The Islamic Stock Exchange

Islamic Stock Exchange

IN THE CONTEMPORARY corporate world, the stock exchange plays an important role as financial intermediary between those who have surplus funds, and those who need the money. The former are the investors while the latter are the entrepreneurs. Therefore, the stock exchange is playing the role of a middleman or intermediary between these two parties. The Kuala Lumpur Stock Exchange (KLSE) is an organized market, and the two parties have to pay transaction costs for the services provided.

This chapter intends to

  1. Analyse the current practices at the KLSE as a financial intermediary and identify the main beneficiaries;
  2. Investigate whether Islam can bring an alternative to the current practices to create a healthy and conducive environment to the stock exchange; and
  3. Propose the establishing of a small Islamic stock exchange (SISE) to cater for the needs of small-and medium-sized enterprise to enable them to raise funds for business expansion.

The KLSE is divided into two boards, namely, the Main Board and the Second Board. For the former, the requirement for a company to be listed is a minimum of RM20 million while for the later it is between RM5-20 million.

We must question whether this division of two main boards serve the needs of small-and medium-sized enterprises (SMEs) with less than RM5 million, whose main objectives are to raise funds (through KLSE) to expand their businesses. As far as we can see, the mechanism prevailing at the stock exchange does not only help the rich get richer but also make corporations bigger, more powerful, and monopolizing the wealth of the nation. Such practices, if not rectified by the relevant government authorities will sooner or latter make the stock exchange more alien to the society rather than part of it. This fact enhances the argument that we are indeed living in a world of unfairness and injustice: the world of the giant corporations where the “bigger fishes swallow the smaller ones.”

In the KLSE, there are also two main players, namely, the genuine investors and the inside traders. For the former, the main reason for their involvement in the stock exchange is simply either to raise funds for business expansion or to make quick profits. Therefore, the investors have to work harder and study the macro-economic fundamentals as their starting point. They have to analyse the various factors that will affect their investment decisions at the second stage. These factors are unemployment rate, inflation, business cycle, rate of growth, interest rates, etc. Once a thorough assessment has been made (by themselves or by their investment consultants) on the macro-economic fundamental, the second stage starts: analysing the micro fundamentals of the chosen companies among which are, their growth rates and past records, dividends, sales turnover, profitability and other financial ratios.

For the latter (the inside traders), they are known to spread rumours in the stock exchanges. This kind of people ;usually do not work hard compared with their counterparts (the genuine investors). Their main objective is to make a fortune over a short period at the expense of others. They would release false information and cause panic to the whole stock exchange, and more specifically, to the genuine investors, to make them quickly sell off their shares. Moreover, we suspect that these rumours are usually started by some of the big corporations in the stock exchange to manipulate the market and force the genuine investors to go out of the stock market forever. Many investors think that the inside traders are a group of people who will be able to buy the shares at a bargain price at the expense of the investors. This is why large number of investors refuse to raise funds from the stock exchange (perhaps also for moral and ethical reasons) for business expansion while others feel that current stock exchanges are becoming more like casinos or gambling dens, and according to their beliefs and ethics, such practices are unlawful and should be avoided. Ironically, such a practise does not only prevail at KLSE but also in other stock exchanges (like the New York Stock Exchange) all over the world. It is indeed based on speculations and manipulations (internal and external factors) rather than economic and financial fundamentals.

The question should be asked: should we continue to have such unfair practices in the stock exchange where few are monopolizing the wealth of the nation at the expense of the others? Or is it the right time for the policymakers in the corporate sector to restructure the stock exchange by bringing changes and introducing new rules and regulations to safeguard the small investors and entrepreneurs. If such changes were introduced and enforced (by the relevant authorities) they will undoubtedly create a healthy environment for the whole financial market to exist. For the small investors, it will bring new hope and they will again be keen to be active players in the stock exchange either in buying or selling shares or by raising funds for business expansion.

An Islamic Alternative

Islam as a way of life can bring an alternative and create a healthy environment to the stock exchange. The most fundamental teaching that Islam advocates in any financial transactions is “you should not do harm to others while others should not do harm to you.”

At the macro level, this dynamic concept has its own grass-root Islamic foundation. It is based on ethical and moral values rather than materialism. It is focused on the role of man in the society as vicegerents (khilafah) of God (the main Creator and the real owner of wealth and natural resources of the universe) on earth. God has given man the responsibility to test him; the life we are in is indeed a test by God to mankind. Everything in life is planned and well monitored by the Creator, and man will be a accountable for his deeds and actions he has made in this life. According to Chapra, God-given resources are indeed a trust and it should achieve the following objectives:

  1. The resources are for the benefit of all, not just a few. They must be utilized equitably for the well-being of all.
  2. Everyone must acquire resources rightfully and in accordance to the Quran and the Sunnah.
  3. No one is authorize to destroy or waste the resources that God has given. To do so is equated by the Quran to the spreading of fasad (mischief and corruption) which God abhors.

If man fully understands the real massage of Islam in life, he will live peacefully and in harmony with others based on the universal brotherhood.

Prophet Mohammad (May the peace and blessing of God be on him) said: “All human beings are dependents of God and the most beloved of them before Him are those who are best to His dependents.”

He should be honest in dealing with others (realizing that God is monitoring him and there will be accountability afterwards) especially in any financial transaction. His main mission in life is hard work, responsibility, time management and sharing and caring for others. This is why Islam has given importance to the concept of universal brotherhood which implies unity, co-operation and co-ordination rather than hatred, selfishness and greed which is prevailing in the conventional corporate world.

Islam encourages people to compete with each other in every aspect of life-in business and commerce, education and research and development–to help develop a solid and healthy society. Competitions raises efficiency and helps promote human well-being, the overall objective of Islam. A society of trust, moral and ethical values. Undoubtedly, for investors, an improvement in the quality of production means that they will have a market for their product not only for the local but also foreign market to sell their products. Ultimately, the consumers (who are the main target) will benefit, so does the society as a whole. Therefore, competition will create a healthy environment and encourage the investors and entrepreneurs to work harder to have a market for their products.

This is why Islam is in favour of competition and against monopoly. The latter can bring harm to mankind and to the society as a whole. The resources will be wasted and he used unproductively and ultimately it will be monopolized and controlled by a few hands at the expense of others. Monopoly usually means selfishness, greediness, and oversized institutions. This is why Islam advocates the concepts of “small is beautiful.” If the small business is well managed, closely monitored and followed up, it can bring benefit to the society. Once these entrepreneurs are motivated through partnership financing they will work harder and improve their standard of living. They have a mission in life, the first and foremost, being to seek the pleasure of the Creator (who has given them the opportunities and the responsibilities) and to bring happiness not only to their families but also to other people and prosperity to the whole society. These investors (or entrepreneurs) are keen to be bigger and their main objectives are maximization of social benefit rather than maximization of the profit.

In Islam, savers and investors are considered as one body. Once a viable project is submitted to them (for financing) by an Islamic investment company (IIC), who will identify and select the projects based on economic and financial merits, the savers will automatically become the investors of those projects. This dynamic formula explains why Islam encourages us to go for partnership financing and venture capital. It is a challenge, and life without it is indeed meaningless. Muslims should face the challenge to survive in the new economic order set in a world of injustice, exploitations, and hatred between those that have and those that have not. Therefore, Islam has advocated planning for long-term financing for the development of human beings rather than short-term gains to please only some of the rich.

Such a long-term mission will require the need to establish an Islamic consultancy house (ICH) to cater for the needs of the development of human resources. The strategy of the ICH relates to firstly, identification of the interrelated functions that should be performed in a certain sequential order for an effective and efficient promotional role; secondly, a mechanism for making effective decisions; and thirdly, the institutional machinery required to perform the various functions identified.

The ICH identifies the interrelated functions essential for its promotional role as follows:

  1. Identification and selection of the project;
  2. Preparation of the preliminary feasibility study;
  3. Identification of entrepreneurs to undertake these projects;
  4. Provision of training to potential entrepreneurs;
  5. Preparation of detailed project reports;
  6. Provision of technical and financial assistance for projects ready for implementation;
  7. Monitoring and following up of projects;
  8. Managerial and technical assistance for operating enterprises with problems; and
  9. Technical appraisal of projects requiring future financial assistance.

Once a viable and feasible project has been identified by a competent Islamic practitioner (or the ICH), based on economic and financial merits, it can be sold directly to the savers (who will be automatically investors) without any intermediary. A profitable project with a high rate of return will automatically find its market in the corporate sector (through the computer networks and information technology) without any financial intermediary.

From the above analysis, one can say that in Islamic economics, the financial intermediation will have a limited role to play in the society. Through financial intermediary, transaction costs will ultimately be paid by the society and the cost of capital will be expensive for many small entrepreneurs who want to start their venture capital. The current economic and financial crisis in the Western world have undoubtedly demonstrated that in the age of recession many small entrepreneurs cannot survive and they have to close down their workshops and factories. Such persistent economic and financial problems will have an adverse affect on the society as a whole. The main causes for such a situation are transaction costs and interest rates. These people in the corporate world cannot grow simply because they cannot provide the collateral to the financial intermediaries (like the banks and other financial institutions).

Proposed Establishment of a Small Islamic Stock Exchange

From the above analyses, we are of the opinion that the policymakers in the government as well as corporate sector should study the proposal of establishing a small Islamic stock exchange (SISE) to cater for the needs of those small companies with smaller amounts of market capitalization requirement. Such a proposal is in line with the leadership Vision 2020 to promote the SMEs and make them more competitive and efficient. This proposal of establishing a SISE goes in line with Islamic principle where monopoly is prohibited and competition from all parties are encouraged. It is also important for the relevant authorities to set up a Securities Exchange Commission (SEC) to regulate the market so that a healthy environment will be created so that the “bigger fishes will not swallow the smaller ones.” Therefore, the government should consider the following steps.

First, It should impose very strict rules and regulations concerning speculation generated by rumours. Those who buy shares, must retain it at least for six months before they can sell them, and if they do sell those shares before the due time, higher tax or levy would be imposed on them. This will gradually reduce the role of rumours in the stock exchange. Recently, it was revealed that a few people were caught for this act in the Union Paper Holding short-selling scandal. According to Islamic values a person is not allowed to sell something which he does not possess. It is indeed unlawful and unethical to do such a thing.

And second, to reduce the role of the stock exchange as the financial intermediary between the investors and the entrepreneurs. For an entrepreneur to mobilize funds, computer networking and information technology can bring the two parties together without any intermediary. The new formula will be partnership financing between the investors on the one hand, and the entrepreneurs on the other. The transaction costs will be removed an the profit and loss sharing will be introduced as an alternative. We cannot deny that partnership financing will bring stability not only to the financial sector but to the whole economy. This new formula of business enterprise known as partnership will forgo the role of the stock exchange as a financial intermediary, and can benefit not only the new parties but also the whole nation.


Islam is not against speculation if it is made by genuine investors who have worked hard and analysed the macro-and micro-economic and financial fundamentals, and therefore have the right to speculate once the environment at the stock exchange is conducive to do so. On the contrary, what Islam is against is insider trading and the role of rumours, whose main interests are to manipulate the market and force their counterparts (the genuine investors) to sell of their shares at lower prices, Islam categorically condemns that, because such actions will undoubtedly bring harm to others and to the society as a whole.

Islam has clearly emphasized that for any financial transaction between two parties or more, a person should not do harm to others while others should not do harm to him. It is for the policymakers to examine the above proposal to promote the SMEs and make them competitive and efficient to achieve Vision 2020.


  1. The views expressed in this paper are entirely mine and should not be taken to represent any official views or policies of any organization.
  2. M.U. Chapra, Islam and the Economic Challenge, The Islamic Foundation and the International Institute of Islamic Thought, London, 1992, p.207.
  3. Quran 2: 205
  4. Saad Al-Harran, Islamic Foinance: Partnership Financing, Pelanduk Publications, Petaling Jaya, 1992, p.337.
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