The fourth installment of a Global Finance FAQ web series on Islamic finance.

Author: Chloe Domat

For hundreds of years, there was no need for Islamic finance because there was simply no financial system to “Islamise.” Up until the second half of the 19th century, the vast majority of the Muslim population around the world was unbanked and the prohibition of interest was applied on transactions by tradition rather than by law or regulatory bodies.

During the colonial era, Western banks and financial institutions penetrated Muslim countries and imposed interest-based methods on the Islamic world. In the 1940s and 1950s, independence movements pushed for the revival of Islamic culture and religious scholars in countries such as India, Pakistan and Egypt started to condemn the use of interest by banks. They proposed to prohibit interest and replace it with Islamic risk-sharing. Localised Islamic finance experiments took place in the 1960s in Egypt and Malaysia.

In many ways, Islamic finance was born as a rebellion against colonialism and for self-determination. The idea was to provide an ethical alternative to the Western-dominated international financial system based on the Quran.

Building an Islamic Banking Network from Scratch

In the 1970s, Persian Gulf countries — which were both suddenly incredibly rich with petro-dollars and extremely conservative in religious belief — took Islamic finance beyond local experiments and created the Saudi Arabia-based Islamic Development Bank in 1975 followed by the Dubai Islamic Bank in 1979. Because the establishment of the first sharia-compliant institutions coincided with the rapid economic development of their home countries, a large share of Islamic investments went into the construction and real estate sectors.

Islamic finance expanded quickly, first in the Arab world and East Asian countries with significant Muslim populations before reaching the West and especially the UK in the early 2000s. In parallel to that expansion, two regulating bodies emerged — the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) in Algeria (now relocated to Bahrain) and the Islamic Financial Services Board (IFSB) in Malaysia.

In 2007, sharia-compliant finance remained somewhat immune to the subprime loan crisis which generated a lot of interest. Islamic finance then surged across the globe at an average yearly growth rate of 10%–12%.

Islamic Debt Market

Islamic bonds also known as sukuks began to be issued in the late 1990s. Although they often serve the same purpose as regular bonds, they should be viewed as certificates of asset ownership rather than as debt obligations. 

The trend really took off in 2006 when total sukuk issuance reached $20 billion. It peaked at $137 billion in 2012 before the pace slowed down. Last year, total Islamic bond issuance reached $95 billion, with a major contribution from Saudi Arabia and its first series of sovereign sukuks for a total of $17 billion.

Today, there are over 350 Islamic financial institutions spread over more than 60 countries and total sharia-compliant assets represent $2.2 trillion. Although Islamic finance is less than 1% of the global financial market, it is one of the fastest-growing segments. While consolidating their existing markets, sharia-compliant entities have started to branch out into new territories, notably Sub-Saharan Africa and Europe.