The first modern experiment with Islamic banking was undertaken in the Egyptian town of Mit Ghamr in 1963. The institution took the form of a savings bank based on profit-sharing, but for the most part kept their activities as inconspicuous as possible during that time, due to fears of being viewed as a manifestation of Islamic fundamentalism.

 

By 1967 there were nine such banks in the country. These banks, which neither charged nor paid interest, invested mostly by engaging in trade and industry, directly or in partnership with others, and shared the profits with their depositors, functioning more as saving and investment institutions than commercial banks.

 

The central feature of Islamic banking is that it is interest-free. Islam prohibits Muslims from taking or giving interest (riba), regardless of the purpose for which such loans are made and regardless of the rates at which interest is charged. While further complexities certainly exist – such as contributions towards a more equitable distribution of income and wealth, and increased equity participation in the economy – it essentially derives from the fact that the establishment of interest is not permitted in the Islamic order.

 

However, this ban on interest does not mean that capital comes without cost in an Islamic system. Islam recognises capital as a factor of production, but it does not allow the factor to make a prior or pre-determined claim on the productive surplus in the form of interest. Therefore, in its place, profit-sharing becomes the viable alternative. In Islam, the owner of capital can legitimately share the profits made by the entrepreneur. What makes profit-sharing permissible in Islam while interest is not, is that only the profit-sharing ratio, not the rate of return itself, is predetermined.

A new era

“The growth over the past three decades was spectacular and evolutionary, however the pace has now intensified and we are shifting to a different gear,” says Khairil Anuar Mohd Noor, head of marketing for Emirates Islamic Bank.

 

The escalating business is not attributed to one single factor. Anuar sees it as part of the evolution of Islamic banking itself. “The growth of Islamic banking, particularly in predominantly Islamic environments, is fuelled by demand by Muslims for banking solutions that comply with Islamic principles. Banks that offer Islamic solutions in such areas have the extra advantage of being able to appeal to the Muslim customers.”

 

The seamless integration of Islamic banking with modern and contemporary banking services helps to further enhance the delivery of Islamic banking services to the market. “While the focus initially was on product development, the current emphasis is on meeting the diverse needs of the banking consumers, retail and corporate entities as well as other stakeholders,” says Anuar.

 

The heart of the Islamic banking industry is the Gulf Cooperation Council, comprising Saudi Arabia, UAE, Qatar, Oman, Bahrain, Kuwait – all the states of the Arabian peninsula except Yemen. In terms of assets and profits the largest Islamic banks are concentrated in this region.

 

And it’s no surprise this is where the largest base of customers reside. “As oil-based liquidity has increased, the purchasing power of the Islamic investor has risen,” says Yavar Moini, Dubai Bank’s senior manager of Islamic Structured Finance.

 

Yavar has also seen growth and increased sophistication in the type of products being offered by Islamic institutions. High-net-worth and insti-tutional investors have been targeted with highly structured real estate funds that source stock from North America and Europe, utilising conventional leverage while abiding to Sharia, or traditional Islamic law.

 

“We are currently pioneering an Islamic leveraged buyout fund that will target German mid-cap companies, which will be the first of its kind,” says Yavar.

 

More products have also been offered on the retail side, with new structures for credit cards, mortgages and investment opportunities. Products such as capital protected notes are evidence of the industry’s move away from its traditional reliance on murabaha-based products.

 

One of the more commonly used concepts in Islamic banking, murabaha was first introduced as a simple method of financing property purchases according to Islamic principles. While the documentation differs from normal mortgage documents, the procedure is straightforward and no more complex or time consuming than any other method of buying property.

Global growth

Indeed, Islamic financial institutions, some of them owned by conventional banks, are being established to cater to market demand for Islamic banking. What is also interesting is that the growth of Islamic banking and finance are not confined to the traditional Islamic market only. It has made inroads in non-traditional markets such as Thailand, the United States, Canada, the United Kingdom and other European countries. And they are not just catering to the needs of Muslim customers but non-Muslims as well.

 

Success in Malaysia, where the users of Islamic banking services are split approximately fifty-fifty between Muslims and non-Muslims, shows that Islamic banking goes beyond compliance with Islamic principles, providing acceptable, need-based banking solutions.

 

One distinguishing factor that contributes to the ready acceptance of Islamic banking products and services in a matured market like Malaysia is the greater understanding of Islamic practices and how the different concepts used in Islamic banking can be a good and viable alternative to users of banking products and services, be it for retail or corporate and institutional customers.

 

According to Yavar, Islamic banking has already made an impact on the non-Islamic world, as he feels that ethical investing is a universal phenomenon. 
“Increasingly, international institutions are joining the bandwagon and we are now seeing products that are
competitive both from an Islamic and conventional perspective.”

 

The availability of these services means that all investors can participate, allowing Islamic banking to access a mainstream customer base rather than being confined to a faith-based niche market.
“The new breed of services and products brings together investment bankers and lawyers from Wall Street of all persuasions – investors and financiers from the Middle East and Sharia scholars from all over,” says Yavar. “What better example of international collaboration can you have currently?

 

Nevertheless, there is still much room for development and expansion, and new frontiers to be explored.

 

“The acceptance in the non-Islamic countries will not happen overnight. It will, however, certainly continue to grow over time once the general public is aware of the virtues and benefits of conducting their banking transactions the Islamic way,” says Anuar.

 

While research is becoming increasingly important, it still has some way to go. Saudi Arabia may have more faith-based investors at both the corporate and retail level than, say, the UAE. With a large non-Muslim population, the latter could follow the Malaysian model, where a great deal of the customers of Islamic banks are non-Muslim.

 

The importance of distinguishing between different markets is key, but a comprehensive understanding of the wider macro and micro dynamics has not yet been attained. Yavar feels that further research into local markets will help to better identify niches where large gaps exist between consumer demand and supply.

 

“The underlying basis of Islamic finance’s prominence is a more equitable sharing of risks and rewards between the owners and users of capital,” says Yavar. “Surely that is a concept that is worth replicating universally.”