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26 September 2011

Islamic finance: Niche market defies its critics, gaining in depth and sophistication

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By Robin Wigglesworth

Islamic banking has faced a series of squalls over the past few years, both financial and philosophical, but has kept on growing, defying many critics and even surprising some adherents.

The industry may have sidestepped the main brunt of the financial crisis, thanks to prohibitions against interest that precluded investments in the complex credit derivatives that felled many conventional banks. Nonetheless, it still felt the pain of the resulting downturn.

Several sharia-compliant investment companies tottered. Islamic bonds defaulted for the first time. And many Islamic banks were hammered by losses on real estate loans and investments.

Coupled with political unrest in the Arab world – particularly in Bahrain, the regional hub for Islamic finance – it could have been a perfect storm for a young and vulnerable industry.

Yet overall, Islamic finance has continued to expand, both in absolute terms and relative to conventional banking. Many experts estimate that it has comfortably surpassed the symbolic $1,000bn of assets mark.

“Despite all the turmoil we’ve seen in the Arab world, this has been a good year,” says Razi Fakih, deputy chief executive of HSBC Amanah, the British bank’s Islamic arm. “Driven by customer demand, retail and commercial Islamic banking continues to make inroads into the conventional space,” he says.

“Many individual Islamic finance companies experienced a difficult time, and continue to do so but, overall, the industry has fared better than many people expected.”

The growth has been most pronounced in traditional strongholds such as Malaysia and the Gulf, but advances have also been made into western markets. Companies such as Nomura and General Electric have issued Islamic bonds, or sukuk, and Islamic banks have sprung up in the US, Europe and Asia.

“The statistics vary, but the industry is definitely growing,” says Humphrey Percy, chief executive of UK-based Bank of London and the Middle East, a sharia-compliant institution backed by Kuwaiti investors.

Even Islamic debt markets have continued to grow, despite the still-uncertain outcome of restructuring of several prominent sukuk, such as one issued by The Investment Dar, a Kuwaiti house that owns part of Aston Martin, and one sold by Maan al Sanea, the Saudi billionaire.

The global volume of Islamic bond sales reached $15.3bn through 60 deals by the end of August 2011, the highest total over that period since 2007, and up 52 per cent on the $10bn raised over the same period last year. Malaysian issuers have accounted for three-quarters of Islamic bonds in 2011, but several big Gulf-based entities have also tapped the market this year – including the Islamic Development Bank in Saudi Arabia and HSBC Middle East.

In addition to growing in size, Islamic finance has also grown in depth and sophistication. In the past, it has largely been a commercial banking phenomenon. But it now spans retail banking – including sharia-compliant credit cards, car loans and insurance – to investment products and services.

“Islamic finance has come out of the corner over the past few years. It started with bank lending, and has now even crept into derivatives,” says Tobias Muller-Deku, partner at Freshfields Bruckhaus Deringer, the law firm.

However, not everyone is enthusiastic. Some experts say growth has come at the expense of Muslim jurisprudence and principles. In 2008, Sheikh Taqi Usmani, arguably Islamic finance’s leading scholar, argued that some sukuk structures were too lenient, which severely rattled Islamic debt issuance for several years. In 2009, the International Islamic Fiqh Academy, a body of clerics tied to the Organisation of the Islamic Conference, ruled that a common Islamic banking instrument was prohibited.

Critics outside the industry can sometimes be sharper – even those who are sympathetic. In his book The Crisis of Islamic Civilisation, Ali Allawi, an academic and former minister of defence in Iraq, lambasted the “artful delusion” of Islamic banking, accusing it of relying “on acquiescent boards and elaborate artifices that appear to meet the outer forms of the sharia, with no regard for its inner meaning and purpose”.

In many respects, Islamic banking – at least in the Middle East – seems undecided whether to go down a more lenient, but practical route where some compromises with conventional finance are made; or to pursue a stricter path, most likely at the expense of growth.

Malaysia has pursued a pragmatic approach, and enjoys an industry far more vibrant than that of the Middle East. Yet many view the Malaysian approach as too liberal.

“It’s a debate the Muslim world needs to have,” says one expert. “At the moment you can almost finance a pork belly factory as long as you don’t have overt interest.”

(Courtesy: Financial Times)

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