The Islamic law prohibits charging and paying of interest but allows
earning profits on the basis of participation in the market. This legal injunction
has motivated the establishment and successful operation of a number of
Islamic financial institutions. The emergence and rise of these institutions is
an important academic and practical development of our time. The theory of
Islamic finance evolved on the basis of profit and loss sharing (PLS) principle
underlying participatory Islamic financial contracts. However, the practice of
Islamic finance does not conform to the theory and overwhelmingly relies on
the mark-up principle which underlies deferred trade. The PLS is in striking
contrast to the interest mechanism, but the mark-up is not.
The present research inquires the causes underlying the negligence of
the mark-up mechanism at the time when the theory was developing. Looking
at the preferences of users and suppliers of funds, the causes of the
overwhelming use of mark-up in the practices of Islamic finance are also
analyzed. Pakistan has remained at the forefront of financial Islamization. The
research also draws on this practical experience with a view to explore how
the market rewards risk. The study also analyzes the prospects of financial
Islamization in a real world scenario in which most Muslim countries rely
substantially on foreign financial resources.
Thq central conclusion of the study is that the mark-up and PLS
mechanisms have their own merits and weaknesses. The merit of the markup
is that it facilitates the acquisition of assets. The merit of the PLS is that it
links financiers' interests with the outcome of projects. The study
concentrates on the analysis of the inherent characteristics of the PLS and
mark-up as parent principles of Islamic finance rather than the institutional
environment in which these are practiced. It implies that given the market
environment, the strength of Islamic finance lies in the integration of the
prime merits of mark-up and PLS and in developing a comprehensive set of
Islamic financial instruments.
A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University.