Golden opportunity for $1 trillion Islamic banking industry

Now that the entire Western banking system has been exposed as a massive scam that has overcompensated bankers and defrauded shareholders, the $1 trillion Islamic banking industry ought to be coming into its own as an ethically based alternative. But the sector is not without its problems.

Yesterday the Governor of the UAE Central Bank, Sultan bin Nasser Al Suwaidi told the first annual World Islamic Banking Conference in Singapore that the two main challenges are standardisation of Sharia products and the short-term liquidity requirements of the Islamic banks.

Profits for whom?

He also pointed to the need for a ‘distinction between profit to shareholders and profit for investors or despositors, which is not a clear-cut issue at the moment. We need a standard formula to calculate profit in an equitable and fair way at all Islamic banks.’

Not having industry standards for Islamic products makes them more difficult to evaluate for borrowers and less easy to compare to the alternatives. Companies raising Islamic bonds or sukuks, for example, complain about the lack of standardized documentation.

Short-term liquidity also posed a challenge for Islamic banks in the global financial crisis. In the UAE the Islamic banks were the last to receive bailout cash from the UAE Central Bank due to the complexities of Sharia asset management.

Then there is the issue of what is a profit for a shareholder and what is the profit for a depositor. Under Islamic banking depositors are considered to own rights to a share in the profit of the bank, even though they have not actually bought shares in the bank like a shareholder.

Sharia compliance

However, these are all issues that can be addressed by bank regulators in friendly association with their counterparts in the Sharia boards. Much discussion will be necessary but a marriage of pragmatism and ethical banking should be a successful one.

Not that the Islamic banking world has emerged unscathed from the recent financial crisis. Islamic banks have traditionally been strong in real estate and that leaves a part of their money tied up in some assets now worth less than the value of the debt associated with them.

As the real estate sector gradually consolidates and amortizes its debts scandals may come to light. Only yesterday a civil lawsuit alleging a $500 million fraud was lodged against four Dubai Islamic Bank executives in a Dubai court.

Islamic banking does place the onus of trust on its bankers, perhaps encouraging a niave faith in its practitioners. That sort of trust can be compromised and lost. All the more need for the regulators to step in and turn this dynamic banking sector into something stronger for the future.