Is Islamic Finance the new challenge to Wall Street?
By Andrew Sheng
November 7, 2010, 10:30 pm TWN
I was in Kuala Lumpur in October attending the Global Islamic Finance Forum, organized by Bank Negara Malaysia and the Malaysian International Islamic Finance Centre. The whole glitterati of the Islamic world was here, and coincidentally, the HSBC Asia Board also held their meeting here, so it was also good time to catch up with all the Hong Kong good and great, including the incoming taipans at the Bank.
In the 1990s, Islamic finance was a fledgling fringe industry. But today, its size has grown from roughly US$150 billion to about US$1 trillion in size. This is of course still small relative to some of the largest global fund managers and universal banks, who manage more than US$1 trillion each. But the double-digit growth and potential size of the market cannot be ignored. Some pundits think that the market size will reach US$2 trillion within the next five years.
There are roughly 1.3 billion Muslims in the world, with 138 million in India and roughly 30 million in China. These are growing markets in terms of income and wealth. As the Muslim community seeks to invest in interest-free banking, Islamic funds have been growing in leaps and bounds. Today, there are roughly US$800 billion in Islamic banking funds, US$100 billion in the sukuk (or Islamic bond) market and another US$100 billion in takaful (Islamic insurance) and fund management business. Hong Kong, of course, introduced the Hang Seng Shariah Compliant China Index Fund in 2008 to attract Muslim investors.
As oil prices continue to remain at high levels, the Middle East oil-producers will continue to generate surpluses that must be parked somewhere. With the Western markets and economies under pressure, some of that money has moved Eastwards.
Will Islamic finance be a serious challenge to traditional Wall Street finance? That is a question that deserves a good answer.
First of all, thanks to the good work of Bank Negara Malaysia and the Gulf central banks, the infrastructure for Islamic finance has been laid, with the establishment of the Accounting and Auditing Organization for Islamic Financial Institutions (AOFFI), the Islamic accounting standards authority, the Islamic Financial Services Board (IFSB), the international Islamic financial regulatory standard-setting organisation and the Institute for Education in Islamic Finance (INCEIF). The International Shari'ah Research Academy for Islamic Finance (ISRA) also provides an invaluable website that is increasingly the transparent source for shari'ah interpretations on what is considered acceptable under Islamic law.
For people unfamiliar with Islamic finance, the basic principle of Islamic banking is the sharing of profit and loss and the prohibition of usury. Simply put, interest is prohibited, but profit sharing is not. A cynic can say that with zero interest rate policies adopted by advanced country central banks today, they are also practicing Islamic banking.
The distinctive elements of Islamic finance are its ethical element (the prohibition of usury and exploitation of the borrower), the preference for trading in real assets (rather than synthetic products), partnership between the investor and investee and its governance structure (requiring a Shariah council).
The point to remember in Islamic finance is that there is no Islamic global reserve currency. Although Islamic banks are growing rapidly, there is no assurance that they are not subject to the problems of non-performing loans and bank runs that are endemic in commercial banking.