Conceptualization of the real economy and Islamic finance: Transformation beyond the asset‐link rhetoric

• Date: 01 September 2019
• Author: Mohammad Selim,Mohammad O. Farooq
• DOI: http://doi.org/10.1002/tie.22013
• Published date: 01 September 2019

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Conceptualization of the real economy and Islamic finance:

Transformation beyond the asset-link rhetoric

Mohammad O. Farooq | Mohammad Selim

Department of Economics and Finance,

University of Bahrain, Sakheer, Bahrain

Correspondence

Mohammad O. Farooq, Department of

Economics and Finance, University of Bahrain,

PO Box 32038, Sakheer, Bahrain.

Email: farooqm59@gmail.com

A key factor behind the chronic crises in modern economies is the growing dominance of finan-

cialization and the resulting disconnect between the real economy and the financial sector, to

which conventional financial industry is a key contributor. In contrast, Islamic finance claims to

be real-economy-oriented, as all transactions must be asset-linked (asset-backed or asset-

based). However, is Islamic Finance based on proper conceptualization of the real economy?

What is the real economy and its dynamics? How Islamic finance is interfaced with the real

economy? In this article, the claimed real-economy-orientation is examined by presenting a con-

ceptualization of the real economy and then evaluating the related discourse accordingly. The

analysis presented, especially for noneconomists, exposes a serious gap between the claims

about Islamic finance and the real economy it is supposed to advance. Appropriate conceptuali-

zation of the real economy can help the industry to be relevant and effective for broader socio-

economic transformation.

KEYWORDS

asset-backed, financialization, Islamic banking, Islamic finance, real economy, Shari'ah-

compliance

1|INTRODUCTION

Modern economies are vulnerable to chronic economic/financial cri-

sis, and a key factor behind such crises is the growing dominance of

financialization and the resulting disconnect between the real econ-

omy and the financial sector. Conventional financial industry, of which

the banking sector is the dominant component, is a key contributor to

that disconnect.

The emergence of Islamic finance over the last half century as an

alternative to the conventional, interest-based financial system has

been notable, engaging the interest of Muslims as well as attracting

interest of non-Muslims, especially toward Islamic banking and Islamic

capital market. The industry has an asset base of US $2+ trillion and

has been growing steadily with presence in almost all 57 Muslim-

majority countries and in many non-Muslim-majority countries in Asia,

Europe, North America, and Australia.

Overall, apart from its most important feature being riba-free (or,

interest-free, blanketly equating riba and interest), a key claim about

Islamic banking and finance (IBF) is that, unlike its conventional coun-

terpart, it focuses on the real economy. However, by referring to real

economy what is often understood or implied is that IBF is asset-

linked, that is, asset-backed or asset-based. Asset-linked means that

every transaction in IBF has underlying asset(s). “This is in contrast to

conventional banking where the asset's importance lies only in terms

of collateral security but the asset is not necessarily part of the loan

transaction.”(IMF, 2017) Asset-link can have two forms: Asset-backed

or asset-based

1

While Islamic finance transactions are generally

described as asset-backed, it becomes more nuanced when comes to

products like Sukuk (Shari'ah-compliant equivalent of bonds). In capi-

tal market activities, if a Sukuk contract does not have any designated

asset to which the Sukukholders have a recourse in the case of

default, it is classified as asset-based, while if there are designated

assets to which Sukukholders have recourse in the case of a default,

then it is asset-backed.

2

Asset-link distinguishes IBF transactions from

generally pure conventional financial intermediation of loanable funds.

IBF correctly emphasizes the real economy, and therefore, the

asset-link is relevant.

3

However, is the asset-link adequate as an inter-

face for the real economy? Is IBF as it is understood and practiced

1

Notably, there are contracts, such as wakala, cash waqf, etc., which are linked

to real economy even without necessary involvement of tangible assets.

2

Exceptions include, for example, airtime sukuk (Vizcaino, 2013).

3

Asset-link is not unique to IBF. Even conventional banks have many asset-

linked transactions, such as auto or home financing, though such transactions

are not regarded by IBF proponents as Shari'ah-compliant.

DOI: 10.1002/tie.22013

Thunderbird Int. Bus. Rev. 2019;61:685–696. wileyonlinelibrary.com/journal/tie © 2018 Wiley Periodicals, Inc. 685