Dec 24 2010
Islamic banking has emerged as one of the most rapidly expanding sectors of the global financial industry, with expectations that it will play a growing role in the years to come.
Banks and financial institutions that comply with Islamic law (sharia) showed impressive resilience during the financial crisis that hit the world economy at the end of 2008, knocking out dozens of conventional banks, particularly in the United States.
This encouraged even countries with Muslim minorities, such as Britain, Germany, the US and France, to add Islamic banks to their conventional banking industry.
The size of the global Islamic banking industry is believed to have grown from about 820 billion dollars at the end of 2008 to more than 1 trillion dollars in 2010.
Latest studies indicate that the steadily growing Islamic banking system could reach 1.5 trillion dollars in 2012 and 3 trillion dollars by 2015.
“I believe Islamic banks stand to gain more ground in future, thanks to the confidence they have come to enjoy during the financial crisis,” Jordanian economist Jawad Anani told the German Press Agency dpa.
He attributed their recent successes to the abundant liquidity that they managed to secure in spite of the financial meltdown.
“The successful performance of Islamic banks during the world crisis enabled them to attract funds from foreign conventional banks, which hurried to open windows for Islamic finance and bonds,” said Anani, who runs an economic consultancy bureau in Amman.
Islamic banks play a similar role to those performed by conventional banks. But there are fundamental differences.
The underlying concept in Islamic banking and finance is justice, which is accomplished through the sharing of risk. Stakeholders are under obligation to share profits and losses and to refrain from dealing with exorbitant interest rates, which Islam consider tantamount to usury.
The Islamic financial system emerged more or less unscathed from the global financial crisis, mainly due to its strict prohibition of investments in risky instruments like toxic assets and derivatives, which have adversely affected their conventional competitors.
“The Islamic financial system has proved to be the least affected by the fallout of the global crisis, thanks to its strict management of financial instruments, its focus on financing real operations and keeping away from speculation,” Kholoud Saqqaf, deputy governor of the Central Bank of Jordan said in early December during a conference in Jordan to assess the success of the Islamic financial system.
Not only rich countries were impressed by the performance of the Islamic finance. Cash-stripped states have also shown interest in the fledgling system.
Jordanian Finance Minister Mohammad Abu Hammour said recently that his government was mulling the issuance of hundreds of millions of dollar-denominated sukuk Islamic bonds “as a new window of borrowing on the basis of the Islamic sharia.”
According to a recent study by the International Monetary Fund (IMF), Islamic banks “contributed to financial and economic stability during the crisis, given that their credit and asset growth was at least twice as high as that of conventional banks”.
The IMF attributed this growth to the Islamic banks’ “higher solvency, and to the fact that many Islamic banks lent a larger part of their portfolio to the consumer sector, which was less affected by the crisis than other sectors in the countries studied.”
Despite the strong growth displayed by Islamic banks in the first year of the crisis, they suffered a significant decline in profitability in 2009, mainly due to what economists describe as a weakness in risk management.
“I believe one of the challenges facing Islamic banks is innovating methods for developing the management of risks that face the application of Islamic law to the financial industry,” Anani said.
“If Islamic banks fail to develop such mechanisms, I think they will continue to attract deposits but will be unable to lure clients and investments, particularly when global interest rates go up with an economic upturn,” he added.
Anani, a previous cabinet minister and economic advisor to the Jordanian government, detected another shortcoming for the Islamic financial industry – a failure by Islamic banks to improve understanding with central banks regarding certain issues.
“A problem still exists with the insistence of central banks to treat Islamic banks as ordinary commercial banks that should abide by their monetary policy rules,” he said.