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Sunday, 11 October 2009

Islamic Banking – Reality and Myth

By: Dr. Nimrod Raphaeli*


Islamic banking is based on Islamic law and principles known as shari'a, a system of rules derived from Islamic principles of jurisprudence and dictated by a sometimes modern and sometimes ancient interpretation of the Quran. It is equivalent to conventional banking, except that the investor is rewarded through a share in profit rather than through the payment of interest or riba (usury), which is prohibited under the shari'a. Islamic banking prohibits investment in, or lending to, companies that do business or trade in pork, alcohol, gambling, pornography, and a broad array of entertainment activities. On the other hand, Islamic finance does includes stocks, real estate investments, insurance, currency swaps, sukouk (Islamic bonds based on profit sharing rather than interest payment) and murabaha (a trading transaction where a bank sells a specific commodity at a price plus specific profit agreed upon in advance). There are also other financial vehicles, such as wadi'a and mudharabah, which were discussed in an earlier MEMRI report. [1]

Some Muslim bankers maintain that Islamic economic principles go beyond the narrow issue of riba into broader domains. They argue that these principles are applicable to all aspects of economic activity, and "guide the individual's relationship with his Creator (Allah) in respect to his wealth, as well as his relationship with society, with his partners, and with his legal heirs, and his overall dealings with them." Muslim bankers argue further that "Islam has laid down general principles for every aspect of economic activity, great or small, which are applicable to all situations at all times." [2]

The Islamic system does not allow the creation of debt through direct lending and borrowing; rather it requires the creation of debt through the sale or lease of real assets. Spelling out the regulatory regimes in the Islamic system, a Saudi economist and winner of the King Faisal International Prize for Islamic Studies, offers this explanation: "The asset which is being sold or leased must be real, and not imaginary or notional; the seller must own and possess the goods being sold or leased; the transaction must be genuine with the full intention of giving and taking delivery; and the debt cannot be sold and thus the risk associated with it cannot be transferred to someone else." [3]

This paper will argue that a) Islamic banking is relatively small in assets by global banking asset standards; and that b) there is a considerable amount of deception in many of the practices of the Islamic banks, as asserted by a number of Arab and Muslim critics.

Islamic Banking in a Global Context

Islamic banking has expanded at a considerable pace since the inception of the first Islamic banking institution in Malaysia three decades ago, and it is no longer restricted to banks owned or operated by Muslims. A number of multinational banks, particularly on the European continent, have opened their own branches or windows dedicated to practicing Islamic banking. According to a 2005 study by the International Monetary Fund, the number of Islamic institutions rose from 75 in 1975 to over 300 in 2005, in more than 75 countries. At the time of the study, the total assets worldwide were estimated at $250 billion, and growing at about 15 percent per annum. [4] In 2008, before the advent of the global financial crisis, the 100 largest wholly Islamic banks, ranked by assets, held approximately $520 billion in assets, 90.8 percent of which was owned by the Gulf countries, with Saudi Arabian Islamic banks controlling 49.5 percent, the UAE about 20 percent, Kuwait 17.4 percent and Bahrain about 11 percent. [5] Oman is an exception, being the only member of the Gulf Cooperation Council which does not allow the establishment of Islamic banks within its territory. The governor of Oman's central banks explained this by stating that there is no difference between the country's Islamic banks and conventional banks. [6]

When contrasted with the 50 top banks in the world, the total assets of Islamic banks are not very significant. Measured by their December 2008 balance sheet, the assets of the 10 top banks on the Bankers Almanac list ranged from $3.483 billion for the Royal Bank of Scotland Group, Plc (which is number one on the list) to $1,456 billion for UniCredit, Milan (which is number 10 on the list). Taken together, the 100 largest Islamic banks have assets equivalent to those of bank no. 48 on the December 2008 Bankers Almanac list, namely the National Australia Bank Ltd., with assets of $512 billion. [7] In the second half of 2009, the total assets of the top 25 Islamic banks in the Gulf Cooperation Council (GCC) stood at $218.76 billion. [8] This data indicates clearly that not a single Islamic bank is likely to be included in the world's list of top 50 commercial banks in the foreseeable future. Of course, the central banks in most Islamic countries, which are conventional banks, present a different picture. For example, Saudi Arabia's central bank, the Saudi Arabia Monetary Authority, would be rated fairly high on a global scale.

It should be pointed out that all the figures on the size and growth of Islamic banking must be treated with a degree of caution. As stated by Mahmoud Al-Jamal, a professor of Islamic economics at Rice University (Texas), no official authority is able to provide the International Monetary Fund with credible data on the financial and investment products of the Islamic banks. As he says, there are no "clear statistics about the activities of the Islamic banks, their number, and their branches." [9]

Criticism of Islamic Banking- Financial Smoke and Mirrors

Islamic economic institutions claim to operate on the basis of "zero interest." However, critics of Islamic banking argue that the fundamental practice of charging interest (e.g., charging a premium on the principal amount of the loan, for the time value of the loaned money) is not truly eliminated in Islamic banking, but is merely relabeled and disguised using various legal tricks. The Financial Times, drawing on the book Islamic Banking - A $300 billion Deception by a former adviser to Islamic banks, Mohammad Salim, [10] referred to these practices as "financial smoke and mirrors." [11] Arab and Muslim critics have likened them to "contractum trinius," a method devised by European bankers in the Middle Ages to circumvent the church laws against charging interest on borrowed money. [12]

In an article in the Kuwaiti daily Al-Qabas, titled "The Non-Usury Deception," Kuwaiti banker Ahmad Al-Sarraf maintains that dealing with conventional banks is less costly than dealing with the Islamic banks. Founded on principles and practices developed over centuries, the conventional banks know their way around, while the Islamic banks have yet to find their bearings, in the absence of traditions to guide their activity. Citing fundamentalist cleric Professor Hamid Al-'Ali, who teaches Islamic culture in a college in Kuwait, Al-Sarraf explains that the Islamic banks disguise usury by inventing documents that appear on the surface as sales documents, but that are actually interest-bearing loans. Therefore, anyone who distinguishes between traditional and Islamic banks is ignorant, he says. Al-Sarraf adds that most of the Islamic banks are guided by well-paid clerics who are employed by the bank, and issue rulings according to the bank's needs. The entire corpus of paperwork created by these Islamic banks, Al-Sarraf concludes, is in violation of the rules of the shari'a and is inherently deceptive. [13]

The Deceptive Mechanism of Murabaha

One common instrument of deception is what is known as murabaha (the word is derived from Arabic ribh, meaning "profit"). This refers to a mechanism in which a borrower enters into a mark-up or cost-plus financing contract with a lender. In daily usage, murabaha means a sale of an item on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and profit. As a financing technique, it involves a request by the client that the bank purchase for him certain merchandise, real estate, or consumer durables such as cars or household appliances. Since the client lacks the cash to make the purchase himself (otherwise he would not have turned to the bank), the bank buys the item and sells it to the client on deferred payment. Repayment, usually made in regular installments, is specified in the contract. The bank's profit is calculated either on a percentage of cost basis or as a fixed amount.

Critics have questioned the alleged religious foundation of murabaha because the profit margin attached to the total amount of the sale is tantamount to riba - it is interest in disguise. However, experience teaches that financial deals, no matter how religiously controversial, are nearly always sanctioned by the well-paid clerics employed by the Islamic banks. [14] Muqbil Saleh Ahmad Al-Dhukair, a professor of economics at King 'Abd Al-'Aziz University, points out that the Islamic banks determine their profit margin by checking the interest rates prevailing in the markets. [15] It is hardly surprising that customers have complained bitterly about these "deviations" from the Islamic banks' religious objectives. In fact, many have complained that most Islamic banks collect more profit than the conventional "usury" banks.

After 15 years of studying the Islamic banks, Dr. Mohammad Ibrahim Al-Rumaithi, a professor of Islamic economics at the University of the United Arab Emirates, has concluded that there are three types of Islamic banks: those that adhere to the shari'a and are less preoccupied with making profit; those that ignore the shari'a completely, and those that only carry the title "Islamic." All three, Al-Rumaithi maintains, violate the shari'a in various ways." [16] In fact, the head of the Salafi movement in Kuwait, Abdul-Rahman Abd Al-Khaleq, has denounced the system of murabaha as deceptive, stating, "Pursuing what is haram [forbidden] openly is kinder towards Allah than attempting to deceive him." [17] The issue of usury deception by Islamic banks was also the subject of a symposium held in Riyadh in 2007, in which the participants pointed to "an alarming expansion" of these deceptive practices. [18]

Professor Mahmoud Al-Jamal has said that Islamic mortgage companies likewise "use cheap tricks to attract customers and entice the believers to pay more for less. All that these companies sell to their customers is holy water sprinkled over a real estate mortgage." [19]

Absence of an Effective Supervisory Authority

As already mentioned, Islamic banks often employ resident shari'a scholars to rule on deals when questions arise regarding their Islamic nature. These scholars often issue contradictory edicts regarding what is permitted and what is forbidden. Experts on Islamic banking have warned that these jurisprudence controversies [al-jadal al-fiqhi] place the future of Islamic banks at risk. [20] At a symposium organized by the Dallat Al-Baraka Group (a major Islamic banking group in Saudi Arabia), held in Jeddah in 2008, scholars and experts called for sustained in-depth study and research into Islamic economy and banking, in order to make them more acceptable and viable. [21]

Professor Samir 'Aabid Sheikh, of the Center for Research in Islamic Economics at the King 'Abd Al-'Aziz University in Jeddah, has pointed out that most Islamic banks operate under a shari'a supervisory authority in their country. However, he adds, Islamic financial institutions work closely with many conventional (usury) banks all over the world, and it is difficult for the supervisory authorities to examine their dealings with these banks. 'Aabid Sheikh therefore suggests that "it is necessary to introduce [mechanisms] to actively supervise the banking transactions carried out by [the Islamic] banks." [22]


In order to survive, Islamic banking must observe the rules of the shari'a and at the same time keep afloat in a highly competitive market. So far, however, it has failed to establish a distinct identity or to draw a clear demarcation line between its mode of operation and that of the conventional "usury" banks. The establishment of a rigorous supervision system consisting of clerics, who do not necessarily understand the business of banking, could spell disaster for Islamic banking. How to remain Islamic but also competitive is the greatest challenge that Islamic banks will have to deal with in the future. In the meantime, they also have to contend with a chorus of critics who accuse them of, at best, violating the rules of the shari'a, and at worst of deliberate deception.

Although Islamic banking is gaining ground, it remains on a very small scale by global standards. In order for it to reach the economies of scale and play a significant role in a globalized world economy, Islamic banking will have to strike a fine balance between the rules of the shari'a and global banking practices that are rapidly changing, particularly with the advent of internet banking. In the 1970s, renowned economist E. F. Schumacher developed the notion that "small is beautiful." After last year's global crisis, the new slogan will most likely be "small is not competitive" - and if one cannot compete on a global scale, one is destined to perish.

*Dr. Nimrod Raphaeli is Senior Analyst (emeritus) at MEMRI.


[1] See MEMRI Inquiry and Analysis No. 297, "Islamic Banking - a Fast-Growing Industry," September 29, 2006,

[2] Arab News (Saudi Arabia), September 12, 2008

[3] Arab News (Saudi Arabia), October 23, 2008

[4] International Monetary Fund, "Islamic Finance Gears Up," Finance Development, Vol. 42 No. 4, 2005

[5] Al-Watan (Jordan), August 10, 2009



[8] Emirates, Business 24-7,August 31, 2009

[9] Al-Sharq Al-Awsat (London), May 26, 2009

[10] Salim, Mohammad 2006, Islamic Banking - A $300 billion Deception, XLibris Corporation.

[11] The Financial Times (London), September 23-24, 2006


[13] Al-Qabas (Kuwait), August 15, 2009

[14] Al-Iqtisadiyya (Saudi Arabia), June 30, 2007

[15] Al-Qabas (Kuwait), August 15, 2009

[16] of June 26, 2009

[17] Al-Watan (Kuwait), June 20, 2009


18 Al-Sharq Al-Awsat (London), May 26, 2009

[20] The International Islamic Federation for Economics and Financing ( ), June 20, 2009. See also the website of the Islamic Chamber for Trade and Industry, www.lccionline.nt/ar/News.aspx?id=161§ion=3.

[21] Arab News (Saudi Arabia), September 12, 2008


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