388 AN INTRODUCTION TO ISLAMIC FINANCE
clear that this state of affairs, in turn, stems from a general lack of familiar-
ity with these rules among Muslims.
In an Islamic economic system, various levies are imposed on produc-
tion or income to redeem property rights accrued by different members
of the society. It is important to realize that in no way are these levies to
be considered as charity, a common misunderstanding among laymen and
scholars alike.
According to some estimates, the assets of the non - bank fi nancial sector
will make up around 8–10 percent of total Islamic assets.^13 Given the size
of the Muslim population and the GDP of Islamic countries, this estimate
appears to be on the low side. Actual potential is much more, as these insti-
tutions have to be expanded to cover wider segments of society.
The following steps are suggested to strengthen this sector:
■ (^) Develop institutions to formalize the implementation of redistribu-
tive instruments of Islam. Formal institutions to channel these fl ows
in the most effective fashion need to be developed. These could be
dedicated institutions specializing in the distribution of funds in the
most cost - effective and most benefi cial manner. If there are well -
functioning Islamic fi nancial intermediaries, these can become a dis-
tribution channel for these social welfare services as part of their
customer services. A reputation of positive contributions to social
welfare could serve as an asset for the institution in attracting or
retaining customers.
■ (^) Develop a legal framework to encourage and protect non - banking fi nan-
cial institutions to enable them to operate in a friendly environment.
■ (^) Design and implement a prudent regulatory and policy framework for
a broad - based and effi cient non - bank fi nancial sector. Some regulatory
overview may also be needed to instill confi dence and protect stake-
holders and to ensure the healthy growth of the industry. Furthermore,
tax neutrality can play an important role in further growth of this
sector.^14
Promotion of SME Financing
The Islamic fi nancial industry and policymakers should develop ways to
promote SMEs and their access to the formal fi nancial sector. In developing
appropriate products, mudarabah contracts based on principal/agent prin-
ciples would be well suited for the purpose. However, this type of contract
has yet to be institutionalized in most Muslim countries. While conventional
banks are constrained by their conservative approach to risky assets and by
protective regulatory regimes from extending credit to SMEs, this need not
be the case for Islamic banks, which can hold mudarabah - based assets with
no regulatory constraints. Furthermore, IFIs are encouraged to enter into
equity partnerships, which can be used to promote the SME sector. These