Islamic Banking a view from the US

[MMM]

Islamic Banking
Dr. Rachel Ehrenfeld
15 Dec 2008

Originally Published: Washington Times

Co-authored by: Samuel A. Abady

If "cash is king," then Middle East coffers are irresistibly enticing. During a recent tour of Saudi Arabia and the Gulf states, Deputy Treasury Secretary Robert Kimmitt applauded the "growing role" of Arab banks in the U.S. economy. Treasury is seeking buyers for its newly acquired bailout assets because more than $1 trillion in cash is urgently needed to rescue the largest U.S. banks.

However, cash from the Arabian Gulf comes with a vital string attached: Islamic banking, erroneously viewed as an ancient practice. In fact, Islamic banking is a newly invented institution: "Neither classical nor medieval Islamic civilization featured banks in the modern sense, let alone 'Islamic' banks," notes Timur Kuran, professor of economics and law at the University of Southern California. According to the Dinar Standard, "assets managed by Islamic banks are in excess of $700 billion - predominantly concentrated in the Middle East."

Islamic banking took off in the 1970s, but was first concocted by Muslim Brotherhood founder Hassan al-Banna in the 1920s. The stated goal was to penetrate the Western finance system, corrupting it from within in hopes of creating a parallel system to re-establish a global Islamic empire governed by Islamic law (Shariah). Islamic rules of commerce (fiqh al-muamalat) forbid interest (riba) and investing in a prohibited (hara'am) enterprise. They also mandate tithes on wealth (zakat). However, the Koran fails to precisely define these concepts. Imams and ayatollahs differ, for example, on whether riba prohibits all interest or only usurious interest.

While the overhaul of American and Western banking regulations is urgent, Islamic banking cannot be the answer because Muslim clerics - not U.S. laws and regulators - make the rules. In 1969, the Saudis created the Organization of the Islamic Conference (OIC), which is now leading the charge for global expansion of Islamic banking and has established new regulatory, accounting and auditing organizations to govern such banks. Notably, the OIC's charter is to "liberate Jerusalem and Al-Aqsa [mosque] from Zionist occupation."

Not surprisingly, zakat from Islamic banks often funds terrorist groups like the Muslim Brotherhood's Hamas. That organization's agenda was exposed during the Dallas trial of The Holy Land Foundation, a Hamas front group and an American Muslim charity just convicted of terrorism crimes. Evidence of the charity's true purpose included an 18-page "explanatory memorandum" outlining its "strategic goal … that all their work in America is a kind of grand Jihad (holy war) in eliminating and destroying the Western civilization from within."

Sharia financing forbids loans to entities labeled hara'am, such as industries that use alcohol, and to all Israeli businesses The Arab League Council established the boycott against Israel on December 2, 1945, (more than two years before creation of the Jewish state). The boycott prohibits all Arab states, companies and individuals from any financial or trade relations with Israel. Companies worldwide are blacklisted for doing business with Israel, as are companies doing business with boycotted firms. The OIC high commissioner for the boycott of Israel coordinates the efforts of its 57 member states from the Central Boycott Office in Damascus.

In response, the United States made it illegal for individuals or companies to cooperate with the Arab boycott. The law mandates reporting of boycott requests and imposes civil and criminal penalties against boycott participants. Arab boycott requests have risen sharply in tandem with the U.S. financial crisis and the rapid growth of Islamic banking. The Commerce Department's Bureau of Industry and Security reported a 20 percent increase in Arab boycott requests overall from 2005 to 2006, and the Congressional Research Service reported 24 boycott requests to U.S. companies in fiscal 2007 from little Bahrain alone.

On April 5, 2006, Congress unanimously condemned Saudi Arabia for its continued enforcement of the boycott - which violated commitments the Saudis made to the World Trade Organization in 2005. Nonetheless, last August Saudi Arabia and other Gulf states threatened to boycott Nissan, which aired a commercial on Israeli television promoting a fuel-efficient car, and demanded the Japanese carmaker's apology. Not a word from Washington.

Instead, the Treasury Department, hungry for petrodollars, is holding seminars to promote Islamic banking and U.S. taxpayers are footing the bill. This practice must stop. Islamic banking corrupts our financial system, enables the illegal Arab economic boycott of Israel and entangles government with Islam in violation of the First Amendment's Establishment Clause.

Rachel Ehrenfeld is director of the American Center for Democracy. Samuel A. Abady is a civil rights lawyer.

[Selim Ashrak]

Islamic Banking and the Collapse of Capitalism

15/12/2008

By Lahem Al Nasser
The global financial crisis has shaken the foundation of capitalism all over the world, from the rich North to the poor South, from democratic regimes to dictatorial ones. Voices were raised everywhere; I am talking of course about the Muslim writers and intellectuals who predicted the collapse of capitalism, and the bankruptcy of capitalist countries, announcing that the Islamic financial system would soon prevail. After the dust settled around the US financial institutions, and the subsequent impact of the US financial crisis on the global financial system emerged, it became clear that this collapse will not be limited to US financial institutions alone; it will affect many financial institutions worldwide.

This financial collapse has also resulted in a crisis of confidence following the international credit crisis. This crisis further expanded to include the real economy worldwide, and it has shown the extent to which international markets are linked to, and affected by, one another. The prices of oil and basic commodities, and the transport, tourism, and real-estate markets have declined significantly worldwide, while purchasing power has also been weakened. On the other hand unemployment rates worldwide, from New York to Dubai, have soared, and charitable organisations all over the world have suffered. All sectors have suffered, including even the sports sector, for example Honda has pulled out of Formula One racing. No regime or country is immune from this [economic] crisis.

The world has woken up and realised the importance of the tie between the world economy and the US economy, and it has felt the impact of this connection during the economic crisis, more so than it did in times of prosperity. The crisis also revealed the spread of capitalist ideology and its permeation throughout the world’s political regimes, even the autocratic regimes such as China. It also revealed that those most harmed by the economic crisis are the developing countries and the emerging economies around the world, which include many Muslim countries whose economies have sustained heavy losses.

It is expected that many Muslim countries, which had fast-growing economies, will suffer [from the global financial crisis] and experience a decrease in growth, which will have a negative effect on their development projects. There is no doubt that the consequences of this crisis and the subsequent impacts on the Islamic countries mean that those rejoicing at the crisis should reconsider their position, and use a more rational and realistic discourse, especially that we have not witnessed the collapse of the capitalist countries or the disintegration of the capitalist system. Rather, we have seen how the Western world has mobilized all international forces in order for capitalism to overcome its current crisis by making a few amendments to the system.

What truly collapsed was the Anglo-Saxon capitalist model, which calls for a free market system away from the interference of the state, with the least possible amount of legislation and restriction. This crisis has highlighted that the Islamic financial model was not harmed directly by the financial crisis, and also shown that the Islamic financial model is in need of a political regime to adopt, sponsor and support it, as no economic system can prevail without political support. The crisis also revealed the lack of research into the Islamic financial model in various languages so that the world can better understand it.

This was clearly reflected in the lack of publications detailing the Islamic financial system at the Frankfurt Book Fair during the economic crisis. Sales at the fair were predominated by works of Karl Marx, as everybody sought to understand the causes of the crisis and how it could be solved. Undoubtedly this failure to explain the Islamic financial system to the world is due to the lack of research centres specializing in this industry and institutions such as development centres and specialized financial and legal consultancy agencies.

The crisis also revealed the lack of an Islamic financial model that is capable of covering all financial aspects of this system, and is not reduced to Islamic Banking alone. We believe that capitalism is a system that is in a transitional process; the capitalist system is coming to an end in the same way that socialism, feudalism and the bourgeois system came to an end. This is an historical year, and we believe that the solution [to the global financial crisis] is to follow the Islamic financial model, which will undoubtedly prevail, as we are sure that God has decreed that there is a reason for everything.

[Grose]

The Rise of Islamic Banking in a Time of Economic Crisis
How some financial institutions avoid trouble by following the strict rules of the Koran
By Thomas K. Grose
December 10, 2008

Shopping for a business loan during a global credit crisis is tough work even if you're a fast-growing start-up like Ireland's Blue Ocean Wireless. And the scrutiny can cut both ways. Blue Ocean, which supplies wireless communications for merchant shipping, was giving a closer-than-normal look at whether possible lenders could be counted on amid the ongoing financial shakeout.

When the company got a $25 million loan this fall, it came from what might seem an unusual source: the Bank of London and the Middle East, or BLME, which strictly follows Islamic sharia law rather than conventional western banking practices. Islamic banking requires transactions be structured in alternative ways since the rules ban interest and trading in debt. Blue Ocean is one of many European companies benefiting from a surge in Islamic financing that's pushing sharia-compliant banking into the mainstream and extending its appeal to non-Muslims. The sector's growth comes at a time when the western banking system is caught in a liquidity crisis. Blue Ocean took comfort in the fact that BLME draws on the petrodollar surpluses of Persian Gulf oil producers. "The liquidity was there," says Blue Ocean's chief financial officer, Tariq Aslam.

The boom in Islamic banking is providing a crescent-shaped sliver of good news for the City, London's beleaguered financial district. It's fast becoming the main hub of Islamic banking outside the Middle East, a development encouraged by Britain's Labor government, which laid out the welcome mat to sharia-compliant banks several years ago. "The government sees it as another way to draw business to London, to bring investors to the U.K.," says Duncan McKenzie, director of economics at International Financial Services London.

Growth field. London now is home to 25 companies offering some form of Islamic financing. BLME is the largest of five wholly sharia-compliant banks operating in Britain. The first, the Islamic Bank of Britain, opened in 2004, and the number is expected to double within five years. Moreover, most of Britain's conventional banks also have established "Islamic windows," units that offer sharia-compliant products. Globally, the sector's total assets are pegged at between $500 billion and $1 trillion and growing at a rate of 10 to 15 percent a year.

Certainly, business is brisk at Kuwaiti-owned BLME, which is somewhat ironic, given that it opened its doors in July 2007, on the eve of the banking crisis. It is just completing a big leasing project for a major transportation company, and other deals it has sealed this year include financing for apartment buildings and a language school in London. It also provided an $11 million loan to RecovCo, a British aluminum reprocessor that is expanding its operations in France. For the first six months of this year, BLME reported pretax profits of $2.7 million and its assets more than doubled, to $931 million.

The basic concepts of Islamic banking go back 1,400 years, but the world's first modern Islamic bank didn't open until 1975. And the sector didn't really blossom until five years ago, when it was buoyed by rising oil prices and the strengthening economies of Asia's Muslim countries. Sharia law prohibits investing in certain industries or products, including alcohol, tobacco, pork, and pornography. The Koran also forbids usury, so financial transactions are structured to rely on income in the form of rents or profits from the loan, technically not interest. Sukuks, for instance, are a type of Islamic bond backed by ownership of a tangible asset that produces a financial return. Another popular instrument is the commodity murabaha, essentially cost-plus financing, which involves the sale and repurchase of a commodity to fund a loan.

The financing BLME arranged for Blue Ocean, for example, was a commodity murabaha. Here's how it worked: The amount of the first portion that Blue Ocean wanted from its $25 million loan arrangement was relatively small. So an appropriate, low-cost commodity was selected to accommodate the transaction, in this case special high-grade zinc. The bank purchased the commodity—an amount equal to the cash Blue Ocean wanted to withdraw—then sold it at a small profit to the company for the same price on a deferred payment basis. Blue Ocean, with the bank's assistance, then resold the metal at the original purchase price, thus raising the cash it wanted. All transactions occurred nearly simultaneously so that the deal wasn't whipsawed by market price fluctuations.

Conservative approach. Islamic banks have avoided the subprime fiasco. "There are no toxic assets," says Natalie Schoon, BLME's head of product development. "As a result, there are no problems with big write-offs. One of the advantages that the Islamic sector has as a whole is that there is still liquidity." That, as well as the conservative nature of its business model, is a big reason that it's attracting more non-Muslim clients. Middle Eastern investors have amassed so many petrodollars they have no choice but to look for opportunities beyond the Persian Gulf region, particularly in the politically stable environments of the United Kingdom and Europe. That's why Islamic banks are setting up operations there. Also, London is attracting those outposts because of Britain's historical links to the region and the strong financial talent pool to draw on. In fact, most of the top executives at the Islamic banks in London are British or European, and they are old hands in City banking. The government's concerted wooing efforts have also helped. "The government is actually supporting Islamic finance," Schoon says. "It's not seen as a threat; it's seen as an opportunity."

As with traditional banks, the Islamic banks in London must meet levels of transparency sometimes lacking in other parts of the world. "Regulation is important," Schoon explains. "Investors like the fact that you are regulated." The London Stock Exchange began listing sukuks this year, and 18 are now trading there, a useful increase of liquidity. The British government, as early as next year, is expected to make the country the first in the West to issue its own sovereign sukuks to raise as much as $3 billion. That should help set a benchmark price and encourage more banks to issue the bonds.

The government's sukuks, which would be the first in the world to be triple-A rated, would also give the United Kingdom an alternative route to raise money from the oil-rich Middle East. The plan is not without critics, however, who claim the government is giving religious-based sharia law official standing. Critics also raise concerns that sukuks could be used to finance terrorism. But Rodney Wilson, an expert on Islamic finance at Durham University, says that's an unlikely scenario. "Most Gulf banks do have fairly sophisticated monitoring systems in place" to ferret out money-laundering, terrorism, or other abuses, Wilson says. The 9/11 terrorists, he notes, used western banks to finance their operations.

A more practical problem is a lack of product standardization. Sharia-compliant financing relies on Islamic scholars to determine if products are in accordance with the Koran. But definitions of what is acceptable can vary greatly, not only from region to region but from bank to bank. Typically, Malaysian scholars tend to offer more flexible interpretations of sharia law than do their counterparts in the Gulf. Each bank has its own board of scholars, and even among the London banks there's no uniformity. Schoon says she's seen deals arranged by rival London banks that BLME's board—which comprises two scholars from the Gulf and two from Asia—would have vetoed.

BLME's toxic-free balance sheet helped convince Blue Ocean's board that, despite being a new bank, it was fundamentally strong. The company also liked the "shared-risk, shared-reward" ethos of Islamic banking, Aslam says. Essentially, each is making a vote of confidence in the other. If they're both right, that bodes well not only for the future of BLME but for the continued growth of Islamic banking in London. And that should give City burghers at least one thing to smile about.