Syria’s embryonic Islamic banking sector is up and running. In late 2007 the country’s first two sharia-compliant banks opened to the public and a further five have received preliminary licenses and are in the process of setting up shop. All are hoping to tap the finances of a population increasingly keen to express its Muslim identity in the last country in the MENA region to liberalize its banking sector, and the early indicators suggest they will find much success.

Cham Bank became the country’s first Islamic financial institution in August 2007 when it opened its services to the public from its branch and headquarters in Damascus. The bank, a $108 million joint venture between a number of key investment firms from Kuwait, Saudi Arabia and Syria, reportedly took $100 million in the first six months of operations.

The Syrian International Islamic Bank, a $108 million venture between Syrian and Qatari investors, opened to the public in mid-September and was the only Islamic firm to have published audited figures by the time of this publication. At the end of 2007 — after two and a half months of operations — the bank recorded assets of $254 million and customer deposits of $84.1 million. The bank had a total investment portfolio of $31 million. As an Islamic institution, SIIB does not extend credit but shares the investment risk with its clients.

SIIB general manager Abdel Qader Dweik said the bank had taken $261 million in deposits from its two branches in Damascus and Aleppo at the end of March 2008, its first six months of operations. “The results have exceeded all expectations and we plan to expand considerably throughout 2008,” Dweik said. “We feel the country is ready for Islamic banking services.”

SIIB’s end of year figures provide the first indicator of the potential market size of Islamic banks in the Syrian market. The figures are impressive when compared to traditional banks such as the Syrian Gulf Bank which began operating around the same time and recorded deposits three times less than the SIIB at $26.5 million and loans of $12.4 million.

Untapped market

Independent analysts have predicted Islamic banks could eventually snare up to 50% of Syria’s banking market. “There is a gap in the market that can only be filled by Islamic institutions,” Abdul Kader Husrieh, general manager of Ernst & Young Syria, said. “That gap is large and has waiting to be filled for some time now.”

A further five Islamic banks have been licensed and several will commence operations this year. These include Bank of Baraka-Syria, a $108 million venture of the Bahrain-based Al Baraka Banking Group; Dubai Islamic Bank, a $216 million venture in partnership with the state-owned Real Estate Bank; Noor Financial Investment Company, a $216 million venture being backed by the Kuwait-based Noor Investment Group and the Pakistan-based Meezan Bank; Tadhamon International Islamic Bank, a $108 million affiliate of the Yemen-based Hayel Saeed Anam Group and the Global House Group of Bahrain which recently outlined plans to launch Syria’s largest Islamic bank with a capital of $540 million in partnership with a number of large financial institutions from the Gulf and several Syrian businessmen.

On paper, Islamic banks have a number of advantages. Unlike sharia-compliant institutions in other countries, Syrian firms are entering the market at the same time as their commercial rivals, allowing them to sidestep the challenge of having to promote a relatively new concept in competition against well established commercial firms — a challenge Islamic banks in neighboring Jordan and Lebanon have struggled to overcome. Syrian authorities have also granted Islamic banks a wider range of investment activities than their commercial rivals, including being able to enter as partners into trade, industrial or other ventures. Given the difficulties commercial firms have experienced in providing long term credit, being able to act as an investment partner opens up new lending opportunities commercial firms can not access.

Challenges to growth

Not that it is all smooth sailing. Like other Islamic financial institutions around the world, public awareness about Islamic products remains low. A lack of qualified staff also looms as a major hurdle for Syrian firms. To put in place a long term remedy, Cham Bank has approached a number of universities in Syria in a bid to see them add sharia-finance courses to their business and economic faculties.

The higher cost often associated with Islamic banking also looms as an obstacle. While the newest members of Syria’s private banking sector say they plan to unveil competitive products, the experience in other countries has been one where customers have had to pay a premium for banking services that are deemed legitimate under Islamic law. Whether price-sensitive Syrians will be willing to do so remains to be seen. “What part of the Syrian personality is more dominant,” Jihad Yazigi, editor of The Syria Report, asked. “Is it their religious side or is it their trading side?”

With Islamic banking gaining momentum throughout the Middle East, questions about its regulatory framework are increasingly asked. Executive interviewed Dr. Ahmad Jachi, First Vice-Governor of the Central Bank of Lebanon and Chairman of the Islamic Banking Committee, about the issue.

E What is the view of the Central Bank on regulating Islamic banking in Lebanon?

The duty of the Central Bank is to safeguard the currency, economic stability and basic structure of the banking system as well as the development of the monetary and financial market. Therefore, the bank’s approach to the regulation process resides in creating a level playing field for a sound and stable Islamic financial system, one that is viable and well integrated in our financial system.

E What is the legislative framework for Islamic banks in Lebanon?

The promulgation of Law 575 in 2004 allowed the Central Bank’s Central Council to license Islamic Banks in Lebanon. The Central Bank started by establishing a special Islamic banking committee, chaired by its First Vice-Governor. This committee is in charge of defining the regulatory framework for Islamic banks. It outlined the banking, financial and other activities that were to be provided by Islamic institutions and set the ground rules for the protection of depositors and customers as well as the preservation of an adequate level of liquidity and capital. The commission examined the standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and reviewed the Islamic banking legislation and practices in several countries in order to gain from their experiences before setting proper practices in Lebanon. Commission members were in majority part of the Central Bank staff.

E What is the regulatory framework for Islamic banks in Lebanon?

In Lebanon, only fully fledged banks are allowed to operate in the field of Islamic finance, if they have a minimum capital of $20 million and a share value of $100. Islamic banks provide all banking, commercial and investment services and operations, including the establishment or participation in new or ongoing ventures. Deposits have a minimum term of six months and are protected by the deposit guarantee law. Investments and placements in Lebanon must account for at least for 50% of the bank’s total assets. The Central Bank has also stressed the establishment of a Corporate Governance Committee, whose primary responsibility is to safeguard stakeholders’ interests. Islamic banks will also be monitored by an independent sharia auditor and will have to publicly disclose their sharia board annual report. In addition, Islamic banks will have to feature monetary and special reserve requirements on deposits and investments.

E What is the role of the Sharia Supervisory Board (SSB) and what is the background of its members?

The Sharia Supervisory Board is usually comprised of scholars versed the interpretation of Islamic law and its application within Islamic financial institutions. The role of the SSB is to ensure and certify that all contracts and agreements related to the institution’s financial transactions are sharia-compliant. In Lebanon, each Islamic bank will have its own Sharia Supervisory Board, which usually consist of three scholars specialized in sharia who have deep knowledge of financial and banking operations. This consultative body reports to the respective board of directors and the general assembly.

E Do Arab central banks do oversight on sharia-compliant products?

There is no unified practice among the Arab central banks vis-à-vis the centralization of SSBs. Countries like Bahrain and Sudan have established centralized SSBs, which in turn supervise the SSBs of Islamic banks. Other countries, like Lebanon and the UAE, do not have a central SSB. Moreover, there is no standardization regarding the supervisory authority’s model. Some countries have created a separate supervisory authority drawn on the FSA model overseeing Islamic banks’ operations, such as in Lebanon, Bahrain and Sudan, while in others, like Saudi Arabia, the supervisory authority is still part of the central bank.

E How are Islamic products usually benchmarked? Is this done from a perspective of absolute returns or risk-adjusted returns?

Islamic financial instruments co-exist with conventional financial instruments in an open market structure governed by demand and supply. Although sharia-compliant finance is centered on return on investment rather than on interest rate, the competitive forces in an open market would eventually mediate between both systems to create a level playing field and hence comparable ‘rates of return’. Islamic banks are faced with the same classes of risk and risk exposure as their conventional counterpart. Credit risk, market risk, operational risk and legal risk are inherent to any financial operation regardless of its nature, whether conventional or Islamic. However, IFIs are faced with some additional types of risk such as reputation risk and sharia-compliance risk. Displacement risk — as a result of lower yields given by the Islamic banks as compared to the conventional ones — is also important for IFI stakeholders.

E How are the different Islamic funds structured to comply with sharia principles?

In order to be sharia-compliant, investments need to go through a set of conditions or filters. The main filters are related to the company’s business activity, whether or not it is in accordance with sharia requirements, the interest component of company revenues, whether the company borrows and lends frequently on interest basis and the leverage of debt to equity and whether the sale and purchase of shares is backed by debt.

The role of any fund’s Sharia Supervisory Board is to screen and accept asset classes underlying the investment vehicle, which is usually done twice a year. For instance, the SSB of the Dow Jones Islamic Fund has developed a two-step process whereby companies are subject to both an industry and a financial screening. The industry screening rejects companies dealing with non-sharia-compliant products and services such as alcohol, pork, defense, pornography, entertainment, insurance and conventional banking.

The financial screening excludes companies with unacceptable levels of debt or interest income and is subdivided in three applied filters. Companies excluded are those with a total debt divided by trailing 12-month average market capital greater than 33%. Investment is also prohibited in companies whose sum of cash and interest-bearing activities divided by trailing 12-month average market capital is greater than 33% or whose account receivables divided by total assets are greater than 33% .

E Doesn’t the prohibition of speculative behavior in Islamic finance contradict the basic principles of financial investment?

It is true that gharar, which is translated to ‘speculation’, is prohibited. However, the true meaning of gharar is any element of uncertainty in any business or contract. This is quite different from financial speculation as we know it. Therefore, I do not see any salient contradiction between financial speculation and sharia.

E What about prohibition of riba? Aren’t Islamic financial products usually more expensive than conventional ones?

In some cases, structuring new Islamic financial products entails relying on the expertise of lawyers or sharia scholars. This may account for the incremental fee faced by investors or depositors who pay the price of an added level of expertise.

E How is due diligence implemented on the different Islamic instruments?

Islamic financial instruments are in general asset-based or asset-backed. The intermediary role of an IFI is to ensure the financial prudence necessary to preserve its depositor’s investment. Due diligence for IFI is mainly done on utilizations and sources of funds. It takes into consideration the quality of the client and project at stake, its inherent risks and default probability, as well as, the liquidity and quality of the underlying asset. The IFI should inform its stakeholders of the placement target of their funds, the expected rate of return and tenure along with any change in the investment portfolio. Profit calculation, allocation and distribution schemes should be clearly disclosed, besides the SSB qualification of the investment scheme.

E Are there any special ratings for Islamic financial products and how accurate are they?

Some of the Islamic financial institutions as well as Islamic products such as sukuk are currently rated by Moody’s, S&P and Fitch. The different types of liabilities are being addressed by the different rating types. For instance, Moody’s bank ratings comprise the Bank Financial Strength Rating (BFSR), the baseline credit assessment, the local and foreign currency deposit ratings. Fitch and Moody’s do not believe, however, that a separate rating methodology or rating scale is needed as they deem their rating criteria and methodologies flexible enough to cover the specificities of sharia-compliant issuers and issues. It is worth noting that their analysis does not extend to whether or not a transaction, security or issuer is in compliance with the sharia. The Islamic International Rating Agency (IIRA) is the single institution that offers in addition to credit rating, sharia quality rating and corporate governance rating.

E Do you think that the Islamic financial market is at risk of facing a crisis comparable to the subprime one?

Investment share of the Islamic financial institutions in the structured products is very negligible; therefore their exposure to the current subprime crisis is very limited.

E What type of growth are you forecasting for Islamic products in the next year?

Fueled by the oil boom, the Islamic finance industry witnessed in the past decade a strong growth rate varying between 15 to 20%. While investors request liquidity, capital protection and profit on their investment, some investors are also seeking sharia compliance as well. The industry is currently driven by a high demand, exceeding the supply, and there are no signs that this trend will slow down as witnessed in the sukuk market boasting a compound annual growth rate of 121% from 2001 to 2007. Additionally, some 150 Islamic funds and funds of funds are available in the GCC and global market with a total capitalization of $10 billion as of 2005. All indicators seem to point to a faster expansion of the sector as through financial engineering, new contracts can be designed in compliance with gharar and riba prohibitions. Moreover, many Western banks and fund managers are entering this new field, relying on their financial acumen and the sharp know-how of strategic asset allocation.

Until 1956 Sudan was a British colony, and its banking system was designed in the English style. The first foreign bank branch operated in Sudan was the National Bank of Egypt in the year 1903. Barclays Bank followed in 1913, the Ottoman Bank came in 1949, and Misr Bank and Credit Lyonnais arrived in 1953. The National Bank of Egypt branch had been carrying out the duties of a central bank in the Sudan up to independence. From 1956 to 1960 the Sudan Currency Board took over the responsibilities of local currency issuance. The central Bank of Sudan was established on February 1960. During the 1962-69 period, a series of national commercial and development banks were established. In 1970 the foreign bank branches and foreign companies in Sudan were nationalized. Three years later, some foreign bank branches were allowed to operate again in Sudan such as Abu Dhabi Bank in 1976 and City Bank in 1978.

That year also witnessed the establishment of the first Islamic bank in Sudan, Faisal Islamic Bank, which had been licensed under a special act. Then a series of Islamic banks started to emerge, such as Tadamon Islamic Bank, the Sudanese Islamic Bank, the Islamic Cooperative Development Bank and Albaraka Bank. In September 1983 Islamic sharia rule was applied on all transactions and this led to the banks’ Islamization program. In 1984 the general laws of transactions were amended, especially Article 110 prohibiting all receiving or paying of interest.

The previous conventional developments in the Sudanese banking system segued into pure Islamic banking. Islamic banking as a concept was developed as a result of the religious prohibition on the payment or receipt of interest. The conventional banking system was considered by Islamic sharia scholars as a type of usury.

Sudan’s Islamic banks apply all typical Islamic financial instruments. The relationship between the Sudanese Islamic banks and the international foreign banking systems is based on normal corresponding and agency arrangements. The strongest links are with the international Islamic banks, mainly in Bahrain, Malaysia, Jordan and the Gulf. The Sudanese Islamic banks do not mix the received interests from the international conventional banks with their budget accounts, but instead donate it to social needs within the country. The Sudanese Islamic banking system is applying Islamic bank ratios as dictated by AAOIFI and Basel 1 and 2 requirements.

Dr.Isam El Zein El Mahi is the General Manager of Khartoum Stock Exchange

Islamic banking and finance has clearly found its home in the Gulf. The region leads the industry by housing two thirds of global assets, worth roughly $350 billion. Also, the world’s leading Islamic financial institutions are all headquartered in the Gulf states and they routinely export their business model to Asia, Europe and Africa. Ninety percent of incremental retail-banking production in Saudi Arabia is Islamic, but Bahrain acts as the regional hub for Islamic finance. This is largely because the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is based in Manama.

However, despite Bahrain’s role as a hub for Islamic finance, with 28 Islamic banks based in the island state, the market share for Islamic banks in the country is only 7%, according to a recent report by Moody’s. The other surprise in the study is that Oman is a Gulf state with no Islamic banks.

A closer examination of the regional sharia-compliant scene reveals that the largest Islamic commercial bank by total assets is Saudi Arabia’s Al Rajhi Bank, with more than $28 billion in assets. Second in line comes the historic Kuwait Finance House at $21.8 billion, followed by Dubai Islamic bank with $17.5 million.

Future Trends

It will be important to watch Noor Islamic Bank, based in Dubai. Started as a project of Sheikh Mohammed bin Rashid al Maktoum, Noor’s ultimate goal is to become the largest Islamic bank in the world. It only recently launched with ten branches in the UAE and intends to follow an Emirates Airlines model in order to solidify the market base, including a significant focus on customer service and innovative products.

When asked when Noor will break into the regional banking scene, a senior official at the bank remarked that this is confidential, but added: “I can say that whenever we are feeling very strong in the UAE, then we will look to the outside.” Considering who is backing the project, this will probably not take very long and one can expect an aggressive, regional Noor very soon.

Another bank to watch is the Abu Dhabi Islamic Bank, the second largest Islamic bank in the Emirates. ADIB recently entered the Egyptian market with the purchase of a 51% stake in Egypt’s National Bank for Development for $28 million. This was a bold move considering the poor reception Islamic banking is receiving in Egypt at the moment. Five years ago, a ruling by Mohammed al-Tantawi, one of Egypt’s highest-ranking Islamic scholars, essentially permitted earning a fixed amount of capital on an invested principle, largely seen as allowing interest. The move has been a large contributor to the crippled pace of development of Islamic finance in the country.

However, despite the current poor climate, the potential for Islamic banking in Egypt is huge, and one should expect more moves from Abu Dhabi Islamic Bank into Egypt, possibly in the form of a buyout.

A recent Middle East Business Intelligence report said it best, when it opined, “If Abu Dhabi Islamic Bank can make a success of offering Islamic products, the whole market will open up. We have already seen some of the local banks start to advertise their Islamic products in view of the competition for customers they see about to begin.”

Clearly Islamic banks in the Gulf are already anticipating the day when their home markets are saturated. And it appears that Egypt will be on the next front-line in the development of regional Islamic banking and finance.

The Islamic banking sector’s phenomenal growth in recent years has not been universally welcomed. Among some powerful and influential circles in the West, particularly the United States, there is an assumed association between the increased financial capacity of sharia-compliant financial institutions — with the roughly $500 billion in wealth currently under sharia-compliant management expected to grow to $2.8 trillion by 2015 — and an increased ability for those who follow radical interpretations of Islam to fund terrorist operations.

In April 2008 the Center for Security Policy (CSP) — a Washington, D.C. based organization describing itself as specializing in identifying policies, actions, and resources “vital to American security” — launched a national campaign to counter what the group describes as the “serious risks” sharia-compliant finance poses for US financial institutions “and the national security of the United States of America.” In CSP literature its President, Frank Gaffney, warned that “US financial institutions and businesses engaged in sharia-compliant finance may have criminal and civil exposure on the grounds of securities fraud, consumer fraud, racketeering, antitrust violations, material support for terrorism and aiding and abetting sedition.”

Among CSP directors, advisers and staff are R. James Woolsey, former head of the CIA, former and current congressmen and senators, high-level staffers at the White House, the Defense Department and Congress and numerous other US government departments, while during the past several months CSP said it briefed the U.S. Treasury, members of Congress, the Securities and Exchange Commission, law enforcement personnel and others on its legal memorandum regarding sharia-compliant finance.

Analyzing the risk

Is sharia financing such a threat to West? Are mechanisms within the Islamic banking system any more at risk of being used to finance terrorism than conventional banking methods?        

“The easiest way in which a terrorist group can move funds around is through the conventional banking system,” said Ganesh Sahathevan. The Australia-based counter-terrorism financing expert has researched extensively the support structures of terrorist groups in Southeast Asia and their links to Jihadist networks globally, and explained that services conventional banks have developed to better serve customers — correspondence banking, internet banking, Automated Teller Machines (ATM) able to access funds through worldwide banking networks, etc. — are conveniences that make the work of terrorism financiers easier as well.

He pointed to the example of Saudi millionaire Yassin al-Qadi, who Sahathevan has been tracking for several years and who is also a “Specially Designated Global Terrorist,” according to the U.S. Treasury, for his financing of al-Qaeda and other extremist Islamic groups.

“Two companies within his group — a futures trading company and a stock broking company — had wire arrangements with Clearstream Banking of Luxembourg,” explained Sahathevan. “There’s no evidence that money had been transferred, but had Yassin al-Qadi wanted to transfer money through to anyone in any part of the world, he could have easily used these two entities, and no one would have known because no one would have been looking.”

Another example he gave is of Malaysian-owned MBF Bank located in Tonga — a tiny South Pacific island — with only two known overseas branches in Rangoon, Myanmar (Burma) and Pyongyang, North Korea. MBF Bank also happens to have a correspondence banking arrangement with Bank of Wachovia in the US. “So it becomes extremely easy for someone in Pyongyang or Myanmar to circumvent all sanctions — deposit the money in Myanmar, and through Tonga, it gets transfer to the banking system in mainland US. And who would know? It would be simply lost in the daily transactions.”

Where Islamic banks may have a greater propensity for facilitating the financing of terrorist groups comes at the level of ownership, said Sahathevan, as “an Islamic bank is more often than not owned by Muslim shareholders who have a desire to promote Islamic banking as a form of Dawa [the prorogation and promotion of Islam].” And among those who believe in the promotion of the Islamic way, there are some for whom this may also include Jihadist leanings, “so then a bank in the ownership of shareholders who already have that inclination, it becomes an obvious tool through which to move funds through the international banking system [for terrorism financing].”

According to Jean-Charles Brisard, an international expert on terrorism financing, a characteristic unique to Islamic banking often cited as a means used to finance international terrorist operations is zakat. He described it in a report prepared for the UN Security Council as “a legal alms-giving required as one of the five pillars of Islam on current assets and other income… [and] takes three forms, depending on its recipients: feesabeelillah (in the way of Allah), lil Fuqara (for the poor) and lil Masakeen (for the needy).”

The first form of zakat — feesabeelillah — is money spent in fighting for the cause of God (jihad), where jihad can mean struggling for personal purification (i.e. becoming a better Muslim), social betterment, or armed struggle — i.e. “Holy war” — actual physical combat waged in self defense or in fighting oppression.

“There is a clear distinction between the Koran’s concept of a defensive Jihad and the usurped form of offensive Jihad developed by several scholars [mostly followers of the Wahabbism doctrine of Islam]… justifying zakat for un-legitimate violence against peaceful nations,” noted Brisard.   

Zakat past to present

Before Islamic banking, zakat would typically have been collected by the local imam or mosque, said Sahathevan. Given their localized base, these amounts of money remained relatively limited, and would typically be used towards local projects such as schools or orphanages, though small amounts could have ended up supporting violent Jihad.

“Once you have a banking system feeding into zakat, then it becomes quite different, because there you’re talking of a very large sums of money… feeding into zakat, and then the zakat can be distributed by that very same banking network,” explained Sahathevan, pointing out that once the money leaves the banking system through distribution to charities — which can then distribute it to other charities both locally and internationally — it becomes nearly impossible to trace. Should money originally earmarked for buying Qur’ans or building religious schools in Pakistan be diverted once it arrives to an al-Qaeda training camp across the border in Afghanistan, no one would be the wiser.

In Saudi Arabia alone, where zakat is enforced by law and levied much like a general taxation across the entire economy, figures from the early 2000s estimated total zakat funds even then at $10 billion annually. While the vast majority of this was undoubtedly spent in benevolent pursuits, it takes only an extremely small percentage of $10 billion to fund a major terrorist organization, as Brisard estimated pre-9/11 al-Qaeda revenue at $50 million annually — of which, interestingly enough, 90% was spent on organizational infrastructure, such as communication, networks, training facilities and protection, while only 10% was spent on operations, such as day-to-day money, terrorists attacks planning and execution.   

According to the US Department of State, since the 9/11 terrorist attacks American authorities have initiated a broad range of measures to counter terrorism financing including: designating some 400 individuals as “linked to terrorism” and freezing their US-based assets, passing counter-terrorism financing legislation at home and prompting the UN to adopt the Convention for the Suppression of the Financing of Terrorism; pushing the Financial Action Task Force (FATF), an inter-governmental body consisting of 32 countries, the European Commission and the Gulf Cooperation Council to expand and revise its mandate to

include counter-terrorism financing, while pushing for the formation of the Middle East and North Africa Financial Action Task Force (MENA-FATF) in 2005 — consisting of the 320-member Union of Arab Banks and governments across the Arab world.

By many accounts however these efforts, among others, have done staggeringly little to stem the flow of funds to terrorist groups.

“It is continuing unabated,” said Sahathevan. “No doubt people are more aware of it, there’s more discussion about it, more regulations, and certainly there have been some convictions in some places… but by and large it continues unabated.”

Lax regulation

Brisard said that the “MENA-FATF initiative has proven efficient in identifying the legal and structural weaknesses in the fight against terrorism financing. But many countries… still lack proper regulations and tools, as recently pointed out by the FATF.” He noted a number of Gulf countries have not ratified the UN anti-terrorism financing convention, while other 87 countries still had not criminalized terrorism financing by the end of 2007.

In particular Brisard named  Kuwait, Pakistan and Saudi Arabia as countries that “have failed to take legal action to prevent the misuse of charitable and other nonprofit entities that can be used as conduits for the financing of terrorism, while weak implementation of regulations is a cause of concern as to the potential for the financing of terrorism through the misuse of charities.” An example of this Brisard pointed to is the Saudi High Commission for Charities, announced in 2002 to oversee Saudi charities with foreign operations, yet six years on it is still to be formally established.

“At the same time, countries such as the UAE, have taken several important regulatory and conventional steps with the banking sector that obviously go in the right direction,” he adds.

Among the other difficulties in cracking down on terrorism financiers is the ability they have developed, especially in the case of al-Qaeda, to make and move money through legitimate, recognized financial institutions and businesses to fund illegal activities. This largely distinguishes terrorism financing from money laundering, where money is made through illegal means, then moved through businesses and financial institutions — both legitimate and fraudulent — to make the money appear “clean” for use in the normal economy.

And perhaps therein lies part of the reactionism motivating groups like the CSP against sharia-compliant financing and Islamic banking: not only have the huge amounts of resources poured into counter-terrorism financing efforts since 9/11 been relatively ineffective, but terrorist networks are showing incredible aptitude at using the same capitalist structures America and the West were build on to fund Jihad against the West.  

“By integrating themselves into the Western financial structure, proponents of this doctrine can essentially shield from regulatory mechanisms the transfer of millions of dollars in zakat, or charity payments, from wealthy Middle Eastern radicals to violent and/or subversive organizations in Europe and the United States,” wrote the CSP November 2007 in literature from it’s Sharia Risk Project. The CSP followed that statement with one that highlighted what may be the fear at the group’s core: “Advocates of sharia’s financing believe that they may have found an indirect way to begin imposing their obscurantist code upon the free peoples of the world.”

Assets managed within Islamic banking and finance are massive and growing rapidly in both monetary and geographic terms. In Sudan, Saudi Arabia, Iran and Malaysia, Islamic banking is the premier form of financial transaction. The industry also has a niche presence in the rest of the MENA region and many other countries around the world are toying with the idea of sharia-compliant banking.

On a technical level, analysts often separate the sector into four separate segments: commercial Islamic banks, investment Islamic banks, takaful institutions and Islamic finance houses.

But Abdel-Maoula Chaar, the Islamic finance project manager at the Beirut-based Ecole Supérieure des Affaires, applies what he considers a more important dichotomy. Chaar believes it is more helpful to view the industry in terms of “Islamic banks versus sharia-compliant banks.” He suggested that Islamic banks, like Dubai Islamic bank, have a moral underpinning to their operations. Banks of this nature tend to hold all of their products and actions under the microscope of sharia.

On the other side of the equation are sharia-compliant banks. Most of the time the big Western banks with Islamic windows, like Citi Islamic and HSBC’s Amanah, receive the attention in that category. Nevertheless, this group also includes conventional banks based in Arab countries, like the Arab Bank for Investment and Foreign Trade (ARBIFT). ARBIFT was established in 1976 as a joint venture between the federal government of the United Arab Emirates, the Libyan Arab Foreign Bank and Banque Exterieure d’Algerie. Reflecting the era in which it was born, the bank initially had a strong Arab unity character and the establishment stressed promoting the collective ownership of Arab capital funds in the international financial markets. This has, however, recently begun to change.

Just this year ARBIFT changed its name to Al Masraf. Furthermore, the bank has been steadily increasing the number of Islamic financial products it offers with an eye to capturing part of the growing Islamic finance market. According to Saeed Khan, Head of Corporate Banking at Al Masraf, the bank started offering sharia-compliant products in 2006 as “we had to cater to our customer’s needs. Our clients in the emirates were asking for Islamic products.”

He added that “the launch of Islamic products has yet to touch the corporate sector and that within the retail division Islamic products represent just five percent of the portfolio.” It seems that the most popular type of Islamic product at Al Masraf is murabaha. When compared to the counterpart conventional car loan offered by the bank, the products are almost identical. The repayment period is flexible up to 72 months, no down payment is required and there are no processing fees.

When one compares the cost, however, discrepancies appear. The conventional car loan interest rates start at 2.99%, while the profit rates for the vehicle murabaha start at 4.25%. The 1.26% difference in cost is significant when tacked on to the sticker price of a new car. Perhaps this factor is keeping interest in the bank’s new Islamic products low.

Khan said the existence of conventional, interest-earning products next to the newly established Islamic ones does not bother the bank’s customers. Khan said that his customers have “no concerns over the presence of both products,” and that this is normal in many banks in the region. Furthermore, he implied that the bank’s sharia-compliant offerings would only grow, saying that “Islamic finance is the future of banking” in the region.

Regulation

The Islamic banking and finance industry is predominantly regulated on the national level. In addition to the in-house sharia supervisory boards present in most Islamic financial institutions, those entities are also obliged to follow the standards set by the advisory board of their respective national central bank. The industry, and its strongest central bank supporters, have also recognized the importance of international regulation and have formed two strong self-regulatory bodies: the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB).

According to a handbook published by the Securities and Investment Institute, based in London, “AAOIFI is the autonomous entity responsible for the formulation and issuance of accounting, auditing, ethics, governance and sharia standards for the international Islamic banking and finance industry.” Despite the overarching and unifying image accorded to AAOIFI, the organization itself recently fell pray to the ubiquitous growing pains of the Islamic finance world.

Late last year, Sheikh Muhammad Taqi Usmani, chairperson of AAOIFI’s advisory board, declared 85% of sukuk to be un-Islamic. The specifics of the statement were not immediately clarified, throwing Islamic investors and institutions into a panic. After three months of debate, the organization issued a statement saying that any financial product with a buyback clause was un-Islamic because this effectively eliminated the risk-sharing aspect of the investment, a necessary part of sharia compliance.

The advisory board also declared that, in order to be considered Islamic, sukuk must be asset-backed, and not merely asset-based. This development will make things difficult for CFOs, as they will be forced to adapt to new structures. Under the new ruling it appears that those original 85% of sukuk are still un-Islamic and it is likely that the market will now bifurcate under the pressure of the ruling, with half of the investors adopting new asset-backed products, while the other half pursues new structures. The organization has taken a lot of heat for the ruling and AAOIFI’s leadership is reticent on the topic.

In an interview with Executive, Dr. Khairul Nizam, AAOIFI’s Assistant Secretary General, was quick to note that the standards of the body are five-fold: accounting, auditing, governance, ethics and sharia standards. Nizam stated, our “sharia standards have been adopted by most of the world’s Islamic financial centers. And in fact, all Islamic banks in the world follow our sharia standards.”

However, when asked about the AAOIFI ruling that would effectively make 85% of sukuk un-Islamic, Nizam took a different tack, saying that, “Although our standards are used by almost all of the banks around the world, each bank also has its own sharia supervisory board and has to decide for itself. And this may vary as different products are designed for different markets… We are part of the finance industry and we have to work with that industry.”

Given the massive amounts of capital at stake and the relative youth of the industry, more sukuk-style episodes are likely in the future. It is also likely that regulatory authorities will come under immense pressure to make the ‘right decision’ when it comes to controversial products.

All this is bound to make the future developments of Islamic financial product regulation a challenging and exciting process.