U.S. banks looking for high-growth opportunities might consider fathoming the mysteries of Islam.
With one billion people adhering to the Islamic faith, and becoming increasingly devout by the day, it is not surprising that Islamic banking is growing 15% a year.
In fact, this special style of banking, which forbids the charging of interest, the cornerstone of Western banking, is close to crossing the $100 billion threshold in deposits and investments.
A number of large banks, such as Chase Manhattan Corp., Citicorp, and Bankers Trust New York Corp., have conformed their practices to Islamic requirements in countries as far-flung as Saudi Arabia and Malaysia.
Others bankers are considering taking a first step into this world.
Islamic banking, based on the Koran, the Islamic holy book, forbids riba, or usury-the charging of interest. That means there is no time value or even inflation adjustment for money.
Therefore, Islamic banking is based on the philosophy of partnership. In that context the aim of Islamic banking is to contribute to the distribution of wealth in a fair and equitable manner.
Hence Islamic banking products must uphold the concept of Halal, the Arabic word for purity, by deriving their income from profits on investments in which one participates and shares the risks.
The major Islamic products include trade finance, involving the resale of goods, especially of commodities such as grain and oil; equity sharing with the joint venture, involving both a capital partner and a working partner; profit sharing partnerships; and leasing.
There are now about 150 banks and financial institutions that are fully, or partially, Islamic - with their own boards of wise men who ensure that bank practices adhere to religious law.
Among Islamic banking's recent entrants is Citicorp, which in April 1996 initiated the Citi Islamic Investment Bank (CIIB) in Bahrain, with capital of $20 million. It thus became the first Western bank to create a purely Islamic bank with a board that monitors its adherence to Islamic principles.
Nearly 80% of Islamic funds are invested in short-term commodity trades, where a Western bank brings together a buyer and a seller of commodities at a predetermined markup.
The Western bank makes a fee and ends up with the buyer's deposit. Citibank, before launching its Bahrain bank, had served Islamic banks through special divisions at Citi.
Other Western financial institutions involved in offering Islamic banks this type of business include Chase Manhattan Corp., J.P. Morgan & Co., Republic New York Corp., Goldman, Sachs & Co., Arab American Bank, and Bankers Trust.
Another business for U.S. banks to consider is the creation of equity investment funds that conform to Islamic law.
Companies designated for investments should not operate in the following sectors: banking and insurance, alcoholic beverages and tobacco, gambling and games of chance, pork, and arms manufacturing.
Selected companies should carry out business in a manner consistent with Islamic values. Moreover they should not generate a significant part of their revenues from interest income, and they should maintain a limit on their debt-to-equity ratio.
Islamic banks, however, differ in defining these ratios. Several "equity funds," whose main purpose is to invest in selected companies in the United States and Europe, have been launched since 1986. Their assets total about $1 billion.
Malaysia's seven mutual funds alone total more than $500 million. The potential size of the Islamic equity fund market is estimated at between $50 billion and $100 billion.
Fund managers that are developing this product on behalf of Islamic banks include Kleinwort Benson (U.K.), Wellington Management, Wright Investors' Service, and State Street Boston Corp.
Last year, Flemings, the British investment bank, became the first Western house to launch its own Islamic equity fund.
Project finance is expected to become a major form of financing for Islamic banks.
The recent mandate won by Kuwait Finance House to manage a $200 million tranche of Islamic financing for the $1.2 billion petrochemical complex in Shuaiba, Kuwait, which is being built by Equate Petrochemical Co., is a good example of this potential for partnership.
Islamic banks are definitely seeking partners to comanage and fund their long-term projects-a major financial strategy in the expansion of Middle East economies.
In the Islamic bank, the seventh century meets the 21st, as the partnering of investors and entrepreneurs continues to be an effective and economically viable technique.
Now Islamic financial engineers are even restructuring derivatives to meet the requirements of the Koran.
In short, traditional and Islamic banking are converging in a symbiotic fashion that promotes growing cooperation. Western financial institutions cannot ignore the enormous potential for growth in this multifaceted market.
