Cicero Policy Briefer

Issue 13, June 2007

The growth of Islamic finance

By Alex Macpherson

Around this time last year, Gordon Brown announced his intention to “make Britain the gateway to Islamic finance and trade”. His speech to the Islamic Finance and Trade Conference, in which he pointed out that London currently has more banks supplying services under Islamic principles than any other Western financial centre, was a recognition of the increasing significance of this alternative to mainstream financial practice.

The tenets of Islamic finance are based in religious shari’a law, and central to it is the belief that money has no intrinsic value (heresy, perhaps, to many business figures; but given its increasingly broad appeal, not an approach to be dismissed out of hand). Consequently, making money from money is forbidden—in other words, interest (or riba) can be neither paid nor earned on an Islamic account. Interestingly, this is historically also in accordance with Christian practice: usury is denounced in a New Testament parable, and was considered sinful by the medieval Catholic church; only in the 16th century, with Henry VIII’s break from Rome, did Western attitudes begin to change.

Instead, Islamic banks make profits from trading goods and services, using the money deposited by customers (as opposed to clients’ capital) and sharing both the risks and rewards with them. They can can help customers to purchase property via an ijara leasing scheme, whereby the customer is charged an agreed rent.

Furthermore, shari’a law means that there are firm rules regarding the types of business which banks can trade with: customers of an Islamic bank can be completely certain that their money will not be invested in companies which deal in armaments, tobacco, alcohol, drugs or pornography—in stark contrast to some of the recently uncovered dealings of mainstream banks. The HSBC Life Amanah pension fund, for instance, uses the Dow Jones Islamic Market Titans index in order to track companies whose primary activity complies with shari’a law. And it is this point which is making Islamic banking an increasingly attractive option, not just for the 1.8 million Muslim residents in the UK, but also for non-Muslims.1

In recent years, the financial services industry has shown signs that it is ready to jump on the bandwagon. In May 2005, Standard Life added the aforementioned HSBC Life Amanah option to its range of funds, and in June 2005, the Children’s Mutual launched the UK’s first shari’a-compliant child trust fund. Islamic mortgages, current accounts and student accounts have been developed, and in April of this year, Lloyds TSB became the first mainstream bank in this country to offer a fully shari’a-compliant business account. Even more significantly, the Government indicated in April that it was considering borrowing money through bonds compliant with shari’a law.

With more than £125bn of Islamic finance assets worldwide, the potential for this market to grow is vast. It remains largely untapped by the mainstream industry, but the signs are that it can no longer be considered a mere niche concern.

1. http://news.bbc.co.uk/1/hi/business/6168800.stm

Alex Macpherson can be contacted on +44 (0)20 7665 9530 or click here to email.

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