The growth of Islamic banking

Africasia:Islamic banking is steadily moving into the mainstream of conventional financial systems and has remained largely insulated from the global credit crisis.

It is expanding not only in the Muslim world, but also in other countries where Muslims are a minority, notably Britain, France, the US and even Japan. The industry has grown at a prodigious rate of 15-20% annually over the past decade; a trend that is likely to continue as the economic and construction boom in the Middle East and Asia regions will boost the value of Shariah assets.

There are now over 300 Islamic financial institutions (IFIs) spread over 75 countries and 300 Shariah-complaint mutual funds, whereas, just one Egyptian-based Islamic bank existed in 1975.

Currently, about $800bn is deposited in Islamic banks, mutual funds, insurance schemes and Islamic branches (windows) of conventional banks. By contrast, the market was valued at only $140bn in 2000. McKinsey & Co, the business consultants, estimates Islamic financial assets could reach $1 trillion by 2010.

Moody’s Investors Service, the ratings agency, is very bullish, predicting that a relatively young industry could boast worldwide assets of $4 trillion within five years. It notes: “Oil is creating liquidity and wealth through profits for companies and salaries for individuals. This finds its way through to the banks, whether it is in Shariah-compliant personal loans or from investors wanting to buy Sukuk bonds. A booming and profitable market attracts entrants because excess demand needs to meet additional supply.”

The US led sub-prime fiasco that wiped billions off balance sheets of western giants, or worse, the liquidation of Lehman Brothers, the fourth-largest US investment bank, underpins the benefits of Shariah law, which bans the trading of ‘toxic’ debt contracts and profit-sharing or leasing without underlying tangible assets. Those fashionable investment bandwagons, such as Collateralised Debt Obligations (CDOs), Asset-backed Securities Index - an index of credit default swaps referencing 20 bonds collateralised by sub-prime mortgages.

Leveraged bank loans (rated below investment grade) and Swaptions (options on interest rate swaps) are strictly forbidden, while lending must be prudent and linked to real economic activity. Thus, Islamic businesses offer a safety net against dubious or junk structured securities, which have triggered market turmoil since late 2007.

Of all the rapidly growing Shariah-compliant products none are gaining in popularity as much as Sukuk. The market for Islamic bonds has swelled in the past six years. According to the Islamic Finance Information Service (IFIS), over $43bn of Sukuks were issued in 177 deals last year. That total compares with $27.39bn in 2006 and $5.71bn in 2003. The bulk of Shariah securities originated in Asia (specifically Malaysia) and the Gulf Cooperation Council (GCC) states.