Hidden Interest? Islam and Finance

Islamic finance presents an interesting contradiction between religion and modern economics. The world of finance is in large part built on the premise of interest. The debt market now dwarfs the equity (stock) market, and a majority of debt products inherently carry some form of interest. The world of Islam, however, strictly forbids usury, or the practice of charging interest. Islam is also the world’s second largest religion with over a billion adherents, which makes it impossible for its practitioners to not participate in the world of finance. This seemingly huge dilemma is solved by the practice of Islamic finance. Bridging the gap between religion and business, Islamic finance is quickly growing in both size and importance.

Some believe that Islamic finance is somewhat of a modern phenomenon, whereas others argue it is a practice as old as the Quran itself. The premise behind this debate is due to the fact that the core tenets underlying the idea of Islamic finance, or sharia compliant finance, have been around since the time of Muhammed. Financial products compliant with sharia law weren’t introduced, however, until the mid-1970’s. Regardless of their beginning, it is their growing influence that has people paying attention. According to consulting and accounting firm Ernst & Young, Islamic banking assets grew by almost 18% from 2009 to 2013, and are expected to grow at an even faster pace going forward to 2018. Countries like Iran, Saudi Arabia, and Malaysia are some of the main players when it comes to creating and distributing sharia compliant financial products, but western banks are becoming increasingly involved in the space. So we understand that it is taking off, but what is Islamic finance?

Sharia compliant finance uses financial engineering to get around the concept of interest, but allow those who offer “debt” to be compensated for their risk. Take for example an Islamic mortgage. Unlike a typical American mortgage where the lender is very upfront about charging you an interest, sharia compliant lenders have a different way to charge you for using their money. Islamic lenders technically buy the house themselves and the tenants or the borrower will live in the house and pay rents to the lender for the term of the arrangement. Once the term of the arrangement is up, say 30 years, the borrower becomes the owner of the home and stops paying the rent. Many argue that the rent charged by the lender is essentially interest, but masked as rents to stay compliant. Some argue that is simply a loophole and not truly compliant with Sharia law. Regardless, in the eyes of many scholars and leaders of Islamic finance, Islamic mortgages and other similar financial products are compliant with Sharia law.

One issue, however, is that not all scholars agree. There have been disagreements between Muslims in the Malaysia and the Arabic world. This has led for a call to have a summit where an international set of laws for Islamic finance are created. Summits have started to occur, such as the one taking place today in Kenya. The particular purpose of this conference is to expand Islamic financial institution’s influence in Africa, and will be key to promoting business and trade between Africa and Muslim countries. Overall, the role of Islamic finance is expanding, and the products are evolving. With an ever-growing Muslim population, and the constant need for finance in the modern world, it seems evident that Islamic finance is here to stay.