Challenging banking ‘fat cats’

In the wake of the global financial crisis, Islamic finance has gathered momentum with Sharia-compliant principles, as Paul McNamara reports

The origins of the Islamic finance industry are rooted in the recent past – 1975 to be precise, with the creation of Dubai Islamic Bank in the United Arab Emirates. It was the brainchild of visionary businessman Haj Saeed Ahmed Lootah, who convinced the then emir of Dubai, Sheikh Rashid bin Saeed Al Maktoum, that a new form of finance was needed.

But it is a financial system that is deeply tied to the basic tenets of Islam, going back hundreds of years. Unlike conventional finance, Islamic finance prohibits all forms of interest, as well as investments in industries such as gambling, pork, pornography, alcohol and drugs.

“Essential concepts in Islamic finance, such as the ban on usury and speculation, are rooted in the very early days of the religion,” says Hamed Ali, acting chief executive of NASDAQ Dubai. “The belief that parties should deal with each other equitably and without exploitation was as strong then as it is now.”

According to the theory, Islamic finance would serve as a pure economic system that would see people treat each other like respected brothers rather than as gullible consumers to be exploited – a common criticism of conventional finance today.

Essential concepts in Islamic finance, such as the ban on usury and speculation, are rooted in the very early days of the religion

Estimates vary on its true size. A recent report by Ernst & Young suggests that growth of Islamic financial holdings will slow in 2013 to 11 per cent or $1.8 trillion. That is down from an average annual growth of 19 per cent over the past four years. Still, supporters believe that the financial crisis highlighted the failings of the conventional system, leading to more interest in Islamic finance.

From its early days in Dubai, the Islamic retail banking industry grew slowly throughout the Gulf Co-operation Council states and parts of North Africa. It emerged in other Muslim-majority countries, including Malaysia, Indonesia, Brunei and Pakistan. Islamic retail finance offerings can now be found in most countries, even China, North America and the UK.

As Islamic retail finance grew, so did Islamic investment, or wholesale, banking, with Bahrain serving as a hub. The twin body blows of the global financial crisis and the Arab Spring, however, forced a re-evaluation of the previous business model, which relied heavily on real estate or property as an asset class. The private equity model also took a beating as the cost of borrowing rose in the face of spiraling global risk profiles and debt defaults.

It is in the sphere of Islamic investment banking that the UK has had greatest success in asserting itself as a serious contender for the crown of leading Islamic finance centre of the world. Bank of London and the Middle East jostles with Gatehouse Bank; QIB UK survives alongside European Islamic Investment Bank. And many global investment banks, such as Deutsche Bank, Goldman Sachs and Standard Chartered have dabbled in Sharia-compliant business.

The retail Islamic banking scene in the UK, however, continues to look thin ever since HSBC Amanah, the Sharia-compliant arm of HSBC, withdrew its retail offering from the UK and several other international markets in October 2012. This leaves only the Islamic Bank of Britain (IBB) to service the roughly 2.7 million Muslims living in Britain.

IBB reported a loss of £8.99 million for 2011, the last year for which figures are available, which followed a £8.1-million deficit in 2010 and a loss of £9.5 million in 2009. Indeed the bank, launched in 2004, has yet to close a year in profit.

London recently launched a campaign to promote itself as an international hub for Islamic finance. But it faces significant global challengers. Malaysia dominates the global Islamic bond, or sukuk, market and NASDAQ Dubai has avowed its aim of becoming the global platform for the trading of Islamic securities.

Elsewhere in the world, Islamic finance is putting down new, stronger and deeper roots in places as far flung as Azerbaijan, Kazakhstan, Nigeria and South Africa, as well as less predictable jurisdictions such as Australia and Japan.

The fillip the industry hoped for, as investors and savers in the West showed an increasing dislike of conventional banking “fat cats”, has not yet materialised, but nevertheless it has grown apace.