Risk Sharing versus Risk Transfer in Islamic Finance : A Critical Appraisal

Abstract

Some writers on Islamic finance have recently resuscitated the old ‘no risk, no gain’ precept from the earlier literature in the wake of the 2007-2008 financial crisis. They argue that the basic reason for the recurrence of such crises is the conventional interest-based financial system that subsists purely based on the transfer of risks. In contrast, Islam shuns interest and promotes the sharing of risks, not their transfer. The distinction is used to make a case for replacing the conventional system with the Islamic; for that alone is thought as the way to ensuring the establishment of a just, stableand crisis-free financial system. As evidence to support this thesis, it is cited that Islamic banks have faced the current crisis better than their conventional counterparts. The present paper is a critique of this line of thought. It argues that risk sharing is not basic to Islam. Islam approves profit-and-loss sharing;sharing of risk is a consequence of that, not its cause. There is no such thing as a risk-sharing contract per se in Islamic finance that, when entered into,gives rise to profit-and-loss sharing. The paper concludes that while there is a case for encouraging participatory finance in Islam, there is none for treating risk sharing as its inviolable principle. What really requires emphasis is the need for transparent moral conduct and commitment to Islamic ethical norms.