Sample Political Science Essay on Islamic Finance and Banking

Islamic Finance and Banking

Introduction

The Muslim world has, over the recent decades undertaken measures to reconstruct banking and finance (Askari et al 1). The restructuring has specifically championed a system that recognizes the dictates of sharia laws in the field of banking and finance.  The laws totally negate the conventional western practice of charging interests on loans and financial aid (Venardos 74). In as much as the practice translates as a charitable initiative, it harbors great potential in building economic empowerment. This empowerment is more critical to the people in developing countries who already have unmanageable public debts.

What is Islamic Finance?

Islamic finance refers to the kind of financing initiative that derives its mode of practice from the dictates of the sharia laws (Askari et al 11). This principle of financing requires the financier to decide whether the lending is financial aid or has the intent of making a profit. The financier must not ask for an additional amount upon return in the case of financial aid. However, in the case of the intent of making a profit, the financier must agree to share in both the profits and losses of the receiver. This practice stems from the two concepts used in Islamic financing known as musharakah and Mudarabah (Uusmani et al 31).

Islamic finance is currently in its infancy stage in many parts of the world. The concept has majorly picked up in Muslim states as compared to other countries (Venardos 145). This is because most of the non-Muslim governments and taxation systems do not support the idea given their capitalist nature (Askari et al 12). It, therefore, causes a breach of some of the dictates of sharia courtesy of the conditions in the non-Muslim states. However, different countries such as the European Union have embraced the practice that is slowly picking pace (Iqbal& Abbas 16).

Musharakah and Mudarabah

The word musharakah is an Arabic term used in the jurisprudence of the Quran and sunna with the meaning of sharing (Uusmani et al 19). It is used to refer to the terms of engagement in different fields such as business and finance. This law only applies to two or more parties engaging in a joint venture. The law forbids either of the partners from charging a predetermined interest (Askari et al 13). This means that the musharakah dwells on the actual profit made as opposed to the fixed interest rates in capitalist economies. This means that the musharakah creates a balance in the society by favoring the rich and the common people in equal measure (Uusmani et al 21).

Mudarabah or mudharabah on the other hand works on the principle of financier and the financed. This Arabic term refers to an arrangement where one partner is the sole capital provider to an investment run by another partner (Uusmani et al 31). In addition, the investor otherwise known as rabb-ul-maal has no control over the capital once given out. Mudarabah is divided into two major categories, which are the restricted Mudarabah and the unrestricted Mudarabah. The restricted Mudarabah refers to one where the debtor or the mudarib can only venture into a business frontier recommended by the investor or lender (Uusmani et al 32). The unrestricted one gives the debtor the freedom to choose his or her preferred venture.

Other Arabic words found in the Quran and sunna that provide guidelines for Islamic financing and banking include ijarah and istinah (Al-Bashir 61). The dictates of ijarah have similarities with the capitalist definition of leasing (Venardos 61). The term has the meaning of transferring the rights to use a property to someone for rent from the person. Nevertheless, in this arrangement, the corpus of the property remains with the owner. This means that the owner takes responsibility for the liabilities pertaining to the ownership of the property (Askari et al 13). The one using the property only bears the costs of transferrable liabilities. Istina and salam are terms used to refer to the advanced sale of goods and services (Uusmani et al 135).

The importance of Islamic banking and finance

The constant growth and expansion of Islamic banking and finance best explain its significance in the current world economy. This is major because of the critical role it plays in creating financial inclusion. In addition, the concept has helped in effecting economic change and development. The poor people in society often experience a challenge in accessing funds for purposes of entrepreneurial activities. This is because of the high-interest rates coupled with tough conditions from banks and other financial institutions on collateral for financing. This inaccessibility of finance for potential entrepreneurs automatically spells a major threat to the economic growth of the particular economy.

Risk inclusion

Islamic banking, therefore, forms a formidable prerequisite for encouraging and effecting financial inclusion (Askari et al 13). This concept started out as a route of making finance available even to the segments of the society with significantly low income. However, it developed to include easy access to funds by all people in the society coupled with fewer but prudential regulations. Furthermore, the concept has included competition from different financial institutions as a way of giving the customer alternatives (Al-Jarhi 10). Governments also have to ensure the sustainability of banks and financial institutions. The ideas embodied in the concept of inclusion all occur in the dictates of Islamic banking and finance.

Islamic banking and financing use risk-sharing to encourage inclusion. The principle of liability in this practice of banking helps in effecting inclusion. It works on the assumption that both the entrepreneur and the investor must take responsibility of the business outcome (Al-Jarhi 9). This means that partners and investors have the responsibility to embrace either profit or loss in equal measure (Ayub 81). The banking and finance strategy, therefore, endorses sharing of risks at all levels of economic endeavors (Ayub 68). This ensures the prohibition of explicit charging of interests when signing a contract. It further ensures that all parties share the risks involved accordingly. This concept further aids in creating the diversification of risks.

The importance of Islamic finance in overcoming economic obstacles reflects on its role in inspiring economic justice (Ayub 68). This becomes possible through the instruments of redistribution used to enhance inclusion. The sharia laws help in creating a fair environment that ensures the prevalence of justice in the production, distribution, and exchange of property (Ayub 200). This means that the laws ensure equal access to resources. The law governs the redistribution of resources by way of financial obligations and institutions such as zakah and sadaqat (Visser 31).

The zakah as an instrument of the redistribution for example derives money from those who overproduce. The money, often confused as a charity initiative, finds its way to the less fortunate in society (Visser 31). This finds based on the tenets of the Quran that regard the denial of property or assistance to the poor as a forbidden act. This conformation of brotherhood by way of redistribution of wealth helps in overcoming economic obstacles in the society (Visser 31).

The other instrument of redistribution, sadaqat, works on the assumption that economic disparity in society occurs because of misallocation of finance and resources. The inefficient management of those resources furthers this condition. However, sadaqah forms one of the main instruments used to ensure that people with a surplus give it back to society. This helps in reintroducing the resources back to the cycle, with the poor as the targeted beneficiaries (Ayub 68). In as much as this kind of redistribution occurs on a charitable platform, it proves very effective in redistributing resources (Warde 145).

Economic development

Risk inclusion in this scenario increases the chances of economic development. This is because it makes resources readily accessible for poor entrepreneurs (Ayub 456). This satisfies the requirements of Islam that require a three-dimensional development strategy. The development of the individual comes first, followed by the human society than the physical dimension of the earth. Islamic banking and finance strategy helps in realizing this dream. People in developing parts of the world for example face problems concerning access to finance (Al-Jarhi 9). This causes backtracking in the endeavors to alleviate the countries from economic underdevelopment. However, the implementation of the sharia laws on banking automatically opens up the financial system of the regions to empower more people to economic development (Ayub 68).

The implementation of Islamic banking and finance strategy on such systems as the small and micro enterprises (SMEs) can increase the chances of poverty alleviation in these regions. The Islamic concept of financing SMEs indicates a comprehensive model. This model supports both equitable and asset-based economies (Al-Jarhi 11). The model, therefore, helps in realizing the expectations of the society of becoming a poverty-free zone. It subsequently creates a socially just society with sustainable development (Mashayekhi 4).

SMEs have proved the best strategies avenues of developing economies. This is because they heavily contribute to the creation of employment. The strategy also has the ability to cultivate a better relationship between the bourgeoisie and the proletariat. Furthermore, the strategy helps in mobilizing the effective use of wealth in society(Al-Jarhi 11). Developed countries further enjoy the fruits of SMEs courtesy of such things as technological innovations and advancements. Consequently, the increased rates of employment help in stabilizing economies and solving most of the social and political challenges often caused by poor economies. It is also a prerequisite to reducing social discrimination caused by poverty in society (Ayub 199).

This strategy further guarantees unprecedented growth in using microfinance institutions to curb economic obstacles. The sharia-oriented microfinance initiatives undertaken by banks in countries such as Indonesia, Egypt, and Bangladesh have proved the tenability of the strategy in effecting economic development (Venardos 145). The microfinance institutions in these countries have managed to roll out comprehensive financial aid to people. Other countries such as European Union and the United States have also managed to use the strategy to reach out to more people in need of the funds (Al-Bashir 206). Countries in sub-Saharan Africa have also started embracing the Islamic banking and finance strategy in driving economic empowerment and development (Dusuki 51).

Conclusion

Islamic banking and finance strategy, despite its Muslim orientation, proves one of the most sustainable development solutions for the world economy. This has special regard to developing economies that still face the challenge of high unemployment rates coupled by poverty. Furthermore, the concept has, in the recent past received gradual support in non-Muslim countries (Iqbal and Abbas 16). Therefore, economists have registered their recognition for the potential in this model of finance to revolutionize world economy (Dusuki 54).

Works Cited

Al-Bashir, Muhammad. Risk management in Islamic finance: an analysis of derivatives instruments in commodity markets. Vol. 1.Brill, 2008.

Al-Jarhi, Mabid Ali. “Islamic Finance: An Efficient and Equitable Option.”Islamic research and training institute, Islamic development Bank (2002)

Askari, Hossein, ZamirIqbal, and Abbas Mirakhor. New Issues in Islamic Finance and Economics: Progress and Challenges.Vol. 753.John Wiley & Sons, 2011.

Ayub, Muhammad. Understanding Islamic Finance.Vol. 462.John Wiley & Sons, 2009.

Dusuki, AsyrafWajdi. “Banking for the poor: the role of Islamic banking in microfinance initiatives.” Humanomics 24.1 (2008): 49-66.

Iqbal, Zamir, and Abbas Mirakhor. An introduction to Islamic finance: theory and practice.Vol. 687.John Wiley & Sons, 2011.

Mashayekhi, Ali, et al. Islamic finance in the UK: regulation and challenges. Vol. 9. London: Financial Services Authority, 2007.

Uusmani, Muhammad Taqi, and MuḥammadTaqīʻUs̲mānī. An introduction to Islamic finance.Vol. 20.Brill, 2002.

Venardos, Angelo M. Islamic Banking and Finance in South-East Asia: Its Development & Future. Vol. 6.World Scientific, 2011.

Visser, Hans. Islamic finance: Principles and practice.Edward Elgar Publishing, 2013.

Warde, Ibrahim. Islamic finance in the global economy.Edinburgh University Press, 2010.