With many banking institutions forced to their knees by the global financial crisis of recent years, one sector appeared to come out of it stronger than ever – Islamic finance. Experts claim its unique asset-based approach to finance has protected it from recession. But with some banking giants reducing their Islamic finance operations in 2012, does it still represent a strong financial alternative?
What is unique about Islamic finance?
In essence, Islamic finance relates to banking services and financial products that adhere to Sharia law. It is this adherence that leads to the key practical difference that separates it from ‘Western’ banking – Sharia law bans the charging of interest, meaning interest-based profits and other forms of speculative investments are therefore outlawed.
The Islamic model is instead built on trading assets, not borrowing and lending. Customers buy directly from the banks, rather than borrow money to pay for items elsewhere.
For many experts, not relying on the debt-based system used by traditional lenders has enabled Islamic banks to flourish while Western banks in the US and Eurozone have struggled during the recession.
Are there any benefits to mainstream banks?
Many Islamic banking institutions appeared virtually immune to the credit crunch which meant the system gained more and more attention from intrigued bankers around the world. For some, this conservative and controlled approach based on assets rather than interest and debt means Islamic banks are built on firmer foundations than those relying on credit. It was this firm asset-based footing which spurred numerous global banking names to adopt Islamic banking products – plus, being able to tap into the world’s population of two billions Muslims was no doubt an incentive in itself. But it has not proved quite as worthwhile as some predicted and after HSBC announced last October that it was scaling back its Islamic products, other international names have similarly reduced their Islamic finance operations, with both Deutsche Bank and Barclays reducing staff levels at their Dubai based Islamic finance arms. The huge profits needed by huge banks are, it seems, hard to come by in a system which is fundamentally opposed to the principle of profiting from the finances of the masses, so in many ways it is of little surprise.
What does the future hold for Islamic finance?
Despite this recent trend of mainstream banks scaling back their Islamic finance operations, there is still huge demand for not only financial products which are in line with principles of practising Muslims but also those which are backed by credible assets rather than credit. Islamic banking is said to be growing at a rate of 20 per cent a year so the withdrawal of major players such as HSBC has simply created more space for Islamic banks to continue their impressive expansion to the point where they will be able to compete with major lenders and traditional Western banks for both Muslim and non-Muslim customers.
While Islamic finance remains a niche market to many onlookers, it is one which is still very much on the rise. Islamic banks operate in 75 counties worldwide and Ernst & Young has predicted that Islamic banking assets will hit $1.8 trillion this year, while requests for sukuk securitues – Sharia compliant bonds – are predicted to swell from US$300 billion to US$900 billion by 2017. And those are figures which simply cannot be ignored.