ISLAMIC banking is in fashion this year. A string of international conferences and a deluge of new investment products testify to the growing interest of Western institutions in the Islamic alternatives to conventional banking. Islamic finance is no longer perceived as exotic, but as a potentially lucrative niche that deserves everyone's full attention. As economic development and privatisation in many Muslim countries puts more assets into the hands of religiously, inclined investors, Islamic banking has the potential to attract a steady flow of new funds.
Recent events in three specific areas give an idea of the way Islamic banking is blossoming in the Middle East - healthy profits at the top institutions, plans by several international banks to set up Islamic units in the Gulf, and the launch of a number of new funds offering to invest according to the dictates of the Sharia.
The rise in profitability has been particularly striking at Al-Rajhi Banking and Investment Corporation, which emerged for the first time as Saudi Arabia's most profitable bank in 1995. Net profits rose by 27.5 per cent to SR 1,117.4 million ($298 million). Its total assets rose only 6 per cent to SR 30,662,6 million ($8,177 million). Founded in 1987, Al-Rajhi is the fifth biggest of the kingdom's 12 commercial banks in asset terms and the only one dedicated to banking that is compatible with the Sharia.
Elsewhere, Kuwait's only Islamic commercial bank, Kuwait Finance House (KFH), reported a rise in gross profits of 44 per cent to $253 million. The bank's assets rose 8.9 per cent to $4,651 million. KFH is ranked third among Kuwaiti banks in terms of assets. The bank was assigned investmentgrade credit ratings by Moody's Investors Service, the US ratings agency, which says its strong position in the Kuwaiti market could be threatened if another Islamic commercial bank is launched in the emirate.
Faysal Islamic Bank of Bahrain (FIBB) did less well in 1995, reporting a 22 per cent fall in net profits to $12.6 million. FIBB, which is part of the Geneva-based Dar Al-Maal AlIslami Group, has interests in Islamic banks in Pakistan in addition to its Gulf businesses. Its total assets fell 11.7 per cent to $368 million in 1995. However, the bank has bounced back in the first quarter of 1996 according to unaudited results, with a 121 per cent rise in net profit to $3.3 million.
Indigenous banks are not being left alone to monopolise the potential rewards of Islamic banking, however. Three conventional banks have announced plans to set up Islamic units in the Gulf this year. Some of these new subsidiaries will be banks in their own right. In upgrading their Islamic banking business and bringing it under one roof, the parent banks appear to be positioning themselves to take advantage of a market which is not only growing, but also becoming more competitive as local Islamic banks get more skilled at investment banking.
Among the new developments, the US' Citibank plans to launch its own whollyowned Islamic banking subsidiary this summer to be called Citi Islamic Bank. The new bank will have its own separate capital base of $20 million.
Bahrain-based Arab Banking Corporation (ABC) also plans to start up an Islamic subsidiary with paid-up capital of $35 million. One of its main aims will be to offer products that supply short-term liquidity to Islamic banks, which are barred as a matter of principle from borrowing at interest on the conventional interbank market. This area is currently covered by two ABC subsidiary companies.
The Dutch ABN-AMRO plans to set up an Islamic banking division as part of its offshore banking unit in Bahrain. In a slightly different field, Russia's Mezhkombank has floated the idea of an Islamic bank designed both to serve the needs of Russia's Muslims and to channel Arab investment funds into southern Russia. The proposal, announced in Babrain in April, appears to be at an early stage.
The expansion into the Islamic market of big conventional banks with their huge asset bases and worldwide networks might pose a potential threat to indigenous banks. But some bankers argue that familiarity with the terrain gives the local banks an advantage. 'Islamic institutions can compete on their own territory with international institutions,' one Western banker involved in Islamic finance says. However, he also notes that the entry of the big banks into the Islamic sector has caused some unease in the Gulf.
'The most serious competition is going to be from 100 per cent devoted entities - that is, new Islamic entities rather than international operators,' says Adnan al-Bahar, managing director of The International Investor, an Islamic finance house based in Kuwait. 'To these guys (the international Lanks) it's just a side business, and you never excel in a side-business.'
Yet, it is the newcomers as much as the specialists who are tackling some of the thorny issues thrown up by an industry that roscribes certain activities. Islamic banking as a modern industry only dates back to the 1970s, and a problem in the past has been a shortage of investment opportunities. This year has seen the launch of a number of investment funds guided by Sharia principles that attempt to correct this deficiency. The funds are not expected to raise large sums at first, but their creation indicates the growing interest in the possibilities of Islamic fund management.
Two London-based merchant banks with a history of involvement in Islamic banking have launched their own investment products. Flemings launched its Oasis equity fund internationally in February, following up with a UK launch in May. Oasis, which has so far raised about $7 million, is an umbrella fund which will invest in onenended sub-funds targeting equities around the world. The first sub-fund will buy into stocks in developed economies while a second sub-fund, still being developed, will be aimed at emerging markets.
The second of these funds was set up by Kleinwort Benson, a pioneer in the area of Islamic investment funds in the 1980s, in partnership with Bahrainbased Islamic Investment Company ot the Gulf. The Al-Meezan fund will invest in commodities, principally base metals because their prices tend to move on basic supply and demand factors rather than on speculation. The fund hopes to raise at least $25 million.
Al-Tawfeek Company for Investment Funds, a unit of the Jeddah-based Dallah Albaraka Group, has set up its own Islamic equity fund that it hopes will raise between $150 million and $200 million. Stock selection will be managed by US firm Roll & Ross Asset Management, while Tawfeek will supply the Islamic expertise for the fund.
At the end of last year, Faysal Islamic Bank of Bahrain launched two Islamic investment vehicles to operate within the Gulf and is now working on an open-ended global equity fund.
Islamic banking as a whole is expected to be a growth area in the next few years, driven by economic growth and liberalisation in Muslim countries in southeast and south Asia, as well as the Middle East. Governments in these countries are as also looking for new sources of funds to pay for development and the emergence of a vibrant Islamic banking sector with assets to invest could assist this objective.
There are still many hurdles for Islamic bankers to overcome, not least the need to work out exactly what the Sharia will allow as global banking as a whole becomes more complex. Yet with most Muslim deposits still invested in conventional banks, the possibilities for the expansion of Islamic banking are enormous.