Ethics and Impact of Islamic Finance: Exploring the Gap between Theory and Practice

Abstract

Islamic finance comes forth on the assumption that the business activity that leads to improved social and economic conditions for society generally should be encouraged, while exploitative business activity that creates socio-economic barriers and disparities should be restricted. Thus, the notions of fair trading and proper circulation of wealth are pivotal as they will lead to the pursuit of socio-economic justice and common good for society. To achieve this end, interest (Riba) is strictly forbidden as it can become a tool for exploitation and put people in desperate situations. Moreover, there is also a strict prohibition on Gharar which refers to the uncertainty that may persist in contracts and can create ambiguity. Consequently, it is also important that financial transactions should be systematically linked to tangible assets to increase certainty. Moreover, the basic methodology of Islamic banking is to involve the aspect of risk and profit sharing in contracts for both the parties, in a manner that the weaker side is not exploited. The purpose of these principles is to align with Maqasid al-Sharia (the objectives of Islamic law) and be more ethical than conventional banking. However, the essay uses the Islamic contracts of Mudarabah, Musharaka, Murabaha and Salam to demonstrate how in practicality they often do not conform to such objectives. Moreover, the essay also shows how while it is a growing industry, it remains a minor part on a global scale, and is mostly only used in Muslim countries. To do this, first there will be a brief overview of the history and current status of ethical and Islamic finance globally and in Pakistan. Second, there will be a discussion on why Shariah-compliant finance does not gain global significance. Third, there will be an analyses of the four types of contracts and their ethical nature and low market share. Fourth, the overall ethical nature of all of the contracts will be discussed which will lead to a conclusion.