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This page grew out of class notes provided by Luma Zetani.  I owe her a big thank-you! Her  PowerPoint Presentation used for my International Finance class served as the basis for this page.   However, like most things I probably messed it up in many ways.  Therefore I ask you to please notify me of any errors or suggestions and bare with me as I make the changes in the coming weeks. 
 

Executive Summary

Islamic Finance is based on interpretations from the Qua ran.   Its two central tenants are no interest can be earned on loans and socially responsible investing. The key difference from a financial perspective is the no-interest rule since the Islamic socially responsible investing paradigm is not much different than what other religions do.
 

Video on Islamic Finance from CNBC (via YouTube)

Introduction

Roughly 20% of the world's population is Islamic.  While some in the Western world think this population is only in the Middle East, the religion is truly global: from the Middle East, to Afghanistan, to the US, to Indonesia, and every where in between.  While the extremists are the ones in the news each day, the vast majority of Moslems are peaceful, respect other religions, and do not hate business nor finance.  Attention to Islamic finance obviously accelerated since 9-11, but it is worthy to note that an Islamic finance was  meeting was actually scheduled for 9-12 in the WTC and that the Islamic Finance movement was already growing very rapidly.   According to estimates in the Wall Street Journal Islamic finance is roughly a $150 billion dollar market. 

So what is Islamic Finance? and how is it different from the traditional Finance we are familiar with in the Western World?

There are two key differences: 

1. The first and most famous (and on which we will focus the bulk of our attention) is the no-interest rule.  That is, you can not earn interest on a loan nor be required to pay interest on loans. 
2. The second difference is that money is to be invested only in worthy causes.  This is largely equivalent to the western concept of socially responsible investing. 

The Quran is the holy book of Islam (you can think of it as their bible if it makes it easier for you).  In it, believers find the verses that forbid Riba (or interest).  Alarijhi Bank has created a site (in both English and Arabic) that has the 4 key verses upon which the no-interest principle is based. 

Many of the differences in Islamic Finance (especially Islamic banking) revolve around this no interest principle.  For example, Islamic banks must take equity positions in homes rather than taking a traditional mortgage.  Others examples include essentially profit sharing plans, leasing, and repurchase plans.  These allow the Financial Institution to make money while satisfying the no-interest principle. 

The second difference between Islamic finance and traditional finance is the emphasis on socially responsible investing.  While in the western finical tradition there are many investors who  invest in "socially responsible" means, Socially Responsible investing is not as wide spread as it is within the Islamic tradition. 

Islam takes a holistic view of the person.  Thus someone who is good does good things.  This includes investing responsibly to assure that the money does not go 
for "bad" purposes.  These "bad" purposes include the usual subjects such as drugs, weapons, alcohol , porno and of course terrorism.  Again this is really no different than traditional socially responsible investing. 

Recent developments

It should be mentioned however that all of this is not locked in stone in this rapidly evolving field. 
For example, recently there was a decison by a committee of Egyptian Clerics that seems to open the door for fixed rate interest on commercial loans.  The rationale, (and this is where I would urge a second opinion for I am by no means an expert), is that the market for loans has changed so much that loans today would be seen as part of the course of business and not a undue burden or usurious. 
http://news.bbc.co.uk/2/hi/business/2488525.stm

Moreover in November of 2002, the Central Banks of 8 Islamic nations agreed to come together and help to standardize Islamic Banking Practices, regulation, and supervision.
http://news.bbc.co.uk/2/hi/business/2393685.stm
http://www.ifsb.org

Links:

While we have only scratched the surface on this topic, you would be better served if I serve more of a facilitator rather than a teacher here as there are so many who know much more than I on the topic.  Thus some of the links that I have found insightful and helpful when learning about Islamic Finance include: 

The IFSB and the Edge (no not the radio station) have provided an interesting Roundtable on Islamic Finance .  It is from October 2002 and I would recommend it to any interested party.  (in English)

The University of Durham (in the UK) has a special Islamic Finance program of study. 

Islamic Development Bank

from Harvard

Islamic Finance .org

I will be adding more in the weeks ahead!
  

Q. Why a separate page for Islamic Finance? 
A. Because it is growing in importance, in the news regularly, and few non-Moslems have much of an idea of what makes Islamic Finance any different than regular finance. 

Q. If banks can not charge interest, how can they make money?
A.  Through fees, leasing, and even ownership.  The risks are a bit greater and their are some added steps. 

Q. What is an Islamic Mortgage?
A. Essentially an installment purchase plan.  I would recommend reading what the BBC has to say.  They have a fabulous case study that compares an "Islamic mortgage" to a tradional mortgage. In the latter the bank takes ownership of teh property and the mortage is really an installment purchase plan.  The pop-up window in the middle of the case shows the exact cash flow differences is absolutely a great learning tool. HIGHLY recommended! 

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