Islamic banks

Due to the Islamic code of ethics, there has been a strong resistance to modern financial developments in many parts of the Muslim world, particularly in the Middle-East. Arab-owned banks only appeared in this region in the 1920s. The view that banks are foreign institutions serving the « infidels » still persists today in the mind of many devout Muslims with the consequence that only the more Westernized people use modern banking services.

Although a first bank to follow Islamic principles appeared in Egypt in the 1963 (the Misr Ghams Savings Bank, which became later the Nasser Social Bank), the concept of an « Islamic bank » was born at the Islamic Summit of Lahore in 1974 which recommended the creation of an Islamic Development Bank.

The underlying principle of banks and other financial institutions which define themselves as « Islamic » can be summarized as follows: there can be no riba, or interest, charged on any transaction or service as interest is considered as usury and is condemned by the Koran. Interest is replaced by a share-out key determined beforehand for a share of risks and profits between the borrower, the bank and the productive capital.

As Islamic banks are quite new, they submit all new types of transaction to a « Sharia committee » in order to check its conformity with Islamic principles. It must be said that these Sharia committees have become more and more flexible in their definition of what is acceptable for Islamic banking.

No Arab country, not even the most Islamic, has banned conventional Western banks, although they got to adapt to the prohibition on any interest payment in Saudi Arabia (in an apparent paradox, Saudi Arabia did not licence any Islamic bank dealing with the general public until 1982, as every bank in the country was already supposed to follow these principles…).

Four kinds of Islamic banks coexist now with conventional banks:

  • the Islamic Development Bank which was set up in 1975 and in which 44 Muslim countries participate, based in Saudi Arabia;
  • some banks – linked to the Islamic Development Bank – operating in some poor Muslim countries;
  • the national banks of some Gulf countries;
  • some international banking groups such as « Dallah Al-Baraka » and the « Al-Rajhi Banking and Investment Company » (both based in Saudi Arabia) or the « Kuwait Finance House » and « The International Investor » (both in Kuwait), the « Dar Al-Maal Al-Islami » Trust (Switzerland) and the « Faysal Islamic Bank » (Bahrain).

At the end of 1998, the total amount of deposits in the 200 Islamic banks, the three-quarter of which are in the Arab World, was evaluated at 140 billions US$. The importance of these banks is growing and they have rapidly developed in the Gulf where they account for more than 10% of total bank deposits. In terms of domestic market penetration, the most successful so far is the « Kuwait Finance House » which account for one-fifth of total bank deposits in Kuwait.

The assets under Islamic management are used in different ways. While the bulk of it is still used for leasing (« ijara ») and trade finance (« murabaha »), other activities are developing such as equity participation (« musharaka ») and profit and loss sharing partnership («  »mudaraba »).

Like the Islamic banks, Islamic management of equity funds is developing rapidly. While some 25 of these funds exists at the time of writing, they were only 5 in 1996. The total value of these funds is estimated between 1 and 3 billion US$. Consequence of this growing interest from Muslim investors, the first global Islamic stock index, the « Socially Aware Muslim Index » (SAMI), was launched in November 1998. It tracks stocks of 399 companies in which investment can be placed under Sharia law. A second Islamic index, the « Dow Jones Islamic Market » (DJIM) was launched in February 1999.

The main difficulty facing such indexes is the divergence of opinion between Sharia scholars about what is permissible (or « halal ») and what is forbidden (or « haram »). Two areas are easy to identify: the one covering clearly un-Islamic activities like production and trade of alcoholic beverage or gambling and the other one covering activities undoubtedly respectful of Muslim principles like Islamic banking. The problem is the very large grey area in-between and there is a tendancy to interpret Koranic proscription more and more imaginatively. Some scholars for example accept nowadays an ingenious system by which funds can cleanse income streams by donating to charities the proportion of these revenues originating from « haram » activities.