Perspectives of Western Countries on Islamic Financial System

In the middle of 1970s, conventional financial institution started to offer Islamic

to offer Islamic finance. Before that, it is a slow growing industry which many people
tend to neglect. However, it has started to gain its momentum after the occurrence of
global financial crisis. The low oil price which strikes the world recently stresses on the
importance of Islamic finance to the world. Many scholars from different countries
especially Western countries such as United Kingdom and France opined that Islamic
finance industry is essential to the sound functioning of economy. It is evidenced when
the annual growth rate is around 15% to 20% (Shabbir, Rehman, & Akhtar, 2016, p. 2).
Thereby, it has successfully attracted the banks and businesses to supplement
conventional financial products with Islamic products.

As time goes by, countries such as Iran and Sudan develop full-fledged Islamic
banking system while Malaysia, Bahrain and Pakistan has successfully develop dual
banking system. In Western countries, global players like HSBC, Deutsche Bank, JP
Morgan and others invested in Islamic finance. United Kingdom, among all other
Western countries, has reaped the greatest benefit from Islamic financial industry with its
active participation and implementation. Countries like United States, France, Germany
and Spain are relatively lag behind in the aspect of the development of Islamic finance
industry. This is because of its passive involvement and the incompatibility of Islamic
financial institution with the conventional financial institution (Shabbir, Rehman, &
Akhtar, 2016, p. 2). Hence, they are still in the infant stage since its inception. Despite all
this fact, Islamic finance begun maturing into a global industry, with total assets today
believed to exceed $2 trillion and Islamic financial services available throughout most of
the Islamic world as well as parts of Europe and North America given the prevalence and
increase in demand.
Approximately 80% of these assets are concentrated in Islamic banks or Islamic divisions
of other commercial banks (so-called Islamic windows). Sukuk (the Islamic equivalent
of bonds) represent about 15% with Islamic investment funds and Takaful (Islamic
insurance) making up the remainder (Grant Thornton, 2017).
 Lets take a step back into the financial crisis caused by the bursting of housing
bubbles to banking sectors in year 2007. At that point in time, conventional bank suffers
net losses of around 400 million more than the Islamic banking which is virtually zero.
The conventional bank failed during economic crisis for a few reasons. Firstly, the
creation of debt via direct lending and borrowing of money caused the insolvency in the
conventional financial institution (Hussain, 2014, p. 9). Secondly, the banks expect
central bank to back them up if they encounter financial distress so they do not have a
commendable plan to tackle financial problems (Hussain, 2014, p. 11). Lastly,
conventional bank which does not operate on the basis of profit or loss sharing contract
results in unhealthy credit which is bad for the economy as the investor has no incentive
to assess the profitability of investments. The other example is the bankruptcy of major
bank players in United States like Lehman Brothers, Bear Stearns and Northern Rock
because of their easy lending approach (Hussain, 2014, p. 10). They strive for greater
return on interest charged to outperform the competitors and thence, they increased the
volume of loan facilities to customers even if the loan offered has exceeded the
predetermined ceiling.

Since the developments in the global economic sphere are distressing as a result
of financial crisis, there has been a trend toward legal reformations in the financial
sphere. Islamic financial institution started to gain its popularity in Western countries
because of their ability to survive in the midst of economic turmoil and operate even
more efficiently than conventional banks. The underlying factor that drives good
performance is mainly its value proposition and operations based on Shariah principles.
Banking institutions in many Western countries have started to offer Shariah-binding
financial products. France, Germany and The Netherlands demonstrated their passion for
Islamic finance and therefore commenced to produce legal framework for Islamic
financial market (Daniela, 2009, p10).

The advent of Islamic finance is to promote maqasid al-Shariah, in other words,

advance public interest (maslahah) and prevent harm (mafsadah). Islamic banks are
thought to be more stable because money is created based on the principle of equity
generation rather than expanding credit. Moreover, Islamic financial institutions operate
based on mudarabah and musyarakah model are better as they repeal the risk-based
conventional financial institutions.

Generally, Islamic banking is as common as interest free banking. In fact, it goes

beyond that to prohibit illegal and impermissible activities under Shariah like gambling
and prostitution (Hussain, 2014, p. 2). Firstly, the creation of debts through direct lending
and borrowing of money or financial securities is prohibited in Islamic finance because it
is injustice. The reason is lender must waive the outstanding loan in the case of
bankruptcy and loan delinquency to cater to the borrowers insolvency condition
(Daniela, 2009, p13). This is undoubtedly high risk to the lender. Secondly, Shariah law
prohibits the investment in companies which deal with illegal and unethical activities.
The positive repercussion is that Islamic financial institution is insured against the risk of
losses (Daniela, 2009, p14). Those companies involved in illegal activities like
production of drugs are at stake of being investigated if they are accused for
wrongdoings. Thence, shareholders lose confidence on companies and they will pull their
investment off the companies, causing the share price to drop. When the share price
drops, banks which also invest in it will earn negative return. That is why the investment
in illegal companies is forbidden. Lastly, Islamic financial law emphasizes on the
productive use of capital (Daniela, 2009, p14). Because of these good attributes, Islamic
financial institution is able to stand still through hardships.

Prospects of Development of Islamic Financial Institutions in Western Countries

Moving on, Islamic finance has the potential for further contributions in at least 3
dimensions. Firstly, it helps to foster greater financial inclusion, especially of large
underserved Muslim populations. According to the CIA World Factbook, there are 1.4
billion Muslims representing over 21% of the world population of 6.8 billion
(Nooraslinda, Rohana, & Rafidah, 2013, p. 116). They are currently being underserved
and want to be served. Many Muslims who have had to rely on conventional finance
would surely like to consider Islamic finance, as would non-Muslims who are looking to
diversify their choices and fulfill their ethical values. Islamic finance extends choice and
enables Muslim to conduct their financial affairs in a manner consistent with their beliefs
and values. Besides that, the data collected by Pew Research Centre (2011) exhibited that
the population of Muslims in European Union is projected to increase by over 10 million
by the year 2030 (Sobol, 2015, p. 192). Increasing customer base among Muslim
untapped potential for growth of Islamic finance. This is because Islamic financial
institutions will normally target Islamic financial products to Muslim.

Secondly, Islamic finance which stresses on asset-backed financing and risk-

sharing feature could lend a helping hand to small and mediumsized enterprises (SME)
which need funding for development. SMEs are mainstay of economies and an essential
building block of economic development in Europe. However, the nature of SMEs is a
stumbling block for them to get funding. Better funding can be accessed when there is a
sound regulatory framework, financial inclusion through integration of other alternative
frameworks, and proper models for SMEs Based on research done on French SMEs, the
lack of equity hampers its ability to obtain funding. Next, they are lack of access to
financial markets for their financing needs as most of the SMEs are not large enough to
be listed in the stock market. Lastly, SMEs suffer from a risk rating system (Umar, Kabir,
Dorsaf, 2013, p. 156). They may not earn a good rating for risks because their financial
information is not published and even if they do, the financial information is very limited
for banks especially to assess their credit risks. Combining these challenges embodied in
SMEs, Islamic finance can resolve this by entering into productive partnership with
SMEs. For instance, Muslim entrepreneurs are flourishing due to their expertise in the
French all food market. (Umar, Kabir, Dorsaf, 2013, p. 156).

Thirdly, the growing trade relations between the European Union and the
Association of Southeast Asian Nations (ASEAN) and the countries of Gulf Cooperation
Council (GCC) (Sobol, 2015, p. 193) where Islamic financial institutions play important
role pave the way for the development of corporate Islamic banking in Western countries.
Globalisation increases the commercial, industrial and import-export transactions
between Western countries and predominantly Muslim countries and enterprises in
Middle East and North Africa (MENA) region (Spalding & Kim, 2014, p. 616). For
instance, in view of the need to develop the region because of the population growth,
government takes initiatives by inviting Western countries to expand infrastructures.
Consequently, as interaction with MENA region companies increases, Western companies
will be entering into wide variety of Shariah-compliant contractual arrangements.

In addition to this, Oil-exporting countries are some of the key drivers of the
global Islamic finance industry. As such, those countries public finances are likely to be
most affected by the decline in the oil prices. Governments of those oil-exporting
countries have often used Islamic finance to diversify their funding profiles but also to
demonstrate their support for the growth and development of what is seen as an
indigenous industry with many local stakeholders. All six energy-exporting Arabian
Gulf states have ambitious development plans and are likely to continue to spend to
support overall growth, but if oil prices fall further they may rethink their investment
strategy and policies, which will inevitably have an impact on Islamic finance. As such,
the decline in oil prices will be a challenge that the Islamic financial services industry
needs to closely manage. However, while the industry is still young compared to its
conventional counterparts, it is far more experienced now having had to weather several
economic crises over the years while its regulators and professionals are more seasoned
now, having more risk management and diversification tools that they can utilise than
perhaps was the case 20 or 30 years ago.
https://www.stratfor.com/analysis/who-wins-and-who-loses-world-cheap-oil

http://www.grantthornton.ae/page/islamic-finance-oil-prices-where-to-now-

http://economia.icaew.com/opinion/july-2015/will-islamic-finance-solve-the-growth-
problem-for-all-mankind

http://www.londonstockexchange.com/specialist-issuers/islamic/downloads/ukti-uk-
excellence-in-islamic-finance.pdf

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/503491/20
15047_Is_Fin_A5_AW_ENG_WEB.pdf

According to Standard & Poors Ratings Services, growth in the Islamic finance industry
may moderate in 2016, growing at a slower pace but will be to some extent
counterbalanced by the opening up of Iran and more issuance from non-core markets
such Europe, Russia, CIS countries and Africa. S&P, though, expects growth to pick up
in the next decade. Iran could be a key market for growth as it emerges out of decades-
old sanctions, thanks to the nuclear deal with the West (expected lifting of sanctions in
2016).

At the same time, Malaysia has always been a significant player in the global Islamic
finance industry and often dominates global sukuk issuance volumes and yet it would be
hard to argue that its economy is heavily dependent on oil prices. Many non-Muslim
governments also continue to study Islamic finance as an avenue to diversify their
budgets as they maintain their spending momentum in a low oil price environment but
also to attract inward foreign investment from new sources. The British Government
made a landmark sovereign sukuk issuance in 2014 to demonstrate its commitment to
Islamic finance and the fact that the British economy was open for business with Islamic
finance.

To conclude, the global economy remains in a difficult place due to the steep fall in oil
prices, challenging global equity markets, high regional political tensions and continued
reform of global financial markets. Islamic banks only seem more affected by this drop
solely due to the fact that the majority of the concentration of Islamic banking takes place
in oil rich regions. Conversely however, the performance of Islamic banks in comparison
to conventional banks during these times of crisis and as demonstrated historically, can
be deemed more resilient due to more stable and conservative business models.
References

Shabbir, M. S., Rehman, A. K., & Akhtar, T. (2016). The Role of Islamic Leading

Organizations for the Promotion of Islamic Finance in Western Countries. Journal

of Internet Banking and Commerce, 21(1), 1-12.

Hussain, M. (2014). Performance and Potential of Islamic Finance: A

Contextual Study in the UK. Journal of Shi'a Islamic Studies, 7(4), 441-510.
doi:10.1353/isl.2014.0038

Daniela, E. (2009). Islamic Finance: Complement or Substitute? An Empirical

Analysis. THE MICHIGAN JOURNAL OF BUSINESS, 1.

Grant Thornton. (2017). Islamic finance & oil prices: where to now? | In the
press | Grant Thornton. Retrieved from
http://www.grantthornton.ae/page/islamic-finance-oil-prices-where-to-now-

Nooraslinda, A. A., Rohana, O., & Rafidah, A. M. (2013). Islamic Financial

System Epidemic: The Effect of Financial Crises. Colloquium on Administrative
Science & Technology 2013, 1.

Umar, O. A., Kabir, H., & Dorsaf, M. (2013). An Islamic Finance Model for The
Small and Medium-Sized Enterprises in France. JKAU: Islamic Econ, 26(2), 151
- 179.

Sobol, I. (2015). ISLAMIC BANKING IN THE EUROPEAN UNION

COUNTRIES. European Integration Studies, 0(9), 184 - 197.
doi:10.5755/j01.eis.0.9.12806
Spalding, A. D., & Kim, E. K. (2014). Should Western Corporations Ban the Use
of Sharia Arbitration Clauses in their Commercial Contracts? Journal of
Business Ethics, 132(3), 613-626. doi:10.1007/s10551-014-2363-9