Islamic Finance: an overview

With the banks and the economy dominating the headlines more than ever in today’s world, Islamic finance is often overlooked as an ethical and appropriate means of finance.

However, the Islamic finance industry is worth almost $2 trillion and growth doesn’t look like it’s going to decelerate anytime soon.

The industry is governed by Sharia, which defines what is permissible and impermissible for Islamic finance transactions. At the heart of Islamic finance is ethics: the purpose and aim of such transactions is to be as ethical as possible.

Certain key doctrines of Islamic finance

The principles of Sharia are derived from four main sources. The Qur’an (holy book) and Sunnah (recorded examples of the life and actions of the Prophet Mohammed) are the most commonly used sources; however, Sharia also allows scholarly consensus (Ijma) and legal analogy (qiyas) to establish rulings for matters.

The latter two, in particular, are ever-more relevant today, given how rapidly the industry is developing and the challenges it faces in order to truly become a dominant method of finance.

  • Interest (riba) – is one of the most important areas of Islamic finance. The basic principle is to ensure a party doesn’t unfairly exploit another and money cannot be used to make money as Sharia regards money as a means of exchange. Therefore, mortgages, savings accounts, or any other financial products that have interest payable or receivable are totally impermissible within Islam.
  • Speculation (maisir) – transactions of such nature are void for the purposes of Islam. Although commercial risk taking in the context of business enterprise isn’t prohibited, the prohibition is more relevant to transactions such as conventional derivatives, which involve a greater degree of speculation, bearing some resemblance to that of gambling.
  • Uncertainty (Gharar) – Contracts that intentionally and unintentionally conceal information such as the parties, price and method and time of delivery are automatically void. This test of uncertainty used by Islamic finance contracts is far more rigorous than the test applicable under English law.

Challenges to the industry

Differences of opinion challenge the growth and development of Islamic finance. Different scholars have different opinions. There are four prominent schools of thought, Hanafi, Maliki, Shafi and Hanbali. Each school has its own set of jurisprudence and differences occur through interpretations of the rules. This makes it very difficult to implement and standardise Islamic finance globally, affecting the range of innovative products the industry is able to offer.

A lack of skills and knowledge is another major hindrance to Islamic finance. At present, it can take up to 30 years to become a fully-qualified Sharia scholar. Though there is no universal agreement on what makes a person qualified, it’s expected that an understanding of the various texts and the Arabic language is essential, in addition to relevant banking experience.

The future outlook

Although Islamic finance still has many hurdles to overcome, the future is undeniably very bright. It is still the preferred method of finance in the Middle East and is often chosen for some European transactions, such as financing the Shard building in London. Many of the largest London law firms have Islamic finance specialists.

Furthermore, in 2014 the United Kingdom became the first western country outside the Islamic world to issue an Islamic Bond, known as a Sukuk. This was a momentous achievement given the various difficulties and hurdles that had to be overcome.

There seems to be a strong willingness and optimism from the UK to become the central European hub for Islamic finance; however in order to categorically achieve this, the UK government will need to continue working with industry’s leaders and the relevant Sharia councils.

Kaleem Mahmood is a part-time LPC student at the University of Law, Birmingham, and also works for DAC Beachcroft

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