Islamic Finance — How Does It Work, Why Is It Protected?

 

As the launch of FINTERRA’s WAQF Chain grows nearer, I am constantly reminded about the origins of Islamic Finance and how it positions itself as a contributor to society through its charitable activities. An article from the Global Finance magazine maps out key attributes of Islamic Finance and why it is gaining traction the world over.

Most people know that Islamic finance is a way of performing financial transactions and banking while respecting Islamic law or sharia. The same people would be surprised to know that Islamic finance hardly existed 30 years ago. Yet today it is a $2.2 trillion industry with hundreds of specialised institutions located in more than 60 countries. Islamic banks are by far the biggest players in the Islamic finance industry and account for $1.5 trillion in assets. According to a 2017 Reuters report, Islamic bank assets should reach $2.7 trillion while total sharia-compliant assets are expected to grow to $3.5 trillion by 2021. The IMF plans to add Islamic finance to its financial sector assessments beginning in 2019.

Saying that, Islamic finance only represents about 1% of global financial assets but with a 10%-12% annual growth rate, it is expanding more quickly than conventional finance. In some geographies like the Gulf or Sub-Saharan Africa, Islamic banks now compete directly with Western banks to attract Muslim clients.

So, what is behind the success of Islamic finance? What makes Islamic finance special? Why is it growing rapidly?

Interest-Free Lending

The most famous rule in Islamic finance is the ban on usury. In economic terms, this means lender and borrowers are forbidden from charging or paying interest or riba. Sharia-compliant banks don’t issue interest-based loans.

The obvious question then becomes: how do Islamic banks make money? Instead of lending money to their clients at a profit, they buy the underlying product — the house, the car, the refrigerator — and then lease it or re-sell it on installment to the client for a fixed price typically higher than the initial market value. The key notion here is risk sharing — the banks make a profit on the transaction as a reward for the risk they took with the customer. Instead of thriving off of interest rates, Islamic banks use their customers’ money to acquire assets such as property or businesses and profit when the loan is successfully repaid.

 

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