The Growing Popularity of Islamic Banking

By Siddiqi, Moin A. | The Middle East, June 1999 | Go to article overview

The Growing Popularity of Islamic Banking


Siddiqi, Moin A., The Middle East


Islamic banking is a financial system, the fundamental aim of which is to fulfil the teachings of the Holy Koran, as opposed to reaping maximum returns on financial assets. The basic principle in the Sharia (Islamic Canon Law), is that exploitative contracts based on riba (interest or usury), and gharar (speculation) are unenforceable, though the Koran contains no condemnation of fair/legitimate profits.

Islamic doctrine says profit is morally acceptable if an investment yields economic/social "added-value". Direct correlation between investment and profit remains the main difference between Islamic and conventional banks.

In Western banking, earnings/returns to shareholders is the sole criterion of success. Islamic banks, however, seek to maintain a greater balance between the interests of investors, shareholders, users and society.

The rapid growth of the Islamic market from its humble roots in the early 1970s into a several billion dollar niche industry has been unprecedented in modern financial history. Its growing popularity stems from the simple rules of nature propagated by Islam.

By some estimates, the sector has grown at an annual rate of between 10-15 per cent in this decade, reflecting higher demand from both corporate and retail clientele. The governor of the Bahrain Monetary Agency describes Islamic banking as the "last frontier for significant financial innovation."

According to the Jeddah-based International Association of Islamic Banks (IAIB), there were 166 Islamic institutions worldwide at the end of 1996, with total assets of $137 billion, deposits exceeding $100 billion and tier-one capital of $7.3 billion.

This figure excludes sizeable amounts held by conventional, Arab and Western, banks that also invest in accordance with the Sharia. The combined net profit of Islamic banks in 1996 was $1.7 billion.

This gave a return on capital of 23 per cent, and 1.24 per cent respectively on assets, which compare favourably with interest-based banks. The US financial institution Standard & Poor describes Islamic banking as being highly profitable, although, it notes, its profitability will decline as more banks offer Islamic banking services.

The World Bank estimates market turnover will rise to $100 billion by the year 2000, compared with only $5 billion in 1985. About 31 per cent of Islamic financing goes into commodity trading, 18 per cent into industry, 13 per cent into the services sector and 11 per cent into real estate.

The Middle East constitutes almost two-thirds of the Islamic market, and demand for niche banking facilities is booming, especially in the Gulf Cooperation Council states. Asset growth of Islamic banks has overtaken their conventional counterparts in the 1990s.

There are strong retail operations in Saudi Arabia and Kuwait. Al-Rajhi Banking & Investment Corp (ARBIC), the world's largest Islamic bank, has 350 branches in Saudi Arabia through which it offers current accounts, credit cards, money transfers and mortgages.

In Bahrain, the regional Islamic financial centre focus is on corporate finance and investment banking services for tapping the deposits of high net worth individuals (HNWIs). The emphasis in the UAE is on trade financing, and in Kuwait, major players Kuwait Finance House and International Investor have participated in Islamic structured and project finance. For example, International investor helped raised $500 million for Kuwait Airways to purchase new jets.

Besides leading Arab banks ABC International, Gulf International Bank, National Commercial Bank and Arab Bank Group, an increasing number of Western banks have either established Islamic subsidiaries or specialist divisions, with a view to generating incremental growth by attracting new wealthy clients. In the GCC region, an estimated 200,000 HNWIs own about $800 billion of liquid assets, of which Saudi Arabia's share is $500 billion. …

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