Getting Started

Well, better late than never. At least that’s the sentiment of some of Lebanon’s top bankers, eager as they are to satiate an increasingly ravenous global and local appetite for Islamic Banking (IB) services.
Indeed, as with so many aspects of Lebanon’s socio-economic maze, the country’s relatively late entry to the IB trend is puzzling, if nothing else.
We host many of the leading banks in the region, we are routinely ranked as the top country for Human Resources recruiting, and Gulf investors, typically the ones most interested in conservative investing, have long made Lebanon a second home of sorts – both financially and from a tourism perspective.
Moreover, according Jamil Jaroud, Deputy General Manager at Lebanon’s Arab Finance House, an estimated seven billion dollars in deposits is potentially available from Lebanese who want to invest their money here according to Sharia principles.
“This industry should be very crucial to the Lebanese economy,” said Jaroudi. “In other words, if there wasn’t something called Islamic Banking then we should have invented it to help bring capital and partnerships into the economy… After all, this is what most Lebanese companies need.”
Nevertheless, as it currently stands, the central bank (BDL) only recognizes one fully functional IB: Islamic Credit Libanais.
And while there are two other contenders, AFH and Al-Baraka bank, both of these institutions have yet to be licensed as IBs – although the bulk of their services already adhere to IB principles.
According to Pierre Kanaan, who is heading up BDL’s legal effort to expand Islamic Banking, the reason why Lebanon hasn’t fully joined the estimated $250 billion (and growing) global Islamic marketplace is mostly due to one factor: the law.
Although banks here can competitively conduct some IB transactions for their customers under the current Fiduciary law, IB’s prohibition against charging interest, among other Sharia principles, necessitates a wider use of contracts  – a fact that often moves IBs into a different and less competitive class of activity under the law.
One prominent example of this, cited by Jaroudi, is when AFH wants to do business with certain sectors of the economy that receive state subsidies, such as healthcare.
Although regular banks here can benefit from an interest rate subsidy, in effect, when lending to hospitals, AFH is not permitted to do so under the current law because such deals are structured without interest. Instead, the transaction gets considered as a merchant transfer: Equipment is purchased for the hospital by the IB who then benefits from the profit margin that it charges the hospital.
Of course, in the meantime, that margin is reduced by the state subsidy that the hospital is unable to obtain because of the nature of the deal.
An even greater barrier to Islamic Banking in Lebanon is double taxation.
Because a transaction may be regarded as a merchant transfer, both the IB and the ultimate buyer, the client, must pay the VAT.
Crunch the numbers in either of the cases and you’ll see why IB has been largely throttled in the domestic market.
As Jaroudi put it, ““why would anyone want to do business with us?”
To top it all off, the current banking law, even as it was modified last year to allow greater IB activity, does not allow a Lebanese bank to simply open an IB window.
Instead, the entire bank must be licensed as a separate entity, necessitating a separate Sharia audit committee, separate tax structure etc. – a costly procedure, in any case.
While BDL has issued a number of circulars over the past year and a half, allowing more attractive capital to deposit ratios, for example, there is only so much it can do without Parliamentary action.
Unfortunately, even as over a dozen banks are said to be preparing IB licenses (and at least three foreign banks already have approached BDL for branch licenses), there still has been no action to consider a number of draft laws that might put IB on an even competitive playing field with conventional banking.
The story of IBs seemingly meteoric rise dovetails, at least on its face, with that of the oil-driven region.
As it is usually told, three decades ago IB got off to a slow start in the Gulf, prompted by the needs of conservative investors who did not want to invest in certain prohibited activities and who wanted to respect Islam’s prohibition against interest rate taking.
Of course, that’s not an entirely faithful way to tell the story (pardon the pun).
As one seminal IB publication put it in 1997, “Although the western media frequently suggest [sic] that Islamic banking in its present form is a recent phenomenon, in fact, the basic practices and principles date back to the early part of the seventh century.”
Nonetheless, the sector did lie mostly dormant until the late 1990s, when the industry began to take off as a result of a confluence of factors: Pent up oil wealth, an increasing focus on adhering to Sharia principles and, most importantly, a new breed of educated Sharia experts who were deeply familiar with both Islam and modern banking structures.
“The industry is growing so fast because the scholars now are connected,” said Jaroudi.
“Not to undermine previous scholars… but the previous ones may not have known, and would have ruled a certain instrument was haram, perhaps because of a lack of knowledge. It was better for them to stay no than yes.
“The modern scholar goes and researches the fatwa, and says yes you can do this under this school of thought. This is what has pushed the industry forward in the past few years.”
And indeed, pushed forward would be something of an understatement.
Further buoyed by the post 9/11 environment that prompted regional money to stay put, the industry is now a $250 billion market (in terms of assets), having grown by an average of 15 % each year over the past decade, according to one leading Lebanese Bank who is currently surveying the marketplace.
There are now 265 IB institutions worldwide in 60 countries, though 2/3 of Islamic funds are from the Middle East.
Led by Malaysia and Bahrain, among others, total deposits now total $202 billion.
Islamic equity funds, of which there are now 125, have grown an average of 25 % each year for the last 7 years. Islamic Bonds too are estimated to be worth between $25-30 billion, a market that has nearly doubled over the past few years.
And finally, in a clear sign of its arrival on the banking scene, it is now anticipated that Islamic finance will be responsible of managing 40% to 50 % of total Muslim wealth (3 trillion USD) worldwide by the 2010-15 period.
Even the US Department of Treasury has gotten on board, recently appointing an IB Scholar in Residence who will spearhead the regulatory changes necessary to introduce IB to the American market.
“There are two important things when it comes to IB,” Jaroudi explained. “The contract must be structured according to Islamic principals and second, you should have the intention that you are adhering to sharia,” that your deal is ethical throughout.
As a result, “you become a partner in the operations more so than the conventional bank,” a fact that often raises the due diligence costs, not to mention certain risk factors.
“Any delay,” Jaroudi said, “in repaying an IB causes us to lose the opportunity cost of the money… With conventional banks, if you are late, you accumulate interest for the delay on top of the interest you owe.”
He added that AFH was able to get a ruling from the Sharia board that permits collecting penalties from clients who have delayed payment intentionally.
The amount, however, goes to charity, not the bank.
“It’s kind of like building a society. There is no remoteness between the money and the outcome of it.”
Despite the apparent difficulties, according to Kanaan, the BDL expects that between 12 to 15 banks will indeed apply for IB licenses shortly.
Although he was unable to predict how many of these applications would ultimately be successful, he noted that the BDL has wide authority to grant such licenses – after all, the law says that a potential licensee must yield a “public benefit” as well as meet any and all legal requirements.
“I am convinced that it will have a good impact to try to develop this sector, to make some exemptions in this area,” said Kanaan.
“But we have to deal with these issues [such as double taxation], which demand a law.”
Although he added that the prohibition against window operations would continue, Kanaan did say that at least a few more circulars regarding IB regulations would be issued in the coming months by the BDL.
Of course, if the IB sector in Lebanon, not to mention the world, is to develop, its Human resources must grow – and fast.
Recognizing this, Lebanon’s Ecole Superior des Affaires recently unveiled a new training program in Islamic Finance.
According to Ahmad Barghout, ESA’s administrative and financial manager,  “ESA is always looking for new things. We launched a feasibility study and found that we can contribute to this industry on the HR development level.
“HR is the key here,” he added. “Everything starts from the HR level.”
As a part of its effort, at the end of March ESA launched a foundation for research in Islamic finance that aims to provide business cases and applied research to the industry. Through its educational programs, ESA will also soon offer a module in Islamic finance as a part of its Masters in Finance, possibly as early as October 2005.
“We don’t need repetitive seminars with the same people,” Barghout said. “ And two days is not enough. We need practical applications… We need to understand the ways of thinking which are completely different from regular finance.”
By assembling a retinue of junior experts – approximately 8-10 people, ESA is positioning itself to become what Barghout said would be a “hub for Islamic finance on the HR level.
“Look, if you have the whole structure but not the human assets you will fail, that is certain.”