Islamic Finance

Islamic finance, despite its name, is not a religious product. It is however

one of the most rapidly growing segments of the global finance industry.
Starting with Dubai Islamic Banking 1975, the number of Islamic financial
institutions worldwide now exceeds over three hundred, with operations in
75 countries and assets in excess of $2.5trillion. Islamic Finance is
considered the most developed sector within the various pillars of the Islamic
economy. The growth in the global Sharia-compliant economy is broadly
measured by the value of Islamic Finance assets. In 2014, Islamic Finance
assets had an estimated value of $1.8 trillion. The value of assets in the
Islamic finance sector is expected to increase by 80 per cent over the next
five years, reaching $3.24 trillion in value by 2020, according to initial
findings garnered from the upcoming State of the Global Islamic Economy
(SGIE) report.
Islamic finance has started to grow in international finance across the
globe, with some concentration in few countries. Nearly 20 percent annual
growth of Islamic finance in recent years seems to point to its resilience and
broad appeal, partly owing to principles that govern Islamic financial
activities, including equity, participation, and ownership. In theory, Islamic
finance is resilient to shocks because of its emphasis on risk sharing, limits
on excessive risk taking, and strong link to real activities. Empirical evidence
on the stability of Islamic banks, however, is so far mixed. Conventional
finance includes elements like interest and risk which are prohibited under
Shariah law. While these banks face similar risks as conventional banks do,
they are also exposed to idiosyncratic risks, necessitating a tailoring of
current risk management practices. The macroeconomic policy implications
of the rapid expansion of Islamic finance are far reaching and need careful
considerations.
Three key principles govern Islamic finance: equity, participation, and
ownership. These principles imply that in an Islamic financial system,
financing can only be extended to productive activities, trade, and real
assetsthus it is often considered an asset-based financial system. If fully
complied with, these principles ensure appropriate leverage and help limit
speculation and moral hazard.
Consistent with these key principles, there are two sets of Islamic modes
of financing, excluding fee-based services: (a) profit-and-loss-sharing (PLS)
modes of financing; and (b) non-PLS contracts. A strong preference is
attached to risk sharing modes of financing, as they are closest to the spirit

of Islamic finance. In addition, even in debt-like modalities, financing is linked

to real assets, thereby limiting the extent of leverage associated with
financing.
Islamic finance has expanded rapidly and is spreading across many
regions. Islamic financial assets grew, on average, about 20 percent annually
over the past decade. Despite this growth, Islamic finance still represents a
very small share of global financial assets. To this end,
several factors still constrain the realization of the full potential of Islamic
finance. A few are discussed in this paper, such as lack of liquidity
management instruments and underdevelopment of appropriate safety nets,
notably Shariah-compliant deposit insurance scheme and lender of last
resort facilities. Islamic banks operating in many conventional systems do
not have access to Shariahcompliant tradable short-term treasury
instruments to channel excess funds to other Islamic financial institutions.
The absence of such instruments restricts growth, forces banks to hold
excessive reserves, and also curtails the central banks ability to conduct
monetary policy operations. The process of advancing Shariah-compliant
lender of last resort facilities and deposit insurance schemes has been
challenging. Developing a robust liquidity infrastructure to facilitate both
liquidity risk management at Islamic banks, and help conduct monetary
operations by central banks, is a priority policy and research area. Promoting
the soundness and resilience of Islamic banking, particularly in times of
distress, would require instituting a Shariah-compliant financial safety net
infrastructure.
To further enhance financial stability of the Islamic financial systems,
there is a need for strengthening the supervisory and regulatory frameworks,
including with a set of comprehensive prudential standards. In this context,
achieving full compliance with regulatory, and supervisory standards offered
by two Islamic standard-setting authorities (AAOIFI and IFSB), should be a
priority. Both AAOIFI and IFSB have issued multiple guidelines and standards,
but much work is still needed to ensure compliance, including a transparent
and credible assessment process for evaluating compliance with standards.
Conducting
monetary
operations
through
Shariah-compliant
instruments is challenging. To this end, it is necessary to adapt monetary
policy instruments and spur the development of Islamic interbank markets.
Sukuk issued by governments appear to be suitable collateral for monetary
operations in the context of Islamic banks (as currently practiced in Sudan
and Iran). Monetary policy transmission mechanisms are, however, still not
well understood and require further research.
The Kerala government has got a go-ahead from the Reserve Bank of
India to launch a financial institution following the principles of Islamic

finance. Kerala set the stage to start first Islamic non banking finance
company (Al Barakah Financial Services Ltd) in India with the partnership of
state government department (Kerala State Industrial Development CorpKSIDC) after dismissal of petition filed by Subramaniam Swamy and RV Babu
in High court. Barakah would be a unique company with an authorized share
capital of Rs.1, 000 Crores and would perform on the principles of Islamic
financial institution. Al Barakah will not operate as a bank and extend loans
but make direct investments into infrastructure projects not linked with pork,
alcohol and other non Halal products, after which profits would be shared in
the form of dividends and not as interest. KSIDC has 11 percent stake and
rest would be raised by NRIs and state Muslim population.
According to the 2001 Census of India figures, 56% of Kerala residents
are Hindus, 24% are Muslims, 19% are Christians, and the remaining follow
other religions including Sikhism, Jainism, Buddhism, Judaism. In oppose to
common perception that initiative of Islamic financial company has been
taken by state government to woo the Muslim voters, we analyzed that
financial company based on Islamic finance will attract the Muslim emigrants
of state from gulf region NRKs to invest the money in infrastructure projects
based on Shariah principles instead of keeping the same in cash form. As per
CDS report for the year 2008, Muslim constitutes around 40% shares of total
emigrants of Kerala. Muslim has almost 45% percent share (18998 crore INR)
of total state remittance flowing to state from overseas.
As per the report Inflow of about Rs 43,288 crores to the Kerala
economy by way of remittances has had a very significant effect on the
states economy and the living conditions. For a total population of 3.371
crores in Kerala in 2008, the total Remittance of Rs 43,288 crores means an
average per capita remittance of Rs 12,840. For an average household, it is
Rs 57,215 per year. Remittances thus contribute substantially to the annual
income of the households in Kerala. Remittances were as much as a third (31
percent) of Keralas NSDP. The per capita income of the state was Rs 41,814
without including remittances but would be as much as Rs 54,664 if
remittances were also included. The importance of remittances in Kerala is
evident from the fact that remittances were 1.74 times the revenue receipt
of the state, 5.5 times of the money Kerala got from the Central Government,
2.3 times the annual non-plan expenditure of the Kerala Government. The
remittances were sufficient to wipe out 70 percent of the states debt in
2008. Remittances were 36 times the export earnings from cashew and 30
times of those from marine products.

All these aforementioned facts indicate to the positive results which

would reflect in state economy by incorporation of Islamic financial company.
After getting the consent of High court, Kerala industry minister Elamaram
Kareem said "There is enormous interest among Gulf-based NRIs in investing
in Kerala through the Shariah route. There has been an offer to bring in Rs
10,000 crore from Oman alone, through the initiative of Muscat-based
Keralite businessman, P Mohamed Ali",
"The interest in the proposed NBFC is so strong, that immediately after it
was floated a large corporate with interest in multiple domains sought 74%
stake in it, and the Doha Bank expressed desire to pick up a 46% equity",
says Kareem. After introduction of Shariah index in Bombay stock Exchange
(BSE), it is second serious attempt to include the Indian Muslim in
mainstream financial setup and certainly would be milestone to achieve the
inclusive growth vision of country.