Feb 20 - 26, 20

Islamic finance is becoming one of the major contenders in the global financial industry. In some countries, it holds significant importance and, in many others, it is too big to be ignored.

As stated in the 'Economic Update Report' by the Oxford Business Group, Islamic banking is commonly seen to have two advantages over conventional banking. The first is a perception that Islamic banks are bound to a higher moral standard: they will not take on irresponsible amounts of risk or pay outsize bonuses to their top bankers. The second is that earnings come from identifiable assets, not opaque combinations of derivatives and securities.

Because Islamic banks cannot make money through interest, they rely on ties to tangible assets such as real estate and equity, charging rent instead of interest.

Table 1, below, identifies the difference in Islamic Banking and Conventional Banking risk sharing and risk transfer operations.

The recent global crisis has renewed interest in the relationship between Islamic banking and financial stability-and, more specifically, the resilience of the Islamic banking industry during crises.

According to the IMF Working Paper titled 'The Effects of the Global Crisis on Islamic and Conventional Banks: A Comparative Study', authored by Maher Hasan and Jemma Dridi, Islamic banks contributed to financial and economic stability during the crisis, given that their credit and asset growth was at least twice as high as that of conventional banks.

This growth is accredited to their higher solvency and to the fact that many Islamic banks lent a larger part of their portfolio to the consumer sector, which was less affected by the crisis than other sectors in the countries studied.

IMF's findings were corroborated by external rating agencies' reassessment of Islamic banks' risk, which was generally found to be more favorable than-or similar to-that of conventional banks. See Chart 1.

In view of their robust growth during the crisis (See Figure 1), Islamic banks will likely take a growing market share in the future-but this implies greater supervisory responsibility.

Contrarily, the challenges relate to, firstly, a shallow money market due to the small number of participants and the absence of instruments that could be used as collateral for borrowing or could be discounted (sold) at the central bank discount window; and secondly, the inability to attract or maintain deposits by promising higher return. However, there are some, which have managed to move past these obstacles.

National Bonds Corporation (UAE) is one of those and there are a number of reasons why it has stood firm against the strong financial winds of 2008. Firstly, asset based investments rather than lending has laid down its foundations, being an Islamic bank it cannot gain from interest on loans therefore the basic Islamic principles of the bank were the reason for its success. Secondly, it has managed to secure tangible assets in the healthcare and education sector, which generated revenues before, during, and after the crisis took place, being only slightly affected by it.

Finally, deposits from the retail clients rather than financial institutions allow it to maintain a large number of small accounts. This means that it can protect itself from unexpected withdrawal of funds from large depositors.

National Bonds Corporation continues to excel in the global market with investments from over 650,000 customers in over 200 nationalities with an asset portfolio in excess of US$1.5 billion. It is the world largest Islamic retail savings scheme in existence.

The writer is an analyst at Emaan Financial Services.