An analysis of the normative parameters of reward and risk in Islamic finance

Abstract

Purpose: This study aims to define the parameters of the reward-risk principle in Islamic finance as established in the literature and discuss propositions that are presented on how such a principle is to be applied to Islamic banking products. Design/methodology/approach: A descriptive approach is used to explore the normative parameters and criticisms of the application of reward-risk in Islamic finance. Findings: The study finds that the principle of reward-risk is embodied in the multi-component concept of ʿiwaḍ (counter value) which must be evident in market transactions that involve commercial exchanges. The components include risk, costs, effort, value-adding and capital, all of which apply uniquely to different contractual forms of financing. Research limitations/implications: The study uses academic literature and industry documents along with modest contact with prominent practitioners who provided general feedback on prevalent Islamic finance industry practices. Practical implications: This study exposits the variety of approaches in applying the reward-risk principle and sheds light on the primary elements of the principle which will facilitate its greater consideration by the Islamic finance industry. Originality/value: This study is a meaningful attempt at conveniently summing up and applying the parameters that are considered when discussing the scope of the reward-risk principle in Islamic finance.