According to a recent KPMG international report Islamic financial industry is estimated to grow between 15-20 percent annually, but some institutions have reported faster growth. Of current, the sector has estimated assets under management of US$500 billion. Rapid emergence of new markets like Syria, Lebanon, UK, Turkey and Canada are evident to the growth of this sector. Also some conventional banks and financial institutions are embarking to the process of conversion for example in 2006 Kuwait Real Estate Bank converted to a licensed fully fledged Islamic Banks.
The question to ask is ...what is this animal called Islamic finance and how is it any different from conventional finance? According to Mabid Ali Al-Jarhi, Islamic banking and finance can be described as a system through which finance is provided in the form of money in return for either equity or rights to share in future business profits, or in the form of goods and services delivered in return for a commitment to repay their value at a future date. Islamic Finance is not a new concept it is actually fifteen centuries old. The origins of Islamic finance can be traced to the birth of Islamic and even earlier pre- Islamic era. There were sophisticated trade contracts that laid foundation to the modern Islamic financial system.(will discuss those contracts in my later posts). A lot of institutional borrowing occurred during medieval times. (for a better and elaborate overview on origins Islamic finance and cross institutional borrowing read Dr Murat Cizakca's book called Islamic capitalism and finance).
We know that economic activities gives rise to financial institutions that provide capital to fund enterprises. Now to understand the framework of economic activities we need to look into that particular system's "World view". World views reflect a society's social vision and thus defining its social norm therefore it exerts significant influence on its economic discussions. One now asks this question- what actually is the Islamic world view and what has it to do with Islamic financial markets? According to al- Attas, an Islamic world view is the vision of reality and truth that appears before our mind's eye, revealing what existence is all about. The world view of Islam encompasses both al - dunya (Life) and al-akhirah (After life), In which dunya aspects must be related in a profound and inseparable way to the akhirah aspect. Such world view requires one to acquire knowledge about the concept of:
- Din (religion)
- God
- Man
- Universe
- Prophethood
In other words Islamic world view is an holistic view that combines reason and divine revelation. The Holy Quran says "By time, man is in loss, except those who believe and do good works and exhort one another to truth and to patience" (Al-Asr:1-3). This shows that for muslims Islamic world view is a basic need without which they will be in utter loss and confusion. With Islamic world view, Islamic banks and financial institutions are able to pursue transactions manifesting the Quranic conception of trading and commerce (al bay) as an alternative to conventional transactions which are based on conventional world view that is only based on reasoning alone. (This was a very brief note on world view for a clear understand about the Islamic world view in comparison to the conventional refer to the IDB lecture by Dr Mohammad Umar Chapra http://bev.berkeley.edu/ipe/readings/IslamicEconomics.pdf )
Having talked briefly about the world view lets now highlight the fundamental principles
- The prohibition or taking or receiving interest at exorbitant rates (Riba), but this does not preclude a rate of return on investment. (My next post will be about riba I will discuss why riba is an impediment)
- Risk in any transaction must be shared between at least two parties so that the provider of capital and the entrepreneur share the business risk in return for a share in profit.
- The prohibition of speculative behavior (Gharar) is not allowed, meaning that gambling (Maysir) and extreme uncertainty or risk is prohibited and thus contractual obligations and disclosure of information are a sacred duty. This also restricts traditional derivatives.
- Investments that violate the rules of Shariah (Islamic Law), advised against by Shariah boards, and are generally non-ethical meaning that investment in businesses related to alcohol, pork related products, entertainment (gambling and casinos, pornography). In addition, some Shariah boards recommend against tobacco, weapons and defense. An example of index restriction can be seen on Page 5 of The Dow Jones Islamic Market Index Rulebook.
