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