The origins of Islamic Finance date back many centuries and can be traced to the origin of Islam as a religion. It is a form of financing which is based upon the principles of Shariah as prescribed in the Holy Quran, the Sunnah (practices and citations of the Prophet Mohammed and as deduced by way of analogy by Shariah Scholars).
Islamic finance is materially different from conventional financing as the payment and receipt of interest is strictly prohibited under Islam. Moreover, given that it is based on concepts such as “ethical investing” and “moral purchasing”, Islamic Finance is therefore governed by a set of rules which prescribe how to conduct business and trade within an economy based on justice for all participants.
The core principles that govern Islamic Finance are:
- Prohibiting the collection and payment of interests or fees on loans (‘Riba’ or ‘usuary’) as money itself does not have an intrinsic value and therefore, the concept of making money from money is not allowed under Shariah principles;
- Sharing of Profit, Loss and Risk as Islam encourages partnership and social integration and ensures that no return can be guaranteed without taking risk;
- Prohibiting Speculation to ensure that return is linked to effort rather than chance or pure speculation;
- Prohibition of Uncertainty ensuring that all aspects (such as price, nature of the goods, description, etc.) of a contractual transaction / relationship need to be clear and documented;
- No hoarding of money and wealth to ensure widespread economic development and generation of wealth that benefits society as a whole;
- No unethical or immoral investments prohibiting investments and transactions in certain products or industries such as alcohol, arms, gaming and gambling, pork and usurious financial transactions.
Under current practices, most Islamic financial institutions have a governing body made up of prominent Shariah Scholars who approve Islamic finance structures and transactions that are entered into by those institutions. By signing off, the board acts as a confirmation of Shariah acceptance and provides a stamp of adherence.
If we look at recent history, Islamic Finance in its current form dates back to the 1970s when the first Islamic Financial institutions such as the Islamic Development Bank (a supranational Bank set up by member countries of the Organization of Islamic Cooperation) and Dubai Islamic Bank (the first commercial bank) were set up. We now talk about – and estimates vary – about an industry which includes more than 300 institutions with multi-billion dollars in assets under management. Despite the Middle East and South East Asia being where most of Islamic assets are concentrated, there is presence and activities across the world in global cities such as London, Geneva, Singapore, and Hong Kong.
With this sheer size and widespread global presence, the industry has grown and seen a multitude of innovations in terms of product offerings to its client base fueling further growth in this industry. When it first started, Islamic finance was limited to commercial banking activities, it has now grown to encompass more sophisticated structured finance, debt capital instruments (Sukuk) and risk management solutions.