The banking sector was historically the darling of investors,
with stocks offering steady income and high secured yields
universally. However, the 2008 global financial crisis laid bare
the risky dealings by individual banks and the lack of regulatory
oversight that made up leeway for such practices.
In the melee that ensued, regulators finally awakened to the
risky dealings by the banks, and stringent regulations became the
order of the day. Five long years after the Great Recession,
which shattered the economic stability of the U.S. banking
sector, banks are still struggling to put the past behind. In the
first half of 2013, U.S. banks showed progress, signaling a
bright future for the sector. But it is too early to be
confident about the sector's growth prospects.
Many fear that structural changes in the sector will continue to
impair business expansion and investor confidence. Yet, entering
the new capital regime will ensure long-term stability and
Nevertheless, the sector is still clouded by many dampening
factors. Tighter regulations aside, banks face asset-quality
troubles, mortgage liabilities and run-ins with the government
regulators. U.S. banks are also subject to never-ending lawsuits
besides being subject to criminal and civil investigations from
authorities. Therefore, five years on, the American banking
system is yet to show any dramatic change.
Is There an Alternative?
It is hard to find an alternative to U.S. methods of banking.
Risky endeavors and huge profits made these banks the poster boys
of the financial world, till the reality check after recession.
The resulting endeavor to find a viable option to U.S. banking
has paused at an intriguing question: if high debt and inadequate
equity were to a certain extent responsible for the financial
crisis, might Islamic Banking be the solution?
Islamic principles prohibit financial transactions involving
interest rate payment on debt and hence financial institutions
rely on profit-loss risk-sharing measures. This culture of shared
responsibility has led the think tank to see Islamic banking the
answer to the debt crisis plaguing the U.S.
In fact, Wall Street major
JPMorgan Chase & Co.
) operates an Islamic Banking unit in Middle East & North
Africa. London-based Standard Chartered PLC and
HSBC Holdings plc
) -- HSBC Amanah - also acknowledge that Islamic Banking is fast
catching up and growing globally.
Notably, Britain is a world-leader in sharia banking. Evidently,
17 leading financial institutions including
The Royal Bank of Scotland Group plc
Lloyds Banking Group plc
) have already ventured into Islamic Banking in the past. Taking
a cue from these British banking giants, many global banks such
) have also opened their Islamic banking units.
Islamic Banking: An Overview
First the highlight: the core of Islamic economics is a
proscription on interest on debt. Almost instantly, a question
arises on the profitability of these banks with interest ruled
out of the picture. In sharia banking, an organization enters
into a partnership with its depositors and invests their money in
a sharia-compliant business. The profit from this investment is
shared between the depositor and the bank after a certain period
Islamic banking has developed products that bear a striking
resemblance to those offered by conventional banks, just leaving
out the interest rate payments and excluding fees and conditional
This Islamic concept has fast grown in recent years primarily due
to investments in the oil-rich Gulf and Asian regions that were
relatively untouched by the global financial crisis. Islamic
banking is growing globally at a rate of more than 20% a year, as
a larger part of the world's Muslims seek finance that agrees
with sharia laws.
According to Ernst & Young, global Islamic banking assets are
set to cross $1.1 trillion by the end of this year, up from
$800 billion a couple of years ago, driven in particular by
strong growth in the Middle East and Malaysia.
The Underlying Risks
Beneath the rosy picture of debt free finance is the risk of
lower profitability. Many large global banks like
Deutsche Bank AG
) and Barclays have started downsizing their Islamic banking
operations. The wider implications of banks shrinking Islamic
banking services are doubts on the ability of Western banks to
serve Muslim communities with a relatively small customer base
and earn profits at the same time.
Pundits see two basic problems. First, is the challenge of
expense management, elevated charges due to intricate structuring
and legal overheads, constrained demand as well as profits, and
the resulting revenue crunch. Second, the integrity of some
products is a huge question. In many cases, these financial
products have become an Islamic modification of interest-based
debt. Therefore, many experts believe that the Islamic model,
chiefly in the retail sector, is fundamentally troubled.
The fact that Islamic Banking is gaining popularity in the
Western world is a major advantage for the business, which is
still in its nascent stage. It is encouraging to see that
investors have finally woken up to the advantages of
interest-free finance, even though certain headwinds remain.
Additionally, the business has to evolve. It is only 40 years old
and is competing with a conventional banking system that has
survived more than 800 years.
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