Islamic finance rises on ruins of conventional banks amid turmoil

Gulf Times:The Islamic finance industry, which refers to the banking activity conducted in accordance with the principles of Shariah (Islamic law), gained the limelight over the past two months during the global financial turmoil as one of the relatively safe havens for investments.

Executives of Islamic banks and financial institutions have been arguing from the very beginning of the crisis that their businesses were relatively immune to the repercussions of the world financial turmoil because Islamic financial products were different from those inherent in the conventional banking system.
Islamic equities also turned out to be the least affected in the meltdown that swept global as well as Arab stock markets.

As a matter of principle, Islamic teachings reject taking interest on money loaned or deposited at banks and consider it as “reba” (usury).
“There is no information so far indicating that any of the Islamic financial institutions has been exposed to the fallout of the world financial crisis,” former governor of the Central Bank of Jordan, Mohamed Nabulsi, told Deutsche Presse-Agentur DPA.

“However we believe that any Islamic financial institution will not be completely immune to the spillovers of the turmoil, because Islamic banks usually do have money deposited at foreign banks. “At the same time, Islamic finances enjoy a type of immunity because they operate under strict legal restrictions and consequently barred from dealing with the conventional credit tools such as the real estate mortgage instruments,” he added, referring to the factors which sparked the financial crisis in the US.

Nabulsi believed that several banking and other business institutions throughout the world could now be interested in exploiting these characteristics of the Islamic banking system particularly in their operations in Arab and Islamic countries.
“However, the credit crunch which currently grips the world financial system could limit the opportunities provided by Islamic institutions,” he said.
The Islamic finance system recorded a rapid growth over the past decade that has been fueled not only by surging demand for Shariah-compliant products from Muslim financiers but also by investors around the world, who have been moved by the system’s profitable prospects.

According to reliable sources in the Islamic financial industry, there are currently over $800bn worth of deposits and investments lodged in Islamic banks, mutual funds and insurance schemes known as “takaful,” more than five times the volume compared with $150bn in the mid-1990s.

Islamic financial institutions are reportedly expanding their balance sheets as demand continues to grow in Europe for financial products that avoid paying interest, in line with strict religious rules.
These products instead pay profits from an underlying business or rent from a building used as collateral to raise money.

The expansion of Islamic finances rests on a lack of exposure to toxic assets and derivatives, often related to mortgages that prompted the collapses in the US and elsewhere in October.
“This is why we believe that Islamic banks are so far immune to the offshoots of the global financial crisis because they are run in accordance with Shariah principles,” said Saleh Kamel, president of the General Council for Islamic Banks and Financial Institutions.

However the Saudi tycoon, who also chairs the Dallah al Baraka Group, did not rule out Islamic banks coming under pressure in future “if the crisis unfolds further to create currency and central bank problems.”
Adnan Yousuf, chairman of the Arab Banks Federation, shared this viewpoint saying the impact of the world financial crisis on Islamic banks had been “minimal” due to the nature of their operations.

“This is mainly because Islamic banks are not involved in debt buying and most of their operations are inside the Arab world,” he said.
Besides its wide geographical scope, the expansion of the Islamic finance has been also taking place across the whole spectrum of financial activities, ranging from retail banking to insurance and capital market instruments.

The most striking phase could be the growth of sukuk, the most popular form of securitised credit finance within Islamic finance. Sukuk commoditise capital gains from bilateral risk sharing between borrowers and lenders in shariah-oriented finance contracts into marketable securities without interest rate charges.
The rise of the sukuk market as an alternative investment activity, is attracting the attention of an increasing number of private sector and official circles across the globe including the British government which is reportedly mulling to become the first Western government to buy this kind of Islamic bond.

According to a new study by the International Financial Services London (IFSL), an independent organisation representing Britain’s financial services industry, Islamic finance will emerge largely “unscathed” from the current world crisis.
It attributed its findings mainly to the fact that Islamic financial institutions make little use of many of the complicated instruments blamed for the current problems in conventional banks such derivatives and short-selling.