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Since its inception in the mid-1970s, Islamic finance was been firmly embedded within the US-centred international economic order under the tutelage of Saudi-supported pan-Islamism. With the end of the Cold War and the increased globalisation of the economy, new sets of rules, norms and institutions began to emerge. The position of Islamic finance is paradoxical. On one hand, Islamic finance thrived. But political Islam grew more diverse and complicated, and was designated in many influential circles as the successor of Communism as the main enemy of the post-Cold War period. Adding to this is the events of September 11th, which bolstered the view of Islam as the new enemy in the West. As the war against terrorism came to be the staple of world politics, many Islamic institutions came under attack and their integration in the global economy suffered a severe blow. This chapter discusses the evolution of global politics, Islamic finance and Islamist politics over three periods, beginning its discussion with the later stages of the Cold War (1917 to 89), during which the first aggiornamento of Islamic finance took place. It then discusses the ‘New World Order’ that followed the end of the Cold War (1990 to 2001) and ends by examining the ‘New New World Order’ which was ushered in by the events of September 11, 2001. Each of the periods in the chapter was characterised by different political alignments and priorities, different forms of Islamic finance and different types of Islamist movements.

Modern Islamic finance started in the 1970s, its emergence driven largely by the oil boom. However, it was bound to be transformed by the collapse of oil prices in the 1980s, and by the changes in the global political and economic system. This chapter focuses on the evolution of modern Islamic finance, placing emphasis on three distinct stages: the early years (1975 to 91); the age of globalisation (1991 to 2001); and the post-September 11, 2001 period.

This chapter provides background information on Islamic finance, beginning by defining Islamic finance whose operations and objectives are consistent with the Islamic law or the Shariah. It also discusses the different factors that set Islamic banking apart from conventional banking, such as: riba, gharar, zakat and halal. The chapter also discusses the geo-economics of Islam, and its diversity and fundamentalism. The second section of the chapter discusses the depictions and demonstrations of Islamic finance and banking in literatures. It discusses the emphasis placed by many literatures on Islamic banking, the historical backdrop of the Islamic financial institution and the need for interdisciplinary approach to capture the many facets of Islamic finance.

Critics of Islamic finance focus on the political mischief of Islamic banks on domestic and international terrain. The suspicion surrounding Islamic banks rests on the syllogism: political Islam at the domestic and international level requires financial resources, Islamic banks are committed to Islam and have vast financial resources; therefore, Islamic banks are likely to advance the political goals of potentially subversive Islamic groups. Do Islamic banks have a domestic or international political agenda? Do they play a role in promoting radical Islam and international terrorism? The answer is that they usually do not. Banks, by virtue of being part of the existing power structure, have a strong status quo orientation. However, there are exceptions to that general rule. As will become evident in the succeeding discussions, the benign view is not widely shared among authoritarian leaders, who often see financial Islam as a destabilising force. This chapter discusses the connection between Islamic finance and politics in domestic and international contexts, comparing the evolution of financial Islam in Saudi Arabia, Egypt, Turkey, Sudan and Indonesia. It also discusses the role of Islamic finance in the New World Order and in the post-September 11 world, where Islamic financial institutions have often been considered ‘guilty by association’.

The role, the importance, the status and the characteristics of Islamic financial banking differ from one country to another. In some countries, the role of Islamic financial banking in the national economy may be significant, while in others, it is deemed insignificant. Its ‘special character’ may be recognised or may not be acknowledged by the regulators. Some countries are strongly encouraged by the authorities, while in others, they are barely tolerated. One of the themes running through this book is the diversity of the Islamic finance. Even those countries that have fully Islamicised their financial systems did so under different religious, political, economic and cultural milieu. In most cases, Islamicisation did not occur in a carefully thought out application of Islamic principles and jurisprudence, but in an ad hoc manner and as a result of situational factors. This chapter discusses the experiences of countries that have undergone full Islamicisation of their financial systems. It evaluates the case of Malaysia, a country that has promoted Islamic finance alongside conventional banking, and examines those countries and territories such as Bahrain, UK, Singapore and Hong Kong which have announced their intention of becoming hubs of Islamic finance.

For years, the Islamic sector has experienced a tremendous growth and has reached a sixfold increase over the past decade. No longer confined to the outer fringes of global finance, Islamic finance has also gone mainstream. Most major financial institutions are now involved in Islamic finance, and Islamic financial institutions now operate in at least 105 countries. Within the Islamic world, Islamic financial institutions have become major economic players, with five countries dominating Islamic banking: Iran, Saudi Arabia, Malaysia, Kuwait and the United Arab Emirates. This economic boom in Islamic finance is due to a number of interrelated demographic, political, economic and financial factors. Initially scarce, Islamic financial products have multiplied over the past years, attracting new clientele – even those who had initially ignored the Islamic markets. Especially notable is the appearance and the popularity of sukuk or Islamic bonds, which skyrocketed the market to $100 billion. Islamic banking has long been criticised for being overly conservative when it comes to financial innovation, but is still work in progress. This book aims to understand the current state of the Islamic sector by tracing its evolution through three distinct phases: the early years (1975 to 91); the era of globalisation (1991 to 2001); and the post-September 11, 2001 period. The first part provides background information on Islam and finance (Chapters 1 to 3). It debunks common myths about Islam and Islamic finance, traces the historical evolution of Islamic economics and finance – as well as the mechanisms by which Homo Islamicus and Homo Economicus were reconciled – and considers religious injunctions as they pertain to finance. The second part of the book introduces and describes the world of Islamic finance (Chapters 4 to 7). It outlines the birth and evolution of modern Islamic finance through the three phases described earlier, and places Islamic finance in its proper political and economic context. The third part (Chapters 8 to 12) deals with the issues and challenges facing Islam from different vantage points.

Much of Islamic World finance is generated locally but then invested in the Western markets; this phenomenon is called capital flight. In contrast, Muslim governments mostly fail to raise sufficient revenue to cover their expenditures, and as a result become dependent on international borrowing to fund their deficits. There are, in other words, varying degrees of private affluence, and this is not exclusive to the oil-exporting states of the Gulf. To what extent can Islamic finance help solve these imbalances? Is the application of shariah law a help or hindrance to the development of domestic financial intermediation and national financial markets in Muslim countries? This chapter examines the direction of Islamic investment. It examines the financial flows through the Islamic Development bank, with particular focus on the outward portfolio investment flows, particularly those through managed funds. The chapter argues that there is little Islamic foreign direct investment. This reflects the failure of indigenous multinational companies to develop in most Muslim countries where governments are resistant to competing local centres of economic power beyond their control. The Islamic managed fund industry remains modest in scale, with assets worth less than $10 billion, but it is qualitatively significant, as its experience demonstrates the constraints in redirecting Muslim capital flows to emerging Muslim markets.

In the wake of the terrorist attacks on the United States, the UN Security Council passed a resolution targeting transnational sources of terrorist funds. As the US and multinational institutions such as the IMF encouraged the Middle East governments to adopt policies of economic liberation, a new capitalism emerged based on Islamic values and beliefs. This book focuses on the emerging connections between Islamic capital, with particular attention to Islamic finance and Islamist political movements in the Middle East and North Africa. It includes not only the funds deployed by Islamic financial institutions but also the assets of the Muslim entrepreneurs who are associated with Islamically oriented businesses. The political associations as well as the political and economic constraints faced by Islamic banking are discussed also. The book is divided into two parts: first it provides thematic essays that serve as ground-work for the country-specific political analyses of Part II. In this introductory chapter, the growth of Islamic markets and the political opportunities and constraints faced by Islamic banks are examined.

Islamic intellectuals observed that the Muslim societies' banking and finance, which should be pegged on religious tenets, have undergone a rapid transformation in the past decades. According to the prevailing interpretations of Islamic law, financial instruments should be based on the principle of profit-and-loss sharing (equity contracts) and should avoid predetermined or fixed returns (debt contracts). However, evidence on the current practice by Islamic banks suggests that the majority of their financial operations are not based on equity, but rather on the use of the murabaha contract – an instrument which is akin to the standard debt contract in conventional banking systems. This departure from the theory and religious doctrine has spurred debates among scholars, and economics and finance specialists. The predominance of the murabaha represents a challenge to the very notion that Islamic finance would provide an alternative to interest-based conventional financial systems. And while there has been a tendency on the part of critics of Islamic finance to overplay the murabaha syndrome, defenders have been equally guilty of dismissing its significance for evaluating the contribution of modern Islamic capitalists. This chapter aims to provide a comparative framework for explaining the murabaha syndrome in Islamic finance. The observation that the financial structure in Islamic sub-systems is no different from those in conventional banking systems establishes the necessity of a systemic examination of financial structure. Starting from the paradigm of corporate governance, the chapter incorporates the insights of recent work on the systemic determinants of financial structure, including the role of law, institutions and politics. This analysis places the murabaha syndrome into a broad national and international context, and elucidates the constraints faced by Islamic capitalists in adhering to the goals of the equity-based model of Islamic finance. The implications for the future of Islamic finance are included also in this chapter.

The chapter illustrates contestations over the definition of Islamic finance by describing conflicting opinions among experts about what makes Islamic finance Islamic. It focuses on two main definitions of Islamic finance by showing how industry professionals and many shariah scholars defined Islamic finance in formal terms, seeking to identify whether a financial device adequately conformed to scriptural prohibitions. In contrast, Islamic economists saw prohibitions in Islamic doctrine as surface manifestations of an implicit set of substantive economic principles, especially risk sharing. The chapter argues that these experts exercise an interpretive approach insofar as they seek to extract an authentic Islamic economic theory from Islamic texts and contrast it with conventional liberal economics.

The rapid growth of Islamic finance is likely to last for a few more years given the opportunities presented by the huge Islamic market, which is only partially tapped. However, the picture is not all rosy. The Islamic financial market is increasingly becoming competitive, and alongside that rapid growth are challenges and growing pains. This chapter discusses the strategic, managerial and cultural challenges facing Islamic banks. Some of the issues it discusses are common and universal to emerging markets, and are not exclusive to Islamic banks or even Islamic countries. Indeed, even the most advanced markets are not, as the recent financial meltdown has shown, immune to strategic, managerial and cultural dilemmas. The world of finance is not cushioned from crises, panics and crashes. In the Islamic financial banking market, the religious dimension adds an extra layer of problems.

This chapter examines the underlying reasons behind the widening gap between the conventional theory and current practice of Islamic banks, arguing that ‘No risk, no gain’ is not a sufficient general principle for organising Islamic finance. It is also not always valid to claim that Islam is averse to granting a time value for money. The overuse of deferred payment contracts in Islamic finance threatens to violate the juristic principle of sadd al-dharaī that is controlling the potential avenues for the circumvention of the law. The chapter suggests some structural changes to the Islamic financial arrangements to create a balance in the usage of profit and loss sharing contracts and deferred payment contracts in Islamic banking.

In the three eras identified in the previous chapters, the evolution of Islamic finance was paradoxical. The creation of the first Islamic banks could be seen, especially in the context of oil crisis and the calls for a New International Economic Order, as a challenge to the existing political-economic order. In reality, the first Islamic banks were firmly rooted within the existing Western financial system. By the same token, the age of globalisation allowed a financial system rooted in the Middle Ages to survive and to thrive. What is more striking is that even amid the Islamaphobia spurred by the September 11 events and the ‘Global War on Terror’, Islamic finance experienced its most dramatic growth in the first years of the twenty-first century. These paradoxes can be understood only in connection with the evolution of the global political economy during those three periods. The first section of this chapter discusses the political and economic context of the birth of modern Islamic finance, as well as the emergence of pan-Islamism, petrodollar windfall and relations with the West. The second section discusses Islamic finance and the global economy, as well as the transformation of banking and the rise of Islamism.

Most of the products offered by conventional financial institutions have some Islamic counterpart. Importantly, however, the underlying contracts are often fundamentally different. Take, for instance, the case of sukuk or ‘Islamic bonds’. From an investor's point of view, the two are similar. As both offer a fixed return at periodic intervals, they can be traded on the secondary market and redeemed at a certain date. Nevertheless, the underlying financial transactions are not the same. The conventional bond is an interest-bearing debt, while the sakk or suku represents a share in an asset, and the periodic return usually represents a lease payment. Hence, while Islamic products were often created to resemble conventional ones, their implications are different. The contractual documentation is also different. In conventional leasing, the contract is usually short, whereas in Islamic documentation, transaction includes several contracts consistent with the Shariah principles. This chapter discusses Islamic financial products and instruments, starting with a discussion of the main building blocks of Islamic finance. The second part focuses on the new horizons in Islamic finance and the ways in which the building blocks can be combined to create new Islamic products.

This chapter aims to increase awareness of the prevailing US-based VC (venture capital) model as an acceptable Islamic vehicle by providing a critical analysis of this mode of financing in the context of Islamic economic principles. In doing so, it evaluates the underpinning legal contract between the investor and entrepreneur, where the distinctions between the VC and Islamic finance are apparent. Of major concern in the chapter is the issue of common versus preferred stock. While the former is accepted in Islamic finance circles, the latter is categorically rejected, since it provides one investor with a liquidity preference over another. The chapter argues that establishing a thriving venture capital industry is crucial not only for further evolution of the Islamic finance industry, but also for the long-term development of ailing economies in the Muslim World.

For a long time, Islamic finance has been discussed from the supply side, and asymmetric information and agency problems have been given as the reasons for lack of use of mushārakah by Islamic banks. This chapter aims to provide some empirical evidence on the relationship between mushārakah and the degree of preference by end users of such a tool. While the relationship between equity finance and control is well documented in the literature, the relation in terms of Islamic finance is not. Therefore, the chapter attempts to link Islamic finance tools with the mainstream theory of finance. The first section of the chapter discusses the existing literature on the Pecking Order Hypothesis and the empirical results of similar studies. The second section focuses on the hypothesis and research methodology used in the chapter. The last section presents the empirical results of the chapter.

When it first appeared in the mid-1970s, Islamic finance was generally dismissed as an inconsequential epiphenomenon of the oil boom. Introducing the religious factor in what was perceived as a quintessentially secular area struck many as bizarre, and many critics asserted that the growth of Islamic banks was bound to remain stunted. However, in reality, Islamic finance experienced growth rates in the double digits, and has become a permanent feature of the global financial system. It did not, however, quite live up to its original billing. While it has come near to the structure of conventional banking, Islamic banking did offer an alternative. Islamic products, while lacking originality, retained their specific features. Islamic institutions warded off predatory transactions and vulture funds. And Islamic banks avoided investing and partnering with institutions belonging to non-halal sectors. Because of this, Islamic banks are criticised for being conservative and for upholding the Shariah law. At a time when conventional banking was transforming beyond recognition, Islamic banks remained conservative and ethical. These qualities served them and shielded them from the financial meltdown. In sum, as the financial crisis has brought about a rare moment of reflection and critical thinking, the logic of Islamic finance can no longer be dismissed out of hand. At the same time, it may be dangerous to overstate the virtues of Islamic finance and present it as a panacea, especially since its principles state what is permissible and not what is necessarily advisable. Islamic finance is still in its early stages of development and is still beset by tensions and problems.

This chapter examines Dubai, one of seven emirates that together constitute the United Arab Emirates (UAE). Although Dubai occupies a forbidding desert terrain along the Arabian (Persian) Gulf, the small emirate’s diversified modern economy includes a financial center rapidly achieving regional and even global significance. In particular, Dubai is widely recognized as one of the world’s most significant centers for Islamic financial products and services structured to ensure compliance with Sharia law. Although undoubtedly reflecting an approach to financial and commercial relations differing starkly from conventional Western financial structures, this chapter nevertheless reveals the striking degree to which Dubai’s geographic and cultural characteristics, competitive strengths, and development strategies reflect the MDSJ paradigm.

This book has examined the conditions that may facilitate the growth of what appears to be a distinctively Islamic variety of capitalist development, identifying self-consciously Islamist financiers and trying to discover the conditions under which they best thrive. It has found that distinctive financial practices seemed to mobilise the capital which would have otherwise stayed hidden in the mattresses of the MENA region. The processes of economic globalisation, coupled with the steady accumulation of Islamic capital, were deemed to eventually overcome the present barriers to the integration and promotion of a more political pluralism in the region. The studies in this book have identified Islamic capitalism as a natural evolution of gentle commerce. This chapter argues that if big international business can polish the manners of the Bush Administration sufficiently to avert a clash of globalisations, this will aid Islamic finance to promote the steady structural transformation of the region that the essays of this book have envisioned.