Global Islamic finance is growing at a fantastic rate with over half a trillion dollars currently under management. Conservative estimates put the growth rate at 20%, while more optimistic estimates set it at almost 30%. Wealth under management by Islamic financial institutions is expected to skyrocket over the coming years as the world’s 1.3 billion Muslims become increasingly well-off. It is anticipated that by 2015 the sector will be worth $2.8 trillion.
A big part of that wealth is coming in the form of petro-dollars, which have saturated the Gulf with liquidity over the past few years. That wealth, in turn, needs to be invested and Islamic financial products are rapidly becoming a popular option. But with Islam’s thirteen-hundred-year-old history, why is Islamic banking just now starting to make the headlines?
Historical perspective: product development
Beginning of the Islamic bank
The answer to that question is long and complicated, but to start it is useful to take a brief glance at the history of Islamic banking. For over 1,000 years the concept of Islamic banking remained rigidly fixed to the form it had held when the faith was in its formative years. Due in part to its prohibition on riba (usually translated as interest), Islamic banking was largely seen as incompatible with contemporary conventional banking methods. By the early to mid-twentieth century, however, attitudes were starting to change and small experiments with Islamic banking were taking places in countries like India, Malaysia and Pakistan.
But the first real Islamic bank worth mentioning got it start in Egypt. Ahmad al-Najjar was a young Egyptian graduate student in West Germany in the 1950s when the concept of an Islamic bank for Egypt’s poor, rural population first came to him. Inspired by the major role local savings banks played in West Germany’s reconstruction after World War II, al-Najjar became convinced that a similar scheme organized along Islamic lines could help to boost Egypt’s economy.
So al-Najjar returned home and launched his project in the tiny Nile delta town of Mit Ghamr in 1961. Although the Mit Ghamr Savings Bank fizzled after an initially modest success, the concept of Islamic banking had been born.
Islamic banking took on its contemporary form just over a decade later, in 1975, when the Islamic Development Bank (IDB) was established by the members of the Organization of the Islamic Conference. And although the Mit Ghamr Savings Bank had followed sharia (Islamic law) guidelines, it was in fact the IDB that was the world’s first purpose-built Islamic bank. In the same year, the Dubai Islamic Bank was founded. Just two years later the Faisal Islamic Bank in Sudan and the Kuwait Finance House were inaugurated.
Global Development in IBF
Expanding product base
The trend continued over the years with the launching of new Islamic banks and creation of new Islamic financial products. In terms of products, Islamic banking in the 1970s was rather limited and only the simplest services were available. The most basic of these is murabaha. This Islamic method of finance is defined as ‘cost plus financing’. Murabaha refers to contracts in which a bank purchases goods upon the request of a client, who then makes deferred payment that covers cost and an agreed upon profit margin for the bank.
In the 1980s, the hot item was takaful, Islam’s answer to conventional insurance. The 1990s saw the rise of Islamic equities and the sukuk market (the Islamic bond market now worth over $120 billion). Islamic scholars are still breaking new ground deep into the present decade with sharia-compliant structured alternative assets.
Islamic banking and finance continues to grow geographically as well. Malaysia has rapidly become a leader in terms of product development and London is now a major international Islamic financial center. With the West’s financial markets in disarray after the subprime crisis in the US and the collapse of the UK’s Northern Rock, it is very likely that interest in Islamic finance will continue to grow on the international scene.
