Islamic Finance Instruments and Systematic Risks: A Call for Financial Framework Reform

This manuscript examines the contemporary practices in Islamic finance and the associated systematic risks. It critiques the current instruments of Islamic finance and the conventional financial framework within which Islamic banks function, highlighting their suboptimal nature. The discussion extends to the challenges of tenor and currency mismatches and their influence on systematic risk, as observed in the deposit banking model concerning asset-liability management. The study advocates for a direct connection between resource mobilization and lending activities, aiming to counteract the trend of Islamic finance converging with conventional finance and to prevent the recurrent financial crises attributed to the disparities between resource mobilization and bank lending. The arguments rest on the premise that the profit-loss sharing principle in Islamic finance is designed not to absolve borrowers of their obligations. Rather, it ensures that investors, as opposed to the general public, share in both the profits and the risks. Furthermore, the manuscript suggests the potential development of Shari’ah compliant capital market alternatives within an appropriate financial framework, which is currently absent. Additionally, it addresses the Shari’ah compliance concerns associated with sukuk, specifically the issues surrounding the sale and lease-back-based (bai’ al-’inah) and commodity murabaha (organized tavarruq) transactions. This paper anticipates several outcomes from the proposed measures. These include establishing a fair risk-sharing system aligned with Islamic finance principles, enhancing resistance to speculative bubbles by mitigating systemic risks in the current structure, and contributing economically to society through genuine financing models.