FEATURE: Islamic banking - growth and prospects

The Islamic banking industry is now worth almost an estimated $US1 trillion and is widely considered to be one of the fastest growing sectors in the world of finance. Even in the midst of a global economic crisis, Islamic banks have weathered the storm to great effect, thanks to strict regulations administered by Islamic law, or Sharia. Industry experts highlighted the growth of an emerging force in global finance during the Asialink Islamic Banking Colloquium held recently in Melbourne.

Girish Sawlani

Last Updated: Thu, 8 Jan 2009 15:49:00 +1100

Imagine a bank that embarks in partnership and shares risk with customers - a bank that does not charge interest, and uses capital derived from deposits and profits to engage in ethical investment such as education and infrastructure development.

It may sound Utopian, but these are just some aspects of Islamic banking, founded on the principles of Islamic law or Sharia.

What is more peculiar, though not surprising, is that during a time when the world's largest banks and financial institutions, have either collapsed or in need of multi-billion dollar government funded bailouts, Islamic financial institutions are holding their ground well, although not completely immune to today's crisis.

Despite this, the Islamic banking industry is expecting growth rates of 15 per cent annually.

Economist, bankers and academics were on hand to foreshadow the state of Islamic banking in a global context, during the recent Asialink Islamic Banking Colloquium in Melbourne - and the outlook is a positive one.

"The rising demand for Sharia compliant investments form an estimated 1.6 billion Muslims worldwide and Islamic assets are set to hit $US1.4 trillion by 2010," said lawyer, Mohamed Ridza, a leading consultant on Islamic finance in Malaysia and managing partner of Mohamed Ridza & Co.

"And it is projected that the Islamic financial system will soon be managing approximately 4 per cent of the world's economy."

One of the key tenets of Islamic banking is its profit and sharing scheme or Mudarabah, where the banks go into partnership with entrepreneurs, and in doing so, shares their risk, prompting banks to make serious considerations before providing funds to the investor.

The other is the cost plus scheme known as Murabaha where banks purchase assets desired by customers and sell it to them via instalments at an agreed sum, thus adhering to Sharia principles banning the provision of interest.

The chair of banking at Monash University and a director at the Asia Pacific Finance Centre, Professor Michael Skully, explains these and other aspects have so far sheltered Islamic banks from the crisis face by institutions in Europe and the US.

"When you see some of the predatory lending that was done by US financial institutions, particularly in the subprime area, that's something you wouldn't anticipate an Islamic bank doing," he said.

"They're probably more involved with their customer and there could be some protection there as well."

The responsibility of banks in taking calculated risks and investments is governed by Islamic administrators known as Sharia boards.

Islamic banks not only have to comply with the economic reality and the financial reality but it also has to ensure that it matches the religious reality.

Therefore, Islamic institutions are much more careful in what they're investing in.

It through such guidelines that Islamic financial institutions continue to provide funding for development and infrastructure.

In the gulf, the Islamic development bank for example, does a lot of work in helping out communities by helping build water reservoirs and so forth," said Hussain Gulzar Rammal, a researcher on Islamic finance from the University of Adelaide.

"The principle there is to help the communities rather than making large profits."

And it's these ethical investments that could be the drawcard for non-Muslims to engage in Islamic banking.

I think that would be for non-Muslims who are interested in various forms of ethical investment," said Professor Abdullah Saeed, chair of Islamic studies at Melbourne University and the author of Islamic Banking and Interest.

"In particular Islamic understanding of ethical investment can also be attractive to people who are interested in where their money is invested in."

With Islamic banks holding steady in these gloomy times, institutions are looking to expand beyond the Gulf and into the Asia Pacific region, including Australia.

Much of the estimated $1 trillion within the Islamic financial sector is tied to the big boys in Gulf states and dominated by companies such as Saudi Arabia's Al Rajhi bank and the Kuwait Finance House.

The presence of Western developed nations, however, is almost negligible in terms of assets associated with Islamic financial institutions.

But there is potential for growth beyond the Gulf.

Since August, there has been a lot of questions asked, where people are saying, "Is there an alternative, not just for Muslims but also for non-Muslims?" said Adelaide University's Hussain Gulzar Rammal.

"It is growing in the UK, it is certainly growing in the US, as well, and there's hope that it will be setting a pattern for ethical investment for other corporations."

In fact, some of the world's biggest international banks have already begun ventures into Islamic finance, engaging in Sharia-compliant bonds known as 'Sukuk'.

"You've got all these international banks operating in many Muslim jurisdictions," said lawyer Mohamed Ridza.

"They're already getting themselves subscribed to bonds, subscribing to syndicated financing.

"HSBC has set up a subsidiary unit, a unit by itself, HSBC Amanah, which engages strictly on Islamic finance.

"Standard Chartered is also going into Saadiq, which is the Islamic unit subsidiary."

In the Asia-Pacific region Malaysia has been leading the way in Islamic banking, with many of its banks such as Bank Negara Malaysia and the RBH Group offering products and services that are compliant with Islamic law.

Mohamed Ridza attributes the exponential growth of Islamic banking in Malaysia to the swift establishment of a regulatory framework.

"Back in 1983, Malaysia started this journey to Islamic banking by actually enacting a specific Islamic banking act," he said.

"Subsequently, there were many other Islamic banks, which came up and after that Malaysia took another step ahead by getting involved into the Islamic bonds market."

Following Malaysia's success, he says other South-East Asian nations are now recognising the potential of Islamic banking.

"They've [Brunei] started to produce their first Sukuk, and it was a joint venture of Shell and Brunei Government, so even Shell is opening up to the concept of Islamic Sukuk.

"Indonesia has started already; they've already got a new law on the Sukuk, so Indonesia is good.

"Singapore - they are fast catching up, they see that there is a value there, so they've done some legislative amendments to ensure they are moving up."

Meanwhile, Australia is making small inroads into this fast-growing sector in global finance, with the world's second-largest Islamic financial institution - Kuwait Finance House - setting up a base in Melbourne.

But there is much ambivalence about Islamic banking down under, and this will be one of the industry's biggest challenges.

However, with a growing Muslim population, Australia could become a major centre for Islamic banking and finance. Professor Michael Skully is the chair of banking at Monash University.

"They can see that it's been used very successfully in some countries, and I think it would certainly have some market potential in this country," said Professor Michael Skully from Monash University.

"We do have quite a number of Muslims and I think - it's certainly a business proposition to consider for Australian bank and foreign banks perhaps, wishing to establish here."

Indeed, the major drawcard for Gulf-based Islamic banks is that Australia possesses real assets in the form of resource commodities.

Islamic law legislates transactions can only involve real assets, as opposed to a series of repackaged loans.

Professor Michael Skully, however, says much needs to be done to establish a regulatory framework for Islamic banking to form part of Australia's financial sector.

"At the federal government level, we need some positions, in terms of the licensing and prudential regulation of these Islamic financial institutions," he said.

"In the case of banks, would be by APRA and to a lesser extent by ASIC, and then we would also need to have a look at the issue of consumer protection legislation, in terms of lending."

The Australian government, however, is now taking over the consumer-credit legislation from the states - and this could be an opportunity for the government to ensure that Islamic financing services are available to working families - Muslim and non-Muslim.

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