Islamic finance meaning
In today’s global economy and finance, the weight of the capitalist market system is overwhelming. However, and ignoring the states that are still governed by a socialist economic system, other means of articulating the economy and finance are experiencing a period of growth and popularity. The havoc wrought by the latest economic crisis and the design of the gigantic global financial network has caused some misgivings among some sections of the population in various parts of the world. Therefore, other ways of understanding and acting in the financial field are spreading. If in the West we could talk about ethical banking as a “third way”, the Muslim world seems to be hovering over what is known as Islamic banking.
This banking, far from following Adam Smith’s thesis, acts under the premises of the sharia or Islamic law. In a mixture between social commitment and faith, the institutions that adhere to this way of understanding the economy have experienced a spectacular rise in recent years, and although at the moment they only hold 1% of the financial assets that circulate in the world – some two trillion dollars – the weight that it is beginning to have in some Muslim countries and above all the future perspectives on its development make it necessary to understand the mental schemes with which this parallel financial world acts. If you are looking for PhD in Islamic finance in USA.
What is Islamic banking and finance
Islam is nearly a millennium older than modern capitalism, so to a large extent, the Islamic economy has a long history. However, until its revival in the 1970s by the banking industry of the same name, it had been relegated to irrelevance in the global economy for many centuries.
Islamic banking, as we say, is based on the Shariah, a whole compendium of laws that come from the Koran and that generally regulate many aspects of life, ranging from social customs to politics and economics. In this sense, there is an ethical self-limitation in the operation of the bank as a result of conformity with Islamic law, in addition to an increasing acceptance of some social sectors that are grateful to be able to practice the economy under the precepts of their religion.
The basis of the business is similar to that of traditional banking: receiving deposits and granting loans. However, the similarities end here. All the whys and wherefores of that activity diverge greatly from the capitalist conception, resulting in a genuine system regulated by religion. Nor should it be concluded that Islamic banking is not about profit. Like any other business or activity, it tries to maximize its profits, only, in this case, the limits of how it can and cannot obtain them are more or less defined, since the only discussions are given by different interpretations of Islamic law in relation to these issues.
Firstly, Sharia law prohibits the charging of interest – usury – both to lenders and to those who deposit their money in the bank. It is neither conceived nor approved in Islam that money in itself can create more money – the basic premise of modern banking operation – so wealth can only come from productive activities and real work. Similarly, Islamic banking cannot invest or acquire financial items that yield interest, such as public debt. However, the ban on the riba is somewhat easily circumvented. In Islamic banking, money as such is not lent – at least from the institution to the individual – but the bank acts as an intermediary between the client and the good or service he intends to acquire. Thus, both agree beforehand on what management costs the operation will entail – the item where the bank makes the profit – and how the customer will pay for it. Once this has been resolved, the bank buys the good or service that the customer wants and then sells it to him in installments for the agreed amount. In the case of businesses or companies, the peculiarities are also numerous. Both the entrepreneur and the entity are going to share profits or losses in an investment. Under the precepts of Islamic law, since they cannot charge interest, the banks finance part of the investment, and the profits of the company are matched in the same proportion as the financing. Over time, the businessman can buy the bank’s share of the company, while the entity makes a profit on its investment with the dividends. Logically, and in line with what has been said before, this company can only engage in an activity that produces real wealth through work.
However, it is not worth any activity, however manual and laborious it may be. This is where the term halal comes in, which reflects the adaptation of activities to Islamic law. Under this premise, Islamic banking cannot finance or collaborate with companies or economic sectors that contravene the Muslim tradition and the Sharia. Thus, it cannot invest in activities that are related to the manufacture of tobacco, the processing, and distribution of alcohol, gambling, pornography, drugs, the manufacture and sale of weapons and even the pork industry. All of these are against the will of Allah, and the good Muslim must be kept away from them, even in the financial sphere.
Another concept that does not escape Islamic control is that of gharar. In the unfriendly relationship between Islam and gambling, this idea is of paramount importance. In short, it advocates that in a commercial, financial relationship for the issue at hand, there should be no element of uncertainty or ambiguity. In recent times this is oriented towards changing interests. Within the capitalist banking system, it is quite common for interest or returns to be subject to some fluctuating indicator – interest rates in particular -, causing the amount of the debt to vary, usually to the detriment of the creditor and with potentially disastrous consequences. That is why this type of dependence on variable elements is forbidden in Islam.
Finally, and related to the gharar, we find the idea of maysir. Similar to the previous concept, maysir, which means luck, does not allow playing with chance or time. In this sense, it prevents activities related to pure speculation -that by which something is bought only to sell it later at a higher price-, which takes the Islamic banking out of many and usual activities of the international financial markets, especially in matters of the so-called arbitration and the futures markets.
The last precept to be followed is the evaluation of the solvency in the investments or financing to be carried out. In general, the custom of this bank is to support companies with little debt with solvent projects. The logic they follow is that since this bank is more of an investment partner than a lender, as a partner it will require certain guarantees so that the company will do well and see its investment rewarded. After all, it is from these returns and dividends that they obtain a good part of their income.
Therefore, from an economic point of view, Islamic banking is positioned in a conservative but enormously solid attitude, since it moves away from its activity the biggest dangers of the current markets such as fluctuations and speculation, giving weight to the productive and real economy. This quality of its assets and the refusal to enter into risky financial ventures is what has earned it notable popularity in many Muslim countries, as well as robust growth in recent years.
Why Islamic banking is successful
The origin of Islamic banking can be traced back to the Persian Gulf area in the 1960s and 1970s as a formal business model. The abundant flow of income that both the small emirates and Saudi Arabia began to obtain during those years largely motivated the emergence of this banking model in an attempt to diversify investments in “petrodollars”.
Over the years, these entities, in addition to the ethical character in accordance with Islam, have developed very attractive financial products, and although they do not invoice millionaire sums as many commercial banks do, the model has gradually spread to Muslim and non-Muslim countries. Thus, it has ended up being implemented with some success outside the Middle East in countries such as Malaysia and Indonesia – the latter being the country with the most Muslims in the world – and then attracting the interest of some Western banks, which in their own way have developed subsidiaries or products in accordance with the Sharia.
Today, approximately 38 million people are customers of Islamic banks. Sharia mortgages or savings accounts for the pilgrimage to Mecca are some of their star products. It is true that the customer profile is of a certain status, according to the business people and professionals settled in the different Arab countries and the flourishing Malaysian and Indonesian middle class. In this sense, the penetration of Islamic banking in the popular Muslim classes is still very limited, as is that of any non-Islamic commercial bank. However, this is by no means an impediment to its spread.
Although there are some 300 Islamic banks and 200 other related entities such as investment funds or insurance companies, the concentration of capital is, also in this banking model, considerable. If we said earlier that their assets were around two trillion dollars, half of these are spread over 17 banks, especially Saudi, Qatar, Kuwait and the Arab Emirates. However, one of the company’s trademarks is the international spread of the model. In 2012, when assets totalled 1.5 trillion dollars, 60% of them were outside the Arabian peninsula and Malaysia and Indonesia. The reproduction of subsidiaries and the interest of more and more entities, Muslim or not, to reproduce this model in other parts of the world is leading to a real geographical decentralization of Islamic wealth. However, the power behind these assets is clear. It even has an acronym: QISMUT, or in other words, Qatar, Indonesia, Saudi Arabia, Malaysia, United Arab Emirates and Turkey. Between entities in these countries they control just over three-quarters of the assets of global Islamic banking, although the two heavyweights in this business are Saudi Arabia and Malaysia.
However, both banks and countries with strong roots in this sector are pressing for the legislation of other states, whether or not they have adhered to Islam, to be opened up to this type of investment. The West, on the one hand, and Sub-Saharan Africa on the other, are its two focal points, as well as, of course, continuing to deepen in Asian Muslim countries. In the case of the West, they seek liquidity and large masses of capital that permanently need destination and profitability. Besides, the own design of the Islamic banking prevents European and North American capitals from acting as they are used to in the Western markets, that is, speculating and migrating constantly. In spite of this, several European countries have been politically receptive to allow Islamic banking to have a place in their financial network. Even on the stock market, it has had an impact; proof of this is the creation of the Dow Jones Islamic Fund, formed only by halal companies. In the case of Africa, they are seeking to extend their presence to large Muslim populations in states where their presence is a minority but significant, such as Nigeria, Kenya, Tanzania or Uganda, in addition to a certain economic development that will allow them to adhere to this banking model.
Islamic banking growth
Islamic banking growth between 2009 and 2013 by 17.6%, reaching $1.7 trillion in assets. Thus, this model has managed to wade through the economic and financial crisis with remarkable success, in addition to the challenges present almost permanently in the Middle East.
More general estimates suggest that Islamic banking will double the value of its assets every five years, an exponential growth that the current situation of the sector does not seem to disprove. If in 2013 the value of Islamic banking companies was 1.7 trillion dollars, in 2018 they will be around 3.4 trillion, a growth in which the aforementioned QISMUT will triple its wealth; however, the Malaysian-Saudi duopoly will not be broken. Likewise, the number of clients they plan to reach by 2018 will be around 70 million, a figure that is not overwhelming since there are around 1,600 million Muslims in the world, but it is representative of the growth that is being experienced in the sector.
However, the most interesting points are those of a political-economic nature. Islamic banking already buys public debt; even the London government-issued ad hoc public debt for Islamic banking, the so-called “sukuk bonds”, a financial element that logically does not bring interest but dividends. Shortly afterward, Luxembourg successfully followed the British tactic by placing 200 million euros in this type of bond. Because even Western countries, accustomed to “classical” finance, are adapting to the style of Islamic banking.
Likewise, Islamic banking is and will be a tool of political control. Especially for the Arabian Peninsula, where the reserves of the sovereign funds are high and the power of investment and commercial banking is of great importance, the strengthening of Islamic banking can be a form of projection of soft power – economic – to the Muslim world, while traditional banking works in the global and Western political-economic arena. To each scenario, the best tool. Even at the identity level, this banking is important. Globalization, largely exercised unidirectionally – from the developed/industrialized world to the periphery – is loaded with values that do not have a high degree of compatibility in the mind maps of some parts of the world, including the economy. Thus, Islamic banking can act as a counterweight to some of the globalizing economic dynamics that have been taking place globally in recent decades, especially in the “micro” sphere.
It is not by chance that the Asian middle powers – Saudi Arabia, Iran, Turkey, Indonesia or Malaysia – are interested in developing and promoting this model. On the one hand, it represents a reaffirmation of their Muslim character and an opportunity to stand out economically and politically in a regional context, either in the Middle East or in Southeast Asia. Islamic banking will be simple, but not naïve. If you are looking for masters in Islamic finance online