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From Wall Street to Dubai – The Lucrative Idiosyncrasies of Islamic Banking

Religious limitations within Islamic jurisprudence have kept Islamic banks more cash awash than their risk-taking Western counterparts after the recent economic hubbub, but gradual reforms need to take place for the industry as a whole to experience a structurally sustained positive growth in the future.

By Marquis Codjia

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A supranational symposium of key financial players took place recently (March 2nd and 3rd, 2010) at the posh King Hussein Bin Talal Convention Center on the shores of the Dead Sea, circa 25 miles southwest from Amman, Jordan.

The event received trifling media interest from major western news outlets; however, behemoths in the global banking industry were closely eyeing pivotal decisions that may be announced in the final communiqué.

They were right to do so.

The gathering, the first Islamic Finance and Investment Forum for the Middle East, occurred in economically healthy and politically stable Jordan – a prominent ally of the West in a geostrategically susceptible region, – which enjoys the highest quality of life in the Middle East and North Africa Region, according to the 2010 Quality of Life Index prepared by International Living Magazine.

Another essential factor to heed lies in the fact that participants were among the crème de la crème of the Islamic financial marketplace, a group of over 350 bankers and experts from 15 countries that are spearheading transformational shifts in an economic sector likely to experience solid growth in the foreseeable future.

A bird’s eye view of Islamic banking is utile to fathom the industry’s core dynamics.

Islamic banking – and to a larger extent, Islamic finance – is deeply rooted in Islamic economics and quintessentially governed by Sharia, a legislative corpus that encapsulates the religious precepts of Islam.

Sharia or its financial section known as Fiqh al-Muamalat (Islamic rules on transactions) allows financial intermediaries to engage in any form of economic activity so long as they don’t charge interest (Riba) and shun businesses implicated in forbidden (Haraam) undertakings.

Sharia strongly furthers risk sharing among investors and economic transactions collateralized by tangible assets such as land or machinery but outlaw derivative financial instruments.

A derivative instrument is a product that derives its value from other financial instruments (known as the underlying), events or conditions. It is mostly utilized for hedging risk or speculating for profit. The recent turmoil in global capital markets and the ensuing socio-economic pandemonium owe much of their existence to a type of derivative called Credit Default Swap (CDS).

Viewpoints alien to the Muslim world may find Sharia restrictions deleterious for sustained economic development because what Muslim jurisprudence defines as vice (gambling, adult filmography, alcohol, etc.) not only plays a vital role in many countries’ GDPs but is also an arguable social and temporal concept.     

Notwithstanding, a plethora of observers now contend that constraints within Islamic finance have successfully shielded Sharia-compliant institutions from the recent economic meltdown while keeping their coffers cash awash.

Several factors support a potential Islamic finance boom, including skyrocketing deposits from denizens of oil-rich populated countries, numerous infrastructure projects and the emergence of a large middle class.

UK-based International Financial Services London estimates that Sharia-abiding assets have grown by 35% to $951 billion between 2007 and 2008, even though the industry “paused for breath” in 2009 amid the ongoing economic lethargy.

According to Mohammad Abu Hammour, Jordan’s minister of finance, the Islamic banking sector witnesses an annual growth rate of 10-15 % and there are currently over 300 Islamic banks in more than 50 countries, with large concentrations noted in Iran, Saudi Arabia and Malaysia.

Most of those banks and financial intermediaries are owned by native shareholders but growing swaths of the Islamic banking sphere are being populated by specialized sections of “ordinary” full-service Western banks.

HSBC Amanah, the Islamic finance arm of HSBC, is an illustration of that trend.

Islamic banking is highly profitable and the heightened foreign interest conspicuously corroborates the notion that the industry is bound to expand once emerging nations within the Muslim world are willing and able to use their gigantic cash reserves to structurally develop core sectors of their economies.

Nonetheless, many pending issues are still crippling the Islamic finance sector and prevent it from exceeding the 1% share it currently holds in global banking business.

The first relates to the need for Islamic banks to devise risk-hedging strategies – especially those engaging in cross-currency transactions – and instruments that are compliant with regulatory precepts. Specialists within the industry have to be creative because derivatives, a major hedging tool, are prohibited by Sharia. Progress in that area is still timid.

Second, Islamic scholars need to devise and inculcate a homogenous body of legislation to financial agents to avoid asymmetric disadvantage in the marketplace. The immensity of such a task cannot be underrated because Islam has multiple schools of thought and divergent interpretations of certain religious precepts can often turn out to be insurmountable stumbling blocks.

Sunni Islam is the largest branch of Islam with at least 85% of the world’s 1.5 billion Muslims although the endogenous variety of schools of thoughts often creates a diversity of views.

If a bank located in Sunni Saudi Arabia finds itself at a regulatory disadvantage versus an Iranian bank ruled by the precepts of Shiite Islam or a financial institution in Kharijite Oman, then evidently fundamental market disequilibria will emerge.

Third, the sector needs to harmonize practices to grow. Uniformity is needed not only in regulatory oversight but also in accounting and risk standards, both internally (within the Islamic world) and externally (vis-à-vis Western or other regional financial zones). A practical example will be to seek compliance with I.F.R.S. (International Financial Reporting Standards) and Basel II Banking Accords.

Finally, Islamic banks will need to engage in a sophisticated, well-targeted communication campaign aimed at educating skeptical U.S. and E.U. regulators (primarily), as well as prospective clients in the Western hemisphere. This effort will be pivotal in shifting public perception of the quality and positioning of their products and services and in expunging the stigma that erstwhile (and current) geopolitical happenings may have placed on the “Islamic brand”.

Dr. Abu Ameenah Bilal Philips on Interest and Islamic Banking

  1. Ahmed
    March 5, 2010 at 6:06 am

    Great article here. Thanks for enlightening us on this topic!

  2. Shekina
    March 5, 2010 at 6:08 am

    As-Salāmu Alaykum! Thank you for an excellent analysis. Hopefully Islamic finance will grow in the future and help most poor countries.

  3. Special
    March 5, 2010 at 6:10 am

    Thanks for ur insight. 😀

  4. Nobel
    March 5, 2010 at 6:11 am

    Wonderful article here……….

  5. Shah
    March 5, 2010 at 6:13 am

    I like how you analyse this subject from a practical and analytical standpoint. You should teach my friend.

  6. Peter
    March 5, 2010 at 6:16 am

    This is a very good site for more information

  7. CrisisGuru
    March 5, 2010 at 6:19 am

    Very good article my friend. I do think however that islamic banks do charge interest, they just don’t call that way. Otherwise how can they compensate their investors or depositors? That’s just my opinion.

  8. Dose28
    March 5, 2010 at 6:20 am

    great article here 😀

  9. Christina
    March 5, 2010 at 6:22 am

    thx GREAT 😀

  10. Maria Gonzalez
    March 5, 2010 at 6:26 am

    Hi Marquis,

    I wanna thank you for your precious answers to my questions and thorough analysis here. I didn’t tell you but I’m preparing for a thesis on a same subject and your explanations helped me a lot.

    Thank you,

  11. Moore
    March 5, 2010 at 6:28 am

    Great work here. Kudos………..

  12. ToolKit
    March 5, 2010 at 6:31 am

    Thanks for your article. I must add that investment banking in the muslim world is currently nil and they have to get their house in order before attempting to conquer markets outside the muslim sphere. They have a long way to go.

  13. TurkeyMan
    March 5, 2010 at 6:33 am

    awesome article 😀 😀 😀 :D:D 😀 😀 :D:D 😀 😀 😀

  14. Rars
    March 5, 2010 at 10:02 am

    one word: great

  15. Arechie
    March 5, 2010 at 10:03 am

    Kudos for writing on this Marquis.

  16. Sheman
    March 5, 2010 at 10:06 am

    It’s good to read the Kuran to understand Shariah.

  17. Robert
    March 5, 2010 at 10:07 am

    It’s true that they were less affected by the crisis than many of us but yet again they remain poor anyway.

  18. Maya
    March 5, 2010 at 10:09 am

    islamic finance must be more explained so non Muslims can understand it because it has many values that can help international finance.

  19. JobsMan
    March 5, 2010 at 10:12 am

    Thank you for this.

  20. Ricardo Juan
    March 5, 2010 at 10:35 am

    I always wanted to learn more about this topic and I’m glad you covered it finally.

  21. Rora
    March 5, 2010 at 10:36 am

    “Unissa to hold yearly Islamic finance conference
    Unissa to hold yearly Islamic finance conference

  22. Mohamed
    March 5, 2010 at 10:39 am

    Great contribution to this subject my friend. Regards, Mohamed

  23. Matinee34
    March 5, 2010 at 10:41 am

    Interesting way of analyzing islamic finance

  24. Sunday
    March 5, 2010 at 10:44 am

    Great sharing this.

  25. Howard
    March 5, 2010 at 10:45 am

    Islamic finance may be the way 2 go if we can’t accept the word “Islamic” in it …… Not that easy. 😎

  26. HolyCross
    March 5, 2010 at 10:47 am

    Great article but a bit brief for me. The author should’ve gone deeper about islamic finance in today’s world.

  27. Karl38
    March 5, 2010 at 10:48 am

    I don’t believe interest doesn’t exist in islam. How do they pay investors then?

  28. john
    March 5, 2010 at 10:50 am

    Thanks for sharing your views on this topic.

  29. Julie394
    March 5, 2010 at 10:50 am

    😀 du courage

  30. Serges
    March 5, 2010 at 10:51 am

    Merci de vos articles éclairés.

  31. Hosht
    March 5, 2010 at 10:52 am

    Great articles goin on this site

  32. Ragord
    March 6, 2010 at 7:21 am

    Thanks for ur help in explainng this opaque subject.

  33. Tirade39
    March 6, 2010 at 7:22 am

    I disagree with u that interest free is what characterized islamic banking. They do charge interest, I don’t see how else they can survive.

  34. WorldSchene
    March 6, 2010 at 7:24 am

    A lot of people in the west think that islamic banking is not going to boom. Just wait and see…

  35. Abu48
    March 6, 2010 at 7:28 am

    Thanks Marquis for building this analysis my friend

  36. Traore
    March 6, 2010 at 7:30 am

    I luv this essay u put here mate but I think u shd have gone deeper on how sharia affects islamic banking and the issues we muslim bankers are still facing. I sent u an email and we can pursue the debate.

  37. Ordera
    March 6, 2010 at 7:32 am

    Thx, great.

  38. TeamUSA
    March 6, 2010 at 7:34 am

    Mr Codjia, thank you for this analysis. I thought u were a finance professor based on the other articles I’ve read. But keep it going.

  39. Kass
    March 6, 2010 at 7:35 am

    Thanks for doing a paper on this.

  40. Sheikh
    March 6, 2010 at 7:36 am

    Wow… simply great. I just signed up to ur blog

  41. AmericaUnited
    March 6, 2010 at 7:37 am

    Thank fro ur blog. I just sent a private mail, please reply when u can.

  42. Gruppe
    March 6, 2010 at 7:39 am

    That’s where the future in banking lies. They have everything rihgt, only their house need to be put in order.

  43. Tyeps
    March 6, 2010 at 7:41 am

    got it!

  44. Coal
    March 6, 2010 at 7:42 am

    😀 😀 😀

  45. Prossib
    March 6, 2010 at 7:43 am

    Ok and good for all.

  46. Prof
    March 6, 2010 at 7:44 am

    u shd this good site about islamic finance http://ifinanceexpert.wordpress.com/

  47. Kingsshet
    March 6, 2010 at 7:45 am

    Excellent work, thanks.

  48. ifinanceexpert
    March 6, 2010 at 10:48 am

    Great article on islamic finance. Expect more. Please send me some articles in French about Islamic finance.

  49. Rafia
    March 6, 2010 at 11:20 am

    Well methinks Islamic Banking System do support Interest in the back end, but may be at some less extent as compared with the conventional banking. And they still keep the slogan of ‘Interest Free Banking’ which I think is a kind of deception, and deceiving the customers make the trade worst(as described in the video), so my pov is that why not to go for conventional banking rather than this deceiving system. After all whats the conclusion is a trade forbidden by Almighty in both cases, but deception is the worst of all strategies a trade can have!

  50. Rafia
    March 6, 2010 at 11:21 am

    Btw Great article Codija, compelled us to think in this direction..
    Thank You!

  51. Rorsa
    March 7, 2010 at 5:47 am

    Thansk Marqius for working on this for us.I wanted to invest in an islamic bank for a while and this is helping.

  52. Gakeb
    March 7, 2010 at 5:48 am

    thank u sir 😀

  53. ToiMoi
    March 7, 2010 at 5:52 am

    I don’t agree that banks always in Islam don’t charge interests. They do but they hide it in complex ways.

  54. Journey
    March 7, 2010 at 5:53 am

    Thanks very much, this is an excellent article!

  55. Shemar
    March 7, 2010 at 5:55 am

    thanks for all 😀

  56. Eyiud
    March 7, 2010 at 5:57 am

    Islamic banks are bound to grow that’s for sure and western banks will soon be surpassed. Mark my words………..

  57. Vayim
    March 7, 2010 at 5:58 am

    simply great

  58. Carlito
    March 7, 2010 at 6:00 am

    great work here. next time pls cover other issues in islamic finance.

  59. March 8, 2010 at 8:30 am

    Excellent research. I appreciate the guidance expressed.

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