There has been surprisingly little written on the politics of Islamic finance, yet government policy has obvious implications for the development of Islamic finance. Some governments have been very supportive, notably those of Bahrain, Kuwait, Iran, Qatar and Malaysia; others have been hostile, such as those of Algeria, Morocco, Tunisia and Libya, partly because they have had a mistaken view that Islamic finance is somehow linked to Islamic militants. In several countries, notably Turkey and Egypt, governments have oscillated between opportunism, seeing Islamic finance as a means of securing capital from the Gulf, and suspicion, concerned that it could be used by Islamic political movements, that are perceived to be a threat.
Supporters of Islamic finance should not be equated with Islamic militants however, or seen as challengers to existing political authority. All advocates of Islamic finance are seeking is the ability to manage their finances in a manner that complies with shariah law, a reasonable demand in any country, whether predominately Muslim or indeed largely non-Muslim. In the latter case, which corresponds to the situation in most western countries, religious minorities should have the right to adhere to their religious faith in every aspect of their lives, including financial dealings. The exercise of these rights need not be a threat to the rights of others in a pluralist society where citizens have choices about how they conduct their business affairs.
Pre-requisites for Islamic finance to prosper
The experience of Islamic finance during the last half century demonstrates that it has tended to fare best in pluralist and tolerant societies where Governments give it the freedom and the space to develop. Malaysia is perhaps the best example, a multi-religious society that represents a microcosm of Asia’s cultural and ethnic diversity. There a large proportion of Islamic banking clients are non-Muslim ethnic Chinese, Islamic finance providing a bridge between the communities. Similarly within Islam there are no divisions between Sunni and Shia over Islamic finance, indeed given the widespread agreement amongst Islamic scholars about how the teaching of the Koran should be applied to banking and finance the Islamic finance movement can be seen as a force that overcomes sectarian differences and unites Muslims.
It is also evident that Islamic finance flourishes in free market economies with vigorous private sectors, rather than in states where governments try to control and interfere in every facet of economic activity. The contrast between the success of Islamic finance in the Gulf, and its inability to develop significantly in the states of North Africa illustrates this. Where banks are largely government owned, and industry is dominated by the state and financial markets are feeble, Islamic finance is weak. A comparison between Jordan and Syria is instructive in this respect. Syria with its state owned banking monopoly has no Islamic finance. In contrast Islamic banking has flourished in Jordan since the 1970s, where small private manufacturing and retailing businesses have constituted the main client base for the Jordan Islamic Bank, itself a quoted company on the Amman Stock Exchange.
If Islamic finance and socialist planned economies are clearly incompatible, how compatible is Islamic finance with capitalism, viewed by many in the Muslim World as a western system dominated by an economic ideology imposed by the United States. In practice the argument of Islamic economists with capitalism concerns it system of accumulation that relies heavily on interest, which is equated with riba, and therefore is viewed as haram. There is no dispute over the system of private ownership that underpins capitalism, as property rights are respected in Islam. Nor is there any argument against markets, which are seen as the normal means of conducting economic transactions. Rather the Islamic economists criticism of capitalism concerns its excesses, the tendency towards greed, and ultimately the temptation to worship false material Gods at the expense of spiritual well being.
In the following sections some country experiences of the interaction of politics with Islamic finance are reviewed in greater depth.
Bahrain as the most pro-active state
Bahrain has arguably done more to promote Islamic banking than any other state, with the Bahrain Monetary Agency, the Kingdom’s Central Bank, playing a particularly active role. These efforts have brought substantial economic benefits to the island, as Bahrain boasts the largest concentration of Islamic financial institutions in the world, with 27 Islamic banks and investment institutions managing assets worth over $4 billion, more than double the amount of five years ago. There are in addition six Islamic Takaful insurance companies serving the Gulf market from their base in Manama. Over 5,000 people, including many citizens of Bahrain, are employed in the local Islamic finance industry, and as most have well paid jobs, the multiplier effect of their spending for the Kingdom’s economy is very strong, with perhaps three jobs created for every Islamic finance job.
The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is based in Bahrain and the Bahrain Monetary Authority was the first central bank to implement its standards. Bahrain was also a founder member of the Kuala Lumpur based Islamic Financial Services Board (IFSB). The link with Malaysia has brought business, as Maybank, the largest bank in Malaysia, has established a branch in Bahrain. Although Maybank is primarily conventional, its Islamic windows are becoming increasingly significant.
The Kingdom has also become the major international centre for the issue of Islamic sukuk securities following the pioneering issue of sovereign Islamic bills and notes by the government in 2000. By 2004 over $1.5 billion has been raised by the government through the issue of sukuk, the largest issue of a $300 million leasing sukuk being announced in December 2003. This has diversified the sources of government funding and reduced its cost by tapping into a different market rather than becoming over-extended in conventional debt instruments. The liquidity in the Bahrain market was recognised by Malaysia, which has chosen to list its $600 million global sukuk on the Bahrain Stock Exchange. Bahrain boasts a Liquidity Management Centre in which Islamic banks can invest their liquid assets.
Kuwait’s supportive and well considered role
The government of Kuwait has been positive and receptive to ideas about Islamic banking. The Kuwait Finance House was established in 1977, with the government taking a significant shareholding. Since then it has become one of the most successful Islamic retail banks in the Gulf, with interests in real estate as well as consumer finance. The Kuwait Finance House has enjoyed a virtual monopoly of Islamic finance in its home market, the only other Islamic institution being the International Investor, which is more focused, as its name implies, on global asset management.
In 2003 Kuwait passed an Islamic banking law to govern Islamic finance, the aim being to allow new entrants into the market to promote competition. Following the passing of the new law ten banks applied to the Central Bank for Islamic banking licences, but the policy has sensibly been to take a gradual approach rather than have the market swamped by new entrants. Consequently just two licences have been granted so far, one to the Kuwait Investment Authority that has applied to set up an Islamic division, and the other to the Kuwait Real Estate Bank that plans to convert its entire operation to be compliant with shariah law.
Positive stance towards Islamic banking in Qatar and the UAE, but no licences granted in Oman
In Qatar Islamic finance has been offered for over two decades, with the Qatar Islamic Bank operating since 1983. The experience in the UAE has been even longer, with the Dubai Islamic Bank being established in 1975, the first Islamic commercial bank to be established in the Gulf. Although initially both these institutions were monopolies in their home markets in the provision of shariah compliant financial services, the authorities in both states encouraged competition by granting further Islamic banking licences, with the Qatar International Islamic Bank established in 1990, and the Abu Dhabi Islamic Bank established in 1997. The latter operates Dubai as well as in its home emirate, while the Dubai Islamic Bank has branches throughout the UAE.
Further competition in the Islamic banking segment in the UAE has resulted from the conversion of all the National Bank of Sharjah’s operations to shariah compliant methods of finance. This was partly in response to the ruler of Sharjah’s commitment to shariah law, as the bank handles much of the business of the government of Sharjah.
Although Dubai has not become a centre for Islamic finance comparable to Bahrain, it is the location for the headquarters of Amanah Finance, the Islamic banking division of HSBC, one of the world’s largest banks. The choice of Dubai for this operation was largely made on business rather than political grounds, but in Dubai politics is largely about business, and the environment is very favourable for multinational enterprises seeking to establish new ventures that have potential in Arabian society and respect the cultural values of the region.
Saudi Arabia’s lack of a policy
A few governments have been indecisive, notably the government of Saudi Arabia, that has been increasingly tolerant towards Islamic finance, but which has no policy on the issue, or indeed even much knowledge of how to regulate the industry, despite the Kingdom being the world’s largest market for Islamic finance. Of course no policy leaves a vacuum, and arguably Islamic finance has been able to flourish in Saudi Arabia because there has been no interference by government ministers or the Saudi Arabian Monetary Agency (SAMA), and state meddling could be counterproductive.
Although there has been much awareness of the incompatibility of conventional riba based finance with shariah law in Saudi Arabia ever since the inception of the state, there has been reluctance by policy makers to tackle the issue directly, perhaps because of excessive caution. This is reflected today in the lack of engagement between the SAMA and the Islamic finance industry, with the former rarely being represented at conferences on Islamic finance, in contrast to central bankers and regulators from Malaysia and Bahrain, who rarely miss a major conference. SAMA does not recognise the standards of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and was not amongst the founder members of the Islamic Financial Services Board (IFSB), the joint initiative by Bahrain and Malaysia already mentioned. Most seriously there is no Islamic banking law in Saudi Arabia that might provide a framework for the regulation of the industry.
Saudi Arabia’s substantial government debt is financed largely through conventional bills and development bonds that are held by local banks. There could be savings in debt service payments if at least some of these government liabilities were funded through the issue of sovereign sukuk, as in neighbouring states such as Bahrain and Qatar. There has been a missed opportunity to tap into alternative sources of funding, not least those of the local Islamic bank, Al Rajhi, that cannot hold interest earning development bonds, but which could hold sovereign sukuk that are shariah compliant.
Given the Saudi Arabian government’s role as the custodian of the holiest sites of Islam and its central position in the Muslim World it might be expected that it would be one of the most innovative countries in the development of Islamic financial products. The banks all provide Islamic deposit facilities, which are estimated to account for around 17 percent of total bank deposits in the Kingdom, and if Al Rajhi is included, the proportion rises to 25 percent. This success in the growth of Islamic however largely reflects the banks response to customer demand, not government policy. Furthermore although the Saudi banks have committees of shariah scholars to advise on their Islamic banking operations, this is not a regulatory requirement. There is no monitoring of Islamic products by SAMA, or any scheme for the accreditation of shariah scholars or professional standards as in Malaysia where the Central Bank has a list of approved shariah scholars with a knowledge of finance from which the banks should appoint their committees.
The limited role of Islamic finance in North Africa
As already indicated there is little Islamic finance in the Muslim states of North Africa, the sole office of Al Baraka in Tunisia accounting for less than one percent of the country’s bank deposits.
Egypt has the longest history of Islamic finance in the region, with Mitr Gamr Savings Bank, an Islamic credit union, dating from 1963. Ali Sabri, Egypt’s leftist leader under Nasser, closed this down however in the late 1960s, as he disapproved of all Islamic institutions, and thought the state should control banking. In 1977 under Sadat’s Open Door Policy the Faisal Islamic Bank of Egypt was established, partly with Saudi Arabian capital, but although it grew in the 1980s, it was always on the fringes of Egypt’s largely state-owned banking system. In 1987 a number of Islamic investment companies that were unregulated collapsed, the most notable being Al Rayan. There was no government compensation made available to investors, and over 400,000 relatively poor Egyptians lost most of their savings.
The problems confronting the Islamic finance industry in Egypt were made worse by the appointment by the government of a new Rector of Al-Azhar University in 1989, Dr Muhammad Sayed Tantawi. Traditionally the holder of this position is regarded as the most influential religious authority in Egypt, and a major figure in the Islamic world. Tantawi ruled that the interest paid by conventional banks on deposits should be regarded as profits rather than usury or riba. The implication of this ruling was that there was no difference between Islamic and conventional banks. No surprisingly Tantawi’s fatwa was denounced by Islamic scholars in the Gulf who were much more supportive of Islamic finance, with Sheikh Yusuf Qaradawi, an Egyptian born, but Doha based, Islamic scholar leading the attack. Despite these criticisms, the Tantawi fatwa still stands, although its main consequence has been to undermine the authority of Al-Azhar, with the rulings of the Fiqh Academy in Jeddah being much more respected throughout the Sunni Muslim World, including their fatwa that all interest receipts or payments constitute riba, and are therefore prohibited.
In the West reactions to Islamic finance ranged from polite interest to scepticism. Those in the conventional banking, especially the asset management industry, saw it as a profitable opportunity to acquire private clients from the Gulf of high net worth and provide liquidity management facilities for Islamic banks that would otherwise have idle cash balances. Unfortunately however the same institutions made while little effort to serve local Muslim communities in Europe or the United States. Secularist republican countries such as France were at best indifferent to Islamic finance, but in the United Kingdom, where at least the political establishment increasingly prides itself in being in favour of multiculturalism, there has been a growing concern that Muslims should not be disadvantaged or discriminated against because of their beliefs.
The example of Islamic mortgages illustrates the supportive stance of the United Kingdom government towards Islamic finance. These have been offered through murabahah and ijara since 1997, the main provider being the United Bank of Kuwait, which following a merger, became the Al Ahli United Bank. Their home finance scheme, designated the manzil programme, would undoubtedly been more successful if the tax treatment had been more equitable. The difficulty was that as the stamp duty on house purchases was raised, this was a double burden for Islamic mortgages, as stamp duty arose both when the bank purchased a house on behalf of the client, and when the bank resold the property to the client. Not wanting to disadvantage Islamic home finance, the British Treasury agreed that the double stamp duty would be abolished, and from December 2003 this exemption took effect. As a result other players have entered the Islamic mortgage market in the United Kingdom, most notably HSBC Amanah Finance, and the West Bromwich Building Society, with the latter distributing Al Ahli manzil mortgages from its Birmingham branches. Thanks to government sensitivity to the needs of the Muslim community, Islamic home finance looks likely to take-off in the United Kingdom, with most of the major mortgage providers now expressing an interest in serving the market.
In the United States the antagonism to Islamic militants resulting from the events of 11th September 2001 resulted in a generalised, and largely ill-informed campaign against supposed sources of terrorist funding. Although funding was probably the least important concern for suicide squads, whose financial needs were as limited as their brief lives, the words Islamic banking immediately raised the suspicions of the ignorant. In fact it was western conventional institutions rather than Islamic banks that were used for the modest financing of the terrorists, perhaps because the former were least likely to arouse suspicion.
Fortunately the campaign to combat misinformation by the Islamic banks, including the presentations by Islamic Development Bank at the 2002 IMF-World Bank Annual Conference and subsequently at a Royal United Services Institute conference on money laundering in London, has been largely successful in winning over the opinions of the better informed and more financially aware in the United States, if not the wider public and investigative journalists with hidden agendas.
Islamic finance and political development
It is evident that Islamic finance needs particular political conditions to flourish that are not present in many Muslim countries. Firstly the industry needs space to develop its ideas and products, and regulators who are sympathetic towards new thinking. This is more likely in pluralist societies such as Malaysia than countries that are dominated by a single inflexible political ideology and where there is a monopoly of ideas. Secondly it is clear that Islamic finance has fared best in the economies of the Gulf where the private sector plays a significant role rather than the Arab Mediterranean states where governments still control much of the economy and own the major utilities and even the banking sector. Encouraging the private sector aids Islamic finance, with for example enormous potential for corporate sukuk where major firms have high standards of financial reporting. Finally representative governments are more likely to be responsive to Islamic finance than authoritarian regimes, as there is a client demand for finance that is compatible with shariah law and governments need to listen to the views of their own populations and act accordingly. Economic and political liberalization aids Islamic finance rather than hindering its development.