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How Islamic Finance can Contribute to the Global Economy

3p is proud to partner with the Presidio Graduate School’s Macroeconomics course on a blogging series about “the economics of sustainability.” This post is part of that series. To follow along, please click here.

By: Arif Hasyim
While not many ordinary Western consumers understand the principles of Islamic finance, an increasing number of Western institutions have begun to incorporate its principles into operations in some parts of the world.

Islamic finance bans interest, gambling and speculation. Few people know that it also promotes the kind of focus on partnership and productive investment that seems to have been missing from the global boom of the first decade of the 21st century.

The Islamic financial system could help stabilize the global economy, thanks to its nature:

  • Financial assets grow in step with growth in real economic activities.

  • Potential for excessive speculation is reduced.

  • Social and ethical responsibilities are embedded in the investment activities.

  • Maintaining genuine liquidity adds to the stability of the financial service institutions.

  • Natural economic growth is sustained.

To understand Islamic finance, it helps to know that the foundation of the Islamic finance is ‘good intention’ -- in Arabic called niah. Niah represents a philosophy of conducting life and business according to Islamic values, but it is not necessarily restricted to Muslims. The justice and fairness embedded in niah can be actually practiced by all.

The Islamic finance industry has moved beyond borders and religion. Outside of the key Muslim countries, there’s been significant growth of this industry in the United Kingdom, Australia, Hong Kong, Korea, and United States. Since the first Islamic bank, Dubai Islamic Bank, was established in1975, global finance institutions such as Citigroup, HSBC and Standard Chartered have formed affiliates devoted to Islamic finance.

According to the Islamic Finance Services Board, during the last decade the global Islamic finance industry has grown nearly 15 percent annually. The industry today accounts for $1.2 trillion of assets, and could reach $4 trillion over the next few years.

At this point in the Western economic recovery – where the excesses of speculation in everything from ordinary suburban houses to exotic financial instruments continue to impede growth – the principles underlying Islamic finance are worth thinking about.

Critics think recent reforms haven’t gone far enough to refocus big global financial institutions and reduce the risk from investments in derivatives and other sophisticated instruments. Islamic financial principles, meanwhile, put a premium on transparency and investing in genuinely productive assets and businesses. Could applying these principles help overcome the current economic challenges?

The fundamental difference between Islamic finance and conventional finance is that Islamic finance does not put a cost on money. Islamic finance promotes transactions that have a high degree of transparency in order to preserve the rights of the involved parties, where investors share with the recipient in the ultimate gain from the use of their funds. They are based on profit and risk sharing through partnership of work and capital (mudarabah) and joint venture (musharakah). A conventional financial institution separates risks from assets, which can set prudence and greed against each other. And it tends to treat risks as commodities, increasing the potential for instability and systemic peril.

Of course, this would not be simple to implement. But some leaders are beginning to encourage policy makers and regulators to consider these principles as they structure reforms. Says Sri Muliani Indrawati, formerly Indonesia’s Finance Minister, now Managing Director of the World Bank: “It is important to ensure that the regulatory and supervisory framework is consistent with global financial reforms, especially in the context of Islamic finance increasingly becoming mainstream and integrated into the global financial system.”

Arif Hasyim is an MBA candidate at Presidio Graduate School. He is co-founder of The Climate Reality Project Indonesia, and has a passion for creating sustainable community through education. See his website: http://www.hasyim.org.

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