The subprime crisis that peaked in 2008 has pushed the world economy into the deepest recession since the end of World War II. As doubts mount over the proper functioning of the conventional banking and finance industry during the crisis, growing attention is being given to Islamic banking and finance.
Headed by Iran, Saudi Arabia, and Malaysia, Islamic finance has penetrated more than 65 countries around the globe. By the end of 2013, Islamic financial assets were estimated to be around US$1.3-1.5 trillion.
Although Islamic assets are roughly less than 1% of global financial assets, their rapid growth, especially in Southeast Asia and the Middle East, and their superior performance during the crisis, have led many to believe that Islamic finance is a viable alternative.
The rapid growth of the Islamic finance can be seen in various regions of the world. To provide perspective and an overview of the Islamic finance industry, key developments of the industry for various regions are highlighted in this introduction.
Southeast Asia can be considered one of the key centers of Islamic banking and finance, with Malaysia being a leader. In Malaysia, the formal development of Islamic finance began with the establishment of Tabung Haji (an interest-free savings-like or deposit-taking institution for Muslims to perform Hajj [pilgrimage] in Mecca) in 1963.
The first Islamic bank in Malaysia, Bank Islam Malaysia, began operations in July 1983 with the passage of the Islamic Banking Act of 1983. In 1984, the government has enacted the Takaful Act 1984 to pave the way for the establishment of the first Takaful (Islamic insurance) company, Syarikat Takaful Malaysia.
Since then, the Islamic banking industry has seen the participation of conventional banks in providing Islamic banking services, initially through Islamic windows at banks and presently through Islamic bank subsidiaries as well as the establishment of new domestic and international Islamic banks. Aside from experiencing a rapid development of the Islamic banking industry, Malaysia introduced the Islamic money market in 1994 to provide an avenue for short-term investment based on Shariah (Islamic law), and it has made its mark in the development and issuance of Sukuk (an Islamic bond).
In 2012, the government consolidated various acts into two separate acts, namely the Islamic Financial Services Act (IFSA) 2012 and the Financial Services (FSA) Act 2012. Both acts came into effect on the 30th June 2013.
Neighboring Indonesia, which has the largest Muslim population in the world, has recently recognized the need to harness the Islamic finance industry’s potential. In 2012, Indonesia’s Islamic banking assets were US$17 billion, an increase of more than 50% from the previous year. Propelled by government support, Islamic financial assets in Indonesia are expected to continue their rapid growth. The republic is showing positive signs in Islamic retail banking, Sukuk, project and infrastructure financing, Takaful (insurance) and Islamic microfinance.
Currently, Indonesia houses five Islamic banks as well as 24 banks that have Islamic windows. With a population of 230 million, Indonesia has a huge market potential for Islamic finance.
Being the international financial hub of the region, Singapore is no exception to the development of Islamic finance. The most prominent developments witnessed in recent years were the 2007 inception of the Islamic Bank of Asia, a full-fledged Islamic bank, and the issuance of more than US$11 billion-worth of Sukuk in January 2013. Islamic finance has also gained prominence in Brunei with the presence of two Islamic banks and three Takaful companies. In Thailand, Islamic finance has developed to provide Islamic financial services to the predominantly Muslim population in the southern part of the country and the capital city of Bangkok.
The Middle East and North Africa
Islamic finance in the Middle East and North Africa (MENA) has become an important ingredient in these countries’ development agendas. The significant pressence of Islamic finance can be seen in various MENA countries. These include the UAE, Iran, Saudi Arabia, Bahrain, Kuwait, Oman, and Egypt. In addition, Islamic finance has made its way in Jordan, Morocco, and Tunisia.
The first Islamic bank was set up in the UAE when Dubai Islamic Bank came into being in 1975. Apart from Dubai Islamic Bank, there are now four other fully dedicated Islamic banks in the UAE: Sharjah Islamic Bank, Emirates Islamic Bank, Abu Dhabi Islamic Bank, and Dubai Bank. Conventional banks also offer Islamic products through either an Islamic window or a subsidiary. Several major Sukuk issuances originate from the UAE financial market as well.
Iran is one of the few countries in the world to have converted its entire financial sector to an Islamic system that governs the Central Bank of Iran. Iran is the world’s largest market for Islamic finance.
However, the Islamic capital market has not yet developed in Iran as it has in Malaysia and the Gulf Cooperation Council (GCC), a consortium of six Persian Gulf countries. Nevertheless, Islamic bonds have existed in Iran since 1994 in the form of so-called participation bonds issued by municipalities or large companies to finance projects.
Iran’s legal framework for Islamic banking envisages four types of deposits: demand deposits, which are interest-free loans to the bank; savings accounts; term deposits or investment accounts, in which the depositors share in the general profits of the banks; and, since 2011, special-purpose investment accounts, in which the investor or depositor restricts the use of funds to designated projects in which the bank is also an equity partner. Savings deposits receive some remuneration in the form of bonuses in cash or in kind through random drawing. The provisional remuneration of term deposits is set by the Money and Credit Council (MCC) each year with a view to ensuring reasonable funding costs.
Saudi Arabia’s Islamic banking is making good headway despite the fact that there are no separate Islamic banking laws in the country. There are two major players in Islamic banking in Saudi Arabia: Al Rajhi Banking and Investment Corporation and Bank Al Jazira. Conventional banks are also serving the Islamic banking clientele by establishing their own Islamic windows or subsidiaries. The Saudi financial sector comprises 14 commercial banks and five credit unions and holds assets worth more than US$20 billion. Islamic banking operations capture 64% of the total market share in Saudi Arabia.
In 1978, Bahrain Islamic Bank, the first Islamic bank for Bahrain, was established. There are 351 financial institutions in Bahrain, of which 33 are Islamic and have a total capital of US$2.24 billion. Islamic banking operations in Bahrain are undertaken by full-fledged commercial banks, offshore banking units, and investments banks. A significant number of Islamic banks use Bahrain as a base from which to operate in the Gulf states, the European Union, and North America.
Kuwait has been ranked third in the holding of Islamic banking assets; it is worth US$22.7 billion. The establishment of the Kuwait Finance House in 1977 laid down the foundation of Islamic banking in Kuwait. It has had great success over time and at present is successfully competing with 12 conventional banks and three specialized government banks in the Kuwaiti financial market.
Meanwhile, in Oman, as the result of a decree passed by His Majesty Sultan Qaboos in 2011, two fully-fledged Islamic banks and a number of conventional banks have already received licenses to start Islamic operations. The two Islamic banks, Bank Nizwa and Alizz Islamic Bank, went public in 2012, and several conventional banks have announced setting up Islamic windows.
Egypt currently accounts for about 9% of the Arab world’s gross domestic product (GDP), and its banking system is one of the largest in the region. Yet Egypt has hardly been involved in the recent expansion of Islamic finance, the most exciting development in Middle East financial markets for decades. In January 2013, the Egyptian cabinet of ministers approved a new draft Sukuk bill after Shariah scholars rejected a previous version.
Egypt now has 14 Islamic banking licenses but only three fully-fledged Islamic banks, including Faisal Islamic Bank of Egypt; Al Baraka Banking Group, headquartered in Bahrain; and Abu Dhabi Islamic Bank of Egypt. Despite several more lenders with Islamic finance windows, the approximately US$17 billion of assets in Egypt’s Islamic banking industry are dwarfed by Egypt’s conventional banks. Total assets of the entire banking sector are about US$198 billion, according to Egypt central bank data in 2012.
The Islamic Finance Handbook: A Practitioner’s Guide to the Global Markets by REDmoney; ISBN: 978-1-118-81441-3. Copyright © 2014 by REDmoney. Reprinted with permission of Wiley.”