HONG KONG (Reuters) – The global credit crisis presents the $1 trillion Islamic finance industry with an opportunity to expand its appeal beyond devout Muslim investors as a haven from speculative excess.
The message may have particular resonance in the West after the collapse of the U.S. mortgage market left banks holding hundreds of billions of dollars of nearly worthless credit instruments tied to home loans by a web of complex structures.
While conventional banks are nursing losses of more than $400 billion from the credit crisis, Islamic banks are virtually unscathed. The industry is playing up the contrast to scalded shareholders, bondholders and borrowers and fearful depositors.
“It’s very much a return to old fashioned conservative lending,” said David Testa, chief executive of Gatehouse Bank plc which began operations in April as Britain’s fifth Islamic bank.
“The current global market condition has given Islamic finance a great opportunity to show what it can do — help to fill the liquidity gap,” he said.
There is some merit in the argument.
Investors traumatized by the global crisis may seek comfort from the stricter rules imposed on lending by Islamic law, banning certain structures and funding methods which fast unraveled during the U.S. mortgage crisis.
Testa said Islamic finance practices were more fiscally conservative, with genuine end-investor participation that did not involve parking of assets in off-balance-sheet vehicles.
“They don’t allow infinite leverage and the structure that you will be seeing increasingly will be tied ever more closely to underlying assets. This is the right time for Islamic finance to spread its wings,” he said.
Islamic finance is based on the sharia or Islamic law. It requires that gains be derived from ethical and socially responsible investments and frowns on interest-based banking and sectors such as pork, gaming and pornography.
The Asian Development Bank estimates Islamic assets globally aggregate around $1 trillion with annual growth of 10 to 15 percent a year.
Saudi Arabia’s Al-Rajhi Bank 1120.SE and Kuwait Finance House are the two biggest Islamic banks in the Gulf region. Malaysia’s biggest Islamic lender is Maybank Islamic Bhd, subsidiary of Malayan Banking Bhd.
The jump in popularity of Islamic finance is drawing the interest of companies outside the Middle East.
Southeast Asia’s second-largest developer, City Developments, said last week it may launch Islamic debt and sell hotels to boost its financial prowess to make acquisitions.
The Islamic finance industry, which was nearly non-existent 30 years ago, has certain distinguishing features which makes it less risk-prone, analysts say.
Islamic bonds, or sukuk, replace coupons with payouts backed by tangible assets. Islamic law prohibits the payment of interest and requires transactions to be linked to assets, thus deterring the kind of complexities prevalent in conventional financing.
“The really complex products like CDO squared, which has such a remote link from the asset that you can’t tell when it is defaulting, can’t happen in Islamic finance because debt cannot qualify as an asset,” said Dubai-based Debashis Dey, head of capital markets with law firm Clifford Chance LLP.
He added that while Islamic finance was adapting conventional products to make them shariah-compliant, it was a long way from sophisticated products such as collateralized debt obligations.
“The complexity of trying to adapt even some straightforward conventional products like securitized products is daunting enough, let alone trying to think of a CDO,” Dey said.
NOT IMMUNE FROM RISK
But while Islamic products are coming into favor, analysts say market commentators and intermediaries may be too zealous in promoting the merits of Islamic finance as a safe-haven product.
Mohamed Damak of Standard & Poor’s cites the case of the Gulf’s boom in real estate financing mainly by Islamic banks in the past three years amid soaring property prices.
“A correction of the real estate sector would impact Islamic banks involved in this business line. Islamic finance is not immune from risk,” he said.
Even as experts are weighing the degree of insularity that Islamic finance provides, there are differences in the way accounts are prepared and in how sharia law is interpreted.
Banks in Britain differ in their accounting operations from banks in Bahrain, for example, which in turn differ from banks in Malaysia and Indonesia.
Clifford Chance’s Dey says the lack of standardization poses a hurdle to growth, but there are others who say a cookie cutter approach is not desirable and differences will remain.
“Complete standardization may not happen — there will always be variants,” said Raj Maiden, managing director at Five Pillars Pte Ltd, who feels it is more important to tailor products according to the needs of each market.
“Let us not try to design a product that will sell in every market. Some standardization may be required but it may not be an absolute hindrance to growth.”
While the debate rages on whether Islamic finance provides a safer bet or is merely an object of irrational exuberance, most agree it should leverage on the attention it is receiving now.
“If Islamic banks step up to the mark, then they will gain traction,” said Gatehouse’s Testa.