From the simple rules of nature

Islamic banking began as a theological dream, but today it has become a practical reality across the Middle East.

The big question now is how far will Sharia boards and Western regulators let it spread?
The success of Islamic banking and financial institutions rests in part with the fact that both the US and the UK have large Muslim communities in which Islamic banking has a unique appeal.
A survey shows that 30 per cent of the over seven million American Muslims want to adhere to strict Islamic principles when dealing with their finances.
In the UK, experts say the Muslim population of some two million includes over 160,000 high net worth potential banking and financial services clients.
Although these numbers are small compared with the populations in the Arab world, they might have a significant impact on trends in Arab overseas investment and even the very nature of how Western money centres run.
Since the establishment in 1975 of the Dubai Islamic Bank, the first Islamic bank, more than 300 Sharia-compliant banks have been set up with a spread of 25,000 branches worldwide.
Currently, Islamic banks and financial institutions worldwide hold $300 billion in assets that are predicted to grow to $1 trillion by 2013.
Bahrain has emerged as the world’s Islamic financial capital, with 27 Islamic banks, five key industry-support organisations and 16 Islamic insurance (Takaful) companies. Total assets of Islamic banks stood at $10.2 billion at August-end 2006.
Also, Bahrain is home to some prominent organisations: the Accounting & Auditing Organisation for Islamic Financial Institutions, the International Islamic Financial Market, the Liquidity Management Centre and the Islamic International Rating Agency.
For both religious and financial reasons, Islamic banking remains a field with great, unrealised potential. A case in point is: GCC member governments have invested almost $1 trillion abroad; individuals from those countries hold another $500 billion in overseas portfolios. Most of those funds are in conventional Western-style investment vehicles.
According to the World Bank, 90 per cent of those funds have flowed to the US and the European Union.
If Islamic principles governed as little as 5 per cent of those funds, it could revolutionise western financial markets.
Personal wealth in the Middle East is expected to increase to $1.8 trillion by 2010 from $1.2 trillion in 2005, says a report by Merrill Lynch and Capgemini Group.
The region’s high-net-worth individuals increased to 300,000 – or 9.8 per cent – between 2004 and 2005.
The rapid growth of the Islamic market from its humble roots in the early 1970s into a several-billion-dollar niche industry has been unprecedented in modern financial history. Its growing popularity stems from the simple rules of nature propagated by Islam.
The basic principle in the Sharia is that exploitative contracts based on riba (interest or usury), and gharar (speculation) are unenforceable.
Islamic doctrine says profit is morally acceptable if an investment yields economic/social “added-value”. Direct correlation between investment and profit remains the main difference between Islamic and conventional banks.
In Western banking, earnings/returns to shareholders are the sole criterion of success. Islamic banks, however, seek to preserve a greater balance between the interests of investors, shareholders, users and society.
In some Middle East markets, especially in the Gulf, surveys show upwards of 50 per cent of the consumer population favouring an Islamic banking option.
Despite its potential, Islamic banking has had a bumpy ride.
After early success in the 1980s, fuelled in large part by soaring oil revenues in the Gulf, Islamic banking suffered several setbacks.
There were a series of failed or discredited attempts in Egypt, Iran, Sudan and Pakistan. Several Islamic financial institutions went bust after dangerously leveraging their funds (violating a basic Islamic financial tenet to avoid excessive risk). Moreover, the surviving Islamic banks were often unable to offer competitive and consumer-friendly financial products.
This challenge prompted Islamic bankers and scholars to develop new product menus, and to reach out to a broader client base.
Among the innovations have been the development of fixed-return instruments, Islamic bonds (sukuk), and the creation of a global Islamic money market.
Assets of Islamic banks rose by an average of 24 per cent a year over the last decade and are at least expected to maintain this growth in the next few years.
Growth quickened after the September 11 2001 attacks on the US. There used to be banks with $40-70 million capital each; now we hear of $1 billion and more. Islamic banking has proved the ideal model for the needs of Islamic societies.
Governments and central banks have taken the lead in supervising Islamic banks and encouraging growth of the system.
However, McKinsey says in a report that the lack of standards inhibits the development of the international Islamic banking markets and results in an industry that is little more than a collection of national strongholds.
Islamic banking works by sharing profit or loss between the bank and its clients, instead of interest.
Under the system, the bank works closely with clients on financing, such as jointly setting up projects with the aim of selling them to third parties.
Islamic finance has already made progress in US real estate circles. Both Freddie Mac and Fannie Mae—popular names of two leading government-underwritten housing finance agencies—have purchased Islamic housing financial instruments.
However, for most proposed Islamic operations the regulatory hurdles are still daunting. Anwar Khalifa Alsada, deputy governor of the Bahrain Central Bank, says Islamic banks should be separately regulated.
Ironically, the challenge posed by American markets may help spur the development of new products and services that would make Islamic banking more mature and a useful and competitive alternative.

Talking Business with
K S Sreekumar
sreekumar@tradearabia.net