An Introduction to Islamic Finance: Theory and Practice

168 AN INTRODUCTION TO ISLAMIC FINANCE

information and moral hazard. The banks are not willing to allocate
their limited resources for monitoring purposes. In addition, the market
for partnership - based fi nancing requires a well - functioning infrastructure
where information about potential entrepreneurs and their projects is read-
ily available, and the majority of markets where Islamic banks are correctly
operating lack such sophisticated infrastructure.
Figure 8.2 shows the composition of various modes of fi nancing across
different countries for 2008. The bulk of the fi nancing is undertaken in the
form of trade fi nancing activities and, contrary to the partnership - based
fi nancing the system promotes, equity - based assets are seriously lagging
behind. Heavy reliance on trade fi nancing is often referred to by critics
as “mudarabah syndrome” and is not considered as a positive feature. In
addition to trade - based instruments, Islamic banks prefer leasing, which is
considered to have less - uncertain returns than the partnership - based musha-
rakah or mudarabah.

Separation of Investor Classes

Another aspect of the divergence between the practice and the theory is
the choice and application of accounting policies that affect the allocation
of income between shareholders and account holders or between different
classes of account holders. In theory, Islamic fi nance has clear barriers in
the deployment of assets between those funded by demand deposits, general
investment accounts, special investment accounts and equity. However, cur-
rent practice does not include such barriers, with the asset side treated as one
large bucket with all stakeholders’ funds mixed together. In its functions,
an Islamic bank is a hybrid of both a commercial and an investment bank,

Other

Istisna’

Salam

Musharakah

Mudarabah

Leasing and Hire Purchase

Murabahah and Deferred Sales

%100

%90

%80

%70

%60

%50

%40

%30

%20

%10

%0

Kuwait

Saudi Arabia

JordanYemenEgyptLebanonQatarBahrainUAE

Qard-ul-hassan

FIGURE 8.2 Composition of assets of Islamic banks, 2008
Source: Middle East Flagship Report (2010)