The Regulation of the Institution of Fatwa and the Need for Islamic Economics Policy Think Tanks

One of the main observed divergences between the professed ideals of Islamic economics and the reality of Islamic finance can be seen in the limited use of profit and loss sharing (PLS) financing structures and the prevalence of debt based structures. Islamic economists historically argued that PLS structures would address economic problems such as unemployment and inequality of wealth distribution and argued against debt structures as being more in line with capitalistic objectives and leading to concentration of wealth in the hands of a few at the expense of the many. When Islamic banks tried to implement PLS structures in light of modern times, they found a number of implementation problems which led them to move towards debt based structures, particularly on the asset side of the balance sheet. Moral hazard, information asymmetry, as well as a global banking regulatory system built upon the concepts of conventional banking all made implantation of PLS based financing unworkable as envisioned by Islamic economists.

The industry has also seen a lot of criticism on the role of Shariah scholars who sit on the boards of Islamic banks and who bless this divergence. This paper attempts to show the inherent limitations of the institution of fatwa from both classical sources of Islamic law as well as industry accepted standards on fatwa, such as those issued by the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions). It will show that the institution of fatwa, as classically defined and implemented contemporarily, is limited to answering questions and judging whether a particular legal contract is halal (permissible) or haram (impermissible). In this role, they are more like Supreme Court judges who determine if a particular law is constitutional or not, using a strict interpretation standard. As a Shariah board member of an Islamic financial institution, they do not have the authority to enact particular laws or policies, just as a Supreme Court judge cannot enact legislation. It is only in their personal capacity, and not in the capacity of Shariah board members, can Shariah scholars advise policy makers and the public in light of Shariah principles.

The paper will argue that in the latter capacity, i.e. that of advising policy makers, Shariah scholars and Islamic economists have a great deal of leeway because they are not limited by the institution of fatwa. Rather, in this capacity, they can advise the policy makers to limit or even prohibit certain financial transactions that are generally halal for a greater benefit. Islamic law gives the ruler the authority to limit permissible actions for the benefit of the greater society as a policy measure. Although this policy exercise can be informed by Shariah scholars, it cannot be led by them since it is not within the preview of their authority under Islamic law. The paper will present a proposal for the establishment of Islamic economic policy think tanks which will include Shariah scholars, Islamic economists, policy makers, as well as other stakeholders to present policy papers informed by the ideals of Islamic economics to lawmakers and policy makers.