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Islamic Finance is a Supply-Driven Market

February 18th 2013

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Despite the claims by proponents of Islamic finance that there is a "pent-up demand" for Islamic financial products, in reality there seems to be a growing disinterest in such products. Regardless, the proponents continue to argue for adjusting the conventional secular financial system to sharia, regardless the market's dwindling interest.

The decision by HSBC late in 2012 to significantly downsize its worldwide Islamic banking operations serves to illustrate the point. According to Reuters , HSBC made the decision despite being one of the pioneers in developing Islamic finance within the international banking sector. In 2012, HSBC was the first Western bank to issue an Islamic bond, when Its Middle East unit sold a US $500 million sukuk.

However, following that, HSBC decided the business was not of a scale that made commercial sense. Thus, HSBC will now offer Islamic banking services only in Malaysia and Saudi Arabia, but not even the UAE and Qatar.

HSBC is not alone. According to the Financial Times:

"...many experts believe the Islamic model, particularly in the retail sector, is fundamentally troubled. Barclays and Deutsche Bank have also scaled back their Islamic banking teams in Dubai."Clearly the Islamic business is not making enough money for them [HSBC] and I don't think they're the only ones. Standard Chartered has the same issue," says one senior Islamic banker in Dubai. "Given the size of their presence the revenues are not commensurate."
 
The FT went on to say that "even optimistic estimates put the proportion of Muslims that use Islamic finance at barely 10 per cent ." This low demand even among Muslims was attributed to costs due to the complex structures required to sanctify what remain interest paying structures, and the consequent legal overheads.
 
That there is hardly any demand from even Muslims for sharia compliant products should not come as a surprise given that the secular banks of the City have long been the preferred bankers of many Middle East governments and businessmen.
 
Indeed, in the case of Citibank, they liked it so much that they bought into the company. Saudi prince Al-Waleed , the Kuwait Investment Authority and the Abu Dhabi Investment Authority have been at various times among Citi's large shareholders, providing funds in times of crisis; Al-Waleed during the Crash of 87 and the latter two during the GFC of 2008. It is not apparent that any of them sought to re-orientate Citi's banking practices towards sharia. The wealthy Saudi and Gulf rulers preference of conventional Western basking have not diminish despite recent glitches in the system.
 
Nonetheless, many Muslim commentators propose sharia finance as an alternative to conventional financial practices which continue to be blamed for causing the GFC.
 
Despite the evidence that there is not sufficient demand for sharia compliant financial products, the sharia finance sector continues to grow in size.The Saudi Gazette, quoting Ernst and Young's World Islamic Banking Competitiveness Report2013 wrote: "Global Islamic banking assets are forecast to cross $1.8 trillion in 2013 up from $1.3 trillion in 2011.
 
It noted that the Islamic banking industry continues to record robust growth, with the top 20 Islamic banks registering a growth of 16 percent in the last three years. The report said the Islamic banking industry in Saudi Arabia - with an estimated $207 billion of Islamic assets - was ranked first in 2011 followed by Malaysia with total assets of $106 billion and UAE third with total assets of $75 billion.
 
If growth is not driven by demand it follows that it must be driven by supply. That Saudi Arabia and Malaysia lead the growth in sharia compliant banking assets provide an important clue as to what drives this supply.
 
In both countries Islam is being used as a political tool. In Saudi Arabia Islam justifies the continued existence of the monarchy and the rule of the Al-Sauds, while in Malaysia Islam mixed with Malay nationalism is used to justify the continued rule the Muslim United Malays National Party. Given that Muslims comprise over 70% of the population, the opposition also relies on that religion to make its case as an alternative government.
 
That the growth in sharia finance is supply rather than demand driven. Surprisingly, Malaysia's usually pragmatic neighbor, Singapore, ignored or misunderstood the situation. In 2007 the state owned DBS Bank launched, together with a number Middle Eastern investors the Islamic Bank Of Asia (IBA). Official backing for the venture came from the very top, as evidenced by the appointment to the IBA board of Lee Hsien Yang, second son of Lee Kuan Yew.
 
Regardless, by May 2010 DBS announced the effective closure of that venture. Again, lack of demand was sighted as the factor.
 
Meanwhile, the proponents of Sharia finance continue to generate a seemingly endless stream of academic publications which ignore the lack of demand, and instead attribute the poor reception of Islamic financial products to structural issues within the conventional financial system. A good example is "Embracing Sharia-Compliant Products through Regulatory Amendment to Achieve Parity of Treatment," published by the Sydney Law Review.  The abstract of says:

This article recognizes the potential importance of Islamic finance products in Australia, along with the current regulatory impediments preventing Australia from bhighlights, through the historical development and contemporary state of Islamic finance, its economic, social and political benefits to Australia.

Once a case for embracing Islamic finance is made, the main current regulatory impediments to Australia becoming a key player in the Islamic finance market within the Asia-Pacific region.. [emphasis added] ....the economic, social and political benefits potentially warrant Australia embracing Islamic finance and that, with the right regulatory measures."

Put simply, the argument is for adjusting the conventional secular financial system, to sharia regardless of demand. Clearly, in a free world, one cannot force a market into existence.

Ganesh Sahathevan writes for the American Center for Democracy, from where this article is adapted. He has investigated financial mismanagement in Malaysia prior to the financial crisis in the 1990s, and continues to research and report on Southeast Asian business, economics and politics.


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