Addressing inconsistencies within Islamic finance

Islamic financial institutions should standardize investment screening methods to ensure future growth, a new report suggests.

A lack of standardization among investment screens could potentially hinder the future growth of Islamic financial institutions.

All Islamic financial institutions, including Islamic branches of global financial giants such as Dow Jones, Morgan Stanley and Standard & Poor’s, screen investments for compliance with sharia principles, which are derived from religious scholars’ interpretations of the Koran and other texts. For example, Islamic banks and fund managers are prohibited from investing in activities that involve alcohol, tobacco, weapons, and certain types of entertainment, gambling, speculative trading, or interest charged for lending money.

However, a lack of standardization among investment screens could potentially hinder the future growth of Islamic financial institutions, according to a report by Catherine Ho of Malaysia’s Universiti Teknologi MARA.

“There is a general lack of consistency for a universal, acceptable compliance method, and this may pose confusion and hamper growth in global Islamic investments,” states the report published in the International Journal of Islamic and Middle Eastern Finance and Management. Standardization would enable investors to more clearly understand how their money is being used while sidestepping potential “misunderstandings between scholars and investors”.

With an average annual growth rate of 20%, Islamic financial institutions have become a driving force in the economies of Muslim-majority countries as well as emerging economies. Along with sharia principles, Islamic financial institutions are governed by the central ideal of mutual risk and profit sharing, and by a fundamental intent to enable investment that promotes social well-being.

To see how these principles are implemented, Ho compared the investment screening methods employed by 34 prominent global Islamic financial institutions. She found that some institutions strictly avoid prohibited activities, but the majority invest in mostly sharia-compliant companies that “may occasionally get involved in non-permissible transactions.” Firms normally use a dual screening process: a qualitative screen determines which activities are prohibited, while a quantitative screen determines how much of the enterprises’ non-core business is noncompliant.

The report concludes that standardization would not only reassure Muslim investors, it might also attract positive attention from the growing global movement for more ethical investment practices.

Further information
Professor Dr Catherine S.F. Ho | E-mail: [email protected]
Arshad Ayub Graduate Business School
Universiti Teknologi MARA

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Published: 02 Apr 2018

Contact details:

Chief Information Officer (CIO)

Institute of Research, Development and Commersialisation (IRDC) Universiti Teknologi MARA (UiTM) Shah Alam, 50450 Shah Alam Selangor Malaysia

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