The Islamic Financial Market includes banking, capital markets, and insurance that comply with shari’a (the code of law based on the Koran) principles. Islamic finance is structured to avoid the following, which are all prohibited under shari’a: riba (interest), maisir (gambling), and gharar (ambiguity).

Islamic banking has grown both as a concept and in practice since the Islamic Development Bank (IDB) opened in 1975 to finance economic development and foster social progress in compliance with shari’a principles.

The International Islamic Financial Market (IIFM), founded through the collective efforts of the IDB; and the central banks and monetary agencies of Bahrain, Brunei Darussalam (Brunei), Indonesia, Malaysia, and Sudan takes part in the establishment, development, self-regulation, and promotion of Islamic capital and money markets. IIFM is in the final stages of developing the first standardized shari'a-compliant Master Agreement for sukuks (Islamic bonds).

The Islamic Financial Services Board (IFSB) is the international standard-setting body of regulatory and supervisory agencies that aims to ensure soundness and stability in the Islamic banking, capital market, and insurance industries.

Under its standards of development, IFSB defines sukuk, or Islamic bonds, as certificates representing a proportional undivided ownership right in tangible assets, a pool of tangible assets, or a business venture in a specific project or investment activity in accordance with shari'a principles.

Demand for Islamic bonds has grown substantially, but still lags behind demand in mainstream debt markets. Sukuks operate within the rules and principles of shari'a and presently remain in markets where investors hold bonds to maturity. Islamic bonds have gained universal acceptance as a viable alternative to conventional products. Aside from the obvious attractiveness among Muslim investors, Islamic bonds may also appeal to conventional investors looking for attractively-priced instruments for regular income and capital gains. The strong investor demand offers issuers access to an alternative cost effective fundraising option. In addition, efficient price discovery processes for Islamic securities in some countries (e.g., the issuance of Islamic treasury bills and Government Issues in Malaysia) has led to the establishment of an Islamic benchmark yield curve.

The international Islamic bond market is divided into sovereign and quasi-sovereign, and corporate markets. A prerequisite for an Islamic issue is shari'a compliance, which prohibits the charging of riba (interest). Sukuk markets are particularly innovative and are rapidly expanding with significant new issuance. Islamic bonds are structured financial instruments based on a specific contract of exchange that can be made through the sale and purchase of an asset based on deferred payment, leasing of specific assets, or participation in joint-venture businesses. They are issued internationally by sovereign or corporate entities and are generally of medium-term maturity with risk–return characteristics similar to conventional debt securities. Structuring Islamic bonds requires approval from recognized shari'a advisors to ensure compliance with Islamic rules and principles. In addition, Islamic bonds can be structured to provide investors additional protection against late payment, prepayments, and potential write-offs, among others. This protection comes as part of credit or liquidity enhancement schemes.

In recent years, several countries in East Asia, most with large Muslim populations, have developed shari’a-compliant products and markets. Several of these markets are growing.

Malaysia

Malaysia is at the forefront of Islamic finance. It is the largest issuer of Islamic financial products in East Asia. In 2008, Islamic bonds accounted for nearly 38% of total local currency bonds outstanding. The Securities Commission of Malaysia supervises the Islamic Capital Market (ICM), which operates parallel to conventional capital markets. ICM plays a complementary role to the Islamic banking system by broadening and deepening instruments and access to Islamic financial markets. Malaysia is also host to the Islamic Financial Services Board (IFSB).

Indonesia

Bank Indonesia (BI) published The Blueprint of Islamic Banking Development in Indonesia in 2002, which defined the vision, mission, and objectives for developing Islamic Banking; and outlines strategic initiatives through 2012. Corporate bond activities, including Islamic bond offerings, have been accelerating since 2003. In December 2006, BI launched a program to accelerate Islamic bank development, with shari’a-compliant bank assets targeted to grow from 1.68% to 5.25% of the country’s total bank assets by the end of 2008. In April 2008, the Islamic Shari'a Debt Bill was passed into law to enable the Government to issue Islamic bonds.

The Jakarta Stock Exchange began a Jakarta Islamic Index (JII) in 2002, which covers approximately 30 companies and has become the benchmark for shari’a investors.

As of November 2006, there were 47 insurance and reinsurance companies licensed to operate shari’a-compliant divisions.

Thailand

The Islamic financial system is relatively new to Thailand. The Pattani Islamic Saving Cooperative was created in 1987 to mobilize and manage funds in southern Thailand (THB 90 million in assets at the end of 2001). At least four other Islamic saving cooperatives have been established since then. In 1998, the Government Savings Bank, which serves a small-savings clientele, introduced an Islamic Banking Window to provide Islamic banking products and services. The Bank for Agriculture and Agricultural Cooperatives followed suit in 1999. The Krung Thai Bank opened its first Islamic Branch in 2001, offering a full range of shari’a-compliant banking products and services. In 2002, passage of the Islamic Bank of Thailand Act facilitated the establishment of the Islamic Bank of Thailand.

On April 2009, the Stock Exchange of Thailand (SET) and the FTSE Group created the FTSE SET Sharia’h Index. Using the FTSE SET All-Share Index as the base universe, the new index screens companies against shari'a principles. The FTSE SET Sharia’h Index was created for both domestic and international investors looking to invest according to Islamic principles. This index can be used for a wide range of Islamic products including funds, exchange-traded funds (ETFs), and other index-linked products.

Brunei Darussalam (Brunei)

The Government plans to strengthen banking and insurance services by offering conventional and Islamic financial instruments. Islamic banks are regulated under the Islamic Banking Act. There are three Islamic banks in Brunei: Islamic Bank Berhad, Tabung Amanah Islam Brunei, and Islamic Development Bank Berhad. In 2006, the Government issued its first sukuk offering, a USD96 million Sukuk Al-ijarah. Since then, sukuk issuance has become a regular activity of the Government through the Ministry of Finance.

Singapore

The Monetary Authority of Singapore (MAS) continues to review its tax and regulatory framework to promote Islamic financing as a parallel option to conventional financing services. In 2005, MAS allowed local banks to offer mudharabah (profit-sharing) financing. Singapore was accepted as a full member of IFSB the same year.

The FTSE Group and the Singapore Exchange (SGX) are developing a set of indexes for shari’a-compliant stocks. This set of indexes will exclude stocks of companies dealing in activities such as the sale of pork or pork-based products, liquor, and gambling. The first index of the series is the FTSE SGX Asia Shari'a 100 Index. It is designed to represent the performance of shari’a-compliant companies from markets in Hong Kong, China; Japan; Republic of Korea; Singapore; and Taipei, China. The index is calculated in real-time, published in US dollars, and is expected to be used as the basis of index-linked funds, exchange-tradede funds, and over-the-counter (OTC) products.

In November 2008, MAS began setting up a sukuk issuance facility to provide shari'a-compliant regulatory assets to financial institutions in Singapore. Sukuks issued by the facility will be given equal regulatory treatment as Singapore Government Securities (SGS). Returns will be tied to the risk-free yield of an SGS of equivalent tenor. In January 2009, Singapore launched its first Islamic bond program worth a total of SGD200 million.

Japan

Japan is planning to launch the first sovereign shari’a-compliant bond by a G-7 nation, designed to attract Middle Eastern petrodollars to Asia. The sukuk bond, which would be placed in Malaysia and valued at USD300–500 million, will be launched by the Japan Bank for International Cooperation (JBIC). Philippines In 1996, the Bangko Sentral ng Pilipinas’ (BSP) monetary board provided regulations on Islamic banking in its Manual of Regulations for Banks. The manual discusses the functions of a Shari’a Advisory Council for Islamic Banking in the Philippines. Islamic Bank, or the Al Amanah Islamic Investment Bank (AAIIB), is the only shari’a-compliant bank in operation in the Philippines. A government-controlled bank, its board is composed of representatives from the Government, Development Bank of the Philippines, Social Security System, and Privatization and Management Office. BSP issued a warning in 2001 for the public to be wary of other groups referring to themselves as an “Islamic bank.”

China

In December 2006, China Resources (Holdings) Co., Ltd. (CRC) partnered with Al Rajhi Bank and Investments, one of the largest joint stock companies in Saudi Arabia. They are planning to offer shari'a-compliant investments in the Chinese market.

Hong Kong, China

In November 2007, Hang Seng Bank launched an inaugural Islamic equity fund, the Hang Seng Islamic China Index Fund. In January 2008, the Hong Kong Monetary Authority (HKMA) applied to become a full member of IFSB. It is currently an associate member.

On May 2008, Hong Kong’s Securities & Futures Commission and the Dubai Financial Services Authority (DFSA) signed a memorandum of understanding to establish mutual cooperation on capacity building and human capital development in Islamic finance. The memorandum of understanding also promotes development of their respective Islamic market segments. In addition, the Airport Authority of Hong Kong, which was planning to issue bonds in October 2008, has gained tax exemption from the Government.