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Sun 6 May 2007 12:00 AM

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An unconventional truth?

How long will it be before Sharia-compliant investment becomes the market's dominant force?

Islamic banking is one of the buzzwords of 2007, and with good reason. Sharia-compliant total assets worldwide are close to an estimated US$500 billion, and have registered growth at more than 10% a year over the past 10 years, placing Islamic finance in a global asset class all of its own.

In particular, Western financial institutions and investors are becoming increasingly comfortable with Sukuk structures. According to global rating agency Standard & Poor's, the total Sukuk issuance is expected to exceed US$100 billion by 2010.

"If you have a look at the number of bond issues, the number that are being placed through Sukuks, which are Islamic issues, is increasing. The market wasn't there five years ago, but it is there now," says Kafil Badar, manager of strategic planning at Dubai Bank.

"It is still relatively small compared to the conventional market," he admits. "However, it has grown with the bigger-price-tag Sukuks coming along - and if you compare that growth with that of conventional banking, we're easily outstripping conventional banking."

In the Gulf and Muslim Asia, Standard & Poor's estimates that 20% of banking customers would now spontaneously choose an Islamic financial product over a conventional one with a similar risk-return profile. The market share of Islamic banks currently stands at 12% in Malaysia and 17% in the six GCC countries, and retail banking services and issuance of Sukuk, have been and will continue to be frontrunners in the global Islamic finance boom.

Nor is the surge confined to the Middle East and Asia. Western nations are embracing the tenets of Islamic finance and offering their clients a range of Sharia-compliant product lines. Badar suggests that this trend has been spurred by a number of factors, though one in particular stands out - it is not often, after all, that the notion of ethical responsibility springs to mind when such large sums of money are involved.

"Islamic banking has two edges to it - it is Islamic banking, but it is also ethical banking, which has been in the West for a long time now," he insists. "If you look at some of our Western counterparts they have offshoots or subsidiaries in ethical banking, and they don't invest in some of the arms areas or the defence industry. Islamic banking undoubtedly has the same sort of value sets."

The UK in particular is establishing itself as Europe's centre for Islamic finance. Gordon Brown, who Prime Minister Tony Blair last week backed to succeed him in the post, has instigated a series of changes to the tax system in order to attract Sharia-compliant investment. In addition, the Bank of England is considering issuing Islamic notes - another sure sign that the West spots an opportunity.

"It's a good way of showing your value set, because it's about social responsibility now," argues Bader. "When you talk about products and services, customers are focused on price, they are focused on service, and they're also focused on what you're doing for back in the community and the environment.

"Look at the other concerns that are going around now, such as global warming," he continues. "People are being asked to make direct choices, and Islamic Banking is another one of those choices."

By way of demonstrating this hypothesis, Bader points towards his own bank's conversion from conventional banking to Islamic banking. Dubai Bank's customers, he insists, made a decision that was at least partly founded on ethics.

"We've gone through conversion and lost no customers through that process," he says. "It was very recently, between November and January, and customer numbers stayed very stable.

"We had no churn and that our normal, ‘conventional' customers are comfortable with the product range and understand what we are trying to do, and are happy to stay because of the ethical side to it."

Afaq Khan, global CEO of Islamic Banking at Standard Chartered Bank, echoes Badar's assertion that greater customer choice has been a major driver behind the Islamic banking boom. "Islamic banking is a belief-based product, so people are buying efficiency of product, price and service, and above all belief," he says. "Initially when this started off, there were incomplete solutions so people were buying only on price, or only on belief.

"Now the product suite has expanded and become a little more transparent and standardised, so people have a true choice," he continues. "The customer does not have to compromise - instead, the bank has gone and changed for the customer. Of course, that is not to suggest that conventional banking is not ethical.

Nevertheless, Khan insists that the ethical benefits of Sharia-compliant investments are accompanied by other, less strictly altruistic benefits.

"The non-Muslims who are looking at the Islamic solution are saying that because it is belief-based, it must be more equitable to them, because there is a third party, the Sharia board, looking at it," he explains. "Because it is based on a religion, they consider that there must be equity in this contract."

Badar believes that we will reach a point within the next decade when Islamic banking overtakes conventional banking as the world's first-choice banking instrument. Indeed, he argues, the term ‘conventional banking' will prove to be a misnomer. "You're looking at populations that are becoming more ethical and more Sharia-compliant," he says. "The population of Muslims is more than 1.6 billion, but there are more than that number who do Islamic banking. In terms of a tipping point, I think you're looking at a five-to-seven year window. "In Malaysia, for example, conventional banks are outnumbered one-to-ten, and that's a very well developed Islamic market," he continues. "As we become more and more sophisticated, so our product range will increase. Five years ago, whoever thought an Islamic credit card would be successful? It will happen in the medium term, and it will happen across the developed world." Khan is less convinced, and dismisses out of hand the suggestion that Islamic banking might one day usurp conventional banking as the dominant instrument in the world of international investment.

"I don't see it going that way in any country, although it will become a parallel banking system in some countries maybe, and each country will have its own different rate of change," he explains.

"In Saudi Arabia, for example, the consumer business of the commercial banks is now predominately Islamic," he continues. "I don't think that we can credibly say though that in the Muslim world conventional banking will ever die out. I just don't think that's going to happen.

"Conventional banking will always be the dominant force in banking - this is trillions and trillions of dollars worth of business, and the Islamic assets are being quoted between US$700 billion to US$1 trillion.

"Individual global banks represent more money than the whole Islamic industry."

That may be. Nevertheless, Islamic banking is an industry that is catching up - and fast.

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