ISLAMIC FINANCE & CAPITAL MARKETS

The Growing Global Appeal of Islamic Finance

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1 year ago

December 12, 2022

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Islamic finance is increasingly attracting attention among investors worldwide, especially in 2019 which saw a double-digit growth in assets. Despite the tumultuous year for global financial markets last year due to the COVID-19 pandemic, there is growing interest due to three reasons—greater appreciation around the role that Islamic finance plays in responsible investing; geographical interest in markets where Islamic finance is gaining prominence; as well as digital transformation, which makes Islamic investments more accessible.

A Growing Industry, Attracting New Interest Globally

Islamic financing emerged 50 years ago, in countries with large Muslim populations who were keen to ensure their sources of funding were governed by the requirements of Shariah and the principles of Islam. In 2019, Islamic finance assets amounted to US$2.88 trillion, the highest recorded growth for the industry since the global financial crisis. The prospects look positive: by 2024, this is set to rise to US$3.69 trillion. While Muslim countries have turned to Shariah financing to fund their thirst for capital, another underlying reason for its popularity is that Shariah financing is beginning to broaden its appeal among non-Muslim countries too.

The acceleration of technology as a result of COVID-19 has also benefited the Islamic finance industry as more financial institutions are now offering their products via digital platforms, making it easier for Muslim and non-Muslim investors to access. Sustainability has also become a more important consideration for investors, which could potentially lead to increased take-up by non-Muslim investors who are drawn to the ethical and responsible investing dynamics of Islamic finance products and services.

This broader appeal is necessary to drive growth in Islamic finance assets globally. Until now, investor demand has, understandably, been concentrated in jurisdictions where Islamic finance is of systemic importance. The Gulf Cooperation Council (GCC) region still accounts for the largest share of global Islamic finance assets (45.4%), followed by the rest of the Middle East and South Asia (25.9%) and Southeast Asia (23.5%).

But there remains significant opportunities elsewhere in the world. For instance, Africa offers growth potential as African sovereigns and financial institutions use Sukuks as alternative funding sources and issuance is supported by increasing financing needs in Africa, especially for infrastructure projects. Beyond Africa, the UK presents a huge prospect for the Islamic finance market. The country became the first western nation to issue a sovereign Sukuk in 2014 and is currently the biggest center for Shariah-compliant finance in the West. It is also home to the world’s first actively managed equity Shariah-compliant exchange-traded fund (ETF) launched in September 2020.

As more awareness and knowledge of Islamic finance starts to build up in non-Muslim countries, we expect to see steady growth in Islamic finance assets and expansion in Shariah-compliant investment products and services to cater to the rising demand.

A Natural Role for ESG in Islamic Finance

There is growing awareness among global investors of the synergy between ESG (environmental, social and governance) investing and Islamic finance, contributing to the rising appetite for Shariah-compliant investments as investors look for greater portfolio diversification and an alternative to more traditional ESG investments.

Islamic finance and ESG investing are complementary investment approaches sharing significant common ground, such as being a good steward to the society and the environment. Both offer products that appeal to Muslim and non-Muslim investors alike, and hold strong practices and policies that each can learn from the other.

The fundamental teachings of Shariah in finance can be summarized in three broad ways:

Prohibition of interest – The ban on interest-based borrowing or lending in a financial transaction means capital cannot be borrowed or lent on interest.

Type of contracts – Shariah provides guidelines on acceptable and permissible forms of entering into contractual agreements. For example, certain conventional financial contracts such as forwards and futures are deemed not to be in accordance with the guidelines of Shariah. Similarly, contracts on notional amounts, treating currencies as asset classes, purchase and sale of risk and options, are viewed as non Shariah-compliant. Contracts are based on principles of risk sharing, avoidance of excessive uncertainty, and real asset-backed or asset-based transactions.

Restrictions on activities that are not in the public interest – These guidelines are set to preserve life and honor humankind. In line with this, Islamic financial institutions do not deal with any entity nor transact in areas that intersect with the restricted activities. These include participating in betting and gambling, along with its restrictions on alcohol, drugs, weapons and industries or activities that have a negative impact on societies.

In line with these practices, societal values are at the forefront with Islamic finance, just as they are with ESG investing. In addition, Shariah restrictions on activities or industries that are not in the public interest are consistent with the negative screening that forms part of the ESG approach.

Beyond these evident socially focused similarities between ESG investing and Islamic finance, there is also convergence in environmental objectives. For example, green Sukuks, a Shariah-compliant financial instrument similar to a bond, are designed to finance sustainable, climate-resilient and environmentally friendly projects, generating returns in line with Shariah principles. In terms of governance, Islamic institutions are automatically subject to an additional layer of oversight compared with their conventional counterparts as they are being regulated by Shariah boards that are responsible for providing guidance and issuing opinions on whether a product or service conforms to Shariah principles.

With growing consensus that the objectives of generating returns and prioritizing global social welfare are not mutually exclusive, investors are exploring Islamic finance to complement their ESG investments for enhanced overall risk-adjusted returns and greater portfolio diversification while building more sustainable economies.

Digital Transformation in Islamic Finance

Just as how fintech has already disrupted the way traditional financial services operate, this new breed of tech enablers has also accelerated digitalization of Islamic finance products and services, making it more accessible to investors globally and redefining client experiences.

Countries across Asia, Europe, the Middle East and the U.S. have created dedicated start-up hubs, venture capital initiatives, regulatory sandboxes and funding programs to develop Shariah-compliant fintech innovations, helping to fuel this trend. These include launching new Islamic robo-advisors using artificial intelligence to determine optimal investments based on a set of criteria to ensure Shariah compliance. In the crypto space too, industry stakeholders have taken various initiatives to create alternatives for digital assets and trading platforms that are in accordance with the Shariah principles.

Similarly, regtech has the potential to be a game changer for the Islamic finance industry. It aims to solve regulatory and compliance barriers using robust digital tools to achieve compliance with Shariah requirements. Smart contracts on blockchain, for example, provide a level of transparency by enhancing traceability of underlying assets, cash flows and investors, making them attractive as they provide both surety and security. Several Islamic banks are already using or testing blockchain to assist with payments and remittances.

Higher Level of Standardization Needed to Drive International Adoption

Harmonization in Islamic finance practices and the adoption of global best practices have enabled Islamic finance to evolve from being a boutique offering initially, to being recognized by the International Monetary Fund (IMF) as systemically important in over 14 jurisdictions, and is now offered by more than 300 financial institutions across 60 countries.

The efforts of industry bodies have largely reduced differences in the interpretation and practice of Shariah principles to ensure soundness, stability and integrity of the Islamic finance industry.

IFSB / Islamic Financial Services Board

Provides governance and disclosure requirements for Shariah-compliant institutions

AAOIFI / Accounting and Auditing Organization for Islamic Financial Institutions

Provides standardization of Shariah rules through the publication of standards for Shariah contracts and principles

IIFM / International Islamic Financial Market

Provides standardization of contracts in key areas such as risk participation, interbank transactions and money markets

Yet, continued efforts are needed to homogenize industry practices to drive a set of globally accepted standards. In cases where it requires greater clarity, institutions would rely on the Islamic ruling or Fatwa, issued by a recognized authority such as an Islamic scholar to provide legal guidance and greater assurance of Shariah compliance among stakeholders within a transaction.

Uniformity in standards will also bring about scalability of services and industry efficiencies; improve public confidence; as well as increase cross-border marketability, enhanced transparency and consistency in financial reporting. Regulators are increasingly aware of the importance of developing an international, comprehensive and more structured legislative framework for Islamic finance, with the goal of accelerating growth and reducing discrepancies around the globe.

An Overlooked Asset Class?

Today, Islamic finance is a multi-trillion dollar industry that is no longer operating on the fringes of global financial markets. In the coming years, Shariah-compliant assets are expected to keep growing, driven by rising interest from investors beyond Muslim economies due to:

Increasing demand for a sustainable, stakeholder-focused and socially responsible financial system, emphasizing synergies between ESG investing and Islamic finance
Greater digitalization and fintech collaboration creating new avenues for growth and enhancing transparency
Opportunities for scalability and industry efficiencies via greater harmonization of Shariah practices and standards

When moving in this direction, investors will require the infrastructure, insights and related solutions to safeguard and manage their Islamic finance assets across every stage of the investment life cycle.

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ISLAMIC FINANCE & CAPITAL MARKETS

What is Microtakaful and How Does It Work?

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1 hour ago

May 6, 2024

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By Hafiz M. Ahmed

In recent years, the concept of microtakaful has emerged as a significant development in Islamic finance, offering a Shariah-compliant insurance solution tailored to the needs of the less affluent segments of society. This form of microinsurance is designed not only to adhere to Islamic principles but also to provide financial protection to those typically underserved by conventional insurance systems. This blog post will explore what microtakaful is, how it operates, and its impact on communities.

What is Microtakaful?

Microtakaful is a form of Islamic microinsurance that offers Shariah-compliant insurance solutions to low-income individuals and communities. This system operates on the principles of mutual assistance and risk sharing, where participants contribute small premiums to a collective pool. The funds are managed according to Islamic law, ensuring no investment in prohibited activities, and profits and risks are shared among all participants.

Difference between Takaful and Microtakaful

Takaful and microtakaful are both forms of Islamic insurance, but they cater to different segments of the market and have distinct operational scales and objectives. Here are the key differences between the two:

Target Audience:
- Takaful is geared towards a broader audience, including businesses, middle to high-income individuals, and larger entities seeking Shariah-compliant insurance solutions.
- Microtakaful specifically targets low-income individuals and communities, offering them affordable insurance coverage to help mitigate financial risks associated with accidents, health issues, and other unforeseen events.
Scale and Scope of Coverage:
- Takaful policies generally cover a wide range of risks and can offer substantial coverage amounts, similar in scope and scale to conventional insurance policies.
- Microtakaful provides smaller, more limited coverage aimed at essential needs, reflecting the lower premium capacity of its clientele. The focus is on accessibility and essential protection rather than comprehensive coverage.
Premiums and Contributions:
- Takaful involves higher premiums reflecting the broader and more significant coverage it offers, and these premiums are also used to invest in permissible (halal) ventures according to Islamic law.
- Microtakaful requires very small, affordable premiums to ensure that the financially weaker sections of society can also access insurance. These contributions are pooled to cover the collective risk of the group.
Objective and Impact:
- Takaful aims to provide a Shariah-compliant alternative to conventional insurance, ensuring participants avoid Riba (interest), Gharar (excessive uncertainty), and Maysir (gambling).
- Microtakaful not only aims to be Shariah-compliant but also focuses on social impact by enhancing financial inclusion and providing safety nets to economically vulnerable groups.

How Does Microtakaful Work?

The operational model of microtakaful is fundamentally different from conventional insurance. Here’s a step-by-step breakdown of its mechanism:

Risk Pooling: Participants contribute small, affordable premiums into a collective pool, which is used to cover potential losses or damages. These contributions are considered donations and thus embody the Islamic principle of charitable giving and mutual assistance.
Takaful Operator: A takaful operator manages the pool. The operator is responsible for ensuring that the fund is used properly, adhering to Shariah principles, and overseeing claims and compensation. Importantly, unlike conventional insurance, the operator does not own the fund but acts as a custodian or manager.
Shariah Compliance: The operations of microtakaful are governed by a Shariah board, which ensures that all transactions remain free from interest (riba), uncertainty (gharar), and gambling (maysir). Investments made with the pooled funds must be in halal (permissible) ventures, avoiding industries like alcohol, gambling, and tobacco.
Surplus and Deficit Handling: Any surplus in the takaful fund (after claims and expenses) can be distributed to the participants as dividends or reinvested to increase the fund’s capacity. In the case of a deficit, the takaful operator may provide an interest-free loan (qard hasan) to the pool to cover the shortfall, which is subsequently repaid.
Claims and Compensation: When a claim is made, compensation is paid out from the collective pool. The focus is on solidarity and support among the members rather than on profit-making.

Benefits of Microtakaful

Microtakaful has several advantages, particularly for low-income communities:

Accessibility: It provides financial security to those who may not afford or access traditional insurance products.
Community Empowerment: By promoting mutual assistance, microtakaful strengthens community ties and resilience.
Economic Stability: It helps stabilize the economic conditions of individuals and small businesses by mitigating risks and providing support in times of need.

Challenges and Future Prospects

Despite its benefits, microtakaful faces challenges such as low awareness, regulatory hurdles, and the need for more tailored products to meet diverse needs. However, the potential for growth is significant, especially in countries with large underserved Muslim populations. As awareness and understanding of microtakaful increase, it is expected to play a more prominent role in global Islamic financial services.

In conclusion, microtakaful represents a pioneering approach to financial inclusion, blending traditional Islamic principles with innovative risk-sharing mechanisms to protect the most vulnerable. Its expansion can lead to more equitable access to insurance and contribute to the broader economic empowerment of disadvantaged communities worldwide.

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ISLAMIC FINANCE & CAPITAL MARKETS

IsDB Forecasts $15 Trillion Needed by 2040 for Global Sustainable Infrastructure

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6 days ago

April 30, 2024

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By Aamer Yaqub

At the Islamic Development Bank’s (IsDB) 2024 Annual Meetings in Riyadh, President Dr. Mohammed Al-Jasser articulated a compelling vision for addressing the global infrastructure deficit, which demands an estimated $15 trillion by 2040 to meet burgeoning needs. This statement aligns with the headline: “World needs $15 trillion to bridge the financing gap for sustainable infrastructure projects by 2040: IsDB”. This gathering, which also marked the bank’s Golden Jubilee, was themed “Cherishing our Past, Charting our Future: Originality, Solidarity, and Prosperity.”

Dr. Al-Jasser’s comments, as the Saudi Press Agency reported, emphasized the critical inadequacies of current public financing mechanisms in keeping pace with the escalating demands for sustainable infrastructure. He underscored the urgency of rethinking financing strategies to effectively support long-term investment in infrastructure, particularly in the world’s least developed countries.

These nations, hardest hit by resource depletion exacerbated by the COVID-19 pandemic, face a stark reality. The pandemic strained their development efforts and posed significant risks to their future growth and stability. Dr. Al-Jasser pointed out that these countries are at risk of enduring further economic and social degradation without immediate and decisive action.

Highlighting the unique position of Islamic finance in this scenario, Dr. Al-Jasser noted its suitability for funding substantial, long-term infrastructure projects. Islamic finance, known for being asset-based and embracing risk-sharing, dovetails with sustainable and environmentally responsible investing principles. This makes it an ideal approach to tackle these countries’ infrastructural challenges, ensuring that development aligns with ethical financing principles.

Dr. Al-Jasser called for a global mobilization to leverage the principles of Islamic finance to not only bridge the financing gap but also catalyze prosperity, solidarity, and equitable growth across the least developed nations. His vision extends beyond financial growth, aiming to foster enhancements in healthcare, education, and job creation, thus attacking the roots of poverty.

This focus on sustainable and responsible finance underscores a broader shift in global development priorities, where ethical considerations are increasingly becoming as significant as economic factors. Dr. Al-Jasser’s advocacy for a strategic reorientation in financing reflects a deep understanding of Islamic finance’s challenges and transformative potential in the contemporary global economy. This strategic shift is crucial as the “World needs $15 trillion to bridge the financing gap for sustainable infrastructure projects by 2040: IsDB,” emphasizing the urgency and scale of the financial challenges ahead.

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ISLAMIC FINANCE & CAPITAL MARKETS

How Islamic Social Finance Contributes to Poverty Alleviation

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2 weeks ago

April 22, 2024

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By the ISA

The global Islamic economy has burgeoned to an impressive $2.29 trillion in 2023. A significant part of this growth story is the transformative role of Islamic social finance. Rooted in principles of equity, charity, and social welfare, Islamic social finance is a beacon of hope and a practical solution in the fight against poverty. The Islamic economy isn’t just thriving in the newer modest fashion and digital entrepreneurship sectors, but it is also making substantial strides in ethical and socially responsible finance. Leveraging mechanisms such as Zakat (almsgiving), Sadaqah (voluntary charity), and Waqf (endowment), Islamic social finance has shown its potential to significantly impact poverty alleviation, especially in regions with substantial Muslim populations. In this article, we’ll explore how this ancient yet evolving financial system addresses one of humanity’s most persistent challenges: poverty.

Mechanisms of Islamic Social Finance

Islamic social finance, deeply rooted in Islamic principles, offers unique mechanisms for wealth distribution and social welfare. These instruments align with religious teachings and provide practical solutions for poverty alleviation and community development. Here, we explore the key instruments of Islamic social finance:

Zakat

The Pillar of Islamic Giving Zakat, one of the five pillars of Islam, is a mandatory charitable contribution calculated as a fixed proportion of a Muslim’s savings and wealth. As a compulsory act of worship, Zakat profoundly redistributes wealth and aids people in need.

Halal saving techniques.

It is estimated that if properly collected and distributed, Zakat has the potential to reduce poverty levels in Muslim-majority countries significantly. Today, Zakat is collected and distributed through various channels, including government bodies, NGOs, and digital platforms, ensuring a broader and more efficient reach.

Sadaqah: Voluntary Charitable Acts

Unlike Zakat, Sadaqah is a voluntary charity without any fixed amount or percentage, making it a flexible tool for social welfare. Sadaqah contributions often fund community projects, emergency relief, and other social welfare initiatives, directly impacting living conditions and providing support in times of crisis.

Waqf: The Endowment System

Waqf, an Islamic endowment of property or money for a specified philanthropic cause, has historically played a crucial role in developing Islamic societies. Modern Waqf systems are evolving, with initiatives like cash Waqf and corporate Waqf emerging, allowing for more diverse and sustainable social projects.

Qard Hasan: Interest-Free Loans

Qard Hasan refers to an interest-free loan provided for welfare purposes or to help someone in need, embodying the Islamic principle of helping others without seeking personal gain. These loans are particularly impactful in empowering low-income individuals or entrepreneurs who lack access to traditional banking services, thereby fostering economic growth and self-reliance.

Muslims give away a lot.

Each instrument plays a vital role in the Islamic social finance ecosystem. They not only adhere to Islamic principles but also offer practical, ethical, and sustainable means of supporting social welfare and poverty alleviation. As the Islamic economy continues to grow, these mechanisms are increasingly being integrated with modern financial practices, expanding their reach and impact in addressing global socio-economic challenges.

Islamic Social Finance in the Modern World

Adopting technology in Islamic social finance has streamlined processes, from the collection of Zakat to the distribution of funds. Digital platforms have enabled faster, more transparent, and more accountable transactions. Technology has also democratized participation in Islamic social finance, allowing individuals worldwide to contribute easily to Zakat, Sadaqah, and Waqf.

Fintech innovations in the Islamic finance sector have been pivotal in mobilizing resources. Digital platforms facilitate the efficient collection and allocation of funds, ensuring they reach the intended beneficiaries promptly and effectively.

Islamic fintech platforms play a vital role in financial inclusion, offering services tailored to the needs of the unbanked or underbanked populations, who often need financial support.

Muslims give charity a lot.

Case Studies: Islamic Social Finance in Action

As a crowdfunding platform focused on the global Muslim community, LaunchGood.com has been instrumental in supporting various causes, from disaster relief to community projects, showcasing the power of collective, community-based support. Platforms offering Islamic micro-financing and crowdfunding have opened new avenues for small-scale entrepreneurs and individuals in need. These platforms directly contribute to poverty alleviation and economic empowerment by providing interest-free loans and investment opportunities.

Platforms like Malaysia’s Ethis and Indonesia’s Evermos are prime examples of how Islamic social finance can be integrated into the business world. These platforms adhere to Islamic principles and support small and medium-sized enterprises (SMEs), fostering job creation and sustainable economic growth.

Impact on Poverty Alleviation

Islamic social finance has a tangible impact on poverty alleviation, addressing both immediate needs and long-term economic stability.

Direct Impact on Poverty Reduction

Zakat and Sadaqah provide immediate financial assistance to those in dire need, helping to alleviate poverty at the grassroots level. For example, in many Muslim-majority countries, Zakat collections amount to significant sums, directly supporting millions of impoverished individuals. Waqf endowments have historically funded educational institutions, healthcare facilities, and other community infrastructure, contributing to sustainable poverty reduction. Modern Waqf projects continue this legacy, often focusing on long-term community development. For example, the Waqfeyat Al Maadi Community Foundation (WMCF) in Egypt aims to create sustainable social impact through a longstanding but part-forgotten Islamic tradition.

Helping those in need is sunnah.

Indirect Impact through Economic Empowerment

Islamic microfinancing and crowdfunding platforms have empowered countless entrepreneurs, particularly in underprivileged communities. These platforms enable individuals to start or grow businesses by providing interest-free loans and investment opportunities, creating jobs, and fostering economic independence. A study conducted in Indonesia showed that Islamic microfinance institutions helped increase the income levels of small business owners, demonstrating the indirect impact on poverty alleviation.

Challenges and Opportunities

While Islamic social finance has made significant strides, it faces several challenges that must be addressed to maximize its impact.

Challenges in Islamic Social Finance:

Regulatory Hurdles: One of the primary challenges is the lack of a unified regulatory framework across different countries, which can hinder the efficiency and scalability of Islamic social finance initiatives.
Limited Awareness and Understanding: There is still a significant gap in awareness and understanding of Islamic social finance mechanisms among both Muslims and non-Muslims, limiting participation and support.

Opportunities for Growth and Innovation:

Technological Integration: The continued integration of technology offers immense growth opportunities. For instance, blockchain technology can enhance transparency and trust in the distribution of Zakat and Sadaqah.
Global Partnerships: There is a growing opportunity for global partnerships between Islamic and conventional financial institutions to expand the reach and impact of Islamic social finance.
Educational Initiatives: Increasing educational efforts to raise awareness about Islamic social finance can lead to greater participation and support, furthering its impact on poverty alleviation.

Conclusion

The unique combination of traditional Islamic principles and contemporary financial practices positions Islamic social finance as an effective tool for addressing poverty and promoting social development. Integrating Islamic social finance principles can create a more inclusive and equitable global economy. The path ahead for Islamic social finance is filled with potential and essential for fostering a balanced and just economic system worldwide.

Courtesy: The Islamic Services of America (ISA) is a leading authority in Halal certification within the United States and North America.

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