Risk and Regulation of Islamic Banking

Risk and Regulation of Islamic Banking

Foundations of Islamic Finance series

Edited by Mervyn K. Lewis, Mohamed Ariff and Shamsher Mohamad

From a single product offering in 1963, the Islamic financial services industry has grown to an estimated $1.6 trillion in assets. Products must comply with profit and risk-sharing criteria and regulations preventing banks from venturing into activities with high risk and excessive uncertainty. This timely volume analyses these matters and considers the range of new products, discussing both conceptual and practical dimensions. It connects Islamic finance to the mainstream theoretical literature on financial intermediation while also exploring its differences. The expert contributors also examine why an ethical foundation is important and why the system requires well-thought-out regulations to ensure outcomes that protect the community’s well-being.

Chapter 6: Foundations of risk-sharing finance: an Islamic view

Abbas Mirakhor

Subjects: asian studies, asian economics, economics and finance, asian economics, financial economics and regulation, islamic economics and finance, money and banking


Before the inception of the Islamic Finance Industry (IFI), there was what could be called a ‘market failure’ in the conventional system: significant unmet demand for Shari’ah-compliant financial products. IFI grew out of conventional finance to meet this demand. Muslim scholars writing since the 1970s emphasized that Islamic finance was about risk-sharing (or profit/loss-sharing) contracts (see Siddiqi, 1985). Practitioners grounded in conventional finance, however, were interested in developing ways and means of finance that, while Shari’ah-compliant, were familiar to and accepted by market players in conventional finance. Scholars emphasized risk-sharing while practitioners focused on traditional methods of conventional finance based on risk transfer and risk shifting. In doing so, financial instruments of conventional finance were replicated, reverse engineered or retrofitted for Shari’ah compatibility, a somewhat regrettable process.

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