What is Islamic Finance and how does it work?

As the launch of FINTERRA’s WAQF Chain grows nearer, I am constantly reminded about the origins of Islamic Finance and how it positions itself as a contributor to society through its charitable activities. An article from the Global Finance magazine maps out key attributes of Islamic Finance and why it is gaining traction the world over.

Most people know that Islamic finance is a way of performing financial transactions and banking while respecting Islamic law or sharia. The same people would be surprised to know that, Islamic finance hardly existed 30 years ago. Yet today it is a $2.2 trillion industry with hundreds of specialised institutions located in more than 60 countries. Islamic banks are by far the biggest players in the Islamic finance industry and account for $1.5 trillion in assets. According to a 2017 Reuters report, Islamic bank assets should reach $2.7 trillion while total sharia-compliant assets are expected to grow to $3.5 trillion by 2021. The IMF plans to add Islamic finance to its financial sector assessments beginning in 2019.

Saying that, Islamic finance only represents about 1% of global financial assets but with a 10%-12% annual growth rate, it is expanding more quickly than conventional finance. In some geographies like the Gulf or Sub-Saharan Africa, Islamic banks now compete directly with Western banks to attract Muslim clients.

So, what is behind the success of Islamic finance? What makes Islamic finance special? Why is it growing rapidly?

Avoiding Interest Pays Off

This ethically-driven approach to business partly explains the success of Islamic banks at a time when many customers lack trust in the financial system. Moreover, sharia-compliant entities have proven themselves in times of crisis.

Because Islamic law holds that making money from money is wrong, sharia-compliant institutions tend to refrain from engaging in speculation. They traditionally avoid derivative instruments such as futures or options and prefer to have assets grounded in the real economy.

This substantially protected Islamic banks from the 2008 financial crisis. Unlike their conventional counterparts, sharia-compliant banks were not involved with toxic assets and resisted the shock better.

“Adherence to Shariah principles — which precluded Islamic banks from financing or investing in the kind of instruments that have adversely affected their conventional competitors — helped contain the impact of the crisis on Islamic banks” concluded a 2010 IMF report.

This is a major reason why Islamic finance now has a serious, stable and trustworthy image around the world.