What is Islamic Finance? Is it an answer to the volatile global financial system?

Since the global financial crisis, policymakers have sought to address the fault lines that helped trigger one of the most devastating financial crises in a century, and to enable a more inclusive, stable financial system that promotes stability as well as economic development and growth.

Islamic finance offers several features that are consistent with these objectives. Islamic finance refers to financial services that conform with Islamic jurisprudence, or Shari’ah. Instead of trading in money and earning profit from the interest, Islamic banking trades in goods and services and earns profit from real economic transactions. It also has restraints on highly speculative transactions, and refrains from financing or participating in businesses and activities dealing in alcohol, gambling, tobacco, and pornography, as these are not permissible under Islam. All other activities remain very much as with any other banking and financial institution. It requires fair treatment; and institutes sanctity of contracts. And these principles hold the promise of supporting financial stability, since a key tenet of Islamic finance is that lenders should share in both the risks and rewards of the projects and loans they finance.

Islamic finance has an important potential to act as an engine of stability and inclusion. Since investors are required to bear losses that may arise on loans. there is therefore less leverage, and greater incentive to exercise strong risk management. These risk-sharing features also serve to help ensure the soundness of individual financial institutions and help discourage the types of lending booms and real estate bubbles that were the precursors of the global financial crisis.

The focus on asset-backed and risk-sharing financing also has the potential to improve access to finance by small- and medium-sized enterprises, and to support inclusive growth- by having more money for lending to stable businesses.. It is well-suited to financing large-scale infrastructure projects, whereby—similar to public-private partnerships—investors finance the construction of roads, bridges, and similar projects, and receive the returns on these investments. Finally, Islamic financial services also promise to improve financial inclusion for the large number of Muslims that are discouraged from using banks for religious reasons.

Many secular countries such as the United Kingdom (UK), France, and Singapore are promoting Islamic finance to improve financial inclusion of their domestic population and also to attract funds and investments from other countries. UK alone has more than 25 Islamic financial institutions including five full-fledged Islamic banks. In June 2014, it became the first non-Muslim country to issue a sovereign sukuk (Islamic bond). Other countries which followed suit were South Africa and Thailand. The latter already has a state-run Islamic Bank since 2002. At present, more than 75 countries offer Islamic banking products and the global market for these assets is around $2 trillion.

However, India recently saw the deferment of the launch of State Bank of India’s Shariah Equity Fund in December 2014.

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