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Islamic finance is a system of economic activity governed by Shariah – the moral and legal code of Islam. Unlike the conventional (Western) financial model, in which profit comes from capital as such (like interest on a loan), the Islamic model requires that profit be the result of entrepreneurial risk and participation in real economic activity. This is because, from a Shariah perspective, money has no intrinsic value and serves merely as an ‘auxiliary tool’ to enable the circulation of goods and services. Income only arises as a result of a product being created.
The principles of Islamic finance were laid down in the early days of Islam, but were only institutionalised from the middle of the 20th century. The real breakthrough came in the 1970s following the oil boom, which brought about substantial capital flows into the Gulf states. At the time, the Islamic Development Bank and the Dubai Islamic Bank emerged as the industry’s key institutions. By the 2000s, codification processes evolved through new international organizations. This was followed by expansion, as Islamic financial practices spread, alongside the establishment of specialized institutions setting standards for risk management and prudential supervision, including in non-Islamic countries. As of 2025, the industry includes more than 2,000 publicly reporting institutions in 140 jurisdictions.
Between 2018 and 2024, total Islamic finance assets grew at an average annual rate of 16% to $5.98 trillion, making Islamic finance one of the fastest-growing sectors of the global financial system.
Since its inception, the main centre for Islamic finance has been the Middle East. According to some estimates, the Gulf Cooperation Council states (Bahrain, Qatar, Kuwait, the UAE, Oman and Saudi Arabia) accounted for 53.1% of global Islamic finance assets at the end of 2024, with a further 16.9% attributable to other countries of the Middle East and North Africa. The second-largest region is East Asia and the Pacific, accounting for 21.9% of the global market, primarily led by Malaysia and Indonesia.
At country level, the most advanced Islamic finance ecosystems and most sophisticated regulatory frameworks are found in Malaysia, Saudi Arabia and the UAE.
It is important to distinguish between Islamic finance and economies of Islamic countries. The latter are generally not fully Islamised and host conventional economic mechanisms that are successfully operating. Moreover, Islamised instruments are often of secondary importance within the economies of Islamic countries.
Islamic principles
At the foundation of Islamic finance is the concept of risk-sharing, rooted in the idea of fairness. According to the basic principles of Islam, all factors of production – capital, labour and expertise – are equal. An investor putting money into an enterprise risks losing their capital in the event of failure; the entrepreneur invests their labour and time, which are likewise lost if the venture fails. From an Islamic standpoint, these are equivalent losses. In the case of success, both investor and entrepreneur share the profits.
This concept sets three fundamental requirements for any transaction:
- It must be linked to a real asset or economic activity.
- Both parties must participate in the distribution of profits and losses.
- Full transparency of all material terms of the contract must be ensured.
These requirements are enabled by a system of prohibitions. In Islamic finance, the following is forbidden:
- Interest (riba). Fixed income for the use of money is forbidden, that is, lending at interest in any form is prohibited.
- Transactions involving excessive risk and uncertainty (gharar). It is directly forbidden to invest in complex financial and speculative instruments, for example options and forwards.
- Speculative operations and gambling (maysir). Transactions that allow one party to benefit without a corresponding economic transaction are prohibited.
- Certain types of activity (haram). There is a ban on financing industries that Islam deems intolerable, such as the production and sale of alcohol, pork, tobacco, gambling, and the arms trade.
This ban prevents an Islamic bank acting as a direct lender. Instead, it must either become the owner of an asset (and grant the client the right to use or purchase it), or act as a trading intermediary or a partner in a profit-and-loss sharing project. This is a drastic change in the methodology for assessing creditworthiness, provisioning structures, and prudential standards, which explains precisely the emergence of a parallel regulatory framework with its own standards and supervisory bodies.
Islamic financial instruments
Islamic instruments are conventionally divided into two main groups: equity-based and trade-based.
The trade-based instruments include murabaha – a sale-and-purchase transaction in which the bank itself acquires the goods or asset its client wants and then sells them to the client on a deferred-payment basis with a fixed mark-up, which is a substitute for the interest prohibited on loans. This is equivalent to a mortgage, consumer loan or other forms of credit: murabaha is used to purchase a property, a car, household appliances and business equipment, etc. The bank does not earn from a loan, but from the resale, with money remaining merely a tool to execute the transaction, while income arises from the real asset. Various estimates put murabaha at 80–90% of Islamic banks’ operations.
Ijarah is another trade-based instrument: it is comparable to financial leasing – a lease with an option to buy. The bank buys the property and leases it to the client, who becomes the owner at the end of the term. Ijarah extends to almost any tangible asset that does not lose its substance when in use: a property, vehicles and industrial equipment. Importantly, the bank shares risks with the lessee, for example in the event of equipment breakdown.
The equity-based instruments include mudarabah and musharakah. Mudarabah is a partnership of capital and labour: one party provides the money, and the other commits labour, time and managerial expertise. Profits are distributed in pre-agreed proportions, but financial losses are borne solely by the investor.
Musharakah is essentially a joint venture of two or more parties who invest capital in a business or project and share profits and losses in accordance with pre-agreed ratios. Musharakah can also serve as an equivalent of lending. For example, a bank and a client establish a joint enterprise, each contributing funds. Profits are distributed as agreed, and losses in proportion to each party’s stake.
Takaful is an Islamic form of insurance based on the principle of mutual assistance. Participants in a takaful fund make contributions to a ‘joint pool’ and receive payouts if a covered event occurs.
Another Islamic financial instrument is sukuk, often called an ‘Islamic bond’. It is indeed comparable to bonds, with the crucial difference being that whereas a ‘regular’ bond is essentially an investor’s loan in return for interest, sukuk is a share in a real asset purchased by an investor. Similar to other Islamic financial instruments, sukuk does not involve interest income: investor returns depend on profits of the underlying business, which the investor and the issuer share, as well as any losses.
The first mention of sukuk dates back to the 7th century. In modern times, the first corporate sukuk papers were issued by Shell in Malaysia in 1990; they were worth 125 million ringgit (about $46 million). In 2025, the global market for circulating sukuk was worth more than $1 trillion.
Institutional infrastructure
Compliance with Shariah rules requires a multi-tiered system of oversight. At organisational level, a Shariah supervisory board, made up of independent religious scholars, is mandatory. These scholars assess banking products in terms of compliance with Shariah rules and conduct regular audits. No product may be brought to market without the supervisory board’s approval, and the organization publishes audit results in its annual reports.
At national level, Islamic contract requirements are set by central banks.
In a number of countries, e.g. Malaysia, Bahrain, Pakistan and Oman, central Shariah councils operate on the basis of national regulators. Their decisions are binding on all market players and help resolve differences between boards of different entities.
At international level, there are three key organisations:
- The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), established in 1991 in Bahrain, which develops standards for accounting, auditing and Shariah-based governance (as of 2025, it has released over 60 such standards).
- The Islamic Financial Services Board (IFSB), established in 2002 in Malaysia, which issues standards for banking supervision and adapts international requirements to Islamic finance.
- The International Islamic Financial Market (IIFM), also founded in Bahrain in 2002, which develops standard documents for capital markets and interbank operations.
Additional oversight is exercised by external Shariah auditors and rating agencies, which assess compliance with Shariah rules when assigning ratings to sukuk papers and Islamic funds.
This multi-layered supervisory architecture is meant to create a favourable investment climate, seeking to reduce agency risk through the mandatory linkage of transactions to real assets, limit speculative exposure, opt out of industries with high regulatory and reputational risk through haram screening, and enhance transparency of contractual terms, ensuring they are verifiable by an independent expert body.
Taken in their entirety, these factors broadly explain why Islamic financial institutions showed lower asset volatility in the 2008 financial crisis, and why their products have gained informal recognition as more resilient to economic shocks. For the same reason, ESG-oriented institutional investors are increasingly looking at sukuk as an instrument compatible with responsible investment principles. According to Fitch Ratings, ESG sukuk grew more than 60% to $18.5 billion in 2025, and are well on track to exceed $70 billion by end-2026.
That said, there are a number of divergences between the theoretical models of Islamic finance, built on moral and religious principles, and actual practice. One reason is that Islam has no single central authority to formulate universal norms, and substantial differences persist between the legal schools of Islamic tradition (madhhabs). This makes standardisation of financial products quite challenging.
In Sunni Islam, there have been four principal schools of law: Hanafi, Maliki, Shafi’i and Hanbali. In Shia Islam, the second major branch of Islam, the most prominent and widespread madhhab is the Jafari school. Differences exist both between the two main branches of Islam and among individual schools within each.
For example, Sunnis are predisposed towards institutionalisation and unification of rules at global level. Unlike them, Shia are more flexible in specific cases, and recognise the right of living religious leaders (ayatollahs) to make legal and religious decisions, but they are more conservative as regards speculation and debt. There are also differences in the way individual schools interpret the legitimacy of certain contracts. For instance, the Gulf states, taking instructions from a dominant Hanbali school, are generally more conservative as regards instruments that are similar to conventional loans. The Malaysian approach, mainly based on the Shafi’i school, allows a more flexible interpretation of such contracts.
In practice, Islamic finance today coexists almost everywhere with conventional institutions, and banks of both types compete with each other. Moreover, conventional institutions often offer ‘Islamic products’ to boost their competitive performance. The two exceptions are Iran and Sudan, where the banking systems are fully Islamised (link in Russian).
Central banks’ monetary policies in Islamic countries rely on reserve requirements, operations in Islamic securities (sukuk), and interest-free interbank facilities based on partnership agreements (mudarabah, musharakah), instead of a policy rate. But in practice, Islamic banks in mixed systems tend to watch conventional rates to set their markups; in fully Islamic systems, they seek to replace them with the rate of return in the real economy. Ultimately, central banks manage to substitute interest by combining asset-based market instruments and administrative measures.
Russian experiment in Islamic banking
In 2023, Russia joined the ranks of countries with dedicated Islamic finance regulation. Under a federal law (link in Russian), a two-year pilot was launched, subsequently extended, for ‘Islamic’ financial services in four regions inhabited by historically significant Muslim populations: Tatarstan, Bashkortostan, Chechnya and Dagestan. Of note, the law uses the term ‘partnership financing’ rather than ‘Islamic banking’. This emphasises the economic, not religious, component of the model based on risk-sharing between transacting parties.
The law has established a parallel regulatory regime. The following operations are compliant with Shariah principles and permitted: deferred-payment purchase (murabaha), leasing (ijarah), equity participation in projects (mudarabah and musharakah), interest-free loans (qard hasan), and discretionary investment management.
There is, however, an important distinction between deposits and conventional bank deposits: funds raised under partnership contracts are not covered by the deposit insurance system, in accordance with the fundamental principle of risk-sharing by all parties to the transaction.
As of the end of June 2026, the Bank of Russia’s register (link in Russian) included 36 entities providing Islamic finance services, ranging from specialist non-bank companies to some major federal banks.
In 2025, the pilot was extended to 1 September 2028. Also, the list of permitted operations was expanded to include insurance and transactions in securities. In a further sign of sectoral development, in May 2025, Russia hosted an AAOIFI International Conference on Partnership Finance and Investments for the first time, held as part of the 16th KazanForum. This event is the latest evidence of growing interest in the Russian market from the international institutions that set the standards for Islamic finance.
By way of comparison, Kazakhstan passed a dedicated law back in 2009, and since 2018 has developed its Astana International Financial Centre, where the legal framework is based on common law, to encourage capital raising from the Gulf states through a legal infrastructure familiar to investors. Russia’s pilot has so far been more modest in terms of its objectives, seeking to set up legal and operational foundations for potential future demand.
Challenges and the state of the industry
In just over half a century, Islamic banking has evolved from a local experiment into a fully fledged financial industry with its own regulatory framework and a presence in 140 countries.
Today, Islamic finance boasts advanced international infrastructure comprising operating standards, supervisory mechanisms and professional institutions. New countries and market players are gradually joining the system, contributing to its further development and better standardisation.
The Islamic Corporation for the Development of the Private Sector (ICD) and the London Stock Exchange Group (LSEG) forecast that total assets in Islamic finance will amount to $9.7 trillion by 2029. They are expected to grow at about 10% on average annually.
Recent decades have seen Islamic finance evolving into an attractive investment vehicle for both institutional and retail investors globally. Its investor appeal, on the back of strong resilience to macroeconomic shocks particularly after the 2008 global crisis, has spurred the development of an international regulatory infrastructure.
The relative stability of Islamic financial instruments is primarily attributable to a unique risk-management architecture. The requirement to link financial transactions to real assets or economic activity reduces the probability of conflicts of interest between counterparties. The ban on transactions involving excessive uncertainty (gharar) and speculation (maysir) serves as a constraint on market speculation.
Islamic banking is often described as ethical finance since its philosophy extends well beyond the pursuit of commercial profit and is grounded in the principles of social justice and moral responsibility. The ban on interest (riba) excludes enrichment through merely lending money by replacing the debt concept logic with the principle of fair partnership and profit-and-loss sharing. Socially responsible screening (prohibiting haram activities) places a total ban on financing socially destructive industries. It is this value-based alignment that makes Islamic instruments, particularly sukuk, highly compatible with modern ESG criteria for responsible investment.
At the same time, structuring Islamic financial products can be costlier overall than their conventional peers. This is due to the need to maintain a complex multi-tiered system of Shariah compliance, costs related to independent Shariah boards and external auditors, and the fragmentation of standards caused by differences between the legal schools (madhhabs). Nevertheless, despite higher transaction costs, these instruments continue to resonate with investors.
In Russia, the partnership financing pilot is gradually expanding, building a legal and operational framework that can meet domestic demand and open new channels for cross-border capital mobilisation.
In summary, both global and local practices confirm that the Islamic financial model is successfully integrating into the economic and legal system of today’s world. Its evolution rests on both economic pragmatism and a set of ethical imperatives that remain appealing to many investors.
