Assignment (Essay)

Student Name: xxxxxxx

Module Name and Number: UJUGUPF-15-M International Banking and Finance Law

Word Count: 3000

Coursework Question: Is the growing phenomena of Islamic Banking an alternative form of

banking or is it simply a niche form of banking within wider system of international banking?

Discuss in light of Form v Substance debate.

Introduction:

Islamic Shariah law 1(clear path) underlies Islamic financial philosophy. Islamic banking cannot

engage in transactions containing Riba (interest), according to Islamic Shariah. Additionally,

they are not able to interact with the components Gharar or Maiser. Likewise they are not

authorized to participate in any transaction that involves illegal substances (haram in the eyes of

Islam). Islamic banking is defined as a financial system that adheres to Islam's spirit, ideology,

and moral framework and is governed by Islamic Shariah regulations. The term "incentive

banking" 2refers to a variety of investment bank services and products. The more generic term,

Islamic banking, is focused not only on the avoidance of market transactions, which are

prohibited in Islamic Shariah, as well as the avoidance of immoral and un-social behaviour. The

Islamic banking proposed system results in the creation of a system that aids in the achievement

of economic progress. The teachings of Islam are not restricted to Muslims; due to their

worldwide nature, they also address non-Muslims. Islamic banking is based on ethical principles

and an environmentally accountable structure. The basic characteristics of Islamic banking

includes principles such as fairness, mutual help, fee agreement, and honesty on the part of

contract parties, the avoidance of fraud, deception, and misrepresentation of facts, and the denial

of injustice or exploitation.

1
Kettle, B. “Introduction to Islamic banking and finance.” John Wiley & Sons (Vol. 551) (2011).

2
Mbawuni, J., & Nimako, S. G. “Muslim and non-Muslim consumers’ perception towards introduction of Islamic
banking in Ghana.” Journal of Islamic Accounting and Business Research. (2018).
Principles of Islamic baking

When carrying out any Islamic banking transaction, at least six key principles3 are considered.

1. Contract sanctity

2. Risk distribution

3. No Riba/interest

4. Economic goal/activity

5. Fairness

6. There is no invalid topic matter

As a consequence, Islamic banking principles direct the economic system in the direction of the

general welfare and economic progress. As a result, Islamic banking would become a viable

alternative for anybody, regardless of creed. Banking is the most difficult component of Islamic

financial system to understand. Iran and Pakistan, for example, have state constitutions that

require their financial institutions to be entirely consistent with Islamic law. Islamic banking

coincides with international banking in Egyptian, Southeast Asia, Malaysian, Sudanese, and the

Gulf Cooperation Council (GCC) countries. Islamic banking is different from the international

banking, like international banking has different laws, rules and regulations from the Islamic

banking. An Islamic bank, like every bank, is an institution whose principal function is to receive

demand deposits and use them to support businessmen's/entrepreneurs' economic operations.

While an international bank uses interest rates to collect cash from deposits and offer these assets

to businessmen, an Islamic bank performs comparable functions utilizing Shariah-compliant

financial modes.

3
Rosly, S. A. “Critical issues on Islamic banking and financial markets.” Author house, Bloomington. (2005).
Islamic banks versus International banks in different scenarios

However, on a socio-religious level4, Islamic banks are trading and investment enterprises rather

than lending organisations. Islamic banks follow socio-religious guidelines that forbid collecting

and paying interest, as well as engaging in prohibited activities like as trading, speculative,

derivatives trading, and the transfer of loans and receivables. Islamic banks must not lend to

businesses that are damaging to community, such as tobacco and alcohol. On the other hand

International interest-based banks lend and borrow money on the basis of interest. Such limits do

not exist in international banking. Short sells, bankruptcy sales, and speculative transactions are

common, and interests are the system's backbone. International banks fund all industries; only

firms considered criminal by local law are not supported. According to framework scenario

Islamic banking model is built on trade; Islamic banks must actively participate in the trade and

manufacturing processes and activities. Islamic banks have a rigorous Shariah regulatory system

that is composed of a Sharia Advisory Board that allows Shariah-compliant transactions and

products. Whereas International banks, on the other hand, normally do not engage in trading or

enterprise because they solely operate as a money lender. In international banks have, no such

structure exist. At implementation level Islamic banking classifies loans as noncommercial and

excludes them from the realm of commercial transactions. Islamic banking must provide interest-

free loans.to the contrary Almost all financing and deposit side products in international banks

are loan-based.

4
Hassan, M. K., Sanchez, B., & Safa, M. F. “Impact of financial liberalization and foreign bank entry on Islamic
banking performance.” International Journal of Islamic and Middle Eastern Finance and Management. (2013).
Discussion:

Islamic banking 5is growing as an alternative form of banking. It doesn’t work under any

authority. Islamic banking has different rules and regulations and laws as compared to other

banks. Islamic banking is not working in one country, yet it is gradually growing day by day.

Islamic banking has acquired considerably greater worldwide acceptance since the 1990s, for

example The Asian-Pacific area accounts for over 25% of the worldwide Islamic financing

economy. Australia is on its way to becoming the newcomer to the block. The country's first

Islamic bank is slated to open in early 2021. Sub-Saharan African contributes only for around

1.5% of the worldwide Islamic finance market, but with the fastest in the world population, 80%

of unbanked people, and 16% of Muslims, the opportunities for Islamic financiers look infinite.

Several countries have already started to reform their rules and regulations to enable Islamic

finance to thrive. Following the 2008 financial crisis, Islamic financing emerged as a

comparatively secure alternative to the wobbling Western banking system. Sukuk appeared to be

a good method to enter new markets, Islamic funds provided chances to access significant

quantities of cash, and Islamic banking promised a means to monetize local Muslim populations.

As the global financial crisis6 has deteriorated, trust in international banking has

dwindled, resulting in an increase in global interest in Islamic banking. The financial crisis in the

Western world, which resulted in severe economic downturns in various countries, interest in

Islamic banking has surged. Islamic banking has acquired a more major position in global

5
Khan, M. M., & Bhatti, M. I. “Islamic banking and finance: on its way to globalization”. Managerial
finance, 34(10) (2008): 708-725.

6
Chong, B. S., & Liu, M. H. “Islamic banking: interest-free or interest-based”. Pacific-Basin finance journal, 17(1)
(2009): 125-144.
banking since the economic and financial crises, although having a smaller reach than banks in

Western nations. Shariah rules originating from the Quran underpin Islamic banking principles.

The most important truth is that Islamic banks cannot prosper without taking risks or putting in

effort. They never use financial instruments that are not backed by assets (derivatives). Islamic

banks, on the other hand, accept all or a portion of the risk if losses arise during project

implementation. They value the potential of making loans with the primary goal of funding

projects and boosting company development; they share the risk with customers and value

collaborative efforts. Faster bank growth is also likely to help the industry expand.

Islamic banking continues to expand rapidly.

Islamic bank 7continues showing large number of growth; the Islamic Finance Development

Indicator (IFDI) included the new FinTech Sandbox statistic to the Governance indicator to stay

up with industry changes. Islamic financial governance is built on regulations, with Islamic

banking being the most broadly covered. Shariah Governance is the second most powerful after

Regulations since some nations have centralized Shariah boards and the majority have Shariah

experts who represent Islamic financial organisations. Corporate Governance is the worst, with

numerous financial institutions reporting poor performance. Malaysia, Oman, Bahrain, Pakistan,

and Kuwait are the Governance leaders. IFDI 2022, the key Islamic finance economies of

Southeast Asia, the Gulf Cooperation Council, and South Asia dominate the 136 nations we

evaluated. Malaysia leads the pack with an IFDI score of 113, followed by Saudi Arabia (74),

Indonesia (61), Bahrain (59), Kuwait (59), the United Arab Emirates (52), Oman (48), Pakistan

(43), Qatar (38) and Bangladesh (36). As we reach the fourth quarter of 2022, economies are

being impacted by Russia's ongoing invasion of Ukraine, which is influencing energy prices and
7
Van Greuning, H., & Iqbal, Z. “Risk analysis for Islamic banks”. World Bank Publications (2008).
sending ripples across a major portion of the world's supply chain. Most countries are likewise

concerned about inflation.

In terms of Islamic finance8, various large-scale governmental policies and roadmaps will

help the business. Afghanistan, Brunei, Indonesia, Kazakhstan, Labuan, Malaysia, Oman,

Pakistan, and Saudi Arabia are among them. Key developments in North Africa, where Islamic

banking and takaful are gaining support and growth, will also help to the future spread of Islamic

finance. Another zone to examine is Central Asia, where nations like Tajikistan, which will be

one of the fastest growing Islamic banking markets in 2021, will also launch its takaful industry.

Kazakhstan's Islamic banking industry is also rapidly increasing, with significant development in

Other Islamic Financial Institutions, particularly FinTechs.Overall, IFDI expects the global

Islamic finance industry to rise to $5.9 trillion by 2026, up from $4 trillion in 2021, mostly due

to the growth of its two largest divisions, Islamic banks and sukuk.

Trends and challenges in the development of Islamic Banking

Despite challenges9, Islamic banks are working around about 75 countries in the world. Bank

financing growth is likely to accelerate as the economic outlook improves for several Islamic

finance nations. In 2006, the Islamic financial industry expanded by 21%, 29% in 2007, 16% in

2008, 18% in 2009, 22% in 2010, 20% in 2011, and 24% in 2012. Stronger economic

development in the core Islamic finance nations is predicted to increase industrial assets by 10%

between 2022 and 2023. The worldwide Islamic finance industry grew by 10.2 percent in 2021,

compared to 11.4 percent in 2020 (without Iran), and fueled by banking asset growth. Last year's

8
Boukhatem, J., & Moussa, F. B. “The effect of Islamic banks on GDP growth: Some evidence from selected MENA
countries” Borsa Istanbul Review, 18(3) (2018): 231-247.

9
Hesse, H., Jobst, A., & Solé, J. “Trends and challenges in Islamic finance.” (2008).
surge was fueled by Islamic banking assets in various GCC nations and Malaysia, sukuk

issuances surpassing maturities, and the Islamic funds industry's strong performance. Total

sharia-compliant assets could exceed $3.5 trillion by 2024, as according Arab News' 2019 State

of the World's Islamic Market report, albeit this is reliant on the economic stability of these 10

markets. Furthermore, the majority of these nations are reasonably immune to macroeconomic

shocks 10caused by the Russia-Ukraine war. This will help the industry's prospects in 2022 and

2023. However, global headwinds such as persistently high prices, Covid-19-related lockdowns,

and the US Federal Reserve and other major central banks stepping up their efforts to control

inflation might change the picture. Continued financing demand and the realization of Vision

2030 projects in Saudi Arabia will present chances for industry development. More favorable

economic attitude, government expenditure, and investment will assist drive development in

other GCC nations. We anticipate that the $290 billion Islamic banking business in South-East

Asia will grow at a compound annual growth rate of roughly 8% over the next three years. We

anticipate a fall in overall sukuk issuance in 2022, following stability at $147.4 billion in 2021,

vs. $148.4 billion in 2020, and a 105% growth in foreign-currency-denominated issuance over

the same time. Several variables are at work. Shrinking global liquidity 11 and growing regulatory

complexity are anticipated to limit sukuk issuance in 2022, provided that any unfavorable Covid-

19-related disruption in key Islamic banking nations is contained. We also anticipate fewer

funding requirements for several core Islamic finance nations, as well as some corporates, as

they gradually recover from the epidemic.

10
Banna, H., Alam, M. R., Ahmad, R., & Sari, N. M. “Does financial inclusion drive the Islamic banking
efficiency?” A post-financial crisis analysis. The Singapore Economic Review, 67(01) (2022): 135-160.
11
Rosyada, F. A., & Adinugraha, H. H. “The Influence Of Hijab Fashion Trends On Consumptive Behavior Of
Islamic Banking Students At IAIN Pekalongan.” Journal of Management and Islamic Finance, 2(1) (2022): 43-53.
Simultaneously, a more favorable economic climate and more government investment are

anticipated to generate possibilities in commodity-exporting countries. Furthermore 12, some

governments are expected to continue issuing local currency in order to create local capital

markets and provide alternative funding options for their economies. We notice that overall

issuance was down 23.2% in the first quarter of 2022, while foreign currency denominated

issuance jumped 12.3%, as some issuers’ frontloaded their plans to capitalize on market

circumstances ahead to interest rate hikes. Many of these issuances were from low-rated

counterparties or as capital-boosting instruments. Despite the drop in quantities, we expect sukuk

issuance to outnumber sukuk due in 2022, which we estimate to be around $96 billion. Although

their impact to the economy remains negligible, we anticipate growth in the takaful and fund

sectors this year. We continue to see the takaful industry growing at a pace of 5% to 10% every

year. Due to market disruptions since the beginning of 2022, fund growth is less guaranteed, with

one-quarter of the industry equities funds and another 60% money market or sukuk funds

anticipated to suffer from increased global interest rates. Liquidity risk management is a key

challenge in Islamic banks, impeded by a paucity of marketable Islamic money market

instruments and a shortage of systemic liquidity structure. There is presently no Shariah-

compliant brief Islamic money market (with a maturity of less than one week) in either national

currency or US currencies, and Islamic repossession markets have yet to emerge. Local Islamic

banks are hampered by a lack of liquidity and viable alternatives, which, combined with a

competitive disadvantage, might lead to a liquidity crisis. When compared to international banks,

the profitability of Islamic banks is negative. Islamic banks outperform international banks in

terms of financing, deposits, assets, efficiency, investment, service quality, and loan recovery.

12
Boukhatem, J., & Moussa, F. B. “The effect of Islamic banks on GDP growth: Some evidence from selected
MENA countries.” Borsa Istanbul Review, 18(3) (2018): 231-247.
Form v Substance: What is the Debate?

Over the previous few decades, the Islamic financial system 13 has grown dramatically. It has,

however, come under criticism for its procedures, commodities, and services. Some analysts

believe it is a carbon copy of the global financial system. Critics have contrasted it to recycling

old wine in different bottles with a different brand and a Shariah-compliant label. Furthermore,

while Islamic financial transactions follow Sharah (Islamic law), they face failure in content and

spirit. However, many conflicts have centred on the use of "form," so evading the "economic

content" of Islamic financial transactions. The acknowledgment and offering of the fundamental

objective of the parties to the contract initiates the debate over form over content. Substance over

form refers to the concept of recording a major performance based on its responsible for

financial or financial actuality rather than its legal document. The Shafi School, for instance,

favours form above content in differences between interior will and external permission,

recognizing simply Bi al-kitabah (whatever is written) as a standard in the courts. The Hanafi

School, on the other hand, emphasises material over form in compensation for offering and

acceptance; for instance, a bay al-wafa (redeem sale) contract is viewed as a promise instead of a

price reduction. Shariah emphasises the significance from both substance and form in this regard,

but they must not dispute one another. Concerns have been expressed about the employment of

certain procedures to certify contracts as Shariah-compliant in the dilemma of socioeconomic

substance and type of contract in Islamic finance. "Form over substance is a device that locks a

front door of riba (usury) whilst concurrently exposing the back window for riba," concludes the

author.

Form v substance: Shariah Perspective

13
Hamour, M., Shakil, M. H., Akinlaso, I. M., & Tasnia, M. “Contemporary issues of form and substance: an
Islamic law perspective.” ISRA International Journal of Islamic Finance. (2019)
Shariah is a religious rule that establishes regulating rules for moral, mental, and physiological

behaviour and attitude that Muslims should indeed obey. In general, Shariah 14 emphasises the

need of each transaction according to its legal form, which contains its main requirements

including its nature and repercussions. This indicates that both the form and substance of the

transaction are necessary. In contrast, generally Islamic financial instruments are produced

through a series of contracts. Deliberations occur over whether to record the effects of each

agreement in isolation, so distinguishing the "form" of each contract, or whether to preserve the

economic effect of the series of transactions, thereby expressing the "economic content" of the

entire operation. Ijarah is a subject that has sparked heated discussion about the adoption of

substance over form (leases). To demonstrate the subject 15, the item ijarah muntahiyah bi al-

tamlk could be employed (lease ending with ownership). It is a form of financial lease that

occurs when the lessor leases an asset to the lessee for a certain amount of time after which the

lessee becomes the legitimate owner of the asset. The lessee (buyer) contracts the asset for the

duration of the ijarah. The lessor (seller) often makes a commitment (guarantee) to convey the

property's ownership to the lessee at the beginning of the lease period, with the lessee

committing to purchase the asset as from lessor at the end of the lease term. The lessor may

transfer property ownership in one of the following ways: gift; sale contract for a token, set, or

current value; or gradual shareholding transfer. If the property is sold at the conclusion of the

lease period via a sale contract, the lessor and lessee would enter into a distinct

14
El‐Gamal, M. A. “Mutuality as an antidote to rent‐seeking Shariah arbitrage in Islamic finance.” Thunderbird
International Business Review, 49(2) (2007): 187-202.

15
Hamour, M., Shakil, M. H., Akinlaso, I. M., & Tasnia, M. “Contemporary issues of form and substance: an
Islamic law perspective”. ISRA International Journal of Islamic Finance. (2019).
purchase and sales agreement. A bay al-nah (sell and buy-back) agreement highlights the

question of substance versus form. A bay al-nah is a selling contract that includes an instant

repurchase.

If the information16 method is used, financial reporting would show the aggregate impact of all

agreements engaged in the deal, with the income generated from the agreements reported as the

client's financing cost. In contrast, the financial statement would record two different transactions

if the form over content approach is followed:

(1) The financier selling an asset to the client

(2) The consumer selling the same asset to the banker.

As a result, when Islamic financial products are developed through a series of contracts, Shariah

opinions on the concept of content over form must be clarified.

16
Hanif, M. “Economic substance or legal form: an evaluation of Islamic finance practice.” International Journal
of Islamic and Middle Eastern Finance and Management. (2016).
Conclusion

The prospects of Islamic finance seem promising. Financial firms in Qatar, the Emirates, and

Malaysia have been preparing for further Shariah-compliant investment vehicles and asset and

liability securitization. Furthermore, financial innovation will help to design and enhance

Shariah-compliant financial derivatives. Simultaneously, the world's main financial centers,

including Hong Kong, London, New York, and Singapore, are progressing rapidly in providing

the legal and regulatory groundwork for Islamic finance to cohabit with the international

financial system. Many of the world's largest banks have become active, and in some cases

leading, people participating in financial innovation and new Shariah-compliant financial

products, attempting to alleviate many of the current constraints, such as a weak systemic

liquidity infrastructure, through their Islamic windows. More foreign banks, especially in the

Middle East, are anticipated to provide Islamic goods, enticed by high profit margins and

unlimited liquidity. With an expanding number of Islamic institutions establishing in the Middle

East and Central Asia, banks may deliver the correct product mix to more affluent consumers

through diversification. Some few institutions are already operating in many countries, and this

trend is projected to continue in the near term, potentially through mergers. Many obstacles

remain, but the banks' search for profitable opportunities, as well as the ensuing financial

innovation process, as well as beneficial regulatory improvements at the local and international

levels, will assure that the Islamic finance industry keeps growing at a sustainable rate.
 Bibliography

Banna, H., Alam, M. R., Ahmad, R., & Sari, N. M. “Does financial inclusion drive the Islamic

banking efficiency?” A post-financial crisis analysis. The Singapore Economic Review, 67(01)

(2022): 135-160.

Boukhatem, J., & Moussa, F. B. “The effect of Islamic banks on GDP growth: Some evidence

from selected MENA countries” Borsa Istanbul Review, 18(3) (2018): 231-247.

Boukhatem, J., & Moussa, F. B. “The effect of Islamic banks on GDP growth: Some evidence

from selected MENA countries.” Borsa Istanbul Review, 18(3) (2018): 231-247.

Chong, B. S., & Liu, M. H. “Islamic banking: interest-free or interest-based”. Pacific-Basin

finance journal, 17(1) (2009): 125-144.

El‐Gamal, M. A. “Mutuality as an antidote to rent‐seeking Shariah arbitrage in Islamic

finance.” Thunderbird International Business Review, 49(2) (2007): 187-202.

Hamour, M., Shakil, M. H., Akinlaso, I. M., & Tasnia, M. “Contemporary issues of form and

substance: an Islamic law perspective.” ISRA International Journal of Islamic Finance. (2019)

Hamour, M., Shakil, M. H., Akinlaso, I. M., & Tasnia, M. “Contemporary issues of form and

substance: an Islamic law perspective”. ISRA International Journal of Islamic Finance. (2019).

Hanif, M. “Economic substance or legal form: an evaluation of Islamic finance

practice.” International Journal of Islamic and Middle Eastern Finance and Management.

(2016).

Hassan, M. K., Sanchez, B., & Safa, M. F. “Impact of financial liberalization and foreign bank

entry on Islamic banking performance.” International Journal of Islamic and Middle Eastern

Finance and Management. (2013).

Hesse, H., Jobst, A., & Solé, J. “Trends and challenges in Islamic finance.” (2008).
Kettle, B. “Introduction to Islamic banking and finance.” John Wiley & Sons (Vol. 551) (2011).

Khan, M. M., & Bhatti, M. I. “Islamic banking and finance: on its way to

globalization”. Managerial finance, 34(10) (2008): 708-725.

Mbawuni, J., & Nimako, S. G. “Muslim and non-Muslim consumers’ perception towards

introduction of Islamic banking in Ghana.” Journal of Islamic Accounting and Business

Research. (2018).

Rosly, S. A. “Critical issues on Islamic banking and financial markets.” Author house,

Bloomington. (2005).

Rosyada, F. A., & Adinugraha, H. H. “The Influence Of Hijab Fashion Trends On Consumptive

Behavior Of Islamic Banking Students At IAIN Pekalongan.” Journal of Management and

Islamic Finance, 2(1) (2022): 43-53.

Van Greuning, H., & Iqbal, Z. “Risk analysis for Islamic banks”. World Bank Publications

(2008).