The years 2008 and 2009 weren’t exactly auspicious for many banks, brokerages, and other financial firms around the globe. (How’s that for an understatement?) In the United States, large financial institutions such as Lehman Brothers and Bear Stearns collapsed after getting entangled in the mortgage-backed securities market. Other large financial firms required government support to stay alive. The severity of the global financial crisis that followed has been described as second only to the Great Depression. Yet from 2008 to 2009, the assets of the 500 top Islamic financial institutions grew — from $639 billion to $820 billion.
For people like you and me, who earn a living (or plan to earn a living) within the financial sector, a statistic like that provokes questions. What sets apart the Islamic finance industry from the rest of the financial world? And how have its differences helped this sector thrive when the rest of the global financial market struggles to regain its balance?
I wrote this book because so many people like you — bankers, investment advisors, fund managers, and other financial professionals (or students with an eye on becoming the next generation of these professionals) — are hearing from their peers that Islamic financial products are the next big thing. But other than knowing that a market exists for products that adhere to the tenets of Islam, many financial industry students and professionals don’t know what the term “Islamic finance” really means.
As you find out in this book, I’m bullish on Islamic finance; I’m a firm believer in the market potential of this industry. I’m also a firm believer in the benefits of Westerners understanding the concepts that lie behind the Islamic financial products — knowing why a separate industry exists and why many conventional products don’t work for Muslims. As I explain in these pages, the concepts supporting Islamic finance are crucial to Muslims and can’t be compromised. This enormous — and quickly growing — market sector is actively seeking financial products and investment opportunities that adhere to Islamic principles. By recognizing and meeting these needs, conventional banks and other financial institutions can tap into a rich and thriving global market.
About This Book
For all its potential, the Islamic finance industry is a bit distant and removed from the conventional commercial finance sector. In the West, the general public and even many financial professionals know absolutely nothing about Islamic finance. Those who’ve at least heard of it may assume that they can’t understand or participate in it because they aren’t Muslim and don’t speak Arabic. (As I show you in this book, you absolutely can participate in the Islamic finance industry — as a professional or as an investor — even if you aren’t Muslim and don’t know Arabic.) Western women may assume that they aren’t allowed to participate in the Islamic finance industry because of misconceptions about Islamic law. (Women can and do fully participate in Islamic finance — as professionals and as investors.)
Islamophobia is a prejudice against Islam or Muslims that has unfortunately become more commonplace and more intense in the West since the attacks on the United States on September 11, 2001. Some people simply don’t want anything to do with an industry that’s affiliated with Islam. Until now, searching for a book to help you navigate the subject of Islamic finance wasn’t very rewarding. That’s because Islamic finance has been the topic of textbooks but not many nonacademic titles.
I wrote this book to bridge the gap between people who need and want to know about Islamic finance and an industry that needs and wants their participation. If I’ve done my job well, you won’t feel intimidated by the information in this book; instead, you’ll be comforted in knowing that Islamic finance and conventional finance share a lot of basic features. And you’ll find out that you don’t need to learn a new language to work in Islamic finance, that you don’t need to change your personal religious views, and that job prospects are strong for both men and women with conventional banking and finance skills who are open to learning about new products and a new way of conducting business.
As with any For Dummies book, this volume is a reference book. That means I don’t necessarily expect you to sit down and read it cover to cover. (Of course, if you choose to do so, I won’t argue a bit.) Instead, I assume that you’ll jump in and out and around the book, reading the sections and chapters that are most relevant to you. Therefore, I’ve written each chapter so it makes sense on its own; I don’t assume that you’ve read the preceding chapters.
Conventions Used in This Book
To help you navigate this text, I use the following conventions:
When I introduce a new term, it appears in italics, and I provide a definition or explanation nearby.
I use bold text to highlight the active steps you take in a process and the keywords of bulleted lists.
All website addresses appear in monofont so they’re easy to pick out if you need to go back and find them. Keep in mind that when this book was printed, some web addresses may have needed to break across two lines of text. If that happened, rest assured that I haven’t put in any extra characters (such as hyphens) to indicate the break. So, when using one of these web addresses, just type in exactly what you see in this book, pretending as though the line break doesn’t exist.
Sharia, the Islamic law that all Islamic financial products must adhere to, goes by many different spellings throughout the world. I use the spelling sharia for general references throughout this book, but other spellings you may see elsewhere include sharia’a, shariah, and shari’ah (and sometimes references are capitalized). I use such alternative spellings here only in the names of specific banks, funds, and so on that utilize them.
Similarly, many Arabic terms that end in -a have alternative spellings that end in -ah. I use the -a spellings for such terms, but know that this spelling discrepancy doesn’t affect the meaning. So if you read an article somewhere about mudarabah contracts, for example, rest assured that they’re the same mudaraba I discuss in this book.
One final convention note: In Islam, the respectful acronym pbuh (peace be upon him) customarily follows all references to prophets, including the Prophet Muhammad (pbuh), and I adhere to that convention here.
What You’re Not to Read
I happen to believe that every word in this book has value. (Perhaps I’m a touch biased?) But if you’re looking for just the essentials, you can skip the sidebars (the gray boxes) in the book, which offer supplemental information. You can also skip over paragraphs that are accompanied by a Technical Stuff icon because they contain information that may be more detailed than you need.
I wrote this book assuming that you have a strong interest in the financial industry already. Maybe you’re a banker, a mutual fund manager, an investment consultant, or an insurance agent. Perhaps you have Muslim clients asking you to consider adding sharia-compliant products to your roster of offerings, or your boss mentioned in passing that Islamic finance has been growing like crazy in recent years and your company should find out how to tap into the market. Maybe you’re a college student focusing your studies on finance, and you’ve read that job prospects are good for people with specific knowledge about Islamic finance.
Whatever your background, you’ve heard that Islamic financial products exist, and you need to know more about them to supplement your industry knowledge.
Although I don’t assume that you know every in and out of every aspect of finance, I do assume that you bring some fundamental knowledge to the table. I don’t bother defining in detail what a mutual fund is, for example, or how conventional insurance products work. But I do refresh your memory about slightly more technical topics such as financial reports. Don’t worry though; this text isn’t an accounting book. I focus on drawing connections and distinctions between Islamic financial products and the conventional products you likely already understand.
I absolutely do not assume that you’re Muslim or plan to convert to Islam. And I don’t assume that you know Arabic. I share with you some essential Arabic terms related to the Islamic finance industry, but I don’t expect you to become fluent in the language.
How This Book Is Organized
I’ve divided this book into seven parts for easy navigation. As I note earlier in this Introduction, you can pick and choose your way through these sections as you need. Here, I explain what you find in each part.
Part I: The Basics of Islamic Finance
I begin the book by covering the fundamentals of the Islamic finance industry, including the key principles behind it. If you’re looking to gain a big-picture understanding of the subject, Chapter 1 is definitely the place to start.
Obviously, the principles supporting the Islamic finance industry derive from Islam. Chapter 2 is your very brief introduction to both the religion and to the sharia code of conduct that Muslims are called to follow.
To add some perspective to the importance of the industry, Chapter 3 quickly runs through the centuries-old history of Islamic finance (while focusing primarily on events since the 1970s). And in Chapter 4, I outline the current state of the industry by explaining the variety of institutions that are in business, considering how the global credit crises have affected them, using my crystal ball to predict their growth, and pointing out some challenges that they face.
Part II: Introducing Islamic Commercial Law
For some people in the West, the word sharia has negative connotations. News stories that highlight extreme punishments for going against sharia law cast a harsh light on the word and what it stands for.
But for a Muslim, sharia is a positive word. Sharia is Allah’s (God’s) law (though not every Muslim agrees about what it says), and it’s a set of ethical guidelines that help Muslims know how to behave in all circumstances, including business dealings.
Part II contains two chapters that explain sharia ethics as they apply to the business world. Chapter 5 defines Islamic ethics as they relate to commercial pursuits. Chapter 6 illustrates how sharia compliance influences the development of all Islamic commercial contracts and the many financial products based on such contracts.
Part III: Eyeing Islamic Banking Operations
Conventional and Islamic commercial banks have a lot in common. For starters, both provide products and services that their customers and communities absolutely rely on. (Imagine how different your town or city would be if all the banks shut down. Where would you and your neighbors put your money for safekeeping? Where would you turn if you needed help buying a home or a car or starting a new business?) But conventional and Islamic commercial banks differ in some significant ways. In Chapter 7, I outline differences in function, structure, supervision, and concept, and I describe how each type of bank relates to its customers.
Neither banking industry functions in a vacuum, and Chapter 8 looks at ways in which Islamic and conventional banks — including the central banks of various countries and regions — cooperate in order to achieve their goals and meet their customers’ needs.
To round out the coverage of Islamic banking, Chapter 9 paints a big picture of how Islamic banks receive and use their funds. Then Chapter 10 goes into detail about how Islamic banks use their funds to generate income and provide crucial financial instruments to their customers.
Part IV: Islamic Investment Markets: Equity and Bonds
Islam discourages the hoarding of wealth and instead encourages people who accumulate surplus funds to find ways to invest their wealth for the betterment of the entire community. However, Islam forbids supporting any business that promotes gambling or pornography, participates in the construction of weapons of mass destruction, produces pork or tobacco products, or engages in other prohibited activities. What’s a Muslim investor to do?
In Chapter 11, I explain the fairly recent development of Islamic capital markets that feature sharia-compliant equity products. In Chapter 12, I explain the screening processes that ensure the assets traded on Islamic markets are indeed compliant with sharia.
In Chapter 13, I focus on nonequity investment products called sukuk, which are commonly called Islamic bonds but differ fairly significantly from conventional bonds. A wide variety of sukuk products are available, and the market for them is substantial. I offer a thorough introduction here.
Part V: Reporting, Corporate Governance, and Supervision
Chances are you didn’t focus your studies or career on finance in order to spend day and night thinking about financial reports. If that were your cup of tea, you’d probably be an accountant or auditor instead. However, financial reporting is part and parcel of the finance industry, including the Islamic finance industry. And Islamic institutions, like their conventional counterparts, must meet reporting requirements established by regulatory authorities and auditing standards boards. In Chapter 14, I explain what those requirements look like and who is setting them in the Islamic sector.
Chapter 15 considers the governance typically found at Islamic financial institutions and how it likely differs from the governance of a conventional firm. The existence of a supervisory sharia board is the most visible difference, and Chapter 16 explains who may sit on such a board and what its responsibilities are.
Strong leadership is a key component of managing risk, and Islamic finance institutions face a few risks that their conventional counterparts don’t. In Chapter 17, I explain those risks, which are related to sharia compliance, and how they’re most often mitigated in the Islamic system.
Part VI: Islamic Insurance: Takaful
Functioning in Western society without buying insurance is tough. Almost every state in the United States requires some minimum level of auto insurance, for example, and you’re running a huge risk if you own a home and don’t insure it and its contents. But what do you do if you’re Muslim and your religion prohibits your purchase of conventional insurance products because they involve prohibited elements of risk, speculation, and gambling?
The Muslim alternative to conventional insurance is called takaful, and in this part, I explain what this product is and how it differs from conventional insurance. I describe specific takaful products, as well as retakaful, the Islamic equivalent of reinsurance or company-to-company insurance.
Part VII: The Part of Tens
In this part, I give you two short chapters featuring quick pieces of information. First up are the ten reasons I think Westerners should become informed about the Islamic finance industry. (Globalization and industry growth are just two of the most obvious.) Then I spotlight ten economic benefits of adhering to sharia.
Because many of the product and contract names I discuss in this book are Arabic words, I provide a thorough glossary immediately after The Part of Tens. If you get stuck on the difference between murabaha and musharaka, for example, don’t despair; just turn to this appendix for help.
Icons Used in This Book
Throughout the book, I place icons in the margins that call your attention to certain types of text. Here’s what each icon means:
When it comes to religion and the code of ethics derived from it, you can bet that some disagreements exist. This icon points out current or ongoing points of contention in the Islamic finance industry.
This icon denotes paragraphs that contain useful how-to’s for better understanding the Islamic finance market and perhaps positioning yourself for a career in it.
When you see this icon, pay close attention. The point I’m making is something that’s worth recalling long after you read the words.
If you’re looking for just the essentials and don’t want to get bogged down in the nitty gritty details and historical background of certain topics, feel free to skip past paragraphs with this icon attached. If you do read them, keep in mind that they likely contain information that’s a bit more technical than the rest.
This icon flags descriptions of what is actually happening in the Islamic finance industry: real-world situations and products that illustrate the topic at hand.
Where to Go from Here
The great thing about this book is you can start anywhere you want. If you know absolutely nothing about Islamic finance, I encourage you to read Chapter 1 first because it sets the stage for understanding the whole subject. Beyond that, feel free to use the table of contents or index to pinpoint subjects of particular interest.
If you’re a banker, Part III may be your most logical starting point. If you’re an equities broker, Chapter 11 may hold the most interest for you. Are bonds your thing? Flip to Chapter 13. Is insurance your specialty? Part VI on takaful should be a good read.
Feel free to skip around and glean the information that’s most useful to your career or your studies. And if you get tripped up at any point by the terms I’m using, don’t hesitate to dog-ear the glossary at the end of the book so you can keep your definitions straight.