The history of modern day Islamic finance emerged in the 1960's with the establishment of the first Islamic bank in Mit Ghamr in Egypt by Ahmad El Najjar and the set up of Lembaga Tabung Haji in Malaysia. Until the 1970s, Islamic banking was mostly focused on the retail market.

The rise of Islamic finance in the late 1970s coincided with the oil crises of that decade, which created an immense amount of wealth by bringing a large amount of capital to oil producing countries. The emergence of wholesale banking and the associated product innovation is, however, a more recent development.

In recent years, Islamic finance has attracted a number of western multi-national financial institutions, which started offering Islamic financial products in the International Islamic Financial Market and to a lesser extent in the western world.

But what is Islamic Finance? It's a subtle mix of economy, ethics and Islamic Law (Shariah). Its aim is to perform financial transactions based on fairness, profit and loss sharing and real transactions.

The difference between Islamic finance and conventional finance in investment consists of the fact that investors should observe certain principles in order to reconcile their belief with their investment practices. This requires specific contracts and agreements while doing business.

Such contracts are generally based on a risk-reward distribution key and their drafting necessitates a lot of attention so as to exclude any ambiguity between the different contracting parties.
What will this mean for the banking industry?

Main principles - restrictions

Avoid Riba

Based on the notion of Riba, interest is forbidden in Islamic transactions and is considered as usury. This is a fundamental principle for Islamic finance and banking. Therefore a conventional loan, for instance, is impermissible as it includes interest.

Avoid gharar and maysir

Any agreement that has a significant part of Gharar (uncertainty) or Maysir (speculation) will be considered as invalid from a Shariah point of view. Preventable ambiguities and faults in the terms of the contract are also banned.
Avoid haram

Under the Quran law, trade is only permissible in the goods and commodities that are declared halal (lawful). Any stock of a company that derives its substantial benefits from haram (unlawful) activities (e.g. alcohol, gambling, pork, tobacco, weapons…) cannot be a part of an observant Muslim investor's portfolio.

The Islamic banking principles extend further into other areas but, in summary, Islamic finance is set for more growth as the widespread socio-economic development in the MENASA region is expected to continue, especially after the minister proposed to amend the law to allow for interest-free Islamic banking.
With this in the pipeline, the amendment of the law should mean that Islamic transactions will be more easily implemented.

—The views expressed in the article are those of the authors and not necessarily those of Deloitte.
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