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Thursday, 23 August 2007

As Oil Revenues Boom, Islamic Banking Goes Global

Caribou Coffee, the second-largest U.S. java seller, seems at first blush like a fairly ordinary American company. The chain was founded in 1992 in the small town of Edina, Minn., the brainchild of idealistic newlyweds, and has since expanded to over 400 coffeehouses in 18 states. Caribou's menu is muffins and lattes -- not an Arabic coffee in sight. It may come as a surprise, then, to know that Caribou Coffee is "Shariah compliant," one of the largest American businesses to run its operations in accordance with Islamic law. Caribou isn't alone. After decades on the economic backburner, flush oil revenues are giving Middle Eastern companies and investors new prominence on the global financial stage. As a result, rising demand for Islamic-friendly investments is forcing multinational corporations -- and not just in Muslim-majority countries -- to consider what the Quran has to say about their business practices. The boom carries over to the financial sector, where firms offering Shariah-compliant products or consulting services to companies that seek compliance have themselves seen explosive growth rates. Caribou went Shariah-compliant in 2000 after the Bahrain-based investment bank Arcapita purchased a controlling stake in the company. In terms of day-to-day operations, the Shariah-compliance designation primarily affects how the firm manages its finances. Under Islamic law, or Shariah, it is forbidden either to pay or receive interest. Interest -- the fee charged for the chance to borrow money -- is one of the central principles of modern economics, but Shariah-compliant companies structure their financial operations in a manner that bypasses interest altogether. Jawad Ali, a partner at the law firm King & Spalding who specializes in helping companies adjust their financial operations to attain Shariah-compliance, recently explained to me in an interview how this process works. In many cases, Ali says, firms and would-be lenders structure Shariah-compliant deals around the principle of leasing. Suppose a company wants to buy a property. Rather than granting a loan for the price of the property, a bank can instead buy the property and rent it to the firm. The arrangement is acceptable under Islamic law, Ali explains, because the bank has taken the risk of owning the property, and no interest is charged in the process of the transaction. Lease arrangements of this sort represent one of the most common types of Shariah-compliant contracts, but there are many others. The Web site has a useful primer that takes a more thorough look at the technical workings of different types of Islam-compliant contracts.The financial nitty-gritty aside, though, the simple fact of Islamic banking's rapid growth within the financial services sector stands out as striking. The multinational accounting firm KPMG estimates in a prospectus that the global Islamic finance sector encompasses around 270 banks, $265 billion in assets, and over $400 billion in investments. Moreover, KPMG says the sector is growing at a clip of roughly 15 percent per year, and could serve 40 to 50 percent of the world's Muslim population within a decade. Ali, for his part, says King & Spalding's Shariah-compliance services have seen even faster growth, expanding at 35 to 40 percent per year. This growth comes in part as soaring oil wealth and simultaneous commercial development have contributed to the burgeoning political clout of Middle Eastern oil states. In 2006, when crude oil sold in the range of $55 to $65 a barrel, the Middle East's oil producing nations raked in roughly $320 billion in oil-based revenues. Now the price of crude has climbed higher yet, to around $70 a barrel. Jamil Hassan, an Islamic banking expert with the consulting firm i-flex solutions, explains in a podcast that cash-flush oil states seek out Shariah-compliant investments particularly as they try to diversify away from the energy industry. Hassan cites a "realization of Gulf States that there is a need to invest money so that dependency on oil revenue will become less." The influx of investment itself spurs further growth, Ali notes, particularly as competition within the Islamic banking sector drives firms to create more efficient Shariah-compliant investment products. Banks now provide Shariah-compliant mortgages and other products at little or no added expense over traditional interest-based loans. "The investors started to say, 'Well, it is possible, I don't really have to kill my return,'" Ali says. "That was the first push for growth in the industry, when people became aware that it is possible to do it and it is not as costly as people thought."Given the ripe market for Shariah-compliant investments, European and U.S. banks quickly joined in on the rush. Major international banks including Citigroup, Deutsche Bank, HSBC, and Lehman Brothers now offer Shariah-compliant financial products. In a recent article, the Wall Street Journal highlights a push among U.S. mutual fund managers to offer funds investing exclusively in Islamic-friendly equities. The article notes that Islam-friendly products also draw an enthusiastic response on a local, individual level, citing a Chicago bank that began offering Shariah-compliant loans in 2002. The bank's owner describes an outpouring of local enthusiasm in response to the venture: "People said, 'Can you do houses, cars, lines of credit, and how about my sister in Connecticut,'" he says.Both the Muslim car-buyer in Chicago and the Muslim Middle Eastern oil magnate play a role driving the Shariah finance boom. It over-simplifies the sector, however, to peg it as 100 percent Muslim-specific. When HSBC offered Shariah-compliant mortgages in Malaysia in 2004, over half the purchasers were non-Muslim. Ali says Islamic-friendly investments are best compared to "ethical" investment funds, or "green" funds, which consider aspects of a company's operations besides its spreadsheet before making an investment. Anyone can invest in a "green" fund, all ideology aside, if they think the fund is a good investment. Similarly, the Malaysia trend in Islamic banking may become increasingly common, with non-Muslims purchasing Shariah-compliant financial products simply because they are competitively priced. - (WPR, 22 Aug 07)
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