Islamic Finance

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The Koran forbids charging interest or paying it. Yet even strictly observant Muslims can participate in modern-day commerce. They use alternative arrangements designed to comply with sharia, or Islamic law. These financial instruments, in which the buyer and the seller typically share risk as well as profit, are some of the fastest-growing on the market. Even companies and governments outside the Muslim world are using them. And why not? The world’s Muslim population is growing rapidly and in many places growing wealthier, creating new customers for sharia-compliant bonds, mortgages and insurance. Fans of these arrangements think they can compete with conventional ones even for non-Muslim customers. How big Islamic finance can become, however, is a matter of debate.

The Situation

Shariah-compliant financial assets are forecast to reach $3 trillion sometime in the next decade from an estimated $2.1 trillion at the end of 2016. Sales of Islamic bonds, called sukuk, rose 24 percent to $44.1 billion last year as some issuers rushed to lock in borrowing costs before an increase in U.S. interest rates. The U.K., which hopes to become a global center of Islamic finance, in mid-2014 became the first non-Muslim country to raise funds by selling sukuk; Luxembourg, South Africa and Hong Kong followed. Kenya and Morocco are also planning debuts in the Islamic bond market. Companies such as General Electric Capital and Goldman Sachs also have sold sukuk. Rather than lend money to a conventional borrower in exchange for interest, sukuk holders own a share of the asset that backs the debt and receive income from any profit it generates. Investors in Muslim-dominated countries in the Middle East and Asia aren’t the only ones buying sukuk: There’s strong demand in Europe and the U.S., too. Islamic insurance, which operates on a cooperative business model, is also expanding. Ernst & Young projects it will maintain double-digit growth, with member contributions totaling $20 billion by 2017.  Ethical investing has gained impetus in Islamic finance after the sale of bonds to raise funds for vaccines in 2014 and the issue of socially responsible Islamic bonds by Malaysia’s sovereign wealth fund the following year. In November, gold was ruled acceptable as an investment in Islamic finance for the first time after the World Gold Council adopted Shariah-compliant regulations for trading the metal. 

Sources: Institute of Islamic Banking and Insurance,

The Background

In Islamic texts, charging interest is regarded as exploitation of a person in need. A rudimentary form of Islamic finance existed from the time of the Prophet Muhammad, in the seventh century, but the modern version took root only during the colonial era. The first sharia-compliant bank was established in Egypt in 1963. Iran, where all banks must be sharia-compliant, is the largest market for Islamic banking. Bahrain, Qatar, Indonesia, Saudi Arabia, Malaysia, United Arab Emirates, Turkey, Kuwait and Pakistan account for 93 percent of Islamic banking assets. The Islamic Bank of Britain, established in 2004, was the first such institution outside the Muslim world.

The Argument

Even with its explosive growth, Islamic finance makes up just 1 percent or so of global financial assets. Champions of the approach argue that in the aftermath of the 2008 financial crisis, it can appeal beyond devout Muslims to other customers worried about the stability of the financial system or to those interested in ethical banking practices. They say sharia-based financing promotes stability because it prohibits speculation and the practice of overloading companies with debt. Money is channeled toward investments in enterprises that produce actual goods and services, rather than buying and selling on financial markets. Skeptics note that ethical banking enthusiasts are usually interested in an institution’s environmental policies and engagement with the local community, not whether it forbids profiting from alcohol, tobacco, gambling and pornography, as sharia requires. More women are entering management at Islamic financial companies, helping to address one concern among critics. Others worry about institutions being exploited to funnel money to Islamic terrorists, an issue raised in a U.S. State Department memo about Islamic finance in the U.K. After Christian groups in South Korea raised the same issue, the government put off making tax changes to accommodate Islamic finance. The industry is also challenged by high costs due to the complexity of the instruments and the fees paid to scholars to certify sharia compliance. And many products, such as hedging instruments and short-term government securities, are in short supply. Progress in establishing common standards for sharia compliance has been gradual, restricting the acceptability of Islamic bonds in some jurisdictions.

The Reference Shelf

  • S&P Global's 2017 outlook for Islamic Finance.
  • A 2016 study of the global sukuk market by International Islamic Financial Market.
  • A report by Ernst & Young on Islamic banking competitiveness.
  • An IMF 2015 paper on Islamic finance.
  • The Institute of Islamic Banking and Insurance offers explanations of industry concepts.
  • The Council on Foreign Relations explains the rise of Islamic finance.

    First published Feb. 12, 2015

    To contact the writer of this QuickTake:
    Y-Sing Liau in Kuala Lumpur at

    To contact the editor responsible for this QuickTake:
    Grant Clark at

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