History and Overview of Growth of Islamic Finance
According to El-Gamal (2006), Islamic finance started such a diminutive industry in several GCC nations in the 1970s, which differentiates this commencing conventional finance in its noticeable consistency with the dogma of Islamic regulation named Shari’a; while its progress has accelerated taking into account of the number of functioning countries where this system has implemented and where it is going to introduce. Iqbal (2007) argued that currently, the industry has engrossed numerous financial organizations of the developed nations like Citigroup and HSBC are offering Islamic financial products in several GCC nations and in the western world (consisting of the US). In addition, these financial products also encompass the accomplishment to grasp of resources and wealth resembling housing as well as the property market in the US and Europe where “Islamically-structured” financing deals.
KPMG (2007) stated that Islamic finance depends significantly on 3 types of persons with appreciative abilities. Moreover, it is suggested by Ünal (2010) that the first is those people who specialize over financials and are proverbial in the middle of conservative financial services, in addition to the demand for stipulated Islamic equivalences of those services surrounded by a range of Muslim societies throughout the globe. The second type comprises of Muslim jurists (fuqha and specialists over orthodox jurisprudence that improved largely from eighth to fourteenth centuries), assisting Islamic financial suppliers to identify precedent financial processes from orthodox manuscripts, ahead of which modern equivalences of unadventurous financial services have constructed (KPMG, 2007). Hesse, Jobst, and Solé (2008) added that the third type consists of legal representatives who support all these people in the configuration of Islamic equivalences financial services, as well as assuring their acquiescence with every valid and appropriate lawful and dogmatic restraint.
KPMG (2007) stated that in the late nineteenth century, Ottomans initiated western-style banking to the Islamic world to finance their costs, whilst some Islamic jurists permitted the modern banking practices and the majority found those practices to be violations of Islamic prohibitions against usury; this antipathy sustained through the European colonial period that lasted until the mid-twentieth century. According to Kuo, et al. (2008), Islamic revitalization played one of the most essential roles in the academic and societal fundamentals of autonomy movements of the mid-twentieth century; to numerous scholarly originators of the movement, political liberty had to complement with economic liberty, by the description of an Islamic economic structure. Former manuscripts, which has acknowledged as “Islamic Economics” concentrated on macroeconomic advancement concerns; by the 1970s, hypothetical dialogues of Islamic economics gave rise to realistic consultations, which turned juristic-natured emphasizing on how can Islamic-groups can substitute conventional financial practices (regarded to be usury-based) with Islamic substitutes; additionally, mid-century literature recommended a profit-and-loss sharing partnership substitute to interest-based lending (Skubik, 2008).
Growth of Islamic Finance in Global Context:
Through past few years, the growth rate of Islamic finance has noticed to increase inexplicably throughout the world; in this context, the practice of Islamic finance is becoming more and more popular in not only the GCC or Muslim nations, but also in many European, American, African, and South Asian provinces (Fukui, 2008). To be specific, many giant multinational financial institutions of the UK, Switzerland, and the US, for example, have already come up with Islamic financial practices in some of their operating areas; therefore, the Islamic financial system has shaped as flourishing diligence that is capable to complying concurrent global fiscal scheme (Cunningham, 2007). Pointing to the reasons that led to the growth comprising with variety to financial products and dealings where the competitors penetrate into the market that grow up a range of financial dealings that raise enlargement and generate opportunity for enhanced profit-making; simultaneously, it has an optimistic upshot on the real economy through more well-organized resource allotment (Trabelsi, 2011). Sorenson (2005) noted that no specific statistics are available for illustrating the market-size of the Islamic financial industry; however, as forecasted by the Islamic Financial Services Board (IFSB) and various such bodies, in December 2005, above 300 monetary organizations at above sixty-five fields administered resources within the Shari’ah-like-way that had a sum of between $700bn and USD 1tn. Although 2005’s figure symbolizes one-percent growth of Islamic financial-sector in international financial-assets, its growth has remarkably improved recently, which has continued to grow by ten to fifteen percent annually on average from the 1990s and has anticipated upholding growth over the concurrent situation that prolong to the Meddle East, the constituencies pigeonholed by the active advancement of Islamic finance. For instance, Islamic finance services have projected to encompass above half of the financial services provided in the GCC area within 2015 more than fifty percent of the private debt and securities of Malaysia would be Islamic bonds; and this success goes to the guidance of Governor Zeti for his approval to make Malaysia an Islamic financial-center (Khan and Bhatti, 2008).
According to Trabelsi (2011), the current augmentation occurred in opposition to the backdrop of amplification of financial products sustained by the Arab countries and an emergent amount of followers in quest of having their assets handled under religious code of belief; a uniformly significant aspect, which boosted enlargement in Islamic finance, is modern progress in the financial system that controlled finance. Chong and Liu (2009) have stated that Islamic finance engineering would capable of initiating the coordination of profit partaking rather than forbidden interest-paying and focussed on the technique to the improvement the assortment for financial services, comprising an Islamic bond like Sukuk.
Prospect for the Development of Islamic Finance in Global Financial Crisis:
In current times, the global financial crisis has demonstrated the economic commune an indication of how flimsy an international financial system could be that depends merely on financial markets; the capitalist system that became medium for international economic mobility was unsuccessful to generate an esteemed economic command that is complementarily unbiased and capable to offering security to people (Chapra, 2008). Conversely, the evolution of Islamic financial practices has drastically transformed the preferential ideologies together with global fiscal exercises of recent customs connecting Islamic economics, comprising Islamic bankers to obtained noteworthy advancement, however, challenges to potential advancement would be inflexible for conquer; consequently, diverse partisan on rudiments must carry on the optimizing of aid accelerating the potential advancement of Islamic economies (Winship, 2010). Taylor (2004) and Islam (2003) stated the feasibilities may not recommend any fresh structural plan devoid of shaping the principal grounds of the crisis that has commonly predictable along with largely imperative ground on nearly every crisis are extreme as well as irresponsible to providing banks’ loan.
The exercises have encouraged through 3 major issues – insufficient market discipline in the financial-system ensuing from the non-existence of profit as well as loss sharing while the implausible extension of financial derivatives is principally credit defaulting exchange with huge fall notion that aimed to provide huge banking and insurance that would certainly approach rescue and prohibit those to stop working (Ilias, 2008). According to Haron, Ahmad, and Palnisek (1994), through the above-stated standpoint, the perception of Islamic banking is quite dissimilar as of traditional banking for the reason that riba (interest) has forbidden for Muslims as per the direction of religious conviction; to elaborate, banks are not cannot proffer the unchanging velocity of return on investment may not impose interest over lending. An exclusive attribute of the Islamic system of banking defines PLS doctrine that is principally centered over the mudaraba as well as musharaka observation of Islamic astringent; underneath this PLS-paradigm, resources, and accountability of this system has included through the judgment that borrowers divide up profits along with losses with banks as well as depositors (Wilson, 2009).
Iqbal (2007) has noted to the followers of the Islamic system of banking, in consequence, had increasingly commented that Islamic banks have a good situation hypothetically other than conventional banks would soak up peripheral revelations for that reason that their monetary plunges would some extent engross through the depositors. Correspondingly, risk partaking distinctive of the PLS hypothesis are speculation, permits Islamic banks to lend for long term basis connecting the scheme among advanced risk arrival contours and subsequently for endorsing economic growth; additionally, Islamic banks are convincingly proficient in the management of risk were (Ali, 2008).
Drawbacks and Challenges for Growth:
El-Gamal (2008) argued that there are several drawbacks in the Islamic financial system, and specifically in the Islamic banking system. The non- existence interest prolonged to Islamic finance indicates that this banking system may not take into account interest rate exposures; but still, it also does not point towards the issues of lesser intensity with hazards in relation to the traditional banking (Schmith, 2008). Lovells (2004) stated that similar to traditional banks, Islamic banks lay open to liquidities connecting with available credits, accounting settlements, leverages, operating risks; in addition, the Islamic banking system also earn hazards that are uncommon within the traditional banking system – there is a number of drawbacks of the Islamic banking comprise the following:
- Displaced-Commercial Risk – Kuo, Aziz, and Akhtar (2008) argued that this kind of drawback has associated with the frequent exercise amongst Islamic banks to achieve the aim to even the financial return for the investors relating accounts maintenance next to altering the proportion of profit distributed like the Mudarib shareholders those could contrast with preparation or agency-fee;
- Fiduciary-Risk – as stated by Hesse, Jobst, and Solé (2008), in particular, drawbacks associated with the character of the Mudaraba agreement that imposes burden for fatalities connecting Mudarib is an instance of recklessness, as well as violation of the agreement upon a fraction of administration concerned with Mudaraba, has included over here
As the industry has a rising number of new entrants, banks would have to compete with the entire industry to a higher extent and enhance business operations, and numerous arduous concerns confronted by banks of a similar kind, which are functioning extremely less than their prospective, as such system itself cannot obtain root in non-attendance of other essential apparatus of this financial movement. Furthermore, an assortment of challenges is present in the operational areas that all Islamic financial institutions must address before the origination of the long-term policies:
- A standardized authoritarian and lawful agenda accommodating the Islamic financial model had not so far improved rapidly as the existing set of laws for banking in Islamic nations has derived from the Western financial model (Ahmad and Haron, 2002). Likewise, Islamic banks confront complications functioning in non-Islamic nations because of non-appearance of the dictatorial authority that runs according to Islamic morals; advancement of an authoritarian and managerial structure that would deal with the concerns precise to Islamic organizations must promote a new structure to merge two distinct systems (Walker, 2005).
- Mettawa and Almossawi (1998) argued that the financial system has an absence of particular, and prearranged financial center, which is able to help affirm and run with harmony to establish Islamic morals; even though this system is promising in Muslim nations, for instance, Egyptian or Pakistani people are dynamic but they are not entirely well suited with such view. Iqbal (2007) argued that both the authority of Iranian and Swedish stock exchanges would interested to operate the market according to Islamic morals; furthermore, the secondary market is tremendously superficial to provide Islamic services, while currency markets are nearly fictional. Sapir (2008) pointed out that the improvement of the inter-bank market is one of the great threats as there are no feasible tools presently obtainable;
- According to Hasan (2010), another big problem has associated with the sluggish pace of innovative activities in the Islamic financial industry; for a long time, the market has been providing identical conventional tools equipped for short with medium-term maturities; however, it was unsuccessful to establish as an essential tool to manage maturities at limits. Schoon (2007) have argued that the financial system requires risk management features for providing clients with devices to escape adjacent to soaring volatility in the exchange rate as well as commodity-market; additionally, this market does not possess essential devices to offer feasible substitutes in favor of public debt financing (Ünal, 2010).
- Hassan (2009) and Iqbal (2007) stated that Islamic organizations should require suitable accounting actions with standards; however, global financial regulations are inadequate owing to the diverse traits and action of economic devices, in fact, precise actions and listing requirements are decisive to develop investors’ assurance and scrutinize entire system. Moreover, staffs of Islamic organizations are not skilled enough to investigate or manage portfolios, and build up pioneering services in relation to Islamic financial morals – merely an inadequate proportion of Islamic organizations have the capability to instruct the workforce and arrange funds to develop products (Gerrard and Cunningham, 1997). Therefore, appropriate standards would also assist these institutions to join Islamic finance in global culture;
- According to the Iqbal (2007), the problem with consistency in aspects of religious morals implemented in Muslim nations is one of the alarming issues for deficiency of unanimously established fundamental Islamic financing system. However, Islamic banks are interested to create religious panels to guide in this issue; therefore, they should discuss with honorable religious boards, or Shari’ah consultants to take sanction for all upcoming instruments (Kuo, Aziz, and Akhtar, 2008).
- Islamic morals interpretation system by dissimilar academics indicate that the same economic tools have been abandoned by a single panel but not acknowledged by others – consequently, a single system would not be effective in all Muslim countries (Iqbal, 2007); such difficulty can address or remove by building standardized assembly to characterize unified regulations and accelerate the procedures of introducing new services (Hasan, 2009).
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