See latest resources »
Faith in banking

Faith in banking

Source: Chris Skinner, TowerGroup

Chris Skinner looks at the opportunities created for Western banks by growth in Islamic Banking.

With the growing understanding of Islamic Banking and the needs of the global communities who use these services, what is the role of Islam in banking?

Following the 9/11 attacks in America, many changes occurred in how we view and treat the needs of Muslim communities in the banking industry. On the one hand, the USA introduced legislation to regulate the Hawala method of transferring money between American immigrants and their families in Asia and the Middle East. On the other, the UK government decided to endorse the opening of Europe’s first fully-compliant Islamic bank with a local mandate. So what are the implications of the Islamic faith in banking, and what are banks doing to exploit the opportunities these create?

Before discussing the implications, it is worth explaining how the markets we are going to discuss operate.

First, there is Hawala – an ancient method of transferring money between people in Asia. Today, it is a method of transferring money overseas that does not involve complex payment infrastructures and processes, but more of a trust with traditional ways of doing business.

In the context of the USA, Hawala is primarily used for transferring money between American immigrants and families in India, Pakistan, the Middle East and Asia.

The way it works is that you go to your local money broker – a ‘Hawaladar’ in New York, Miami or wherever you live – and ask for the transfer of money to your family overseas. The Hawaladar is often a friend or contact who has a mainstream occupation in the USA, whilst offering Hawala dealings as a second business. The Hawaladar will quote you an exchange rate and a fee which will be far more competitive than a usual bank rate. Rather than taking the first rate offered, it is more likely that you would then ask a few more Hawaladars for their rates, until you find the price and fee that is the most competitive. At that point, you pay the Hawaladar your money and they ring their contact in the town you want the payment made. Their contact makes the payment in local currency to your relatives and keeps the amount paid ‘on account’. The account is settled at some point in the future, when the Hawaladar meets his contact face-to-face. All of this is held together by trust and book-keeping of accounts, which has worked for centuries.

Second, there is the growth of Islamic banking in the ‘Western’ world. In its current form, Islamic banking traces its roots to the Mit Ghamr Saving Bank in Egypt, which created the principles of Islamic banking in the early 1960’s. However, the concepts only really began to gain traction in the early 1970’s when banks in Jeddah, the United Arab Emirates and Bahrain began to trade seriously in Islamic financial instruments. Today, more than 75 countries operate Islamic banks in an industry worth over $230 billion and growing by more than 15% per annum. As a result, many Western banks have started to look at this area as a future growth opportunity.

The way Islamic banking works is that the mainstream Western financial instruments that are interest-bearing, such as a mortgage, credit card, loan or savings account, are forbidden. Interest, as with usury in traditional Christian and Catholic traditions, is considered to be evil and under the Quran, interest – or riba – is specifically prohibited.

Therefore, other ways to buy a car or own a house are used in Islamic banking, with the majority of financing being placed through a Murabaha contract. In this contract, the bank buys the asset, for example a car, on behalf of the customer and then sells the asset to the customer with a mark-up, payable on a deferred payment basis. The result is similar to a car purchase scheme from your local garage, except that the Murabaha contract fundamentally excludes any interest payments.

The reason for this brief discussion is that it helps us to understand why there is a growing interest in these areas of financial services. On the one hand, following 9/11, the US authorities determined to stop Hawala dealings as they were a major source of concern over Al Qaeda funding and money laundering. On the other, the UK government was persuaded to change their banking laws to enable the opening of Europe’s first official Islamic Bank, the Islamic Bank of Britain.

Hawala was targeted by the US authorities because it is an anonymous network. No monies actually physically move around borders, but everything is done through contacts and connections. As a result Hawala could be capable of funding both legitimate and illegitimate activities. It is this latter concern, and Hawala’s anonymity, that sparked the US Government’s interest. For example, worldwide remittances from rich countries to poorer ones were worth more than $100 billion in 2003. Hawala is one of the primary means of moving that money and the concern was that, even if it was just a small amount going towards terrorist activities, it was an amount too much. To illustrate the size of the money transfer market in the USA using Hawala, US customs agents estimated that over $50 million moved between Michigan and Yemen alone in 2002.

The result was that the US Patriot Act, passed in October 2001, gave the FBI and other agencies increased powers. The Act specifically made failure to register with the US Treasury’s Financial Crimes Enforcement Network (FinCEN) a crime for businesses engaged in remittance services, such as Hawala businesses. The result is that Hawala activities have been subject to supervision that, until 9/11, went fairly unnoticed.

Meanwhile, the UK government was persuaded to change its approach to banking in the UK because there was no way for Britain’s two million Muslim citizens to maintain their religion in their banking operations. British Muslims either had to use normal UK bank financial products and services which were interest-bearing; or Islamic banking services that were not 100% compliant with the religious laws of Sharia. On top of this, the lack of Islamic banking principles meant that the Muslim communities were being subjected to much higher tax rates. For example, if you purchased a car, you paid tax twice: once on the sale of the asset to the agent who purchased it for you under the Murabaha contract, and once again when the agent transferred the asset to your ownership under that contract. The Government’s view was that the assets had been sold twice – once to the agent and the second time to you, the customer – and hence were taxed twice. That may not be a big issue on a small loan, but when it came to buying a car or a house, that’s a large chunk of taxation for reasons that did not make sense.

As a result of a greater understanding of the needs of Britain’s Muslims, legislators were persuaded to change the law in the UK to allow fully-compliant Islamic Banking products and services in the mainstream banking system. This meant changing legislation, taxation and banking regulations, and resulted in the launch of the Islamic Bank of Britain in August 2004.

So, two systems – one official, Islamic Banking, and one unofficial, Hawala – that work closely in line to allow the free flow of funds between global Muslim communities. So what?

Well, what is interesting is that we now see Western financial providers muscling in on the Islamic financial markets. Thanks to the greater understanding of the needs of these communities and the flow of funds between Western and Islamic financial centers, there are a range of banks and firms now offering Islamic Banking and Hawala-focused trading. For example, type ‘Hawala’ into google and you will see a sponsored link to Western Union’s remittance services. Equally, since the launch of the Islamic Bank of Britain, we now see Lloyds TSB – a traditional UK bank – offering Sharia-compliant mortgage services in their branches … because they can. The laws have been changed to make it easier for banks to follow the leadership set by those who were first to market. As a result, the Islamic Banking products offer new lines of business to grow market share through appealing to a community that represents 5% of Britain’s citizens.

And these offerings are likely to grow. After all, few banks can afford to ignore a market that is under-served and offers great opportunity. The opportunity is an industry with over $230 billion of assets that is growing by more than 15% per annum. The numbers being under-served represent the second largest religious group in much of Europe and the USA, with estimates of up to 10 million Muslims living in North America. This therefore has to be a space to watch for both banks and solutions providers.

In conclusion, a much greater understanding of Islamic needs, laws and religion has been introduced as a consequence of 9/11 and subsequent activities. This is leading to opportunity for many Western financial institutions, as they learn to change and adapt to support the financial needs of the Muslim communities in their countries. In particular, the Western interest in Islamic Banking as a growth market is a new phenomena, but is one that will become significant in those markets over the next decade.

Chris Skinner is a director of TowerGroup and founder of
Web links: and
Author's email: Chris Skinner

Comments: (0)

Comment resources
See all Comment resources »
The millennial mindset

The millennial mindset

Globalisation, demographic change, virtualisation, new technologies - the confluence of these drivers is forcing European banks to adapt rapidly to stay on their game and remain relevant in a world that, five years from now, will demand an entirely new way of doing business.

Thomson Reuters and multimedia

Thomson Reuters and multimedia

Learn how financial services firms are using multimedia.

Sepa - where do we stand?

Sepa - where do we stand?

The European Central Bank's Gertrude Tumpel-Gugerell, outlines the obstacles to the creation of a Single Euro Payments Area at an offsite meeting of the European Payments Council.