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Working
Islamic Finance an alternative capital
mode for short term financing – management

working capital management

Umar Nawaz Kayani
College of Business Administration, Al Falah University,
Dubai, United Arab Emirates Received 20 July 2021
Revised 17 October 2021
26 January 2022
Accepted 5 March 2022

Abstract
Purpose – This paper aims to review and compare the conventional and Islamic perspectives of working capital
management (WCM) to devise the best option of financing for managing working capital (WC) in South Asia. The
paper also aims to help the business world for running its operations more smoothly by devising an alternative
source of financing especially during crises such as the global financial crisis 2008 and the COVID-19 pandemic.
Design/methodology/approach – The divergence approach is used for a critical analysis of existing
literature to derive the best possible alternative to the conventional system of financing.
Findings – This paper identifies that Islamic financing is an appropriate mode of financing as compared to
conventional financing for meeting WC requirements in South Asia. Furthermore, under Islamic financing,
the best available alternative way for managing WC needs is the Mudarabah Islamic mode of financing.
Research limitations/implications – This is a theoretical paper and thus does not include empirical results.
Practical implications – This paper provides conventional and Islamic perspectives of WCM. The Islamic
banks in South Asia may devise policies to encourage and convenience firms for using Mudarabah mode for
meeting their WC needs instead of conventional sources. This paper also identifies that small and medium
enterprises may be targeted by Islamic banks in Asian markets for providing funds for their smooth operations
especially during a financial crisis when conventional banks refuse to lend. This will help managers to run
businesses more efficiently and effectively especially during any kind of financial crisis in the future.
Originality/value – To the best of the author’s knowledge, this is the first study that studies the
relationship between WCM and Islamic financing in comparison to conventional financing. Although prior
studies identify an alternative to conventional financing as Islamic financing, no one studied while
considering the WC as the main variable. This paper informs practitioners and researchers about a “state of
the art” Islamic perspective of WCM.
Keywords Conventional financing, Divergence approach, Global financial crisis, Islamic financing,
Working capital management
Paper type General review

1. Introduction
Working capital management (WCM) plays a vital role in affecting firm performance (Tarek
and Rafik, 2020; Kayani et al., 2021). According to Alvarez et al. (2021), the efficient
management of working capital (WC) is critical for the financial health of firms. Efficient
WCM is not only important during financial disturbances but it also helps to increase firm
performance by handling WC strategically (Seth et al., 2020). To meet WC requirements, a
International Journal of Islamic
and Middle Eastern Finance and
The author would like to thank Editor and anonymous reviewers for their constructive feedback and Management
comments. Furthermore, the author acknowledges the research support of Dr Tracy-Anne De Silva © Emerald Publishing Limited
1753-8394
and Professor Christopher Gan, Lincoln University New Zealand. DOI 10.1108/IMEFM-07-2021-0290
IMEFM firm generally depends on banks and other financial institutions for securing sufficient
funds to operate smoothly, especially during financial turmoil (Fernandes et al., 2021).
However, several conventional banks faced failure or received bailout packages from
Governments in the USA, Europe, the UK and in other parts of the world during the global
financial crisis of 2008 (hereafter GFC 2008) (Hassan and Kayed, 2009b, 2009a; Elasrag,
2015). In fact, their survival was a big challenge for themselves, so it was not possible for
conventional providers to financially support firms (He et al., 2021). In general, the GFC 2008
affects the all dimensions and all sort of businesses across the globe (Hassan et al., 2021b).
The number of businesses recorded closure as a result of the GFC 2008 due to non-
availability of sources for meeting their WC requirements as banks refused to provide loan
(Sumedrea, 2013). The GFC 2008, in all asset’s classes, caused stocks crash, jobless markets
and failure of banks and firms. There is still a fear in the business world that these causes
may only be a starter and there may be many more if the crisis spreads to derivative dealers,
credit card institutions and financial corporations. The root causes and its remedies will
keep on being debated in future years in academic research. Now it’s the time for pandemic
COVID-19 which is affecting the business world tremendously (Zimon and Tarighi, 2021).
The major factors for this GFC 2008 crisis was interest, usury, gambling and speculative
activities somewhat similar to gambling (Ahmed, 2010). There are two forms of financing
available to firms – conventional and Islamic. The conventional system of banking finance
is based on interest/riba. Whereas, the Islamic finance is based on Shariah, which is based
on principles of teaching of the Muslim Holy Book the “Quran” and Hadith. Shariah strictly
prohibits all kinds of financial activities which involve interest/riba, gambling, speculation
or any other similar kind of activity, and encourages risk sharing (Kayed and Hassan, 2011;
Bourkhis and Nabi, 2013).
Islamic financing is increasing at a rapid rate in the last two decades (Paltrinieri et al.,
2019; Godil et al., 2020). It has current assets worth of US$2.88tn (Mumtaz Hussain, 2015)
with minimum risk of failure as is evident from the GFC 2008, which did not have any effect
on Islamic financing (Ahmed, 2010). Islamic financing is free from financial crisis shocks
because it takes only a moderate risk and is based on real activities (Mumtaz Hussain, 2015).
The proper check and balance in Islamic finance helps to keep the economy regulated.
Mainly Islamic finance links credit enlargement with real gross domestic product (GDP)
growth which conventional banks lack.
The disturbing side effects of GFC 2008 would have been prevented if financial
fairness and socio-economic justice were prevailing in society, which is the prime nature
of Islamic financing mode. As Islamic finance is based on moral values which contradict
with interest, riba, gambling and speculation (Dridi and Hasan, 2010; Smolo and
Mirakhor, 2010; Hassan and Kayed, 2009b; Hassan, 2009). Islamic financing institutions
operating on the basis of Islamic finance principles aim to keep individual, society and
institutions away from facing any kind of financial crisis (Chong and Liu, 2009; Chapra,
2011). The financial markets including firms who were severely affected by the GFC 2008
and failed to meet their WC requirements started to rethink and revise their source of
funding strategy.
Chapra (2011) and Kayed and Hassan (2011) identify that Islamic financing is a suitable
alternative to conventional mode of financing. Under Islamic financing, there are various
submodes such as Mudarabah, Musharakah, diminishing Musharaka, Murâbahah,

Musawamah, Istisna, Bai Salam and Ijarah for meeting the shareholders requirement.
However, to date no prior (to the author’s knowledge) study identifies the appropriate mode
of Islamic financing for meeting the WC requirements of the firms.
 Furthermore, under Islamic financing, Mudarabah and Musharakah modes are most Working
appropriate for providing funds to firms for meeting their WC requirements as compared to capital
other Islamic modes. However, firms prefer Mudarabah than Musharakah as the
Mudarabah mode, which operates on a profit and loss sharing concept, provides loans with
management
no interest (i.e. riba in Islamic finance). This mode not only provides loans to entrepreneurs
but also allows them to operate freely for making their financial decisions. Whereas, under
Musharakah mode, every stakeholder has an option to interfere into financial and
management decisions. Therefore, firms to avoid interference in their operational decision-
making power opt for Mudarabah.
It is pertinent to mention that WCM and firm performance have been established by
various studies; however, the relationship between WCM and Islamic finance has been
ignored so far in the literature (Croom et al., 2000; Hofmann and Kotzab, 2010; Peng and
Zhou, 2019). Whereas WCM holds a key role in optimizing the cash cycle (Peng and Zhou,
2019; Kayani et al., 2020). Therefore, this paper in general aims to identify the appropriate
mode of financing out of conventional and Islamic financing for WCM and how, based on
Islamic financing, the efficient levels of WCM can be achieved. In particular, this paper aims
to identify the best available submode of Islamic financing for meeting WC needs of firms
especially during any crisis time. For this purpose, a divergence approach confirms that, in
general, Islamic financing is a most suitable alternative to conventional financing, which is
free of interest or riba. The divergence approach used in this article is based on the
bibliometric and systematic review of earlier studies such as Hassan et al. (2021a) and
Alshater et al. (2021).
This paper has manifold contributions. First, this study adds to existing body of
literature by comparing conventional and Islamic perspectives of financing by providing the
fresh literature. Second, this study attempts to find the relationship between WC and Islamic
mode of financing based on existing literature. Third, it provides an alternative mode of
Mudarabah for meeting WC needs. The Islamic banks operating in various countries around
the globe may devise policies to convenience firms for using Mudarabah mode for meeting
their WC needs instead of conventional sources.
The remainder of the paper is organized as follows. Section 2 discusses Islamic finance
perspectives. Section 3 discusses conventional and Islamic finance during GFC 2008. Section
4 discusses conventional and Islamic perspective of WCM. Section 5 discusses Islamic
Finance in South Asian Association for Regional Cooperation (SAARC) and WCM. Finally,
Section 6 concludes the paper, social and managerial implications and provides future
research opportunities.

2. Islamic perspective of financing

The Islamic law or Shariah has been derived from the Quran and other sources such as
Hadith, qiyas and Ijma (El-Gamal, 2006). A financial law set under these rules which, in
principle, restrains or prohibits the inclusion of interest is termed “Islamic finance”. Islamic
finance normally operates on the concept of profit and loss sharing (Ilias, 2009) by
restraining from interest-based activities. Profit and loss sharing is mostly based on
Mudarabah (profit-sharing) and Musyarakah (joint venture). In this way, the borrower
shares profits and losses with the banks, and banks in turn share with depositors (Wanke
et al., 2017). The prohibition of interest in financial dealings is one of the main principles of
Shariah that need to be respected (Abozaid and Abozaid, 2016). However, this does not mean
that all kinds of return are prohibited in executing financial transactions. In addition,
Islamic finance does not allow investing money into sinful activities such as gambling or
depositing money into the conventional banking system (any business conducted based on
IMEFM riba/interest is not allowed in Islam). The flow of financial intermediaries in Islamic banks is
reflected in below given Figure 1.
In 1963, Mit Ghamr Savings Bank in Egypt was a pioneer in Islamic banking. The latest
four decades have seen a tremendous expansion in the volume of Islamic banking. Over 70
countries now practice Islamic banking including Muslim and non-Muslim countries
(Hassan and Lewis, 2007). Pakistan, Iran and Sudan are countries where Islamic banking is
allowed; other countries work in liaison with conventional banking standards (Chong and
Liu, 2009; Majeed et al., 2017). Recent estimates show that Islamic banking has
tremendously expanded its operations and increased net worth from $5bn in the 1980s to
$1,000bn in 2010 (Mohieldin, 2012). Furthermore, the Islamic financing has increased almost
40 times since 1982 (Akbar et al., 2021). In 2014, the total asset value reached US$2tn
(Mumtaz Hussain, 2015) and increased by 10% growth rate and reaches to US$2.05tn in
2017 (Ureta, 2020). However, in 2018, growth rate extended by 2% only. Figure 2 reflects the
worth of Islamic finance over couple of years, whereas Figure 3 reflects the real GDP growth
in major Islamic markets.

3. Islamic finance in Asian markets

The Asian continent and the countries situated in it always hold a significant place in world
indicators including economic, political and geostrategic advantages. The concept of Islamic
finance is emerging and grabbing deeper attention in the Asian markets (Komijani and
Taghizadeh-Hesary, 2018). As the matter of fact, the population in most of key Asian
countries is Muslim. Stating the fact, Pakistan has 96.4%, Bangladesh has 86.3%, Indonesia
has 87.2% and Malaysia has 61.4% (Board, 2019). Islamic finance is not a matter of only
Muslim Asian countries; even in case of India, 172 million Muslims live which is 14.2% of
total population. Hong Kong, China and Singapore have emerged as key players in terms of
Islamic finance by investing in sovereign Sukuk (Iqbal and Mirakhor, 2011).
At the moment, Sukuk and Islamic financing is taking lead in Asian markets. According
to the Ahmad et al. (2019), Asian markets have 22.4% of share in terms of global Islamic
financial assets which amounts to be $419bn. Out of these $419bn, $203.8bn are covered by
Islamic banking assets, $188.4bn are covered under Sukuk dimensions, $23.2bn Islamic

Investment Accounts Saving Accounts

Depositors Finance Users

Financing Income
Income Attributable
to Depositors

Figure 1. Financial Intermediary

Financial
intermediaries flow in
Islamic banks
Source: Adapted from Chowdhury and Haron (2021)
 (Bil. $) Funds Takaful Sukuk Banking Assets Working
2,500
capital
management
2,000

1,500

1,000

500

0
2013 2014 2015 2016 2017 2018 Figure 2.
Islamic finance worth
Source: Central Banks, Islamic Financial Service Board, Eikon, financial
S&P Global Ratings. Copyright © 2019 by Standard and Poor’s intermediaries flow in
Islamic banks
Financial Services LLC. All rights reserved

Iran Malaysia GCC Turkey

(%)

15

10

(5)

(10)
Figure 3.
2013 2014 2015 2016 2017 2018 2019 2020
Key actors in Islamic
Source: S&P Global Ratings, International Monetary Fund. Copyright © 2018 by Standard and growth in terms of
real GDP
Poor’s Financial Services LLC. All rights reserved

funds and $3.9bn in Islamic insurance (Takaful) (Board, 2017). In support to this, Khan et al.
(2020) is also of the view that Islamic financing is increasing at a tremendous rate. However,
Islamic banks in Asia need to have more in depth consultative process among investors,
regulators and sukuks issuer to more quickly be developing a uniform standard based on
fixed income to equity instruments. The same is reflected in below Figure 4.
IMEFM Bond
Decision to Standard
Market
issue documents

Sukuk
Identify the Negotiation
of legal Finalization of
asset (Sharia,
environment documents
structure lawyers)

Figure 4.
Bonds and Sukuks
standardization
Source: S&P Global Ratings

4. Conventional and Islamic finance – GFC 2008

The GFC 2008 was caused by weak management practices and poor surveillance systems
(Lin et al., 2012). During GFC 2008, various industrial countries of the world injected $3tn as
bailout packages to minimize the effects of the crisis. The Bank for International Settlements
(BIS), in its annual report published on 30 June 2008, declared that excessive lending by
banks was the major factor in this crisis. The literature has cited various factors which lead
to the GFC 2008. Table 1 reports these factors as outlined below.
It is imperative to discuss why the conventional banking sector provided more loans.
There were three main factors: poor market discipline; expansion of derivatives; and the
incompetence of central banks. Poor market discipline was due to lack of a profit and loss
sharing concept in the conventional banking sector (Chapra, 2009). Secondly, the extra
expansion of financial derivatives and credit facilities helped to lift GFC 2008 (Hassan and
Kayed, 2009b). Finally, the weak assurance policies of central banks which assured

Reasons – financial crisis Outcomes

Leverage As a result of leverage issue, bankruptcy happened across the

world starting from USA
Mismanagement of asset liability Bank runs
Governance issues The governance issues include fraud and corruption cases. Based
on these factors, the subprime mortgage issue arises
Failure of financial institutions As a result of such situation, the market risk increased, and the
failure of institutions become one of key outcome
Table 1. Injection of money supply in economy As a result of more injection of money in the economic societies
Reasons and lead towards the higher inflation
outcomes – Global
financial crisis 2008 Source: Adapted from Kayed and Hassan (2011)
commercial banks that central banks will support in shape of loans to commercial banks at Working
the time of need. However, in reality, central banks withdrew the support during crisis time. capital
This crisis exposed the world economy and created the need for an alternative approach to
financing to minimize the shocks of any such future crisis.
management
GFC 2008 did not have any impact on Islamic banks’ mechanisms (Ahmed, 2010).
Furthermore, Islamic banks have a higher rate of progress during GFC 2008 (Boumediene,
2015). This provides a strong indication that firms adopt Islamic financing were in a better
position even during a financial crisis (Hassan et al., 2009).

5. Working capital management perspectives – Islamic finance context

In addition to discussing financing perspectives during GFC 2008, financing perspectives in
the context of WCM also needs to be considered. WCM revolves around its four components
i.e. cash, accounts receivable, accounts payable and inventory (Brigham and Ehrhardt, 2013;
Kayani et al., 2019b). The major component of WCM is cash, which is most vulnerable in
terms of management behaviour (Isshaq et al., 2009). Firms hold cash to fulfil transactional,
precautionary and speculative purposes. In the business world, transactional motives are for
day-to-day operations, precautionary motives are to meet unforeseen conditions and
speculative motives are to take advantage of any situation that arises in the context of
purchases (Besley and Brigham, 2005; Gill and Shah, 2012). The amount of cash required for
smooth operation of the firms is determined on the basis of its WC policies (aggressive or
conservative), the payment of dividends, investments and asset management (Opler et al.,
1999).
Kim et al. (2011) explain that transactional and precautionary motives are crucial in
explaining the determinants of the cash holdings of firms. Current practice for firms around
the globe is to keep the extra cash in banks and sometimes the firms need a loan to run
operations. In both cases, interest is involved, which is against Islamic principles (Hossain
and Leo, 2009). This is where the application of Islamic finance’s concept of profit and loss
sharing comes into play, especially for Mudarabah and Musharakah according to which
firms can avail themselves of Islamic banking, particularly in Muslim countries (Ahmed,
2010).
Almost 80%–90% of Islamic banks operate based on the Mudarabah model, as it
provides more freedom for firms to operate with having no interference from bank in
the management decisions of the firm. According to Dhumale and Sapcanin (1998) and
Hassan (2010), in this model, Islamic banks need to arrange the money for short-term
purposes to fulfil their financial requirements for meeting the day-to-day basis
operations.
Accounts receivable is another important component of WCM. It is not only
important for survival of firms but also important for their performance, especially as
it has an important role during any kind of financial crisis (Kayani et al., 2019a;
Biswal et al., 2012). Under conventional financing, accounts receivable is traded on a
mechanism in which customers or clients are provided with some product or service
and they must pay for that product or service in due course. For making such re-
payments under conventional financing business, clients depend on banks which
charge interest for borrowing. In comparison, Islamic financing offers “Murabaha
Receivables”. Under this mechanism a fixed fee is charged to the customer instead of
charging interest. The GFC 2008 shows that many firms became bankrupt due to a
failure to collect their accounts receivable from their customers as banks refused to
provide some loans to some of their clients. However, under Islamic financing only a
fixed fee was charged to clients by Islamic banks for providing this service and
IMEFM required payments were made even during GFC 2008. As GFC 2008 did not have any
effects on Islamic banks liquidity (Boumediene, 2015) and vice versa of this is
applicable for accounts payable component. According to Abuhommous and
Abuhommous (2017), banks should help firms to achieve target accounts payable by
offering financial services in lieu of an interest under “Murabaha Guarantee” (Fiqh
Academy, 1992; Saadallah, 1994).
Finally, inventory is also an important component of WCM. Commodity Murabaha is a
best option in Islamic finance, in which Islamic banks facilitate customers to open bank
accounts and receive financing for management of inventory, which is lacking in the
conventional approach to financing (Dusuki, 2007; Alsayyed, 2010).

6. Conclusion and future avenues

This research reviews and analyses the literature on conventional and Islamic financing
with specific focus on WCM for an in-depth understanding of Islamic perspective of WCM
with south Asian perspective. For this purpose, a divergence approach methodology was
adopted. This research is of view that the most suitable alternative to conventional
financing to meet WC requirements is the Islamic financing, which is free of interest/riba.
Thus, firms for having a smooth supply chain system can depend on Islamic financing
especially during crisis times, when the loans/financial assistances become slow from
conventional banks. Furthermore, under Islamic financing mode, various submodes exist,
and out of these modes, Mudarabah is the best available alternative for meeting WC
requirements, especially during any kind of financial crisis. The reason for best alternative
is that it provides freedom to business world in making their own financial and management
decisions. Secondly, Mudarabah mode is also free from financial crisis shocks because it
takes a moderate risk and is based on real activities. This Mudarabah mode is also very
fascinating for business world as it is based on profit and loss sharing concept. In case of
any loss under this mode, the capital provider i.e. Islamic banks bear all loss and
entrepreneurs, or firms do not face any consequences of financial loss except the loss of
labour work and work finishes without any fruit. Finally, this mode allows firms a more
freedom of terminating the contract at any point of time as per the contract terms or by a
long notice.
Hence, Mudarabah mode of Islamic finance may be used as an alternative option for
firms in comparison to conventional financing for managing its WC needs. This will help
firm managers to run business operations more efficiently and effectively not only during
normal time but also during any kind of future financial crisis.
Gambling and Karim (1986) are of the view that ideas in accounting need to be
reconsidered in the light of Islamic finance based on Shariah teachings. The existing
studies reveal that a much focus while studying WCM has been paid to large firms by
ignoring the small to medium enterprises (SMEs). These SMEs constitute the major
portion of business activities around the globe, as only alone in USA 97% firms are SMEs
firms. Access to finance for SMEs and small firms is a question of survival. It was very
difficult for them to get financing by banks, government organizations and financial
institutions during GFC 2008 when conventional banks refused to lend to them. Hence,
this review provides an opportunity for future researchers to explore the role of
Mudarabah mode of Islamic financing in meeting WC requirements for these SMEs. For
this purpose, Islamic banks need to target SMEs, small firms and all other firms
operating across the globe after devising an effective policy to encourage and convince
them to use Mudarabah model of Islamic financing. This is possible for Islamic banks
after developing a liaison with microfinance institutions that have good contacts with
SMEs and small institutions. Also, these microfinance institutions have links with SMEs, Working
small firms and farmers in villages which may be helpful for Islamic banks while capital
reaching out to these SMEs and small institutions. The role of media can be studies in
disseminating the role of Islamic finance, as media really plays a crucial role in
management
organizational context (Zaman et al., 2018).

6.1 Social and managerial implications

This review also provides a new direction for future researchers to investigate the
empirical relationship between WCM and firm performance based on funding obtained
from Islamic financing which is still non-existent in research. Furthermore, the
empirical research explaining the role of Islamic financing and impact of WCM on the
financial performance of firms during GFC 2008 and COVID-19 may be conducted in
comparison to conventional financing (Aysan et al., 2020). Furthermore, this article
provides a few implications for regulators such as banking regulators can attract new
markets that is SMEs by using the alternative concept of Islamic financing. These
regulators can focus on organizations where they look for Islamic financing due to their
beliefs and can convince them they can use Islamic financing for meeting WC
requirements. The WC regulators may use the findings for considering the Islamic
financing an alternative medium for fulfilling the WC needs. Finally, investors may
prefer to invest in such firms where the Islamic financing is in practice as it will save
them from the disturbance of any kind of financial crisis such as GFC 2008 and COVID-
19 pandemic.

6.2 Generalizability
The findings of this study are mostly generalized to all sectors and countries across
the globe, as the phenomenon of WCM and Islamic financing prevails across the
globe. However, a caution may be provided where Islamic financing is not in practice.
The sole limitation of this work being a descriptive study is the lack of quantitative
analysis.

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About the author Working
Dr Umar Nawaz Kayani is working as Assistant Professor at Al Falah University, Dubai, United capital
Arab Emirates. Dr Umar Nawaz Kayani is an ambitious academician and researcher who graduated
from Lincoln University, New Zealand, with a PhD in Accounting and Finance. He was awarded management
Lincoln University Doctoral Scholarship and Lincoln University Summer Research Scholarship.
Furthermore, he has two Post-Doctorates, one from Lincoln University, New Zealand, and the second
from Istanbul Sehir University, Turkey. He has published in various renowned and reputed journals
of Accounting and Finance and is also a reviewer for various renowned international journals. He has
presented his research work at various international conferences and won outstanding paper awards.
Besides academia, he also worked for the Higher Education Commission of Pakistan as Quality
Assurance and Accreditation officer. The Higher Education Commission of Pakistan is a regulatory
body over the higher educational institutions of Pakistan. Umar Nawaz Kayani can be contacted at:
Umar.Kayani@afu.ac.ae

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