Chapter 1
Epistemological Foundation of Finance: Islamic and Conventional Abbas Mirakhor and Wang Yong Bao
Simply stated, epistemology deals with the question of what we know about a phenomenon and how do we know it. For precision, it is helpful to clarify terms used currently in discussions of Islamic finance. Practitioners use the term “Islamic finance industry” to refer to their activities in designing and trading ways and means of financing acceptable to Muslims. Taxonomically, industries in an economy belong to a sector, and sectors belong to subsystems that in turn belong to a larger system. For example, airplane manufacturing firms belong to the airline industry, which in turn belongs to the transportation subsystem, within an overall economic system. Similarly, a bank belongs to the banking industry, which belongs to the financial sector, which belongs to the financial subsystem, which belongs to the larger economic system, which, finally, belongs to an overall sociopolitical-economic system. What then of the Islamic finance industry? It was the conventional finance subsystem that gave birth to the current “Islamic finance industry.” Before the inception of the Islamic finance industry, there was what could be called a “market failure” in the conventional financial system. There was substantial unmet demand for financial products in compliance with Islamic belief. The Islamic finance industry grew out of the conventional finance subsystem to meet this demand. Muslim scholars’ writings since the 1970s on the theory of Islamic finance had envisioned a financial system based on risk sharing in which there would be no interest rate-based debt contracts. Practitioners, most of whom had been operating in the realm of conventional finance, however, were interested in developing ways and means of finance that, while avoiding the appearance of interest-based debt, would nevertheless be familiar to and accepted by market players in conventional finance. The former emphasized profit-loss sharing (PLS); the latter focused on traditional methods of conventional finance, Abbas Mirakhor is professor at the International Centre for Education in Islamic Finance, Kuala Lumpur, Malaysia, and Wang Yong Bao is associate professor at Xi’an International Studies University, Xi’an City, Shaanxi Province, China. Economic Development and Islamic Finance • http://dx.doi.org/10.1596/978-0-8213-9953-8
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