What’s so Islamic about Islamic finance? Do you have to be a Muslim to do it? Does it make more money than conventional finance? Here’s a quick guide with everything you need to know
An Iranian gold coin. Iran came top of the list for global islamic finance last year, could the UK be next? Photograph: Atta Kenare/AFP/Getty Images
London is hosting a meeting of the World Islamic Economic Forum – the first city in a non-Muslim country to do so. David Cameron will use the opportunity to boast British credentials when it comes to Islamic finance, announcing plans to create a £200m Islamic bond by early next year.
Finance is described as Islamic when it complies with sharia, a set of moral laws laid out in the Qur’an and writings about the prophet. Sharia forbids making money from money which begs the immediate question; how can banks that don’t charge interest survive? It’s a question worth answering, not least because academics have argued that the financial crisis wouldn’t have happened if the global economy was regulated by Islamic finance.
How it works
Islamic finance is all about sharing risk between financial institutions and the individuals that use them. To do that, the two parties are tied into a longer-term relationship with each other that is supposed to shift incentives and avoid cut and run financial deals.
So, for example, sharia-compliant mortgages mean that the bank and the borrower share the risks of repayment rather than charging any form of interest. Similarly, Islamic bonds like the one announced by David Cameron today involve both parties owning the debt, rather than a simple promise to repay a loan.
Since it’s Islamic, that also means that financial trading is off-limits for things that are forbidden even if no interest is charged – so investments can’t be made in alcohol, tobacco, non-halal meat products such as pork, pornography or gambling companies. So if there’s no interest and gambling on high-risk ventures is a no-no, how can Islamic banks be profitable? Hilary Osborne explains:
banks can profit from helping customers to purchase a property using a ijara or murabaha scheme. With an ijara scheme the bank makes money by charging the customer rent; with a murabaha scheme, a price is agreed at the outset which is more than the market value. This profit is deemed to be a reward for the risk that is assumed by the bank
You don’t have to be Muslim to use Islamic financial services – a fact which has stimulated further interest in the sector. The Islamic Bank of Britain reported a 55% increase in applications for its savings accounts by non-Muslims last year after the Barclays rate-fixing scandal.
275: The number of Islamic financial institutions in the world.
75: The number of countries where they have a presence.
US$1.357 trillion: The value of the global Islamic finance services industry by the end of 2011.
US$4 trillion: The projected value of the global Islamic finance services industry by 2020.
£200m: The value of the planned Islamic bond being unveiled by David Cameron today.
11th: The ranking of the UK (up 4 places from 2011) in the Global Islamic Finance Report which weighs up variables like the number of institutions involved in Islamic finance industry, the size of Islamic financial assets and the regulatory and legal infrastructure.
bay ‘al-mu’ajjal: Instant sale of an asset in return for a payment of money (made in full or by instalments) at a future date
gharar: Describes a risky or hazardous sale, where the details of the sale contract are unknown or uncertain
ijarah: Leasing contract
istisna’: Refers to an agreement to sell a non-existent asset, which is to be manufactured or built according to the buyer’s specifications and is to be delivered on a specified future date at a predetermined selling price.
mudarabah: Profit and loss-sharing
musharakah: Joint partnership
qard hasan: Interest-free financing
riba’ : Usury
sharikat al-‘aqd: Contractual partnership
sharika al-milk: Proprietary partnership
sukuk: Islamic bonds
takaful: Islamic insurance
wadiah: Safe custody
wakala: Investor entrusts an agent to act on his behalf
zanniyyat: probabilistic evidence