Islamic Finance: Different Stories Around the World

Islamic banking and financial services have seen rapid growth across the globe over the past few years, with Middle Eastern and south east Asian countries pioneering Islamic finance. Although estimates vary, there is little dispute that annual global growth is consistently in the double digits and has surpassed conventional banking growth in some regions. Islamic banking assets are currently close to US$1 trillion.

Although the first instance of Islamic banking appeared in Egypt in 1963, the true phase of development of Islamic financial institutions occurred in the 1980s. Earlier initiatives were more inclined towards interest-free Islamic banking, but the emergence of financial systems evolved during this decade. Non-payment of interest (riba) still remains the pivotal part of Islamic banking. The new, wider spectrum of Islamic finance not only covers banking activities but also capital markets, capital formation and other financial instruments and intermediaries.

When conventional banks in western countries went through the credit crisis and economic recession in 2007/8, Islamic banking and finance was recognised as an alternative model. While interest income is considered the main source of income in conventional banking, riba is not acceptable in Islamic banking. This played a key role in the financial crisis, as Islamic banks were shielded from conducting interest-bearing activities in line with Shariah principles. Islamic financial institutions were also restricted from investing in interest-bearing bonds and securities.

Despite Islamic banks being confident about the practice, the crisis in the Middle East shook their confidence, leaving certain questions unanswered. The global financial crisis finally stuck the Arab Gulf at the end of 2009, after it managed to avoid this for more than a year. Dubai stunned financial markets when it said it might need to freeze debt payments by its largest conglomerate, Dubai World, and two of its flagship real estate firms – Nakheel World and Limitless World – for a standstill on debt worth US$59bn. The two subsidiaries are run according to Islamic law through the issuance of billions of dollars worth of sukuk. This led to a wave of aftershocks that struck the global financial markets, that themselves were in the process of recovering from the effects of the global financial crisis. While Singapore and Malaysia have been largely unaffected by the crisis, neighbouring countries such as Saudi Arabia, Qatar and Bahrain attracted more focus in the aftermath.

The incident resulted in calls for tighter regulations and higher standards. A lack of framework regulations is the single biggest threat to Islamic finance, as the customer and the institution share the risk of any investment and divide any profits between them. In some countries, even today, there are no regulatory norms governing Islamic finance activities, either through the Shariah board or the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), which regulate and audit the Islamic banks. This has not only resulted in a dilution of Islamic products in terms of Shariah compliance, but also in a lack of uniform regulation across regions.

In Saudi Arabia, for example, there is no structured system in place for banks and each bank has a different view of Islamic finance. The central bank also has no specific division for Islamic finance. In contrast, Malaysia has well-regulated governance and laws for every type of Islamic product issued, and the National Shariah Council (NSC) edicts are enforced throughout the industry.

Industry Developments

As investors flee debt in Dubai, Bahrain, Qatar and Saudi Arabia are likely to pick up much of its Islamic banking business. The financial hub is expected to bounce back eventually since the emirate is well-positioned and acts as a financial hub between Asia and Europe. Post-crisis, however, much of the talent and money flow was directed to neighbouring countries.

Singapore and Malaysia are relatively unaffected by the Dubai crisis and have seen more investment as a result of the crisis. Malaysia has the world’s largest Islamic bond market and is known for more business-friendly interpretations of what is allowed under Shariah law than many Gulf countries. This has opened doors for a far greater range of financial products.

The recent Dubai crisis has prompted several countries in the region to re-examine regulatory aspects, and work on the operational and structural framework of Islamic banking. Many countries across the region are promoting Islamic banking under three broad categories:

  1. Allow foreign/private banks to open new fully-fledged Islamic banks.
  2. Allow conventional banks to set up Islamic banking subsidiaries.
  3. Allow the existing conventional banks to open stand-alone Islamic banking.

Pakistan, Bangladesh and Indonesia have good potential for growth for Islamic banking. In all three countries, a majority Muslim population makes it all the more attractive for Islamic banking. While all these countries are still in the growth stage, various foreign banks are also targeting the market, offering Islamic banking either as a window or as a subsidiary. In addiiton, the Reserve Bank of India (RBI) has recently permitted Islamic banking in the country. This development is expected to provide some exciting results.

Technology, like any other service offering, is playing a key role in Islamic banking. While some banks are opting for dual offerings (Islamic and conventional banking together), technology vendors are struggling to accommodate various forms of Shariah-approved financing. While most of the technology players have achieved this efficiently, challenges such as quicker implementation, support for back-office functions with straight-through processing (STP) capabilities and web-based interfaces still exist.

Areas of Concern

The following are areas that the Islamic banking sector needs to address to ensure that it is able to maintain its current growth:

  • While the need for uniform Shariah regulation is a must, a clear definition of each Islamic product will avoid dilution of such product offerings.
  • Islamic banks will have to appraise credit risk and indeed need to be more cautious about their credit exposure.
  • The increasing competition among incumbent and new players presents challenges not only in terms of fighting for market share but also in creating innovative products.
  • A dearth of scholars is no longer a concern, but a dearth of experienced scholars is still a worry.


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