Few in the Western world would question the fairness of interest payment to a loan creditor. In Islamic banking, interest or ribah, is incompatible with sharia, Islamic code. Curiously, the other two big monotheistic religions Judaism and Christianity share some queasiness about charging interest. Islamic financial products tend to be arranged like partnerships, would-be creditor and borrower share on the risk as well as its consequential profit or loss. What specific instruments meet these requirements of fair share of risk is a matter of debate.
Too big to ignore
Islamic finance is no longer an esoteric segment of finance confined to the middle east and Muslim regions. London and Hong Kong along with Dubai and Kuala Lumpur are making efforts to become Islamic finance hubs. The relevance of Islamic finance was pointed out by the IMF in a comparative analysis of financial stability of traditional and Islamic banks after the 2008 financial crisis. Authors suggested that for some countries, Islamic banking had become systematically important and in others highly impactful. The study concluded that Islamic banks showed higher resilience in a crisis but where more directly impacted by the real economy. This is unsurprising given the Islamic restrictions on speculative trading, bias of equity over debt and disapproval of intermediation unless intermediaries have skin in the game. Around the time of the study in 2010, Islamic fiance was estimated at $820 billion. The current estimate is around $2 trillion.
In search of consensus
In spite of a this growth, Islamic finance still makes up just around 1% of world assets. Lack of an Islamic central authority to govern Islamic banks translates into absence of enforceable standards, opacity and fragmented liquidity. Even classifying what constitutes a sharia compliant instrument is a matter of contention. A product offered by an Islamic Indonesian bank may not be acceptable to a Pakistani bank sharia board. International bodies like the Islamic Financial Services Board (IFSB), have attempted to set standards and provide guidance, however they lack the influence of entities like the Bank of International Settlements (BIS) or the ISDA. Even the Islamic development bank (IDB), well position to play a unifying role with over 50 capital contributing governments, has yet to produce a standard enforceable in its member countries after 40 years of existence.
Shared control
Rather than aiming for an elusive centralization, a combination of centralization and decentralized elements is a more realistic approach, such a hybrid system is described in Arthur Breitman’s cryptogrphic ledger nomenclature, as a centralized distributed ledger. This seemingly contradictory categorization, conveys the idea that while ledgers will not be exclusively localized at any particular peer, a defined set of administrators would maintain a shared ledger being replicated to all members. Allowing the co-existence of different Islamic asset types on the same shared ledger. This shared infrastructure could also be integrated to the broader global financial system where non-Muslims institutions are already consumers and issuers of Islamic assets. Continuing with Breitman’s terminology, the ledger would have the additional traits of permissioned and tokenless. Permissioned alludes to the rejection of unknown validators while tokenless means no native token is required to operate the ledger.
The flexibility to share a common infrastructure without fully relinquishing control to a central authority, where levels of centralization can be adjusted as needed, would help overcome the current impasse among Islamic bank boards. Varied asset types associated with different sharia interpretations in the same platform can also lead to the emergence of a bottom up ‘standardization’ where the market votes with their investment what instruments better align to investors religious requirements.