Islamic Banks: Prospects And Challenges In The Post Credit Crunch Era
‘Islamic banks have withstood the recent turmoil in the global banking industry triggered by the subprime mortgage crisis because their rules do not allow dealings in products like derivatives, options or papers that caused the meltdown.’
At least that’s what I keep reading in the media. And it’s a fair point. If the credit crunch was essentially caused by gambling and inadequate regulation, then surely a system in which gambling is banned, where everything must be backed by tangible assets, should be cleaning up in its aftermath. In this era of scarred savers and investors, why is everyone not moving their money over to this low-risk system?
Well, a lot of us are. And not just Muslims either. Even the Pope agrees. One of the most important points about Islamic banking is that, even if global banking assets continued to tank for the next five, ten, fifteen years, Islamic banks could keep on growing because they still account for such a small proportion of the market.
Bahrain – Banking Sector Asset Growth (%)
Don’t ask me for numbers. One of the other most important points about Islamic banking is that consistent reliable figures are hard to come by. By way of example, in Bahrain, a Muslim state and global pioneer of Islamic finance for several years, shari’a-compliant banks account for 10% of total assets. In Indonesia, Islamic banks’ assets have grown by around 35% on average between 2004 and 2008. Now accounting for a still fairly meagre 2.2% of total commercial banks’ assets, the central bank estimates that this figure will growth to 15% by 2015.
This rate of growth makes sense, not only for the reasons outlined above, but also due to the sheer number of Muslims who would prefer not to be committing a sin every time they pay into their bank accounts. Anecdotal evidence suggests that most Muslims would choose shari’a-compliant banking if they believed these services to be of equal financial benefit at no additional cost, which makes for a huge potential market.
But have Islamic banks managed risk better than their conventional counterparts? It’s true, we haven’t seen any solvency problems with any Islamic financial institution, we haven’t seen any go under and we haven’t seen worried customers queuing round the corner demanding to get their money out. Come to think of it, though, we haven’t seen those scenes anywhere in the Middle East or Asia, where Islamic banks are concentrated. Looking at balance sheets as well, Islamic banks do look well capitalised. But then again, so do their non-Islamic competitors in the same markets.
Saudi Arabia - Q209 Provisions For Loan Losses (SARmn)
There’s also an argument that the rigidity of the regulation in fact restricts banks’ ability to diversify risk. One of the problems that has affected both Islamic and conventional banks in the Middle East is exposure to the declining real estate market. Because sukuk and other sharia-compliant instruments have to be backed by tangible assets (as opposed to representing money as a commodity in itself), and many of the projects in the Middle East have been real estate-focused, this affected conventional banks as well. However, by their very nature, Islamic banks are unable to diversify risks as well as conventional banks because there are less investment avenues open to them.
Developments To Watch For
So what should we be looking for as signs that the good news story for the Islamic finance industry is back on? There are one or two positives to watch out for over the coming year or so: perhaps the single most encouraging development for the Islamic finance industry will be the launch of the world’s largest Islamic bank. The planned UAE-based megabank, which has not been named so far, will have a paid up capital of US$200bn, allowing it to compete on the global stage in a way that Islamic banks have so far been unable to. Meanwhile, the Malaysians are not too far behind: Bank Negara Malaysia has received several enquiries on the proposed setting up of a mega Islamic financial institution, Governor Tan Sri Dr Zeti Akhtar Aziz said in July.
One interesting indicator is to see what trends are playing out in markets with no real history of private sector banking. In Syria, for example, the banking sector is starting from a clean sheet. The government relinquished its monopoly on the banking sector six years ago and the sector now has 13 privately-owned banks and six state-owned ones. Of these 13 new lenders, only three so far are Islamic, but the government has granted licences to six more, and looks keen to encourage growth in the industry. In 2008, Ernst & Young said that it expected Islamic banks to eventually snare up to 50% of the market, and the government has hosted several Islamic banking conferences. Although Syria is nowhere near as wealthy as most of the countries mentioned in this report, the development of the banking sector in this country will be an excellent benchmark for the choices Muslim consumers make when fear of departing from the old tried and system is not an issue.
August 21st, 2009 at 11:00 am
I don’t think banks, governments and even religious authorities in the Muslim world are yet entirely convinced of the viability of Islamic banking. If they were, Saudi Arabia would have created a pure Islamic banking system. Pakistan’s move towards a pure Islamic banking system following the Sharia Appellate Court’s ruling against interest in 1999 has been a disaster. The people who are pushing for conversion to purely Sharia-compliant banking systems in Muslim countries are ideologically-driven Islamists. Consequently, Islamic banking doesn’t appear to have the confidence of the Muslim world and as such may never be anything but an interesting niche sector on a par with ethical banking.
There is great division on the application of Islamic precepts on riba (interest), gharar (trading in risk) and maysir (speculation) in the banking sector. Although in Islam ‘riba’ (usury) is haram, the Al-Azhar University (the leading religious authority in Sunni Islam) decreed that bank interest is not un-Islamic. The ruling was perhaps an acknowledgement of the severe limitations such precepts pose to normal banking and financial operations and their effect on a capitalist economy.
What I think is happening in scholarly debates is the move from strict observance of Sharia as the basis of banking to the Islamification of conventional banking, such as the offering of Islamic financial products alongside non-Islamic products. This is giving conventional banks an opportunity to dominate Islamic banking, eg HSBC Amanah which is Saudi Arabia’s leading manager of sukuk. I wonder whether purely Islamic banking institutions will find it hard to compete.
August 25th, 2009 at 7:29 am
Thanks for your comments Daniel.
You’re right – there seems to be a lot of pragmatism involved when it comes to Islamic banking. The sector is still in its infancy, and while countries such as Saudi Arabia may espouse strict adherence to Islamic principles in other walks of life, when it comes to banking, they recognise that many firms have financing or investment needs that are not adequately served by the Islamic banking sector (not yet, at least).
So while we see the Islamic sector growing, both in absolute and relative terms, there will always be a place for conventional banking in the Middle East and beyond. As such, I would argue that purely Islamic banks can still flourish alongside their non-Islamic counterparts, as long as they can prove their stability and reliability, even to non-Muslim investors.
For that reason, and as you point out, there seems to be an acceptance from religious authorities that Islamic banking products have to offer investors a return that is comparable to the conventional banking sector if they are to be successful. Making money in itself is not forbidden under Shari’a, and what’s the point of setting up the world’s biggest Islamic bank if no-one’s going to use it because the financing terms on offer at the bank next door are more advantageous to their business?
In my opinion, those people with a stricter view of what constitutes Shari’a will take more time to investigate the basis of Islamic banking products and make their choice accordingly. Of course, the man on the street may rely on religious authorities to guide his decision, but given that Islam has no central authority to rule on religious doctrine, there will inevitable be different interpretations from different scholars.