What is it and what can you learn from it?

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In today’s edition is about Islamic banking and its principles, which are also exciting for “normal” investors.

topic of the week

Islamic banking: what is it? And what can you learn from it?

Earlier this week, Muslims around the world celebrated one of their most important festivals – the sugar festival, the festival of breaking the fast. This gave us the idea of ​​using Islamic banking as an example to show you how religious values ​​are also applied in financial investments – and which principles could also interest investors who have nothing else to do with Islam. All of this regardless of our beliefs or worldview.

What is Islamic Banking?

Islamic banking is “Shariah-compliant” investing. The Sharia is a binding legal doctrine of Islam and includes the interpretation of the Koran and the Hadith. Rules of conduct and commandments for Islam were written down here, such as the implementation of the fasting month of Ramadan, but also principles for banking and finance and their “Islamic” regulations. One of the core elements is the ban on interest, which is also a big difference to our well-known financial system.

How does Islamic banking work?

In Islamic banking there are three main criteria that a devout Muslim is obliged to comply with:

The ban on interest

Sharia prohibits the collection and payment of interest altogether. Accordingly, a Muslim cannot take out or grant interest-bearing loans or mortgages. It’s not that easy in our world, for example, if you want to buy an apartment – probably very few of us have the purchase price of a condominium or a house in our account.

Islamic banks have different approaches here. For example, the bank can buy the house and then resell it to the customer in monthly installments at a higher price. There is also the possibility that you pay a surcharge directly when buying and get an interest-free loan in return. In this case, of course, the bank still makes money from it, and it stands to reason that the premium probably corresponds to the current interest rates.

It’s more about the connection to the real economy, because dividends are allowed. Such distributions to shareholders are not mandatory for companies. If the profit was particularly high, then a company can distribute money. If things don’t go so well, then don’t. This connection to the real economy is a very important basis for Islam-compliant investing and is closely related to the next principle.

The ban on speculation

Speculative transactions, such as transactions with derivatives or general trading, are forbidden in Islamic finance. Here you can see the orientation towards the real economy. According to Sharia, one should not bet on things that could happen in the future, but participate in today’s economy. An interesting point, which is also very close to the principles of passive investing. These mean that all the information is already priced into the market and you can’t really beat the market because you never know anymore or you can’t know all the information at the same time.

All conventional insurances, on the other hand, fall under the ban on speculation, because they can be understood as a bet on the occurrence of the insured event. After the last financial crises, some experts therefore pinned their hopes on the impact of Islamic banking. Because a look points to the pastthat the Islamic markets, for example, were less affected by the financial crisis of 2007/2008 than the conventional markets. “Islamic banking appears to be having a stabilizing effect on the financial market,” he said such as Professor Matthias Casper from the University of Münster, who researches Islamic banking.

That may also have been one of the reasons why 2015 the G-20 finance ministers advocated Integrate Islamic banking more closely into the global financing structure. The former pope has also praised it 2009 for these reasons Islamic banking. Interesting right?

«Halal» and «haram» investments

In addition to the ban on interest and speculation, there is another important aspect in Islamic banking. It matters which companies are invested in, so that one’s own money is also invested ethically. It is divided into “halal” (permitted) and “haram” (forbidden) sectors. The latter include alcohol, pornography, prostitution, armaments, tobacco and pork.

We already know the principle a little bit from sustainable investing. Because here, too, according to the ESG criteria (Environmental, Ssocial, Governance) very similar industries excluded. For example, production and trade in weapons, gambling, tobacco, alcohol and nuclear energy. In addition, there are criteria such as human rights and labor law violations, environmental destruction, corruption and bribery. As Lukas wrote in a previous issue, it is not always that easy to invest sustainably, because the funds in which we as investors can invest have a certain amount of leeway in interpreting and defining sustainability. There is a similar problem with Islam-compliant financial products.

Who certifies Islam conformity?

It is now clear to us that there are some important points in Islamic banking that need to be considered. But the question is: Who makes sure that this is also possible for investors? Banks and companies that want to offer an Islamic financial product need a certificate, which they get from a so-called Sharia Council. Islamic banks have such councils, and in many Muslim-majority countries they also exist at the national level. They may come to different conclusions as to whether a financial product complies with Sharia principles or not.

Which principles we as investors can adapt

If you look at the basics of Islamic banking, new opportunities can arise from this to let your money work for you according to different rules. So which principles can we adapt and which not?

Ban on speculation: Back and forth makes pockets empty. That is scientifically proven. Only 1 percent of traders are successful. Most fare significantly better with less speculation and more sustainability in the form of long-term investments and a focus on the broader market. In my opinion, this is a lesson that everyone should really integrate into their portfolio – regardless of religion.

Ethical investing: With the money we invest, we support companies within specific sectors. It therefore makes perfect sense to ask yourself which values ​​you live by (and want to live by) and how you design your life and portfolio accordingly. The principles of sustainable investing in the form of ESG and SRI criteria (Ssocially Rresponsible IInvesting) are meanwhile becoming more and more established in our world and can bring the same returns despite the exclusion of certain sectors. If you compare the MSCI World and MSCI World SRI indices, you will see few differences – although certain sectors are excluded from the SRI. However, one thing to keep in mind here is that excluding companies reduces diversification – which can of course increase the risk in the portfolio.

Conclusion

Islamic banking is an exciting topic, the principles of which you can learn from, regardless of your religion. The orientation towards the real economy runs through all principles in this system. Which aspects you ultimately want to implement yourself and how, of course, as always, depends on your own risk profile as well as on your financial possibilities and experience.

Here you can find more on the topic:

Thank you very much for your attention! If you have any questions or comments, feel free to reply to this email.

Good buy!

hava