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Risk and Islamic Finance: A Misconception Corrected
Abstract
The discussions on risk – its bearing, sharing, or transfer – have recently assumed prominence in Islamic finance literature in the wake of devastations the 2007-2008 financial crises unleashed across nations. Islamic scholars were quick to claim that there was no impact of the crisis on Islamic banks because they worked on a risk-sharing principle. In contrast, mainstream institutions suffered because they worked on a different plank – the transference of risk to other parties. This Chapter argues that neither the current practice of Islamic banking supports risk sharing as its sole principle nor do its future prospects depend on it. The proposition only seeks to put Islamic finance on a non-existent trajectory. It clarifies confusion regarding the proposition and some of its corollaries. Contextually, it deals with measurement of risk, its relationship with return to capital, and its distributional equitability. The focus of the Chapter is rather restricted. It does not deal with various types of risks the banks face in their financing activities or with issues in risk management.
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