Islamic Finance in the Global Economy

By Ibrahim Warde | Go to book overview

9
ECONOMIC ISSUES:
ISLAMIC FINANCE AND DEVELOPMENT
Insofar as “money is the only good that trades against all other goods,” the financial sector “is unique in the degree to which its markets, prices, institutions, and policies impinge upon all others.”1 More specifically, in any modern economy, financial systems are central to long-term economic development in that:
1. they facilitate trade: at the most rudimentary level, money minimizes the need for barter and thereby encourages commerce and specialization;
2. they facilitate risk management, by pricing risk and providing mechanisms for pooling, ameliorating, and trading risk;
3. financial intermediaries mobilize resources from disparate savers to investment in worthwhile investment projects;
4. financial systems obtain information and evaluate firms, projects, and managers; and
5. financial systems provide corporate governance. It is difficult if not impossible for individual investors to evaluate and monitor the performance of firm managers. Consequently, financial intermediaries are often charged with compelling managers to act in the best interests of firm claim holders (stockholders or creditors).2

Promoters of Islamic finance have argued that Islamic finance is not only consistent with capitalism (that is, with a market-driven allocation of resources), but that it is in many ways better suited to a dynamic economy. More specifically, Islamic finance could bring about more efficient mobilization of savings, more equitable and just distribution of resources, more responsible and profitable lending, as well as less volatile business cycles and more stable banking systems.3

This, of course, is the theory. The difficult part has been to translate the broad principles of Islamic finance into concrete reality. More specifically, in order to contribute to the process of economic growth and development, banks must learn how to transform savings into real investments, and how to do it efficiently – transforming small deposits into larger loans, acting as risk arbitrageurs among investments with different rates of return and risk levels, devising an attractive mix of financial instruments, etc. Following some comments on Islam and economic liberalism, this chapter considers four sets of economic issues and challenges: the mobilization of savings; economic development and fund allocation; Islamic

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