How Islamic Finance Shapes the Global Economy

Today, Islamic finance, whose principles are firmly based on the Islamic Law, also known as Sharia, has become one of the fast-growing forces in the global financial system. Established in the last few decades, it has quickly grown from being marginal in nature to being mainstream and impossible to avoid in any of the world economies. This was a concept rooted in ethical and moral concerns. Hence, there is no possibility in such practices as a charge of interest, also known as Riba in Arabic, or to invest in businesses that share connections with forbidden, or Haram in Arabic, activities-let alone the production related to alcohol, gambling, or pork. Rather, the operation puts stress on the likes of risk-sharing and profit-and-loss sharing, etc., with the use of real assets.

The development of Islamic finance through the years has been nothing less than phenomenal. Going by the Global Islamic Finance Report, the global Islamic finance industry crossed the $2 trillion mark in 2020 and is set to see yet another rise. The Middle East, Southeast Asia, and parts of Africa remain the cradles of Islamic finance. The impact is slowly percolating into Europe, North America, and the rest of the world as more countries learn of the potential and effect of the Sharia-compliant financial products by conventional banks.

This paper discusses how Islamic finance has been shaping the world economy: the main principles, the importance of the Islamic bank, the relevance of major financial instruments, and an impact perspective about different regions. We would also come to know about the challenges and potential that lie ahead on the way for this rapidly growing sector and focus on education-related issues of Islamic Finance and regard the prospects.

Islamic Finance: Core Values

There are very vital principles which underlie Islamic finance, and they are always one of the striking differences between this kind of finance and the conventional finance sector. These are not religious strictures, but ethical imperatives which shall ensure that any dealing within finance is fair, transparent, and just.

Prohibition of Riba (Interest)

Perhaps the most prominent feature of Islamic finance is its abhorrence of Riba in Islam or interest. Riba is considered predatory in the sense that it basically enables creditors to profit from the disaster of others’ finances. Money is not considered a commodity in Islam from which one gains more money; it is just a vehicle for circulation. This is probably one of the most frontal attacks that can be presented on conventional banking, which so seriously depends on lending supported by interest.

Instead, Islamic finance encourages arrangements of profit-loss sharing between them. That is, the risks will be shared equally while both the lender and the borrower had an interest in the venture.

Islamic finance allows for an element of risk sharing, yet it does not guarantee returns, and therefore there is concordance of interest among all the involved parties that make a more just financial system. For instance,  in a Musharakah (partnership) mode of financing all the partners inject their capital and share profit and loss according to the proportions of capital provided. In the conventional model of finance, the moneylender is supposed to have no risk and the borrower to bear all the risks.

Asset-backed Financing

Another core principle is that each and every monetary transaction must have some physical backing or some service for it. This would prevent creating money through debt a la fractional reserve banking and ensure that financing is attached to some real economic activity. It thus cuts down on pure speculation and possibilities of financial bubbles, normally due to excessive lending and borrowing without the backing of some asset.

Prohibition of Haram Activities

It is stated that Islamic finance does not allow investment in any kind of industry or allow someone to involve oneself in activities that can be considered haram, or illegal according to the Islamic law, hence the involvement in things such as alcohol, gambling, pork production, and many others. Sharia-compliant organizations engaged in Islamic finance illustrate the exclusion of these industries. Rather, they encourage the placement of ethical investments and align the financial practices accordingly to the set of values dictated by moral and religious principles.

Introduction of Islamic banking to the economy of the world:

Islamic banking diploma is the nerve center of the Islamic financial industry. It has over the years developed from minimally regionalized operations to having Islamic banks in more than 70 countries across the globe. Growth has been ingredient by the increasing appetite for financial products that are compliant with the Sharia in countries dominated by Muslims and but also from countries that have much smaller Muslim populations lured in by the ethical considerations of the products.

Growth and Development in Islamic Banks

Islamic banks have grown considerably on the Middle East and South East Asia; they have become well-intrenched into the economies of countries such as Saudi Arabia, UAE, Malaysia, and Indonesia. The performance of Islamic banks revealed that in some countries, they could capture up to seventy-five percent market share by offering the retail as well as corporate products and services. The performance of these financial institutions ignited the interest in some other parts of the world, and as of this date, some Islamic financial institutions have taken roots in Europe, North America as well as in Africa.

Products and Services in Islamic Banking Notes

There are some principal products and services of Islamic banks notes that have been formulated in compliance with the rules of Sharia law; let’s discuss some of them below.

Murabaha (Cost-Plus Financing):

This is one of the widely used ways of financing in Islamic banking, where a bank purchases an asset and then sells it to the client at an added fee. The cost and the amount of mark-up are disclosed.

Ijarah (Leasing):

In this financial product, too, the bank first acquires an asset and later leases the same to the client for a certain period of time, and at the end of that period, makes an offer to him/her to buy it for keeps. 

Musharakah:

A partnership in which the capital belongs to everyone, and all parties to the venture share the profits, as well as the losses between them, based on the contributed capital.

Sukuk or Sharia-Compliant bond means a bond that represents ownership of a service, tangible, asset-based investment, or project along with its returns.

Islamic insurance is based on a principle of cooperative insurance, where the participants contribute to the compensation pool or fund from where the contributors agree to compensate, upon the loss, the affected participant.

Case Studies of Leading Islamic Banks

A few large Islamic banks have created a position to lead in the industry, provoking others to follow through strategized steps. The banks include:

Provision for higher rating – Al Rajhi Bank (Saudi Arabia): It is rated among the biggest in terms of asset size among Islamic banks

Dubai Islamic Bank (UAE):

The world’s first fully fledged Islamic bank. This bank has set standards ahead of all others, setting the trend in Islamic banking.

Bank Islam Malaysia Berhad (Malaysia): One of the leading Islamic bank players in Southeast Asia, with a comprehensive range of Shariah-compliant products and services.

Such institutions have enabled not only the growth of Islamic financing in their own specific localities but also close to worldwide recognition of Islamic banking to becoming a utilizing and “good” alternative compared to conventional financing/ banking.

The Implication of Islamic Banking on Global Economic Stability

Meanwhile, certain scholars based a way in promoting financial stability on the notion of risk-sharing and asset-backed financing along with principles in prohibiting excessive risk-taking. Lately, it is from this perspective that interest in Islamic banking has recently picked up again in relation to the possibility of a more stabilized financial system in the benefit of globalization. In the recent global financial crisis, re-proposition of Islamic banks in large part was considered as ‘isolating the banks from the worst impacts of the crisis due to their forbidding speculative activity”.

Islamic Finance Instruments

The mass availability of Islamic financial instruments is widespread throughout the world market. The development of the Islamic financial market has enabled the availability of funds for various sectors and the needs of investors. The available instruments are highly profitable and sustainable for the provision of reasonable profits for both investors and firms.

Murabaha: Cost-Plus Financing

Murabaha forms one of the most common Islamic finance instruments. This involves a bank selling an asset to the customer at an agreed cost-plus price. In this case, the client shall be informed beforehand of the cost and profit margin transparently. Murabaha is greatly applied to financing real estate, vehicles, and other big-ticket items.

Ijarah: Leasing

Ijarah is another major category of instruments in Islamic finance, similar to leasing in conventional banking and finance. An Ijarah contract would be initiated when a bank buys an asset to let it out to a client against a certain specified period. The value of this asset would be compensated for by the customer through periodic payments, and at the end of this lease, allowance for buying this asset by the lessee may be made. It is majorly used in financing equipment, vehicles, and real estate most of the time.

Musharakah: Partnership Financing

Musharakah is a kind of partnership-based financing where all parties will be contributing capital and share the profit and loss according to their respect Ijarah is one of the most important types of instruments under Islamic finance, as would be leasing in conventional banking and finance. The general lines defining an Ijarah contract involve the bank purchasing or acquiring an asset that it will then lease to a customer for an agreed time period. The latter shall be paying periodical installments on this asset and can enjoy the option of buying at the end of this lease. Ijarah, in most cases, finds its application in the financing of equipment, vehicles, and real estate.

Musharakah: Partnership Financing

Musharakah is a partnership-based finance in which the parties will contribute capital to the business and will share the profit and loss in proportion to their capital contributions. It finds best application in cases of joint ventures, real estate development projects, and business partnerships. It aligns the interests of parties and ensures an equal sharing of profits and risks.

Sukuk:

An Islamic Bond.ive contributions. The instrument is best applied in joint ventures, real estate development projects, and business partnerships. Musharakah aligns the interests of all parties, and it promotes a more equitable distribution of profits and risks.

Sukuk: An Islamic Bond

On the other hand, Sukuk are Islamic bonds, which denote the ownership or usufruct right in an asset or a particular service or project. In simple terms, it is an asset-based structure that pools money and periodically distributes returns to investors against the value of an asset. Sukuk is one of the most agreed-upon modes in Islamic finance around the globe. Even countries around the globe have Sukuk issuances.

Takaful is an Islamic insurance concept that pools and administers contributions in order to indemnify participants who suffer a loss. It is different from conventional insurance, which is based on the transfer of risk from the participants to the company. The concept of takaful stands on the grounds of mutual help and cooperation. In fact, in countries where Islam is the predominant religion, there is also a considerable demand for Takaful services because it is a new kind of insurance that is Sharia-compliant, in its place of conventional insurance.

Sharia Compliant Finance in Various Regions

The Islamic finance industry is very manifest in most parts of the region, especially in various regions in which it comprises specific characteristics that manifest different challenges. The Islamic finance industry in this region is growing for a confluence of religious, economic, and political reasons.

The most developed Islamic finance sectors are based in the Middle East; with the leadership being Saudi Arabia, UAE, and Qatar. This region has widely accepted Islamic finance because of its close economic association with Islam and, of course, the substantial oil wealth. Fully-fledged Islamic banks exist in the Middle East, offering a full range of Shari’a-compliant products and are directed at meeting the needs of both retail and corporate clients.

The Rise of Islamic Finance in Southeast Asia

From that thread, the other hub in Islamic finance comes from the Southeast Asian part of the world, with lead countries being Malaysia and Indonesia. Malaysia is one nation that has ranked it as world leader in Islamic finance through the presence of proper regulatory systems as well as a robust Islamic capital market. That potential in the field of Islamic finance is what has attracted global investors in Malaysia, seeing it as the best practice to follow by every other world nation.

Vistas on Islamic Finance: A Growing Interest in Europe and North America

There is an “increased concern in the history of Islamic finance in Europe and North America” The UK, France, and the United States saw a rapid growth in Islamic financial institutions that focussed depending on the needs of the Islamic community with the concerns of non-Muslims looking at ethical investing. In particular, these regions, together with the fast-growing demand for Sharia-compliant products and the realization that Islamic finance provides a viable alternative to conventional finance, further consolidate these incentives for growth.

Islamic Finance in Africa: The Potential

Africa has slowly become a new market of Islamic finance, and likewise, in the country, several countries are slowly finding an interest in their Islamic finance industry. There are some countries among them in the pipeline to implement and develop the best practices of Islamic banking and finance, such as Nigeria, Kenya, and South Africa. With the largest population of Muslims in the country, there is a need for developing infrastructure along with financial inclusion. Africa can be the most promising field of growth in that end.