Derivatives in Islamic Finance
Islamic Economic Studies, Vol. 15, No. 1
33 Pages Posted: 20 Sep 2007 Last revised: 6 Jan 2010
Despite their importance for financial sector development, derivatives are few and far between in countries where the compatibility of capital market transactions with Islamic law requires the development of shariah-compliant structures. Islamic finance is governed by the shariah, which bans speculation, but stipulates that income must be derived as profits from shared business risk rather than interest or guaranteed return. This paper explains the fundamental legal principles of Islamic finance, which includes the presentation of a valuation model that helps illustrate the shariah-compliant synthetication of conventional finance through an implicit derivative arrangement. Based on the current use of accepted risk transfer mechanisms in Islamic structured finance, the paper explore the validity of derivatives from an Islamic legal point of view and summarizes the key objections of shariah scholars that challenge the permissibility of derivatives under Islamic law. In conclusion, the paper delivers suggestions for shariah compliance of derivatives.
Keywords: derivatives, securitization, structured finance, Islamic banking, Islamic finance, sovereign securitization, shariah compliance, sukuk, mudharaba, ijara, murabaha, riba, istina, gharar, maisir, maslaha
JEL Classification: D81, G15, M20
Suggested Citation: Suggested Citation