Ethics- based financial transactions: an assessment of islamic finance

Abstract

This paper assesses a 45-year old experiment with a new form of ethical financial practice that has rapidly established a worldwide foothold in just that many years. We identify the ethical principles behind this new niche finance, some of which pre-date Islam, and compare these principles with the much older conventional financial principles embodied in modem banking-finance-insurance. Financial instruments created by Islamic fmancial institutions, under this new experiment, are designed to promote seven key ethical considerations that evolved over millennia to promote equitable financial transactions. The operation of these new institutions is based on: profit-shared, and fee-based buy-sell contracts that replaced pre- agreed interest payments; participating in the risk of business before getting a reward, instead of disregarding risk-sharing, as in most modem debt contracts; and explicit prohibitions on financing the few economic activities not promoting society's welfare. The roots of some of these principles are also traceable to other belief systems. We note that this ethical finance experiment (at the current rate of penetration mostly in majority Muslim countries and in major financial centers) has to gain more ground in order to provide sufficient financial services, even in those places where it has established footholds.