In Islamic banking, you cannot make money off money. For instance, you have to have a building that was purchased or a service rendered.

AS Western financial institutions collapsed in the recent financial crisis, another financial sector is gaining confidence: Islamic banking.

Proponents of the ancient practice, which follows the Sharia law and bans interest, have been promoting Islamic finance as a cure for the global financial crisis.

Kuwait’s commerce minister, Ahmad Baqer, was recently quoted as saying the global crisis will prompt more countries to use Islamic principles in their economies.

Though the trillion-dollar Islamic banking industry faces challenges with the slump in real estate and stock prices, advocates say the system has built-in protection from the collapse that has afflicted many institutions. For one thing, the use of financial instruments such as derivatives, blamed for the downfall of banking, insurance and investment giants, is banned.

Underpinning
“The beauty of Islamic banking is you only promise what you own. Islamic banks are not protected if the economy goes down — they suffer — but you don’t lose your shirt,” said Majed al-Refaie, who heads Bahrain-based Unicorn Investment Bank.

The underpinning of Islamic banking is scripture that declares that collection of interest is usury, which is banned in Islam. That translates into an attitude toward money different from that in the West: Money cannot generate more money. To grow, it must be invested.

“In Islamic finance, our dealings have to be tied to actual economic activity like an asset. You have to have a building that was purchased, a service rendered, or a good that was sold,” said Amr al-Faisal of Dar ai-Mal al-Islami, a holding company that owns several Islamic banks.

In the west, bankers have to satisfy government regulators. In Islamic banking, there is another group to please — religious regulators called a Sharia board. Finance lawyers and scholars work together to review a product before issuing a fatwa (ruling) on its compliance with Sharia law.

Islamic bankers describe depositors as akin to partners — their money is invested and they share the profits or, theoretically, the losses. Rather than lend money to a home buyer and collect interest on it, an Islamic bank buys the property and then leases it to the buyer for the duration of the loan.

The lient pays a set amount each month to the bank and at the end obtains ownership. The payments include the cost of the house and a predetermined profit margin.
Sharia-compliant institutions also cannot invest in alcohol, pornography, weapons, gambling, tobacco or pork.

Computer engineer Tarek ai-Bassam said the crisis made him glad that he had chosen an Islamic bank. His Islamic savings account has made about 4% profit, he said.
He has also borrowed from an Islamic bank, to buy a building. Even if he’s late in his payments, he said, he will not have to pay cumulative interest.

But he notes that under this system, it can be hard to get a loan. Islamic banks have stricter lending rules and require that their borrowers provide more collateral. Islamic banking has grown by about 15% a year since its inception in the 1970s, fuelled by the Middle East oil boom of that decade.

“There was a lot of hostility when we started out. Authorities only acquiesced when they saw the huge demand,” said Faisal, who has been in Islamic finance since the 1970s.

Financial instruments
Islamic finance now accounts for about 1% of the global market, according to Majid Dawood, chief executive of Yasaar, a Dubai-based sharia financing consultancy.

“We had expected to be at 12% of the global market by 2025, but with this financial crisis, we expect to get there much faster,” he said.
Growth in Islamic banking picked up even before the current financial crisis, mainly because of strong client demand for religiously acceptable investments and a recent explosion in innovative financial instruments, said Jane Kinninmont, an analyst at the Economist Intelligence Unit, a research company.

Islamic banks now offer credit cards in which the full balance must be paid at month’s end. They have devised a commercial paper known as sulcuk, which generates a predetermined return called a profit. It is tied to a specific asset.
Work in Islamic banking by the King & Spalding law firm has grown abour 40-fold in the past four years, according to Jawad Mi, a Dubai-based partner at the firm.

The firm has 35 lawyers “who structure sharia-compliant investment and financing,” he said.
Islamic finance first sparked interest in the US in the late 1990s. The Dow Jones Islamic Index was established in 1999 and the Dow Jones Islamic Fund, which invests in sharia-compliant companies, the following year.

Vindicated
But interest cooled after some Islamic banks were accused of financing terrorism in a lawsuit filed by family members of September 11, 2001, victims, and a lot of Persian Gulf money left the US for Europe.

In 2004, the first Islamic bank opened in Britain, which now has six branches.

Although the big Islamic banks are in the Persian Gulf, Dubai Islamic Bank, Kuwait Finance House and Saudi Arabia’s al-Rajhi Bank-Malaysia and London are growing as major centres of Islamic banking.

Those who have been in Islamic banking for long feel vindicated. “The current financial collapse is an opportunity. The ugly side of Wall Street is exposed; it was always there but covered by a layer of glamour that is now stripped away,” Faisal said.

“We are more conservative in our investments. That used to be considered a handicap. Now it’s considered the height of wisdom.”

Source: LA Times-Washington Post