Imagine living in a parallel financial world where bankbooks earn rents, leases procure homes and scholars vet stocks. A world where merchants divulge profit margins in advance to buyers and commodities stream as dividends from capital investments. A world whirling around an orbit of gold. You don't have to imagine--this is the world of Islamic finance.
Islamic finance is one of the fastest growing segments of global finance. Evolving gradually from 1970, when the first Islamic banks started in Dubai, it has lately swelled on the wave of globalization and the petroleum boom. Operating in 70 countries with about $500 billion in assets, it is poised to expand geometrically. Western institutions have jumped right in; Citigroup and other Western banking giants recently opened Islamic divisions and are elbowing out much of the indigenous competition. The Islamic Bank of Britain, the United Kingdom's first bank catering to a Muslim client base, listed its shares on the London Stock Exchange in 2004.
In a dash to embrace modern technology and product innovation, Islamic finance is not without detractors. Some economists and Muslim scholars consider it medieval and many find its repackaging of Western products an apostasy.
According to many economists, Islamic finance, in its objectives and operations, is based on Koranic principles (also called Shariah Law). Going beyond the tautology that Islamic finance equals "interest free" banking, it embodies three religious tenets: the avoidance of speculation (gharar), the avoidance of excessive profits (riba) and the focus on permissible activities (halal).
Underlying the system is the philosophy of risk sharing: the lender must share the borrower's risk, making the two in effect partners, injecting a strong social component into the financial system. That viewpoint separates it decisively from Western finance, which seeks to maximize profits and minimize loss through diversification and risk transfer.
At the core of Islamic finance is the sukuk. Much like a western-styled revenue bond, the sukuk returns capital from rents, royalties or user fees. According to Citi Islamic Bank, which unveiled a Citi-Dow Jones Sukuk Index at the International Islamic Finance Forum in Dubai this March, sukuk issuance for 2006 could equal about $14 billion, the combined notional value of the past four years' issuance. Revealing its sophistication level, a recent sukuk offering in the shipping sector named Venus Glory describes its structure as combining "an Islamic mezzanine tranche ... with conventional senior debt and conventional equity."
Retail products in Islamic finance run the gamut from microfinance to mortgages. Because interest-based loans are prohibited, mortgages, like other consumer products, are structured as installment or "lease to buy" arrangements, apportioning monthly payments between rent and ownership. Not amortized the conventional way, they replace the front-loaded interest payment schedule with a linear one, allowing homebuyers to acquire homes in equal parts throughout time. Mortgages are viewed as partnerships between custodian (lender) and occupier (borrower) until the home transfers to the latter. Although controversial, the Western practice of bundling and selling mortgages as asset-backed securities into the secondary market began in Dubai this past April with a $300 million offering.
As for equities, most Westerners' are shocked to see the list of industries forbidden by the Shariah Board, which include businesses engaged in entertainment, gambling, tobacco, alcohol, financial services, defense/weapons and pork production. Yet Islamic equity indexes first started in 1999 are blooming. According to Dow Jones, exchange traded funds (ETFs) also have gained acceptance. Last year, the Istanbul Stock Exchange launched two ETFs: the Turkey Titans, which comprises the top 20 blue …