Sharia law only allows investment in tangible assets
Published 05/11/2009 | 05:00
ISLAMIC banking is conducted under Sharia law, which is taken from the Koran and holds that money has no intrinsic value, while also banning the charging and paying of interest.
This is not as crazy as it might first seem to those used to the less spiritual viewpoints common in Western banks. These beliefs have helped to insulate many Islamic banks from the subprime crisis that has engulfed many rivals in the West.
Sharia only allows investment or trade in tangible and visible assets. While Sharia can permit certain futures and options structures, such as the salaam (sale contract with a deferred delivery) and arboun (sale contract with a non-refundable deposit), it prohibits convoluted derivative products.
In the modern world, that translates into a belief that money cannot just sit and generate more money. To grow, it must be invested in productive enterprises.
"In Islamic finance you cannot make money out of thin air," says Amr al-Faisal, a board member of Dar al-Mal al-Islami, a holding company that owns several Islamic banks and financial institutions. "Our dealings have to be tied to actual economic activity, like an asset or a service. You cannot make money off of money. You have to have a building that was actually purchased, a service actually rendered, or a good that was actually sold," he told the 'Washington Post' recently.
"The beauty of Islamic banking and the reason it can be used as a replacement for the current market is that you only promise what you own. Islamic banks are not protected if the economy goes down, they suffer, but you don't lose your shirt," said Majed al-Refaie, who heads Bahrain-based Unicorn Investment Bank.
Another side to Sharia-compliant institutions is that they don't invest in alcohol, pornography, weapons, gambling, tobacco or pork.
While Islamic banks protected themselves from derivatives and sub-prime mortgages, they have still been hurt by the slump in property and share prices.The Dow Jones Islamic US Index for example, which tracks Sharia-compliant stocks in the US, fell 9pc in the three years to May compared with a 13pc drop in the SP 500 index.
Islamic banking has grown by about 15pc a year since its modern inception in the 1970s, fuelled by the Middle East oil boom of that decade. "There was a lot of hostility when we first started out. We were regarded with suspicion, especially by the regulatory authorities. We were an odd fish. Authorities only acquiesced when they saw the huge demand," said Mr Faisal, who has been in Islamic finance since the late 1970s.
Growth in Islamic banking picked up even before the current financial crisis, mainly because of strong client demand for safe, religiously acceptable investments and a recent explosion in new and innovative financial instruments, said Jane Kinninmont, an analyst at the Economist Intelligence Unit.
But it's not all plain sailing. The sukuk market, which had doubled each year since 2004, growing to a total of about $90bn (€60bn) in bonds issued, fell 50pc recently after a Bahrain-based group of Islamic scholars decreed that most of the bonds were not compatible with Sharia law. Banking is going through a hard time whatever the religion of the bankers it seems.