Issue Brief: Islamic Finance as Social Impact Investing

The principles of Islamic finance, as defined by the Shariah, prescribe that finance must serve society and prohibit unfair and speculative activities. Because the Shariah prohibits usury (charging interest), Islamic finance is equity-based and shares common threads with community and ethical banking, and socially responsible investing.

By definition, Islamic finance is geared towards social enterprise and the creation of shared value within society. In order to achieve social impact investing that adds to social efficiency, sustainability and stability, Islamic finance requires a stronger form of governance, in addition to the oversight role of the Shariah Council, which ensures compliance with Islamic tenets.

Islamic banking means much more than just refraining from usury (charging interest), and observing religious/technical precepts. In conventional banking, the banker-customer relationship is that of a creditor-debtor. In Islamic banking, the financier acts as a partner/investor. The fundamental difference between conventional and Islamic finance is that of a debt contract as opposed to an equity contract. Conventional banking emphasizes profit-maximization, based on the assumption that individual self-interest will deliver overall societal well-being. Islamic banking, on the other hand, is based on the ethical and moral framework of the Shariah, and Islamic banks must incorporate both profits and social responsibility into their decision-making process.

From a relatively niche market at the end of the 20th century, Islamic finance has grown exponentially in the 21st century by a compound annual growth rate (CAGR) of 40.3 per cent between 2004 and 2012 to reach US$1.3 trillion, or just under 1 per cent of the global financial system. There are more than 600 Islamic financial institutions spread across 75 countries. Only 12 per cent of the 1.6 billion Muslims worldwide (one-fifth of the global population) currently use Islamic finance.

Nevertheless, the global Islamic financial services industry has grown in size and geographic coverage, encompassing new jurisdictions and more institutions. The Islamic capital market, namely, the Sukūk or Islamic bond or funds and indices, continued to outpace most other global asset classes, growing by a CAGR of 44.0 per cent between 2004 and 2011. Additionally, Islamic equity indices have outperformed their conventional equivalents in the post-crisis period. Takāful (Islamic insurance) remains a nascent industry, but is expected to expand with growing market demand in Islamic countries, which comprise nearly one quarter of the world's population and US$5.8 trillion, or 8.4 per cent of world GDP.

The views expressed in this report are those of the author and do not necessarily reflect those of the Fung Global Institute. The author is solely responsible for any errors or omissions.