Global Aspirations

• Author: Ananthakrishnan Prasad

Global Aspirations Finance & Development, September 2015, Vol. 52, No. 3

Ananthakrishnan Prasad

Islamic financing is transcending its traditional geographic boundaries and branching out with sukuk and other financial products

British Prime Minister David Cameron announced at the 2013 World Islamic Economic Forum that he wanted London to become “one of the greatest centers of Islamic finance anywhere in the world.” For people following financial developments, the prime minister’s remarks came as no surprise. In recent years, Islamic banks have begun operating in such countries as Denmark, France, Luxembourg, Nigeria, Switzerland, South Africa, and the United Kingdom. In addition, a number of large European and American banks, such as Citibank and HSBC, have opened Islamic banking windows.

The United Kingdom has five banks dedicated to Islamic finance, more than 20 banks offering Islamic products, and 25 law firms with Islamic finance units. There is $38 billion in sukuk—the Islamic equivalent of bonds—listed in London, primarily issued by businesses and banks based in the Middle East. And an issue of £200 million worth of sovereign sukuk in June 2014 was the first such offering outside the Islamic world.

Since then, Hong Kong SAR, South Africa, and Luxembourg have issued sovereign sukuk.

Islamic finance is one of the fastest growing segments of the financial industry, and not just in the Middle East. The growth of Islamic banking outpaced conventional banking over the past decade and now accounts for more than 20 percent of banking system assets in 10 countries: the Islamic Republic of Iran and Sudan, which have full-fledged Islamic financial centers, as well as Bangladesh, Brunei Darussalam, Kuwait, Malaysia, Qatar, Saudi Arabia, the United Arab Emirates, and Yemen (see Chart 1).

Globally, Islamic finance assets grew at double-digit rates in the past decade to reach an estimated $1.8 trillion at the end of 2013, with further growth expected (Ernst & Young, 2014; IFSB, 2014; Oliver Wyman, 2009). This growth reflects demand from large and relatively unbanked Muslim populations seeking to deposit money or invest in sharia-compliant banks and financial products—those that are acceptable under Islamic law (see box). It also represents relatively rapid growth in many countries where these populations reside, as well as the large pool of savings in oil-exporting economies looking for sharia-compliant investment opportunities.

What is Islamic finance?Islamic finance is the provision of financial services in accordance with Islamic ethical principles and law (sharia). Islamic law requires that financial transactions be geared toward supporting productive economic activity and that funding providers share in both the risk and the profit of the investments they finance. Islamic finance therefore encourages parties in a financial transaction to share the risk and the profit. Tansactions are asset backed or asset based—investors have a claim on the underlying assets. Islamic finance bans the payment of interest (because earning profit from the exchange of money for money is considered immoral), prohibits financial products that involve excessive uncertainty (including short sales and gambling), and rules out financing of activities considered harmful to society.

Distinct qualitiesThe absence of fixed interest rates and the asset-backed nature of lending of course mean that Islamic banks operate differently from conventional banks. Islamic banks are typically funded by current accounts, which do not receive interest, and profit-sharing investment accounts, on which investors receive a return determined by the eventual profitability of the bank or the pool of...