Islamic Finance:

The Structure-Objective
Mismatch and Its Consequences
Zubair Hasan*

Abstract

This paper raises the issue of an initial structure-objective mismatch

in the launching of Islamic finance. The abolition of interest and
promotion of growth with equity were goals of the conceived system.
These goals expressed a long term vision to improve the condition of
the Muslim community across the world. However, the organizational
form adopted for Islamic finance was that of the existing commercial
banks, which essentially provided short-term loans on interest
to industry and commerce. The choice thus involved an intrinsic
mismatch between the structure and objectives of Islamic finance.
The mismatch did carry some advantages, but–from a more important
angle–it exposed Islamic finance to commitments and influences
which could not align very well with the goals the pioneers had in
mind. Note that the focus here is not a reversal of the mismatch but
identifying its consequences, which have forced the nascent Islamic
system to converge and compete with the mature conventional finance
dominated by the West. The ground realities are not being adapted to
SharÊÑah norms; it is the norms that are being stretched to the limit to
meet the demands of the conventional system. Ordinary Muslims who
hoped to benefit from Islamic financing remain unattended. Thus,
what Islamic finance can or cannot change will depend on where its
ongoing integration with the conventional system leads it. Currently,

The views expressed in the paper are not necessarily the views of INCEIF
(International Center for Islamic Finance); the author presents them here in his
personal capacity. He gratefully acknowledges the help of his students, Mughees
Shaukat and Nurhafiza Abdul Kader Malim.
* Zubair Hasan is a Professor of Islamic Economics & Finance at INCEIF. He can be
contacted at [email protected].

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

most merits claimed for the Islamic system defy evidence. The basic
reforms financial systems require in the face of current crisis are the
control of credit, leverage lure and speculation. Islamic finance is, in
principle, better equipped to achieve these ends.

Keywords: Islamic finance, convergence; SharÊÑah compliance,

credit creation; leverage; derivatives; financial crisis

I. Introduction

This paper examines the position and potential of Islamic finance

from a so-far unexplored angle: the structure-objective mismatch
in its organization.1 Islamic finance is, of course, a wider term
than its banking constituent, but that being its most dominant and
consequential part, we shall restrict here the use of the term to refer
mostly to banking.
Conventional (commercial) banks were, and essentially remain,
the providers of short-term finance to industry and commerce. On
the other hand, some long-term communal–i.e. Ummatic–goals, like
promotion of growth, improvement in distributional equity and the
alleviation of poverty, were initially conceived to be the focal points
of Islamic finance for resource allocation. Islamic banks adopted the
conventional organizational forms for making their appearance on
the scene. These forms, in retrospect, have not been found suitable for
serving the objectives that early writers on Islamic finance implied
they would. But the choice they made was not without reason.
Muslims had long experienced commercial banks working around
them as dealers in money. What these writers found unacceptable in
their operations, from an Islamic viewpoint, was the use of interest
as the price for loans the banks advanced or the cost for deposits
they obtained. If interest were to be expelled from transactions of
commercial banks, they would obviously be the first institutions

1 This exercise was prompted by an interesting theme for discussion – what Islamic
finance does (not) change – at a workshop the Business Management School of
Strasbourg University in France organized on March 17, 2010. An earlier draft of the
paper was presented in one of its sessions.

36 ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010

 Zubair Hasan

to attract attention as conforming to Islamic norms.2 Participatory

finance of old days–muÌÉrabah and mushÉrakah–based on profit/
loss sharing could take, they thought, the place of interest as return
on funds committed to business or paid to depositors. ‘No risk, no
gain’ was forthwith proposed and projected as the sole, inviolable
and distinctive principle for Islamic finance. The proponents missed
the point that structures erected to meet short-term ends could rarely
be efficient for achieving long-term goals.
Islamic banking thus started with a structure-objective mismatch
on the road to progress. The removal of this mismatch is not the point
of this paper; its consequences are.3 Even today, a large number of
writings on Islamic finance continue sticking to the tradition and
argue, rather innocuously, that the scheme of participatory finance
is the answer to all the ills of modern finance. The writers do not
care to find out why that mode of financing is not picking up pace;
its share, despite the merits claimed, has not yet crossed the 10–20-
percent mark in the aggregate.4 Any discussion of the current position
or future prospects of Islamic finance can hardly ignore the issue of
structure-objective mismatch and what it has led to. Indeed, the failure
to realize this vital fact lies at the heart of many divergent views on
the convergence of the Islamic and mainstream financial systems.
On the one hand, we have those who argue that the convergence
is imminent, though it might remain asymptotic (Askari, Iqbal and
Mirakhor, 2009).5 This, of course, is no discovery: one could have
easily seen this coming as a logical consequence of the organizational
forms Islamic finance chose. On the other hand–and this is more
interesting–there are those who stress that the scope for convergent
evolution of the two systems is very limited due to the narrow range

2 These writers, in all fairness, did make it clear that the Islamic economic system
is much more than merely capitalism plus zakÉh minus interest. Nevertheless,
they lacked the economic acumen to visualize the ramifications of choosing the
nomenclature in conceiving banking without interest.
3 Islamic finance has crossed the point of no return on this road, but there is scope for
course modification and that is taking place in some measure.
4 For hurdles in the way of participatory finance (Hasan, Zubair, 2002).
5 It echoes the same sort of realization that “the search for an alternative to capitalism is
[now] fruitless.…Those who wish to reform the world should focus on the potential
for change within capitalism.” see Khurshid Ahmad (2007) IRTI Lecture.

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

of Islamic financial instruments, if not for any other reason (Honohan,

Patrick, July 2001).
It is, indeed, elating to note that over the decades–especially
during the past 10 years–Islamic finance has made great strides:
the industry has experienced dramatic growth and transformation.
Its reach, coverage, risk diversification, development of regulatory
frameworks, professional education programs, and international
funds movement have all improved and tend to keep pace in a fast
globalizing environment. Opportunities for Islamic finance are
increasing, as are the challenges (Bank Negara Malaysia, October
2008). The total volume of Islamic assets held by banks–Islamic
and conventional–is expected to cross the one trillion dollar mark
by 2010. This is a comforting prospect. But at the same time, one
cannot evade the strong presumption that conventional finance, too,
may be expanding at no less a pace, if not more. The result is that, by
a conservative estimate, the shares of the two sectors in market assets
worldwide remain almost stuck at around 1:100.6 Islamic finance is
still no more than a candle facing the sun. Are the two realistically
comparable systems? Convergence between them has so far recorded
little impact of Islamic finance on its mainstream counterpart.
What Islamic finance can or cannot do in the near future will
largely be determined by the facts stated above. On matters of product
design, rules and regulations, fixing of standards, benchmarking, risk
management and rating procedures, Islamic finance has already been
sucked in by the mainstream whirlpool: follow the leader has been
the underlying reality of the story. However, Islamic finance may
hopefully have some impact on the moral, ethical, regulatory and
social-responsibility aspects of the global financial architecture in the
course of time, for reasons we shall mention later.
This paper is spread over five sections, including the present
one. In the following section, we shall discuss in some detail the
reality with reference to the much-talked-about convergence between
the Islamic and conventional financial systems. Section 3 shall be
devoted to some problems internal to the Islamic system, especially

6 The volume of assets held by 1000 top conventional banks was estimated at $ 96.4
trillion for 2008/2009 (Source: Banks, Wikipedia, the free encyclopedia accessed on
12.05. 2010). Thus, the estimate $100 trillion for all banks is reasonable.

38 ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010

 Zubair Hasan

relating to the divergent interpretations of the Islamic injunctions

across countries. In Section 4, we shall elaborate on a few problems
that threaten the future of the world financial systems, irrespective of
their types: Islamic and mainstream. We shall evaluate in particular
the claims Islamic finance makes in that context. Section 5 contains a
few concluding observations.

II. Convergence: Nature and Consequence

Convergence has been an increasingly used term in the more recent

literature on Islamic finance. Interestingly, most of the writings that
speak of convergence are emanating from the West, more so from
the economists working with the international financial institutions,
the World Bank or the IMF.7 Even so, the nature and implications
of convergence remain largely unexplained. Convergence means the
movement of two objects from opposite directions such that the gap
between them becomes steadily narrower. This would be relatively
rapid if both objects approach each other with the same speed, albeit
convergence is still possible if one remains in place while only the
other moves. Differences in these two processes, bidirectional and
unidirectional–as depicted in Figure 1–means they may not have the
same implications or consequences.

7 The Arab Financial Forum (AFF) at Harvard University some time ago focused the
yearly discussion on the convergence issues. A paper of this author dealing with
sustainable development and Islam was also included in the proceedings because it
was seen as implying another area bearing promise to promote convergence of the
two systems.

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

I I C C I I
C

Bidirectional Unidirectional
Convergence
Figure 1: Convergence types between Islamic (I) and conventional (C) financial systems

As the two systems operated side by side, one may have presumed
their convergent evolution would be in a bidirectional fashion, each
influencing the other, for prudential risks were considered as high for
Islamic intermediaries as for conventional ones, since the difference
between the instruments the two used was not found as great as was
usually imagined (Patrick Honohan, 2001).8
Convergence has benefited Islamic finance and contributed to
its rapid growth in many ways. The literature helped to critically
evaluate the role and character of interest finance and find how the
institution is a hindrance to achieving growth, equity and stability in
modern economies. It helped avoid isolation of Islamic finance from
the global structures: dealings with the international organizations
like the World Bank, the IMF and the WTO remained intact. More
importantly, modifications for product designs were found ready at
hand to make sure they meet SharÊÑah requirements. This is seen as
a great facility. In fact, a jurist who sits on the SharÊÑah boards of a
couple of banks informed me in response to a question that scholars
on such boards invariably avoid initiating new products. Instead,

8 Indeed, some saw in this development “the first seeds of convergence” much later.
Doromir Rudnycky (2009) and Zubair Hasan (2010) arrived at similar results with
reference to five Islamic banks.

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 Zubair Hasan

they prefer to ask the bank managers the details of the conventional
product for which they need to have an Islamic counterpart. It is
much easier, he said, to put an Islamic face on it than to structure an
entirely new product. Imitation is, of course, easier than innovation
and, thus, abounds. This need not imply that Islamic finance has been
completely devoid of innovations; in fact, they have been many and
varied, some even novel (Honohan, 2001).9 However, the advantages
of convergence have not been an unmixed blessing.
The fast expansion in the volume of Islamic finance in recent
years has led many to see a clear functional parallelism between most
of the modern Islamic and conventional financing instruments. Some
have gone so far as to postulate–rather exaggeratedly–that Islamic
finance in most areas of economic activity is at par with mainstream
capabilities. In any case, the expansion has led to a convergence that
is essentially unidirectional. The conventional system, because of its
size, age and maturity, has had a tremendous gravitational pull that
the nascent Islamic system could hardly resist. Islamic products are,
and will increasingly be, structured for the global marketplace, thus
hastening convergence to a universally accepted mainstream norm.
Policy makers for Islamic finance are relentlessly pushing the system
to that destination. The Governor of the State Bank of Pakistan was
candid on the point when she observed:

Practically, the Islamic industry currently is bank-

based. Product diversification, albeit slow, is emerging,
but returns are engineered to ensure conformity and
convergence with conventional industry (Akhtar,
Shamshad, April 2008).10 [Emphasis added]

The convergence of Islamic finance towards the mainstream

positions has resulted in making Islamic instruments to be seen as

9 See Honohan (2001). for some interesting examples from Iran, the Sudan, Malaysia
and Pakistan.
10 Indeed, convergence has already been replaced with integration. Note that the
Seventh Harvard University Forum on Islamic Finance (April 2006).was titled
“Integrating Islamic Finance in the Mainstream: Regulation, Standardization, and
Transparency”.

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

a subset of those available in conventional finance. The pressure for

making products simpler, more diversified, appealing to customers,
and conforming to mainstream standards is being insisted upon for
being more competitive. Is it not strange that countries have so often
advanced the infant industry argument to protect their manufactures,
insurance and shipping for example–but the initiators of Islamic
finance ventured to challenge the giant from day one? Palpably, the
sort of convergence that is being forged must serve the interests of
developed countries more than those of others in two ways.

1. Conventional banks that dominate and control the global financial

system can do in the Islamic finance arena what they cannot do in
the conventional system. To illustrate: in the mainstream system
the rate of interest must observe the central banks’ ceiling. There
are as yet no such restrictions on mark-ups used in Islamic
transactions. In participatory finance, using the interest rate to
benchmark the return to depositors enhances leverage benefits
for bank owners. Islamic finance is potentially more profitable
for them (Weill, Laurent, 2009).11
2. Currently, there is much liquidity in Muslim countries, especially
in the Middle East, because of high and oftentimes rising oil prices.
Most of this money came from the developed countries. Islamic
finance promises to enhance the possibility of a larger flow of
this money back to where it came from. Western countries eye
effective control over the use of this wealth .12 This observation
can be an important topic for research.

The compulsions for unidirectional convergence have put experts

and scholars alike under pressure to make SharÊÑah norms somehow
adaptable to the demands of modern finance and its increasingly willful

11 Laurent Weill (2009) observes that returns on saving deposits are found to be similar
for Islamic and conventional banks in Turkey (Refers to Kuran), and an Islamic
bank explicitly mentions that its loan rates are similar to those of conventional banks
(Refers to El-Gamal), p. 9.
12 Islamic Finance Report (2009), concludes: “Islamic finance has moved beyond
uncertain experiment during its embryonic life. Teething problems remain, but with
the right tools, collaboration between regions and greater transparency, convergence
towards Western conventional markets and a greater share of investors’ portfolios is
well within reach. The Project Finance International (PFI) Tuesday, 9 February 2010.

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 Zubair Hasan

mechanisms. Islamic finance now operates more as supplement to the

conventional system rather than as a parallel competitor.13 This has
made public opinion in the Muslim world turn to another presumably
more potent issue: the convergence between the instruments being
used in Islamic finance and their compliance with the SharÊÑah norms.
In Malaysia, both the Governor of Bank Negara, and the chairperson
of the Securities Commission have voiced this concern. Governor
Zeti Akhtar Aziz, drawing attention to the ongoing development of
mechanisms for risk mitigation and liquidity management, made a
significant observation: “Of importance are the solutions needed to
converge the market requirements and the SharÊÑah compliance (Bank
Negara Malaysia, 2008).”14 Zarina Anwar, the SC Chief, is candid
that Islamic finance products must be strictly SharÊÑah compliant, but
believes that convergence to law could have spatial differences to
internationalize Islamic finance. But her more significant observation
is “There is always the need to explore how Islamic finance can help
the Muslim community (the Ummah)”15 –a point we referred to in the
Introduction above. This brings us to our next section, on the issue of
SharÊÑah compliance of Islamic financial instruments.

III. Divergent Views on Compliance

In recent years Islamic finance has seen the surfacing of some

serious differences on what instruments and practices have or have
not been SharÊÑah compliant. Most of the controversy is centered
on the activities of banks, which hold the bulk of the Islamic assets,

13 “I don’t think that this Islamic banking system is the alternative, that we have one
or the other. I think this is a complementary service, a way of doing service.” Prof.
Ekmeledin Ihsanoglu, Secretary General of OIC quoted in Robin Brant: Is Islamic
Finance the answer? http://news.bbc.co.uk/2/hi/8025410.stm
14 See Zeti Akhtar Aziz (2008) The observation is a bit cryptic on the nature of
convergence she implied.
15

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

followed by ÎukËk issues, investment funds and takÉful.16 The modes

of business these banks use mostly involve murÉbaÍah transactions
and the issuance of ÎukËk. Both have run into difficulties on SharÊÑah
compliance in recent years.
Commodity murÉbaÍah has so far been the most widely used
financing instrument in Islamic banking. But some court decisions
in Malaysia, having lately gone against Islamic banks on murÉbaÍah
contracts, have put people in a quandary; it is being increasingly asked
if commodity murÉbaÍah defies Islamic requirements? Evidently, in
principle it does not. Commodity murÉbaÍah falls in the same generic
category of ÑuqËd al-muÑÉwaÌÉt (exchange contracts) that covers all
types of transactions that Islam allows. In exchange contracts, a given
quantity of one commodity is traded for a given quantity of another
commodity, including money. The money value of a commodity is
called its price. The delivery of a commodity and the payment of
price may be simultaneous, i.e. on the spot, or the obligation of one
of the parties may be deferred to a future date. Contracts involving
commodity murÉbaÍah belong to the deference of obligations group.
A client may, for example, request a bank to purchase a car for him on
a cost-plus basis. The arrangement per se does not contain any element
of interest. Mark-up pricing is allowed on the basis of a legal maxim
that “time has a share in price” (lil-zamani Ìann fil-thaman). Indeed,
it is this juristic pronouncement that constitutes the justification for
allowing the deferring of obligations in Islamic contracts. It was not
the principle but the structuring of contracts17 that went wrong in the

16 Of the total global assets of Islamic finance estimated at US $951 billion for the
year 2008, commercial banks accounted for about $704 billion or 74%. For
investment funds, ÎukËk, other funds and takÉful, the percentages were 10, 10, 5 and
1 respectively. Source: Islamic finance 2010, IFSL Research, January 2010.
17 On the structuring of contracts, also, opinions differ considerably. A significant
example is the commonly upheld prohibition of multiple contracts in a single sale
transaction. But Yaqubi argues that the prohibition refers to specific instances where
the combination of contracts is used as a legal device to permit or facilitate ribÉ,
or where the combination leads to any other textual prohibition (e.g., gharar). He
supports the view that the strict rules of combining contracts can be relaxed in certain
cases to facilitate Islamic finance contracts: ijÉrah, murÉbaÍah and mushÉrakah are,
to him, the clear examples. Harvard University Forum on Islamic Finance, (April
2006). Eyebrows may be raised on this interpretation of the ÍadÊth.

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 Zubair Hasan

cases mentioned. The reasons for the current disquiet are to be sought
elsewhere.
Commodity murÉbaÍah contracts may not defy the SharÊÑah
norms if viewed on a case-by-case basis, i.e. in a micro frame of
analysis, but their overwhelming use at the aggregative or macro
level is working against the SharÊÑah spirit.18 Debt transactions
dominate the scene at the cost of the real economy. The use of deferred
contracts seems to have already been carried too far. Even Zeti, the
Governor of Bank Negara Malaysia, had to advise Islamic banks to
curb the use of fixed return transactions. Presumably, it is time to
invoke the principle of sadd al-dharÉ’iÑ19 that closes the potential
avenues for circumventing the SharÊÑah, particularly its objectives
and spirit. It is not the permissibility of murÉbaÍah contracts per se
but their defective structuring and indiscreet use which is fueling the
perception that Islamic bankers are providing cover for the taking
of interest through the back door (Hasan, Zubair, 2009). Debt sales,
ÑÊnah and tawarruq have palpably divided juristic opinion within and
across countries; Malaysia and the Middle East stand poles apart on
the issue of their permissibility. Here, two observations may not be
out of place.
• The Islamic economic system has some faith-based social
implications related to economic development, especially
regarding the fulfillment of basic needs and achievement of
distributional equity. Islamic banking operations do not contribute
to these goals; they are essentially guided by profit considerations.
Admittedly, profit is important–rather, imperative–for Islamic
banks as for any other business, but it cannot be the sole criterion
in evaluating their performance. Econometric models on the
performance of Islamic banks invariably consider profit, cost,
or size as determinants of efficiency. Their structuring blemishes
apart, no social welfare measure appears in such models,

18 SharÊÑah scholars tend to miss the point what may look perfectly permissible at the
micro level may become violative of the spirit of the law at the macro level. On this,
see El Gamal (2009).
19 Editor’s note: Sadd al-dharÉ’iÑ is a principle in Islamic Law by which something is
prohibited that is in-and-of-itself legal but will most likely lead to an illegal outcome.
The intention of the actor is irrelevant to the judgment in such cases.

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

presumably because quantification is not possible on a uniform

basis.
• Islamic banks too are diverting–like their conventional cousins–the
savings of those at the lower rungs of society to the upper classes,
aggravating income inequalities.20 In addition, the distribution of
earnings between the owners of banks on the one hand and their
depositors on the other is skewed in favor of the former.21 The
combined GDP of 57 Muslim countries is estimated at more than
one trillion dollars, but individuals in the street are still asking
how SharÊÑah-compliant Islamic finance benefits them.

Islamic ÎukËk22 are mostly based on commodity murÉbaÍah and are

the class of Islamic instruments that has recently been getting all
the attention. Broadly speaking, ÎukËk are asset-backed, SharÊÑah-
compliant trust certificates. They are generally used in conjunction
with two types of contracts: (i) an ijÉrah structure, in which the lease
rental provides an income (profit) to the holder or (ii) a mushÉrakah
structure in which profit share becomes the income (Bijur, Darshan,
2007). The juridical validity of ÎukËk became suspect since Sheikh
Taqi Usmani cast doubts on their SharÊÑah compatibility in 2008
(Singh, Harbhajan, 2008).23 His reasons for declaring 85% of ÎukËk
as noncompliant with the law were, in brief, as follows:
• There have been cases where the assets in the ÎukËk were the
shares of companies that do not confer true ownership but which
merely offer ÎukËk-holders a right to returns.
• Most ÎukËk issued today are identical to conventional bonds

20 Wide income inequalities are not the bane of developing economies alone; affluent
societies are also not free from that malady. Even in the U.S, as of 2007, 20 percent
of households got 85 percent of private wealth, while the remaining 80 percent
households had to be content with the remaining 15 percent. See G. William
Domhoff, as quoted in Muhammad Taqi Usmani (2009).
21 Zubair Hasan (2010): arrives at similar results in his Islamic banks: Profit sharing,
equity, leverage lure and credit control, (Forthcoming) JKAU Journal Islamic
Economics, Vol. 23, No. 1.
22 Editor’s note: ØukËk are, in theory, SharÊÑah-compliant alternatives to conventional
bonds.

23

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 Zubair Hasan

with regard to the distribution of profits from their enterprises

at a fixed percentage benchmarked on interest rates. The legal
prescription regarding ÎukËk is that neither a fixed rate of profit
nor the refund of capital can be guaranteed. And this brings us to
the third point.
• Virtually all ÎukËk issued today guarantee the return of the
principal to holders at maturity, just as in conventional bonds,
through a binding promise from either the issuer or the manager
to repurchase the assets at the stated price, regardless of their true
or market value at maturity.

However, in one of his recent writings referred to earlier, Taqi Usmani

does not touch on the issue. Rather, he appears to approvingly quote
an AP Business writer who says, “ØukËk are the equivalent of bonds,
but instead of selling a debt, the issuer sells a portion of an asset
which the buyer is allowed to rent.” (Usmani, 2009, pp. 34-35)
Thus, ÎukËk help avoid the nominal and real transaction mismatch.
As though anticipating such positions, Islamic economists have been
arguing from the very beginning that the sharing of profit (loss) is
the basic distinguishing feature of interest-free finance. Indeed,
participatory finance is claimed to be the panacea for numerous ills
of the conventional financial system.24 Of late, the claim has been
shouted louder. It is being vociferously stated that one of the most
serious gaps in Islamic finance is the reluctance of market players
to promote risk-sharing equity-styled financing and investment
(Askari, Hossein, Iqbal, Zamir, and Mirakhor, Abbas, 2009).25 Thus,
the promotion of institutional support for risk-sharing partnerships is
considered vital to realizing the full potential of an Islamic financial
system. On this point, economists, jurists and central bankers seem to
be in accord. However, claims do not win conviction; evidence does.

24 This argument implies the need to research the evolution of the capital structures of
modern corporations as we find them today and nullify the arguments against having
equity shares as the sole source of funding’.
25 In fact, the history of Islamic finance is replete with claims that participatory finance
is the most distinctive feature of the system, and its poor share in total finance is
always lamented.

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

Despite all efforts, participatory funds currently do not constitute

more than 10-15 percent of Islamic financing worldwide.26
What blocks the way is, again, the structuring of Islamic banking
on the conventional pattern. Mainstream banks could bring long-term
investment financing under their umbrella by introducing universal
banking, even though they still remain short-term credit providers.
Islamic banks because of their infancy, small size, and lack of
adequate funds, in addition to a dearth of managerial skills, may find
it difficult to go universal. Western banks running Islamic windows
or subsidiaries are a different category in this context.
Finally, the mismatch is a complicating factor in interpreting the
law. This has been, to a certain degree, a factor causing the regulatory
regimes for IFIs to vary across countries. The variations may possibly
widen as Islamic financial centers gain strength in places like London,
Singapore, Hong Kong, and now France, in a conventional banking
environment. Some differences may be accommodated, but narrowing
them down is always advisable. International organizations have
been established to set standards that are expected to strengthen and
eventually harmonize prudential regulations as they apply to IFIs (El-
Hawary, Dahlia, Grais, Wafik and Iqbal, Zamir, 2007).27 It is hoped that,
rather than being led by convenience-inspired imperatives, evolving
regulatory frameworks will propel convergence of the practice of
Islamic financial intermediation with its conceptual foundations.
One possible reason for divergent interpretations of Islamic
law could be the dearth of qualified jurists, which has given rise to
oligarchic competition. A recent study, Shariah Scholars in the GCC:
A Network Analysis Perspective, provides valuable insights into the
engagements of the jurists in financial institutions within and across
the GCC.

26 The share of participatory finance has variations over time and across nations. For
the year 2009, its range over countries has been 10-15, with Malaysia coming top.
See Bank Negara annual reports of recent years.
27 See Table 2, even though it is based on 2000-2001 data; the situation may have since
changed substantially.

48 ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010

 Zubair Hasan

Table 1: Oligarchic concentration of advisory positions in

Islamic financial institutions

No. of advisory Total number Occupancy per Occupancy per

board positions of scholars scholar (minimum) scholar (mean)
467 94 2 5.0
400 38 4 10.5
339 20 6 16.9
253 10 15 25.3
Source: Constructed using data provided in the report “Top Shari’ah Scholars in GCC”: Funds @Works
18.09.0928

It finds that 94 scholars from 19 countries sit on 467 advisory board

positions with 5 positions per head. This looks reasonable. However,
the distribution of positions among scholars is far from uniform, as
Table 1 so clearly brings out. Some doubt that most SharÊÑah scholars
tend to work in unison for promoting mutual interests, which looks
intriguing, if true.

IV. Islamic Finance and the Current Crisis

Islamic finance has won much praise from bankers, experts, scholars
and jurists for remaining resilient and stable during the current global
crisis. In my view, this is largely overblown: the claim ignores the
relative position of the two systems. Arguably, Islamic finance is
risk averse, short-term and liquidity-oriented, like its mainstream
counterpart. The mismatch would have, in all probability, affected
Islamic finance as well; the more so because generalization of tawaruq
and widespread debt sale have brought Islamic finance even closer to
the mainstream environment. If it remained unscathed, the reason is
that Islamic finance has not yet developed enough to attract crises. In
a storm, it is the oaks that are uprooted, not the reeds. Even so, some
Islamic banks did go down because of the turmoil. For example,
Investment Dar in Kuwait, Amlak and Tanweer in Dubai, Islamic

28 Three scholars–Sheikh Nizam Mohammed Saleh Yaqubi from Bahrain,

Dr. Abdul Sattar Abdul Karim Abu Ghuddah, and Dr. Mohammed Eid Elgari
both from Saudi Arabia–alone hold 50% of the positions of the top 10, and 26%
of all positions in the GCC institutions.

ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010 49

 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

Bank in Qatar, Gulf Finance House in Bahrain, and Emirate Islamic

Bank all came to grief in 2009, one way or another (Siddiqui, Rashid,
2010).29 The crisis originated in the conventional finance system for
a variety of reasons; the main ones were the race for credit in the
banking system, corporate leverage lure, expansion of secondary
markets, heightened speculation and reckless fiscal policies of the
U.S. Administration, all being the results of wrong market incentives
(Stieglitz, Joseph, 2009).30 Fortunately, the Islamic financial system
has not yet developed the connectivity with these mainstream
maladies to get thoroughly molded. A detailed analysis of the causes
of the current global meltdown falls outside the scope of this paper,
but Islamic scholars can no longer ignore its ramifications (Ahmad,
Habib, 2009). The mismatch makes it all the more compelling. Refer,
for example, to Taqi Usmani (2009) on the point. Relevant here are
two characteristics of the conventional financing systems that often
bring them to their knees, as happened recently: credit creation and
speculation, especially in the bubbly derivative markets.
Commercial banks are able to create an inverted credit pyramid–
see Figure 2 below–because they do not give the amount of credit
(loan) granted to a client across the counter. He must deposit it in his
account with the bank. Thus, loans create deposits. The average cash
withdrawn daily by the clients from their accounts is normally a small
fraction of the total deposits–cash and credit. This allows banks to
generate a spiral of credit through an operator: the multiplier. It is
easy to understand the working. Suppose that of the legal tender or
base money in an economy, people deposit $M in banks; and from
their accounts, people withdraw, on an average, F fraction to meet
their daily needs, while the central bank of the country wants
commercial banks to maintain R fraction of all deposits as reserves
with it. We then have the credit multiplier M, as below:

M = 1/F [1- R]

29 Taqi Usmani also supports this view.

30 He blames the current (2008) meltdown on three such perversions: under-
regulation of markets; liquidity that the Federal Reserve poured into the post
dot-com economy, which found its way to homebuyers (who lacked credit-
worthiness) and agent fees; and the massive bailouts that maintained bankers’
bonuses.

50 ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010

 Zubair Hasan

To illustrate, imagine that, from the base money in an economy,

people kept $50 million in banks. Suppose further that they withdraw,
on average, F = 0.1 fraction daily from their accounts and that the
central bank of the country requires commercial banks to maintain
with it a minimum reserve ratio R = 0.05, the credit multiplier M will
then be 9.5. The $50 million cash deposit with the bank will enable it
to have deposits worth $475 million. From that amount, if we take out
cash deposits, the remaining $425 million will be the loan deposits
the bank has generated. The interest received on this amount minus
the part of it payable for cash deposits and other operating expenses
will all belong to the bank. Banking is thus an exceedingly lucrative
business. Bank owners reap handsome leverage benefits. So do the
businesses that take loans from banks, as the rates of interest are
usually much lower than the returns that result from the borrowing.
They are tempted to finance even long-term projects from short-term
loans because during good times easy renewals can convert them
into long-term funding. Leverage gains tend to make businesses
over-adventurous. But continued pumping in of “air” ultimately
causes the credit balloon to burst; economies roll down the hill, and
unemployment tends to spread.
Banks, businesses and society all suffer in a crisis. Governments
tend to become hostage to big business. Large banks cannot be
allowed to fail; rescue packages and bailouts involving trillion dollars
have become the order of the day. For instance, Barry Ritholtz, in
his forthcoming book, Bailout Nation, puts the estimate of United
States rescuing costs until now at $4.6165 trillion. He calls the figure
conservative, even though the current credit crisis bailout, he notes,
is the largest outlay in American history.31 This lays bare what seems
to be the latest axiom of capitalism: Profits are private, losses public.
Islamic banks are not yet part of the story because they do not indulge
in multiple credit expansion as their conventional counterparts do.

31 On credit creation mechanisms and consequences, (Zubair Hasan, 2008).

ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010 51

 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

Total deposit $475 m. = Cash $ 50 m. + credit $ 425 m.

Cash deposit $ 50 m.
Figure 2: Inverted credit pyramid with F = 1 / 10 and R = 1 / 20 (Multiplier M = 9.5)

The expansion of credit and its consequences explained above bring

us to our second point. Mounting loans in the lead-up to the current
crisis fueled the expansion of the derivative markets and got, in turn, a
boost from that expansion.32 The risks of the rise in loans were covered
by complex derivatives, but those exotic instruments only generated
an unending cover-risk-cover chain fueled by traders’ greed for
enhanced commissions and short-term capital gains (Stieglitz 2009).
Derivatives draw their value mostly from the worth of an
underlying asset: a security, commodity, or other financial instrument.
Futures, forwards, options, and swaps are the most common types
of derivatives.33 Markets for derivatives have their advantages,
especially in the mitigation of risks, but of late they have become
unregulated dens of high-risk credit bets; they can cook up any kind
of leverage device including caps, collars and floors “to bet the hell
out of virtually anything.” (Jutia Group, 2008) Some 25 years ago,
the derivatives market was small and domestic. Since then it has
grown impressively; for example, at around 24 percent per year in
the last decade. A sizeable and truly global market has come into
existence (Deutsche Borse Group White Paper, April 2008).Today, it
has assumed a size of $1.14 quadrillion (1 quadrillion = 1000 trillion).

32 “I believe that banking institutions are more dangerous to our liberties than
standing armies. Already they have raised up a moneyed aristocracy that has set
the government at defense. The issuing power [of money] should be taken away
from the banks and restored to the people to whom it properly belongs.” –Thomas
Jefferson. http://129.3.20.41/eps/mac/papers/0203/0203005. pdf
33 For definition and use of these contracts, see, for example: Downside World News
http://www.globalresearch.ca/index.php?context=va&aid=10265

52 ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010

 Zubair Hasan

This is more than–almost 20 times over–the entire GDP of the world

in the year 2000. Table 2 compares the volume of the U.S derivatives
with major macro variables: world stocks and bonds, World GDP and
U.S money supply for the same year.

Table 2: U.S. Derivatives and Money supply and

World stocks and Bonds (March 2009)
Particulars U.S. Dollars (Trillion)
Derivatives U.S. commercial banks 1140
World Stocks and bonds 120
World GDP 60
U.S. Money supply (M3) 16
Source: compiled from IMF and World Bank data; Wikipedia, the free encyclopedia (27/1/ 2010).

Figure 3 presents the facts of the table to make the comparison

sharper.

Figure 3: The growing monster of derivatives (U.S. 2009)

Derivatives
$1140Tr.
Stocks and $120Tr.
bonds

World GDP $60Tr.

Money $16Tr.
supply

Source: compiled from IMF and World Bank data Wikipedia, the free encyclopedia (27/1/2010)

Figure 4 shows another and more revealing comparison of a similar

type. Here we see the expansion of U.S. derivatives over the years
vis-a-vis the growth of U.S. wealth and the wealth of the entire world.
The derivatives’ expansion has been exponential, interestingly, more
so after 9/11 in 2001. It may be a moot point to what extent this
growth in derivatives has been responsible for setting in motion the
global meltdown–the first of such intensity and duration since the
Great Depression of the 1930s–but expert opinion is certainly awed
by the heat of speculation that gave rise to it.

ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010 53

 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

Figure 4: Growth of U.S derivatives relative to real wealth of the world

Source: Jutia Group http://www.istockanalyst.com/article/viewarticle//articleid/2432853/ (Edited)

Initially, some jurists–Hashim Kamali in particular (2002)–claimed

that there is scope in SharÊÑah law for the creation of derivatives in the
area of Islamic finance; and a few were, in fact, launched. However, it
is currently being argued that derivatives are un-Islamic for a variety
of reasons, especially because they are no more than bets on bets
on debts on debts. One opinion is that “regulations and prosecutions
are needed to punish and deter present and future self-paid corporate
crooks looting and draining other people’s pensions and savings”.34

V. Concluding Remarks

We have discussed above the issue of what Islamic finanace can or

cannot do from a hitherto unexplored angle: the adoption of the short-
term financing structure of conventional banks to meet the essentially
long-term objectives of Islamic economics. True, the mismatch has
in some measure facilitated the expansion and growth of Islamic
finance, but on a more important side it has forced Islamic finance
into convergence and competition with the grown-up conventional
system. Competition between such grossly unequal parties is like the

34 Internet: Downside World News (March 12, 2009): Global written by eldib.

54 ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010

 Zubair Hasan

competition in a pond where the big fish swallows up the smaller ones.
That process is ongoing: the unidirectional convergence of Islamic
finance seems to be leading it to eventual submergence within the
conventional system.
It is neither expedient nor possible to indulge now in substantive
structural changes in Islamic finance, but it is still not too late to
initiate some sideward diversions. Even remaining within the existing
framework, there is much that can be done to make Islamic finance
meet the ends it was initially meant to serve. Indeed, some policy
measures have already been initiated in that direction. However, the
decisive question still remains: who is Islamic finance supposed to
serve?35 Our stand is that Islamic finance was conceived to serve the
Ummatic interests and that objective need not be sacrificed at the altar
of globalization. Others can, of course, benefit from the system, if
they so desire, following the Islamic norms. It is with this perception
that we venture below some observations for the consideration of
scholars and policy makers.
• One reform the Islamic system calls for is the separation of short-
term from long-run financing. Experience shows that the two are
difficult to handle efficiently under the same organization. Non-
Western Islamic banks attempted, for instance, to diversify their
activities by introducing various types of funds in their ambit,
but the overall progress in the area has not been encouraging.
The money flowing into the Islamic funds from the Muslim
countries has been disappointing. It is reported that there is a very
small number of Islamic funds–just 500 plus–that held assets
under their management in 2008 valued at a meagre US $25 bn.
(approximately), even as the private wealth in the GCC alone was
estimated at US $1800 bn.36 Participatory (PLS) finance too, as
indicated above, is not making much headway. Universal banking
is not the answer for reasons explained earlier. What is needed
is the expansion of well managed and cost-effective specialized

35 One argument advanced for a speedy convergence of Islamic finance to

mainstream requirements is that the system is not for Muslims alone; others can
and are taking advantage of it; the rules of the game must be evenhanded.
36 Project Finance International, op. cit.

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

institutions like unit trusts, investment houses, and multipurpose

cooperative societies.
• Industrial/commercial units in Muslim countries are smaller in
size than in the West. Promotion of microfinancing institutions
can do wonders in alleviating the grinding poverty in many
economies. What rural banks (Grameen) have done in Bangladesh
is an eye opener, not only for what they have achieved, but for the
trick they used. Note that it was the much maligned interest-based
financing, not the exalted banking without interest, that won the
day.37 Presumably, it was the message implied in conferring the
Nobel Prize on Prof. Yunus–interestingly, not for economics but
for peace!
• Another matter that is dragging on in Islamic finance is the
introduction of regulatory rules, procedures and authority
allocation. Much laudable work has been done in this area,
but regulation will always remain an issue in finance for both
economic and ideological reasons (Stieglitz 2009). The question
is: how much regulation do the financial systems require?
There is a clash regarding the proper balance between market
freedom and policy intervention and how to maintain it under
volatile economic conditions and social aspirations today. The
answer, in fact, depends on who commits the mistake of crossing
the perceived limits. In the current crisis, it is vividly market
misconduct that brought devastation. Naturally, the regulators
have their tails up (Greenspan, Alan, 2010). In Islamic finance, the
regulators have the opportunity to streamline inter alia the legal
advisement system. The task may, for example, be centralized, as
in Malaysia. However, finance is not without economics. In order
to keep the bigger picture in view so as to make the implications
of proposed regulations clearer, well qualified economists must
be associated with advisement as full members at all levels.
• One needs sound governance in Islamic finance. That should
include a certain degree of resistance to the conventional forms,
which may be too sophisticated and could result in avoidable

37 Public sector banks in India, too, are handsomely contributing to the

transformation of the rural economy. State Bank has adopted 3000 poor girls in
and around Chandigarh for their education. Mail Daily, March 2010, p. 11.

56 ISRA International Journal of Islamic Finance • Vol. 2 • Issue 1 • 2010

 Zubair Hasan

complications and costs for a still tiny segment of the global

system. It is not necessary to imitate each and every element or
aspect of the conventional system just for the elation of being at
par with it.
• It is futile to think of Islamic finance as being in competition with
the mainstream institutions for market share. What is a favorable
terrain for competition is transparency in contracts, promotion of
information equality, avoiding detachment of finance from the
real economy, and eschewing the temptation of murky dealings.
There is a need to tighten and streamline documentation of
contracts. The legal system, including education and training,
probably needs reform. It is on the moral high ground that Islamic
finance can lead the conventional system, (but) through example;
the current meltdown has shaken the conventional system to its
foundations, and its proponents are realizing the virtues of being
virtuous; they are searching for appropriate ethical norms to
pursue.
• With the rapid growth of Islamic finance, the expectation gap has
increased between Islamic finance practitioners and civil society
members about the role of financial institutions (IFIs) in the
economy. There is a growing feeling that speed is no advantage
if things go off course. The recently released AAOIFI standards
cover 13 aspects of social responsibility, such as client engagement,
employee welfare, charity, the environment, investment quotas
and others. On these criteria, the overall response of the IFIs on
social responsibility has been found quite encouraging, even
though performance varies widely between institutions.38 More
has to be done until the man on the street feels that something
is indeed being done for him. Of the 57 Muslim countries, 25
constitute half of the least developed economies in the world.
• Capitalism runs on the wheels of crises, as Schumpeter’s theory
of creative destructon implies. Islamic finance cannot remain
immune if the trend of its increasing submergence in the global
currents continues unabated. The reason why it remained mostly
unaffected during the current global meltdown was essentially

38 Survey Report (2009) on Social Responsibility Trends at Islamic Financial

Institutions.

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 Islamic Finance: The Structure-Objective Mismatch and Its Consequences

its relative size and the fact that it has not yet developed the
transmission lines to invite the wider maladies of the global
architecture.
• Finally, Islamic finance is no more than a highway under
construction in a vast road map of economies intended to develop
with Islamic orientation.39 Related issues must simultaneously be
attended to if Islamic finance is to deliver. Politics alone is the
key that can unlock the doors to prosperity along the right path.
And remember, no public policy, however well designed, is worth
more than its practical implementation. Governments in various
countries–irrespective of their shades–have to demonstrate that
Islamic norms can be well converted into ground realities to
become a way of life.

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