LONDON, 1 December 2003 — Islamic banking has shown it can deliver returns as strong as those of its conventional peers, but must offer a wider range of products to lure more than a billion potential Muslim investors and borrowers, analysts say.
Hedge funds, asset-back bonds, mortgages, real estate and private equity funds are some of the products Islamic banks are starting to develop in compliance with Islamic law to serve Muslims from Turkey to Indonesia.
Islamic finance, which bans investment in industries related to alcohol, gambling and weapons and forbids the payment of interest, has emerged as a growing market in the past decade, driven mainly by equity funds.
“Our biggest issue at the moment is to come up with as many products as the market wants,” said Tariq Al-Rifai, vice president of the Islamic banking unit of HSBC Bank USA. “Bankers need to understand what the customers want ... This is the key to future growth.”
With available funds totaling an estimated $260 billion, Islamic banking is still marginal in comparison to financial wealth estimated at $1.1 trillion in the Middle East alone, not including Muslims living outside the region.
Despite annual growth of about 15 percent, analysts say Islamic banking is being held back because Muslim scholars have yet to define how compatible the newest financial products are with Islam.
David Waite from Gulf International Bank in London said market research had shown 20 percent of people from Islamic countries would be attracted to investments compliant with Islamic Shariah law, but only if the right products and the necessary performance are there.
“From a marketing perspective, the Shariah compliance brings the customer to you. The performance sells it to them,” Al-Rifai said.
“If your performance is less, you are not going to get anyone, if you are offering equal returns you’ll get Muslims, and with higher returns, you’ll attract non-Muslims.”
A look at the Dow Jones Islamic Market Titans 100 index, launched four years ago, shows performances in Islam-compliant equity portfolios roughly on a par with those of conventional banking over the past three years.
Shariah adviser Sheikh Yusuf Talal DeLorenzo said strict Islamic standards on companies’ products, debt levels and earnings quality sometimes meant sounder portfolio strategies than in conventional investments.
He said careful screening of company fundamentals had, for instance, pushed some Islamic banks to drop a number of highly-indebted firms such as Enron and some technology companies out of their portfolios. Tying debt to the value of tangible assets such as land or property, in the case of asset-backed bonds called sukuks, also offers some protection against sharp debt market downturns, says Adam Nathif of the Abu Dhabi-based National Bank of Sharjah.
Such bonds also offer an alternative to investors looking beyond the US debt market after a recent slide in the dollar decreased the value of US assets held by foreign institutions.
Sukuks are an increasingly popular financial tool in Islamic banking, as growth in sovereign and corporate issues shows. The bonds do not pay interest, but make regular payments based on profits from approved investments.
Qatar, after Malaysia and Bahrain, is expected to launch an Islamic bond soon, having mandated HSBC and Qatar International Islamic Bank as lead managers.
Islamic real estate funds and liquid real estate funds — investments in listed property companies — have also stirred interest among Muslim investors, as have Shariah-compliant mortgages, whereby a bank buys a property and sells it to the new home owner at a premium using fixed monthly installments.
Some observers remain skeptical of whether these products are genuinely different to interest-based mortgages offered in conventional banks, but others say the difference lies in the means used by Islamic banks to make money and spread risk.
Under the Shariah-inspired system a bank’s profits, as well as its loan losses, are shared among all the investors whose assets it oversees.
The launch in October of a Shariah-compliant hedge fund by London-based Permal Investment Management and the Saudi Economic Development Company (SEDCO) opened the door to new investment opportunities for Muslim investors, although skepticism over their compatibility with Shariah law may delay their acceptance.
Islamic banking is still struggling to shed its image as a niche market but greater convergence toward international standards on issues such as capital adequacy, risk management, corporate governance and transparency would enhance its profile, some analysts said.
So would a further standardization of operations and the creation of more regulatory bodies, they added.
Growth in the number of global players, such as HSBC, Citigroup or Deutsche Bank entering Islamic banking lend it further credibility and may help woo new investors, Muslims or not, to the fledging financial arena.
“Islamic banking has reached critical mass and industry-acceptable credibility,” said Saleh Malaikah, CEO of Al Tawfeek, a Saudi fund of Shariah-compliant investment funds.
