The growing popularity of Islamic banking.

Author:Siddiqi, Moin A.
Position:Business and Finance - Includes related article on definitions of major Islamic modes of financing

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.


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