Pitfalls In the Islamic Banking and Finance System

Although Islamic banking and finance has been developing at a steady pace in the previous decades, it does have its fair share of hitches and drawbacks. The main distinction between the conventional banking and finance system and the Islamic banking and finance system is the ethical financial structure that the Islamic financial method operates on. This not only encompasses the sharia compliant transactions, investment and banking method but also an organization that upholds Sharia law and operates on the basis of fairness, transparency and equity. This concept is patent in its principles of interest-avoidance, profit and risk sharing, priority to client’s interest, the market and the industry. As an entrepreneur, irrespective of religion, there are significant benefits to being aware of the intricacies of the different banking and financial systems.

Non-Compliance with Islamic Sharia Regulation

A lot of organisations and establishments who claim to be operating in accordance to sharia laws regarding finance usually violate those rules to different extents. Some may completely disregard those rules whilst others partially break the laws in regards to specific matters.

More often than not, the non-compliance occurs when Islamic financial organizations hire people who are not familiar with the Islamic rulings on finance; the avoidance of riba (interest), the unlawful business industries, evasion of usury and gharar. Islamic rules are quite complex and multifarious and as a result require thorough understanding.

Additional Administration liability

Due to the sharia principle of profit and risk- sharing, Islamic banks have to oversee and more often than not, manage projects or business ventures that they invested in. This puts them at a disadvantage because if the project fails, they lose their capital and time invested in the business.

Difficulties of investment in long-term projects

With regards to investment, Islamic banks usually opt for projects which generate profit in the short-term. This is due to the fact that banks are compelled to pay a substantial yearly fee levied from the profit of the deposits. Because of this, Islamic banks cannot provide loans for long-term profit gains while keeping up with the conventional banks.

As a result of this setback, Islamic banks are less efficient in the long-run than that of the interest-based banks. Islamic banks operating in developing countries cannot be as successful as conventional banks because they (Islamic banks) cannot invest in long-term projects which developing countries need for growth.

The Islamic financial system has also been found to more of a niche market and more beneficial to limited sectors of the economy.  Another challenge that sharia-compliant institutions face is the issue of standardization.

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