The Islamic dimension.

Author:Siddiqi, Moin

The rise of Islamic banking is the most striking feature of the new wave of development in the Arab world. From humble beginnings in the 1970s, the Islamic financial services industry has grown in size and significance in 75 countries spread across four regions: North America, Europe, Middle East/Africa and Southeast Asia, and the multibillion dollar sector is poised to register impressive growth, averaging 15% per annum over the next decade, representing attractive opportunities for regional and international bankers to tap rich deposits and structured project finance business in the Islamic world.

I slam provides a whole body of legal and ethical rules for its followers; guidelines covering all aspects of human behaviour and lifestyle which, naturally, include commercial transactions. The discipline of Figh ul Muamlath, (jurisprudence), lays down which types of contracts are halal (permissible) and which are haram (invalid or impermissible) in the financial arena.

The Islamic banking system is firmly embodied in the principle of ethical and equitable modes of finance. The basic tenet of the Shari'ah is that exploitative contracts underpinned by gharar (excessive risk); maysir (speculation or gambling); and proscribed activities (notably pork, intoxicant, pornography, etc); as well as usurious interest taking are unenforceable. The Koran contains no condemnation of wealth creation. On the contrary, it encourages private enterprise, but opposes 'super-normal' profit based on an unfair competitive edge arising from usury, maysir and gharar. Under Islamic laws, money has no intrinsic value but merely serves as a medium of exchange.

The creation of money, by [rent on money] is void. Money represents 'productive capital'--used for trading tangible assets and undertaking pure [ethical] businesses--which can then yield legitimate profits and attain socioeconomic value. The most popular outlets are trade/commodity financing, real estate investments and leasing. Thus, money becomes capital only when mixed with reasonable risks or enterprise. The direct correlation between investment and profit remains the fundamental difference between Islamic and conventional banks. The latter exploits market imperfections (surplus/deficits) to reap maximum profits; whilst the former seeks to maintain a greater balance between the interests of investors, shareholders, users and society.

The essence of Islamic finance is that capital should be utilised for productive purposes only and, ideally, investment activities should constitute a partnership, whereby the provider of capital and the entrepreneur share in the risks and rewards of the venture, i.e., the concept of profit and loss sharing. Professor J. Presley of England's Loughborough University observes: "Islamic banking is all about taking risks and sharing that risk with the client."

The emerging Islamic market has become sophisticated as well as competitive. In 2006 it comprises a diverse range of institutions including commercial/investment banks and mutual insurance/investment companies; its target clients are pious Muslims (including high net worth individuals), multinational corporates and sovereigns. The product range is effectively similar to those marketed by conventional banking. These include current accounts, where the capital value of demand deposits is guaranteed; participating (flexible savings) accounts, where returns on deposits are linked to the bank's earnings from investment activities; export-credit facilities; performance bonds and letters of guarantee; factoring is permitted only for collecting invoices on behalf of the bank's customers; corporate finance/advisory services; syndicated lending and investment syndications; project financing and asset securitisation; home mortgages--whereby the bank purchases a property and re-sells at a profit to the purchaser--who repays total principal over an agreed period; mutual insurance and pension funds; credit and debit cards that levy Al Ajr (service charges) accounting to Islamic norms; and portfolio management services for affluent devout investors; as well as leasing.

Demand deposits are placed as Amanat (for safekeeping), thus they cannot be used for creating money through fractional reserves. Consequently, banks must apply a 100% reserve requirement on demand deposits. In contrast, investment deposits are used to finance risk-bearing ventures with depositors' full approval. Hence, savings--participating accounts require a zero reserve requirement...

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