Islamic finance could play key role in development

Dubai: Islamic finance has a constructive role, though a modest one, in meeting some of the sustainable development goals set by the United Nations, according to global credit rating agency, Standard & Poor’s.

In September 2015, the UN General Assembly adopted its 2030 agenda for sustainable development, comprising 17 sustainable development goals (SDGs) and 169 measurable targets centred on five pillars — people, planet, prosperity, peace, and partnership.

The UN has stressed that striving for sustainable development will require a revitalised global partnership between all stakeholders.

“Islamic finance could play a role — a modest one at least — in meeting some of the SDGs, particularly those that are in line with the core principles of Islamic finance,” said Mohammad Damak, Standard & Poor’s global head of Islamic Finance.

Some fund raising, through sukuk issues, by global multilateral lending institutions over the past few years illustrates this point — although their overall amount remains small compared with the conventional debt issuances of multilateral lending institutions (MLIs).

To be considered Sharia-compliant, a financial institution or transaction needs to meet tenets against usury and uncertainty.

Perhaps the most famous principle of Islamic finance is the prohibition of Riba. Depending on the school of thought, Riba has been defined as interest or excessive interest, leading to slavery.

Sharia doesn’t consider money as an asset on its own because it is not tangible — therefore, it may not earn a return from the simple fact of time elapsing. Instead, return can be earned on risk-taking activities, as long as the burden or reward is shared between the bank and its client.

“Although the principle of profit- and loss-sharing has not been fully or always applied properly in the past, we think that the industry is slowly inching in this direction,” said Damak.

Sharia prohibits uncertainty of payout, gambling, or speculation (Gharar), and encourages responsible behaviour. Moreover, Sharia-compliant transactions must be backed by tangible and identifiable assets that anchor the financial sector in the real economy.

Lastly, Islamic finance forbids investment in or dealings with those industries banned under Sharia: notably alcohol and brewing, tobacco, weapons and armaments, or pork-based products. The ultimate goal of these principles is to create a sustainable, equitable and socially responsible financial system.

S&P analysts see similarities in UN SDGs and the principles of Islamic finance. For example, the principle requiring underlying assets in each Islamic financial transaction makes Islamic finance a good match for the financing of infrastructure. Another example comes from the parallel between the prohibition of financing certain sectors such as weapons and armaments and SDG 16 which aims to promote peaceful and inclusive societies.

Islamic finance also uses some specific products that can be used to finance SDGs. The first two SDGs aim to end poverty in all forms, halting hunger and achieving food security in the world. Although these two objectives could probably be dealt with through the use of concessional loans from MLIs or bilateral loans from developed countries, Islamic finance has its own forms of concessional lending.

Qard Hassan consists of a loan granted for welfare purposes or to bridge short-term funding requirements where the borrower is required to repay only the principal.

Zakat, one of the five pillars of the Islamic religion, is similar to a tax that is levied on wealth that exceeds a certain threshold.

Zakat is used for social welfare purposes without any expectations of repayment or remuneration.

Waqf consists of a donation of an asset or cash for religious or charitable purposes with no intention of reclaiming it.

The principle of profit- and loss-sharing inherent to Islamic finance could, if implemented properly, contribute to the attainment of SDGs related to reducing inequality and easing the negative impact of economic swings.

This principle has not been applied properly in the past but, in our view, the industry is slowly inching toward its more stringent application.