In today’s fast-booming segments of global finance, Islamic banking is registering its unmistakable presence as a key catalyst catering to global societal financial needs.
In fact, it is a fine example of the consistent digital transformation of a banking industry and how it has branched out into different financial segments in today’s growing financial markets.
This blog is discussing Islamic banking system, its evolution, and other related facts associated with it.
What is Islamic Banking?
According to Investopedia, Islamic banking stands for financial activities conducted under Shariah (Islamic law).
Also known as Islamic finance or Shariah-compliant finance, it works based on two main principles, such as –
- Profit and loss shareability (Musharaka)
- Prohibition or exclusion of the collection and payment of interest by investors and lenders
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Key Facts Of Shariah-Compliant Finance
- Banking activities are governed under Islamic Law
- Equity participation earns Islamic banks profit. In this system, borrowers don’t have to pay the interest on money borrowed but a share in their business profits.
- More than 1900 mutual funds and 560 banks worldwide adhere to Islamic principles.
- The growth of Islamic financial assets between 2015 and 2021 was around $4 trillion from $2.17 trillion. Expected rise, as per the report, is close to $5.9 trillion by 2026.
- It is different from the conventional banking system, as it doesn’t allow Riba (usury), and speculative trading (Maisir) under Shariah. Basically, this financial model promotes risk-averse and non-speculative investments.
- It stands out because of its adherence to ethical investing, in compliance with Islamic principles.
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The Core Principles Of Islamic Finance
The practices maintained under Islamic financial system are based on the moral principles of conducting banking in a responsible way. Sharia law governs its financial activities, like borrowing, lending, and investing, etc.
Islamic banking promotes the concept of an interest-free finance ecosystem based on equal participation between financial institutions and customers, in compliance with Islamic law. Its primary objective is to seek participation of everyone in the creation of wealth and profits.
Shariah-compliant finance differs from conventional banking because it functions under Sharia law that prohibits interest-based banking practices, something that conventional banks always follow, making profits at the expense of others.
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Types of Islamic Banking
- Ijarah – It defines a leasing contract to which banks purchase property or capital goods, such as machinery, equipment, etc. and leases it to the clients. In turn, the clients pay the rent for the use of the leased property. To say otherwise, a bank takes the share of profits based on its investments.
- Mudarabah – It defines a partnership between a financier (rabb-ul-mal) and a working partner (mudarib). According to this participatory arrangement, one party provides funds (i.e. financier) and the other party provides the labor (i.e., working partner). Both the parties share in the profits, based on pre-agreed ratio.
- Istisnaa – Under Istisna, a client can utilize the property leased by the bank only after full payment of the dues. The deal involves profit sharing between the bank and the client.
- Tawarruq – Also called reverse Murabaha, Tawarruq is a method in which a client buys an asset from the bank on a deferred payment. Later, the client sells the asset to a third party to get the required cash. Tawarruq practice exists just to fulfill the running cash needs, it doesn’t reflect the actual need of the buyer.
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Islamic Banking – A Booming Segment of Global Finance
Shariah-compliant finance is not a new phenomenon. It covers a broader global ethical finance audience and caters to 1.8 billion Muslims from around the world for their social financing needs. Islamic fintech ecosystem is playing a substantial role in the global fintech revolution, unleashing positive impacts even at its nascent stage of development.
Interestingly, the growth behind Islamic banking is largely attributed to the young demographic of the global Muslim population which is highly tech savvy with fully modern source markets.
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Evolution of Shariah-Compliant Finance
Though Islamic banking traces its origin to 1963, it debuted its present-day practice in 1975 when banks came into being and were mandated to operate under Sharia law and principles.
Since then, there has been no stopping in the growth of Islamic banking and today it is one of the fastest growing segments of global finance.
Shariah-compliant finance grew rapidly because of the increasing demand for Sharia-compliant goods from financiers and investors around the world.
- The growth of Islamic banking is also attributed to some key factors, such as –
Demand surge from Muslim communities worldwide - Growing fondness for financial services complying with sharia law among non-Muslim investors who favored ethical investments and banking practices
- Oil wealth in GCC nations
According to a report by Statista, global Islamic finance markets are expected to have a total assets value amounting to $5.9 trillion by 2026.
Islamic Banking Business Models
The business model of Shariah-compliant finance generally relies on interest-free processes aiming to generate income. Earlier, the Islamic banking business model was based on the asset and the liability sides. It was shifted later to a more debt-oriented structure through the practices, such as Murabaha (mark-up sale).
Over the course of time, Shariah-compliant finance grew up becoming stronger and matured to adopt different business models overseas, in suitable locations. The goal is to make use of the overseas market potentials and make available funds for their segmented customers.
An Islamic banking business model favoring Islamic windows is an interesting banking concept based on Sharia law provided by conventional banks. Many financial institutions such as American Express, and HSBC, etc. have adopted this business model.
Moreover, non-bank financial institutions that follow Shariah-compliant finance principles are catching up fast in countries where the methodology of alternative banking is not conducive. Apparently, such banks will provide banking services to the customer base which favor banking and investments in compliance with Sharia law.
Islamic Banking Adopting FinTech
There are reasons why Islamic banking is adopting fintech.
First of all, it is a wise strategy to ensure that its business practices are more streamlined. Secondly, it will help expand the reach of their products to engage more customers and generate values and revenue. Thirdly, adopting fintech is also beneficial in terms of providing better banking and investment experience.
In addition, Islamic financial institutions are also getting benefits from leading software development companies who offer Islamic banking software to these banks in compliance with Sharia law.
A fintech software development company becomes imperative in this context as it helps Islamic financial institutions with a full spectrum of software solutions that they can use to streamline their business.
Closing Statement
Islamic banking is no longer a new concept for banking. Its global expansion is increasing, with many countries following the business model of Shariah-compliant finance. For example, LARIBA is a US-based financing house operating under Sharia law.
The UK has also set up its Islamic financial institution and issued Islamic bonds in its financial markets. Moreover, countries like China, Australia, India, and Switzerland, and others have shown interest in Islamic banking business models. They are opening Islamic windows or introducing Sharia-compliant funds and bonds.
Islamic banking is catching up fast worldwide because of its ethical banking principles which adhere to transparency, safety, and assets-backed financing, as well as risk-averse offerings. These attributes of Islamic financial institutions promote a distinctive aura of their journey of a niche banking segment, which seems to grow at a rapid pace, making its presence noticed on a global stage.
