What Is Islamic Finance?

islamic finance

Question:

what is Islamic Finance? Please explain. Jazakallahu khair.

Answer:

In the Name of Allah, the Most Gracious, the Most Merciful.

As-salāmu ‘alaykum wa-rahmatullāhi wa-barakātuh.

Islamic Finance and Banking refers to one adopting the Islamic Law in relation to financial transactions.

Islamic Finance is one of the fastest growing sectors of the finance industry and many new businesses are now venturing into the industry to secure investment for business ideas.  It’s important to note however that the ethical nature of Islamic finance would mean that businesses should provide some sort of positive benefit to society and so investments are not made to businesses promoting alcohol, tobacco, gambling, pornography etc.  Overall it is a lower risk system than the mainstream one in practice today and so is more stable for prospective businesses.  This ethical side of finance would give the whole banking industry a better image which is especially needed when booms turn to busts as modern times dictate.

Islamic Finance is not simply just an interest free system but it offers much more such as the promotion of entrepreneurship, the safeguarding of property rights, transparent transactions and the honouring of contractual obligations.  It is a universal system that can operate in developed and undeveloped countries and takes into account cultural and regional differences.  It appeals to those who have a moral approach to money and is an ethical form of banking.  It is not about promoting the interest of one group of people at the cost of others.  So no bank will rule everything, risk and benefit is shared between banks and borrowers.  There is an emphasis on keeping the financial sector in sync with the other sectors as it deals with the markets for actual goods and services ruling out gambling and speculation, and contrary to some myths it is not just for Muslims.[1]

Islamic Finance has experienced major transformations and growth especially since the year 2000, and its volume has reached almost $1.5 trillion. It has been one of the fastest growing financial markets over the last five years and is expected to continue expanding at an even faster rate.

Its rapid evolution is particularly evident in four dimensions of its development. Firstly, today Islamic Finance is viewed as a competitive form of financial intermediation, drawing significant participation by non-Muslims. The total assets of the Islamic financial system have surpassed $1 trillion, a five-fold increase over their magnitude just five years ago. Islamic Finance is now among the fastest growing financial segments in the world, with an estimated annual growth of 20 percent.

Secondly, with the emergence of more diverse Islamic Finance institutions and the development of Islamic Finance markets, the scope of Islamic Finance business has been expanded to include private equity, project finance, asset and wealth management activities.

The third dimension in which there has been significant evolution is in the regulatory and legal framework of Islamic Finance, which is shaped by the distinct features of Islamic Finance transactions. This has ensured that the growth and development of Islamic Finance is accompanied by the corresponding development of this framework.

Fourthly, the international dimension of Islamic Finance has rapidly gained significance as it evolves to become an increasingly important part of the international financial system and as it becomes poised to contribute to greater global financial integration. The expansion of the network of links among intermediaries and markets in various regions will contribute towards a more efficient allocation of financial resources across borders and thus contribute to enhancing global growth prospects.[2]

One of the most important characteristics of Islamic financing is that it is an asset-backed financing system. The conventional / capitalist concept of financing is that the banks and financial institutions deal in money and monetary papers only.  Islam, on the other hand, does not recognise money as a subject-matter of trade, except in some special cases. Money has no intrinsic utility; it is only a medium of exchange; Each unit of money is 100% equal to another unit of the same denomination, therefore, there is no room for making profit through the exchange of these units inter se. Profit is generated when something having intrinsic utility is sold for money or when different currencies are exchanged, one for another. The profit earned through dealing in money (of the same currency) or the papers representing them is interest, hence prohibited. Therefore, unlike conventional financial institutions, financing in Islam is always based on illiquid assets which create real assets and inventories.[3]

And Allah Ta’ālā Knows Best

Mufti Faraz al-Mahmudi,

Darul Iftaa
Dublin, Ireland
www.darulfiqh.com

 


[1] http://www.corporatelivewire.com/top-story.html?id=benefits-of-islamic-finance-as-an-investment-vehicle

[2] http://www.todayszaman.com/columnistDetail_getNewsById.action?newsId=156567

[3] Introduction to Islamic Finance

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