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Sunday, 30 November 2008

Are Islamic banks the financial institutions of the future?

With the search underway for a new monetary system for the post-financial crisis era, Islamic banking gains a new reputation for stability.

Islamic banking has grown at an annual rate of 15% and reached a volume of $1 trillion, five times higher than in 2003.

With the financial crisis reaching its peak, more and more politicians and economists agree that yesterday's financial world and tomorrow's financial world will not have much in common.

A new codex is needed. Germany's president Horst Koehler said, that the world needs a second Bretton Woods, referring to the gathering of leaders after World War II which led to a global monetary system based on the gold standard and on fixed exchange rates.

Bretton Woods, named after a city in New Hampshire, ceased to exist in 1971, when then-US president Richard Nixon nullified the gold standard. As a reaction Western European states declared their own monetary system in 1973.

Did this nullification led to the current financial crisis? Without the gold standard, dollars could be printed with no limit, leading to excessive leveraging and a debt-laden economy.

Low-interest rates led to asset inflation on the global stock exchanges. In the case of the TMT-bubble at the end of the 1990s this inflation was created without any real economic performance (most internet start-up where in debt).

Asset-based system

In an Islamic monetary system, money itself has no value. 'Islam denies the conventional
mentality that out of every dollar a new dollar has to be created', says Shariah scholar Dr. Imran.

This means, that capital can only increase in value in value if a financial vehicle's underlying asset increases in value. Since interest is forbidden under Islamic law, money can not add value to itself.

Closer to real economy

Loans, derivatives and hedge funds are haram, because short-selling and speculation are also haram. Further more, the risk-sharing concept of Mudaraba, when entrepreneurs are granted capital and share the profits with the bank, moves Islamic banks closer to the real economy.

As a result, most Islamic banks have performed well so far in 2008. Nearly all Islamic banks reported profits in the first nine month of 2008. Despite the recent turmoil in Dubai's real estate market, Islamic home developer Deyaar's Q3 profits jumped 56% to Dhs312 ($84.9).

Other Islamic banks such as Gulf Finance House (GFH) also show no let-up in expanding. On November 10, GFH unveiled its master plan for a $5bn Energy City in Libya.

Although Islamic banks' stocks fell too, Islamic banks seem to be better prepared for any worsening of the financial crisis (as yet). Investing in permissible stocks line with Shariah also has its benefits for the private investor. Conventional banking and insurance shares, which lost the most this year, are haram too.

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