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Islamic Banks Also to Blame for Meltdown

Islamic Banks Also Responsible for Global Financial Crisis: Experts. (Khaleej Times, 6 March 2009) ABU DHABI — Islamic banks must share equal responsibility with conventional commercial banks and financial institutions for the current global financial crisis, a professor specialising in Islamic economics said on Thursday....

From one of our most prolific naysayers in Islamic Finance, Prof Md el-Gamal (who generally has a point!). Also checkout the parallel commentary within our LinkedIn discussion forum.


  1. The bare outlines of a competitive profit-and-loss system are simple to describe. Everything has a price – each commodity and each service. Even the different kinds of human labor have prices, usually called ‘wage rates.’
    Everybody receives money for what he sells and uses this money to buy what he wishes. If more is wanted of any one good, say shoes, a flood of new orders will be given for it. This will cause its price to rise and more to be produced. Similarly, if more is available of a good like tea than people want, its price will be marked down as a result of competition. At the lower price people will drink more tea, and producers will no longer produce so much. Thus equilibrium of supply and demand will be restored. What is true of the markets for consumers’ goods is also true of markets for factors of production such as labour, land, and capital inputs.

    Paul A Samuelson

    Prices jostle up and down keeping supply and demand in perfect balance. With just a little more thought we can stretch the argument further and convince ourselves not only that this process generates a stable equilibrium state, but that it also ensures the best possible arrangement of prices, leading to the optimal allocation of resources; if a better, more-economically productive, allocation of resources could be achieved, then those able to make better use of the resources would be able to pay more for them, causing prices to change accordingly.
    Naturally, if markets tend toward an optimal arrangement of prices, with the most productive allocation of resources, this configuration must also be a stable equilibrium situation. But, when the prices are not in sync with the underlyings ,possibility of confusion and corruption creeps in. The risk and return when studied separately and when leverage has become the norm, mushrooming with interest scavengers and the easy credit to all without studying the demand and supply consideration’s, profit being the sole motto and corruption has spread its tentacles to every strata than suddenly a sub-prime crises that have started in the West bring the whole booming industry on the brink. Overnight, pessimists euphoria is being prevailed with Unfortunately ,all the efforts to resuscitate the economy from the pessimism have failed. The suzzen outcry against the capitalist regime once again validiated that something is going wrong with the disguised system of capitalism. Time has come for the world to realize that the central banks, corporations and the security watch have failed in discharging there responsibilities in monitoring and flow of credit into the markets.There must be resurgence in the whole system or looking out for an alternatives or perhaps, Islamic Banking being the solution to all the problems that creep in our society.
    Many people would argue Islamic banks euphemistically, as a communal banking or religious oriented system or in the West being operated under the Banner of Participatory banking. Had we keep aside all the misconceptions with its name this system have all the answers to the economic problems which otherwise the conventional system have failed to answer in the last 250 years.The Islamic banking system has been worked on the divine principle of Quran and Sunnah(The sayings of Prophet(PBUH)) and its injunctions have to be studied with respect to the Divine reveleation in the Quran.Even there are certain times when this Quran and Sunnah is being silent then a religious body of scholars exert there influence through a discussion called as istinbat or ijtihad (independent judgment in a legal or theological
    question based on the interpretation and application of the principles of Islamic jurisprudence).The Islamic banking system has been active for a long time but its strong resurgence came only after 1970 in the Middle East.In the last 3 decades ,it has made its presence all over the Middle-east and tested water successfully in the East asian countries and now a majority of the western countries have opened there branches or test the Islamic banking window through the existing branch.It has now controlled 3 trillion dollars with an healthy growth year on year is being observed..It is estimated that 50 % of the muslim savings In the Middle east commanded by the Islamic banks till 2015.
    To make this concept on a strong threshold, some parameters has to be elaborated and studied very carefully to accrue the benefits to a vast majority of the population. Islamic financial products like on the issuance of Sukuks(Islamic Bonds) has been receiving lukewarm response in all the muslim countries particularly,in the Malaysia and several other products like Mudarabah,Musharakah,Ijarah,Bai,Muharabaha,sukuks and many financial products that are in line with the Islamic Fiqh(Islamic jurisprudence) and all of them are Shariah Compliant.Some may even ask about the credibility of the system as the main role of the bank is in Lending and borrowing and the Bank thrives on the Interest.While its impossible for the Islamic bank to thrive in present scenario as they are not working on the principle of interest.To counter such arguments one can said that Islamic banks works under a wide array of products which takes into consideration the role of the society and the depositors to the front.There shall be no supercision in the autonomy of the other party,like in the Mudarabah aggrement,Depositors or Rabb al mall deposits the money to the bank and Bank acts a Mudarib or the benefactator to use the money on behalf of the client.The aggrement has been made in advance on the sharing of the profits between the banks and the depositors.The ratio has to be decided or there are variable ratios also but as on a whole the Banking System works on a principle of PLS(profit and loss sharing aggrement).There is no room for the Interest or other disguise charges in the name of administration fees and all the benefits has been given to the depositor and Islamic banks works on increase the efficiency of the whole system.Like wise all other concepts on Leasing(Ijarah),Insurance(Takaful) has been implemented in great detail.Islamic financial products was supposed to carry several merits vis-à-vis an interest based financial intermediary and make the financial industry of the country more stable,more efficient,more equitable and more conducive to generate new entrepreneurs in the society and hence reducing unemployment and alleviating poverty.
    To strengthen the existing system, there must be a renaissance in the existing system to make it further stronger which shall be hedged against all the exigencies of ill capitalist system.To augment that validity, Islamic banks should reorienate themselves by adding vaue to the customers,industry as well as society more generally.And the society has to play a proactive role in realizing that the vast indifference can be curbed through a legitimate Islamic banking system.There are some illustrations on which the Islamic bank has to be strengtend to fight against the convential ill capitalist system:

    1)A proper shariah board has to be appointed by the central bank and work on the Islamic Fiqh as this has been successfully implemented in Sudan,Bahrain and Malaysia.The sharia board is governed by the Islamic banking act under the act of central banks.

    2)The management has no authority over the sharia guidelines and the role of the sharia scholars has to be placed in giving the merit to the product.This supreme body has to be governed by the central banking act and there is no supercession on the management of the board or intoto Sharia scholars itself.

    3)A supreme fiqh for a particular activity has to be established and this independent body has been thrusted with the role of istinbat or ijtihad(independent judgment in a legal or theological
    question based on the interpretation and application of the
    principles of Islamic jurisprudence).This istinbat or ijtihad has to be discussed with the sharia scholars and the implementation of the products depends on the mutual consent of both the bodies.

    4)Islamic rating agency has to be established which gives the ratings to several Islamic products which gives the rating to several Islamic financial products.There working should be in consonance with the Internataional organisations like Standard & poor, Moody’s and many more.

    5)The success of any project depends on the soundness of the Risks.Capital markets in the present day scenario have implemented all the innovative best practise but they have been silent on the risk management.And it has cost them very much when the leveraged positions hav failed and all the best risk management techniques have failed.

    6)The other thing on which the Islamic banks has to concentrate seriously is on the implementation of capital markets.Though all concepts related to the formation of the company structure books of accounts has be studied vis a vis the convential perspective.But,there must be a thorough analysis on the debt structure and its appliciability.Like wise the common parametr to judge the company for investments on the basis of ethical standards and net interest income and Debt equity ratios.While the originality of the companies remains the same but on the structure of accounting terminology the role has to be studied in great depth with refernce to the shariah compliance.

    7)It has also been noticed that certain Islamic banks in actual practise doesnot behave in a sharia compliant way>Especially on the Mudharabah practise it is been observed that they are violating the principles of Islamic financial system and not been compliant with Sharia obligations.Similarly, many critics would argue that Islamic banks would not make any diligence in the screening of the projects and implemenyted on only about the profit motto in mind. When the booming [property market have crashed it fades all the hopes of the profit.

    Finally, Islamic bank elaborate this and now the time has come for the decision maker, management, general public and the state should come up with a defintive action to change the world against the clutches of interest.And on the day we would come out of ignorance.

    Amjad khan Suri,MFC

  2. I have posted below a comment to Mr. Suri splendid write which does address the original article. Here is the "Coles Notes" version by
    Mr. Toby Birch (aka Hugo Bouleau, author of The Final Crash: Addictive Debt and the Deformaiton of the World Economy (published 2007).

    He think it boils down to three things

    :1. One of the purest forms of Islamic Finance is a profit and loss sharing arrangement via the mudaraba or musharaka contracts, which can be roughly equated with western venture capital. The latter has helped to establish some of the greatest companies in American business history. In practice, these arrangements make up only a small percentage of Islamic banking activity and even then, some are suspect in the projects they finance. Activities such as venture capital are hard work, time consuming but potentially very rewarding for investors and society as a whole. Like western banks, Islamic counterparts take the easy route by making money from money i.e. the borrower pays back more than the bank initially lends. The fact that the money has passed through a merry-go-round of commodity transactions does not change this basic truth. In legal-speak, you must have 'substance over form' i.e. long-winded procedures cannot hide a sham.

    2. Islamic tradition favours decision-making by consensus which is great for many aspects of communal life. However, consensus in both business and investment management frequently leads to incorrect decisions. This is why western banks always lend too much to the latest bubble and investors chase the latest craze. From my limited experience, Islamic finance conferences and debates tend to steer clear of controversy and argument - it seems rather politically correct where euphemisms abound. It is difficult to find people prepared to make a stand and say that certain products look suspect, especially where famous scholars have backed the idea. I sometimes feel like the little boy in the crows in the story of the Emperors New Clothes. I had the same feeling when I wrote The Final Crash - I couldn't understand why so few people were trying to warn about the build-up of a bubble. The answer was two-fold - first there was a consensus that everything was fine and second, there was a vested interest to keep the party going.

    3. Suri's idea of a Rating Agency is very good but that in turn needs to be free of conflicts of interest (remember how western ratings agencies were compromised). Mr Suri also makes a valid point that there needs to be an oversight of scholarly decisions and that there has to be a central independent board. I don't know if AAOIFI keep a central record of all fatawa that are issued but this must be a minimum requirement, if only to see what is being passed (and rejected). There is a classic Latin phrase which is translated as 'who guards the guards'. In other words, who is checking on the actions of our leaders. When big western banks with Islamic windows can afford to pay the top scholars to work from them, there must a temptation (if only subliminal) to pass the product that the bank wishes to promote. The bank's motive is to make profit with little regard to the benefit, if any, that it offers society. In effect they are looking to make money from money and therefore use swaps to mimic any asset that happens to be profitable. The whole point of finance is to facilitate business activity or infrastructure projects in the real world. In practice, finance has mutated from its real roots and become self-serving, which is why western banks have stopped lending and fail to pass on rate cuts. They have in effect become parasitic hoarders of capital and like a cuckoo in the nest, gobble up the food at the expense of the other chicks, starving them in the process.

    I recommend a very simple screen for product verification consisting of 5 'yes' answers and 5 'no' answers. For example - does this product benefit society, is there hidden interest, and so on. It may well cause offence in its simplicity but I see so many products that don't make sense to me and there seems to be no one prepared to criticise. It may be to harsh to say that there is a gravy-train but even if these products are being promoted innocently then there should at least be some forum to raise objections without being turned on by the industry. Remember the criticism and vilification of the scholar who raised concerns over sukuk? - we need people like this to raise objections prior to a product launch. No doubt having a central independent board will add time and expense to the process. We are already lacking economies of scale due to the scarcity of scholars. Perhaps we need a 'production line' that can provide a dedicated service. If we had students or scholars-in-waiting to do the groundwork then the scholars could check the sumary and sign-off the product or quarterly review. A similar approach is taken in many professions where a senior person checks the summary rather than doing all the research from the bottom up. It would be great to have a modern version of the House of Wisdom established as a centre of scholastic research. We must realise that the products and principles that are being established right now may well be the foundation of finance for the next thousand years - they must be absolutely sound or Islamic Finance will mutate and eventually implode under the influence of the silent Satan of riba and unethical investing. Like I said on the cover of my book, debt, like the devil, comes in many disguises and we must be vigilant at all times and look through and beyond every product to ensure that their entire cause, effect and consequence are Haram."

    Toby Birch (aka Hugo Bouleau, author of The Final Crash: Addictive Debt and the Deformaiton of the World Economy (published 2007).

  3. For those unfamilar with Dr. El-Gamal (such as myself!) here is a third-party commentary and review on one of his texts (Islamic Finance: Law, Economics and Practice, 2006).

    The review goes on to state that Dr El-Gamal "is very critical on the role of "Shari`ah Supervisory Boards" and calls them as "the rent-seeking arbitrageurs". He likens their role to the "European pre-Reformation practice of selling indulgence certificates". The author argues that these 'rent-seeking legal arbitrageurs' place excessive emphasis on contract forms rather than the substance, thus sacrificing economy and efficiency to preservation of form. As evidence, he presents the example of home mortgage transaction where 'the requirement of multiple sale, special purpose vehicles, and documentations of title may add tax as well as legal costs (p. 5)."

    [http://islamiccenter.kaau.edu.sa/english/Journal/Issues/Pdf/21_2/21-2-Islahi_11.pdf|leo://plh/http%3A*3*3islamiccenter%2Ekaau%2Eedu%2Esa*3english*3Journal*3Issues*3Pdf*321_2*321-2-Islahi_11%2Epdf/YLAF?_t=tracking_disc ]

    Whether he is right or wrong on his views, to me it is vital to have a different/opinionated perspective just to avoid the pitfalls of group-think and all-is-well attitudes.