Islamic finance versus conventional finance

Abstract

Transactions in Islamic Finance (IF) are guided by ethical, moral, and social considerations. Moreover, according to IF money should be used to create social value. With regard to these point of views, IF aligns with Socially Responsible Investing (SRI), which refers to the combination of social, environmental and ethical requirements when making financial investment decisions. In contrast to conventional finance (CF) where the investments are solely focused on risk and return, SRI and IF have also a social value component. The main question in this chapter is; when one decides to invest in or issue bonds following the rules of, does such a decision influence the financial risk-return window? In this study we compare Sukuk (Islamic bonds) and conventional bonds and find that, after correcting for risk, the returns on Sukuk are significantly higher than those of conventional bonds. Our conclusion is that investors are not paying for being ethical, but issuers of Sukuk bear a higher cost of debt compared to issuers of conventional bonds.