Islamic finance – financial institutions and products designed to comply with the central tenets of Sharia (or Islamic law) – is one of the most rapidly growing segments of the global Finance industry. Starting with First Islamic Bank established in Egypt in 1963, Dubai Islamic Bank in 1975 (and operations in the United Arab Emirates, the Cayman Islands, Sudan, Lebanon, the Bahamas, Bosnia, Bahrain and Pakistan), the number of Islamic financial institutions worldwide now exceeds over three hundred, with operations in seventy-five countries and assets in excess of US$400 billion.

Though initially concentrated in the Middle East (especially Bahrain) and South-East Asia (Particularly Malaysia), Islamic finance principles are now increasingly found elsewhere. This includes developing economies where the financial sector is almost entirely Islamic (such as Iran and Sudan) or where Islamic and ‘conventional’ financial systems coexist (including Indonesia, Malaysia, Pakistan and the United Arab Emirates). It also includes developed economies where a small number of Islamic financial institutions have been established and where large conventional banks have opened Islamic financing windows (such as in Europe and the United States).

The global proliferation of Islamic financial institutions has been accompanied by parallel developments in Islamic financial products. Starting with simple prohibitions on usury, investment in tobacco, alcohol, gambling and armaments and a requirement that all financial transactions be based on real economic activity, Islamic financial products now cover a broad range of financial services, including funds management, asset allocation, payment and exchange settlement services, insurance and reinsurance, and risk management. For almost all conventional financial products there is nearly always an analogous Islamic finance product. For example, Islamic securities now account for 42 percent of outstanding private debt securities and 25 percent of outstanding bonds in Malaysia; the sovereign (and quasisovereign) and corporate Sukuk (Islamic medium-term note) market has been tapped by the German State of Saxony-Anhalt in a €100 million issue in 2004.

Unfortunately, this rapid development and the substantial cultural and language barriers that exist have acted against a fuller and more widely held understanding of Islamic finance. This is problematic in a number of respects. To start with, regulators worldwide are now faced with the need to standardize and harmonize regulation and supervision in systems that may include Islamic institutions and products. While a number of specialized Islamic organizations assist in this process – the Accounting and Auditing Organization for Islamic Financial Institutions (2007), the Islamic Finance Services Board (2007), the International Islamic Financial Market (2007), the Islamic Development Bank (2007) and the International Islamic Rating Agency (2007), amongst others – yet other national and international regulators also need to be involved when considering the differences in behavioral assumptions between Islamic and conventional financial institutions, firms and products. As examples of this wider interest in Islamic finance, the International Organization of Securities Commissions (2004) commissioned a recent taskforce on Islamic capital markets; the World Bank (2007) “…recognizes the wishes of its member countries to develop their financial system according to their cultural and ethical principles…To enhance its expertise on Islamic financial services, the Bank is engaged in the analysis of their corporate governance, transparency, market discipline and risk management features”; and the International Monetary Fund’s (2007). Finance and Development series frequently deals with topics of interest in Islamic banking.

The use of all conventional derivate instruments is impossible in Islamic banking. In the late 20th century, a number of Islamic banks were created to cater to this particular banking market.

Islamic finance, in contrast to conventional finance, involves the provision of financial products and services by institutions offering Islamic financial services (IIFS) for Sharia approved underlying transactions and economic activities, based on contracts that comply with Sharia laws. Sharia, the basis for finance that meets the religious requirements of Muslims in line with their ‘aqidah, is the factor that distinguishes Islamic finance from conventional finance. Provision of these Sharia compliant financial products and services must add value to the real economy.

evolution of institutional framework

evolution of institutional framework


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