The Rise of Islamic Finance

Over the past decade, Islamic finance has grown at an exponentially high annual rate of between 10-12 percent. In 2015 there was approximately 2 trillion USD worth of sharia compliant financial assets covering banking, capital markets, money markets and insurance. In many Muslim majority countries, Islamic banking assets have been growing at a more rapid rate than conventional banking assets; however, there has also been an ongoing developing interest in Islamic finance from non-Muslim countries such as the United Kingdom, Luxembourg, South Africa and Hong Kong. For example, Hong Kong issued their first sukuk, ‘in basic terms an Islamic Bond’, back in 2014. Companies such as Goldman Sachs and General Electric have also started jumping on this bandwagon. In 2017, the value of Islamic bonds (sukuk) issued outside the Muslim majority nations reached 2.25 billion USD, which is higher than 2016’s 2 billion USD and more than double the 1 billion USD recorded in 2015. What are the driving forces behind the growth and positive perception of Islamic Finance? Throughout the 2000’s it was the major economic growth in Muslim countries fueled by increases in oil prices and the solid investing decisions (guided by certain principles) made by the banks.

Islamic finance is guided by four principles: 1) prohibition of interest, 2) linking financing with real assets, 3) abolishing engagement in immoral and unethical business and business practices, and 4) linking return to risk. These principles result in Islamic finance being equity based, asset backed, ethical, sustainable, environmentally friendly, and socially responsible. The World Bank uses Islamic finance as a vehicle for initiating economic development and prosperity, promoting financial sector development & broadening financial inclusion, and strengthening financial stability.

The use of profit and loss sharing arrangements encourages the provision of financial support to productive enterprises that can increase output and generate jobs. The emphasis on tangible assets ensures that the industry supports only transactions that serve a real purpose; thus, discouraging financial speculation and usury. Given its link to physical assets and the real economy, Islamic finance offers benefits for economic growth and reducing the amount of poverty.

Though poorly publicised, its Sharia principles encourage a spirit of partnership between suppliers and customers that benefit small businesses in developing nations. These businesses usually have difficult times when applying for credit as they do not have existing teams dedicated to credit management and usually incur great overhead costs when becoming involved with the process. However, the Islamic model enables finance to be more accessible to these businesses due to one of its fundamental principles: partnership, which in consequence results in Islamic banks taking more of the strain.

Islamic finance helps promote financial sector development and broadens financial inclusion. By expanding the range and reach of financial products, Islamic finance could help improve financial access to individuals and families that are otherwise deprived of them. Islamic finance emphasizes partnership-style financing, which could be useful in improving access to finance for the poor and small businesses. It could also help improve agricultural finance, contributing to improved food security. In this regard, Islamic finance can help meet the needs of those who don’t currently use conventional finance because of religious reasons. Of the 1.6 billion Muslims in the world, only 14% use banks so in the end it can help reduce the overall gap in access to finance, especially since non-Muslims are also granted access to Islamic financial services.

Islamic banks and financial institutions were left relatively unharmed during the 2008 worldwide financial crisis primarily thanks to their fundamental operating principles of risk sharing and avoidance of leverage and peculiar financial products. Hence, Islamic institutions and products help promote a more stable financial and economic environment. Nowadays, investors see Islamic finance as a more stable alternative to the conventional banking system and as a more ethical vehicle for money management. Furthermore, the heightened appeal for sustainable and responsible investing could grow Islamic finance to new heights due to their strong roots and commonalities in values and shared principles.

Despite the many positive aspects of Islamic finance, there exists a socially negative stigma around this particular type of banking. Primarily due to Islamophobia and the belief that Islamic banks promote terrorism, many stateside investors are concerned about the rise of Islamic banking.
For instance, this topic has gained attention during the 2016 U.S. presidential election following allegations that both candidates were suspected of dealing with Islamic banks that fund terrorism. Investigations put these claims at ease, but it grew a spotlight on this industry. Despite these allegations, the aggregate capital of Islamic banks has grow from 200 billion USD to 3 trillion USD since the year 2000. Moreover, the share of Islamic finance in the global financial system sits between 5 and 6 percent, but according to analyst reports, the sector is expected to grow by 19.7 percent annually through 2018.

Overall, Islamic banking has tremendous growth potential and has predominantly been gaining ground in the gulf countries and Asia, yet has penetrated many non-Muslim majority countries with the issuance of sukuk. It still holds an insignificant share of the global financial market, but with the many positive aspects revolving around Islamic finance, you can say that it is paving the way to a more sustainable and stable future.

Written by Sebastian Olichwier