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The Fundamentals of Islamic Finance

2 January 2019 | Post Trade | 0 comments

This article talks about Islamic finance, in which we will not clutter you with details about the Muslim religion. Our interest is to give you introductory information and general knowledge so that you can familiarize yourself with the words which are used in this aspect of the financial industry.
Our intention is not to ensure Islamic finance has no more secrets for you, but rather we drawing your attention to a market in strong growth and whose development has not yet reached its end.



Islamic finance shares the aims and foundations of “conventional finance” with, in addition, the concern to respect Sharia, that is to say, all the precepts of the Muslim religion. The essence of Islamic finance can therefore be formulated very simply: Islamic finance operations are based on Islamic principles defined by Fiqh or Islamic jurisprudence.

FIQH Principles

The Fiqh relies on three texts:

    • Quran: Muslims consider the Quran as the literal transcription of the words of God. About fifteen verses, out of a total of 6,236 verses, apply specifically to finance.
    • The Sunnah: brings together the Prophet’s comments and interpretations on the Holy Book (Quran). It is composed of hadiths. The entity describes the acts and words of the Prophet Muhammad and his companions.
    • Ijtihad: brings together the efforts of interpretation when there is debate (for example, if neither the Quran nor the Sunnah answers a question). This effort of interpretation can be done by a consensus of scholars, by analogical reasoning.


Respect for Sharia is Islamic finance’s cornerstone. Financial institutions offering Islamic products or services must set up a Shariatic Compliance Committee (or Sharia Board) in order to be advised and to ensure that the banking institutions’ operations and activities are compliant with Islamic ethics or to the Sharia’s principles.
The Sharia Board gives legitimacy to Islamic finance practices and builds shareholder and public confidence by validating that all practices and activities are in compliance with the Sharia.


Islamic finance originated in the 7th century with the advent of Islam. Its revival arose in the 50’s – 60’s with two founding experiences:

Piligrims’ Administration and Fund (Tabung Hadjji) in Malaysia (1956): Tabung Hadjji, spearheaded and funded by the Malaysian public authorities, was dedicated to investing the resources collected from a large number of small savers in large industrial, agricultural or construction projects.
MitGhamr’s experience in Egypt (1963): MitGhamr was an entirely private initiative and consisted of small savings and investment cooperatives operating in the agricultural areas of northern Egypt. The goal of their founder, Ahmed al Najjar, was to mediate financial resources between savers and small local investors.


1963: The birth of Islamic financial principles in Egypt. Mit Ghamr Saving bank offers savings accounts based on profit sharing and not products.

1970: The Organization of the Islamic Conference is created and launches the idea of the Islamic bank.

1974: Advent of the Islamic Development Bank IDB multilateral organization holding 56 member countries. Its purpose is to assist developing countries and LDCs (26) and PMMA (6) in the form of development aid. This with Islamic financing techniques, whether to finance foreign trade, to fight against poverty, to finance certain infrastructures (roads, hydroelectric dams ..) and some social projects such as the construction of schools or health center.

1975: Creation of Islamic Development Bank and birth of Islamic banks such as Dubai Islamic Bank, Kuwait Finance House and Bahrain Islamic Bank.

1979, 1981 and 1983: Total Islamization of the financial systems of the countries of Sudan, Pakistan and Iran. Many Islamic countries of the Gulf and Asia followed (Arabia, United Arab Emirates, Indonesia, Malaysia …).

1980 – 2000: IF Development in Southeast Asia and the Middle East

2000 – 2008: Development of the IF in Europe and the Middle East, South East Asia, North Africa, both in Islamic banks and traditional banks (HBSC, Deutsche, UBS, Islamic Bank of Britain, European Islamic Bank, BNP Paribas Najma …).



One of the main instruments is “Murabaha”, a sort of interest-free loan. Its role:

In commercial banking, when a customer wants to buy a house, the bank acquires in its place. The customer reimburses in one or several times the amount of the property, plus a commission fixed upstream. When the contract expires, the bank transfers ownership of the property to its client.

In market finance, when a financial institution wishes to place its funds in an Islamic model, the counterpart who collects the deposit will place the funds under a real asset (usually a commodity). Here again the elements exchanged will be predefined in a contractual framework, commissions and profits are known and fixed. At the end of the contract, the real assets are sold on the markets to ensure the payment of principal, commissions and profits.


Another instrument is the “sakk” (Sukuk when plural), a form of bond financing.
They allow companies and sovereign issuers who wish to comply with the principles of Sharia. These are financial products backed by real assets and fixed maturity. The sakk confers a right of ownership on the assets of the issuer, and the holder receives a portion of the profit predicted in advance and at risk near zero. This form of bond is similar to asset-backed securities, with the difference that sukuk do not pay interest but profits.


A company wants to acquire an asset. She creates an SPV-mudaraba of which she is an agent. The SPV-mudaraba issues bonds (sukuk) that allow it to acquire the property in question. As an agent, the company takes delivery of the goods directly delivered by the seller. The agent’s mandate is terminated and a deferred sales contract (BBA-murabaha) is set up in which the company acquires the property sold by SPV-mudaraba with a profit fixed from the outset. The sale price, which includes profit, is paid by the company to the SPV-mudaraba according to a schedule listed in the contract. The money collected can be used by the SPV to pay the coupons to investors according to a predictable schedule.

    1.  The company is advised by the investment bank it has requested.
    2.  An ad hoc SPV is created by the company.
    3.  The Shariah Committee gives a favorable opinion as to the conformity of the SPV and that of the sukuk to be issued.
    4.  The SPV issues bonds (sukuk) to investors.
    5.  SPV collects funds from investors.
    6.  The SPV pays the supplier the amount of the purchased good.
    7.  The company, agent of the SPV, takes delivery of the property.
    8.  The company acquires the property from the SPV with a deferred payment with settlement by maturity.
    9.  The SPV passes on these payments to the investors after deducting the fees accruing to the manager (mudarib) and the agent (wakil).

NB: monetary movements are in continuous line.



By making access to the EU market more difficult, Brexit threatens London’s dominance over other European financial centers. A study conducted by Reuters analyzing the consequences of Brexit revealed that over the next few years about 10,000 jobs could be relocated abroad, which will undeniably benefit Frankfurt and Paris’ squares.

The development of Islamic finance then appears to the City as a mean to counteract this effect by strengthening its links with the two main Islamic financial centers in the world, which are the regions of Southeast Asia and the Gulf. In this context, Brexit will therefore have for consequence of accelerating the development of the Islamic financial sector in London, as the United Kingdom is keen to create economic ties with non-EU countries.

Keep in mind that the London Stock Exchange is a major Islamic securities trading center with 65 sukuk sides valued at $ 48 billion. In addition, as part of its strategy to expand market liquidity, the Bank of England said in April that it will make a liquidity management tool available to Islamic banks.


Developed rapidly in the 1970s in the Gulf countries, Islamic finance develops under three fundamental axes:

    • Attractiveness for an “alternative and ethical finance” as opposed to “conventional finance” since 2008,
    • Increased religious rigor among Muslim populations around the world,
    • Political will to develop Islamic finance among the general public.

The objectives and foundations of Islamic finance are identical to those of “conventional finance”. What distinguishes Islamic finance from conventional finance is respect for Sharia and all the precepts of the Muslim religion.

The Sharia Board determines the “Sharia Compatibility” of organizations or financial products. Also, the organization of “Sharia Boards” varies according to geographical areas. The “Sharia Board” can be attached to the regulator (this is the case for Malaysia) or constituted within financial institutions (as in the Persian Gulf monarchies).

Islamic Finance is based on five main principles of the Muslim religion: 3 “forbidden” and 2 “recommendations”:
The 3 “forbidden”:

    • Prohibition of interest (Riba),
    • Prohibition of uncertainty (Gharar) and speculation (Maysir),
    • Prohibition of illegal sectors (Haram) such as alcohol, pork, pornography, weapons, etc.

The 2 “recommendations”:

    • Sharing of profits and losses (as corollary, no separation between the asset and the related risk),
    • Matching of any commercial transaction to a tangible asset.

The development of Islamic finance requires, in concerned countries, an adaptation of the regulatory and fiscal frameworks.
On a general public level (individuals), Islamic finance marketing remains nascent and must consider local specificities in order to foster its development within Muslim communities.


Islamic finance today is estimated at $ 2 trillion worldwide. While in 2006 it was estimated between 600 and 800 billion dollars.

The growth rate, around 15% per year, was strongly supported by the revenues of the Persian Gulf and Southeast Asian countries in their strong economic development over the 2003-2007 period.

By 2020, this figure could double again to $ 4 trillion.