As the economy sours and populist anger at the banking sector boils, advocates of Islamic finance are billing it as the righteous alternative to a greedy Western system.
Islamic finance emerged in response to the desire of Muslims with rising wealth to comply with their faith in financial dealings. Scholars
who specialize in Islamic finance examine assets for compliance with Islam’s sharia law. These scholars are paid by banks to provide judgment, but differences in interpretation have led to hiccups in the industry. 

Three fundamental tenants of sharia law in finance are the prohibition of interest, the sharing of profit and risk between counterparties and the requirement for all products to have an underlying, tangible asset. 

Malaysia pioneered the concept of Islamic banking, with the first sharia compliant financing for pilgrimages to Mecca in 1962. Malaysia is also the leader in issuance of sharia compliant bonds, or sukuk, with about one third of the $82.2 billion market. With billions of petrodollars to invest, Middle Eastern countries have become a pillar of the 15% per year growth of Islamic assets over the past decade. Globally, the total value of sharia compliant assets is estimated between $700 billion and $1 trillion. Great things are expected for the sector in liberal Muslim economies like Indonesia as well as Western countries with large Muslim populations. BNP Paribas, a French bank, is planning to launch the first ever issuance of corporate sukuk in Europe this summer. In 2004, the UK certified its first sharia-compliant retail bank, the Islamic Bank of Britain. 

Islamic banking avoided the hammerhead of the economic crisis due to minimal exposure in residential real estate and derivatives markets. This dodge has lent the sector some moral credit over its besieged Western counterpart. In reality, the financial whiz kids who design sharia-compliant assets are right now working on the creation of Islamic derivatives. 

Islamic banks are not immune to the liquidity drought of the current crisis and they are heavily reliant on commercial real estate and construction projects. Corrections in Middle Eastern property values could have a serious impact on Islamic financial institutions tied up in these markets. 

The sector has largely resisted efforts to regulate and standardize, on fears that rigidity would hamper creative growth. Arguments over interpretations of sharia could lead to incidents like that of last year when comments by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), a respected industry body, briefly ground the sukuk market to a halt. The AAOIFI declared that two popular types of sukuk violated the spirit of sharia law, leading to a substantial drop-off in issuance of these bonds. 

Still, only a small fraction of the world’s 1.3 billion Muslims have turned to Islamic banking for their financial needs. As developing economies heat up and Muslims turn away from conventional banking, the sector can expect a sunny forecast. However, without serious regulation and old-fashioned prudence, Islamic banks could one day be in the same boat with the rest of the banking pariahs. Regulation is a must for the long term success of any business sector, including a religious
one.