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Can Islamic Finance spur Inclusive Growth & Sustainable Development?

Abayomi Alawode's picture


Islamic finance can connect millions around the globe to the economy (Credit: The Reboot, Flickr)

In the wake of the global financial and economic crisis, the need for a new development model which is more sustainable and also fosters inclusive growth has become more apparent. Could Islamic finance be the answer? Islamic finance promotes risk-sharing, connection to the real economy and emphasizes financial inclusion and social welfare.  Can these dimensions contribute to inclusive growth and sustainable development?

Islamic finance is based on two intrinsic features: risk-sharing and the link between financial transactions and the real economy. Because all financial contracts are backed by real sector assets and risk-sharing among partners, including financing institutions, Islamic financial instruments have relatively more stability than conventional instruments and tend to be more flexible against unanticipated shocks. This critical link brings prudence to the system, promotes equity relative to debt, broadens financial participation, and minimizes overall vulnerability.



Another dimension of Islamic finance is the promotion of economic welfare and social justice guided by the objectives of Shariah. Overall, Islamic financial instruments emphasize morality and ethics in business, respect for property rights and contractual obligations, and pursuit of good governance, specifically though prohibition of riba (interest) and of gharar (ambiguous contracts), and other social redistributive and philanthropic tools such as zakat (obligatory alms), waqf (endowment) and sadaqah (charity).

Whether Islamic finance is a catalyst for inclusive growth and sustainable development is not as straightforward as one may hope. While the inherent features of Islamic finance confer several advantages, the full potential of a complete Islamic economy has yet to be realized. The size of the Shariah-compliant  assets is tiny relative to overall financial assets.

In addition to the main challenge of achieving balanced growth in practice, there are several other areas of Islamic finance which need significant improvements, including regulatory oversight, tax treatment, insolvency frameworks, standardization, risk-management practices, and the level of awareness.  Realizing the potential of Islamic finance will also require capacity building for regulators, policy makers and market professionals.

Despite these limitations, Islamic finance has tremendous potential to serve as a tool for financial inclusion through leveraging the entrepreneurial potential of micro, small and medium enterprises (MSMEs) across sectors and bringing the financially underserved into the economic mainstream. Presently, a predominantly debt-based system poses formidable constraints to MSMEs. Islamic finance could also increasingly provide long-term funding for infrastructure and other development projects critical for sustainable growth, as well as meaningfully contribute to financial stability.  

Comments

Submitted by Dorina Georgieva on

Thank you very much for this article. Islamic Finance is fascinating subject and has certainly great potential. In addition to the areas for impovement that you point, I believe there is also a need of more educational programs. On that note, are there any lectures and seminars on Islamic Finance at the WBG? It would be wonderful if some experieneced professional can be invited to share their experience from Malaysia, Indonesia, Turkey or even South Korea - all countries which have been using Islamic financial instruments. Thank you.

Hi Dorina: Islamic Finance is an area of focus for the World Bank, and we've held several seminars around the topic--including the 'Is Islamic Finance a Catalyst for Inclusive Growth & Sustainable Development" last April 18, and the Regional Islamic Finance Forum in Cairo last November 20. Any future Islamic Finance events will be highlighted on our events page, as well as the Islamic Finance page so please check those pages for more information.
 

Submitted by S IFTIKHAR ALI on

Islamic finance must spend time on research as special projects at universties to take a dispassionate view of the real practices to identify areas where tranparency must be felt by the reseachers
All islamic firms by law must be required to spend a percentage of realized profits otherwise for distribution to shareholders for reseach at top international universities qualified for original reseach under unified programe to uniformly examine issues and not the current practice of adopting models proposed by some institutions for profit
Real progress is possible if uniform adoption is possible based on quality reseachers not representing profit motive of commercial enterprises both ethical and mercantile banks

Very nice and nuance article. Very much inline with the Halal Monk's conversation on this subject with expert Ajaz Khan: http://www.halalmonk.com/ajaz-ahmed-khan-sharia-compliant-finance

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