Islamic finance is a concept that merges the Islamic ethical principles and moral values alongside the Islamic legal rulings with the modern finance and banking system. Islamic finance is about structuring and offering financial products and services according to the Islamic law of contracts, legal (shariah) rulings and fatwas. However, it is not a set of religious products or services per se, rather it is designed to cater the financial requirements of the people who intend to use such products and services while complying to their ideology and faith, or even subscribing to ethical and social aspects of it.Islamic finance also serves as a viable alternative financial system offering a wide range of products and services that cover almost the whole scope of the conventional financial system; in this way, it is also attractive to non-Muslims.
With global assets of well over US$2 trillion, Islamic finance is becoming a force to be reckoned with, particularly in the Islamic financial hubs of the GCC, Malaysia and the UK. The sector is successfully emphasizing its shariah-based foundations that assert Islamic principles to attract new clients, both Muslims and non-Muslims, who are looking for more ethical ways to bank and finance projects.
Islamic Finance is governed by mainly four principles which include principle of justice and fairness, principle of equity, principle of participation and principle of ownership.
1. Principle of Justice and Fairness is the core of Islamic commercial law and law of contracts. Islamic law (shariah) ensures that no party of a transaction is treated unjustly and unfairly, while protecting the rights of all the parties involved. Ultimately, it promotes sustainability and stability of the financial system which is crucial for avoiding financial crisis.
2. Principle of Equity is invoked by the rationale for the prohibition of predetermined payments (riba). This principle is focused to protecting the weaker contracting party in a transaction. Moreover, this principle also focuses upon prohibiting excessive uncertainty (gharar). This reduces asymmetric information as the transacting party has a moral obligation of disclosing information before engaging in a contract. Under the same principle, gambling and betting (qimar) are also not allowed which subsequently decrease instability and uncertainty in the financial markets.
3. Principle of Participation is based upon the key pillar known as profit-and-loss sharing, and partnership-based financing activities, instead of interest-based lending and borrowing mechanisms. Islamic finance lies upon the rulings that the return on investment must be earned in tandem with liability and risk-taking instead of mere passage of time (opportunity cost).
4. Principle of Ownership is based on the rulings that one cannot sell what he or she does not own. Moreover, every exchange transaction involves transfer of ownership and risk of an approved subject matter, be it an underlying asset or service, to gain profits. In this way, Islamic finance forges a robust link between finance and the real economy.
With such golden principles Islamic finance is thriving in many sectors and regions. According to Dinar Standard’s State of the Global Islamic Economy Report (2019), total Islamic finance market assets were USD 2.5 trillion in 2018, and are expected to grow by 5.5% CAGR. By 2024, it is estimated to reach USD 3.5 trillion. The major hubs of Islamic finance are Iran, Saudi Arabia, and Malaysia by asset size; however, the phenomenon is global. There is a total of 1,396 Islamic financial institutions around the globe, while 93 Islamic fintech startups have also been initiated.
Image Source: Dinar Standard (2019), Global Islamic Economy Report
Although, there are various sectors under Islamic financial system, for instance, Islamic bond (sukuk) sector, Islamic insurance (takaful) sector, Islamic equity market, Islamic fund management, but Islamic banking is the main accelerator and the biggest sector in the whole ecosystem, comprising 70% of the total assets of Islamic finance.
Source: Dinar Standard (2019), Global Islamic Economy Report
New entrants including banks and other financial institutions are being attracted towards the Islamic finance Industry.There have been substantial mergers across the GCC which have driven up the creation of scaled global entities. Sukuk (Islamic bonds)are recognized to be an increasingly important financing tool for large businesses and governments.The industry plays a critical role in different sectors which include appetite for Shariah investing for the investors, boosting economic growth which will unlock the growth for the governments and businesses. Moreover, Entrepreneurs can develop their halal industry businesses through synergy with Islamic finance.
Additionally, fintech has been considered a disrupting phenomenon for the conventional financial industry, as well as Islamic finance industry. The issues of decentralization, efficiency, cost-effectiveness, automation and digitization in the traditional Islamic finance industry are being addressed by the technology firms and fintech companies. Fintech is going to be a complete game changer for the Industry,and it will harness the Industry to move closer to its core principles.Furthermore, technology will improve efficiency of Islamic financial institutions such that there will be no operational or cost disadvantage for them when compared to conventional counterparts. Fintech will break borders to create a truly global industry and enable the Islamic financial institutions so they could provide the next generation of financial products and services.
The success of the Islamic finance industry can be explained by the fair, ethical and social approach to businesses, investors, and other parties involved in the financial transactions, specially at a time when there is lack of trust in the conventional financial industry. Furthermore, with the use of latest technologies, it will strive to achieve advantage over the conventional financial industry.
Author : Dr Farrukh Habib holds a PhD degree in Islamic Finance from INCEIF, Kuala Lumpur, Malaysia. He acquired a master’s degree (M.Sc.) in banking and finance from Queen Mary, University of London, UK. Prior to that, he obtained master’s and bachelor’s degrees in Economics as well. Dr Farrukh Habib is currently the Chairman of Leading-Edge Alliance Software Consultant, Dubai, UAE. Previously, he was a Researcher at International Shariah Research Academy for Islamic Finance (ISRA), a research institute under the Central Bank of Malaysia (BNM). He is also the co-editor of ISRA Journal of Islamic Finance (indexed by ESCI and SCOPUS).
Baker, E., 2020. Islamic Finance Goes Global. Strategy and Business. Available at: https://www.strategy-business.com/article/08217?gko=40ed0
Chloe Domat. (2020). What Is Islamic Finance and How Does It Work? Global Finance Magazine. Available at: https://www.gfmag.com/topics/blogs/islamic-finance-faq-what-islamic-finance-and-how-does-it-work
CIMA Global. (2020). An Introduction to Islamic Finance. Available at: https://www.cimaglobal.com/Documents/Islamic%20finance/Rebrand%20Brochures/UPDATED%20Islamic%20Introduction%20brochure%20(WEB).pdf
Dinar Standard. (2019). State of the Global Islamic Economy Report. Dubai, UAE: Dinar Standard. Available at: http://www.siicex.gob.pe/siicex/documentosportal/alertas/documento/doc/661967144radC8C6E.pdf
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Disclaimer: The contents of this article is for information only and is not offered as advice. Readers are encouraged to consult a suitably qualified professional adviser to obtain advice tailored to their specific requirements.
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