Publication:
Do conventional and Islamic finance share common epistemology?
Abstract
Simply stated, epistemology deals with the question of what we know about a phenomenon and how do we know it. The practitioners use the term Islamic finance industry (IFI) to refer to their activities in designing and trading “Shari’ah-compliant” ways and means of financing. Taxonomically, industries in an economy belong to a sector and sectors belong to subsystems which in turn belong to a larger system. For example, a bank belongs to a banking industry which belongs to the financial sector which belongs to the financial subsystem which belongs to the larger economic system which, finally, belongs to an overall socio-political-economic system. Before the current inception of IFI, there was what could be called a “market failure” in the conventional financial system. There was substantial unmet demand for Shari’ah-compliant financial products. IFI grew out of the conventional finance to meet this demand. Muslim scholars writing mostly since the 1970s about Islamic finance focused on development of an Islamic finance system; they not only emphasised elimination of riba contracts but urged their replacement with risk-sharing contracts. The practitioners, most of whom had been operating in the conventional finance, were however interested in developing ways and means of finance that, while Shari’ah-compatible, would be familiar to and accepted by market players in the conventional finance. The former emphasised Profit-Loss Sharing (PLS), the latter focused on traditional methods of conventional finance centred on risk transfer and risk shifting. This article argues that there are two ideal financial systems based on risk sharing, conventional and Islamic, and one actual conventional system focused on risk transfer. There are two industries within the actual system; conventional and Islamic finance industry. The paper then proceeds to discuss the epistemology and the main characteristics of each of the two ideal systems.
Keywords
Finance , Conventional economy , Arrow-Debreu , Financial instruments , Islamic finance industry , Risk
Citation
Mirakhor, Abbas & Smolo, Edib. (2011). Do conventional and Islamic finance share common epistemology? Global Islamic Finance, (August 2011), pp. 48-53.
Publisher
Business Media Group