Islamic Finance Attracts Both Islamic Law and Conventional Investors
By Nana Phiri and Ebrahim Moolla, Rand Merchant Bank
The Islamic finance sector is the largest component of the halal economy. The halal economy comprises industries that conduct themselves in compliance with Shari’ah (Islamic law) requirements and is estimated to have been worth US$4tr in 2015, as published by Reuters Zawya in its annual report of the state of the halal economy. Islamic finance makes up $2tr (50%) of this market, and is expected to grow at a CAGR of 9% to reach $3.5tr in 2021.
Financial institutions have a great opportunity to participate in this market and some have responded to meet the demand for Islamic finance by diversifying their service offering and, at the same time, include a population of 1.6 billion Muslims into the financial system. Islamic finance comprises the following sectors, with banking leading the way:
What is Islamic finance?
Islamic finance has the same underlying purpose as conventional banking but operates in accordance with the rules of Islamic law (Shari’ah). The basic principle of Islamic finance is the prohibition of riba (interest). Although Islamic finance evolved to provide a Shari’ah-compliant alternative to conventional financing, it has now become the fastest growing segment in financial markets across Asia, Africa and Europe. (Islamic banking is not restricted to members of the Islamic faith: it is open to any person who wishes to choose this form of banking.)
In prescribing the form of economic activities under Shari’ah, the key principles are outlined as follows.
- Trade is encouraged whilst interest is prohibited. Islamic finance has developed mechanisms to earn income from productive sources, such as returns from profit generating investment activities and operations. These include profits from trading in tangible assets and cash flows from the transfer of usufruct (the right to use an asset), for example rental income.
- Islam encourages and promotes the right of individuals to pursue personal economic wellbeing, but makes a clear distinction between what commercial activities are allowed and what are forbidden. The Islamic economic model is based on a risk and profit-sharing (and loss-bearing) philosophy.
- Fulfilment of contractual rights and obligations is an integral element of social conduct within an Islamic society. Islamic commercial jurisprudence consists of principles and rules that must be observed for transactions to be acceptable in Islam; the Islamic Law of Contracts is at the heart of this. One important requirement is for certainty in the contractual obligations of the parties involved.
The key differences between the conventional finance model and the Islamic finance model are summarised in Table 1.