Islamic Banking is growing at a tremendous rate under international banking.

The current
Islamic financial structure was first created in the late 1960’s around Egypt. Islamic finance
works on the principle of the Shari’ah legal code and in accordance with the Islamic
Jurisprudence. The presence of various principles and characteristics makes Islamic finance
unlike the conventional legal system of finance. According to an Islamic economy, all human
activities should be productive as Islam does not endorse every human wish. On the basis of
moral grounds, it prohibits all haram(harmful) activities which are related to tobacco, alcohol,
drugs, pork products, gambling, destructive weapons, armaments, pornography, speculation and
charging interest.
One of the main characteristic of Islamic finance is the principle of debt-free financing. Charging
any type of interest is prohibited under Islam because they consider that it is unethical to earn
money on someone else’s debt. It is considered as one of the haram activities because it is like
making money by harming someone else. The banks which run on this ideology are funded by
non-interest bearing current accounts which are either benevolent loans or safe keeping
contracts. They are also funded by profit sharing investment accounts in which they receive a
part of the profit earned by the loan bearer. This type of framework is very different than
conventional type of banking as conventional banks survive by making money from the interest
they charge from their defaulters.
Islamic financial institutions follow the model of profit and loss sharing. It is another
characteristic of Islamic banking which works on the principle of profit sharing and loss bearing
which is also known as ‘Mudarabah’. In this scenario, the financier or the investor provides
capital whereas the beneficiary provides the skills or the labor. There are two types of cases in
this, in the first case, the profits are shared by both the parties but the losses are beard by the
investor. The investor does not interfere in the management of the operation otherwise it is
considered a breach of contract. In the second case, there is equity like financing of the operation
where profits and losses are shared equally known as ‘Musharakah’. This profit sharing model is
often considered as a win-win situation because the loan bearer is not actually taking a loan but
is in a partnership with the bank. The investor or the partner will share both the profits and the
losses. It is a greater amount of risk for the banks but it is also greater amount of profits at the
same time. The loan bearer on the other hand can feel more debt-free and can actually focus on
making profits instead of thinking about repaying the bank.
Based on the Hofstede’s cultural dimensional theory, it can be seen that most of the Islamic
countries are high on uncertainty avoidance and masculinity. Islamic culture is a high-context
culture. Islamic banking works on the principle ‘Do not sell what you do not own’ which means
that things like short selling are prohibited. For example, one cannot lose his/her property except
on the basis of his/her right. Due to these type of conditions, Islamic banking is considered to be
asset based banking.
Islamic banks tend to have high amount of liquidity, but at the same time, they suffer from lack
of high quality liquid assets complied by Shari’ah legal code. There is a big question in order to
have a regulatory body for the compliance and regulation of these Islamic banks. There is a need
of this body as there is no supervision to these banks and some small scale banks take advantage
because of this reason. There is a need to develop methodologies for their asset management,
analysis of their risk taking capability and vulnerability. The international monetary fund has
introduced some standards to govern these banks. One such body is account and audit
association of Islamic financial institutions. Another thing is ‘sukuk’, which are asset based
financial securities. They are certificates of value representing assets which provides the investor
a proof of ownership of the asset. The Islamic banks tend to face more risk because their
investments are physical whose return is uncertain. These banks are more resilient to sudden
shocks than conventional banks due to the ‘gharar’ considerations which prohibits them from
creating investments in super risky and toxic assets.
Islamic banks have shown a great amount of growth in the past decade. Stats show that the
amount of assets owned by Islamic banks grew by double digit rates in the past decade from
US$250 billion in 2004 to an estimated US$1.9 trillion at the end of 2014 (Ernst & Young 2014;
IFSB 2014; Oliver Wyman 2009). Inspite of these growth patterns, it is clear that most of these
assets are limited to the gulf countries. The growth is mainly due to the strong demand from
Muslim populations and tremendous growth of industry in the developing countries. Islamic
banks have great potential to contribute even more towards the growth of these countries as
research shows that investment by these banks in the private and the public sector has helped
boom various economies in the past such as Pakistan and Syria. A big section of the Muslim
population is underserviced by conventional finance – only 24 percent of adults have bank
account and 7 percent have access to formal financing, compared to 44 percent and 9 percent,
respectively, for non-Muslim populations (Demiguc-Kunt, Klapper, and Randall 2013). The
characteristics of risk sharing makes these types of banks very well suited for the financing of
various types of startups and SME. The presence of sukuk has shown great value in the field of
investments, infrastructural financing and economic growth. The issuance of sukuk has also
rapidly increased since 2006, although its diversification is still going on in various African and
middle eastern countries.
If we compare Islamic banks to conventional banks based on their growth and profit, before the
period of the recent global recession, both types of banks were not significantly different. After
the financial crisis, the profitability of Islamic finance slowed down in comparison with the
conventional banks due to the low risk management policies. But the recent studies show that
Islamic banks are on a rise in both the profit and efficiency. These banks are way more advanced
in the developed countries than in other countries due to the same reason of better risk
management policies of these countries. Islamic banks face their own risk in compliance with the
Shari’ah and use conventional risk measures. The overall development of these banks is on such
a rise that in a few years they might be a better option than the conventional banking system.

Hussain, Shahmoradi, Turk, An Overview of Islamic finance, IMF Working Paper 15/120, June
2015, https://www.imf.org/external/pubs/ft/sdn/2015/sdn1505.pdf
Kammer, Norat, Pinon, Prasad, Towe, Zeidane; International Monetary Fund – Islamic Finance;
April 2015
Sources: IFSB Annual reports; Central Banks, IFSB; IFIS; Bloomberg; KFHR; and Ernst & Young