The Size of Islamic Finance - Essay Example

Islamic finance Islamic finance encompasses one of the fastest-developing sectors of modern day’s finance industry. While Islamic finance was traditionally considered a marginal industry, today, it is admired as a crucial and flourishing market. The size of Islamic finance has grown substantially over the years to the present estimated value of between $500 billion and $1,000 billion (Warde 43). However, despite this massive value, and the remarkable growth rates of 10-15%, Islamic finance is still an understated fraction of conventional banking (Iqbal, Mirakhor, Askari and Krichene 201). The value and growth demonstrated by Islamic finance, in recent years, typifies the industry’s overall potential comparative to conventional finance. The growth of Islamic finance has been observed outside conventional Islamic markets in members of the Gulf Cooperation Council (GCC). This signifies the increased attention being paid to Islamic finance by policy markers, as well as other universal market participants. The point of this paper is to refute the argument that Islamic finance cannot serve as a viable alternative to conventional finance. To date, a number of non-traditional Islamic markets such as London and New York have shown increased appreciation for the value of Islamic finance. In fact, London and New York launched indices in their FTSE and Dow Jones indices with a view to offer a benchmark for equity prices attributable to investments in Islamic financial companies (Warde 141). Governments such as the UK government continue to play a major role in extending the scope of Islamic finance by extending support, for instance, by prohibiting the imposition of double stamp duty on Islamic mortgages (Warde 54). This is indicative of the fact that modern governments and private institutions are becoming increasingly aware of the viability of Islamic finance as an alternative to conventional finance. Within the brief period of 30 to 40 year, Islamic finance has developed from a minute industry in a small number of Muslim countries to a globally acclaimed industry. The viability of Islamic finance as an alternative to conventional finance is evidenced by the array of products offered to both Muslim and non-Muslim investors. Typically, Islamic finance offers financial products rooted in the doctrines of Shariah or Islamic Law (El-Gamal 94). Most of these products are offered to Muslim investors while some Islamic products also attract conventional borrowers and investors. Islamic finance centers primarily on the principles of Islamic, and as a consequence, it encompasses a two-tier system. Firstly, the banking system accepts bankers’ deposits primarily for safe-keeping purposes without the accrual of any return while demanding 100% reserves. This means that, under Islamic finance, the payment system of the economy is protected from risks. Additionally, the system also limits the capacity of the banking system to create credit, thus hindering the necessity for deposit guarantee attributed to the conventional reserve system (Iqbal, Mirakhor, Askari and Krichene 196). The second primary component of Islamic finance is the fact that investment factors that act as classical financial intermediaries that channel savings to appropriate investment projects, as well as events where investment deposits are deemed as equity investments, without guarantees at maturity are subject to profit and loss sharing (Warde 128). Depositors are essentially considered as investors and the collection of assets managed by the financial institution appear on the assets segment of the balance sheets. The primary difference of between the conventional financial system and financial intermediation inherent in Islamic finance is that while depositors accrue fixed and pre-determined liabilities in conventional finance, those in Islamic system are party to both profits and losses accrued by the financial institution’s assets (El-Gamal 133). This signifies that Islamic finance does away with the old asset-liability mismatch issue. The conventional finance system is quite unstable, shaken from time to time by financial crises that necessitate massive bailouts. This is primarily since the conventional system is largely a debt and interest-centered system thus produces massive debt, leveraged through credit multipliers. Debt financing is quite detrimental to growth compared to risk-sharing as typified by the Islamic system (Warde 117). Diverse factors, including tax treatment and government insurance schemes have largely favored the growth of debt-centered contracts rather than risk-sharing contracts. This shows the essence of Islamic finance since it provides for risk sharing rather than risk-transfer (Iqbal and Mirakhor 219). This implies that the development of risk-sharing is rather minimal in most countries, especially those that rely on conventional finance. Essentially, Islamic finance deters institutions from expecting rewards without assuming some form of risk, both in terms of resources and labor. This means that no payments are made for labor unless it is utilized in operations and rewards for capital are only attained if they meet business risks. In essence, Islamic finance provides a participatory environment for all financial relationships. Another prominent factor that distinguishes Islamic finance as a viable alternative to conventional finance concerns the imposition of interests. In conventional finance, there is a disparity between the return to equities and the rate of interest imposed due to the accessibility of riskless assets. Conversely, in Islamic finance, the alternative of risk free assets is inexistent, meaning that Islamic finance can take advantage of this gap since equities are not necessarily required to afford massive returns in order to make up for risks over riskless assets. Additionally, Islamic finance is characterized by the nonexistence of interest-based dealings or riba, as well as the deterrence of conventional economic transactions deemed as oppressive (zulm) (Iqbal and Mirakhor 184). For instance, Islamic finance prohibits speculative tendencies (gharar). This prohibition is aimed at deterring risk-taking, opting instead for risk-sharing in all financial transactions. However, Islamic finance appreciates the significant role played by taxes in enabling the achievement of day-to-day activities, particularly on the part of the government; hence allows for the imposition of zakat in line with Islamic law. The imposition of Zakat is aimed at ensuring that organizations operating under Islamic finance maximize their profits conditional on the restrictions of Shariah law (Ahmed). In conclusion, it is clear that Islamic finance provides a remarkable alternative to conventional finance primarily through its provision of policies that counter the injustices and inefficiencies inherent in the conventional system (Warde 71). Islamic finance provides for an efficient environment in which all businesses thrive, hence there is more to Islamic finance, as a substitute of usual finance, than its famous zero-interest-rate system. Works Cited Ahmed, S. A. “Global Need for a New Economic Concept: Islamic Economics.” International Journal of Islamic Financial Services 1.4 (2000). Print. El-Gamal, M. A. Islamic Finance: Law, Economics, and Practice. New York: Cambridge University Press, 2006. Print. Iqbal, Z., and Mirakhor, A. An Introduction to Islamic Finance: Theory and Practice. 2nd ed. New Jersey: Wiley, 2011. Print. Iqbal, Z., Mirakhor, A., Askari, H., and Krichene, N. Risk Sharing in Finance: The Islamic Finance Alternative. New Jersey: Wiley, 2012. Print. Warde, I. Islamic Finance in the Global Economy. 2nd ed. Edinburgh: Edinburgh University Press, 2010. Print. Read More