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Islamic finance is based on principles of shariah, or “Islamic law.” Major principles of shariah
are a ban on interest, a ban on contractual uncertainty, adherence to risk-sharing and profit-
sharing, promotion of ethical investments that enhance society, and asset-backing. The
international market for Islamic finance has grown between 10% to 15% annually in recent years.
Islamic finance historically has been concentrated in Persian Gulf and Southeast Asian countries,
but has expanded globally to both Muslim and non-Muslim countries. There is a small but
growing market for Islamic finance in the United States. Through international and domestic
regulatory bodies, there has been effort to standardize regulations in Islamic finance across
different countries and financial institutions, although challenges remain. Critics of Islamic
finance express concerns about possible ties between Islamic finance and political agendas or
terrorist financing and the use of Islamic finance to circumvent U.S. economic sanctions.
Supporters argue that Islamic finance presents significant new business opportunities and
provides alternate methods for capital formation and economic development.
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Background ..................................................................................................................................... 1
Development of Islamic Finance..................................................................................................... 1
The Global Financial Crisis and Islamic Finance............................................................................ 2
Performance of Islamic Bonds .................................................................................................. 3
Islamic Finance in the United States ............................................................................................... 4
Islamic Finance Regulation ............................................................................................................. 5
Issues for Congress.......................................................................................................................... 6
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Figure 1. Global Issuance of Islamic Bonds (Corporate and Sovereign), 2004-2008 ..................... 4
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Author Contact Information ............................................................................................................ 7
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Islamic finance is based on shariah, an Arabic term that is often translated into “Islamic law.”
Shariah provides guidelines for aspects of Muslim life, including religion, politics, economics,
banking, business, and law.1 Shariah-compliant financing (SCF) constitutes financial practices
that conform to Islamic law. Major principles of shariah that are applicable to finance and that
differ from conventional finance are:
• Ban on interest (riba): In conventional forms of finance, a distinction is made
between acceptable interest and usurious interest (i.e., excessive rates of interest).
In contrast, under Islamic law, any level of interest is considered to be usurious
and is prohibited. Some question how lenders profit from financial transactions
under Islamic law. For instance, in a real estate setting, SCF takes the form of
leasing, as opposed to loans. Instead of borrowing money, the bank obtains the
property and leases it to the shariah-compliant investor, who pays rent instead of
interest.
• Ban on uncertainty: Uncertainty in contractual terms and conditions is not
allowed, unless all of the terms and conditions of the risk are clearly understood
by all parties to a financial transaction.
• Risk-sharing and profit-sharing: Parties involved in a financial transaction
must share both the associated risks and profits. Earnings of profits or returns
from assets are permitted so long as the business risks are shared by the lender
and borrower.2
• Ethical investments that enhance society: Investment in industries that are
prohibited by the Qur’an, such as alcohol, pornography, gambling, and pork-
based products, are discouraged.
• Asset-backing: Each financial transaction must be tied to a “tangible,
identifiable underlying asset.” Under shariah, money is not considered an asset
class because it is not tangible and thus, may not earn a return.3
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Modern Islamic finance has existed internationally since the 1970s. Currently, Islamic finance
represents a small but growing segment of the global finance industry. In some countries, such as
Iran and Pakistan, Islamic banks are the only mainstream financial institutions. In others, SCF
exists alongside conventional banking.4 Estimates vary of the total size of assets held
1 Michael Silva, “ Islamic Banking Remarks,” Law and Business Review of the Americas, Spring 2006, Volume 12,
Issue 2.
2 Andreas Jobst, “The Economics of Islamic Finance and Securitization,” International Monetary Fund (IMF) Working
Paper WP/07/117, August 2007.
3 The National Bureau of Asian Research, “Islamic Finance: Global Trends and Challenges,” Volume 18, Number 4,
March 2008. Standard & Poor’s, “Islamic Finance Outlook 2008.”
4 Shirley Chiu, Robin Newberger, and Anna Paulson, “Islamic Finance in the United States,” Society,
September/October 2005.
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internationally under Islamic finance, generally ranging from $800 billion to $1 trillion, with
growth rates of 10% to 15% annually over the past ten years.5
The Persian Gulf and Southeast Asia historically have been and continue to be the major centers
for SCF. For oil producers in the Gulf region, Islamic finance may offer investment opportunities
for their growing revenues from oil exports. There also has been a growing awareness of and
demand for Islamic-based financial products by Muslim consumers. In 2007, Iran was the largest
market for Islamic finance, reportedly accounting for close to 40% of shariah-compliant financial
assets worldwide.6 However, according to some analysts, the reach of Iran’s Islamic finance
market may be limited because of international sanctions.7 Following Iran, the largest Islamic
finance markets in 2007 were Saudi Arabia, Malaysia, Kuwait, and the United Arab Emirates
(UAE).8
Support for Islamic finance varies in the Middle East. In some countries, such as Libya and
Morocco, Islamic banks are considered by some to be tied to Islamic political parties and
consequently have been refused licenses. Other countries, including Jordan, Tunisia, and the
Sudan, have been receptive to Islamic finance, viewing Islamic financial products as an
opportunity for creating capital and fostering economic development.9
In recent years, SCF has expanded to other parts of the world. Islamic finance is growing in
Europe and North America, areas in which Muslims are in the minority. In August 2004, the
United Kingdom’s Financial Services Authority (FSA) approved a banking license for the Islamic
Bank of Britain (IBB), the country’s first Islamic bank. The IBB would serve the consumer
market with shariah-compliant products.10 In March 2006, the FSA licensed the European Islamic
Investment Bank as the United Kingdom’s first independent bank for shariah-compliant
investments.
In 1999, the Dow Jones presented its first Islamic market index, which follows shariah-compliant
stocks internationally. The Dow Jones maintains more than 70 indices in its Islamic series and is
advised by an independent Shariah Supervisory Board counsel.11
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Internationally, Islamic banks appear to be more resilient to the global economic turndown and
international financial crisis than conventional banks. They tend to avoid the speculative
investments, such as derivatives, that many analysts believe led to the financial crisis affecting
conventional banks. For many observers, Islamic finance serves as a vehicle for recovering from
5 David Oakley, Shannon Bond, Cynthia O’Murchu, and Celve Jones, “Islamic Finance Explained,” Financial Times,
May 30, 2008.
6 “Iran dominates sharia ranking as newcomers make their mark,” The Banker, November 1, 2008, Academic OneFile,
Gale, Library of Congress, access February 6, 2009.
7 “Faith-based finance,” Economist, Volume 388, Issue 8596, September 6, 2008, p. 82.
8 “Iran dominates sharia ranking as newcomers make their mark,” The Banker, November 1, 2008, Academic OneFile,
Gale, Library of Congress, access February 6, 2009.
9 Ibid.
10 Standard & Poor’s, “Islamic Finance Outlook 2008.”
11 Dow Jones Indexes, data current as of February 9, 2009.
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the international financial crisis. The Islamic banking industry may be able to strengthen its
position in the international market as investors and companies seek alternate sources of
financing.12
However, as Islamic banks operate within a global financial system, they have not been
completely insulated from the recent economic and financial shocks. For instance, on the one
hand, the Islamic financial industry is considered by many to be less risky because financial
transactions are backed by physical assets. On the other hand, Islamic banks may be more
vulnerable to fluctuations in the mortgage market, given their high activity in the real estate sector
compared to conventional banks. The recent slowdown in real estate activity in the Gulf
economies raises concerns about some Islamic banks’ financial positions.
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A key segment of the Islamic finance market is Islamic bonds, known as sukuk.13 The global
market for Islamic bonds is estimated to be $80 billion currently.14 After increasing more than
five-fold from 2004 to 2007, global issuance of sukuk hit a three-year low point in 2008 (see
Figure 1). Sales of new Islamic bonds amounted to $15.8 billion in 2008, compared to $46.7
billion in 2007.15 Corporate issuances represented about 60% of total new Islamic bonds issued in
2008, and sovereign and quasi-sovereign issues represented the remainder of new issuances. The
bulk of sukuk issuance comes from Malaysia and the United Arab Emirates, although the Islamic
bond market is widening. While the sukuk market is small in comparison to the market for
conventional bonds, it was one of the world’s fastest growing financial instruments prior to the
recent slowdown.16
Sukuk issuance began slowing down in late 2008, partly due to the global economic turndown,
The international sukuk market faced lower levels of liquidity, resulting from declines in oil
prices and reduced confidence from investor. Additionally, global issuance of Islamic bonds may
have slowed in 2008 due to concerns raised by the Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) about the shariah-compliance of some sukuks.17 Despite
current challenges, many analysts believe that the long-term viability of the Islamic bond market
appears strong, owing to the growing popularity of Islamic financial products, increased
government interest in Islamic finance, investment and financing needs of the Gulf countries, and
financial institution seeking greater diversification.18
12 Stephen Timewell, “A template for averting disaster? - Roundtable,” The Banker, January 1, 2009, Academic
OneFile, Gale, Library of Congress, accessed February 6, 2009.
13 Islamic bonds are constructed as profit-sharing or rental agreements that are tied to physical assets, such as property.
14 Standard & Poor’s, “Islamic Finance Outlook 2008.”
15 Andreas Jobst, Peter Kunzel, Paul Mills, and Amadou Sy, “Islamic Bond Issuance - What Sovereign Debt Managers
Need to Know,” IMF Discussion Paper, PDP/08/3, July 2008. “New sukuk issuance falls to 3-year low,” Business
Times, January 10, 2009.
16 David Oakley, “Sukuk: Islamic bonds go the way of the world,” Financial Times, November 24, 2008.
17
Standard & Poor’s, “Sukuk Market Decline Sharply in 2008, But Long-Term Prospects Remain Strong,”January 14,
2009.
18 Ibid.
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Figure 1. Global Issuance of Islamic Bonds (Corporate and Sovereign), 2004-2008
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Note: Data from the Islamic Finance Information Service.
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With an estimated five to seven million Muslims in the United States, there is growing interest for
Islamic finance and business opportunities for lenders. Some have suggested Islamic finance may
be an attractive option for investors as conventional finance faces challenges from the U.S.
subprime lending crisis and recession concerns.19 In the United States, SCF largely exists in
personal home mortgages. Guidance Residential (Reston, Virginia) reportedly has financed over
5,000 shariah-compliant mortgages since 2002.20 Other financial intermediaries that provide
Islamic-based home mortgages include University Islamic Financial (Ann Arbor, Michigan),
Devon Bank (Chicago, Illinois), and American Finance House Lariba (Pasadena, California).
HSBC is the only large commercial bank that offers U.S. Islamic finance and is focused on New
York. 21 The Federal National Mortgage Association (Fannie Mae) and the Federal Home
Mortgage Corporation (Freddie Mac) purchase shariah-compliant mortgage contracts from
financial intermediaries, allowing providers to originate further mortgages. In 2007, Freddie Mac
reportedly purchased more than $250 million in Islamic home loans, a small but notable fraction
of the enterprise’s $1.77 trillion in business activities.22
Other forms of shariah-compliant services are offered in the United States as well. For instance,
Devon Bank and Zayan Finance offer SCF for commercial real estate. Shariah-compliant mutual
19 Peter Apps, “Global financial centers battle for Islamic markets,” International Herald Tribune, July 25, 2008.
20 N.C. Aizenman, “A Higher Law for Lending,” The Washington Post, May 13, 2008.
21 Shirley Chiu, Robin Newberger, and Anna Paulson, “Islamic Finance in the United States,” Society,
September/October 2005.
22 N.C. Aizenman, “A Higher Law for Lending,” The Washington Post, May 13, 2008.
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funds are offered by intermediaries such as the Amana Mutual Funds Trust, Azzad Funds, and the
Dow Jones Islamic Fund.23
International financial intermediaries also provide SCF in the United States. Islamic investors
from the countries of the Gulf Cooperation Council (GCC) have sought to diversify their financial
portfolios geographically and to invest their oil wealth in U.S. assets. For instance, the Bahrain-
based Arcapita Bank has structured shariah-compliant transactions in private equity and real
estate in the United States.24 Additionally, U.S.-based companies have taken advantage of
alternative funding sources through Islamic-financing abroad. According to Standard & Poor’s,
Loehmann’s Holdings, Inc. and East Cameron Gas Company have issued rated shariah-compliant
bonds.25
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Financial institutions seeking to offer shariah-compliant products typically have a shariah
supervisory board (or at a minimum, a shariah counselor). The shariah board would review and
approve financial practices and activities for compliance with Islamic principles. Such expertise
raises the attractiveness of shariah-compliant financial intermediaries to investors considering
Islamic banking.26
Shariah is open to interpretation and Islamic scholars are not in complete agreement regarding
what constitutes SCF. Islamic finance laws and regulatory practices vary across countries. The
lack of concurrent viewpoints makes it difficult to standardize Islamic financing.27 Many
observers view standardization of SCF regulations as important in increasing the marketablity and
acceptance of Islamic products.
International institutions have been established to promote international consistency in Islamic
finance. For instance, the Islamic Financial Services Boards (IFSB) puts forth standards for
supervision and regulation.28 As another example, the Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI), issues international standards on accounting, auditing,
and corporate governance.29 Many leading Islamic financial centers around the world have
adopted international SCF regulation standards.30
U.S. federal banking regulators have provided some formal guidance about Islamic products. The
Office of the Comptroller of the Currency (OCC) issued two directives concerning shariah-
compliant mortgage products. In 1997, the OCC issued guidance about ijara (“lease”), a financial
structure in which the financial intermediary purchases and subsequently leases an asset to a
consumer for a fee. In 1999, the OCC recognized murabaha (“cost-plus”), under which the
23 “Islamic Finance Gaining Traction in the U.S.,” Dinar Standard, November 22, 2007.
24 “Ali: Islamic Banking is a Rapidly Growing Industry,” Council of Foreign Relations interview, June 8, 2007.
25 Standard & Poor’s, “The Islamic Financial Industry Comes of Age,” Commentary Report, October 25, 2006.
26 Juan Solé, “Introducing Islamic Banks into Conventional Banking Systems,” IMF Working Paper WP/07/175, July
2007.
27 “Islamic Banks: A Novelty No Longer,” BusinessWeek, August 8, 2005.
28 Ibid. Information about standards issued by the IFSB are available at http://ifsb.org.
29 AAOIFI standards are available on AAOIFI’s website, http://www.aaoifi.com/.
30 “Watchdog is developing governance standards,” Misr Information Services and Trading News, July 28, 2008.
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financial intermediary buys an asset for a customer with the understanding that the customer will
buy the asset back for a higher fee.
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As Islamic finance activities grow in the United States, critics raise concerns about the related
capital adequacy and system risks. Proponents of Islamic finance assert that the ban on risk-
taking mitigates many concerns. Some also view the integration of ethics and values into finance
as a positive development, especially in light of recent U.S. business corruption scandals. Many
investors reportedly consider shariah-compliant finance to be more resilient to global economic
and financial crises than conventional finance. However, others point out that Islamic financial
markets are still tied to the world economy and are not completely sheltered from the ups and
downs of international markets.31
The growth of Islamic finance in the United States may have implications for congressional
oversight. Congress may be interested in evaluating the relationship between the current U.S.
banking legal and regulatory framework and Islamic finance. Current U.S. laws and regulation
may be broad enough to accommodate some aspects of Islamic finance. Others aspects of Islamic
finance may pose some unique challenges to U.S. laws and regulations, such as applying rules
created for conventional, interest-based products to Islamic products.32 There is debate about
whether or not, or the extent to which, regulators should apply rules on conventional products to
Islamic product counterparts.33
Some U.S. financial institutions express concerns about the possible ties of some Islamic
institutions to terrorist finance networks.34 According to this viewpoint, there is the possibility
that Islamic banking transactions may channel funds to terrorists or enable terrorists to access
funds. Others assert that the risks of Islamic finance are not significantly greater or different than
those from conventional finance and that the majority of recent terrorist financing cases related to
SCF have been thrown out of court. In congressional testimony, one observer stated “there is no
reason - in theory - to suspect that Islamic finance would be particularly immune or particularly
vulnerable to abuse by money launderers or terrorist financiers.”35
Some proponents also assert that security-related concerns about Islamic finance stem from a lack
of understanding of SCF or from stereotyping.36 There may be a “conflation” of Islamic finance
with hawala, an informal trust-based money transfer system prominent in the Middle East and
many Muslim countries. Hawala transactions are based on an honor system, with no promissory
instruments exchanged between the parties and no records of the transactions. Some analysts
consider the hawala system particularly susceptible to terrorist financing.
31 Peter Apps, “Global financial centers battle for Islamic markets,” International Herald Tribune, July 25, 2008.
32 Thomas C. Baxter, “Regulation of Islamic Financial Services in the United States,” Remarks Before the Seminar on
Legal Issues in Islamic Financial Services Industry, March 2, 2005.
33 Vikram Modi, “Writing the Rules: The Need for Standardized Regulation of Islamic Finance,” Harvard
International Review, Spring 2007.
34 “Islamic bonds improve LSE standing,”Oxford Analytica, March 8, 2007.
35 Mahmoud A. El-Gamal, “Islamic Finance in the Middle East,” testimony prepared for U.S. Senate Committee on
Banking, Housing and Urban Affairs, “Money Laundering and Terror Financing Issues in the Middle East” hearing.
36 Michael Silva, “ Islamic Banking Remarks,” Law and Business Review of the Americas, Spring 2006, 12, 2.
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Congress also may be interested in the possibility of Islamic finance as a vehicle for sidestepping
U.S. and international economic sanctions. For example, the Sudanese government reportedly
issued Islamic bonds to Gulf investors in order to circumvent U.S. sanctions.37
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Shayerah Ilias
Analyst in International Trade and Finance
silias@crs.loc.gov, 7-9253
37 “Turning towards Mecca: Islamic banks join in the race of Africa,” Economist, Vol. 387, Issue 8579, May 10, 2008.
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