370 AN INTRODUCTION TO ISLAMIC FINANCE
growth and low productivity; lagging political and institutional reforms;
large and costly public sectors; ineffi cient and inequitable educational sys-
tems; underdeveloped fi nancial markets; high trade restrictions; and inap-
propriate exchange rate policies.
Many of the ills that contributed to the region’s poor growth perform-
ance could be treated with the legal and institutional developments pre-
scribed by Islam. While there is as yet no great impetus for this process,
a number of Muslim countries have recently implemented macroeconomic
and structural reform policies and have adopted international best-practice
standards and codes. This, together with an increase in oil revenues, has
resulted in a marked improvement in the economic performance of these
countries. The implementation of international best practice in the areas of
transparency and accountability, the development of an independent judici-
ary and the reform of the legal system, and the development of the fi nancial
sector could increase investment, employment and income, and lead to a
reduction in poverty.
RELUCTANCE TO PROMOTE RISK SHARING
Risk sharing is the objective of Islamic fi nance. To foster the development of
Islamic fi nance, there must be a sustained effort to remove the bias against
equity fi nance; to reduce the transaction costs associated with participation
in the stock market; to create a market - based incentive structure to minimize
speculative behavior; and to develop long - term fi nancing instruments and
low - cost, effi cient secondary markets for trading equity shares. These sec-
ondary markets would enable better distribution of risk and achieve reduced
risk with expected payoffs in line with the overall stock market portfolio.
Without true risk sharing, Islamic fi nance may provide a false impression
of being all about developing debt - like, short - term, low - risk and highly liq-
uid fi nancing without manifesting the most important dimension of Islamic
fi nance: its ability to facilitate high growth of employment and income with
relatively low risk to individual investors and market participants.
In the long run, the Islamic fi nancial system requires institutions that
support risk sharing, partnership - based, equity - style fi nancing and invest-
ment. The instruments they use will require close monitoring by the fi nancial
intermediary. To reduce the costs involved in this process, there will need to
be mechanisms to perform collective monitoring of economic agents. Also,
the trading of equity - based securities should be encouraged; this will be
done in a stock market that operates according to Shari’ah principles, and
thus prohibits the use of leverage (through margin accounts) and excessive
speculation (including short sales).
One of the major criticisms of Islamic banks is their reluctance to hold
risk sharing assets, despite the fact that Islam’s economic principles demand
that they should engage in partnerships and equity-sharing fi nancial assets.
For example, from Figure 17.1 it is evident that their fi rst preference is for