Financial Engineering

The essence of financial engineering (FE) is to develop products to address the need of times and help in the growth of economy. The evolution of Islamic Financial products keeping in line with Shari’ah principles and development of various contract forms requires financial engineering. As long as FE is used for this purpose, it is in line with Islam based on the concept of need. Most Islamic products have been based on practices of Islamic economy which was prevalent centuries ago. This was necessary as a start and that effort must continue. Islamic FE developers also need to go beyond these solutions to develop new or hybrid Shari’ah compliant products.

Traditional financial engineering has evolved several new products such as mortgages, options, derivatives, hedging, insurance pension plans, credit cards, etc. to serve the need of times. Niall Ferguson in his book “Ascent of Money” argues that the emergence of West as the most advanced civilization over the past 500 years has as much to do with the innovations in finance and banking as with technology. Islamic finance requires similar innovations. Keeping a check on compliance with principle of Shari’ah will assure that whether these innovations are serving real economic needs or are purely for exploitation purposes.

Based on classical examples, Islamic FE has produced highly beneficial concepts like bai ‘Salam, advance sale; al- Mudarib, agency to run a business; and Murabaha, cost plus markup sale. There are other possible innovations like wage for service or subcontracting. Beyond modifying existing contract vehicles, new and hybrid forms could be developed. These may include combinations of lease and Salam or Ijarah and Musharakah.

Islamic FE can also play a role in defining and regulating the functions of Shari’ah compliance in security trading. Since preferred stocks and traditional bonds contravene Shari’ah, other market products such as Sukuk or leasing stocks could be designed. The regulations should pay close attention to unnecessary market speculation and promote trading of securities. Stability is important for efficient working of security markets.

For growth of Islamic Finance and Islamic economy, new and innovative products and solutions are necessary with an eye for contribution to real economic growth while maintaining compliance with Islamic principles. The goal should be not to just mimic the existing products and somehow make them Shari’ah compliant. The challenge for the innovators in Islamic FE is to go beyond the current product offerings to cover ground which offers products for all levels of risk tolerance.