Banking on piety

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Big business: there is enormous demand for Sharia-compliant financial services in the Arab world, Asia and Europe.

There is no such thing as an Islamic Sukuk; these are conventional bonds that are coated with an Islamic shell." To say Hassan Heikal, the CEO of the leading home-grown investment bank in the Middle East, EFG-Hermes, is sceptical about Islamic finance is an understatement. On the other side of the spectrum, Dr Abdul Moman Al-Olaby, a professor who was one of the pioneers in the industry agrees that some Sharia-compliant structures are questionable, but says "Sharia-compliant finance is our jewel, and even in its infancy, it is well positioned to compete among global banking giants."

Dr Ibrahim Warde, a professor of international business at Tufts University in the USA, and author of Islamic Finance in the Global Community, has been studying the industry for the past decade. As an academic, he takes a more nuanced approach, and tells Arabian Business "the initial hope of the sector was that it would be a completely different approach to finance and it would have many economic and social benefits, and would be based on the principle of sharing profits and losses." Critics today claim that "it evolved into a mimicking of conventional finance" and some question if it is a "new model", but supporters defend the approach on the grounds that they are leading the much needed modernisation of the financial sector.

While the debate will undoubtedly continue, it is undeniable that the cat is out of the bag. Sharia-compliant finance is a growth sector all over the world, and has now become a US$600bn industry. Given the immense wealth of the Arab world and the billion-plus global Muslim population, market dynamics forced the creation of Sharia-compliant finance. From Singapore to London, from Doha to New York, bankers are developing new products, chasing new clients, and laying the groundwork for global expansion.

In this report, Arabian Business examines the origins of Sharia finance, modern banking products, and the rise in corporate finance. We also speak to some of the players behind the burgeoning Takaful (insurance) market, see the Qatari innovation of Sharia-compliant private equity, and look at the scholars and boards endorsing the various structures.

Creating a financial system without interest

First, a quick primer on Islamic finance. The underlying principle of Islamic finance is that it complies with the religion's ban on interest (Riba), and that all structures must be studied and approved by a religious authority. It goes without saying that no Islamic company can be involved in illicit drugs, gambling, and alcohol.

Muslims throughout the world take immense pride in the complete set of legal and moral norms that was revealed to the Prophet Mohamed (PBOH). While previous religions proscribed specific codes for personal conduct, and the mechanism of worship to a deity, Islam augmented these by adding a layer of rules to organise the government and economy.

The question of riba (interest/usury) was among the last verses to be revealed to the Prophet, yet the words were clear: "Allah permits trading and forbids riba" {The Holy Koran 2:275}. Sharia, or Islamic law, is derived from three main sources: the Koran, the Sunnah and Hadith (the Prophet's recorded words and deeds), and the accepted work of scholars. This system of jurisprudence has been effective to adjudicate conflict and sharpen ambiguity over the past 1400 years, but the question of interest remains unresolved. The main reason for this is that the Prophet Mohamed (PBOH) passed away shortly after the riba verse was revealed, and did not clarify the application of the prohibition. Muslim scholars over the centuries have tried to narrow this question. Even Omar bin Al-Khattab, one of the early Muslim leaders and a companion of the Prophet, acknowledged that the issue is not clear and instructed Muslims to abstain from the practice.

All scholars today accept that usury is forbidden, while trade is permitted. The Islamic world historically thrived on trade, but as economies became more complex, financial institutions were not capable of adapting. Dr Abdul Momen Al-Olaby, one of the early economists who worked on Sharia-compliant finance in Kuwait in the 70s, tells Arabian Business "we had to devise modern financial structures that were based on accepted trades that Muslims conducted in the past".

Dr Al-Olaby explains the principle that forms a basis for many Islamic finance structures: Murabaha (rough translation: profit). "Say you want to buy a refrigerator, but you don't have enough funds to buy it in cash. The seller or a bank agrees to buy the refrigerator for you at its current price of 100 dinars, and then sells it back to you in installments over a period of time at the higher price of 120 dinars.

The seller books a profit. This may appear to be an interest rate, but the structure is in fact Sharia-compliant." Murabaha, along with Ijira (leasing), and Mudaraba (alliance of capital and labour), are the main principles used in Sharia-compliant financial engineering. From these simple concepts, an Islamic finance empire is emerging, covering retail banking, corporate banking, alternative investments, and insurance. Of course, anything that is based on religion is open to interpretation, and in the case of Islamic finance, dissent comes from the highest authority.

In 1993, Dr Muhammad Sayyid Tantaway, the Grand Sheikh of Al Azhar University in Cairo - one of the pre-eminent Islamic schools in the world, conducted an in-depth study of the interest in Islam, and asked a now famous question: ‘Riba (interest) is haram (forbidden), but what is riba?'

He went on to explain that riba in Islam is closer to usury (excessive interest rates common in loan sharking and predatory lending practices), but interest rates that modern banks use to determine the cost of money is closer to profit rates.

This is a main cause for Egypt's relative dormancy in Islamic finance, and also explains why many consumers and scholars view the growth in Islamic products as little more than a clever manipulation of language and consumer behaviour.

Dr Warde, believes that Egypt's lag in the development of the Islamic finance sector is mainly the result of a number of "small companies that claimed they were Islamic" that popped up between 1984 and 1988. This had a "huge impact on the Egyptian economy - where about 15% of the GNP evaporated."

Dr Warde suspects that the crisis (and fraud) was the catalyst for Dr Tantaway's fatwa on interest rates.

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