A V Rajwade: Islamic banking

WORLD MONEY

It's back in fashion and attracting hordes of investment bankers looking for higher margins.

As the oil price continues high and the oil exporters in West Asia collect larger surpluses of dollars, Islamic banking seems to be coming back into fashion, with every international bank worth the name, anxious to get its finger in the pie. Several recent reports about Islamic banking reminded me of an "Islamic watch" promoted by an enterprising non-resident Indian business family in the mid-1970s. If memory serves me right, Citizen, the Japanese watch company was the collaborator. The concept was simple, but obviously timely, and the family made millions in profits. The sharp increases in oil prices in 1973 and 1974 had put undreamt of riches in the pockets of millions of people of the Islamic faith, living in the oil-exporting countries. The so-called Islamic watch was nothing but an ordinary watch, with the addition of a small compass at the centre of the dial, with the arrow pointing towards Mecca wherever in the world the wearer may be. This was to help pious Muslims to face Mecca while praying as required by the Koran. The price of the Islamic watch was, of course, three times that of the same watch, without the compass! And, the watches were a hit making huge money for the innovator.

However, the way I look at it, Islamic banking looks to me more and more like the Islamic watch "" standard goods, packaged somewhat differently, with the addition of a few variations to make the product sharia compliant. The key constraint of Islamic banking is that sharia prohibits "riba". Riba can be interpreted as interest or as usury. Those who interpret the word in the latter sense, believe that sharia does not prohibit normal interest: it forbids usurious rates of interest. The more strict interpretation is that all interest is prohibited. Orthodox Christianity also frowned on interest on money lending "" and this was one of the root causes of the hatred for the moneylender Jew, which existed for a long time in Christian Europe, culminating in the holocaust in Germany.

It used to be said, only half in joke, that if you see a Swiss banker jumping from the 13th floor, follow him "" there must be some money to be made somewhere! Today's investment bankers are no less enthusiastic in their pursuit of money, and the higher margins in Islamic banking products are attracting hordes of them. Redesigning traditional banking products into their sharia compliant versions has become the Mecca of Islamic banking "" no pun intended. Simply, if a loan carrying interest, to buy an asset, is precluded, the transaction can be restructured as a lease! (Recently, Air Asia, a low-cost airline in Malaysia, made a large Islamic bond issue of several hundred million dollars to finance the acquisition of aircraft. It was picked up mainly by investors in West Asia.)

The key to acceptance of the product by orthodox Islamic investors is to have it certified as being sharia compliant, by means of a fatwa issued by a respected religious authority. It seems many international banks are looking for bankers, particularly from South Asia, with experience not only of banking, but also of Islamic law. Consultants specialising in the area are charging fat fees to help develop products. At present, the size of Islamic mutual funds and banks is estimated at an aggregate of $500 billion "" even secular money centres such as Singapore have passed special taxation laws for Islamic banking products, in order to attract business. London, of course, remains the principal centre where such products are being developed. Indeed, large London solicitors' firms are recruiting teams specialising in Islamic banking.

Incidentally, the last chapter in the inglorious history of a traditional international bank, with roots in West Asia, got written in the UK, a couple of weeks ago. It may be recalled that the liquidators of the Bank of Credit and Commerce International (BCCI) had filed a suit against the Bank of England. The liquidators argued that, had the Bank of England taken prompt action, the creditors of BCCI would have recovered a lot more money, and that, therefore, the bank should pay damages. The suit could not be sustained and was withdrawn last year; a couple of weeks back the liquidators (in other words, BCCI's creditors) agreed to pay the Bank of England almost £80 million by way of its legal costs.

Tailpiece: On June 1, Financial Times carried two reports from its correspondent in Delhi, on the fall in the stock market and selling by FIIs. The report talked of "concerns over how India will finance its growing current account deficit". The availability of reserves and, therefore, the painless financing of the current account deficit is making us complacent on the issue: the concern should be the turnaround of $30 billion (4 per cent of GDP) in the current account in just one year, and the lost output and growth which the deficit represents.

Email: avrco@vsnl.com