Ten Reasons the West Should Pay Attention to Islamic Finance - dummies

Ten Reasons the West Should Pay Attention to Islamic Finance

By Faleel Jamaldeen

Here are ten good ways that your efforts in trying to understand Islamic finance can reap long-term dividends — and why you should share your newfound knowledge with others who are working in (or planning to work in) the financial industry.

Islamic and conventional finance can coexist

The primary focus of sharia is the promotion of social justice. A financial industry built on sharia compliance doesn’t threaten the Western world or seek to undermine conventional financial structures. Instead, it recognizes that for some people, especially Muslims, traditional banking, investment, and insurance products don’t fit the bill.

A vibrant Islamic finance industry can and will exist in the future alongside its conventional counterpart. In fact, the Islamic financial industry will thrive in part because its conventional counterpart recognizes its value and makes an effort to participate in its success.

The industry is poised for growth

The modern Islamic financial industry has grown up and out to encompass new products, involve new markets, and attract many new customers. Substantial growth will continue for many years to come.

The global asset value of the Islamic finance industry in 2011 was estimated to be $1 trillion. By 2016, some experts project that amount to be $5 trillion — a huge increase.

Predictions about the growth of Islamic finance institutions and instruments vary. Some say to expect 10 or 15 percent growth each year in the coming decade; others anticipate 30 percent growth per year or even more.

The Gulf is rich in oil (and cash)

A key factor influencing the optimistic perspective on the Islamic finance industry is the wealth concentrated in the countries of the Gulf Cooperation Council (GCC) — Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates.

Almost half of the world’s oil and gas reserves are in the Gulf region, and although many governments are actively seeking to reduce their dependence on oil and gas, large-scale alternative energy projects will take time to develop.

Some of the world’s wealthiest countries and individuals are looking for sharia-compliant products in which to invest. As more sharia-compliant products emerge to fulfill customer objectives (including returns and liquidity), more Gulf wealth — more global money, period — will funnel into Islamic financial products.

The Muslim population is large and growing quickly

From just 2008 to 2010, the global Muslim population grew from approximately 1.3 billion to 1.6 billion; that’s an increase of about 300 million people in just two years. And some people predict that it will jump another 35 percent by 2030 — nearly twice as fast as the non-Muslim population — to account for more than a quarter of the projected world population.

If a reasonable number of those people seek out sharia-compliant financial products, the Islamic financial industry will soon be in high demand.

Muslim customers want and need sharia-compliant products

Muslim population statistics represent real people who are a captive market of the Islamic finance industry — people with religious beliefs that drive them toward sharia-compliant products. Muslims are prohibited from participating in interest-based transactions, gambling, creating or consuming products made from pork, supporting the creation of weapons of mass destruction, and more.

Just this abbreviated list of prohibitions offers an idea of why sharia-compliant Muslims can’t put their money into conventional banks or purchase conventional investment instruments.

Muslims want and need financial products that offer the same types of rewards everyone seeks (such as security for their savings and rewards for their investments) without compromising their moral code.

Non-Muslim investors notice, too

When capital markets get as rocky as they have been since 2007, investors look to reduce risk while still earning a profit. Islamic investment products are very different from conventional equity and bond funds.

Islamic investments are based on business contracts that increase transparency and reduce speculation so that all contract partners (including investors) know what to expect and what risks are involved. In addition, screening equities for sharia compliance includes looking closely at companies’ financial ratios to eliminate those that, say, carry too much debt.

The end result of such diligence on the part of Islamic fund developers is that sharia-compliant investment products often involve less risk than their conventional counterparts.

Socially responsible investing is thriving

Sharia law promotes social justice, and sharia-compliant investments are a subset of a larger trend: socially responsible investing (SRI). SRI is a broad term that refers to making investment choices in support of companies whose activities mesh with your values.

Investors who seek out SRI must do their homework before making decisions about where to place their money. SRI requires transparency from investment funds because investors don’t want to unknowingly support industries they oppose. Socially responsible investors look for fund managers to do exactly what Islamic fund managers already do.

Western indexers and rating agencies are in the mix

The emergence of Islamic indexes is a huge industry development. The first player in the Islamic indexing field was none other than Dow Jones Indexes, and it has been joined by Standard & Poor’s, FTSE, and MSCI. The result is that Western investors have access to benchmarks that track the performance of the Islamic finance industry in ways that are familiar and build confidence.

Similarly, Western investors who consider purchasing sukuk, the Islamic alternative to conventional bonds, can now compare sukuk by using the ratings systems so familiar to bondholders.

London is leading the charge

Just as having Dow Jones Indexes and Standard & Poor’s involved in the Islamic capital markets may comfort Western investors, so may the knowledge that one of the world’s largest centers of Islamic finance is London, England.

With about two dozen British banks providing Islamic finance services, managing approximately $19 billion in assets as of 2011, the nation’s Islamic finance sector ranks ninth in the world. A natural extension of this market’s size is that more education outlets offer Islamic finance training in Britain than anywhere else.

Globalization is here

These days, companies of all sizes can easily seek customers across the globe, and doing so has become a matter of survival. Western financial firms certainly recognize the need to tap into global markets, and technology makes it simple to transfer assets quickly among institutions thousands of miles apart.

The financial institutions that succeed in the new economy will be global entities that meet the needs of customers in every major market; many of those customers will be Muslims seeking sharia-compliant products.