Reposted from the web

Summary: This Muslim knowledge guide presents a critical look at Islamic finance, including Sharia compliance, profit-and-loss sharing, murabaha, interest benchmarks, social justice concerns, scholar critiques, banking practice, and the gap between ideal Islamic finance and real-world banking.

This article is a collection and compilation of critiques on Islamic finance. The content mainly comes from the English Wikipedia entry 'Challenges in Islamic finance' and various scholars' blogs. The skepticism from these foreign scholars shows that so-called 'Islamic finance' is not as competitive as we imagine. It has many problems and perhaps should not even be promoted under the name 'Islamic'.



The challenge facing Islamic finance is the difficulty of providing modern financial services without violating Sharia law. The development of the Islamic banking and finance industry centers on avoiding interest, which is seen as an unjust and exploitative gain in trade or business.

Most Islamic banking customers come from the Gulf and developed countries in the Muslim world. Challenges include the fact that interest rate benchmarks have been used to set Islamic 'profit' rates, so the 'net returns are not substantially different from interest-based transactions'. In essence, Islamic banking is 'nothing more than a matter of changing contracts...'.

Religiously, Islamic finance prefers a profit and loss sharing (PLS) model. However, this causes problems, including the need to wait for investment projects to generate earnings before profits can be distributed, which increases risk and complexity for financial service providers.

The Islamic finance industry has been praised for developing a 'theory' into an industry worth about 2 trillion US dollars. It has attracted banking users who could not use traditional banking services for religious reasons, drawn non-Muslim bankers into the field, and (according to other supporters) introduced a more stable and lower-risk form of financing.

However, the industry is also criticized for ignoring its 'basic philosophy' and moving in the wrong direction for decades, leading both outsiders and ordinary Muslims to question it. First, it abandoned the original financing method advocated by its promoters—risk-sharing financing—in favor of fixed-markup purchase financing (especially murabaha). It then distorted the rules of fixed-markup murabaha to effectively provide traditional cash interest loans like conventional interest rates, but disguised them with 'word games' while bearing 'higher costs and greater risks'.

Other issues and complaints raised include that the industry has made no effort to help small vendors and the poor. How to deal with the problem of inflation; Delayed payments; A lack of currency and interest rate hedging; Or a lack of short-term cash deposit accounts that follow Sharia law; Most Islamic banking businesses are owned by non-Muslims;

In a series of interviews with Pakistani banking professionals (traditional and Islamic bankers, Sharia banking advisors, business people using finance, and management consultants) in 2008 and 2010, economist Faisal Khan noted that many Islamic bankers expressed 'skepticism' about the differences, or lack thereof, between traditional and Islamic banking products. He also noted a lack of external Sharia compliance audit requirements for Islamic banks in Pakistan, and that Sharia boards lacked awareness of their banks failing to follow Sharia-compliant practices or were unable to stop them. However, this did not stop devout people from using the banks (one person explained that if his Islamic bank was not truly following Sharia, 'the punishment is on their heads, not mine!'); I have done what I can do.

An estimate of customer preferences in the Pakistani banking industry (provided by a Pakistani banker) is that about 10% of customers are 'strictly traditional banking customers,' 20% are strictly Sharia-compliant banking customers, and 70% prefer Sharia-compliant banking but will use traditional banking if the 'price difference is significant.' A survey of Islamic and traditional banking customers found that Islamic banking customers were more observant (attending Hajj, performing namaz, keeping a beard, etc.), but they also had higher savings account balances than traditional banking customers, were older, better educated, traveled abroad more, and tended to open a second account at a traditional bank. Another study using 'official data' reported to the State Bank of Pakistan found that for lenders who received both Islamic (murabaha) financing and traditional loans, the default rate for traditional loans was more than twice that of the others. If the vote share of religious political parties increases, borrowers are 'less likely to default during Ramadan and in large cities, which suggests that religion—whether through personal piety or network effects—may play a role in determining loan defaults.'

As of 2016, the key challenges facing the Islamic finance industry, including Islamic bonds (sukuk), according to the 2015/16 State of the Global Islamic Economy Report and International Monetary Fund data, include:

Public awareness and understanding of Islamic financial products and services are low, which keeps people from using them.

There is a need to improve regulatory clarity and coordination, strengthen cooperation between Islamic and traditional financial standard-setters, and further improve regulatory tools. This is to address the complex financial products and company structures in some countries where regulatory frameworks fail to handle risks specific to the industry.

There is a scarcity of monetary policy tools that follow halal rules and a lack of understanding of monetary transmission mechanisms.

Underdeveloped safety nets and resolution frameworks. A lack of a complete Islamic deposit insurance system, where insurance premiums cannot be invested in halal assets, or a lack of a halal lender of last resort.

Regulators do not always have the ability or the will to ensure compliance with Islamic law.

Imitating traditional finance.

Some supporters of Islamic banking, such as Taqi Usmani, D. M. Qureshi, Saleh Abdullah Kamel, and Harris Irfan, and skeptics like Muhammad Akram Khan, Mohammad Omar Farooq, Feisal Khan, Mahmoud El-Gamal, and Timur Kuran, have studied the differences between Islamic and traditional banks and expressed regret over their similarities.

Taqi Usmani argues that Islamic banking has completely ignored its basic philosophy. First, it ignores the risk-sharing model (musharaka) between the financier and the user of funds, preferring fixed markup models like cost-plus financing (murabahah) and leasing (ijarah), which theoretically should only be used when risk-sharing is impractical. Second, it ignores the rules of cost-plus financing (murabahah) and leasing (ijarah) themselves. For example, it uses murabahah financing to borrow cash without even buying any goods in the process, or uses leasing (ijarah) where the lessor does not take responsibility for ownership or provide the lessee with any rights of use.

Interest rate benchmarks are used to set Islamic profit rates, so the net result is not substantially different from interest-based transactions. Ignoring these basic principles weakens the influence of Islamic banking among non-Muslims and especially the general public. Usmani believes the public now has the impression that Islamic banking is just a matter of swapping documents.

In March 2009, Usmani declared that 85% of Islamic bonds (sukuk) were non-Islamic. At the time, Usmani was the chairman of the Sharia board for the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), which sets standards for the global Islamic banking industry. Others, such as Hassan Heikal, have also criticized the authenticity of Islamic bonds.

Another pioneer of the Islamic banking industry, DM Qureshi, told a questioner at a 2005 Islamic banking conference, 'With all due respect, today's Islamic banking is a labeling industry.' Everything traditional is just given a new label, and then you call it Islamic.

Mohammad Najatuallah Siddiqui also criticized the trend of copying traditional interest-based financial tools and making minor changes to terms and phrases, such as using sukuk for bonds or tawarruq for loans. He said this trend gives Islamic finance a bad reputation. One Islamic bank, Lariba, even issued a fatwa from its Sharia board, which included famous Sheikh Yusuf al-Qaradawi, stating: 'We have reached a consensus that there is no objection to using the word interest to replace profit or rate of return.' Siddiqui stated that practitioners of Islamic finance are eager to prove in theory that their finance is different from traditional finance, but in reality:

They are busy finding ways to make them similar. Starting around the 1980s, Sharia advisors mainly focused on designing alternatives to financial products that were already familiar to the market while trying to keep them compliant with Sharia.

A Muslim banker at Deutsche Bank, Harris Irfan, wrote about how he felt when selling Islamic banking products that did not truly comply with Sharia. He complained that he felt like a fraud, suffering from incoherent pietism and cognitive dissonance while trying to fit a square peg into a round hole.

Muhammad Akram Khan, a senior expert in Islamic economics, criticized Islamic banks for claiming to build their business on something other than interest while designing a series of tricks and ruses to hide interest.

Mahmoud Amin El-Gamal and Mohammad Fadel complained that Islamic banks charge fees that are too high. Fadel described the foundation of the industry as charging fees to create financial products that seem to meet the formal requirements of Islamic law while keeping all the economic features of traditional products.

El-Gamal described modern Islamic finance as Sharia arbitrage, which means taking advantage of price differences between Islamic and traditional markets because devout Muslims are willing to pay extra for financing they believe follows Sharia. In this system, a bank's Sharia board earns fees by finding a suitable classical Arabic name for an Islamic-style product and using that name to justify the Islamic brand and make it seem more credible.

According to Sayyid Tahir:

There is no evidence that the arrangements of Islamic banks are based on any kind of Sharia foundation. For example, the formulas for legal liquidity requirements, capital adequacy, and risk management standards in Islamic banks are the same as those in interest-based banks.

According to AW Duskuki and Abdelazeem Abozaid, the only difference investigators might find between Islamic finance and traditional finance is

in technical details and legal form, but the substance is the same. In fact, Islamic bankers use the same financial calculations as other bankers to figure out the present and future value of investments. Therefore, in the end, skeptical Muslims and other critical outsiders will find that Islamic banks actually charge interest, just under a different name like commission or profit.

Saleh Abdullah Kamel, the 1997 winner of the IDB Islamic Banking Prize, has a different view. He pointed out that the industry only has most of the features of traditional banking.

The investment models favored by Islamic banks have turned into a mix of loans and investments. This hybrid model has most of the features of interest-based loans and the flaws of the Western capitalist system. It does not highlight the features of Islamic investment based on risk-sharing and actual investment. It does not recognize the guarantee of capital and its returns.

Another criticism of mimicking traditional banking (raised by Mahmoud El-Gamal) is that imitating the 'past returns and past trends' of traditional finance, such as seeking to be the first bank to offer an 'Islamic hedge fund,' can bring huge initial profit margins. This is because the imitator is a 'first mover' in the Islamic finance industry and has 'access to monopoly markets and free indirect publicity.' This tempts other banks to try to follow suit, but long-term returns are often limited.

Skeptics of the industry have offered several explanations for why they believe the industry has failed to provide a real alternative to traditional banking. According to MO Farooq, Sharia boards face pressure, and it is indeed difficult to review the institutions that pay their salaries, which is a modern version of the medieval 'court ulama'.

Feisal Khan argues that Islamic banking is caught in a 'vicious cycle' where traditional piety conflicts with feasibility. Inspired by the Islamic revival movement, a large number of pious Muslims seek to finance, invest, and save in ways that do not use interest and 'standard debt contracts'. Efforts to provide interest-free alternatives that truly comply with Sharia—'participatory' or 'profit and loss sharing' financing—have failed because, in most cases, information asymmetry between the financier and the recipient makes this financing model unprofitable. Large banks are unwilling to let this obstacle stop them from profiting from the vast market of pious Muslims, so they look for 'scholars willing to certify traditional instruments as Sharia-compliant' and give more business to the most helpful scholars. The result is a 'fairly wide' range of financial products and services that 'closely' mimic traditional products and services but come with Sharia certification, which adds extra transaction costs.

Another explanation given by Farooq, citing Muhammad Nejatullah Siddiqi, is the shortage of Sharia experts. Generally speaking, these experts have not received enough training in the intent or purpose of Islamic law, so they cannot evaluate the pros and cons of certain financial products. They also lack training in economics and cannot analyze the consequences of using complex financial transactions like tawarruq, which allows lenders to provide cash to borrowers in a way that complies with Islamic law but is more complex and costly than traditional loans.

Timur Kuran argues that the importance of the Islamic economic foundation in Islamic banking is that it is primarily a tool to reaffirm the primacy of Islam, and only secondarily a tool for radical economic change.

The promises and challenges of profit and risk sharing.

According to a 2006 paper by Suliman Hamdan Albalawi, at least in Saudi Arabia and Egypt, Islamic banks no longer use profit and loss sharing (PLS) techniques as a core principle, and Malaysia has also seen a decline.

A study on the most commonly used Islamic finance models found that PLS financing in major Islamic banks dropped from 17.34% in 1994-1996 to just 6.34% of total financing in 2000-2006. In the sample, debt-based contracts or debt-like instruments were more popular. During the 2004-2006 period, 54.42% of financing was based on murabaha, 16.31% on ijara, and 5.60% on salam and istisna. Another survey of the largest Islamic banks released in 2010 found that the use of PLS ranged between 0.5% and 21.6%.

Authors Humayon A. Dar and J. R. Presley explain why PLS tools, where the financier provides capital and partnership financing, have dropped to a negligible percentage, including:

Bank clients have a strong incentive to report less profit than they actually earn, because the higher the declared profit, the more money the client must pay to the financing bank. This puts banks at a disadvantage when using PLS compared to using fixed-income models.

Property rights are not clearly defined in most Muslim countries, which makes it hard to share profits and losses.

Islamic banks compete with traditional banks that have deep roots and hundreds of years of experience. Islamic banks are still unsure about their own policies and practices, so they avoid taking on risks they cannot predict.

Profit and Loss Sharing (PLS) is often not suitable or possible for things like short-term resource needs, working capital, or non-profit projects in education and health.

In some countries, interest is treated as a business expense and is tax-free, but profit is taxed as income. Because of this, business clients who get funding through PLS pay higher taxes than those who take out loans and pay interest.

At least as of 2001, there was no secondary market for Islamic financial products based on PLS.

As a form of PLS, profit-sharing partnership (mudaraba) gives bank shareholders limited control and leads to an unbalanced governance structure. Shareholders want a consistent and complementary control system, but profit-sharing partnership (mudaraba) financing lacks this.

The industry has not been able to get customers to accept the periodic losses (the L in PLS) that come with investments. The profit-sharing partnership (mudarabah) feature, where bank clients and investors share in the bank's losses, is thought to make Islamic financial institutions more stable than traditional banks. In its 2015 paper, Islamic Finance: Opportunities, Challenges, and Policy Options, the International Monetary Fund listed ensuring that profit-sharing investment accounts (PSIA), also known as profit-sharing partnership (mudarabah) accounts, are handled in a way that keeps the financial system stable as a major regulatory challenge. Supporters like Taqi Usmani argue that normal trade activities naturally lead to occasional losses. They believe that expecting stable returns without any risk of loss is an unnatural product of capitalist banking, caused by separating finance from normal trade. Over decades of development, Islamic banking has faced bad debts and even major financial difficulties, such as the significant corruption scandal at the Dubai Islamic Bank in 1998.

However, at least up until 2004, no Islamic bank had passed bad debts on to its depositors. No Islamic bank reduced the value of depositor accounts when writing down the value of bad assets for fear of losing those depositors.

Beyond the disadvantages for lenders, critic Feisal Khan argues that the widespread use of profit and loss sharing (PLS) could cause serious damage to the economy. He points out that if banks held direct equity in every business as required by profit-sharing contracts (mudarabah) and partnership contracts (musharakah), credit would shrink. Central banks would then be unable to use standard credit expansion methods, such as buying bonds or commercial paper, to prevent the liquidity crises that occur in modern economies. While purists like Usmani are correct that cost-plus financing (murabahah) and other fixed-income tools—which have already pushed out PLS—are essentially just another name for traditional banking, banning them in favor of more authentic profit and loss sharing might leave central banks unable to prevent economic contraction and extreme unemployment.

Besides ignoring profit and loss sharing in favor of cost-plus financing (murabahah), the industry is accused of failing to follow Islamic law rules for murabahah. It often fails to buy or sell the actual goods or inventory that are a key condition for compliance. Banks do this when they want to lend cash rather than fund a purchase, even though it adds extra costs without serving any other purpose. In 2008, Arabianbusiness.com complained that sometimes there were no goods at all, only cash flowing between banks, brokers, and borrowers. Often, the goods have nothing to do with the borrower's business, and there are not even enough existing goods in the world to account for all the transactions taking place. Two other researchers reported that billions of dollars in synthetic murabahah transactions have taken place in London over the years, with many people doubting whether the banks actually owned the deposits or even the underlying assets.

Early supporters of Islamic banking called for setting up different accounts for different types of deposits so that earnings could be distributed to each type. Critic Muhammad Akram Khan argues that, in reality, Islamic financial institutions pool all types of deposits together.

Critics complain that banks following Sharia rules often just take the word of the bank or the borrower that they are following compliance rules, without doing real audits to check if it is true. An observer (L. Al Nasser) complained that when dealing with peers in the industry, Sharia authorities show too much trust in their subjects. He said Sharia audits are needed to reach transparency and make sure institutions keep their promises to customers. Also, when doing outside Sharia audits, many auditors often complain about the high number of violations they see but cannot discuss because the records they check have been tampered with.

Illegal gains

Even though Islamic banks forbid charging interest, their profit margins are usually based on interest rates. Islamic banker Harris Irfan says there is no doubt that benchmarks like LIBOR are still necessary for Islamic banks, and most scholars accept this no matter how imperfect the solution seems. However, Muhammad Akram Khan wrote that following the traditional bank benchmark LIBOR goes against the original purpose of designing and offering Islamic financial products.

Skeptics also complain that the returns on Islamic bank accounts are very close to those of traditional banks, even though their different mechanisms should theoretically lead to different numbers. A 2014 study using the latest econometrics techniques looked at the long-term relationship between time deposit rates at traditional banks and participation banks (Islamic banks) in Turkey. It found that the time deposit rates of three out of four participation banks were significantly cointegrated with those of traditional banks, and the causal relationship between Islamic bank yields and traditional banks was permanent. Skeptics believe this closeness shows that Islamic banks manipulate their yields. These banks are often smaller and have weaker foundations, and they feel the need to reassure customers about their financial competitiveness and stability.

Liquidity issues

The Islamic banking and finance industry lacks a way to earn returns on money that is parked short-term while waiting for investment, which puts these banks at a disadvantage compared to traditional banks.

Banks and financial institutions must balance liquidity—the ability to quickly turn assets into cash or cash equivalents in an emergency without a big loss when depositors need it—with competitive rates of return on funds. Traditional banks use the interbank lending market to borrow money for liquidity needs and invest for any period, including very short terms, to boost their earnings. Calculating the return for any period is simple: just multiply the loan term by the interest rate.

However, the profit and loss sharing (PLS) model preferred in Islamic finance means profits can only be shared after the invested project is finished. Since you cannot determine profit or loss in the short term, money deposited for a short time does not earn any return. Islamic financial institutions cannot use traditional interbank lending markets for short-term borrowing.

Because there are few or not enough Islamic money market investment tools, as of 2002, the liquidity—or money without returns—held by Islamic banks was on average 40% higher than that of traditional banks. The Islamic Financial Services Board found that the daily volume of interbank transactions between Islamic financial institutions, between Islamic and traditional banks, and between Islamic financial institutions and central banks is very low compared to traditional money markets. While Muslim countries like Bahrain, Iran, Malaysia, and Sudan have started developing Islamic money markets and issuing securitized documents based on profit-sharing partnership (musharakah), profit-sharing investment (mudarabah), and leasing (ijarah), as of at least 2013, the lack of a proper and effective secondary market means these securities are much smaller in number than those in traditional capital markets.

Regarding non-PLS, or debt-based contracts, one study found that the business model of Islamic banks is changing over time and moving toward taking on more liquidity risk.

To solve the problem of money held for liquidity or lack of investment opportunities not earning a return, many Islamic financial institutions, such as the Islamic Development Bank and Faisal Islamic Bank of Egypt, openly earn interest from their excess funds, which are usually invested in safer debt-like or overseas debt instruments. Sharia experts do not forbid this practice, but instead provide the necessary religious rulings (fatwa) to comply with Sharia based on the rule of necessity (darurah). Researchers Frank Vogel and Frank Hayes write:

Islamic finance and banking scholars cite necessity to allow exceptions and relax rules. They issued fatwas allowing Islamic banks to deposit funds into interest-bearing accounts, especially abroad, because these banks have no other investments during periods of necessity. However, they usually attach conditions to such fatwas, such as requiring that illegal earnings be used for religious charitable purposes like charity, training, or research.

Lack of social responsibility

According to Islamic teachings, Islamic banks should adopt new financing policies and explore new investment channels to encourage development and improve the living standards of small-scale traders, but Taqi Usmani complains that few Islamic banks and financial institutions focus on this. Islamic scholar Mohammad Hashim Kamali regrets that Islamic banks focus on short-term financing, which mainly focuses on financing already produced goods rather than creating or increasing production capital or focusing on facilities like factories and infrastructure.

Muhammad Akram Khan also complains that in the process of merging with traditional banking, Islamic bank product development mimics traditional banking instead of building a different type of banking consistent with fair and equal income distribution and ethical investment models.

Another scholar, Mahmoud El-Gamal, also regrets that Islamic banks value form over substance and suggests rebranding Islamic finance to emphasize issues like community banking, microfinance, and socially responsible investment.

Criticisms from other unorthodox economists are even more intense.

Muhammad O. Farooq questions the basic premise of Islamic banking, arguing that it focuses on abolishing all interest at the expense of the big picture of pursuing overall economic justice, and cites the Quran's warning against the concentration of wealth:

Whatever Allah has restored to His Messenger from the people of the towns is for Allah and for the Messenger, and for the near relatives and the orphans and the needy and the wayfarer, so that it will not be a perpetual distribution among the rich from among you...

He questioned if greed and profit are bigger causes of exploitation than loan interest. He believes that in a competitive and regulated market, loan interest might not actually count as interest.

The Islamic banking and finance movement has adapted to political tyranny. It is supported by a small, wealthy class of rentiers in the Muslim world and is increasingly manipulated by global financial giants. Because of this, it is easily limited to just talking about opposing exploitation, and it might even unintentionally become a tool for exploitation itself. The real world is full of exploitation, such as child exploitation, sexual exploitation, and labor exploitation. Interest might only be a small part of global exploitation. However, supporters of Islamic economics and finance remain obsessed with interest.

He used the profit motive of the East India Company as an example. Before 1858, the company colonized and ruled India at the expense of the Muslim Mughal Empire, and its shares were equity rather than debt instruments. He found it curious that although books promoting Islamic banking and finance often claim that loan interest exploits the poor and Muslims, there is almost no empirical or focused research on exploitation or injustice within Islamic economics. For example, Farooq complained that in two important bibliographies on orthodox Islamic economics, there was not a single citation about exploitation or injustice. These were 'Muslim Economic Thought: A Survey of Contemporary Literature,' which had 700 entries under 51 subcategories across 115 pages, and 'Islamic Economics: Annotated Sources in English and Urdu' by Muhammad Akram Khan.

Timur Kuran complained that Islamic banks in Egypt and other Muslim countries follow Western banking practices and do little to help economic development or job creation. However, they do not follow the practices of Western venture capitalists, who have funded the global high-tech industry. Since the operating principles of venture capital are the same as profit and loss sharing, even though venture capital does not avoid haram (forbidden) products, using venture capital could bring huge benefits to Egypt and other poor Muslim countries seeking economic development.

Lack of uniformity in Sharia.

Most Islamic banks have their own Sharia boards to rule on bank policies. Researchers Frank Vogel and Frank Hayes believe the four schools of Sunni Islamic law (Madhhab) do not agree on Islamic banking practices. They apply Islamic teachings to business and finance in different ways. There are disagreements on specific points of religious law both between the four schools and within them. Also, Sharia boards sometimes change their minds and overturn previous decisions.

Ibrahim Warde asks if boards just rubber-stamp the banks that pay their salaries. Munawar Iqbal and Philip Molyneux say that disagreements between boards about what counts as Sharia-compliant can cause trouble, because customers might doubt if a bank is truly following the rules. If Islamic banks are not seen as truly Islamic, they will quickly lose most of their market.

Late payments and defaults.

In traditional finance, late payments or loan defaults are discouraged by interest that keeps adding up. Muhammad Akran Khan says that controlling and managing late accounts has become a thorny problem in Islamic finance. Although many suggestions have been made to fix the problem of overdue loans in Islamic banks, Ibrahim Warde says:

Islamic banks face serious issues with late payments, not to mention outright defaults, because some people use every legal and religious trick to delay. In most Islamic countries, various forms of fines and late fees have been set up, but they have been banned or found impossible to enforce. Late fees, in particular, have been treated the same as interest. Therefore, debtors know they can pay Islamic banks last because there is no cost for doing so.

Warde also complained:

Many business people who borrowed large amounts of money for a long time took advantage of the shift to Islamic finance. They paid back only the principal and wiped out the accumulated interest. Given the double-digit inflation over the years, this was usually a tiny amount.

How to deal with inflation

Inflation is also a problem for financing. Islamic banks do not copy traditional banks; they actually provide loans without interest or any other fees. Whether and how to compensate lenders for money that loses value due to inflation is a problem that "troubles" Islamic scholars. If lenders lose money by giving loans, businesses will not be able to get financing. Suggestions include indexing loans to inflation, which many scholars oppose because they think it is a form of interest and encourages inflation. Other ideas include measuring loans by commodities like gold, or doing more research to find an answer.

The influence of non-Muslims

Almost all, if not all, customers of Islamic banking and finance are Muslims. But most financial institutions that provide Islamic banking services are Western and owned by non-Muslims. Supporters of Islamic banking believe that the interest Western banks have in Islamic banking is proof of strong and growing market demand, and therefore an "achievement of the Islamic movement."

However, critics complain that these banks lack a deep commitment to the faith of Islamic banking, which means:

The Muslims hired at these institutions have almost no input into actual management. This leads the Muslim public to sometimes have well-founded doubts about how seriously these institutions follow Sharia law. A traditional Malaysian bank offering Islamic investment funds was found to have invested most of these funds in the gambling industry. The managers running these funds are not Muslim.

The interest from traditional banks does not show that Islamic banking is growing stronger. Instead, it shows how similar Islamic and traditional banks are, so the latter can enter the Islamic banking sector without making any real changes to their business. El-Gamal doubts whether the interest of large non-Muslim banks in Islamic finance comes from the profitability of Islamic financial business.

When the market hits a downturn, these banks are more likely to exit the industry. Harris Irfan believes that non-Muslim banks like Deutsche Bank lack an ideological commitment to Islamic banking, which has led and will continue to lead them to exit the industry when the market hits a downturn. In early 2011, during the bursting of the real estate bubble, Deutsche Bank did not keep a single dedicated Islamic structurer or salesperson. Islamic finance has become a luxury that banks cannot afford. Perhaps partly because of this, in February 2011, the Central Bank of Qatar ordered traditional lenders to close their Islamic operations in the country by the end of the year. The central bank insisted that it was too much for traditional banks to follow alternative capital adequacy rules for Islamic finance, and it was hard to supervise and monitor the Islamic and traditional operations of commercial banks because depositors' funds would get mixed together.

Stability/Risk

Opinions differ on whether Islamic banking is more stable and carries less risk than traditional banking.

Supporters, such as Bank Negara Malaysia Governor Zeti Akhtar Aziz, believe that Islamic financial institutions are more stable than traditional banks because they forbid speculation and, in theory, the two main types of Islamic bank accounts—current accounts and profit-sharing accounts (mudarabah)—pose less risk to the bank.

In a current account, customers do not earn any return, and there is theoretically no risk of loss because the bank does not invest the funds in the account.

In a profit-sharing investment account (mudaraba), an Islamic bank faces less risk from loan defaults because it shares this risk with the depositors. If a borrower cannot repay some or all of the money the bank lent them, the amount distributed to depositors decreases by the same amount. In a traditional bank, depositors receive fixed interest payments regardless of whether the bank's income drops due to loan defaults.

Critics complain that this stability comes at the cost of the stability of the account balances for depositors or partners—a term Islamic banks often use instead of customers or depositors—who face risks that those in traditional banks do not. a critic named Mahmoud A. El-Gamal argues:

In these institutions, investment account holders have neither the protection of creditors in an Islamic financial institution nor the protection of equity holders represented on the institution's board. This introduces many other well-documented risk factors to the institution.

On the other hand, Habib Ahmed wrote shortly after the 2009 financial crisis that the practice of Islamic finance has gradually moved closer to traditional finance, which exposes it to the same dangers of instability.

When looking at the practice of Islamic finance and its operating environment, one can find trends similar to those that led to the current crisis. Recently, stock and real estate markets in the Gulf region have also experienced speculative events. Finally, the Islamic finance industry has grown rapidly with the innovation of complex financial products that comply with Sharia law. The risks of these new Islamic financial products are complex because these tools involve multiple types of risk.

In any case, several Islamic banks have failed over the decades. In 1988, the Islamic investment company Ar-Ryan collapsed, causing thousands of small investors to lose their savings. Later, an anonymous donor from a Gulf country covered their losses. This was a heavy blow to Islamic finance at the time. In 1998, the management of Bank al Taqwa collapsed. Its annual report stated that depositors and shareholders lost more than 23% of their principal. It was later discovered that management violated bank rules by investing more than 60% of the bank's assets into a single project.

Turkey's Ihlas Finance House closed in 2001 due to liquidity problems and financial distress. Faisal Islamic Bank also ran into difficulties and closed its operations in the UK for regulatory reasons. According to The Economist magazine, the 2009 Dubai debt crisis showed that Islamic bonds could help inflate debt to unsustainable levels.

Economic recession

According to a 2010 survey by the International Monetary Fund, Islamic banks showed stronger resilience on average than conventional banks during the 2007 to 2008 financial crisis, but they faced greater losses when the crisis hit the real economy.

At the start of the 2007-2009 Great Recession, Islamic banks were unscathed. One supporter of Islamic banking wrote that the collapse of major Wall Street institutions, especially Lehman Brothers, should encourage economists worldwide to look at Islamic banking and finance as an alternative model. However, the impact of the financial recession gradually shifted to the real sector, affecting the Islamic banking industry. According to Ibrahim Warde, this shows that Islamic finance is not a panacea, and a faith-based system is not automatically immune to the unpredictability of the financial system.

Concentrated ownership

Munawar Iqbal and Philip Molyneux believe that concentrated ownership is another danger to the stability of the Islamic banking and finance industry. They wrote:

Three or four families own a large portion of the industry's shares. If anything happens to these families, or if the next generation of these families changes their priorities, this concentration of ownership could lead to serious financial instability and potentially cause the industry to collapse. Similarly, the experience of national-level trials is mostly based on the initiatives of non-elected rulers.

Macroeconomic risks

Harris Irafan warns that the macroeconomic risks of Islamic banking create a multi-billion dollar ticking time bomb of unhedged currency and interest rates. The difficulty, complexity, and cost of hedging these currencies and interest rates in a proper Islamic way are so high that as of 2015, the Islamic Development Bank was losing cash rapidly, as if it were funding a war. Without relying on conventional markets, it simply cannot consistently exchange dollars for euros or vice versa. Regional Islamic banks in the Middle East and Malaysia do not have trained professionals to understand and negotiate Sharia-compliant treasury swaps, nor are they willing to hire consultants with experience in this area.

High costs and low efficiency

Mohamed El-Gamal believes that because Islamic financial products mimic traditional ones but operate under Sharia rules, they require extra fees for jurists and lawyers, plus costs for multiple sales, special purpose vehicles, and ownership documentation. There are also costs linked to the special structures Islamic banks use for late payment penalties. Because of this, their financing costs are often higher than traditional products, while account returns are often lower.

El-Gamal also argues that another reason for the inefficiency and higher costs of Islamic banking, and why it always lags behind new financial products in the traditional industry, is the reliance on classical nominal contracts like cost-plus financing (murabaha) and leasing (ijara). These contracts follow classical texts written during a time when financial markets were very limited. They cannot untangle various risks, whereas modern financial markets and institutions like money markets, capital markets, and options markets are designed specifically to do that. On the other hand, improving the efficiency of these contracts or products alienates pious customers who believe they should follow classical forms.

In a major part of the financial market—home buying—Islamic finance could not compete with traditional finance in countries like the UK, Canada, and the US as of 2002 in the UK and 2009 in North America. According to Humayon Dar, the monthly payments for Sharia-compliant leasing contracts used by the Islamic investment banking division of Ahli United Bank in the UK were much higher than equivalent traditional mortgages. According to Hans Visser, the cost of Islamic home financing in Canada was 100 to 300 basis points higher than traditional financing, and 40 to 100 basis points higher in the United States. Visser believes Islamic loan financing costs more because Islamic loans have higher risk weights compared to traditional mortgages under international standards for minimum bank capital requirements set by Basel I and Basel II. In some cases, the Islamic profit rate is the same as a traditional mortgage rate, but the closing costs are several hundred dollars higher.

Reports by M. Kabir Hassan in 2005 and 2006 show that Islamic banks dominated by cost-plus financing (murabaha) are not very efficient. The banks studied had an average cost efficiency of 74% and an average profit efficiency of 84%. Although Islamic banks are less efficient at controlling costs, they are generally more efficient at generating profits. A later report on efficiency indicators like cost, allocation, technology, pure technology, and scale noted that, on average, the efficiency of the Islamic banking industry is relatively low compared to traditional banks in other parts of the world.

Other studies found that the efficiency of Islamic banks is, on average, slightly lower than traditional banks in non-Muslim majority regions, measured by bank revenue minus the profits paid to depositors.

This includes studies of Malaysian banks from 1997 to 2003 and Turkish Islamic banks between 1999 and 2001.

In contrast, a multi-country study covering a similar period from 1999 to 2005 found no significant difference in overall efficiency, according to a 2008 study that measured the cost, revenue, and profit efficiency of 43 Islamic banks and 37 traditional banks across 21 countries.

Common explanations for the flaws in the Islamic banking industry from the Islamic finance movement, as noted by M. O. Farooq, are:

Industry problems and challenges are part of a learning curve that will be solved over time.

Unless the industry operates within an Islamic society and environment, it will be hindered by non-Islamic influences and cannot operate according to its true nature.

While the truth of the second explanation cannot be verified until a complete Islamic society is established, Feisal Khan points out regarding the first defense that the industry has shown little evidence of progress since that argument was first made in 1993. That year, critic Timur Kuran highlighted problems in the industry, noting that Islamic banks are basically similar to traditional banks in practice, marginalizing equity-based, risk-sharing models while embracing short-term products and debt-like instruments, while supporter Ausaf Ahmad defended the industry by saying it was in the early stages of transitioning from traditional banking.

Seventeen years later, Islamic finance supporter Ibrahim Warde lamented that murabaha and similar sales products have not disappeared but have grown significantly, and today they make up the bulk of most Islamic banking business.

Most critics of Islamic banking call for more orthodoxy, doubling down on efforts to strictly enforce Sharia law. Some people, like M. O. Farooq and M. A. Khan, blame the industry's problems on treating loan interest as forbidden interest (riba) and the impracticality of trying to enforce that ban.

Finally, I am borrowing an article written by Talha Ahmed Iftikhar on his blog:

Not long ago, my friend wanted to buy furniture from a company that advertised that customers could use interest-free loans for up to 6 months provided by several banks to purchase their products. He decided to get this loan from an Islamic bank to stay compliant with Sharia, but he was shocked when the bank told him his invoice would increase by 30% because it included a profit margin. Then, the deal would be converted into a credit sale contract, and the amount would be paid back in installments over 6 months.

I asked the CEO how an Islamic bank could charge a 30% profit to someone who did not have the money to pay the full amount at once. Isn't this the strong exploiting the weak? Is this the same as the riba or usury that is condemned? His answer left me very confused: "We charge the same fees as the market." For those in need, we have a charity department. They call it a transaction. I left the meeting right away.

Murabaha is not a form of trade, but a banking product designed to trick Muslims into interest-based debt traps. Using it as an Islamic financing model must stop immediately, or at the very least, banks should be banned from using Islam to sell this product. Usury, or riba, is at the heart of an unfair economic system where the strong get stronger at the expense of the weak. Top officials at Islamic banks admit that this product hides the same interest rates used by other banks, which clearly shows these products will never help achieve social justice. view all