Role Of Islamic Finance In Financial Sector Development Finance Essay

The construct of Islamic banking is deriving much popularity these yearss. Muslim finance is one of the most outstanding phenomena over the last decennary in the banking industry in the middle-eastern states and the South East Asiatic states and it has late spread in non-Muslim states, such as the United Kingdom and the United States ( Gheeraert, 2008 ) . The Islamic banking and finance system is about four decennaries old.

Khan and Bhatti ( 2008 ) argue that the Islamic fiscal system ensures the optimum rate of capital preparation and its efficient use taking to a sustainable economic growing and just chances for all. Siddiqi ( 2000 ) had commented that Islamic finance system is a value-based system that chiefly aims at guaranting moral and material well being of the single society as a whole. Harmonizing to Khan and Bhatti ( 2008 ) there are about 300 Islamic banking and fiscal establishments across 75 states, keeping a paid up capital of over US $ 13million, commanding assets deserving US $ 300-US $ 500 and investings of US $ 500billion -US $ 800 billion, with an mean one-year growing of 15 per centum. It has been estimated that Islamic banking and finance industry will make to US $ 4 trillion by 2010.

Shahinpoor ( 2009 ) points out that Islamic banking is a system that provides fiscal services to its clients free of involvement, as the Islamic jurisprudence prohibits having involvement in all the fiscal minutess. She argues that the construct of profit-loss sharing is used alternatively of involvement. By supplying involvement and indirect free fiscal resources consistent with Islamic rules and Torahs, the Bankss play an instrumental portion in promoting the constitution of little concerns by people with no fiscal assets or the hapless. Islamic banking is in a manner related to micro funding ( Shahinpoor, 2009 ) .

Ariff ( 2005 ) points out that Islamic Banking is of great usage in economic development. He outlines six rules of Islamic Banking, which is of great benefit in economic development.

Productive usage of resources ( without involvement )

Continuous usage of fiscal resources

Equitable sharing of hazards and additions.

Procuring due benefits for the proprietor

Use of fiscal resources

Lawful Investment.

He adds that the Islamic Development Bank plays a outstanding function in advancing the economic development. Islamic Development Bank offers involvement free loans, organise undertaking funding, with particular penchant to the agricultural sector.

Choudhury and Hussain ( 2005 ) propose the position that Islamic Bankss are bureaus of sustainability of the socio-economic order, the socio-political order and saving of community assets. This position is echoed by Goaied and Sassi ( 2010 ) who remarks that an efficient fiscal system is the key to economic development. He adds that the chief part of fiscal system to growing depends on the fact that it assures the operation of an efficient and evolutionary payment system, call up the economy and better its mannerism to the investing. Hence the being of a dependable exchange system is one of the most necessary conditions for economic development.

Fiscal markets and banking system can guarantee a better mobilization of the available nest eggs and prolong the economic growing as it facilitates the fiscal resources agglomeration of the economic system, and it besides allows the fiscal intermediation to diversify the hazards associated to single investing undertakings and to offer to rescuers more benefit investings which promote fiscal economy ( Goaied and Sassi, 2010 ) .

Harmonizing to Goaied and Sassi ( 2010 ) , the characteristics of Islamic banking which aid in fiscal development are as follows

The Productive feature

One of the most of import characteristics of Islamic manner of funding is their direct nexus to the existent economic system or physical minutess. The constructs of Mousharaka and Moudharaba are merely possible for productive companies which contribute to real-life concerns that increase the production. Hence it can be seen that Islamic Banking promotes the productiveness of an economic system, which would take to better fiscal development

The Relational feature

The competition between Islamic Banks and conventional Bankss is high. The competition among the Islamic Bankss drives the profitableness to maximum in both the short and long tallies. So the stockholders are more affiliated to the existent market. Hence harmonizing to Goaied and Sassi ( 2010 ) , the relational features of Islamic Bankss accomplishes dual consequences as it reaches the synergism, cooperation and the efficiency internally and externally, it reinforces the corporate image of the bank and its legitimacy towards the portion holder. Hence it leads to fiscal public presentation and existent productiveness.

Shahinpoor ( 2009 ) points out some similarities between Islamic Banking and the construct of micro funding. She argues that both are meant to back up the hapless in under developed economic systems. But Islamic banking would of be of more benefit to the people, as it is free of involvement and therefore more suited for the people. Honohan ( 2004 ) had the position that the engagement of the hapless people in the economic system non merely improves their lives, but it besides contributes to the economic development of the communities and the fiscal development of the state as a whole.

Even developed states like Australia are concentrating their attempts to Islamic banking. They have overhauled their subdivisions of revenue enhancement Torahs to guarantee that they do n’t impact the growing of Islamic Banking.

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Choudhury and Hussain ( 2005 ) remark that the operations of Islamic banking should be holding an mentality, which is aimed at the overall socio-economic development. They add that it would unite the ends of economic efficiency and societal justness into complementary dealingss with each other. Such a theoretical account of socio-economic development would be ideally functioning the society as a whole in bettering the fiscal state of affairs of the economic system. As pointed out Khandker ( 2005 ) , , the construct of Islamic banking coupled with micro funding has significantly reduced the poorness among the hapless borrowers, but besides contributed to the decrease of poorness in the full small town, in Bangladesh.


Islamic banking is in a quickly turning phase as an option to conventional banking. As pointed out by Ebrahim and Joo ( 2001 ) the combination of Islamic Investment banking and retail banking provide twin engines of growing and development for an economic system.

Fiscal technology and merchandise development

Fiscal Engineering is one of the most of import footings in finance. It is a survey about the theories of finance, its methods and the application of mathematical and computational scheduling tools to obtain the coveted consequences. Beaumont ( 2003 ) remarks that the constructs of fiscal technology include creative activity of fiscal merchandises, building of fiscal portfolios and development of a scheme. Harmonizing to Marshall ( ) , fiscal technology involves the application of fiscal instruments like derivates in order to obtain a mix based on the variables of hazard and return. In other words, it fiscal technology involves the application of fiscal engineering to work out the jobs in finance and do maximal advantage of the fiscal chances. Marshall ( 2000 ) argues that fiscal technology applies the construct of invention and engineering to make constructions intended to rectify the jobs.

Finnerty ( 1999 ) points out that fiscal technology is about the merchandise and procedure invention in the fiscal sector, and the developing advanced fiscal instruments and procedures in order to maximize the value of the stockholder ‘s wealth. The most of import fiscal merchandises which come under the fiscal technology are

Chemical bonds – Chemical bonds are instruments issued by the companies to finance their operations. Sometimes it is used to by the authoritiess to bring forth financess for infrastructural disbursals. The cardinal factor which differentiates bonds from portions is that the involvement rate of bonds is fixed. Hence the hazard associated with them is lower than that of portions.

Options- Options are fiscal instruments which give the purchaser the right to sell or purchase a portion.

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Futures- Futures can be defined as a contract between two parties which warrants the bringing of a bond, trade good, currency at a fixed monetary value, on a hereafter day of the month. Futures differ from options in such a mode that there will be an duty to purchase.

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Moore ( 2005 ) remarks that developing new fiscal merchandises is based on the undermentioned factors

Net present Value-Net present value is about ciphering the flow of hard currency over the class of a undertaking. It is calculated by projecting all the hard currency income, all the projected measure of units sold and the cost of units sold.

Internal rate of return-Internal rate of return is really similar to net present value. Harmonizing to DFPNI, Internal rate of return is the price reduction rate that gives a undertaking a net present value of nothing.

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Islamic banking has many conventional banking merchandises like leasing, unit trusts, bonds, hire purchase, financess, venture capital and undertaking finance. Tahir ( 2009 ) remarks that there are non adequate merchandises in Islamic finance, which comply with the spiritual ordinances of the system. Eppinger ( 2004 ) is of the position that design and development of merchandises is a full-blown field in the technology sector.

Tahir ( 2009 ) proposes the undermentioned stairss for developing new merchandises in finance.

Developing the right administration for the merchandise

Identifying the demands of the client and their outlooks from the merchandise

Planing for the merchandises

Stipulating the characteristics of the merchandise

Coevals and choice of the construct

Testing of the construct

Specifying the architecture of the merchandise

Planing for execution

Design of the merchandise

He points out that due to the terrible spiritual limitations some conventional merchandises are absent in the Muslim dominated states. The most common fiscal instruments which are absent in the Muslim states are hedge related financess, venture funding and stock market linked investings. The chief maps of an Islamic finance related merchandise should be

It should pull single investors who want to follow with their spiritual Torahs by puting in a system, which conforms with their spiritual ordinances

Other investors such as the corporate investors want the least possible cost of financess

It should advance the capital market governments to get down debt markets in a mode which complies with the Torahs of the faith

The regulative governments want securities in which the involvements of the interest holders can be safeguarded in an easy mode

The bookmans of the Islamic jurisprudence do non desire to go against the spiritual Torahs while bordering Islamic finance merchandises

Capital suppliers expect the Islamic finance merchandises to be better than the conventional finance merchandises.

Planing the fiscal merchandise

Harmonizing to Tahir ( 2009 ) the freshly planned merchandises can be classified into four classs

New platforms: Wholly new household of merchandises is developed

Derivatives- The bing merchandises are somewhat varied to develop new merchandises

Improvements- Improvements are made to the current merchandises to develop new coevals of the bing merchandises

Basically new- Merchandises which are wholly new and advanced are to be developed

The tendencies in the market and the demands of the clients are the chief influencing factors behind the new merchandise development in Islamic finance. The new merchandise development is chiefly defined by the tendencies in macro-economy, human ecology, political relations and society ( Tahir, 2009 ) . Harmonizing to him the stairss in merchandise planning and merchandise specifications are as given below.

Merchandise planning-Steps

Identifying the chances for new merchandises

Measuring and puting the precedences for the undertakings

Planing and apportioning the resources and puting the timings

Completing the planning of the pre-project

Product Specifications-Processes involved

Fixing a list of the prosodies

Roll uping the information to be used for benchmarking

Puting marks which are ideal and acceptable

Reflecting on the consequences and the procedures


The construct of merchandise development in Islamic banking and finance is still new and emerging. There is non much literature available on the merchandise development in Islamic finance which can be used as a usher for developing a fiscal merchandise. The theoretical account which is used above is adapted from the bing literature on new merchandise development in the technology scientific disciplines. As echoed by Tahir ( 2009 ) , bettering and developing the field of new fiscal merchandise development has great significance in the field of Islamic finance and it holds the key for the success of Islamic banking and finance.

Islamic finance positions on planetary fiscal crisis and crisis declaration.

The crisis which gripped the planetary fiscal universe has brought many issues into focal point, sing the stableness of planetary fiscal architecture. The most noticeable factor during the crisis was the dislocation of the operation of the procedure of fiscal intermediation, which led to a loss of assurance in the fiscal system ( Aziz, 2009 ) . He points out that the Islamic fiscal establishments showed much strength during this crisis, and it demonstrated the built-in strengths of the Islamic fiscal system. Harmonizing to Aziz ( 2009 ) , the cardinal ground behind the strength of the Islamic fiscal system is that, any fiscal traffics must be related to an implicit in productive activity that will bring forth hard currency flow and wealth.

Chapra ( 2008 ) argues that the chief ground behind the fiscal crisis was the imprudent and inordinate loaning by the Bankss in order to maximize their net incomes. He is of the sentiment that an Islamic funding system would n’t hold resulted in such a state of affairs, as the Islamic banking system does n’t let the construct of involvement.

Kabir ( 2009 ) points out that the uncertainnesss in the fiscal markets caused restraints to the recognition flow to the concerns and had a negative impact on the economic system. As a consequence investors lost a fringy portion of their investings. He argues that harmonizing to the Islamic finance ‘s point of position, the crisis is a consequence of the moral failures of the economic system, and it ‘s chiefly due to the relationship failures between the investors and the investing establishments. The Islamic banking sector was n’t affected much by the recent fiscal crisis because, the Bankss did n’t bear down any involvements on their investings, and at that place was a deficiency of structured merchandises in the Islamic banking system ( Kabir, 2009 ) .

Hasan ( 2010 ) is of the sentiment that Islamic banking is based on a set of values, the most of import one being the construct of risk-sharing. He argues that the planetary fiscal crisis would n’t hold happened if there was a proper fiscal system which followed the Islamic fiscal system, as it would n’t let the payment and credence of involvements, and the Bankss would be involved in a hazard sharing understanding with its client, wherein the focal point would be to increase the productiveness and hence the returns in a mode which is profitable to both the clients and the Bankss.

Kabir ( 2010 ) proposes that the Islamic finance system would be of great aid in cut downing the impact caused by planetary recession as it advocates the chances of community banking, the values of societal and economic justness and ethical investings. He adds that the accretion of wealth in the society should be in a just mode and the supply of money should be in conformity with the chances of existent economic growing.

Chapra ( 2008 ) proposes three factors in Islamic banking which would be helpful in avoiding the return of the crisis. They are

Restrictions on the greed to maximize the net incomes

Market subject which is meant to keep inordinate loaning and purchase

To reform the construction of the fiscal system along with rigorous ordinances and supervising designed to forestall crisis, with a position to accomplish development which can be sustained and to safeguard societal involvement.

Dewi and Ferdian ( 2009 ) supports the above statement and adds that the Islamic system of utilizing existent clip assets in the fiscal dealing, will advance productiveness and hence it improves the fiscal province of the economic system, which would be helpful in cut downing the impact of the fiscal crisis. However they argue that there needs to be equal and trained human resources who have good cognition of the Islamic system. Ahmed ( 2009 ) is of the position that in Islamic banking, the accent will be on equity manners of funding, and therefore the funding would necessitate high criterions and will besides be actively monitored. He proposes a different position that the factor of morality entirely would n’t be able to undertake the crisis and that the hazard related issues have to be tackled at the institutional degrees by the creative activity of appropriate Torahs and ordinances and support systems. The value of trust is one of the most of import factors which is traveling to play a major function in the Islamic finance system and trust will non merely be created by holding crystalline traffics, but more significantly by the nature and genuineness of the merchandises in the Islamic fiscal system ( Ahmed, 2009 ) .

Ahmed ( 2008 ) is of the sentiment that the recognition evaluation under the Islamic finance evaluates the existent potency and possibilities of growing instead than measuring the manipulated plus values. Hence he proposes that the fiscal regulators and recognition evaluation bureaus should be following the rules of Islamic banking and finance to forestall any more crises in the fiscal sector. This position is supported by Hassan ( 2009 ) who states that Islamic banking and finance holds high promise in the current fiscal state of affairs and that it ‘s high clip, the values of Islamic finance is introduced to the market participants, economic experts and the populace. He adds that the protagonists of Islamic banking believe that it will hold great function in cut downing the impact caused by the crisis. As proposed by Timewell ( 2009 ) the Islamic banking and finance industry will be able to beef up its function and place the international fiscal market as the companies and investors look out for alternate beginnings of investing and finance.

Many states are following the Islamic banking system as they have recognised the strengths of Islamic banking system and its function in reconstructing the credibleness and stableness of the international fiscal market ( Kabir, 2010 ) . He adds that the hereafter of Islamic banking looks promising, though it would take vision and difficult work in footings of constructing the human capacity and fiscal technology, to guarantee its bright hereafter. As mentioned by Chapra ( 2008 ) , the success of Islamic banking and funding depends on foregrounding the reason of the Islamic fiscal and banking system to convert people about how it ‘s superior to the bing fiscal system.