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Thursday, 21 April 2011

A new dawn for Islamic finance?

There is one advantage to Islamic finance that other banking niches can’t quite claim. 

“Islamic finance is the completion of a person’s identity,” said Fares Mourad, head of Islamic banking at Bank Sarasin. “A Muslim client may feel the need to have financial transactions permissible by Islamic law, if everything else in life follows the Islamic way.” 

Islamic banking provides products and services that comply with Islamic, or Sharia, law. Broadly, Islamic finance tries to include concepts of social benefits of the individual and the overall wellbeing of society into banking and financial transactions.

At the crux of the Islamic model is the tenet that banks operate with no interest. They are not allowed to charge interest on loans.

Sharia law also prohibits Islamic banking clients from investing money in products or businesses considered to pose financial risk that, according to Islamic law, is equivalent to gambling.

To set the scene, it is best to compare Sharia banking to conventional interest-based banking. If a client wants to borrow $20,000 from a conventional bank for a car loan, for example, he or she will pay back $20,000 for the cost of the car, plus about $500 in interest. In the Sharia system, which disallows interest, the bank will buy the car for $20,000 but will sell it to the client for $20,500.

The difference in ownership and payment, which involves the Islamic bank purchasing the car outright, complies with Sharia law. It also sets up Islamic banking as mostly an asset-based system instead of one that’s cash-transaction based.

Regardless of the global economic downturn, the Islamic finance sector has shown increasing growth in past years, about 20 percent each year in recent years, according to audit firm Ernst & Young.

But Ernst & Young warns that Islamic financial firms are at a crossroads. The firm said that Islamic institutions currently tap a small fragment of investment opportunities and asset classes.

Unlike conventional banks, Islamic banks have not diversified their investments on a grander scale, which could be one of the paths that lead to greater growth, the firm said.

Mr. Mourad said that the industry needs to branch out its investment focus, reducing its reliance on real estate investment, a popular business for Islamic banks. 

“Right now there is a heavy focus on real estate,” he said. “Islamic institutions should seek diversity–they could look at alternative energy products, for instance, to finance further investments.” 

Ayman Khaleq, a partner at US law firm Vinson & Elkins in Dubai, agreed. But, he added, their relatively small balance sheets compared to larger conventional banks makes it difficult for Islamic institutions to fund big infrastructure projects.

Earlier studies from Ernst & Young suggest that the new areas for potential growth in the $1 trillion Islamic finance industry could be the takaful, or insurance, and waqf, or Islamic endowments.

Mr. Mourad said that he has seen impressive growth in the takaful industry. Ernst & Young’s World Takaful Report estimated this sector is expected to grow from an estimated $9 billion in 2009 to $25 billion by 2015. 

While challenges remain, he added, the general outlook for Islamic finance looks bright. 

Hussain Al Qemzi, chief executive officer of Noor Islamic Bank, said in an interview that the Sharia finance and investments sector is gradually building popularity around the globe. 

(Al Arabiya/20Apr2011)

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