Blog Home / Study Guides & Resources / How does Islamic finance work?

How does Islamic finance work?

If we examine the objectives of Shariah, we can extract a common theme from them, which is the removal of Zulm or injustice from society. This is done by ensuring that the financing is done adhering to the principles of Shariah, for example, ensuring that the institutions are dealing with financial products that do not… Continue reading How does Islamic finance work?

If we examine the objectives of Shariah, we can extract a common theme from them, which is the removal of Zulm or injustice from society.

This is done by ensuring that the financing is done adhering to the principles of Shariah, for example, ensuring that the institutions are dealing with financial products that do not contain any of the prohibited features.

This makes the Islamic financial system somewhat different from capitalism. 

Islamic Finance vs. Capitalism

Islamic Finance vs. Capitalism

It can be argued that there is not much difference between the Islamic and capitalist financial systems. Scholars mostly have consensus over the general permissibility of the right to private property and limited liability in Shariah, which are two of the fundamental pillars of capitalism.

However, the third pillar, which is ‘rationale’, has a different meaning in capitalism and Islamic finance. 

Rationale translates to logic or reasoning. With reference to a financial system, rationale means that the person working hard should get more reward than the person who is not working as hard.

However, the Islamic economy does not see this reward as merely ‘profit’ or ‘income’. As such, concepts like corporate social responsibility (CSR), sustainability and ethics, do not need to be infused into the Islamic financial system by ensuring compliance with external frameworks.

These concepts are installed directly in the ‘rationale’ of the Islamic financial system. 

For example, the Islamic financial system advocates dealing in real transactions and flow of wealth in the economy.

There is the concept of Zakat in the Islamic financial system, where a person has to give out a portion of their savings back to the economy (i.e. discouraging the accumulation of wealth, and promoting social and distributive justice). This circulation of wealth favours the idea of asset-backed or asset-based transactions.

If we put aside assets from the economy as our savings, the economy will get deprived of ‘real’ assets to transact on.

Thus, the accumulation of assets can lead to financing avenues which promote economic bubbles in the economy (for example, the trading of collateralised debt obligations (CDOs) that is seen as one of the major causes of the ‘real-estate crisis’ of 2008 in the USA). 

Ozair Siddiqui
2 min read
Shares

Leave a comment

Your email address will not be published. Required fields are marked *