Islamic Finance Industry

The Islamic finance industry is here to stay. In the space of three decades it has transformed from a peripheral activity to a sizeable alternative financial management system. Compared to the conventional financial system, it is relatively young. Industry practitioners are constantly learning from the experience of the conventional system, but the learning curve remains steep.

There is a real potential for expansion in retail banking and consumer finance, especially in populous Muslim countries. Non-traditional markets are also expected to become increasingly important, as is the provision of Islamic financial products to non-Muslim customers. The challenge here is to achieve a suitable level of support from the governments and regulators in these markets towards the sector.

The growth and diversification of Islamic finance, along with the geopolitical environment in which it operates, means that it would be unthinkable for the global Islamic finance industry “to go it alone”. Institutions such as the U.S. Treasury, the U.K. Treasury, the International Monetary Fund, the World Bank, and the Basel Committee of the Bank of International Settlements, are all engaging with the sector in an attempt to “demystify” it and to promote global and industry best practice through the introduction of universal prudential and supervision standards. In addition, with many global banking majors entering the market, there is a real impetus in the West to promote the orderly development of the sector.

Muslim countries also want Islamic finance to be part of the global financial system, and are keen to adopt many of the more innovative practices and products as long as they comply with the principles of Fiqh Al-Muamalat (Islamic law relating to financial transactions). On these principles there can be no compromise, otherwise the very ethos and raison d’etre of faith-based Islamic financial management would be undermined.

As such, regulators such as Dr. Zeti Akhtar Aziz, Governor of Bank Negara Malaysia, see much greater convergence of Islamic finance with the global financial system as a niche alternative financing sector.

Muslim countries themselves, however, should seek to address their Islamic financial architecture. They need to establish which model they would prefer to follow – the dual banking model as in Malaysia where the Islamic system operates side-byside

with the conventional system, cooperating but not interacting; or the Islamization of the banking system as in Iran, Pakistan and Sudan.

The latter has to a large extent been discredited because of the fundamental anomalies that persist, especially in dealing with the correspondent banking relations of the Islamic banks. Sudan, Iran and Pakistan have all introduced exceptions to the rule allowing Islamic banks to engage in interest-based banking to accommodate these relationships out of necessity.

Conversely, many GCC countries effectively follow a de facto dual banking model, which many bankers including those interviewed stress is the model to emulate.

As Islamic finance continues its expansion and diversification into new markets and products, there is a real impetus to understand more clearly how it can fit into the global banking sector. As our interviewees indicate, there is a strong appetite for growth and diversification both among regional Islamic banks and global majors. At present, however, there remain a number of barriers to overcome, including human capital shortages, differences in Shariah interpretation, and a lack of consistency in financial reporting. While the prospects for growth and diversification look good, it appears there is still much work to be done to fulfil the core ambitions of the sect