Islamic Finance is Booming

Edited by Elisabeth Eaves and Michael Noer

At least $500 billion in assets around the world are managed in accordance with Sharia, or Islamic law, and the sector is growing at more than 10% per year.

In spirit, Islamic finance seeks to promote social justice by banning exploitative practices. In reality, this boils down to a set of prohibitions--on paying interest, on gambling with derivatives and options, and on investing in firms that make pornography or pork.

No one can say for sure how many of the world's 1.3 billion Muslims will demand Sharia-compliant financial products, but if even a fraction do, the world's largest banks will be happy to oblige.

But just 20 men (and, yes, they are all men) are the gatekeepers to this lucrative realm. These are the top-tier Islamic scholars whose stamp of approval is required before the world's banks can market a new financial product as being consistent with Islamic law.

Why so few? First of all, it can take 15 years of studying Islamic law--and years more of financial training--before one can make a ruling with any authority. There are probably no more than 260 scholars, worldwide, that have the necessary knowledge. And only a handful of these have the combination of business savvy and linguistic skills needed to work with top-tier financial institutions like Citigroup (nyse: C - news - people ), Barclays (nyse: BCS - news - people ) or HSBC (nyse: HBC - news - people ).

"It's a limited specialization with limited practitioners, and even among the people with the specialization only a handful are suitable for working with international financial institutions," said Yusuf Talal DeLorenzo, a U.S.-based scholar who is one of the chosen few. "A passing knowledge of English is generally not enough when a scholar has to wade through hundreds of pages of a prospectus or legal documents."

Additionally, major banks prefer to--and in some cases are required to--turn to people who are already well established.

"Western institutions tend to go with big names who have been working with them and have built up a reputation over the past 15 or 20 years partly because their risk management systems require them to do so," explained Humayon Dar, chief executive of BMB Islamic, a London-based consultancy.

As a result, the top scholars can sit on anywhere from 10 to 40 "Sharia compliance" boards each. The limited supply of experts is reflected in their outsized compensation. Estimates of compensation for each board seat range from between $10,000 to $1 million annually, meaning top-tier scholars are likely earning eight-figure incomes.

"They are certainly pricey by reputation but they never talk about remuneration," said Joseph Connolly, professor of Islamic finance at the École Nationale des Ponts et Chausées in Paris.

The scarcity of scholars poses major ethical challenges, argues Connolly. While it is not entirely unusual in the U.S. for prominent corporate executives to sit on multiple boards, they are not spread nearly as thin as their Islamic scholar colleagues. By way of comparison, there are more than 50,000 directors of public companies in the U.S. Just over 200, or less than one-half of 1%, sit on six or more boards.

"If you are on the board of the bank that is bidding on a multibillion-dollar banking deal, which is being financed according to Sharia law, and you sit on the board of a competitor that is also bidding, there is a real concern about insider information," said Connolly.

So far the dearth of scholars doesn't seem to have held back growth of the industry. "The banks are using these scholars very effectively," said Connolly.

Specialized consultancies such as BMB Islamic and Sharia Capital have sprung up, which do a large part of the groundwork on the products and help banks liaise with the scholars.

But with Islamic finance projected to grow to up to $1 trillion within the next few years, according to McKinsey & Company, an American consultancy, banks are very aware of the importance of bringing in new scholars. "Banks would like to see the number of scholars double within the next year or two," said Connolly.

Rather than training new students in Islamic law, banks are pushing for finance programs targeted at existing Sharia scholars. Connolly will be launching a course in capital markets and treasury products, at the American University in Cairo, specifically targeted at Islamic scholars. The one-week intensive course will be held in Europe, most likely in Switzerland, this summer, with sponsoring banks putting up their own candidates. Connolly is expecting around 25 scholars to take part.

"We will explain complex financial instruments to them and we can leave it up to them to decide whether these are sinful or not," he said.

Source : Forbes.com

Finance the Islamic way at Michigan bank

By JEFF KAROUB and SEBASTIAN ABBOT
Big financial institutions have been battered by mortgages gone bad. But a tiny Michigan bank is getting attention in the industry by turning a profit on loans without even charging interest.

Its specialty: financial products that comply with Islamic law. That means no collecting interest, no short selling and no contracts that are considered exceedingly risky.
It also rules out some of the activity that got Western finance in trouble - subprime mortgages, credit default swaps and the like.

"When you look at the economic crisis we're in, if you were to follow Islamic or Sharia financing, you couldn't have this crisis," said John Sickler, corporate director for the bank, University Islamic Financial Corp. in Ann Arbor.

Islamic finance operations aren't prohibited from making a profit. Far from it. Instead, banks that comply with Islamic law, or Sharia, earn money from fees that are part of the cost of the loan, some paid up front and some over time.

University Islamic Financial has two types of financing, one called a marked-up installment sale and the other a lease-to-purchase sale. Fees in both cases are comparable to interest payments in traditional loans, bank officials say.

For example: A seller who bought a house for $100,000 could sell it for $120,000 or even $300,000, provided the buyer agrees it's a fair deal. The home could be sold on an installment plan negotiated by buyer and seller.

The bank is a subsidiary of Michigan-based University Bank, and its leaders say they have talked recently with executives from two national banks hoping to learn more about the business.
Islamic law says money cannot grow by itself, the way it does with compounding interest. Trade is acceptable as long as the equal amounts of money are traded or two different things are swapped with a fairly negotiated price.

So a dime for an apple would be considered "halal," or religiously acceptable, while one apple for two apples would be "harem," or unacceptable.

Even at University, not everyone is on board. Some customers have closed their accounts when they learned it was engaging in Islamic finance. Some employees who objected to the move quit. The bank also stopped having a Christmas party and no longer serves alcohol at after-hours events.

The Michigan bank focuses on contracts that clearly spell out the risk and reward between lender and borrower. University Islamic Financial says it's the nation's first to offer Sharia-compliant, federally insured deposits.

Islamic banking is more common overseas, but some U.S. banks and credit card companies are exploring the idea of branching out into Sharia products to reach out to the growing Muslim population.

So Islamic banking is only expected to increase in coming years. Already, Citigroup (nyse: C - news - people ) offers Sharia products and services to clients overseas, and Visa says it has worked with banks around the world to offer Islamic-compliant products.

The conventional banking system could learn a lot from the idea, said Jawad Ali, a finance lawyer based in Dubai and London who specializes in structuring Sharia-compliant deals.

"We haven't made as much money as the conventional banks because we can't, for example, sell what we don't own," he said. "We have to own it before we sell it. We may have missed out on gains in good times ... but we haven't suffered any losses."

Of course, there's no guarantee that banks will find immunity in Islamic finance from a severe global downturn.

"I am not doing banking on Mars," said Afaq Khan, the head of Saadiq, the Islamic banking arm of Standard Chartered (other-otc: SCBEF.PK - news - people ) Bank, based in London. "If real economic activity slows down significantly, the Islamic banking industry will also be affected."

A Sharia-compliant mortgage is like rent-to-own: There is no note, or mortgage, but typically part of each month's payment is held toward the ultimate purchase. The property is titled to an individual trust, or limited liability corporation.

Deutsche Bank (nyse: DB - news - people ) estimates total assets in the Islamic finance market at $1 trillion - a tiny fraction of global financial assets, but the bank said in a recent report that the sector been growing at a clip of 15 to 20 percent per year.

Most big international banks already have Islamic banking arms, and a November report by Moody's (nyse: MCO - news - people ) Investors Service shows that Islamic banks have been fairly resilient to the global economic downturn.

The U.S. banking industry has not embraced Sharia banking. Wachovia (nyse: WB - news - people ), Wells Fargo (nyse: WFC - news - people ) and JPMorgan Chase (nyse: JPM - news - people ) said they have not adopted Sharia practices and declined to comment about what they may do in the future.

"As far as the future, we are always looking for opportunities to better serve our customers, but our specific strategy is proprietary," Wells Fargo spokeswoman Lisa Westermann said.

University Bank President Stephen Ranzini declined to name the U.S. banks that University Islamic has talked to. But he said his bank soon plans to offer its services such as residential lending to other banks and credit unions nationwide.

Sharia banking is an idea "that is long overdue in this country," said Amal Berry-Brown, vice president at Comerica (nyse: CMA - news - people ), a Dallas regional bank that has talked with Ranzini. "At the same time, there really is quite a bit of work to be done."

Comerica has a strong customer base around Detroit, home to the nation's most concentrated Muslim population.

One issue: There is "a big variance" within Sharia law about exactly which financial practices are considered good and bad, said Mustafa Gultekin, a finance professor at the University of North Carolina at Chapel Hill.

For University Islamic, the niche appears to be paying off. Ranzini said he expects it to generate more than 25 percent of the overall bank's revenue this year, up from about 20 percent last year.

AP Business Writer Jeff Karoub reported from Detroit; Associated Press Writer Sebastian Abbot reported from Cairo; AP Business Writer Ieva M. Augstums reported from Charlotte, N.C.; and AP Business Writer Emma Vandore reported from Paris.

Source : Associated Press