Islamic Banks: A Novelty No Longer
Lenders that avoid charging interest, in line with Koranic rules, are spreading -- even among Western institutions
When British banking giant HSBC Group (HBC
) began offering mortgages carefully formulated to meet Islamic banking practices last year in Malaysia, it was surprised that more than half of its customers were non-Muslim. What drew these customers to alternative financing that conforms to the strict dictates of Islam? Bank officials say that competitive pricing makes their Muslim-friendly mortgages -- which operate more like leases than loans -- competitive with traditional interest-based financing.
It's all part of a trend in which financial products that comply with the set of Koranic laws that govern a Muslim's daily life, or shariah, are evolving from a novelty into a normal part of doing business in much of the developing world. "Islamic banking isn't just for conservative or radical Muslims. It's mainstream business now," says Ross Mohamad Din, director of HSBC Amanah Malaysia, the bank's Islamic division. "That's why every bank wants a bigger piece of it."
From Jakarta to Jeddah, 265 Islamic banks and other financial institutions are now operating in some 40 countries, with total assets that top $262 billion, according to organizers of the International Islamic Finance Forum, a semi-annual industry conference. That pot of money, the investment of which adheres to the Koran's prohibition against receiving or paying interest, has been steadily building since 1994, when Malaysia created the world's first Islamic interbank money market. Now Islamic banking has broadened its appeal well beyond the confines of faithful Muslims. Indeed, nearly one-quarter of all Islamic banking business in Malaysia is being transacted by non-Muslims.
Islamic finance was long the preserve of specialty banks that handled shariah-compliant products exclusively, such as Malaysia's top-ranked Bank Islam and Saudi Arabia's Al Rajhi Banking & Investment Corp. But Western banks, no longer content to leave the market to Islamic lenders, are competing for a slice of the business. Two years ago, Citigroup (C
) began providing Islamic mortgages in Malaysia and has begun training staffers in Indonesia and Pakistan to offer them there. It also provides Islamic mortgages in Middle Eastern countries such as the United Arab Emirates. HSBC operates Islamic banking services all over the Arab world, and they now make up about 10% of its business in Malaysia. UBS, the world's top player in wealth management, set up a stand-alone Islamic private bank last year in Dubai to cater to its wealthiest Middle Eastern clients. And no wonder. Assets held by Muslims, led by Gulf Arabs, in all banks -- Islamic and otherwise -- are estimated at $1.5 trillion and are growing 15% a year, in large part because of high oil prices.
Behind the rapid growth in shariah-compliant investments are the development of new regulations and standards for Islamic financial services in the past few years. There's also much more awareness of Islamic financial alternatives in the Muslim world than ever before, thanks to stepped-up marketing by banks. Some Western lenders are even rolling out Islamic financial products in their home markets. Lloyds TSB Bank PLC (LYG
), Britain's fourth-largest, recently introduced Islamic mortgage products to cater to Britain's 2.5 million Muslims. "The biggest explosion [in growth] right now is in Islamic consumer banking and investment products," says Mohsin Nathani, Citigroup's Bahrain-based global head of Islamic banking.
What all Islamic financial products share is the absence of interest -- either assessed or paid. Instead, the investments are set up as leasing arrangements or investments in which money is turned over to third-party trustees who share profits with Islamic depositors.
While many countries boast a thriving market for Islamic banking products, Malaysia has positioned itself as the mecca of Muslim finance. That has given it bragging rights in a region where it has long been overshadowed by established financial hubs such as Hong Kong and Singapore. The Southeast Asian country is home to the Islamic Financial Services Board (IFSB), a global organization of Muslim bankers in charge of banking regulation and supervision that also works closely with the Bank for International Settlements. Islamic investments accounted for 11% of total banking assets in Malaysia last year. "By 2007 we expect that to grow to over 15% total banking assets, and we are targeting at least 20% by 2010," says Malaysian Finance Minister Nor Mohamed Yakcop.
There's more to Islamic finance than alternatives to simple savings accounts and home loans. Many banks offer Islamic charge and debit cards, although some Islamic scholars disapprove of them. Unlike standard cards, these are linked to personal lines of credit so users are only "borrowing" money from themselves -- not the issuing bank. The banks make money by charging service fees. What's more, the market for Islamic bonds hit $30 billon in 2004 and has topped $20 billion so far this year, the Monetary Authority of Singapore estimates. Recent issuers of ringgit-denominated Islamic notes include the Asian Development Bank, Swiss food giant Nestlé, and Saxony-Anhalt in Germany. That German state became the first European government body to issue an Islamic bond last year -- a $121 million five-year floating-rate note that provides "rent" in lieu of interest from a series of government properties that form the bond's collateral.
Some of the more sophisticated Islamic debt investments include asset-backed securities, in which Islamic assets such as property are bundled into bonds. A still newer product is a convertible bond that morphs into shares of shariah-compliant companies at a given strike price.
While bankers see Islamic finance as a growth area, they acknowledge that it's not for everyone. First, not all Muslims are as fastidious about how their cash is invested as others -- which limits the appeal of these carefully constructed investments. Some investments have no interest-free equivalent, which may also crimp the sector's growth. Plus, while profit margins on shariah-compliant products are comparable with interest rates on non-Islamic investments, they often cost more to set up. And Islamic scholars still differ on key aspects of shariah, making it difficult to standardize all products across the Islamic world.
At the same time, given a choice, many Muslims do opt for Islamic-approved banking. That may eventually eat into traditional financial services, which is one reason Western banks active in the Muslim world are so eager to bolster their shariah credentials. "There is a segment within the current market that would switch to Islamic if the quality and benefits offered were as good as conventional financial products," says Ray Ferguson, CEO of Standard Chartered Bank UAE in Dubai. Clearly, Islamic finance has moved into the mainstream.