5.5 Phase Eight: Interest-Free Islamic Banking (1970s–Present)
5.5.2 An Empirical Account on Islamic Banking
Modern Islamic banking, a system of banking compliant with Sharia, has been developing in the Islamic world for a number of decades. However, it has been the last 15 years or so that has seen it emerge as a noteworthy alternative to conven- tional banking. Over this period, there has been significant development in the range of and innovation in Islamic finance products, in banking as well as with Islamic mutual insurance, investment funds and syndicated finance. Together with greater religious leader and consumer understanding of Islamic finance, Islamic banking is now an established presence in many Islamic and non-Islamic markets.
Over that period, there has been strong growth in both number of providers and Sharia-compliant assets (SCA), with the latter reaching the $700bn mark at end of 2008.
From a global perspective, this has shifted Islamic finance from being a niche market to one that is attracting attention across the world due to its strong expansion and, with a potential global customer base of around 1.5 billion Muslims, one that still has very significant potential for continued growth. This has not gone unnoticed outside the Islamic world, and with much of this growth centered in the oil-producing and capital-rich Middle East region, a number of Western banks have started to look at the Islamic world as a potential source of funds and revenue opportunity.
5.5.2.1 Islamic Banking in Western Europe
The ascent of Islamic finance remains nascent in Western Europe, despite a sizeable Muslim population. Islamic finance remains a niche sector, serviced by only a few providers, particularly on the retail Islamic banking side. However, as the maturity of Islamic finance as an alternative banking offering has increased over the 15 years, many Western governments are now starting to take a more actively favorable view towards Islamic banking, seeing it as a means to more effectively service a significant minority community group. This is likely to drive a new wave of interest by incumbent domestic banks and entrants from Islamic markets into Western Europe. However, government support alone is unlikely to produce a step- change in the market and to assess whether this will drive Islamic banking from a nascent to emerging position the following areas needed to be considered:
• Development and structure of Islamic banking;
• Market potential and the extent of both latent and possible demand for Islamic finance across Europe;
• Regulatory, legal and tax barriers to Islamic banking and likely developments;
• Competitive dynamics and funding of future Islamic banking expansion;
• Impact of financial crisis and economic downturn on market development.
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A corollary of the variations in Sharia interpretation is that Islamic institutions compete not only on the financial attractiveness of a particular product, but also with respect to their Islamic credentials. Thus, within certain boundaries, there is a trade-off banks can select between Sharia strictness and structure/product innova- tion that banks can choose depending on country market, target customer base and competitive conditions. The main instance of this in practice is in organization structure/delivery model for provision of Islamic products. There are three main structures for this:
• Islamic window—this term is used to describe conventional banking institutions that offer Islamic products through their main distribution network (e.g. branches provide both conventional and Islamic banking products). Sharia restrictions around co-mingling of funds apply; thus funds, accounts and reporting needs to be maintained separately. This effectively means the Islamic window operates as a separate entity, but leverages the same infrastructure.
Although the practical implications of this (e.g. separate teller windows, busi- ness processing functions) do vary depending on Sharia interpretation. Given that processes and operations are shared (e.g. treasury and liquidity management is typically managed by parent company), Islamic windows are typically situated at the lower end of the Sharia compliance credibility scale;
• Islamic subsidiary—here a conventional institution operates a separate subsid- iary, so that the distribution and operational infrastructure is completely separate from the conventional bank. The Islamic product range will generally be broader than bank operating through an Islamic window. Typically only Islamic products are provided; although client relationships and risk may be managed across both conventional and Islamic side (e.g. corporate client may have relationship with conventional bank, but obtain Islamic products from the Islamic subsidiary).
Significantly, capital funding (at least initially) is provided by the parent com- pany, which would be regarded by some as not fully Islamic compliant, although steps can be taken (e.g. charitable donations) to purify the original funds;
• Full Islamic bank (pure or converted)—this would be a solely Islamic banking institution that operates as a standalone entity. This would offer just Islamic products and typically having a full range of products compared to an Islamic window. A pure Islamic bank would be capital funded and set up from Sharia- compliant funds, whereas a converted Islamic bank would be one that converted from a conventional bank operation into an Islamic bank. With a full Islamic bank all transactions within the bank need to be Sharia compliance; this would extend to treasury and risk management operations, with liquidity and risk management tending to look quite different for Islamic versus conventional banks.
A cursory view on Islamic banking in Western Europe would identify a number of primary markets. France has most significant Muslim population presence, both in terms of absolute population and also population density, housing close to half of Western Europe’s Muslim population. In terms of absolute population size Ger- many, the UK, Italy and the Benelux region are the other significant markets from a
potential Islamic banking perspective. Other countries, such as Denmark, Switzer- land and Sweden do have comparatively high Muslim population densities, but due to the size of their respective population bases contain a relatively small potential Muslim customer base.3
It should be noted that due to methodology differences and decennial timeframe for most census statistics, exact Muslim population figures are hard to verify.
Perhaps more significantly, migration movements (particularly illegal), as well as temporary travel movements, mean official figures understate the actual Muslim population in many countries.
Given greater size of Islamic populations in France and Germany, it may seem somewhat surprising that the UK is currently the most developed market in respect of the provision of Islamic banking. While this is partly driven by earlier govern- ment/regulatory backing, this is largely reflective of the background of the Muslim population itself, which drives the latent demand for Islamic banking.
As discussed, despite a potential attractive customer market to be developed in Western Europe, Islamic banking remains, to some extent, nascent. Based on Sharia-compliant assets (SCA), the UK does appear significant from a global perspective. However, this is based largely on HSBC Amanah, the main Islamic subsidiary of HSBC Holdings (headquartered in UK); while a top-ten global Islamic bank (based on SCA) its Islamic asset base is largely derived from outside the UK. It is important to note that HSBC Amanah operations have been phased out in the last 3 years after a strategic review according to the bank.
Additionally, much of the development of the UK has been based on the City seeking to establish itself as a leading Islamic center on the corporate & investment banking side. However, the main focus has been to use its financial expertise to service the Islamic world (particularly GCC states) rather than indigenous Muslim population. Thus, at best, on the retail banking side the Islamic sector could be described as niche within the UK, and dormant would apply to rest of Western Europe up to 2012. This started to change in 2015 and 2016 by the emergence new Islamic bank in Germany, such as KFH Germany and assest management and investment funds in Luxemburg.
On the retail banking side, the UK has led the Western European market in providing a legal and regulatory provision for Islamic banking. Retail Shariah compliant financial products did appear in the UK as far back as the 1990s (mainly around home finance products, e.g. Ahli United Bank in 1997), however, these were general uncompetitive in relation to conventional products and outside FSA bank- ing regulatory framework.
Consequently, little traction was obtained in the market. The market mode changed in mid-2003, with HSBC Amanah expanding its offering into the UK with home finance and a Shariah compliant current account through an Islamic window (i.e. HSBC UK distribution network), followed at the end of 2003 with LloydsTSB moving into the market (also through an Islamic window) with a focus
3Datamonitor, market opportunity report, 2009.
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on Shariah compliant current accounts (direct) and home finance, via an introduc- tion service relationship with Alburaq, a joint venture between Arab Banking Corporation International (ABC) and Bristol & West (Bank of Ireland). With two of the top UK high street banks pushing Islamic products through their nationwide branch networks, Islamic banking entered the mainstream market. Then 2004 saw the launch of the first retail Islamic standalone bank in Europe, the Islamic Bank of Britain (IBB), which offered a range of Islamic savings and financing products.
Since then a number of other standalone Islamic banks have entered the UK market, including the European Islamic Investment Bank in 2006 (currently Rasmala), the Bank of London and the Middle East, European Finance House (currently QIB UK) and Gatehouse Bank, although IBB remains the only standalone retail bank. There have also been a few other institutions offering Sharia–compliant products (e.g. Child Trust Funds) such as West Bromwich Build- ing Society, based on Children’s Mutual’s Islamic investment fund (also available through LloydsTSB) and Principle Insurance launched a Sharia based insurance offering (Salaam Halal) at end of 2008, based onTakaful.
5.5.2.2 Islamic Banking in the United States of America
Abdul-Rahman (2010) started a financial adventure with group of friends to provide interest-free financial products and services in the US. The project started with a modest beginning and kept growing to become the current American Finance House LARIBA.
It is interesting to find a book about Islamic finance written by a person from a chemical engineering background. However, the author also has a relative experi- ence of 22 years in the field of Islamic financial services as one of LARIBA’s founders. Contrary to what the book’s title would imply, the book does not offer a contribution about the art of structuring and developing the tools and techniques of Islamic finance. Rather, the author utilises his book to offer us an insight of the Islamic banking and finance in the US through his own experience which is an interesting one.
The author argues that Islamic finance and banking is a ‘community-based banking’model. This might be true in the context of the US, but that would not be the case with respect to the Gulf Region, Malaysia and other Islamic countries where the Islamic banking system is very dominant. This approach limits the Islamic finance and banking system to being viewed as a community-based banking rather a competitive financial approach. The author discusses in details the issue of interest (riba) and lending from cross-religious perspective based on the Judeo- Christian-Islamic values in light of the laws of America. Abdul-Rahman (2010) goes on explaining the steps to establish interest-free banking in the USA based on the LARIBA model highlighting different legal and financial challenges.
The author in his conclusion and vision for the future of interest-free banking suggests that, this model should only employ well trained bankers who believe sincerely in this model. He also recommends, based on his experience with Bank of
Whittier as an extended branch of LARIBA, to avoid the branch model of banking because it is costly without real benefit. Instead he believes that using internet and modern communication channels is the solution for the fixed cost approach of branches.