HOW ISLAMIC BANKING AND FINANCE CAN
HELP TO PROPEL ECONOMIC GROWTH
FACULTY : FACULTY OF ACCOUNTANCY
COURSE CODE : MAF663
COURSE NAME : ISLAMIC FINANCE
PROGRAM CODE : AC220
CLASS : 7B
PREPARED BY :
NO NAME STUDENT ID
1 SITI NUR HANIS BINTI SHAFIE 2022970443
2 NUR ASNIAH BINTI MOHD ASHRI 2022972869
3 NURUL NADIAH BINTI ABD RAHMAN 2022900479
4 WAN NUR HAZWANI BINTI WAN ZAIN 2022972795
PREPARED FOR:
DR AMRI MOHAMAD
SEMESTER VII [MARCH - AUGUST 2024]
TABLE OF CONTENTS
NO CONTENTS PAGES
ACKNOWLEDGEMENT
1.0 INTRODUCTION 1-2
2.0 CONTENTS 3-9
2.1 BACKGROUND OF ISLAMIC BANKING & FINANCE
2.2 DIFFERENCES BETWEEN CONVENTIONAL
BANKING AND ISLAMIC BANKING
2.3 CHALLENGES OF ISLAMIC BANKING AND
FINANCE
2.4 BENEFITS OF ISLAMIC BANKING & FINANCE
2.5 ISLAMIC BANKING AND FINANCE: PROPELLING
ECONOMIC GROWTH
3.0 CONCLUSION & RECOMMENDATION 10
4.0 REFERENCES 11 - 12
ACKNOWLEDGEMENT
In the name of Allah, the Most Gracious and the Most Merciful, all praises to Allah for
the blessings and the strengths that He has bestowed upon your organisation in order to
successfully complete this group project. All of the members of the group contributed to the
successful completion of this work, which had a big influence on us. The impact was incredibly
helpful to us in terms of expanding our knowledge, and we benefited greatly from it.
Moreover, we would like to take this opportunity to express our appreciation to our
lecturer, Dr. Amri Mohamad, because, without his direction, we would not have been able to
do our project in an appropriate manner. He is always willing to assist us and provide guidance
on how to finish our tasks in order for us to be able to yield a satisfactory outcome based on
the subjects that we have been studying.
Last but not least, we would like to express our gratitude to each and every one of our
cherished members who consistently work together and put in a lot of effort in order to
generate a fantastic assignment that includes all of the required resources and duties. All of
our resources, we hope, will prove to be useful to both us and the project that we are working
on.
1.0 INTRODUCTION
Islamic economics and finance are founded on the unwavering principles of Shari’ah
law. Unlike secular legal systems that separate religion from daily life, Shari’ah law regulates
all facets of life, including social, political, and economic interactions (muamalat). In Islamic
economics, human labour that is productive is vital. Islam morally prohibits the commerce in
firearms and destructive armaments, as well as activities including pork, drugs, alcohol,
tobacco, gambling (maysir), speculation, and pornography. It also does not endorse any
human desires that could cause self-harm. (Hussain et al., 2015).
Islamic finance operates under three core principles. Predetermined payments, or riba,
made in financial transactions to shield the weaker party are forbidden by the equity principle.
Riba, which translates from Arabic as "hump" or "elevation," indicates an unearned gain in
money. This principle also bans excessive uncertainty (gharar) from contract ambiguity or
unclear payoffs. Parties must disclose information before contracting to reduce information
asymmetry, as gharar would invalidate the contract. Furthermore, this principle supports
wealth distribution through zakat, a 2.5 percent levy on wealth charge imposed by Shari’ah on
Muslims who meet certain income and wealth levels in order to strengthen social solidarity
and help those who are less fortunate (Hussain et al., 2015).
The participation concept emphasizes that while Islamic finance is interest-free, it does
reward capital. Returns on investments must be gained through risk-taking rather than just
time passing; this is in line with the Shari'ah ruling that "reward (profit) comes with risk-taking",
which also underpins the prohibition of riba. Consequently, risk-taking serves to legitimize
returns on capital, which are then established ex-post through asset performance or project
productivity, guaranteeing a connection between financing activities and actual economic
activity. This principle assures that increases in wealth are the outcome of productive
endeavours (Hussain et al., 2015).
The principle of ownership mandates asset ownership before transactions,
encapsulated in rulings like "do not sell what you do not own" (prohibiting short-selling) and
"you cannot be dispossessed of property except on the basis of right." As a result, Islamic
finance becomes asset-based, strengthening the connection between the actual economy and
finance. It highlights the integrity of contracts by emphasizing the protection and respect of
property rights as well as the fulfilment of contractual duties (Hussain et al., 2015).
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The Islamic financial system maintains a balance in the returns between savers and
investors since it prohibits riskless returns on investment and encourages profit-sharing and
loss. A lot of emphasis is placed on the fact that justice prevails for both the providers and the
utilisers of capital. In modern commercial banking, while funds are mobilised from the public
through deposits, particularly saving deposits, they are later channelled to the business
community. Under this method, banks can buy stocks and receive a variable profit that
depends on the actual business results and share the proportion of depositors’ funds to be
earned on that stock. This method allows the actual results to be split accordingly; no party is
exposed to risk while no party can reap without exposure to risk (Hanif, 2011).
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2.0 CONTENTS
2.1 BACKGROUND OF ISLAMIC BANKING & FINANCE
Upon analyzing the Islamic finance history, it is possible to divide it into three major
stages where the first one started during the nineteenth century. The first one was before the
1960 pre-colonial period before most of the Muslim countries were politicked and
consequently, cultures and religion were interrupted. However, with such new findings’ certain
fresh resistance regarding the reintroduction of other aspects of Islamic legislation particularly
in the sphere of economy did not put further very serious attempts into until the pinnacle of
colonialism. The emergence of a new face to the Islamic world and that of recovery after
colonisation ignited the need for legal and commercial revival in the Islamic world as per the
Islamic Shari’ah. Some Muslim scholars began to examine and condemn the interest system
of conventional banks as being unlawful and legally prohibited due to usury.
In the second phase, from the year 1960, the preliminary type of theoretical structure
of Islamic economics was created. The first recorded account of an interest-free bank based
on the concept of profit-loss sharing was also set up around this time. The first post oil boom
and thus today’s first modern, fully-fledged Islamic commercial bank, Dubai Islamic Bank, was
established in the same year, 1974. The foundation of the Islamic Development Bank (IDB) in
1975 can be considered as the turning point in the Islamic finance’s development. The find of
the oil revenue, and the petrodollars during this period also called for the desire of the shariah
compliant financial products.
The third phase, in the 1980s, some Islamic countries, Iran, Pakistan and Sudan, tried
to implement the Islamization of the economy by introducing a banking system without interest
charges. B Marked by the expansion of Islamic finance industry, this also raised interest from
institutions in the west. To this end, the IDB set up the Islamic Research and Training Institute
(IRTI) in 1981 in order to meet this important function of research and development in the area
of Islamic finance. The monetary systems of some countries started the dual system of Islamic
and conventional banking systems. In the 1990s, some more regulatory and standardisation
bodies appeared during this decade for example, Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI).
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Other new financial products at the same period included Takaful (Islamic Insurance)
as well as Islamic Equity Funds. After that, from the onset of the twenty-first century to the
contemporaries, the Islamic Financial Services Board (IFSB) was formed in charge of
regulatory, supervisory, and corporate-governance-related affairs of the Islamic finance. Other
instruments that became available during the decade include Sukuk – Islamic bonds. Islamic
finance experienced rapid development and internationalisation, where Shariah compliant
financial dealings were made available in the different areas of the global village. Another
development in is Islamic finance saw universities begin to introduce programs in Islamic
finance.
2.2 DIFFERENCES BETWEEN CONVENTIONAL BANKING AND ISLAMIC
BANKING & FINANCE
Islamic banking and conventional banking differ significantly in their fundamental
principles, modes of finance, and risk-sharing mechanisms. One of the key distinctions lies in
the concept of interest (riba), which is central to conventional banking practices. In
conventional banking, interest is a core component of financial transactions, where banks lend
money (bond) to customers at agreed-upon interest rates. This interest-based system is
considered exploitative in Islamic finance because it allows for profit without sharing risks. In
contrast, Islamic banking operates under Shariah law, which strictly prohibits riba. Instead of
conventional bonds, Islamic finance utilizes sukuk, often referred to as Islamic bonds, which
generate returns for investors through profit-sharing or lease agreements. These instruments
ensure ethical and equitable financial dealings in accordance with Islamic principles.
Sukuk, or Islamic bonds, come in various types designed to adhere to specific Shari'ah
principles. Ijarah sukuk involve leasing assets and sharing rental income with investors, while
Murabaha sukuk are structured on cost-plus sale agreements, where assets are sold at a
markup. Mudarabah sukuk operate through profit-sharing partnerships, and Musharakah
sukuk resemble equity investments with shared profits and losses. Sukuk are widely used by
governments, corporations, and financial institutions to raise funds in a Shari'ah-compliant
manner, providing an ethical and interest-free alternative to conventional bonds.
Moreover, the modes of finance utilized by Islamic banks, such as Musharakah and
Mudarabah, emphasize partnership and risk-sharing between the bank and its customers. In
Musharakah, both parties contribute capital and share profits and losses based on pre-agreed
ratios, fostering a collaborative approach to financial activities. Similarly, Mudarabah involves
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a partnership where one party provides capital, and the other offers expertise, with profits
distributed according to the agreed terms. These participatory modes not only align the
interests of the bank and customers but also promote transparency and shared responsibility
in financial transactions. On the other hand, there is also Murabaha, which is a cost-plus-profit
product used for trade and asset financing, whereby the bank purchases an asset and then
sells it to the client at a premium, to be paid in equal subscriptions. This is somewhat similar
to lease where the bank acquires an asset and leases it to customers, while the legal
ownership rests with the bank till the end of the lease period or till acquisition of the lease
asset. These financing structures asserted by Obaidullah (2005) ensures that the financing is
justifiable and is based on the Islamic Shari’ah law to ensure transparency of the transactions.
Another significant difference is the treatment of money as a commodity. Conventional
banks view currency as a tradable asset, allowing them to engage in interest-based
transactions and speculative activities. In contrast, Islamic banks consider money as a
medium of exchange and prohibit the earning of interest on loans. Instead, Islamic banks focus
on real economic activities and asset-backed financing, promoting ethical investments and
discouraging speculative practices. By adhering to Shariah principles and emphasizing ethical
conduct, Islamic banking aims to create a more inclusive and socially responsible financial
system that benefits both the institution and the community it serves.
In summary, Islamic banking and conventional banking diverge in their underlying
principles, modes of finance, and ethical frameworks. While conventional banking relies on
interest-based transactions and debt financing, Islamic banking prioritizes profit-sharing, risk-
sharing, and asset-backed arrangements guided by Shariah law. By promoting fairness,
transparency, and ethical conduct in financial dealings, Islamic banking offers a distinct
alternative that aligns with the values of social justice and economic equity.
2.3 CHALLENGES OF ISLAMIC BANKING AND FINANCE
Islamic finance currently has its major challenges mainly because it is not well
understood and accepted mainly because of its key principles that greatly differ from
conventional modes of finance. The law against interest (riba) and the focus on profit and loss
sharing are two principles that from a secular world’s perspective are seen as
disadvantageous and therefore questioned in global markets. Thus, El-Gamal (2006) notes
that an attempt to implant Islamic finance into global markets is far from being easy because
of the stark distinctions of its ethical guidelines and its work principles from those of
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conventional finance. This is because the introduction of sharia-compliant practices can lead
to this disparity which acts as a hindrance to the expansion and institutionalisation of Islamic
finance.
However, Islamic finance is surrounded by a number of rules and regulations and they
differ with the conventional laws being dual in many aspects. Islamic banks have to ensure
that they adhere to the precepts of Shari’ah law and also other legal requirements that are laid
down by the varying financial laws of different countries, this in effect leads to high compliance
costs and enhanced business complications. Beck et al. (2013) notes that when there is no
well-developed and specific Islamic finance regulation in many jurisdictions, there is always
uncertainty and risk for investors. This dual regulation presents the need to put in place
suitable legal and institutional framework that would enhance the operations of Islamic finance
which is very essential for natural growth and integration of the system into the global and
domestic systems.
The other important area considered to be crucial is career management of human
capital and building of experts in Islamic finance. Currently, one can identify a mentioned
scarcity of specialists with both religious and economic knowledge. As Kapir Hassan and
Mervyn K. Lewis pointed out in A World of Talents, educational institutions and professional
training programmes must include Islamic finance as a subject in their courses to help
eradicate this talent deficit. When there are insufficient Sharia knowledgeable experts the
market fails to produce new financial instruments that will meet modern day’s economic needs
and are still Sharia compliant. More to the point of this article, the absence of skills negates
the sector's prospect of growing and thereby competing with what is known as the formal
Sector.
Finally, operational and regulatory Integration Barriers of Islamic finance in the global
financial system are operational or regulatory. El-Gamal (2006) further observed that because
there is no single legal system governing the global Islamic finance, bringing the Islamic
finance into the conventional financial market and institutions will not be easy. The
harmonisation of standards and practices is crucial for the improvement of the business
climate in the field of cross-border transactions and the exploration of the maximal
opportunities in attracting international investments. An integrated process aimed at attuning
Islamic finance to the international financial regulation is not only going to improve its
credibility, but also help in advancing its standing and acceptability in the global markets.
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2.4 BENEFITS OF ISLAMIC BANKING & FINANCE
Islamic banking and finance have several opportunities and benefits to the
development of an economy. These systems are based on Shariah law and concentrate upon
ethical and just finance that can make the economic environment more stable and socially
responsible.
The first benefits of Islamic finance are its focus on risk-sharing and profit-loss sharing
arrangements. This technique is reflected in instruments such as Mudarabah (profit-sharing)
and Musharakah (joint venture), which are beneficial for entrepreneurs and help stimulate
investments into productive sectors of the economy. In this way, these tools enable financiers
to share both risks as well as profits, hence creating a partnership between them and those
with whom they work leading to collective mindset that initiates sustainable growth (Habib,
2018).
Besides, Islamic finance does not involve interest-based transactions regarded as
exploitative or economically destabilising. Instead, it encourages trade through Murabaha
(cost-plus financing) as well as Ijara (leasing) associated with real sector activities. It reduces
speculative activities including financial bubbles thereby fostering greater macroeconomic
stability (Hasan, 2023).
Moreover, Islamic finance has allowed for the integration of fintech. For example,
blockchain and smart contracts serve to improve the transparency and efficiency of Shariah-
compliant financial products through lowering costs and deepening access to financial
services. This technological advancement is particularly beneficial in reaching underbanked
populations and supporting small and medium-sized enterprises (SMEs) (Alam et al., 2023).
In conclusion, the principles and practices of Islamic banking and finance with their
focus on ethical behaviour, risk-sharing as well as social welfare provide a solid foundation for
sustainable economic growth. These will make Islamic finance more attractive compared to
its conventional counterparts especially when it comes to inclusive development that is also
stable.
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2.5 ISLAMIC BANKING AND FINANCE: PROPELLING ECONOMIC GROWTH
Islamic banking and finance, grounded in principles that prohibit interest (riba) and
promote ethical financial practices, offer a distinctive approach to fostering economic growth.
Countries that provide Islamic finance products and services have a strategic advantage in
attracting foreign investment, particularly from regions with significant Muslim populations
where Islamic finance is a key component of the financial system. By offering Sharia-compliant
financial instruments, these countries can tap into a vast pool of investors who seek to align
their investments with their religious beliefs. This alignment not only increases capital inflows
but also diversifies the investor base, fostering economic growth (Ishak, n.d.).
In addition, Islamic finance instruments, particularly sukuk, offer a viable solution for
financing large-scale infrastructure projects. Sukuk provides a Sharia-compliant alternative to
conventional bonds, attracting investors who prefer or require investments that adhere to
Islamic principles. The funds raised through sukuk can be directed towards critical
infrastructure projects such as transportation networks, energy facilities, and public utilities.
This influx of capital helps address infrastructure gaps, which are often a significant barrier to
economic growth (Ishak, n.d.).
Furthermore, Islamic finance principles inherently align with the Sustainable
Development Goals (SDGs) due to their emphasis on ethical and socially responsible
practices. Central to Islamic finance is the prohibition of activities deemed harmful to society
and the environment, such as those involving excessive risk (gharar) or interest (riba). Instead,
Islamic finance promotes risk-sharing and asset-backed financing, ensuring that investments
are tied to tangible assets and real economic activities. Additionally, Islamic finance
emphasizes social welfare through mechanisms like zakat (charitable giving) and waqf
(endowments), which directly support poverty alleviation and community development
(Anggraini, 2019).
Islamic finance principles are designed to promote financial stability and resilience by
prohibiting speculative activities (gharar) and excessive risk-taking. These prohibitions reduce
the likelihood of financial bubbles and crises, which are often triggered by high levels of
speculation and leverage in conventional financial systems. The risk-sharing nature of Islamic
finance enhances its resilience against economic shocks, a trait that was notably evident
during the global financial crisis. Unlike conventional banks, which often engage in high-
leverage and speculative activities, Islamic banks operate on principles that promote shared
risk and asset-backed financing (Anggraini, 2019).
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All in all, Islamic banking and finance present a robust framework for propelling
economic growth. Through its emphasis on ethical practices, risk-sharing mechanisms, and
inclusivity, Islamic finance not only enhances financial stability but also promotes sustainable
development. By offering viable alternatives to conventional banking, Islamic finance plays a
pivotal role in broadening access to financial services and supporting entrepreneurial
ventures, thus contributing significantly to the overall economic prosperity of societies
adhering to Islamic principles.
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3.0 CONCLUSION & RECOMMENDATION
Islamic banking and finance can really boost economic growth due to its unique
characteristics as a financing model that is based on Islamic solidarity or risk-sharing
principles. Strict compliance to Shariah on issues to do with prohibition of interest (riba), proper
asset-backed financing and generally Shariah compliant investments mean stability and
proper conduct in matters relating to financing. This system increases the access of the
previously excluded population to the financial services, lowers the risks associated with the
speculative investments which can adversely affect the economy and contributes to the
sustainable economic growth due to the responsible investment activities.
In addition, Islamic finance promotes investments in real sector projects and productive
ones such as construction of infrastructure projects as well as SME businesses which create
employment and fosters economic diversification. In other words, integration of financial and
real sectors, which can be observed in Islamic banking, strengthens economical structure
against global financial crises.
These benefits imply that governments and financial institutions should aim at
improving the regulation to the Islamic banking systems to guarantee compliance with Shariah
provisions. Education and outreach to the general public is also another means of
implementing the trust and understanding of the Islamic financial products also. Also, there is
a need to encourage the issue of sharia compliant financial instruments like Sukuk (Islamic
bonds) and Takaful (Islamic insurance) that will increase the pool of investors and also cater
for various investment requirements. In this way, the countries can build the elaborate Islamic
financial infrastructure that can act both as stimulators to the enhanced economic
development and as efficient tools for promoting justice in the distribution of monetary
resources and ensuring stability in the financial market.
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4.0 REFERENCES
Kettell, B. (2011). Introduction to Islamic Banking and finance.
https://doi.org/10.1002/9781118467299
El-Gamal, M. A. (2006). Islamic Finance: Law, Economics, and Practice. Cambridge University
Press.
Iqbal, Z., & Mirakhor, A. (2011). An Introduction to Islamic Finance: Theory and Practice. Wiley
Finance Series.
Khan, M. F. (2019). Islamic Banking and Finance: An Alternative Approach to Economic
Development. Journal of Islamic Economics.
World Bank Group. (2017). Islamic Finance. In World Bank.
https://www.worldbank.org/en/topic/financialsector/brief/islamic-finance
Foziah, N. H. M., & Azrak, T. (2020). Financial development and economic growth: does
Islamic banking development has a significant effect on. . . ResearchGate.
https://doi.org/10.31838/jcr.07.11.131
Hanif, M. (2011). Differences and similarities in Islamic and conventional banking.
ResearchGate.
https://www.researchgate.net/publication/228201721_Differences_and_Similarities_i
n_Islamic_and_Conventional_Banking
Alam, N., Gupta, L., & Zameni, A. (2023). *Fintech and Islamic Finance: Digitalization,
Development and Disruption*. Springer.
Dusuki, A. W., & Abdullah, N. I. (2007). Maqasid al-Shari'ah, Maslahah, and Corporate Social
Responsibility. The American Journal of Islamic Social Sciences, 24(1).
Habib, S. F. (2018). Fundamentals of Islamic Finance and Banking. Wiley.
Hasan, Z. (2023). Islamic Banking and Finance: Second Edition. Routledge.
Iqbal, Z., & Mirakhor, A. (2007). An Introduction to Islamic Finance: Theory and Practice. John
Wiley & Sons.
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Ishak, K. (n.d.). The Role of Islamic Finance In Economic Development.
Obaidullah, M. (2005). Islamic Financial Services. Islamic Economics Research Center, King
Abdulaziz University.
Anggraini, M. (2019). Islamic banking development and economic growth: a case of Indonesia.
Asian Journal of Islamic Management, 1(1), 51–65.
https://doi.org/10.20885/ajim.vol1.iss1.art5
Naz, S. A., & Gulzar, S. (2020). Impact Of Islamic Finance on Economic Growth: An Empirical
Analysis Of Muslim Countries. Singapore Economic Review/the Singapore Economic
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Ibrahim, M. H. (2015). Issues in Islamic banking and finance: Islamic banks, Shari’ah-
compliant investment and sukuk. Pacific-basin Finance Journal, 34, 185–191.
https://doi.org/10.1016/j.pacfin.2015.06.002
Hussain, M., Shahmoradi, A., & Turk, R. (2015). IMF WORKING PAPER. An Overview
of Islamic Finance. https://www.imf.org/external/pubs/ft/wp/2015/wp15120.pdf
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