented in different countries may have some distinct features. Accordingly, the impact of distinct policies, regulations and institutions prevailing in different countries could be compared to determine their relative advantages and disadvantages.

This section will provide detail discussion on the rationale for the establishment of the Islamic banking and financing industry.