Retail obstacle as France pushes Islamic Finance

France's quest to create a European hub for Islamic finance could yield results for wholesale banking and Islamic bonds, but secular concerns may put the brakes on retail banking.Since launching a drive to develop Sharia-compliant financing and draw Middle Eastern capital to France around two years ago, Paris has made large strides on the legal and fiscal front, with much of the framework already set.

Expectations are growing that it might be a matter of months before a firm or local authority issues France's first sukuk bond, which pays no interest but offers returns on underlying physical assets, and licences Islamic banks.

The country's tiny Islamic finance market has so far largely involved Sharia-compliant property deals, a far cry from neighbouring Britain, which has spent the past five years positioning itself as a major Islamic banking centre.

Whether the size of the French market can really top €100bn euros ($144bn) in time, as suggested by two French professors in a 2008 report, is debatable.

But analysts believe there will be a stream of Sharia-compliant property or corporate financing deals and some sukuk issues over the coming two years in a country which has over five million Muslims, Europe's largest such community.

Islamic finance is derived from Sharia, or Islamic law, and is valued at a global $1 trillion. It avoids interest-based financing and advocates ethical principles with a fair distribution of profits and losses between venture partners.

"On the retail side, I think there is a very big question mark," said Anouar Hassoune, senior credit officer with Moody's. "Otherwise 18 months is doable in terms of concrete activity and it could go quicker than that."

Britain has some 22 banks, including five that are fully Sharia compliant, that are active in the Islamic market and 18 Sukuk issues there raised $10bn up to February 2009, according to International Financial Services London.

In addition, there are an estimated 17 banks that have set up windows in the UK to provide Islamic finance.

But a campaign, driven by economy minister Christine Lagarde, to build on ties with the Middle East and tap deep pockets in the region to finance French firms and projects is showing promising signs.

The government has created a framework for the French AMF market regulator to approve investment funds that abide by Sharia principles, paving the way for Muslim and other retail investors at home to pour cash into French interests.Anticipating the potential, investors have done feasibility studies and lawyers have buzzed around potential clients.

"The French market today is much smaller than London but the lawyers and the accountants have been very active," said Farmida Bi, a lawyer with Norton Rose Group in London.

A handful of overseas Islamic banks have met the authorities to explore the possibility of setting up a presence in France.

Unconfirmed rumours that at least one Islamic bank may secure a licence this year have also been reported by the media.

"The progress is real but this will be a long journey," said Mohamed Damak from Standard & Poor's.

If progress proves real on the wholesale side, it could be a few years before the retail side takes off, if at all.

Beyond possible reticence on the part of the French body that issues banking licenses to back retail before the wholesale side has been tested, thousands of bank staff will need to be trained in the coming years.

But the biggest challenge posed by retail banking is overcoming prejudices towards Islamic finance in a nation that prizes its secular traditions - and where some think the general public will mix the notion of religion with banking.

That could explain hesitancy on the part of French banks, which have developed Islamic finance for overseas markets but steered clear of it at home, some analysts said.

"The crux of the problem is that nobody wants it except for the Muslims and the Muslims have no power in France. They are not organised enough and have no lobbying power to see Islamic retail banking see the light of day," said one industry expert on condition of anonymity.

If Islamic retail were to emerge, it would probably start with a partnership between a French and overseas bank, and would need to be carefully marketed.

"You can't have a bank called the French Islamic Bank. It would be best to talk about alternative financing," pointed out Jean-Paul Laramee of the French Institute of Islamic Finance.

Moody's Hassoune said France should be ambitious and embrace both retail and wholesale activities.

"We are talking about two scenarios for France: one is that Islamic finance emerges but remains small and confined to wholesale banking and a couple of sukuk," said Moody's Hassoune.

"The other is that Islamic finance becomes part of the mainstream and this is what France should be aiming for."