By Abdullah Qosim

“If an institution bears the name ‘Islamic’, should its legitimacy be measured solely by the contracts it executes, or also by the ethical ideals it embodies?  This question lies at the heart of contemporary debates on Islamic banking. Over the past five decades, Islamic banking has evolved from a niche experiment into a global financial industry managing trillions of dollars in assets across more than 80 countries. It emerged as an ethical alternative to conventional banking, promising a financial system founded on the principles of justice, transparency, risk-sharing and the prohibition of ribā (interest), gharar (excessive uncertainty) and transactions involving unlawful (harām) activities.

Yet, as the industry continues to expand, so too does the scrutiny surrounding its operations. While Islamic banks have undoubtedly widened access to Shari‘ah-compliant financial services and strengthened confidence among Muslim consumers, scholars and practitioners increasingly question whether many of their products genuinely reflect the spirit and objectives of Islamic commercial law (Maqāsid -ush- Shari‘ah), or merely replicate conventional banking through different contractual forms. The widespread reliance on debt-based instruments such as Murābahah, the limited application of genuine profit-and-loss sharing models and concerns over the independence of Shari‘ah supervisory mechanisms have fuelled an important debate: is contemporary Islamic banking delivering substantive Shari‘ah compliance, or is it often confined to formal legal compliance?

This debate is not an attempt to undermine the remarkable achievements of Islamic finance, but rather an opportunity to strengthen its credibility and ensure that practice remains faithful to principle. An industry established to offer a morally grounded alternative to conventional finance must continually evaluate itself against the ethical values that inspired its creation. After all, compliance with the letter of the law should not eclipse the pursuit of its higher objectives.

Against this backdrop, this article critically examines the extent to which Islamic banks comply with Shari‘ah in practice. It explores the theoretical foundations of Islamic banking, analyses the practical realities of contemporary banking operations and evaluates the principal criticisms surrounding Shari‘ah governance and compliance. In doing so, it seeks to contribute to the ongoing discourse on how Islamic banking can better fulfil not only the legal requirements of Shari‘ah but also its overarching vision of justice, equity and socio-economic welfare.


THE PROMISE OF ISLAMIC BANKING: PRINCIPLES AND OBJECTIVES

Islamic banking is founded on the conviction that finance should serve society rather than merely generate profit. Unlike the conventional banking model, which principally revolves around lending money for interest, Islamic finance seeks to align economic activity with the ethical and legal principles of the Shari‘ah. Its objective is not only to facilitate commercial transactions but also to promote justice, fairness, accountability and shared prosperity. As Zamir Iqbal and Abbas Mirakhor state in An Introduction to Islamic Finance, “the elimination of interest from the economic system is intended to promote economically just, socially fair,  and ethically and morally correct economic behaviour.”

To achieve these objectives, Islamic banks employ contracts that are rooted in classical Islamic commercial jurisprudence. Among the most common are Murābahah (cost-plus sale), Mudārabah (trust-based partnership), Mushārakah (joint venture partnership), Ijārah (leasing) and Salam and Istisnā (forward financing contracts). Each of these contracts is designed to ensure that financial transactions are supported by tangible assets, involve genuine commercial risk and avoid elements prohibited by the Shari’ah, such as ribā, gharar (excessive uncertainty) and maysir (gambling).

A defining feature of Islamic banking is the principle of risk-sharing. In theory, the provider of capital and the entrepreneur are expected to share both profits and losses in proportion to their agreed arrangements. This model reflects the Islamic conception of justice, where entitlement to profit is justified only by assuming commercial risk. Such an approach distinguishes Islamic finance from conventional debt-based financing, where lenders typically earn predetermined interest regardless of the outcome of the financed venture.

Beyond legal compliance, Islamic banking also aspires to realise the broader objectives of Islamic law (Maqāsid -ush- Shari’ah). These objectives include the protection of wealth, the promotion of economic welfare, the prevention of exploitation and the equitable distribution of resources within society. Consequently, Islamic financial institutions are expected to balance profitability with social responsibility by financing productive economic activities, encouraging entrepreneurship and avoiding investments that are harmful to individuals or society, such as those involving alcohol, gambling, pornography or other prohibited industries.

In practice, these principles have contributed significantly to the global expansion of Islamic finance. Today, Islamic banks operate across the Middle East, Africa, Asia, Europe and North America, demonstrating that ethical finance can coexist with modern financial systems. Their growth reflects increasing public confidence in a model that promises not merely financial returns but also moral legitimacy. Nevertheless, the success of Islamic banking cannot be measured solely by its market size or profitability. Its true credibility depends on whether its operations genuinely embody the ethical values and higher objectives that distinguish it from conventional finance. It is at this point that the debate over Shari‘ah compliance becomes both relevant and necessary.



SHARI‘AH COMPLIANCE OR LEGAL FORMALISM? A CRITICAL EXAMINATION

Although the theoretical foundations of Islamic banking are firmly rooted in the principles of justice, equity and risk-sharing, the practical implementation of these ideals has generated considerable scholarly debate. The central question is no longer whether Islamic banking is permissible in principle, but whether its contemporary practices faithfully reflect both the letter and the spirit of the Shari‘ah.

One of the most persistent criticisms concerns the overwhelming reliance of Islamic banks on Murābahah financing. Originally conceived as a genuine sale contract in which a bank purchases an asset before reselling it to a customer at a disclosed profit, Murābahah was intended to be only one of several financing tools available to Islamic financial institutions. However, in many jurisdictions, it has become the dominant mode of financing, accounting for the vast majority of Islamic banking transactions. Scholars argue that this preference is driven by its predictability and relatively low commercial risk when compared with equity-based contracts such as Mudārabah and Mushārakah.

This development has attracted criticism from both Islamic economists and jurists. Mahmoud El-Gamal contends that many Islamic financial products merely replicate the economic consequences of conventional interest-bearing loans while employing different contractual structures to satisfy legal requirements. According to this view, the emphasis has shifted from achieving the ethical objectives of the Shari‘ah to ensuring that transactions are technically compliant with contractual rules. Consequently, some critics describe contemporary Islamic finance as “Shari‘ah-compliant” rather than genuinely “Shari‘ah-based.”

The distinction between form and substance therefore becomes crucial. While a financial transaction may satisfy the formal legal conditions of an Islamic contract, questions remain as to whether it fulfils the broader objectives of promoting fairness, reducing economic inequality and encouraging productive investment. Mohammad Hashim Kamali argues that the Shari‘ah should not be reduced to a checklist of contractual formalities but should be understood in light of its higher objectives, which seek to secure justice and public welfare. A transaction that complies with the legal form of an Islamic contract while producing outcomes indistinguishable from conventional interest-based finance may therefore raise legitimate ethical concerns.

Another area of debate relates to Shari‘ah governance. Most Islamic banks operate under the supervision of Shari’ah Supervisory Boards (SSBs), composed of scholars responsible for reviewing products and certifying their compliance with Islamic law. These boards play a vital role in maintaining public confidence in Islamic finance. Nevertheless, concerns have been expressed regarding their independence, transparency and consistency. Since members of SSBs are typically appointed and remunerated by the very institutions whose products they evaluate, questions inevitably arise as to whether conflicts of interest may compromise objective oversight. Differences in scholarly opinions across jurisdictions further contribute to inconsistencies, with financial products approved in one country sometimes being rejected in another.

Despite these criticisms, it would be inaccurate to conclude that Islamic banks have failed in their mission. On the contrary, they have made significant contributions to the development of ethical finance by providing Muslims with alternatives to conventional interest-based banking, expanding financial inclusion and stimulating the growth of Shari‘ah-compliant capital markets. International standard-setting bodies such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB) have also strengthened governance frameworks by issuing comprehensive standards on Shari‘ah governance, accounting, auditing and risk management. These initiatives demonstrate the industry’s commitment to improving transparency and preserving public trust.

Ultimately, the debate surrounding Shari‘ah compliance should not be viewed as an attack on Islamic banking but as an opportunity for reform. An institution established to uphold justice and ethical responsibility must continually assess whether its commercial practices remain faithful to its foundational values. In his book titled ‘An Introduction to Islamic Finance’, Muhammad Taqi Usmani stated that  “unless we analyse our merits and demerits, we cannot expect to advance towards our total success”. Genuine Shari‘ah compliance demands more than legal ingenuity; it requires a sincere commitment to the objectives of Islamic law, where commercial success is pursued alongside social justice, equitable wealth distribution and accountability before Allah. The challenge before contemporary Islamic banks is not merely to distinguish their contracts from those of conventional banks, but to ensure that their operations embody the moral vision that this divine command seeks to protect.

BEYOND COMPLIANCE TO CREDIBILITY

The growth of Islamic banking demonstrates that ethical finance is not merely an aspiration but a practical alternative within the global financial system. By prohibiting ribā, discouraging speculation and promoting asset-backed financing, Islamic banks have expanded financial inclusion and advanced the development of Shari‘ah-compliant finance.

However, commercial success alone cannot define the industry’s legitimacy. Its true measure lies in the extent to which its operations reflect the ethical objectives of the Shari‘ah. Where legal form takes precedence over economic substance, concerns about genuine Shari‘ah compliance will continue to arise.

Rather than signalling failure, these criticisms present an opportunity for reform. Greater emphasis on equity-based financing, stronger Shari‘ah governance, increased transparency and faithful implementation of standards developed by AAOIFI and the IFSB would reinforce public confidence. Lastly, the success of Islamic banking depends not only on avoiding interest but on promoting justice, fairness and social responsibility. Its future credibility will rest not on defending itself against criticism, but on responding to it through continuous improvement and a steadfast commitment to the objectives of Islamic law.