Cash & Liquidity Management

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Looking East: The Islamic Alternative? As the global financial markets continue to be fragile and uncertain, many people are asking if there is an alternative to the market systems and practices on which we have all relied for so many years. While the banking system is likely to see substantial changes in the future, this will take time. In addition to the conventional banking system however, increasing numbers of investors are looking to the Islamic banking market, including those without a religious connection to Islam. But what does Islamic banking mean in practice ...

Looking East:

The Islamic Alternative?

by Helen Sanders, Editor

Introduction

As the global financial markets continue to be fragile and uncertain, many people are asking if there is an alternative to the market systems and practices on which we have all relied for so many years. While the banking system is likely to see substantial changes in the future, this will take time. In addition to the conventional banking system however, increasing numbers of investors are looking to the Islamic banking market, including those without a religious connection to Islam. But what does Islamic banking mean in practice, particularly in relation to corporate treasury, and how does it differ from conventional banking? We hear vague mentions about Islamic products carrying no interest, but beyond that, few people, even in the financial sector, are familiar with the scope and principles of Islamic finance.

Furthermore, while Islamic banking is still in its infancy, particularly in the sophistication of its financial products, there are perhaps lessons for the conventional banking market. While Islamic banks have also been downgraded in some cases, due for example to cancellation of projects in which they are invested, many Islamic banking institutions are faring better than their conventional peers during the crisis. However, Surendra Bardia, Cash Management Head, UAE, Citi, explains that it remains a difficult time for all banks,

“Islamic banks are not immune from the current crisis, and like several other banks, they have experienced issues and are finding it challenging to continue to build their asset books. Capital preservation remains key, and as in other markets, the difference between borrowing and lending rates is growing at a rapid rate.”

Background to Islamic Banking

Islamic banking is a banking system consistent with the principles of Shari’ah law (spelt variously Sharia, Sharia’a or Shariah in English). It prohibits the payment of interest, or usury (Riba) in favour of a profit-based system, and allows investment only in businesses that provide goods and services consistent with its principles (see Investments below).

As Islamic regions such as the Middle East and parts of Asia such as Malaysia and Indonesia have developed economically, the Islamic banking system has matured and grown at a rate of typically 15% - 20% per year. An increasing number of Islamic banks have emerged, not only in these regions, but also in financial centres such as London. The French central bank is also looking at regulatory changes to allow Islamic banks to be established in France.

The first modern Islamic banking experiment took place in Egypt in 1963 in the form of a savings bank based on profit-sharing. By 1967, nine similar banks had been established in Egypt. The first modern commercial Islamic bank was the Dubai Islamic Bank, founded in 1975, initially with relatively basic products based on existing products already provided by the conventional banks, but Islamic banking products have developed significantly in scope, sophistication and in the degree of compliance with Shari’ah principles since then, and continue to do so.

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