What is actually Islamic Finance?

Saiful Azhar Rosly, Ph.D

International Center of Education in Islamic Finance (INCEIF)
23rd September 2008.

Islamic finance today is a buzzword that no one actually knows

what it stands for. Early in the 60’s scholars wrote passionately
about Islamic economics. In the 70’s and 80’s the euphoria was the
Islamic banking business. Now it’s Islamic finance. Across the
globe, right from London to Dubai to Kuala Lumpur and Hong
Kong, business forums on ‘Islamic finance” have spread like
mushrooms. Harvard University called it ‘Islamic Finance Forum”.
We have “Islamic Finance News” in Kuala Lumpur. And many more
“International Islamic finance forum” were held in Dubai, New York
and Bahrain. Malaysia’s Islamic Finance Center (MIFC) was set up
to make Malaysia a major Islamic financial hub in the world.
What is Islamic finance? In the academia, the term ‘finance’
usually points to the finance department that offers courses such
as corporate finance, managerial finance, international finance,
financial planning and financial derivatives. So, does Islamic
finance refers to these bodies of knowledge? Not really.
Finance or financing means giving money to someone as a loan or
shares. So the entity that provides the financing is one that has the
surplus money. It can be a bank. So, when an Islamic bank gives
the financing, it concerns Islamic banking.
Certainly, when the financing is given by the public via bond and
share issuances, it is quite accurate to see Islamic corporate finance
in play.
When an Islamic financial institution pays the Zakat, we now see
Islamic public finance in action. It deals with the government’s role
in collecting zakat from the wealthy and distributing the proceeds to
the deserving zakat recipients.
Thus, in total Islamic finance looks like something that
encompasses banking, corporate and public finance and of course
the Shariah discipline. Then throws in takaful and wealth planning
to fill up the loop.
We then look at books written about Islamic finance. We have the
John Wiley Islamic finance series. A book by Muhammad Ayub
called “Principles of Islamic finance” examines the Shariah and
Islamic contracts, banking and sukuks plus Islamic stocks and
mutual funds. Zamir Iqbal and Abbas Mirakkor wrote “Introduction
to Islamic finance” put similar points. El-Gamal critical outlook of
Islamic finance is well-known in his celebrated work “Islamic
finance-law, economic and practice”. Even Taqi Usmani’s book is
named after “Islamic finance”.
What we see in the above, is that Islamic finance represents a body
of knowledge constituting the Shariah, economics, banking and the
capital market. It deals with Shariah based financing given by the
banking firms, the capital market, the venture capitalist, the high
net-worth individuals and government To set a level playing field,
rules and regulation are put forth by the regulators concerning
licenses, taxation, dispute resolutions and Shariah interpretations.
The bulk of the knowledge seemed to take off with the Islamic
banking business. Since 1960’s academic papers on Islamic
banking are aplenty. But less work are evident in Islamic corporate
finance. For example, what causes companies to use sukuk rather
Shariah compliant shares in raising capital? What is the optimal
capital structure of a firm seeking Shariah compliant status? How
is CAPM applied in Islamic fund management? What is the Islamic
conception concerning cost of equity capital and cost of sukuk
capital? These are not discussed in the business forums on Islamic
finance where marketing or promotion is the central agenda. The
basic science of Islamic finance is in utter neglect in these
meetings. So who owns Islamic finance? So far, the finance
professors have not been excited about Islamic finance.