With Islamic banking implementing strict requirements to be consistent with the principles of Sharia law and its practical application through the development of Islamic economics, Iqbal Ahmad Khan, chief executive officer of Fajr Capital, shares his views on Sharia-compliant finance.
During his last year as governor of the Bank of England, Lord Edward George worked with the UK Government, the Muslim Council of Britain and people like Tony Coleman, who was head of the All Party Parliamentary Committee for community banking and socially responsible investment, to enable the launch of modern Islamic finance in the UK. It was clear then that George wanted UK Muslims to 'be more British' by encouraging them to become homeowners and business owners without compromising their faith.
Yesterday and today
Islamic finance in Europe is not a recent phenomenon; it was first introduced to the UK approximately 1,250 years ago. Around 757AD, King Offa of Mercia [then a kingdom of England] decided he wanted to trade in Spain, but the Spanish Government only dealt with solid currency, so Offa minted coins, a replica of which the mayor of Cardiff gave to me when we launched the HSBC Amanah product. One side of that coin has Welsh writing and the other has the Arabic phrase, "Lâ ilâha illâ allâh", which translates as "There is no God but God". This marked the period when Islamic finance first came to Europe.
Islamic finance as we know it today started in the 1970s. UK institutions played an important role by becoming correspondent bankers to their Islamic counterparts by setting up what was known as 'test systems', where test keys are exchanged between banks.
In the '80s, introducing finance to Islamic countries through asset management proved difficult because, at that time, their markets were closed as they came out of colonial rule, which meant they did not have the 'test-and-learn' experience. Another contributing factor was the high rates of inflation and lending.
Trade and commodity finance became a pathway to using the surplus liquidity of Islamic financial institutions, and banks such as ANZ Bank and Citibank in London - as well as others outside the capital - started actively promoting syndicated finance.
Through the Islamic banking system, banks in the UK were gaining access to liquidity and cross-border trading in the Islamic Development Bank (IDB) member countries, which resulted in the establishment of syndications for Pakistan and Turkey. Many Islamic countries were having budget difficulties and needed money to develop and expand, so Islamic finance inductees provided cross-border trading services: these institutions were well-placed to do this because they were close to the risk and so could understand it better and, in turn, price it better. It was at this point that Islamic finance became a competitive reality.
Trade and finance has always been important, both when Muslim countries were under colonial rule and after they became independent. Most of the large European banks have played a role in promoting trade finance. Many trading institutions already specialised in commodities such as oil and gas, but the likes of coffee and other commodities were beginning to be traded, too, and were areas of significant growth.
However, the real catalyst for Islamic finance in the UK came in 2006 when Chancellor Gordon Brown gave a keynote speech at the Islamic Finance and Trade conference in London. He positioned the UK as the gateway to Islamic trade and finance, and promised that the country's financial industry would help promote the Islamic financial sector. There was already a lot of goodwill between London and the Islamic trading community through dealings with law firms, accounting companies and taxation advisers, which provided a solid basis for this support.
When it came to the '90s, equities opened up as an asset class. The first equity fatwa was given in Europe by one of the most prominent Sharia scholars in Egypt. During a visit, we took him to see large pharmaceutical companies and carmakers such as Mercedes-Benz. We explained that we want to buy these companies, but the problem was that they don't want to sell them completely, however, it was possible to buy parts of them. Out of the fatwa came a 'yes', as long as sectoral guidelines were in place there would be exceptions for equity investments (under Sharia law, making money from money is not permitted).
The asset-management sector became mobilised as a result of that landmark fatwa. Most Islamic investors like assets that they can touch, feel, look at and say, "I bought this"; for example, properties in Europe, particularly London, have been popular purchases for decades, and Islamic investors continue to invest.
Private finance initiative
Since the UK launched the private finance initiative (PFI) in 1992, there has been greater investment into infrastructure from the Islamic financial sector. The PFI model has also became a standard for many Muslim countries.
The UK's position in Islamic finance was strengthened further following the World Islamic Economic Forum, which took place in London in 2013, with Prime Minister David Cameron introducing the sukuk Islamic bonds and appointing a cabinet minister to lead the sukuk effort. This created a huge amount of goodwill, and in Baroness Warsi we have a well-respected cabinet member, who is leading the growth of Islamic finance. This will have a demonstrable effect not just throughout Europe, but also across the world.
When a financial centre like London announces a sukuk - though there are people who believe the sukuk may not happen - there is a commitment and a political will. While the sukuk itself is not a landmark event, it will pave the way for borrowers and municipalities through corporates across the UK, and will allow UK companies to become more competitive. The continuing support across the political divide will also lead to the growth of Islamic banking and finance, and investments in the UK.
Approximately 90% of banking is local and the remainder is international. Community banking within niche populations is always hard, especially if the community is spread across the country. In Europe, it is particularly difficult because the cost of distribution is so high. This is where technology will create a sukuk, with the internet and e-enablement helping lower the costs of distribution, thereby making the Islamic financial instruments much more competitive.
The Prince's Trust in the UK offers financing under Sharia-compliant products, which HSBC structured, to allow entrepreneurs and young Muslims to set up businesses without compromising their faith. Also, the prime minister's initiative on university fees will be welcomed by the Muslim community and will pave the way - at a time when such fees are becoming a major issue - for it to be a sukuk not only in the UK, but in other countries as well.
Islamic community banking will become successful as its banking institutions move to smaller branches, and use express banking and technology as tools to lower their distribution costs. When you lower the cost of distribution, you can launch competitive products. And when you launch competitive products, you can then go out and compete in the wider market, not just on values or the label 'Sharia banking', but also on the basis of launching a product and/or service that is competitive. Here, the annual pension and the democratisation of savings and investment are crucial.
Similarly, the area of small-to-medium enterprises is important. An initiative has just been launched where a corporate entity has been created and is being managed, not as a handout programme, but to establish businesses in Medina, Saudi Arabia, under the 'Made in Medina' brand.
Another key to the success of Islamic banking lies in pensions. The pension capabilities of core European markets should be transferred to the Islamic world and to Sharia-compliant structures. Though the world's perception is that Muslim markets are undergoing a population boom, the reality is people are marrying later, having fewer children and, in 30 years' time, there will be one of the largest shrinkages of population ever witnessed in history. Therefore, preparation now is imperative.
Authenticity and opportunity
As a sales plan, an investment programme and business model, the concept of mutuality and cooperative banking, cooperative asset management and cooperative insurance is at the heart of Islamic finance, and brings with it the hope of greater authenticity for the Islamic finance industry.
The biggest opportunity in Islamic finance is asset management in the real economy. Islamic finance was originally based on asset management, but shifted because the realities of the Islamic world did not allow it to be successful; for example, college-led institutions had a series of asset-management contracts in the real economy, but Islamic countries and their institutions were not ready - they had no R&D capabilities, no test-and-learn experience and no management deck. As a result, they lost a lot of money on musharaka and mubaraka contracts [an Islamic mode of finance in which capital is provided by two or more parties for project development]. So, they shifted to muhabaras and mujaras, and the markets followed due to the high inflation - approximately 20% - at that time. As this inflation came though, there was more innovation.
Asset management in the real economy will be a big growth opportunity for the Islamic financial sector, and will give greater credibility and authenticity to Islamic finance. One of the ways to increase authenticity is to have a demonstration effect. And one of the biggest challenges the industry has today is the creation of role-model institutions and economies.
In order to create the demonstration effect, Islamic economies need to separate financial intermediation and the payment system. They need to have what are known as 'narrow banks', which manage people's money, and provide services and financial intermediation shifts to the likes of asset management-based models.
It is only when this is done that we will be able to have a Sharia system of banking and financial intermediation that does not have the risk it currently has.