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Abstract
The development of Islamic finance is governed by Islamic laws (Shariah). The main principles that regulate all forms of transactions in Islamic banking activities include the prohibition of interest or usury (riba),the use of excessive risk (gharar), and gambling (maysir). The Islamic finance industry has become a prominent sector and is one of the fastest growing components of financial developments over the last decade in the global financial system. The availability of large numbers of Islamic finance products will increase significantlyas there have been a growing demand throughout the world, especially in OIC participating countries. Hence, the objective of this study is to identify the important factors that enhances financial development in the selected OIC countries (Malaysia, Indonesia, Jordan, Kuwait, Saudi Arabia, Sudan and Yemen). Three indicators of financial development were used; Islamic finance, broad money and liquid liabilities. The data used in this study is the panel data from the year 1990 to 2012 which were obtained from the International Monetary Fund, Islamic Banks and Financial Institutions Information (IBIS), and World Bank databases. This study employed pooled OLS, fixed and random effect model. The results indicate that there are significant relationships between Islamic finance and financial development. Specifically, this study found that liquid liabilities and Islamic finance are two factors that have significantly influenced financial development in the OIC countries. Furthermore, the findings suggest that the OIC governments are required to develop policies that would integrate Islamic finance into their financial system. These policies should be centred around regulatory framework and supervisory role to utilize Islamic finance for greater economic growth. Keywords: Islamic finance; financial development; OIC countries; pooled OLS, fixed effect; random effect
Highlights
The Islamic finance industry has become a prominent sector and is one of the fastest growing components of financial developments over the last decade in the global financial system
Islamic finance operates on a profit and loss sharing (PLS) mode established within the frameworks of Shariah law that are based on the Quran, Sunnah and other secondary sources on Islamic laws
The regulatory and supervisory functions have become more prevalent in order to build a stronger Islamic finance sector that enables access to financial services for Muslims and individuals who are interested in investing in zero interest markets or towards communities who are in need for sound and profitable investments
Summary
The Islamic finance industry has become a prominent sector and is one of the fastest growing components of financial developments over the last decade in the global financial system. Based on the study by Haron and Ahmad (2000), since the establishment of the first Malaysian Islamic bank in 1963, the number of Islamic banks have increased significantly and have shown tremendous growth over the years. The Malaysian International Islamic Financial Centre (MIFC) 2015 reported that “the current value of the Islamic finance assets, (led by the Islamic banking sector and the global sukuk market) is estimated to be more than $2 trillion (representing a compounded average growth rate of 17.3%). Islamic finance operates on a profit and loss sharing (PLS) mode established within the frameworks of Shariah law that are based on the Quran, Sunnah and other secondary sources on Islamic laws. The prohibition of riba or interest has been articulated and emphasized by Allah SWT in the Surah Al-Imran, 130
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