Islamic financial institutions are one of the fastest-growing industries in global finance. Since 2009, the compound annual growth rate has been 17%. In 2015, the industry’s global assets totalled between $1,900,000,000,000. The Islamic banking sector is of great importance to several Asian countries:
Islamic banking services account for over 15% of these countries’ total domestic banking sectors. Our overview will explore what an Islamic financial institution is, how it works, its main components, and how it differs from conventional banks.
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Islamic finance combines products and financial activities from banks and financial institutions under Islamic law. By the latter, it means sharia law. The sources of Sharia law include:
At the same time, Sharia compliance is a rather broad concept. The point is that these laws are not codified, so they evolve and can have different interpretations. Muftis (that’s what Islamic scholars are called) and Sharia-compliant counsellors follow various laws. It depends on their sect, school and location. That is why laws can be interpreted in different ways.
When analysing Islamic finance products, paying attention to several fundamental principles is essential. The main ones include:
Although Sharia law may be interpreted differently, all the above prohibitions are the same.
Conventional banking differs from Islamic. Islamic banks do not engage in usury and speculation. Shariah imposes strict prohibitions on:
Also prohibited are any investments related to things that the Koran strictly forbids. These include pork, alcohol, and gambling.
Islamic finance is often referred to as Islamic banking or Shariah finance. It is a special financial activity according to the established rules. Conventional banking differs from Islamic banking in 2 important ways. In particular, Islamic banks use the following practices:
Shariah strictly prohibits charging interest on loans. Islamic banks profit from participating in equity. Islamic trust certificates imply that the borrowers must give some of their profits. Islamic banking services are provided without interest.
Islamic finance has certain rules. In particular, they are based on Islamic values regarding commercial transactions. By principles, religion is meant. Financial principles are taken directly from the Quran. Bank gradually transfers funds that must necessarily be by the Shariah. A special Islamic law, fiqh al-muamalat, is used in this situation.
Islamic banks operate based on Shariah principles. In particular, the concept of riba and other key components are used:
The financial stability of Islamic banks depends on many key components. In addition, given the importance of Islamic finance for many countries, an Islamic financial services board has been established.
In particular, it promotes the study of the consequences of using Islamic finance schemes, what benefits they provide, what risks are associated with them, and so on.
The presented institution of financing is most often found in Muslim countries. At the same time, Western countries are just getting acquainted with these rules. Islamic finance works on a special principle, considering prohibitions and other peculiarities.
Islamic banks cannot charge interest as a traditional practice, so they use a different scheme. Citi Islamic Investment Bank and other institutions use equity participation systems. The latter means that the Islamic bank lends money to the company. Then, the borrower repays the debt without interest but gives the Islamic bank a portion of its profits (a substitute for interest).
If the company is unable to repay the debt or does not make a profit, the interest-free banks will also not receive their benefits. In principle, Islamic banks are often more inclined to take risks in their investment activities. Therefore, they are often quite selective when cooperating with different types of businesses for fear of getting involved in an economic bubble that could bring losses.
Islamic banking occupies a relatively small share of the global financial sector. At the same time, the international Islamic financial market is growing quite rapidly. It has a huge potential for development in the future.
Currently, Islamic banking plays a big role in a few countries, including Western countries, where there is a high percentage of economically active Muslims. In addition, the internationalisation of the Sukuk market has increased cross-border financial flows and linkages.
Islamic banking has the potential to promote greater financial intermediation and inclusivity. The latter occurs among a predominantly Muslim population that does not always receive quality service from conventional banks. It also has the potential to facilitate lending to support medium and small businesses.
To understand how the presented banking system works, we propose familiarising ourselves with a case study illustrating practical applications. The first example of Islamic banking in the modern world is Mit-Gamr Savings Bank. It used a system of lending to enterprises based on the profit-sharing model.
However, in 1967, this project was closed down due to political reasons. At the same time, Islamic banking was very cautious — the bank approved only 40% of all enterprise loan applications.
Islamic banking has certain problems and advantages each party can evaluate during cooperation. At the same time, the presented financial system continues to develop, eliminating problems in parallel.
Islamic banking promotes the following:
Those who need money for product launches, business expansion and other tasks of profit and loss sharing with their investors. Islamic finance markets can benefit every income level. As a result, this could have a favourable effect on increasing stability and reducing violence. And this is happening at all levels.
The Islamic finance industry also has certain challenges:
There are many problems, and they all need to be addressed accordingly.
Islamic finance has shown incredible growth over the last 30 years. The number of Islamic finance refers is increasing from year to year, and the number of member countries, companies, and financial institutions involved in this field is also growing.
Most experts have concluded that Islamic banking has a bright future. It is significantly superior to conventional banking and has every chance of replacing conventional finance.
The Islamic finance sector is becoming increasingly attractive to Western countries. However, only some can implement Islamic principles in their financing system. In particular, for this to happen in the future, the presented system requires the introduction of trends and innovations. They must be able to address the challenges mentioned above.
Islamic finance started with a fairly simple model: to provide Muslims with appropriate products to fulfil their spiritual needs. But at the time, only some were convinced they also needed total Islamic finance assets.
The key issue is to educate Muslim consumers on the concept, as growth opportunities in Muslim countries remain at the forefront and are considered the most promising option for the industry.
