Islamic finance encompasses Islamic securities (Sukuk), banking, leasing, Islamic insurance (takaful) and financing. Islamic financial markets have been a subject of talks for the past decade. This is because Islam constitutes 25% of the world’s population and is the fastest-growing religion. As such, the Islamic financial market has been experiencing rapid expansion. In 2003 Islamic financial assets were worth US$200 billion; in 2019, this number increased to US$ 2.88 trillion. This is a 14% growth from the year before (2018), which is “the highest recorded growth for the industry since the global financial crisis.”
The allure of Islamic banks and the associated market is that “they hold more capital, are more profitable than conventional banks, and performed better,” according to Professor Lewis from the university of south Australia. They have even outperformed conventional banks during periods of crisis, such as the global financial markets, without the need to get bailed out by taxpayers' money. This is because Islamic banks avoided and didn’t trade subprime lending and toxic derivative and held more capital. It even led to some discussion about whether the global crisis would’ve occurred if the world followed the Islamic banking model.
The Islamic banks follow the Islamic sharia, the ethical principle, and laws that guide Muslims to lead a fulfilled ethical life. It is based on two primary things: the Quran and the Sunnah (Prophet Muhammed practices). Not going into details, there are several things that a Muslim must avoid in business and finance-related conduct. These are interest (riba), rewards without risk, Gharar (uncertain transactions such as the sale of items not yet present), Maysir (money without labor, such as gambling, possibly speculation), and trade of haram things. Islam in business stresses that an individual must bear risk. The primary mode of financing that tries to follow sharia is Murabaha (bank buys an asset and sells it with a mark-up), leasing, and Islamic bonds.
If we revisit the financial crisis, multiple factors have led to it, misleading contracts, greed, speculation, and poor governance. As we've seen, Islamic banks are against misleading contract Gharar, don’t allow speculation, and is opposed to greed and extravagance. The Islamic financial model stresses the prohibition of usury and lending what is not there, as you expect a fixed future return bearing no risk. Sharia boards are put in place to apply the sharia principle in different circumstances emphasizing the real productive economy over the financial one. As such, it doesn’t divorce the financial from the productive economy as we've seen with modern finance.
Now whether Islamic finance is even Islamic has been a topic of debate. Some have said it's just mimicking the financial market with an Islamic shell, a critique of Hassan Heikal, an Egyptian banker who founded EFG Hermes. However, the financial collapse made it clear that there was something to them. Currently, Islamic finance bears a very low percentage of financial assets. As such has a long way to go to prove itself. For this article am indebted to Professor Lewis's lecture on the rise of Islamic finance.
