al ajmi2009.pdf

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Islamic banking and finance in Bahrain (as in any other country) cater to the needs of
those who wish to avoid conducting their financial dealings operating on riba[2], or
interest, but its use is not limited to those people. Islamic sharia’a (Islamic law) prohibits
paying and receiving riba, gharar (excessive uncertainty), and financing products such
as alcohol. Therefore, Islamic banks do not lend or borrow money. To this end, Islamic
financial institutions structure their products in a way that does would involve riba, or
contracts that are considered to haram (prohibited). As an alternative to riba, Islamic
banks are expected to operate on the basis of profit and loss sharing[3] (PLS) engaging
the bank in both the assets and the liabilities of the project. Under the PLS model, the
ex-ante fixed rate of return in financial contracting, which is prohibited, is replaced by a
rate of return that is uncertain and determined ex-post facto on a profit-sharing basis.
Only the profit-sharing ratio between the capital provider and the entrepreneur is
determined ex-ante. However, “Islamic Banking” is in many ways very similar to (and at
times identical with) conventional banking, except that contracts with clients must
comply with Islamic sharia’a (Iqbal and Mirakhor, 2007). There is no theological debate
about the prohibition of riba. However, some practices of Islamic banks are seen by
many people as contradicting Islamic sharia’a and Islamic economics. All Islamic banks
have either an advisory sharia’a board or sharia’a advisor(s), and as a result all the
products they trade are sharia’a compliant because they have been approved by the
sharia’a board or advisor. However, there has been criticism of some practices of Islamic
banks. Dusuki and Abozaid (2007) called for revitalization of Islamic banking and
finance practices based on a proper understanding and implementation of the maqasid
of sharia’a (Objectives of Islamic law). Furthermore, Asutay (2007) argues that the
current practices of Islamic finance, dominated by debt financing, provide economic
incentives at the expense of robust social justice. He argues that this does not support,
nor is it supported by, the normative assumptions of Islamic economics. He
demonstrates that Islamic banking and financial institutions have opted to provide the
more profitable Islamic financial services, such as mudrabaha, at the expense of
musharakah. Asutay (2007) concludes that Islamic banking and finance has deviated
from the aspirational stance of Islamic economics and suggests that Islamic finance
should be more closely aligned to the social and economic ends of financial transactions,
rather than just focusing on the mechanics of the contract. Aggarwal and Yousef (2000,
p. 94) state that:
Most of the financing provided by Islamic banks does not conform to the principle of
profit-and-loss sharing. Instead, much of the financing provided by Islamic banks takes the
form of debt-like instruments.

Islamic banks are also criticized for not given access to poor people through
microfinance facilities and for moving away from PLS to sales-based system that
operate largely on the basis of contracts that are based on a “mark-up” (Saeed, 2004).
Echoing this view, Hsan (2007, p. 19) states that, “Islamic financial institutions have
mostly been designed on the pattern of commercial banks in terms of their outlook,
objectives, procedures, training and modus operandi”. The imbalance between
management and control rights (the agency problem) is blamed for this major failure
to rely on PLS in the practice of Islamic finance (Dar and Presley, 2000). Dar and Presley
(2000) enumerate several such explanations for Islamic banks entrenched tendency to
avoid PLS modes and overwhelmingly to use murabaha and other non-PLS modes.

Islamic banks in