Islamic finance Essay Example | Topics and Well Written Essays - 2000 words

Islamic finance - Essay Example It may be defined as a finance system that conforms to Islamic law, also known as Sharia, although the definition does not imply that is it limited to Muslims or Islamic countries (Rammal & Zurbruegg 86) Islamic finance is guided by ethical concepts prescribed by Sharia in relation to money and capital and the association between profit and risk as well as the social obligations of financial institutions. It has grown into a global and cosmopolitan financial system, committed to a text that may be accessed by all people. Being open to innovation, the system has been able to effectively compete with the conventional financial system by offering a wide range of financial products suiting numerous customer needs. Serving as an alternative to the conventional financial system, Islamic finance has been forging a more functional link between activities of real economy that generate value and the financial activities which facilitate it. This paper will discuss ways in which Islamic finance can be considered as an alternative to conventional finance and why it is a viable alternative. Governance and Regulation Although it is governed by the same fundamental monetary policies as conventional banking, the key and most significant distinguishing factor is the requirement of a strict adherence to a code of ethics (Zepeda 52). At the microeconomic level, Islamic finance is regulated by Sharia supervisory boards, or Sharia scholars at the least, who are responsible for approving and reviewing financial products and practices for compliance with Sharia guidelines. At microeconomic levels, the key regulatory authorities and institutions are located in Malaysia and Bahrain as the largest segments of the Islamic finance’s market are predominantly found in those jurisdictions. Among the leading organizations that set standards of the system are the Accounting and Auditing Organisation for Islamic Finance (AAOIFI), Malaysia Accounting Standards Board (MASB) and Islamic Fin ancial Standards Board (IFSB). AAOIFI is based in Bahrain while MASB and IFSB are in Malaysia (Zepeda 53). Islamic Finance as an Alternative to Conventional Finance The conventional finance system has been described as being innately unstable mainly due to being based on interest and debt as well as using the credit multiplier to leverage itself while creating debt excessively. It is characteristic of government rules and regulations, insurance schemes and treatment of tax to promote contracts that are based on debt in conventional finance rather than those involving sharing of the risks (Zepeda 48). As such, a finance system founded on debt encourages the transfer of risk while the gains of sharing risks are underused. Islamic finance offers an alternative to conventional finance to those seeking to integrate values and ethics into financial services as a positive development that also promotes social justice. The alternative can best be viewed from the two perspectives through whi ch the system has evolved. First, the system has eliminated interest-based finance, also known as riba, as per the guidelines of Sharia. It is also from this principle that the nature of capital is held exclusively as a medium of exchange since it has no attached intrinsic value. Second, it has developed a comprehensive range of low-risk financial products that aim at giving depositors, shareholders and regulators the same level of confidence. Although most of the products are debt-based and resemble the instruments used in conventional finance, they bear a distinguishing feature in the way they promote entrepreneurship; do not support speculative behavior; preserve property rights; advocate for sharing both returns and risks; and keep contractual obligations transparent (Mahlknecht 71). In this manner, the system has not