Banking On Faith

By HELENA BACHMANN

On the ninth floor of the Seef Tower in Manama, the small, opulent capital of Bahrain, the Noriba Bank offers its well-heeled clientele a wide range of financial services, from portfolio management to leasing. From its offices you can see the city's famous Al Fateh mosque. The proximity is significant, because even though Noriba, which opened in September, is wholly owned by Switzerland's largest bank, UBS Group, it is the only Western bank in the Gulf that insists that all of its services adhere to the strict letter of Islamic law, known as Shari'a.

Compliance is neither easy nor cheap. The law, which derives from the Koran, covers all areas of Islamic life, including management of financial affairs. Pious Muslims are not allowed to invest in industries that have ties to tobacco, alcohol, weapons, pornography or pork products. Since the law prohibits banks from charging or paying interest, Noriba and other Islamic Financial Institutions (ifis) instead make money by using a system based on the sharing of capital gains or losses.

But even with post-Sept. 11 suspicions that Islamic banks may fund terrorist organizations, demand for the services of ifis is on the rise from the towers of Bahrain to the streets of London. Indeed, they represent one of banking's hottest sectors. A recent report by Standard and Poor's found that the growth rate of Islamic banking services outpaced that of conventional banking during the past decade. "Most observers agree on an annual growth rate of 10%," says Anouar Hassoune, a Standard and Poor's analyst in Paris. "Total assets now managed by ifis are close to $300 billion, while Islamic equity funds and off-balance-sheet investment accounts are conservatively estimated between $15 billion and $30 billion." Taken together, that's roughly the equivalent of Russia's gross domestic product.

No wonder Western banks are eager to capitalize on this lucrative market. While Bahrain's Noriba is operating exclusively under Shari'a principles, several others — HSBC, Citibank, Commerzbank and BNP Paribas — provide Shari'a-compliant services along with conventional ones. UBS won't disclose its projected future profits in Bahrain. But Noriba ceo Toufic Kanafani says, "If we didn't see the potential for Islamic banking, we wouldn't have opened this bank. The demand for competent Shari'a products and services is growing continually."

Until the 1970s, banking in the Islamic world was largely confined to the informal hawala system, under which money was transferred through brokers without leaving a paper trail. The system came under scrutiny when it was linked to the al-Qaeda network around the world. But around 1975 Muslim nations in the Gulf and Asia, aided by the Islamic Development Bank, an organization fostering economic and social development in the Muslim world, started to offer Islamic financial services. The banks' first customers were modest families running small businesses. Over the past decade ifis gradually increased their global reach; most customers are small and medium-sized enterprises, Hassoune says.

With the majority of ifis based in Asia and the Gulf region, Shari'a-friendly financial products for small businesses and middle-income individuals are only beginning to catch on in Europe. One exception is Britain, where Islamic banking — including investments, mutual funds and other share-buying options — is rapidly expanding to serve the country's estimated 2.5 million Muslims. The United Bank of Kuwait (UBK) introduced Shari'a home-purchase plans in Britain in 1997; in the past three years it has sold some 600 of its Ijara plans (see illustration) and now approves about 30 a month. Shorof Uddin, a 27-year-old forensic accountant, is awaiting his home-purchase plan approval with UBK. Before learning about Shari'a-compliant mortgage alternatives six months ago, he took out a traditional mortgage to purchase an apartment in East London; now he's switching.

But there's a hitch. In order to avoid paying interest, the property must change hands twice — from seller to the bank and from the bank to the customer — which means two sets of stamp duty to be paid to the U.K. government. In Uddin's case, switching will cost him an additional j7,900 in extra stamp duty and penalties. But he remains undaunted. "Shari'a mortgages cost a lot but it's worth paying the price," he says.

Unless the double taxation is eliminated, Shari'a home-purchase plans will be unaffordable for some of those who want them. And providers have work to do to get the word out. A recent university study of Leicester's Muslim community showed that many respondents did not know about Islamic financial services. "No one really worked closely with that community," says Simon Walker, a sales manager at the West Bromwich Building Society in England's West Midlands, which recently began to offer Shari'a-compliant mortgages.

And there are other obstacles. Because the universe of Shari'a-compliant stocks is limited, funds based on this type of investing tend to under-perform the market — an investor turnoff. Scandal has also taken its toll — in 2000, 17 former managers of the Dubai Islamic Bank were convicted of embezzling millions of dollars of investors' money. "Islamic banking is still a virgin territory," notes Rumman Faruqi, ceo of the London-based Institute of Islamic Banking and Insurance. "We have a lot of catching up to do."

But the sector remains upbeat. "We are seeing more risk-taking innovations in Islamic asset management," says Rushdi Siddiqui, director of Dow Jones' Islamic Market Indexes, which lists about 1,400 Shari'a-compliant stocks in its global-equity index. "Islamic banks and investors have become more sophisticated and will demand more complex investment vehicles," Hassoune predicts. And as long as there are believers like Uddin, the future of Shari'a-compliant banking looks bright.