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For Islamic financiers, the complex toxic securities backed by US sub-prime mortgages, which subsequently wiped out the balance sheets of several Western banks, would never have been allowed under sharia law as it requires that everything has to involve an underlying asset or service.

Islamic principles also indicate that while it is acceptable for financiers to make profits, these profits must be made from an underlying asset or service and not simply from owning capital. Risk must be shared between lender and borrower and everyone involved in a transaction must be able to make informed decisions and there must be transparency about all aspects of the transaction.

Investment in areas considered socially detrimental - including gambling, pornography, armaments and alcohol - is also forbidden. A key sharia ruling is the explicit prohibition of riba, usually described as interest. Modern day Islamic finance has developed mechanisms which replace interest with cash flows from productive sources, for example rental income.

However, the rise in modern day Islamic finance predates the credit crunch. The last few years have seen the global Islamic finance sector expand rapidly, on the back of an oil-fuelled boom in the Middle East and a growing desire for Muslims to find products compliant with their beliefs. The latest calculation of market size for Islamic finance was US$638.3m, which represents growth of some 28 per cent over 2007.

The UK has seen a steady flow of new entrants to the Islamic finance market, particularly so in the last few years. These entrants have been encouraged by the FSA's and HM Revenue & Customs' efforts to establish a level playing field for Islamic finance reflecting the Treasury's stated position of developing London as a European and global centre for Islamic finance. This was demonstrated in 2003 when legislation was passed to remove the double stamp duty which Islamic mortgages previously incurred. It was further advanced in November 2007 when the FSA published a paper on the regulatory aspects of Islamic Finance in the UK.

The UK's efforts to establish itself as a centre for Islamic banking have paid off. There are approximately 1.65m Muslims in the UK, substantially smaller than either Germany (3.05m) or France (4.80m). However, the UK has become Western Europe's, and the Western World's, clear leader in Islamic finance, with more sharia-compliant assets than any non-Muslim country and is home to the only standalone Islamic financial institutions in the EU.

Retail financial products are proving an attraction. Most recently, Pink Home Loans, a subsidiary of the Skipton Building Society, announced in April that it was going to start offering Islamic home purchase plans.

Salaam Halaal, which was established last year to provide the UK's first Islamic car insurance, announced in August that it was going to start offering home insurance. In September last year, Amiri Capital, the UK's first Islamic hedge fund manager announced that its first fund launch had been delayed due to the collapse of its partner, Lehman Brothers. Lehman had been lined up as a prime broker. However, it has persevered and launched the fund earlier this year.

While retail products look to be prospering in the UK, the global market for sukuk - Islamic bonds - is proving far more challenging. Earlier in the year, the first sukuk defaults occurred from two Gulf-based corporates. Islamic bankers are also working through the remark from renowned Islamic finance scholar Sheikh Muhammad that repurchase undertakings, a pledge in most Islamic bonds that the borrower pays back their face value at maturity, violates the responsibility to share risk.

BDO, in conjunction with the Economist Intelligence Unit, surveyed over 170 financial institutions this past August to try and understand the industry's prospects. Respondents were optimistic about growth prospects, with over half expecting the Islamic finance market to expand between 10 per cent and 20 per cent over the next three years. Just 3 per cent of respondents did not expect the market to grow.

In the UK, there are a number of strong arguments to support the considerable potential of the Islamic finance market:

• From a UK perspective, Islamic finance remains an untapped market with less than 1 per cent of total assets classified as being sharia compliant. By way of example, in its prospectus, the Islamic Bank of Britain said that if the 100,000 British Muslims with conventional mortgages transferred these to Islamic home loans, the Islamic finance sector would grow by £8.9bn. The current value of UK Islamic mortgages is estimated by the Treasury at £1.25bn.

• The UK market for sukuk was a winner in this year's budget. Relief from stamp duty land tax in respect of transactions undertaken as part of the issue of property sukuk was granted, as was relief from tax on capital gains in respect of transfers of land to and from sukuk issuance vehicles. The final measure was to ensure that the person obtaining finance remains entitled to claim capital allowances while the land is held by the sukuk issuance vehicle.

• The FSA's recent policy statement on the impact of the liquidity regime on Islamic banks looks set to provide many of them with access to its simplified liquidity approach, conferring a reduced compliance burden on them.

• Other non-Islamic countries are now waking up to the opportunity presented by Islamic finance. In September, France amended its civil code to allow sukuk to be issued there. China, with a Muslim population estimated at 37m, was described this month as a "sleeping giant" by Prudential Fund Management who tipped it as the next big Islamic finance market. However, its tax laws still make Islamic finance a costlier alternative to conventional finance.

• The approach enshrined in Islamic finance structuring deals backed by actual assets has obvious appeal to the post-banking crisis world.

But perhaps we need to reflect back on one the key drivers of Islamic finance, the oil boom. The last five years of rising oil prices have allowed the Gulf States to enjoy robust growth. However, the global downturn could threaten oil prices and reduce the year-on-year growth that these countries have enjoyed. Already, the global downturn has led to a collapse in property prices in Dubai, where many Gulf Islamic banks invested heavily, and are now suffering as a consequence.

A survey also showed that the industry faces a number of challenges. A shortage of expertise in the industry and a lack of regulatory harmonisation were seen as the biggest obstacles to growth, both being cited by more than 40 per cent of respondents.

Nearly one-third also referred to a lack of demand among Muslims. This could be attributed to education or concerns that Islamic finance is not seen as being competitively priced.

Overall, the survey showed that great potential remains for further growth of Islamic financial services, particularly in the UK. Financial services firms will now need to start positioning themselves to take advantage of this market while understanding the challenges they will face.

Dan Taylor is head of banking at BDO