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Analysis

Gold boost to Islamic finance

by Shaokai Fan

Gold boost to Islamic finance

 

The arrival of the Shari’ah Standard on Gold, a definitive guide to Shari’ah-compliant investment in gold products, will enable investors to access gold’s unique attributes as a long-term store of value, diversification tool and risk-mitigating asset through Shari’ahcompliant products. The World Gold Council launched the standard with the Accounting and Auditing Organisation of Islamic Finance Institutions on 5 December.

The industry will see the addition of a large and liquid gold market. The introduction of the standard opens up an entire asset class to Islamic finance, potentially sparking an influx of new products, innovations and ideas.

Complex link between Islam and gold
Gold has a deep historical connection with Islamic civilisations as both a currency and artistic medium. However, the complex treatment of gold in Islamic tradition has limited its development as an investable asset class.

Gold is a ‘ribawi’ item: a staple, everyday commodity that necessitated stringent transaction rules to prevent inequity between transacting parties. Ribawi items must be exchanged immediately, which results in the modern requirement that gold financial products must be exchanged within the same day or trading session. The complexity of Islamic rules led to a lack of Shari’ah guidance, which hindered the development of financial products despite an underlying demand for gold. Creating harmonised and authoritative Shari’ah guidance for gold was therefore imperative to open the asset class to Islamic investors.

Fan

Gold’s investment qualities as a diversifier, risk mitigator and long-term store of wealth resonate well with Islamic investors. Moreover, gold can fill critical gaps in the array of product offerings available in the Shari’ah-compliant market.

Islamic investors cannot typically access derivatives-based risk management instruments or traditional interest-bearing safe haven assets like US government bonds. Since gold can function as a hedge against foreign exchange risk, tail risk and other market fluctuations, its inclusion as a Shari’ah-compliant asset can give Islamic investors a potent new tool.

The gold market is 24 times larger than the volume of issued sukuk (Islamic bonds), affording multitudinous opportunities to investors. The World Gold Council is working with banks and financial services providers to help them develop their first gold products in accordance with the standard, giving easier access to Shari’ah-compliant gold for both retail and institutional investors.

Benefits for industry and policy-makers
The launch of the standard comes at a time when Islamic finance is at a crossroads. After years of rapid expansion, growth of the industry has slowed owing to weaker economic conditions, lower hydrocarbon prices and heightened geopolitical risk.

The sluggish global environment and prolonged decline in oil prices have prompted many policy-makers in Islamic countries to seek diversification, with Islamic finance championed as a driver for innovation.

Embedding gold as a Shari’ah-compliant asset class could propel Islamic finance into the next stage of development by expanding the size and depth of its investment sphere. Shari’ah-compliant institutional investors, pension funds, Hajj funds and individuals are all seeking ways to improve returns and diversification amid the current low yield environment.

Furthermore, gold can act as a primary safe haven asset for Islamic finance. Although the sukuk market has made significant strides in recent years, high credit quality sukuk remain scarce. Gold carries no credit risk and is no one’s liability, and serves as a large and liquid market which is highly accessible to Islamic investors. This can reduce systemic risk in Islamic finance, making the market safer for investors.

The introduction of the standard could signal the beginning of a new relationship between financial products linked to gold and Islamic finance. Gold will now be more accessible to Islamic investors, while the industry overall will benefit from innovation sparked by the inclusion of a new asset class.

Given the long and rich history of gold in Islamic cultures, it is perhaps fitting that this most ancient of elements is now able to help power the future of Islamic finance.

Shaokai Fan is Director, Central Banks and Public Policy, at the World Gold Council. This article is for information only and does not constitute investment advice. The World Gold Council is not responsible for any losses.

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