Islamic Finance and Its Product Challenges

Islamic finance according to the International Monetary Fund (IMF) refers to the provision of financial services in accordance with Islamic jurisprudence (Sharia law). According to a definition from Investopedia, Islamic finance refers to the means by which corporations in the Muslim world, including banks and other lending institutions, raise capital in accordance with Sharia, or Islamic law.The Sharia law or rulings is the religious law forming part of the Islamic tradition. Every Islamic financial institution (IFIs) has the obligation of making sure that these set of guiding principles and regulations are met cordially. 

It is also argued that Islamic finance is more stable than conventional finance, because:

(i)                 Islamic finance involves prohibitions against speculation

(ii)               financing is asset-based and thus fully collateralized, and

(iii)             It is founded on strong ethical precepts.

This can be proved by a recent survey by the International Monetary Fund (IMF) which purported that Islamic financial institutions (IFIs) are more resilient to crises.

Islamic finance is different from other conventional financing. Some of the differences which can be identified based on the type of products they offer. Some of these products include: mudaraba, musharaka, murabaha, etc. Notwithstanding the benefits of these products to consumers, Islamic finance institutions face some problems by rolling out these products to individuals, corporate entities, and the government at large.

The problems associated with the rolling out of Islamic finance-based products include:

1.      Flexibility of Product Innovation

Islamic finance based products need to go through various stages of compliance to test its viability before they can be approved. Due to this, the products take a long time before they can be approved. Since the level of innovation in Islamic financial products tends to be very slow, IFIs find it difficult to compete with the conventional financial institutions. Their inability to compete is likely to propel them towards targeting a smaller market in the financial or banking industry.

2.      High Cost of New Product Development

Financial products issued by conventional financial institutions are required to comply with the normal financial laws which govern all conventional financial institutions across different countries.

Islamic financial products on the other hand not only complying to the Sharia rules also are required to comply with the normal financial laws. This tend to increase the cost and resources that is needed to develop a new product. Most financial institutions which are conscious about their spending would prohibit themselves from incurring such costs by just developing a non-Islamic financial product. When the cost of a new product developed is high, there is a tendency that the products will be more expensive for customers to access.

3.      Lack of Standardization of Islamic Products

Conventional financial institutions have harmonized and approved regulatory standards that banks around the world follow. This has made it easier for them to expand and conduct operations in different countries.

For IFIs, there are no approved standards. They follow the conventional financial regulations in addition with the sharia law. This has led to Islamic financial products being nonstandard as a result of distorted regulations.

4.     Mismatch in the Interpretation of the Sharia Law

Ethics and principles of various Islamic communities vary. In this case, there is a likelihood that Islamic financial products may be accepted in some markets, whilst the same product will be rejected in other markets. The reason for this mismatch is due to the fact that various Islamic communities might interpret the Sharia law in different perspectives.

5.     Compatibility with International Financial Regulations

Some Islamic financial products may not be consistent with international financial regulations. IFIs may want their products to comply with such regulations. In the process of ensuring consistency, they may incur extra costs such as legal and insurance cost.

6.     Interest-Free Products

The Islamic finance industry has been trying for decades to extend its outreach to bring at least to the level of conventional financing. But according to the Sharia law, services provided by IFIs are required to be interest free. The absence of interest bearing products has therefore been a major challenge to Islamic finance products and has been the cause of its low penetration in the financial market.

Alright thanks for making time to read this educative piece. Have a wonderful day 😇.