Sharia is the law in Muslim countries which expresses a strict stance on the finance sector. In fact, the Quran bans both charging and receiving of credit interest. However, despite the rule Muslims are allowed to run a business. Financial experts have found a solution for using alternative instruments which were invented with due respect to Sharia postulates.
The financial tools when both a buyer and seller share equal risks and profits are rapidly gaining in popularity on the Muslim market. Nowadays, such instruments are used even by companies and governments beyond Islamic countries.
It is widely held that the Islamic community has been expanding and growing rich in many countries. So the Muslims are forming a new stratum of clients who deal with bonds in conformity with the Sharia law. Some keen traders involved in such a business are certain that they can compete with traditional investors and speculators.
The first bank to rest on the Sharia law was founded in 1963 in Egypt. At present, Iran is the major market for such activities as all finance institutions there have to fulfil Sharia requirements. Almost 91% of Islamic bank assets belong to Saudi Arabia, Malaysia, the UAE, Kuwait, Qatar, Turkey, and Indonesia. Al Rayan Bank (formerly Islamic Bank of Britain) is the first wholly Sharia compliant retail bank outside the Muslim world. It was founded in 2004 in the UK.
The finance sector of Muslim countries has advanced dramatically for the recent six years. From 2008 to 2013, assets of Islamic banks almost doubled to $1.3 trillion from $820 billion. Sales revenues of Islamic government bonds known as “sukuk” soared to $120 billion in 2013. Interestingly, sukuk revenues came out at nearly $6.6 billion in 2004.
In mid-2014, the UK was the first non-Muslim country which raised funds through selling sukuk. Luxembourg, the SAR, and Hong Kong followed its path. General Electric Capital and Goldman Sachs used to deal with trading sukuk.
So, what exactly is sukuk? How does it differ from conventional treasuries? Classical loans with interest repayments are unlawful in Sharia. Therefore, a sukuk owner holds a part of assets in an investment fund or bank and gains proceeds from profits. Recently, demand for sukuk has been noted not only in the Middle East and Asia, but in Europe and the United States.
Besides, Islamic insurance based on the principle of shared responsibility has reached a new stage of evolution. According to Ernst & Young, this insurance scheme will go on expanding with deposits swelling to $20 billion by 2017.
At the same time, despite the keen interest, the Islamic finance sector accounts for just 1% of the overall global financial market. A lot of experts suggest that the 2008 financial crisis prompted booming popularity of Islamic treasuries not only among Muslim devotees, but other clients interested in ethic banking services. Enthusiasts of this approach believe that Sharia-compliant financial vehicles ensure stability as they bar speculations and refinancing of debts. Money is invested only in the companies engaged in production of goods and services. So the core business should not be focused on trading securities on financial markets.
However, there is the other side of the coin. Sharia scholars of the banking business ethics are interested in a bank’s involvement in activities of locals. Besides, prohibited industries and activities under the Sharia law include the following: alcohol and tobacco sales, gambling, and certain sectors of the entertainment industry. Nevertheless, the US government is worried that Islamic lending institutions could be used for funding Islamic militants. This concern is voiced in the US State Department’s memorandum on Islamic financial instruments in the UK.
Moreover, Sharia-compliant financial vehicles require rather high costs as an institution providing such services has to pay Sharia scholars fees for assessing conformity to the Muslim ethics. Hedge instruments or government bonds of a short maturity are offered in a limited volume. No doubt such a specific finance sector fits well into the Muslim community and it will always take place there. However, the development of common standards on conformity to the Sharia law is progressing slowly. As a result, these instruments could be acknowledged to be impractical.
Islamic financial instruments
Murabaha is an accepted form of credit sale under Sharia. An intermediary, for example a bank, buys a property with free and clear title to it. The intermediary and prospective buyer then agree upon a sale price plus a profit margin that can be made through a series of installments.
Ijara. A client rents, for example, a car from a bank. The client takes possession of the property when all payments cover the value of this asset plus the bank’s management fee.
Musharakah is a partnership structure where each party involved in a business shares profits, losses, and risks from joint investments.
Wakala. A client entrusts one’s investment means to a bank. In exchange, the client is awarded a fixed profit. If the investments are in the red, the client commits to sharing losses.
Takaful is an Islamic insurance concept when several individuals invest in the same asset with the aim of protecting each other from losing money. Profits and losses are shared equally.
Sukuk is an Islamic financial certificate similar to a bond in Western finance. The issuer of a sukuk sells an investor group the certificate, who then rents it back to the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back the bonds at a future date at par value.