The Opportunities In Islamic Finance: An Old Trade, A New World

One interesting feature about finance is that the financial spectrum is remarkably broad. Indeed, there is a multitude of fields that one could specialise in. Islamic finance is indubitably one of them. Although its recent rise, Islamic finance has been implementing Sharia (Islamic law) to finance for centuries.

In the Muslim world, finance differs from the Western one, e.g. lending with interest payments is strictly prohibited in Islamic finance, while this is how banks mainly make money in the West. Nonetheless, the Islamic banking industry grows at an incredible pace: more universities across the world offer programs dealing with the topic and the Islamic sub-branch of finance weighs roughly $2trn in the international market.

Branching Out

Moreover, Islamic finance has just accepted gold as an investment instrument. This major change hit the headlines last week after the Accounting and Auditing Organisation for Islamic Financial Institution (AAOIFI) and World Gold Council’s announcement at World Islamic Banking Conference in Bahrain.

Therefore, the timing could not be more appropriate to provide some insights on that industry and the challenges that it will face, to draw differences between Islamic and Western finance and to analyse the effect of gold’s new status on the market.

Islamic Banking Vs The Conventional Systems

As stated above, Islamic finance is Sharia-compliant. This industry’s main duty is to improve Islam’s socio-economic framework, thus investment industries similar to defence, adult entertainment or gambling is inconceivable. This is why a profit and loss sharing (PLS) system is mandatory in Muslim finance.

This means that neither institutions pay interest to their depositors nor borrowers to their creditors. Deposits are invested in companies and potential profits are shared with depositors afterwards, unlike traditional banks. However, one does not have to take capital for granted since Islamic banks could still wrongly value opportunities.

Islamic finance prohibits the sale of assets non-owned by the seller. Ergo, most of the conventional derivatives do not belong to financial products accepted. The exhaustive list used to comprise equities, sukuk (Islamic bonds), takaful (insurance) and real estate until the recent introduction of gold.

Overview And Challenges

According to the Université Catholique de Louvain, Islamic finance is one of the fastest growing segments of finance. The Louvain-la-Neuve (Belgian city near Brussels) based university reports that it is growing in some key markets at a pace exceeding by 50% the entire banking system.

Chart 1 supports that trend and shows the evolution of Islamic assets between 2007 and 2020. The industry has seen a constant growth of $1trn every five years and should reach $3trn by 2020.

Its major centres are located in the Middle East. The British audit firm, EY provides a ranking of the main markets: Saudi Arabia (33.0%), Malaysia (15.5%), UAE (15.4%), Kuwait (10.1%) and Qatar (8.1%). More than 80% of all Islamic assets are spread out amongst these five countries.

The international finance scene saw the opportunity to become leading places of Islamic banking: London and Luxembourg have the edge currently. However, Paris and Brussels want to be influential spots too. The competition is as fierce on a smaller scale as well: Goldman Sachs raised $500m to start issuing sukuk in 2014, whereas JP Morgan included 8 sukuk in its emerging markets indices last summer as Reuters relayed.

Adapting To The New Realities

Although Islamic finance looks to have a prosperous future ahead, there are challenges that the multi-century industry will have to overcome sooner or later: the standardisation of regulations, the adaptation of technology to Sharia-compliance and the understanding of its framework by non-Muslims.

As claimed by the online magazine World Finance, some steps have been already implemented in order to head to a fully coordinated Islamic banking system. Nevertheless, these primary measures are the beginning of the process and are still viewed as recommendations instead of proper regulations. Ismail Ali, Group Product Director of the International Turnkey Systems (ITS), told World Finance that the current technology does not allow the Middle Eastern banking system to operate at its peak.

He stated that new technologies had to be developed since many Islamic banks used conventional ones. The lack of specialists is a major issue as well. In the past, traditional banks were reluctant to enter that market because it was too costly for them. Nowadays, everyone can get informed, become active in that market and make it more liquid.

Gold’s New Status

The precious metal has just made it to the Sharia-compliant list of financial instruments last week. Source: MarketWatch

The AAOIFI has reconsidered gold’s status within the Muslim world. Gold has joined the aforementioned list of investment vehicles authorised in Islamic banking. According to Bloomberg, this adaptation of Sharia is major and will stimulate demand for the precious metal. American media reports that SPDR Gold Trust’s (most prominent gold exchange-traded fund) stock will be available for investors, while Comex’s (largest physical commodity futures exchange) gold futures will not.

This differential treatment is due to the rules stipulating that same-day settlement of transactions has to be guaranteed by any financial institutions selling gold. Investors are protected since banks will be obliged to sell them gold at fair market price. Silver will benefit from that framework.

Conclusion

By introducing gold and silver as financial assets, the AAOIFI has shown that it was not as rigid as some people may have thought. In spite of its differences from conventional banking, Islamic finance has plenty of opportunities to grow by considering other financial products.

A land of opportunities arises for Muslim as well as non-Muslim future bankers.

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