Islamic law and finance

Abstract

Purpose The purpose of this paper is to discuss Islamic laws which are relevant to finance. More specifically, it covers the types of contracts as foundation for the distinctive Islamic financial products. The current institutional framework of financial institutions seems to be incompatible with the nature of these Islamic contracts. Design/methodology/approach This is a conceptual paper describing the link between finance and economic growth in the present of Islamic contracts, which have various types from contract of partnership, buy‐sale contract, to contract of usufructs. The nature of Islamic contract is to avoid riba (i.e. interest system), because it is unjust and prohibited, meanwhile under conventional system they rely very much on the interest system. Findings The conclusion of the paper is that the distinctive character of Islamic contracts applied by Islamic banking and finance relies mostly on the profit and loss sharing mechanism which contains the cooperative spirit, in the contracts such as mudharabah (profit‐sharing), musharakah (partnership). The development of equity partnership instruments in the financial system necessitates a different set of regulation and institutions in order to achieve Islamic goal through economic/financial activities. Research limitations/implications This paper opines that the current framework of financial institutions does not match with the nature of Islamic contracts. Practical implications This paper suggests that a new framework for financial institutions is necessary in order to accomplish the maqasid‐al‐shariah , by implementing the true spirit of cooperative through various Islamic contracts. Consequently, the rules and regulations and other relevant elements also need to adjust. Originality/value The paper indicates a possible different consequence on the link between finance and growth in the presence of Islamic contracts, i.e. a more positive relation.