Islamic banks have been barely bruised by the global credit crisis so far, but the worst could be yet to come as falling property and commodity prices and slowing economies start to hit the sector.

As the global economy buckles, credit lines tighten and consumer confidence crumbles, Islamic institutions – which manage an estimated US$1 trillion (Dh3.67 trillion) worldwide – might not escape the pain that is plaguing conventional lenders in the West.

Sliding commodity and property prices in predominantly Muslim countries in the Middle East and South East Asia could have a particularly strong impact on the Shariah market due to the industry’s heavy reliance on those assets to support deals.

“Islamic banks are heavily exposed to real estate and private equity in many of these markets,” said Abdulkader Thomas, the chief executive of the Kuwait-based Shariah advisory firm Shape Financial. “If these markets are overpriced, which some of them are, then Islamic banks could well be particularly exposed.”

Strict lending requirements, insistence on transparency and requirements that physical assets underpin transactions have all helped the Islamic industry survive the first round of the US subprime mortgage meltdown, which fuelled a worldwide credit crunch. But the global financial crisis has worsened dramatically in recent weeks, sparking heavy selling of stocks, commodities and oil and threatening to plunge developed and emerging economies alike into recession.

Many companies are freezing or slashing spending and cutting jobs, and consumers are reining in spending.

Prices for most commodities such as crude oil, metals and grains have fallen to multi-month lows as investors pulled billions of dollars from the sector. Bankers estimate that about $50 to $60 billion of value has been wiped off commodity markets in the last quarter.

The Shariah bond market, one of the most popular segments of the industry, has been hit as companies from Japan to Kuwait and Malaysia cite tough market conditions and high borrowing costs as reasons for either aborting or delaying issue plans. The launch of at least one Shariah hedge fund has been shelved and even oil-rich Gulf economies, which are global hubs for Islamic finance, have not been spared.

The UAE Government agreed on Sunday to take measures to shield the economy, promising to protect banks from credit risks. Last month, the Central Bank launched a $13.6bn emergency facility to help keep interbank lending moving.

“The easing of oil and gas prices is unhelpful for the GCC economies, where Islamic finance is most developed,” said Rodney Wilson, an Islamic finance specialist at Durham University in the UK. “Furthermore, governments have had to curtail capital spending due to inflationary pressures, and there are serious worries over the bubble in the property market in the GCC.”

In Asia, where countries such as Malaysia and Singapore are vying to be Islamic finance hubs, once booming property sectors are slowing rapidly. CLSA estimates that half the wealth of Malaysia, Singapore, South Korea and India are tied to property, making the region highly susceptible to a sharp brake on economic growth.

The higher costs of Islamic transactions are also expected to come under greater scrutiny at a time when investors are demanding a greater premium from banks for risking their money.

To satisfy the Shariah requirement that all transactions be based on assets, Islamic deals typically involve more paperwork and higher costs than conventional instruments.

“Shariah-compliant funds have been adversely affected by global equity falls, and 2008 is likely to see more redemptions than new placements,” said Mr Wilson. “No further Islamic hedge funds are likely to be established, and alternative investments are now off the radar for most Islamic investors.”

Modern Islamic banking has been touted as the conservative substitute to the winner-take-all approach of conventional finance, advocating instead a fair division of wealth and profit – and loss sharing – between the partners of a venture. 

There are more than 300 Islamic financial institutions worldwide and the sector is valued at about $1 trillion, just a fraction of the conventional global banking industry. But the sector has been growing about 20 per cent annually as it taps areas that conventional lenders have had a hard time reaching.

Few parts of the global financial system appear completely safe in the near term from the contagion effect of the current crisis and the fallout on economies.

“It is all about sentiment now,” said Ahmad Zaini Othman, the chief executive of Malaysian Shariah bank AmIslamic.

“If Islamic banks also decide that they cannot support a line of credit to other Islamic banks because of the poor sentiment, then definitely there will be a ripple effect.” * Reuters
Source: http://www.thenational.ae/article/20081013/BUSINESS/335559513/1005