ISLAMIC BANKING

ISLAMIC BANKING

INTRODUCTION:

The evolution of Islamic banks from their modest ancestry in the early 1970s into a multi-billion dollar industry has been unprecedented in modern financial history.  Not only has Islamic banking been identified as a potentially lucrative business of rising importance in our primary markets, but the surge of interest in Islamically acceptable financial instruments has also encouraged conventional banks, including those in the west, to vigorously take part in the Islamic banking system.

Despite the significant expansion of the Islamic banking market, supported by the innovative financial engineering, to include almost all conventional banking products, which were adapted to comply with the Islamic law, there is still a huge pool of untapped assets in Muslim countries and among Muslim minorities in Europe, the Far East and the USA.

This study is intended to evaluate the expected benefits to the Arab Bank group via venturing into the Islamic Banking line of business in view of the strategic direction of the bank. 

THE MARKET:

The size of the global Islamic banking market, comprising the financial and capital market sectors, is now estimated between US$ 150 – 200 billion, with more than 200 Islamic financial institutions, managing funds about the same size, and spreading in over 50 countries.  For much of the past decade, this market has experienced a growth rate exceeding 15% p.a., outstripping that of the conventional banking industry.

The latest available official statistics on this market are as follows:

US$ Million

While the number of Islamic banks has increased by more than 76% between 1993 and 1997, their assets have increased by three folds.  The total deposits of Islamic banks are now valued at approximately US$ 150 million.  Deposits of the Islamic banks operating within the Gulf region do account for 10% of the total banking deposits.  In Kuwait, Islamic institutions have successfully managed to capture 20% of the domestic deposits market.

The Islamic banks’ consolidated net profit for 1996 stood at US$ 1.7 billion, a figure which excludes sizeable returns realized by Arab and western conventional banks that also invest in accordance with Islamic law.  This gave a return of 23% and 1.24% on capital and total assets in respective terms, which compares favourably with conventional banks.

Trade financing, which captured 32% of Islamic financing in 1997, continues to be the most popular sector due to the high volume of trade within countries of the region in addition to the relatively short term nature of this form of financing.  The real estate sector appears to be the sector gaining higher momentum and popularity.

The assets under the Islamic banks’ management are used in different ways.  While the bulk is still used in Murabaha (trade finance), which is attributed to the short tenor of the transaction, other activities are rapidly developing, such as Musharaka (equity participation).

BUSINESS LINES (PRODUCTS):

Although a whole range of Islamic products, that are comparable to those of the conventional banking system, is available, only few products have proved to be popular and are widely used by Islamic banks.  This can be attributed to the short term nature of deposits at the Islamic institutions in addition to some technical difficulties embodied into a number of Islamic modes of finance.  This in fact reflects very high potentials for the Islamic institutions that are capable of developing and structuring new Islamic banking products.

Some of the major Islamic products, available to Islamic institutions, can be outlined as follows:

³      Murabaha (mark up or cost plus financing).

³      Mudaraba (profit or loss sharing financing).

³      Musharaka (equity participation finance).

³      Ijara (leasing).

³      Istisna’.

³      Islamic funds.

³      Muqarada.

³      Commercial products (L/Cs, L/Gs, … etc.).

CLIENTS:

The potential client base for Islamic banking is any individual or institution, including corporates, with an interest in Islamic banking products.  High net worth individuals, who reside within the Gulf region and own approximately US$ 800 billion, do represent a targeted group of customers for the Islamic banks’ funds.  Retail clients, on the other hand, are gaining more magnitude and share of the Islamic banking customer base.  In all cases, some clients have a strong desire for Islamic banking products due to religious reasons, while others deal in such products for the purpose of diversifying their financial products and services and / or acquiring other indirect benefits; i.e., taxes … etc.

GEOGRAPHICAL DISTRIBUTION:

The Middle East and the Arabian Gulf region constitute more than two thirds of the Islamic banking market.  The assets growth rate of Islamic banks has outstripped that of the conventional counterparts during the 1990s in light of the booming demand for Islamic banking facilities, especially within the GCC states.

The client base of Islamic banks is not confined to Muslim countries alone, but is spread all over Europe, the Far East and the USA, evidenced by the geographical distribution of these institutions.