Is Islamic Finance Now Mainstream?

Combatting usury, ensuring ethical standards, and sweeping the world: a new financial cornerstone emerges.

Islamic finance has progressively gained traction in the global financial scene, transitioning from niche to mainstream alternative.

This rise has been driven by factors including the ethical attraction of Shariah-compliant goods, the rising integration of Muslim-majority economies into the global economy, and Islamic banking’s financial resilience during the 2008 global financial crisis.

But some key questions remain: Has it truly joined the mainstream? What difficulties and opportunities lie ahead? The answers require a look at the history of Islamic finance, its position in the global market, and its prospects.

The Foundations

Islamic finance is based on Shariah, or Islamic, law. It establishes precise norms for economic and financial transactions. These are based on the prohibitions against riba (interest), gharar (excessive uncertainty), and a demand for risk-sharing. It aims to promote social justice by making financial transactions fair, transparent, and beneficial to all involved.

Some basic elements distinguish it from conventional finance. Interest is prohibited, because it is perceived as exploiting borrowers — particularly those in financial difficulty.

Islamic financial institutions (IFIs) instead make money through profit-and-loss-sharing agreements, trade-based lending, and lease contracts.

Gharar opposes excessive ambiguity or speculation. Contracts must be explicit and transparent, so that all parties understand the terms and conditions.

Asset-Backed Financing

Islamic financial products are often secured by tangible assets, such as real estate or commodities. This requirement is based on the notion that money should not be generated from nothing, but linked to actual economic activity.

Traditional financing frequently transfers risk to the borrower; Islamic finance emphasises risk-sharing between the lender and the entrepreneur. This balances incentives and promotes responsible investing.

Shariah encourages ethical and socially responsible investing while avoiding potentially damaging industries such as alcohol, gambling, and arms.

These principles underpin a range of financial goods and services, including Sukuk (Islamic bonds), Takaful (Islamic insurance), and investment funds. Each has contributed to the expansion and diversification of the sector.

The Rise of Islamic Finance

Modern Islamic finance dates back to 1963, when the Mit Ghamr Savings Bank was established in Egypt. This pioneering institution functioned on a profit-sharing basis, laying the groundwork for global expansion.

Significant financial organisations were established in the 1970s, notably the Islamic Development Bank (IDB) in 1975, which was instrumental in spreading Islamic banking among Organisation of Islamic Co-operation (OIC) member countries. Oil-rich Gulf states began to set up Islamic banks and financial institutions to align their financial systems with their religious principles.

The Expansion Phase

The 1980s and 1990s were a period of growth, as Muslim-majority countries in South East Asia began to use the system. Malaysia, in particular, emerged as a global powerhouse for Islamic finance, with diverse products and a sophisticated regulatory framework.

In the 2000s, Islamic finance gained traction outside of the Muslim world, as non-Muslim-majority countries such as the UK and Luxembourg recognised its potential. The issuing of Sukuk by sovereign and corporate entities demonstrated a growing embrace of the concepts.

Resilience in Crisis

One of the most significant turning moments was the 2008 global financial crisis. Conventional banks were significantly impacted by the collapse of the subprime mortgage market and the resulting credit crisis.

Islamic institutions displayed greater resilience, partly due to the prohibition on interest-based transactions and excessive speculation. This protected Islamic financial institutions from some of the risky products that triggered the crisis.

The relative stability of Islamic banks drew the attention of investors and politicians around the world, sparking renewed interest.

Into the Global Market

The global Islamic finance industry is now valued at almost $4tn. Over the last decade, the industry has grown at a compound annual growth rate (CAGR) of over 10 percent, often exceeding the expansion of traditional finance.

Islamic finance has grown significantly in various key markets, including Gulf Co-operation Council (GCC) countries such as Saudi Arabia, the UAE and Qatar.

These countries have been issuing Sukuk to fund infrastructure projects and diversify their economies. In South East Asia, Malaysia remains a global leader, with a well-established regulatory framework, a robust Sukuk market, and a thriving Islamic banking industry.
Indonesia, the world’s most populous Muslim-majority country, has seen a tremendous expansion thanks to government initiatives and increased demand.

There has been rapid growth in Pakistan and Bangladesh, where Islamic finance is seen as a way to increase financial inclusion.

In Sub-Saharan Africa, Nigeria and Sudan have shown an interest in expanding the sector. Nigeria released its first sovereign Sukuk in 2013, signalling a willingness to developing the finance system.

In Western markets, Islamic finance has made advances in the UK, with London establishing itself as the leading centre. In 2014, the UK government issued its first sovereign Sukuk, and many Islamic banks now operate there. Luxembourg and Germany have investigated prospects in Islamic finance.

Adoption and Challenges

The question of whether Islamic finance has become mainstream remains difficult. While it has achieved global visibility and acceptability, a number of hurdles could prevent its full integration.

One of the most significant issues is the lack of standardised legislation across jurisdictions. This lack could result in inconsistencies and disrupt cross-border transactions.

Because Shariah-compliant instruments are not universally available, Islamic financial organisations frequently struggle to manage liquidity. Traditional banks have access to a diverse range of interest-bearing securities, but Islamic banks must manage with a smaller set of tools, such as Sukuk.

Ensuring Shariah compliance is crucial to the integrity of the system, and interpretations of its principles vary. This has resulted in a lack of consistency in the implementation of the banking rules, which can cause confusion.

While Islamic finance has made great strides, there is still a lack of comprehension in non-Muslim nations. Educating consumers and investors on the benefits and principles of Islamic finance is critical to its continued success.

Competition with Convention

Islamic finance frequently coexists with conventional finance in dual-banking systems. This may present issues in terms of pricing and product innovation. Conventional banks may provide comparable products that are not Shariah-compliant, but are marketed to appeal to the same ethical concerns.

The Islamic finance business is concentrated in areas prone to geopolitical instability, such as the Middle East and North Africa. Political upheaval, economic sanctions and other issues may have an impact on its progress in these locations.

Fintech Integration

The broader financial system is being transformed by technology breakthroughs and the rise of fintech. Its incorporation into Islamic finance brings opportunities and obstacles. Digital banking provides a chance for Islamic banks to broaden their reach, especially among younger, tech-savvy clientele. Digital platforms can help improve financial inclusion by offering Shariah-compliant banking services to neglected communities.

Blockchain and smart contracts have the potential to transform Islamic finance by increasing transparency, lowering transaction costs, and ensuring compliance. Blockchain can be used to verify the legitimacy of Islamic financial products, guaranteeing that they are backed by tangible assets.

Crowdfunding and peer-to-peer (P2P) lending platforms provide alternative financing possibilities consistent with Islamic values. These platforms can help entrepreneurs get access to cash without relying on traditional institutions.

While fintech has great promise for innovation, it also poses regulatory obstacles. Ensuring that fintech solutions adhere to both Shariah principles and local rules necessitates thorough scrutiny and collaboration among regulators and industry players.

The future of Islamic finance seems optimistic, with three major factors expected to drive continuing growth. And expansion into new markets, particularly in Africa and Central Asia, is expected. Countries with large Muslim populations and undeveloped financial systems provide opportunities for Islamic finance to provide financial inclusion and economic growth.

The principles of Islamic finance are in line with the growing global emphasis on sustainability and ethical investing. Islamic financing has the potential to play a critical role in projects involving renewable energy, infrastructure, and social impact. The development of green Sukuk and other Shariah-compliant sustainable finance instruments is expected to pick up in the future years.

As Islamic finance expands, there is room for more integration with global financial markets. This might include more Sukuk cross-listings on foreign exchanges, more engagement of Islamic financial institutions in global trade financing, and enhanced collaboration between Islamic and conventional financial institutions.

The rise of Islamic fintech is projected to spur innovation and increase access to Shariah-compliant financial services. The creation of new digital platforms, blockchain-based solutions, and alternative financing models will all play important roles.

Challenges to Overcome

While the future is bright, the Islamic finance industry must address a number of problems. Improving the standardisation of Shariah-compliant goods and regulatory frameworks is vital for worldwide expansion. Industry players must collaborate to create norms and procedures to expedite cross-border transactions and boost investor trust.

The expansion of Islamic finance necessitates a trained workforce. Addressing any talent gaps via education and training initiatives will be the way ahead. More efforts are needed to raise awareness and educate the public about the benefits of Islamic financing.

This involves clearing up misconceptions and promoting Islamic finance as an ethical and viable alternative to traditional finance. It must adjust to new regulatory regimes, managing new regulations governing fintech, sustainable finance, and global financial stability.

Islamic finance has come a long way. Its ethical basis, durability during financial crises, and alignment with contemporary themes have all contributed to its growing popularity. While it is more widely recognised and used, it still confronts obstacles that must be addressed before it can be considered mainstream.

Islamic finance’s future will be determined by its capacity to innovate, enter new markets, and integrate with the larger financial system — while adhering to its essential values. As it expands, it can serve as a viable alternative and a model for ethical and sustainable financial practices.

The question of whether Islamic finance has become mainstream is about more than just market size or geographic reach. It’s also about whether Islamic finance can continue to provide a unique value proposition that appeals to a broad spectrum of investors, consumers, and governments. If it can meet its challenges, it has the potential to become another cornerstone of the global financial system.