Islamic finance complexity (Part I)

I have been pulled away from blogging, mostly because I was finishing a chapter I am contributing (for a book which is coming out next year) on Islamic microfinance.  Hopefully, I'll be able to address some of the topics I was researching for the chapter in future blog posts (and newsletters).  However, first I thought it would be useful to revisit one conclusion from my last blog post on whether Islamic finance can "return to basics".  I wrote:

"The underlying reason I think that this complexity has arisen is because the Islamic finance industry has focused on creating financial products in a way that they are Shari'ah-compliant, rather than starting from 'first principles' of finance (i.e. what need are they addressing) and looking at how Islamic finance can meet these needs."

Given that the Islamic finance industry has branched into so many different areas, it is difficult to succinctly define the "financial needs" that Islamic finance is supposed to serve.  In some ways, the financial needs are not any different from the "financial needs" that conventional finance, which can lead to (somewhat deserved) cynicism about how the industry works now and whether there is anything that can usefully be accomplished within the Islamic finance industry as it is constructed now. 

But to start the thought process (this blog post and future ones on the topic are almost as much exercises for me to think through the issues as it is intended to share the thoughts with readers) every financial institution should serve two sides as an intermediary, matching the excess funds on the one side with the need for funds on the other.

• Islamic (retail) banks: 
• Hold Excess Funds: Depositors, Investors
• Need Funds: Individuals, Companies

• Islamic (investment banks) banks: 
• Hold Excess Funds: Investors
• Need Funds: Companies, Governments

• Islamic investments: 
• Hold Excess Funds: Investors
• Need Funds: Companies

• Takaful: 
• Hold Excess Funds: Individuals, Companies
• Need Funds: Individuals, Companies (when need arises in the future)

In some ways these different functions (drop any general categories I have missed in the comments) are all inter-linked.  Investment companies will invest in equity (and debt) of the Islamic banks and takaful companies.  Takaful companies will invest the premiums (donations) from policyholders in the Islamic investments.  Islamic banks will provide financing to companies that also receive investments from other Islamic financial institutions. 

These financial needs are not unique to Muslims, and the institutions should not be viewed as specifically targeted towards Muslims, nor should they necessarily be viewed as mirror images of conventional financial institutions.  My goal (if time permits) is to go through the different institutional types and look at how they are set up today both conventionally and as Islamic financial institutions and critique areas where the Islamic financial institutions have moved too far towards excess complexity at the expense of simply providing a service to meet a basic financial need. 

See the index of other posts: http://investhalal.blogspot.com/2011/11/islamic-finance-complexity.html