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The Way Forward for Islamic Finance

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.



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

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,
Malaysias 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 clich to say that education is central to producing Islamic finance talent. But, it is more than
the clich 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 Shariah. Hence, the knowledge of the
Shariah 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
(Look out for Part 2 of Prof Mansors blog later this week.)



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
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 Shariah,
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 prerequisites 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 Shariah courses, one may find those
who have no ideas of the Shariah 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
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.