Turning The Prophet's Words Into Profits

Islamic banking, with its strict codes, is growing fast

Last year, Citibank asked the Federal Reserve Bank of New York to approve an unusual type of trade-financing deal that charged no interest and was governed by Islamic principles. The New York Fed promptly gave its blessing. That it did was a testament to the growing role of Islamic banking in mainstream global finance. Indeed, in little more than two decades, Islamic banking has gone from nowhere to the big time, attracting major Western lenders, as well some 200 players around the Muslim world.

Banks that follow sharia, or Islamic law, boasted assets totaling $137 billion in 1996, a year in which they earned $1.7 billion, says Samir Abed Shaikh, who is general secretary of the International Association of Islamic Banks in Jeddah, Saudi Arabia. Most of the leading Islamic banks are located in the Persian Gulf region, where Al Rajhi Banking & Investment Corp. in Saudi Arabia tops the list with assets totaling $9 billion. The Islamic banking industry's assets have been growing at an annual clip of 15% for the past decade. "The progress has been fantastic," says Henry Azzam, chief economist of the National Commercial Bank of Saudi Arabia.

NO USURY. In addition to banning interest as a form of usury, Islamic banks follow a host of strict rules prohibiting them from earning money from activities that Muslims regard as unclean. The strict code hasn't stopped Western bankers from entering the fray. Citicorp, for example, set up Citi Islamic Investment Bank in Bahrain in 1996 after serving the market in other forms for 15 years. J.P. Morgan & Co.--a longtime adviser to some of the Gulf's Muslim rulers--as well as Deutsche Bank and the Netherlands' ABN AMRO Bank also have Islamic units.

Islamic banking took off during the mid-1970s when a surge in world oil prices poured billions of dollars into the coffers of the oil-producing Gulf states. Even before that, the independence that many Muslim countries gained in the 1960s had reawakened an interest in Islamic heritage. Today, however, Islamic banking is tapping a new demographic reality. Islam is the world's fastest-growing religion. At the same time, more Muslims in Europe and the U.S. want financial services that reflect their religious beliefs. That's why some Islamic banks have set up shop not only in Europe but also in the U.S. And with many Western-style lenders across Asia on the verge of collapse, some observers believe that Islamic banking may gain a foothold in the region, especially among the largely Muslim population in Indonesia. "These people want their own identity as Muslims, including financing," says Shaikh.

In recent years, Iran, Sudan, and Pakistan have banned traditional commercial banking and adopted Islamic banking models. Islamic countries' regulators also have moved to adopt common international standards for the industry, coordinated by a legal academy in Saudi Arabia.

Islamic banks are governed by reams of complex legal rulings that are known as fatwas, or interpretive applications of sayings from the Koran. Each bank has its own board of Muslim scholars to determine the suitability of banking services and investments. Islamic banks are limited by "sharia screens," which prohibit investment in such "sin" industries as gambling or weaponry. Everything else is governed by "sharia mirrors," or areas which are sanctioned by Islamic law, including education, food production, and biotechnology. So Islamic banks would be barred from speculating in pork bellies but not in cattle futures.

END RUNS. Bankers have devised numerous ways to get around the Islamic ban on earnings from interest. For instance, importers and exporters of raw materials rely on a technique that is known as murabaha, such as the one that was approved by the New York Fed, to avoid the ban on interest. In this arrangement, a bank buys goods and sells them to a customer who then pays the bank at a future date and at a markup agreed upon by the bank and its customer. Another form of financing is known as mudaraba, under which investors might supply capital for a project while their bank provides the project with management. The bank and investors then share any profit or loss.

A consumer who wants to finance a new car under Islamic principles might lease it or agree to make a series of payments that total more than the sticker price. As with a loan, until the contract is fulfilled, the bank still owns the car. Just because the contract never refers to interest doesn't mean an Islamic bank can't make money.

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