Point of View: Innovations in Islamic Finance

Dr Humayon Dar, Dar Al Istithmar

The explosive growth in the Islamic banking sector over the last few years may soon be replicated in the insurance sector. NewHorizon talks to Dr Humayon Dar, CEO of Dar Al Istithmar, a subsidiary of Deutsche Bank group that provides Shari’ah consultancy services.

The huge demand for Shari’ah-compliant financial services has created innovative service offerings from the Islamic banks. Nowadays, credit cards, car loans and mortgages are all available to private individuals while investment products, many based around the sukuk and investment funds of different types, are available to wealthy individuals and corporate bodies.

The housing market, in particular, has seen tremendous growth according to Dr Dar. Until recently, banks did not offer mortgages to individuals but the liberalisation of the financial market has meant that these products are now available and Islamic mortgages are becoming very popular. Housing markets across the world have expanded but the demand for Islamic home finance has been even further fuelled by the growth in the emerging Muslim economies, particularly those of the Gulf Cooperation Council (GCC) countries.

Dr Dar thinks the positive image that the availability of Islamic financial services sends to the rest of the financial world is enhanced by Islamic scholars working closely with Western bankers in London, New York and elsewhere. There is evidence that wealthy Muslims tend to invest in Shari’ah-compliant financial products when investing locally, although they may be prepared to invest in conventional banking products when investing overseas.

There is nothing religious about Islamic banking – it is a structure that is used to differentiate between halal and haram products.

Some of the devices used to support Islamic products differ from country to country. In response to the rise in demand for credit cards, Islamic banks in different countries have created different models to replicate the economic effects of conventional credit cards. In Malaysia, for example, Islamic credit cards can be supported by the bai al-ina or buyback sale. In this the bank and the client buy and sell a piece of land between them with the difference in the buying and selling prices being used to provide the credit limit on the credit card.

This is the model used by Bank Islam Malaysia Berhard, the largest Islamic bank in that country. In the Middle East the more popular contract is the tawaruq which is similar to the bai al-ina but there are three parties involved in the buying and selling of the underlying asset: the bank, the client and a third party often found through the general marketplace.

In the UAE, credit cards are often provided as a fee-paying service with no underlying transaction. Banks provide different classes of card – gold, platinum, etc. – based on the client’s income with different fee brackets based on the type of card.

The explosive growth in demand, and the fledging nature of the Islamic financial market means that, as yet, not all business areas are fully serviced. An example of a relatively difficult area is the Treasury Operations function within a bank or large corporation. According to Dr Dar these money market operations are an ‘Achilles’ heel’ of Islamic banking and are a rather more complex area in which to achieve compliance.

In conventional banking circles a bank with excess liquidity will lend to another bank through inter-bank loans. To achieve the same function while still being Shari’ah-compliant, most Islamic banks will use a commodity murabaha. In this both banks instruct a commodity broker – bank A will instruct the broker to buy, say, $100 million of commodity and sell it to bank B on a deferred payment basis. Bank B retains the funds obtained from instructing the broker to sell the commodity for cash on the open market. Repayment occurs at a predetermined frequency agreed by both banks. The sukuk is becoming more prominent in this market, particularly those issued in Malaysia and Bahrain, and this area may present future innovations.

Islamic banking so far has not shown an explicit responsibility towards the community in which it serves so possibly this will be the next step – the emergence of banks that are genuinely socially responsible.

Dr Dar feels that the real growth area is occurring in Islamic insurance or takaful which until recently has been a relatively untapped market. Some analysts think that this sector may prove to be bigger than Islamic banking.

Part of the demand for these products is in response to directives from financial institutions. If an individual obtains financing from a bank for a car or a home, the bank makes it compulsory to obtain insurance. Some of the large Western banks are aggressively entering this market. For example, HSBC Bank Malaysia Bhd has announced that in the next two years it aims to at least double the amount of insurance products used by its existing customers. Currently, around 30 per cent of its customers use insurance products.

The reinsurance market, where insurance companies spread the risk among specialist underwriters, may also present a growth area. Although there are four or five small Islamic reinsurance companies, it is still largely dominated by conventional insurance organisations.

The emphasis in Islamic banking up until now has been on the Shari’ah compliance aspects and whether the underlying contract complies with the law. This is not necessarily ethical banking though, explains Dr Dar. There is not much similarity between Islamic finance and ethical investments or socially responsible investing.

Ethical banking has more of a Western influence. As an example, the Dow Jones screening for Shari’ah-compliant companies includes companies that are doing prohibited business, such as making or distributing alcohol, or casinos. But there are others which are strange from an Islamic point of view such as tobacco or the defence industry. ‘There is no consensus in Islam about tobacco,’ says Dr Dar ‘but Islamic funds will not invest in tobacco because it is considered unethical – an inference that has come from Western influence’.

Dr Dar feels that the next big event in Islamic banking may be what some people refer to as ‘real’ Islamic banking. The existing attempts to conduct business in a Shari’ah-compliant way could be called ‘halal’ banking rather than Islamic banking. There is nothing inherently Islamic about the operations of Islamic banks. They are simply doing business in compliance with Islamic law. Islamic banking to some people implies a social responsibility.

‘Islamic banking so far has not shown an explicit responsibility towards the community in which it serves so possibly this will be the next step – the emergence of banks that are genuinely socially responsible,’ says Dr Dar. ‘Co-operatives and mutuality have gone out of fashion in the UK but it is something that is needed in some countries.’ Dr Dar goes on to say that ‘there is nothing religious about Islamic banking – it is a structure that is used to differentiate between halal and haram products’.

After such an explosive growth period in Islamic banking, it may be time to pause for reflection while the insurance sector takes up the financial expansion.

Source: New Horison - Islamic Perspective on Banking and Insurance