Islamic Finance: How Does It Make Money Without Interest?


Posted November 10, 2020 by finterraventures

Islamic Finance: How Does It Make Money Without Interest?

 
With the move by Financial institutions towards Fintech and the use of blockchain to drive efficiency and cost reductions, there is no part of the financial system that has not or will not be impacted by the changes technology are bringing. Islamic Finance is no different, in fact this sector might be the biggest beneficiary of the technology, given the strict compliance Islamic products need to adhere to. With FINTERRA launching its WAQF Chain in mid — FEB 2019, I have been spending time looking at Islamic Finance and the benefits it has over conventional finance.
The attributes associated with it as a form of financing are certainly appealing. So, I was led to write this article as a brief overview of the Financial instrument allowed in Islam, to inform mostly those that would like to explore more ethical and socially sustainable forms of banking and investment. During my reading on the subject an article posted on Global Finance certainly provided a mine of information.
The article points out that products offered by Islamic financial institutions are comparable to Western or conventional finance even though interest and speculation are forbidden. Banks are by far the biggest players in Islamic finance — some of them are exclusively Islamic while others offer sharia-compliant products but remain mostly conventional. Apart from the absence of interest rates, the key concept behind Islamic finance is risk sharing between parties in all operations.
There are three big models:
• The wakala — where the fund manager receives a fee and the surplus remains the property of the participants.
• The mudarabah — adapted from the banking system where profits and losses are shared between the fund manager and the participants.
• A hybrid model — A mix of mudarabah and walkala.
In some cases, the fund manager creates a waqf, or a charity fund.
Sukuk or bonds: Sharia-compliant bonds began to be issued in the 2000s and standardized by the AAOIF — a Bahrain-based institution that promotes sharia-compliant regulation since 2003. Today, about 20 countries use this instrument. Malaysia is the biggest issuer and issuers outside the Muslim world include the UK, Hong Kong, and Luxembourg.
Sukuk issuance took off in 2006 whit issuance hitting $20 billion and peaked in 2012 at $137 billion before the pace slowed down significantly in 2015. According to Moody’s ratings agency sukuk issuance reached $95 billion in 2017. That year, Gulf Cooperation Council (GCC) markets pushed the growth with Saudi Arabia’s first sovereign sukuks for a total amount of $17 billion as well as contributions from Oman and Bahrain.
“While sukuk issuance increased significantly in the first half of 2017 thanks to enormous deals by some GCC countries, we think they were the exception rather than a new norm” wrote credit ratings agency Standard & Poor (S&P) in its 2018 report on Islamic Finance.
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Last Updated November 10, 2020