Risk management tools under Sharia law : a comparative analysis

Abstract

In the aftermath of the global financial crisis that has characterized the financial landscape in the last couple of years, risk management parlance has become the hot topic of the day. Indeed, this dissertation revolves around one very important aspect of risk management, namely, financial derivatives. The present study may be regarded, to a certain degree, as a multi-disciplinary study including discussions on both Islamic law and conventional law in the sphere of finance, as well as, some economic concepts. By way of introduction, the first Chapter touches upon the legal and economic/commercial reasons behind financial models necessitating good risk management techniques. Moreover, the extent to which Islamic finance faces different types of risks in comparison with its conventional counterpart, will also be addressed in this introductory Chapter. Furthermore, it is acknowledged that post the credit crunch, the global financial world has been exposed to Islamic finance in view of its awakening as a socially responsible alternative to conventional finance. The second Chapter gives an overview of Islamic fundamentals and prohibitions, focusing primarily on the prohibitions of risk and trading in risk i.e. gharar, and speculation i.e. maysir, as well as, the prohibition of riba i.e. interest, and trading in credit. Furthermore, the reverence Islam has towards risk-sharing as opposed to risktransfer, and the concept of 'no risk, no gain' which pervades the Islamic finance industry, will provide the reader with some food for thought for the discussion to follow in the next Chapters relating to the possibility or otherwise under Sharia law of hedging risks by the use of financial derivatives. Chapter 3 proceeds to skim through the main nominate contracts used under Sharia law on the basis of which different Sharia-compliant financial instruments have been recognized and developed by Sharia scholars, amongst which, products akin to financial derivatives under conventional finance. It becomes evident at this stage the extent to which derivatives are somewhat still considered to be a grey area under Islamic law. Chapter 4 goes on to analyze the relevance of conventional financial derivatives to devising comparable Islamic risk management techniques. Consequently, this Chapter will delve into the existence or otherwise of Islamic derivatives and the extent to which this latter phenomenon is proving to be successful in mimicking its conventional counterpart while striving to conform to the form of Islamic law. Furthermore, in this context, the distinction between using derivatives for hedging versus speculation purposes will also be brought out. To this end, the analysis of derivatives is in no way intended to be exhaustive, but rather, it shall refer to the most basic conventional derivative instruments having analogous instruments, whether in form or substance, under Sharia law. The succeeding Chapter wraps up the current status quo of the Islamic finance industry and addresses recent international developments that have occurred in an attempt to promote the Islamic derivatives market. My concluding remarks form the crux of Chapter 6. This Chapter includes my personal judgment as to the afore-presented discussion and the way forward in so far as relates to the development of Islamic finance both as the only rationale underlying finance and investments for devout Muslims, as well as, a viable alternative to conventional finance models for non-Muslims.