Islamic finance: a parallel financial system.

Author:Malhotra, Naveen

    The financial world has undergone quite a number of major changes in a relatively short period of time. It was only a few hundred years ago during the European renaissance that banking and finance began to secularize as the monarchs and theocratic powers began to wither under years of political, religious, and civil change. Over time, laws regarding usury faded and European power extended across the globe. As a consequence of European influence many foreign market's customary financial laws were supplanted by the secularized "Western" financial system. However, as European global authority dissipated, a new interest in a previously discarded non-secular financial system has begun to reemerge.

    In their Islamic Funds and Investment Report for 2010 Ernst & Young estimated that there was around 939 billion dollars (US dollar) in Islamic financial assets, managed according to the Islamic principles found within SharT'ah (Islamic law) in 2008 ("Islamic funds &," 2010). This is certainly not a large portion of the world's aggregate financial assets (estimated at over $200 trillion, in US dollars, for 2011 ("Global financial assets", 2011)), but when one considers the short history of Islamic finance, and the growth found therein, it becomes apparent that understanding the basic principles of this alternative method of finance may be crucial in future financial discussions. This article is therefore designed to provide a basic understanding of the most commonly encountered principles and methods of Islamic finance, as well as providing a brief history of this rapidly growing system of ethics based financial theory.


    While the religious origins of Islamic finance date back to the religion's foundation over one thousand years ago, the principles found within have only re-emerged relatively recently in financial institutions. In the 1940's a dialogue began surrounding the concept of SharT'ah based finance and economics. Economists and financial thinkers such as Anwar Qureshi, Naiem Siddiqi, and Muhammad Hamidullah began to explore the potential for such systems to be reawakened in the modern context (Gafoor, 1995). However, for the actual realization of these theories to take place decades would pass, albeit decades in which further academic support would be established. One of the earliest organizations to use Islamic laws in order to govern financial dealings in the modern era was an Egyptian savings bank in Mit Ghamr, which was established in the late 1960's (Schoon, 2008). The project was intended to provide small loans and profit-sharing styled investments for more social causes, rather than functioning as a traditional commercial bank. However, its moderate success helped to prove the validity of the concepts of earlier economists and financial thinkers surrounding SharT'ah based finance (Gafoor, 1995). In 1975 the first private Islamic bank, the Dubai Islamic Bank, and the first intergovernmental based Islamic bank, the Islamic Development Bank, were founded. Additionally, numerous international conferences on the subject solidified Islamic financing and economics as a distinct form of financing (Schoon, 2008). From the work of these original pioneers of thought and practice SharT'ah based finance and financial institutions grew into a multinational banking system which has continued to grow over the past forty years.

    Although Islamic finance began to establish itself in the 1970's with the founding of numerous Islamic financial institutions, rapid growth would have to wait until the 1990's. However, during the intervening years the world would see the establishment of the first solely SharT'ah based commercial banking systems in both Iran and Pakistan (Gafoor, 1995), as well as an increase in market...

To continue reading