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Banking on Islamic Banks

September 6, 2012

Islamic finance is an ancient concept, but it has only recently developed into a modern day institution.  Adhering  to the Muslim religious law of Sharia, it has prohibitions against charging interest and investing in morally dubious industries, such as alcohol, gambling, and pornography; furthermore all lending is based on profit-sharing.

Under Shariah, hoarding is frowned upon, so savings earn no return unless put to productive use. Rasheed Mohammed al-Maraj, governor of the central bank in Bahrain explains that “money cannot generate money – money should be used for creating better value in the country or the economy.” For some Muslims, conventional mortgages are regarded as sinful; under Shariah both the lender and the borrower share the risk of the investment.  The Islamic home mortgage functions by adding what would have been the monthly interest into the purchase price of a home. Most commonly, the bank actually buys the house at a qualified customer’s direction, and then sells it to that customer through monthly installments modeled on the payments of a 30-year mortgage. If the borrower loses his job and defaults on the payments, under Sharia it is very difficult for the family to be thrown out of their home, as that would be seen as a creditor exploiting a debtor. For any transaction, borrowers must possess underlying assets, an idea primarily driven by the rationale in Islamic law that borrowers do not over-borrow.  Under Islamic finance, the lender is also an investor, so he remains an active participant through the life of the transaction and is in a position to rectify mistakes before any situation occurs.

As of 2011, the global market for Islamic finance is estimated at USD $1.3 trillion, with the total value of Sharia-compliant assets having grown by 150% since 2006.  Globally, Islamic bond issuance in the first quarter of this year was $43.3 billion, almost half the total for the whole of 2011.  

This rapid growth for Islamic finance is not confined to the Muslim world or Muslims. In 2005, the World Bank became the first non-Islamic entity to issue Shariah compliant bonds with a $200 million deal. Since then, an increasing number of international borrowers have followed suit including Nomura Holdings in Japan who, in 2010 issued $100 million in Malaysian bonds. In the U.K., the then Chancellor of the Exchequer, Gordon Brown called for the U.K. to become a gateway for Islamic trade and finance. Furthermore, giant Western conventional banks such as Goldman Sachs, HSBC, and Citigroup all offer Islamic banking and financing options.  Increasingly more individuals are attracted to Islamic financing, not for any religious reasons but simply because if offers the “best deal.” In 2007, at one Islamic bank in Mayalsia, 40% of its depositors and 60% of its borrowers were non-Muslims. In light of the recent housing market troubles, the IMF has written about the potential of Islamic mortgages reducing the financial stability risks associated with conventional mortgages. The advantages Islamic finance products include the greater transparency and accountability from company management, so that it would be more obvious when companies are getting into debt problems.

HSBC Amanah is the global Islamic financial services division of the HSBC Group.

Despite the rapid growth and seeming advantages over conventional Western finance, Islamic finance has not been without controversy.  One of the principal criticisms is aimed at the process of verification for Shariah compliance: every bank, insurance company, or investment firm must have a Shariah scholar, whom they pay, give each product a Fatwa, a seal of approval confirming Shariah compliance. Because these scholars are not always in agreement, cases erupt where a product is declared as Sharia compliant in one market and not in another.  This is especially the case with Malaysian products, which are often deemed not Sharia compliant in the more austere Gulf states.  There have even been reports of “Fatwa shopping” where if a Sharia scholar does not give approval for a product, the bank simply calls another scholar, and another scholar until receiving compliance. Recently, Sheikh Muhammmad Taqi Usmani, the “granddaddy of modern-day Islamic finance” declared that 85% of Islamic bonds were un-Islamic.  leading critics to argue that essentially “ banking is banking” no matter what form is takes.

Whether it is religion, pragmatism, ethics, or expedience, whatever the reasons for engaging or supporting Islamic banking and finance as an alternative to the conventional system can only serve to strengthen the future of the financial system as a whole.

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