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Islamic Finance On the Rise

The International Monetary Fund (IMF) and World Bank held their semi annual meeting this past week in Istanbul. The global economic crisis and its aftermath dominated discussions. But among the topics of discussion was the growing role of Islamic finance. Islamic finance operates without the use of interest, as its forbidden by the Koran. Although Islamic finance has steadily grown from its inception in the 1970's, until now, its has been seen as a small niche market of Islamic countries. But Islamic finance may soon be rising even in European markets.

There was a good deal of "crowing" at western leaders and, in particular, their captains of finance, by ministers from the developing world, at the recent IMF and World Bank gathering in Istanbul. For many years, they pointed out, they had to listen to lectures from western nations on the superiority of Western capitalism. But as the Indonesian Finance Minister Sri Mulyani Indrawati argued, the Islamic world has lessons of its own for the world in the aftermath of the global economic crisis.

"This crisis is just telling us about excessive risk taking and the islamic transactions, which is Sharia based, is actually giving us the built in mechanism to check this excessive risk taking behavior. So I guess (with) this kind of recognition there will be quite a big prospect for the Islamic based instruments to be introduced and this is the opportunity for the Islamic Development Bank," he said.

The first Islamic financial products were launched in the early 1970's by the Saudi based Islamic Development Bank. And they continue to grow in volume throughout the Islamic world. The fundamental difference from the conventional capitalism system is that Islamic financial products don't use interest, as its forbidden by the Koran. Instead, as Dr. Abdul Aziz Al-Hinai, vice president of the Islamic Development Bank, explains, its all about the careful assessment of risk and profit.

"It is based on sharing, sharing the loss and sharing the profit. Where as the conventional, the banking institution, it does not share the loss. It keeps the profit. And it does not share the loss. So you always hear people saying that Islamic finance is dealing with the real economy. We don't structure debt just for the sake of the debt, every debt has to be met with assets. The debt cannot grow more than the assets. So users of this method of finance realize that dealing with the real economy is less risky," he said.

In the post economic crisis, risk-averse world, Islamic finance is being increasingly talked about in the conventional markets says Charles Dallara. He is the Managing Director of the Institute of International Finance and says the particular expertise in assessing risk required in Islamic finance means it has alot to offer to the mainstream financial markets.

"I think we are at a stage where traditional finance has to recognise that it can indeed learn a lot from the strengths of Islamic finance and fundamentally they revolve around the notion that you understand, because it is core to the business of Islamic finance, the notion of finance being linked to underlying productive activity. I dare to say that if this test was applied to some of the activities of our traditional members, in the last few years, that some of the pain could have been avoided. I see growing prospects of synergies being developed between traditional finance and Islamic finance," he said.

Islamic financial products are indeed already making their way into European markets. Their growing reputation as a safe and reliable way of investing - and an increasing demand for alternatives to interest-based lending - has caught the attention of European banks, according to Dr. Al-Hinai from the Islamic Development Bank or IDB.

"Yesterday I had a meeting with a German bank who (that) wanted to start Islamic products , because the state where the bank is located, there is many immigrants and they prefer Islamic products so now they negotiating IDB to give the technical assistance on how to start Islamic products , how to bring them a strategic partner from the Middle East, to work with them in developing new products. Prior to the crisis there was little recognition for this industry in the West but now London for instance is becoming a center of Islamic finance. France wanted to be one. There are other Western capitals who (that are) very much interested in this industry because they see opportunities there," he said.

Both the leaders of the IMF and World Bank said one of the key challenges in the aftermath of the global economic crisis is the realignment of the world market to include emerging and developing markets. Observers say one step in that direction could well be the breakthrough of the increased use of Islamic financial products in the European and U.S. markets.