Umer Suleman, Head of Wahed UK
From relatively obscure to decidedly mainstream, Islamic finance has matured from a niche service offered by a small number of banks in Middle and Far Eastern countries in the 1970s to a global success story, with assets of approximately $2.4 trillion by 2019 – 11% higher than a year earlier, and a third bigger than in 2015.
But how have banking services in conformance with the principles of Sharia law become increasingly popular? There are several reasons behind the growing influence of Islamic finance, particularly when the Covid-19 pandemic is taken into consideration.
Over the past decade, shifting geopolitics, the financial crisis and the resulting exposure of poor practice and corruption across the global banking industry has been a main driving force behind the size of the Islamic finance sector, which has increased five-fold.
Its rapid growth – compared to traditional banking models – is in no small part due to Islamic finance’s ability to demonstrate a higher level of ethical credibility.
After all, a core proponent of Islamic finance is rooted not only in risk-sharing, but also a complete non-tolerance for deception. And with the collapse of the financial system in 2008/2009, faith in Western banking was so severely shaken that an entire generation – who were promised that a recession of this magnitude was a once in a lifetime occurrence, only for another to take place just over 10 years later when Covid struck – began to look for a more socially conscious, morally responsible solution.
That’s why Islamic finance is not just growing in popularity amongst Muslims. In December 2020, The Bank of England announced a launch date for their new Sharia compliant non-interest based deposit facility, the first such account from a Western central bank. The facility, in which deposits from Islamic banks will be backed by a return-generating fund of high-quality Sharia compliant assets, will ‘further strengthen the United Kingdom’s role as the leading international financial centre for Islamic finance outside the Muslim world’, according to the Bank’s statement.
But why is the UK becoming such a hub for Islamic finance? The BoE believes that ‘the fact is that, outside those regions (Middle East, North Africa, South and South East Asia), the UK is the pre-eminent centre for Islamic finance. And that reflects its significant, well-established domestic Muslim population; its strong relationships with the wider Muslim world; and its deep expertise in financial market origination and distribution, embedded in a mature legal and regulatory framework.’
Another thing to consider is the rising interest in ESG, an initiative that places important emphasis on investing based on environmental, social and governmental factors. Many of these tenets were already present and being practiced within Islamic finance, and there’s a growing demand from consumers and investors alike for their money to be placed in ethical investments that align with their own personal values.
Indeed, banks abiding by Islamic law tend to be more stable, particularly during the economically turbulent times of recent years. This stems from the fact that the banks are non-speculative in nature, so when markets endure periods of volatility and uncertainty, they are better equipped to weather the storm.
In turn, this means that banks practicing Islamic finances aren’t making huge, risky bets with people’s deposits. This was, in part, the root of the housing bubble that began the crisis in 2008/9. Essentially, Islamic banks are risk-averse in that they keep themselves away from businesses that can fall victim to economic bubbles. Instead, they focus on corporate ethics and socially aware innovations that can create tangible real-world benefits through financial operations.
In fact, The Bank of England also argues that key aspects of Islamic finance make it particularly well-suited to financing the post-Covid recovery. The focus on equity-like sharing of risk/reward could become increasingly relevant as investors get to grips with the scale of debt accumulated in response to the pandemic. Risk-sharing contracts, including those promoted by Islamic finance, pose materially lower medium-term risks to stability.
But that’s not all. Issuance of so-called ‘green sukuk’ has risen sharply in the past three years and the Islamic Development Bank issued an innovative $1.5bn sustainability sukuk in June 2020, with plenty of scope for further growth.
With a higher demand for these types of services from a socially conscious generation who are seeking sustainable products with a positive impact, Islamic finance is well-placed to become one of the leading sources of innovation.
And this is particularly true for the fintech sector, which has a central role to play in leading the charge for technological solutions that aid accessibility and inclusion. By developing apps and services that enable faster and easier access to Islamic financial products, there’s a palpable sense that fintech will hold the key to the next chapter of Islamic finance.