NEWS reports are suggesting that no Islamic financial institution has failed in the credit crisis, while unprecedented bailout packages have been put together to deal with the systemic threat posed by the falling conventional financial institutions.

Not that Islamic financial institutions have been unaffected by grim market conditions – after all, they are subject to the same economic environment as conventional financial institutions. Still, years of double digit growth and lack of a bankruptcy in the current market conditions have produced optimism in Islamic finance circles and this optimism is being reflected in some press statements made by Islamic economists highlighting its virtues.

But does this survival mean that the youthful Islamic finance is now ready to shine and influence the thinking in the established conventional finance? Perhaps not. There are three simple arguments to suggest that in order to influence the thinking in conventional finance, Islamic finance needs to do a lot more than surviving the credit crisis.

First, despite the havoc wreaked by the credit crisis, conventional finance has not been pushed to the point of rethinking its fundamentals. While experts are identifying a wide range of causes behind the credit crisis, they are not saying that there is something inherently wrong with either money lending or trading risk through derivatives. In fact, mainstream thought in conventional finance is perhaps more concerned with the possibility of over regulation of markets rather than rewriting the text book.

Contrast conventional finance with mainstream Islamic finance that prohibits money lending and trading of risk, requires all trading to be based on real goods and services, and prefers risk-reward sharing contracts. These prohibitions and requirements are an important reason why Islamic financial institutions did not invest in the products that have hurt their conventional counterparts. But that does not mean that conventional finance is now going to be more favourably disposed to such prohibitions nor should the need for excess liquidity in the oil-rich Arab countries be confused with a desire to learn from Islamic finance.

To influence the thinking in conventional finance, Islamic finance cannot rely on a favourable setting produced by the current crisis. It needs to come up with empirical evidence to prove that the costs of money lending and derivatives outweigh their benefits.

While some empirical evidence against money lending is perhaps already there for debt and poverty in developing countries, the challenge is to put it in the Islamic finance context and also come up with evidence in corporate and consumer lending. Unless modern research methods are used to back up the arguments, it is unlikely that conventional finance would be willing to consider learning from Islamic finance.

Second, the Islamic finance industry needs to establish a track record that it can employ to influence the thinking in conventional finance. Modern Islamic finance is less than forty years old and estimates of its global total assets tend not to exceed $1 trillion whereas the asset of a large conventional bank could be more.

While the share of Islamic finance varies significantly across countries, so far in no country is Islamic finance being associated with a positive impact on economic development which was not achieved by conventional finance. On the other hand, Islamic finance remains subject to fierce criticism for putting form over substance.

For instance, critics of Islamic finance say that some Islamic banks effectively lend money on interest through Tawarruq, where the bank first purchases a commodity with a stable price from a broker on spot, sells it to the customer on credit, who in turn immediately sells it on spot to realise the proceeds. The purchases and sales are done instantaneously and none of the parties needs the underlying commodity making the transactions look like a meaningless ritual.

Similarly, the tendency in Islamic finance has been to replicate conventional financial products, sometimes by increasingly liberal interpretations of Shari’a. Thus many consider Shari’a compliance to be a question of structuring the desired form rather than a change in substance. Take for instance the market for Sukuk (often called the Islamic bonds). Some of underlying structures in Sukuk had become so dangerously close to conventional bonds that the influential and conservative scholar from Pakistan, Taqi Usmani, had to issue a biting critique that shook the Sukuk market.

Still, it is not difficult to find those who justify the inclusion of conventional derivatives in Islamic finance or defend controversial practices like Tawarruq. Clearly, replicating conventional products and structures in this manner is not the way to teach a lesson to conventional finance.

Third, many underlying causes for the credit crisis are problems of governance which are not unique to conventional finance. Decision- makers - whether mortgage brokers, credit rating agencies, the US legislature, regulators, or others - were either unable or unwilling to exercise independent judgment due to conflicts of interest. These governance challenges are clearly relevant for Islamic finance.

Take the case of Shari’a Supervisory Boards that rule whether a product or service is impermissible or not. Ordinary Muslims have high, and at times unmet, expectations of wisdom and piety from the scholars serving on these boards. Given the potentially large compensation of scholars, the Shari’a Supervisory Boards are subject to conflicts of interest and critics have been hitting them hard.

Mahmoud El-Gamal, a professor at Rice University in the US, charges the scholars with promoting “rent seeking Shari’a arbitrage” and earning large sums for themselves. Products approved as Shari’a compliant by some boards have later been criticised for lack of such compliance. Still, we are yet to see a systematic response based on transparency and accountability to such criticism. And the conflict of interest in Shari’a supervisory boards is not the only governance issue facing Islamic finance.

There is cynicism that given the general lack of good governance in many countries with large Muslim populations -- not unlike other developing countries -- Islamic finance may not be able to break free and chart a course of success of its own. In an environment that does not foster trust or enforce contracts, investments based on risk-reward sharing – the essence of Islamic finance - are unlikely to compete effectively with collateralised money lending.

In sum, despite the credit crisis, conventional finance remains unlikely to reconsider its fundamentals and Islamic finance needs research, genuine risk-reward sharing, and a track record of success to be able to influence the thinking in conventional finance.

Usman Hayat, CFA is Director Islamic Finance & ESG Investing at CFA Institute.