Islamic Banking: Steady in
Shaky Times
Principles Based on Religious Law Insulate Industry From Worst of Financial
Crisis
By Faiza Saleh Ambah
Washington Post Foreign Service
Friday, October 31, 2008; A16
JIDDAH, Saudi Arabia -- As big Western financial institutions have teetered
one after the other in the crisis of recent weeks, another financial sector is
gaining new confidence: Islamic banking.
Proponents of the ancient practice, which looks to sharia law for guidance
and bans interest and trading in debt, have been promoting Islamic finance as a
cure for the global financial meltdown.
This week, Kuwait's commerce minister, Ahmad Baqer, was quoted as saying
that the global crisis will prompt more countries to use Islamic principles in
running their economies. U.S. Deputy Treasury Secretary Robert M. Kimmet,
visiting Jiddah, said experts at his agency have been learning the features of
Islamic banking.
Though the trillion-dollar Islamic banking industry faces challenges with
the slump in real estate and stock prices, advocates say the system has
built-in protection from the kind of runaway collapse that has afflicted so
many institutions. For one thing, the use of financial instruments such as
derivatives, blamed for the downfall of banking, insurance and investment
giants, is banned. So is excessive risk-taking.
"The beauty of Islamic banking and the reason it can be used as a
replacement for the current market is that you only promise what you own.
Islamic banks are not protected if the economy goes down -- they suffer -- but
you don't lose your shirt," said Majed al-Refaie, who heads Bahrain-based
Unicorn Investment Bank.
The theological underpinning of Islamic banking is scripture that declares
that collection of interest is a form of usury, which is banned in Islam. In
the modern world, that translates into an attitude toward money that is
different from that found in the West: Money cannot just sit and generate more
money. To grow, it must be invested in productive enterprises.
"In Islamic finance you cannot make money out of thin air," said
Amr al-Faisal, a board member of Dar al-Mal al-Islami, a holding company that
owns several Islamic banks and financial institutions. "Our dealings have
to be tied to actual economic activity, like an asset or a service. You cannot
make money off of money. You have to have a building that was actually
purchased, a service actually rendered, or a good that was actually sold."
In the Western world, bankers designing investment instruments have to
satisfy government regulators. In Islamic banking, there is another group to
please -- religious regulators called a sharia board. Finance lawyers work
closely with Islamic finance scholars, who study and review a product before
issuing a fatwa, or ruling, on its compliance with sharia law.
Islamic bankers describe depositors as akin to partners -- their money is
invested, and they share in the profits or, theoretically, the losses that
result. (In interviews, bankers couldn't recall a case in which depositors
actually lost money; this shows that banks put such funds only in very low-risk
investments, they said.)
Rather than lend money to a home buyer and collect interest on it, an
Islamic bank buys the property and then leases it to the buyer for the duration
of the loan. The client pays a set amount each month to the bank, then at the
end obtains full ownership. The payments are structured to include the cost of
the house, plus a predetermined profit margin for the bank.
Sharia-compliant institutions also cannot invest in alcohol, pornography,
weapons, gambling, tobacco or pork.
Computer engineer Tarek al-Bassam said the crisis made him glad that he had
chosen an Islamic bank to take his money. His Islamic savings account has made
about 4 percent profit, he said. "Usually it's a very low risk or a very
low gain. But I'm happy with it," Bassam said.
He has also borrowed from an Islamic bank, to buy a building. Even if he's
late in his payments, he said, he will not have to pay cumulative interest or a
larger sum than the one agreed upon. But he notes that under this system, it
can be harder to get a loan than from a conventional bank. Islamic banks have
stricter lending rules and require that their borrowers provide more collateral
and have higher income.
Islamic banking has grown by about 15 percent a year since its modern
inception in the 1970s, fueled by the Middle East oil boom of that decade.
"There was a lot of hostility when we first started out. We were regarded
with suspicion, especially by the regulatory authorities. We were an odd fish.
Authorities only acquiesced when they saw the huge demand," said Dar
al-Mal al-Islami's Faisal, who has been in Islamic finance since the late
1970s.
Islamic finance now accounts for about 1 percent of the global market,
according to Majid Dawood, chief executive of Yasaar, a Dubai-based sharia
financing consultancy. "We had expected to be at 12 percent of the global
market by 2025, but now with this financial crisis, we expect to get there much
faster," he said in a telephone interview from New York, where he was
speaking at a conference on Islamic banking.
Growth in Islamic banking picked up even before the current financial
crisis, mainly because of strong client demand for safe, religiously acceptable
investments and a recent explosion in new and innovative financial instruments,
said Jane Kinninmont, an analyst at the Economist
Intelligence Unit, a research and advisory company.
Islamic banks now offer credit cards in which the full balance must be paid
off at month's end. They have devised a kind of commercial paper known as
sukuk, which generates a predetermined return that is called a profit, not
interest. It is tied to a specific asset and conveys ownership of it. A sukuk
might be issued by a government or a company that is building a hospital or a
bridge, for example.
Work in Islamic banking by the King & Spalding law firm has grown
roughly 40-fold in the past four years, according to Jawad Ali, a Dubai-based
partner at the firm. The firm has 35 lawyers "who do nothing but structure
sharia-compliant investment and financing on a daily basis," he said.
Islamic finance first sparked interest in the United States in the late
1990s. The Dow Jones Islamic Index was established in 1999, and the Dow Jones
Islamic Fund, which invests in sharia-compliant companies, the following year.
But interest cooled after some Islamic banks were accused of financing
terrorism in a lawsuit filed by family members of Sept. 11, 2001, victims, and
a lot of Persian
Gulf money left the United States for Europe.
In 2004, the German state of Saxony-Anhalt issued a 100 million-euro
sovereign Islamic bond. That same year, the first Islamic bank opened in
Britain, which now has six Islamic financial institutions, including a retail
bank.
Although the biggest Islamic banks are in the Persian Gulf -- Dubai Islamic
Bank, Kuwait Finance House and Saudi Arabia's al-Rajhi Bank -- Malaysia and
London are growing as major centers of Islamic banking as well.
Islamic institutions are not immune to ills plaguing other banks, such as
corruption charges and bad investments. Differences of interpretation between
sharia scholars about what is permissible and what isn't also create confusion.
The sukuk market, which had doubled each year since 2004, growing to a total of
about $90 billion in bonds issued, fell 50 percent this year after a
Bahrain-based group of Islamic scholars decreed that most of the bonds were not
compatible with sharia law.
But as banks turn borrowers away in these times of economic turmoil, Islamic
institutions continue to close deals in Europe, the Gulf and the United States,
bankers said. "Banks feel safer and more comfortable with us because we
put down more money, more equity. We are not allowed to borrow with very little
down," said Tariq Malhance, a former chief financial officer for the city
of Chicago who now heads Unicorn Investment Bank's U.S. office.
And those who have been in Islamic banking for a long time now feel
vindicated.
"The current financial collapse is an opportunity. The ugly side of Wall
Street is exposed; it's always been there but covered by a layer of glamour
that is now stripped away," Faisal said. "We are more conservative
and sober in our investments. That used to be considered a handicap. Now it's
considered the height of wisdom."