Islamic Banking, a Market with U.S. Potential, Hampered by Politics

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Islamic finance is growing, but politics, and perhaps prejudice, might be hamstringing this business in the United States.

In the past few years bills have been introduced in at least 20 states to forbid courts from invoking foreign laws in rulings. Proponents have touted the bills as a way to prevent Sharia, a code derived from Islamic law, from becoming the law of the land — a risk that many attorneys say is nonexistent. Arizona, Louisiana and Tennessee have passed "Sharia ban" laws, which critics call a way of scoring political points by exploiting anti-Muslim sentiment.

It is unclear whether those laws would directly affect the growth of Islamic finance, which follows the tenets of Sharia law, such as a ban on paying interest. But at the very least, the political climate for Muslims is certainly not fostering a welcoming environment for what experts call an emerging market.

"The U.S. is behind. There is a strong and rapidly growing Muslim population," said Steven Watts, a partner with KPMG's financial services consulting practice in Toronto. "The holdup seems to be largely political, but it is to the detriment of the U.S."

Karen Hunt-Ahmed, an assistant professor of finance and management at DePaul University, said that even if the state laws have no direct effect on Islamic finance, they could still discourage Muslims from seeking such products.

"They could make it psychologically more difficult for Muslims to participate in our banking system," she said. "There are social implications here."

The United States began to lag in Islamic finance after the 9/11 terrorist attacks, she said.

"Europe and other parts of the world decided to increase funding to study Islamic finance. Generally, the governments wanted to actively watch it and said they were going to be more involved and interested," Hunt-Ahmed said. "In the U.S., funding got cut and the sector became marginalized."

A few small banks in markets with large Muslim populations view Islamic banking as a worthwhile.

The $115 million-asset University Bancorp in Ann Arbor, Mich., has offered Sharia-compliant products since 2003 and is expanding to offer mortgages in places like New York City and Washington, D.C. This year it opened a branch in Chicago.

The Pew Research Center estimates that there are 2.6 million Muslims in the United States, but not all adhere to Sharia.

"There's not enough of a business to attract a major bank," said Stephen Lange Ranzini, University's president and chief executive officer. "It is a big enough niche for us to make a small profit."

Watts said there are more opportunities, namely "ethical" investments that avoid putting money in gambling or alcohol and could appeal to Muslims and non-Muslims alike.

However, Sharia-compliant mortgages (which are permissible under Islamic law because they are structured as lease-back or co-ownership arrangements) are a great entrance to the Islamic finance world, he said.

Ranzini said that while anti-Sharia legislation has largely been passed in states that have small Muslim populations, he sees it as harmful.

"Passing laws to ban Sharia when we have American soldiers in two Muslim countries and bases all across Europe where there are large minority Muslim populations is an ill-considered idea," Ranzini said. "The people that are hyped up about this issue are just very uninformed."

A central player is the Center for Security Policy, a Washington think tank that published a book titled "Shariah: The Threat to America."

Chris Holton, the center's vice president, said the state measures ensure that foreign laws do not impinge on Americans' constitutional rights. "It has no impact at all on Sharia-compliant finance," he said.

Targeting Islamic finance is on the center's agenda, though.

In 2009 the center's general counsel filed a lawsuit against Treasury Department Secretary Timothy Geithner and the Federal Reserve in the U.S. District Court for the Eastern District of Michigan.

The complaint accused American International Group Inc. of using the money it received as part of the Troubled Asset Relief Program to fund its small Islamic finance business. The court ruled for the defendants, saying that the Tarp investment was secular and that there was no evidence AIG used Tarp money to support the Islamic finance business.

"What we specifically call for is a standard of full and fair disclosure," Holton said. "They are already falling short."

Holton claimed regulators have not adequately monitored Islamic finance. "You could take what the FDIC knows about Sharia and put it in a thimble and have room left over," he said.

Holton has also criticized the Fed for holding informational sessions about Islamic banking.

A spokesman for the Federal Deposit Insurance Corp. said that the industry is expecting to see more Islamic finance products in coming years and that some examiners specialize in Sharia compliance.

Regulators have gone to great lengths to vet and understand Islamic finance.

For instance, University Bank is two years into a process with the FDIC to get cleared to offer Islamic financing for residential homes.

Ranzini said there are further hurdles, such as getting approval for Sharia-compliant loans backed by the Small Business Administration and Federal Housing Administration.

Ranzini said there are 300,000 Muslims in the United States who are renters, despite having the attributes of creditworthy borrowers.

"Bringing these Muslims onboard as homeowners is good public policy and would assist with solving the housing crisis," Ranzini said.

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