In a world characterised by economic dynamism and financial innovation, Islamic finance emerges as a distinctive and increasingly influential system.

It emphasises real trade and economic activities while prohibiting interest-based transactions, speculation, artificial financial instruments and toxic assets like conventional derivatives.

Rooted in Islamic commercial law and underpinned by a robust ethical foundation, Islamic finance promotes fair conduct, risk-sharing and asset-backed transactions.

According to the Islamic Finance Development (IFD) Report 2023, the global Islamic finance industry has maintained its growth momentum, with assets surpassing $4.5 trillion and the number of Islamic financial institutions rising to 1,871.

The sector’s annual growth rate is approximately 11 per cent. This impressive financial performance demonstrates that Islamic finance is no longer a niche market but a significant player in the global financial landscape.

Islamic finance now has a presence in over 120 countries, manifesting in various forms such as Islamic banking, fund management, takaful, sukuk, and Islamic fintech.

In terms of governance, at least 55 global jurisdictions have issued laws or regulations to facilitate the industry, and 20 countries have established central Shariah governance boards.

Regarding global sustainability efforts, the Environmental, social, and governance (ESG) Sukuk outstanding has surpassed $24 billion, according to the IFD Report 2023, while ESG-related funds manage over $6bn.

To enhance the sustainability impact of Islamic finance, 42 countries have issued sustainability guidelines. Additionally, the amount of CSR funds disbursed by Islamic financial institutions has exceeded $1.5bn.

Understanding the value proposition of Islamic finance and advocating for its ethical approach to financial affairs reveals a pathway to financial inclusion, ethical prosperity and sustainable growth.

Under increased globalisation, Islamic finance presents avenues for financial inclusion, cross-border collaboration, and investment that foster social welfare and ethical, risk-sharing transactions

At its core, Islamic finance is based on principles derived from Islamic commercial law, which prohibits activities such as interest-based transactions, uncertainty in commercial contracts, speculation and gambling.

Islamic finance serves as an alternative to conventional financial practices by promoting risk-sharing, asset-backed trade transactions and equity-based modes that emphasise profit and loss sharing.

It also includes ethical screening, which requires Islamic financial institutions to avoid businesses involved in alcohol, gambling, tobacco, the weapons industry and adult entertainment. This ethical framework fosters stability, transparency, and social responsibility, aligning with broader societal values.

One of the key pillars of Islamic finance is the concept of equity partnership and profit and loss sharing contracts, such as Musharakah and Mudarabah, which are commonly used on the deposit side. Unlike conventional finance, where lenders are guaranteed fixed returns regardless of the outcome, Islamic finance encourages shared risk and reward.

Additionally, Islamic finance emphasises asset-backed trade-based financing, such as Murabaha, which is a cost-plus sale transaction involving the sale of tangible assets like real estate, commodities, or equipment — an approach that provides greater security for both parties involved.

Islamic finance promotes institutions taking ownership stakes in real assets, including plant and machinery, and supports rental-based contracts (Islamic leasing). In this setup, the Islamic financial institution assumes the ownership risk, while the customer pays rent for using the asset. This method is widely used for financing infrastructure projects and other large ventures.

The principles of Islamic finance go beyond individual transactions, extending to broader economic objectives. The domain of Islamic finance also encompasses Islamic social finance — an integral area that not only widens the reach of Islamic financial practices to nearly all Muslims but also holds the potential to contribute globally to sustainable growth and economic development.

Islamic social finance instruments primarily consist of Zakat (obligatory almsgiving), Sadaqah (voluntary charity), Waqf (endowments and trusts) and Qard al-Hasan (benevolent, interest-free loans).

Recent innovations in this field have expanded to include Islamic microfinance, social sukuk, socially responsible investments (SRI) and Islamic crowdfunding and ethical investments. This focus on social welfare supports the broader objectives of financial inclusion and poverty alleviation.

Additionally, Islamic finance fosters ethical conduct and responsible financing practices. By prohibiting interest, it discourages excessive debt accumulation and encourages prudent financial management. This approach reduces the risk of financial crises and supports long-term economic stability.

In our interconnected global landscape, Islamic finance presents avenues for financial inclusion, cross-border collaboration, and investment. Driven by a burgeoning Muslim population and rising demand for Sharia-compliant financial instruments, Islamic finance has transcended its traditional markets, capturing the attention of investors worldwide.

Furthermore, Islamic finance is well-suited to meet the specific needs of certain demographic groups, such as Muslims living in non-Muslim majority countries. These individuals often encounter difficulties accessing financial services that align with their religious beliefs.

Islamic finance offers viable alternatives, including Islamic banking, insurance, investment funds, and sukuk (Islamic bonds), thereby promoting financial inclusion and empowerment.

Critics of Islamic finance often raise concerns about its complexity, limited product offerings and regulatory challenges. However, these issues can be addressed through education, innovation, and collaboration.

As Islamic finance evolves, efforts to standardise practices, enhance transparency, and improve regulatory frameworks will strengthen its value proposition and appeal to investors.

In conclusion, Islamic finance provides a compelling value proposition that extends beyond financial returns to include ethical conduct, social responsibility, sustainable growth, financial inclusion and poverty alleviation.

The writer is the director of the Institute of Business Administration’s Centre for Excellence in Islamic Finance.

Email: aasiddiqui@iba.edu.pk

Published in Dawn, The Business and Finance Weekly, August 12th, 2024