UAE. Although Sharia forbids the kind of complex derivatives and opaque instruments which helped ignite the global financial meltdown, Islamic finance was nevertheless unable to escape the crisis because of its asset-backed nature. Falling real estate prices have hit the sector particularly hard, the DIFC Forum heard this week.

The potential for Islamic banking remains enormous, even in the Western world, where it can be marketed side-by-side with other “ethical” investments. But significant regulatory hurdles must be overcome in both the Muslim and non-Muslim world; and that will require action from both the industry and the regulators, themselves.

Four of the leading experts and players in Islamic finance took the industry’s pulse at the DIFC Forum, at a challenging time for the global financial industry. These included Hari Bhambra, Senior Partner, Praesidium; Professor KC Chan, Hong Kong Secretary for Financial Services and the Treasury; Khalid Abdullah-Janahi, Chairman, Ithmaar Bank, Group Chief Executive, DMI; and Iqbal Ahmed Khan, CEO, Fair Capital.

Last year, the Islamic finance market was worth an estimated US$1.3 trillion. The panellists did not offer a current valuation, but, “it is a myth that Islamic banking is not affected by the global financial crisis”, said Khalid Abdullah-Janahi, Chairman of Ithmaar Bank, and Group Chief Executive of DMI.

“We have been affected, not from the investment side, but we do suffer from the perspective of liquidity."

Professor KC Chan, Hong Kong’s Secretary for Financial Services and the Treasury, agreed that “it was the over-leveraging that led to this." And that poses a challenge to any country or region hoping to become a centre for Islamic finance, or any other sector, for that matter, he said.

“My hunch is that you cannot escape the globally-felt liquidity crunch and loss of confidence as a result of the drop in stock prices and the recessions you see, worldwide. So my hunch is that it is difficult for any single region to have its own destiny in this time," he said.

Nevertheless, Janahi said, grassroots demand for Islamic banks is growing across the Gulf region, and beyond, despite resistance from many governments. “Whether or not they want it to happen, it’s happening”, said Abdullah-Janahi. “In Saudi Arabia, now, all of the banks have Islamic branches. It’s the same in Dubai, Abu Dhabi, Kuwait."

The irony, he said, is that most of the prevailing Islamic financial products were actually developed “by the Citibanks of this world, because there’s been money to be made. The day the liquidity goes, believe me, they’ll go to something else. But the important thing is that the people in the region - in Singapore, Malaysia, Indonesia, Iran, Turkey - suddenly everyone wants to do it, even if they call it by a different name. And it’s the investors, the clientele who are pushing for it," he said.

Hari Bhambra, Senior Partner at Praesidium, agreed that some countries or jurisdictions were “jumping on the bandwagon, if you will. Others have a demand from a client base, but can’t necessarily offer the product as Islamic. It may be difficult to introduce Islamic-aligned products in places like Morocco, for instance, where you’re not even allowed to use the word," she said.

On the other hand, Bhambra said, Islamic finance products had potential take-up in markets like the US, where they may be repackaged as ‘ethical,’ or moral products, like the 'green' or Christian funds already on offer.

Ethical finance, by all means, said Iqbal Ahmed Khan, CEO of Fair Capital. He applauded the idea of “an alliance of goodness” with other ethical products around the world. Islamic finance needs to be an agent for “democratised wealth, to bring more people into the banking system”, he said.

The sector could emerge from the current crisis as a potential role model. “It could create a major force of goodness, and hopefully will address the needs of the most vulnerable members of society," Khan said.

However, the industry faces regulatory problems on two fronts, the panellists agreed. In Western markets, Islamic banking has been hampered by regulatory structures which try to fit it into conventional moulds. And in the Muslim world, Islamic banks are subject to far stricter regulatory regimes than their western competition is in their own markets.

The Islamic banking industry also has a confidence problem. It won’t become a major force in the region until current investors gain confidence in their own regional structures, and sovereign wealth funds are invested locally, rather than in markets like New York or London, the panelists said.

In the past year, Janahi said, “US$30 billion was spent across the region on saving banks in the West, but that money should have stayed here." As the financial crisis has deepened, some of that money has been brought back, he said, “because they have to. But that tells us they have no confidence in things in this part of the world. Instead they have confidence in collapsing banks like CitiBank.

“We need the private sector to be part of this”, Janahi said. “And that will only happen if sovereign wealth funds invest in it. It’s all very nice to go build a hospital in New York or wherever, but if I don’t have good hospitals, good schools, good roads in my own place, what am I doing developing outside? So, it’s not ‘shame on the other guy’, it’s ‘shame on us’."

Khan, however, pointed out that some of that sovereign wealth was being invested in Islamic-compliant structures abroad. The British government, in particular, was working to develop the sector. “I don’t see it as a ‘them and us’ situation”, he said. “I think many commercial banks have succeeded in bringing a lot of know-how to the industry. That’s where the demonstration effect will come."

The Hong Kong-based Professor Chan pointed to a middle path. “You need to have institutions that understand local needs, and be regulated accordingly”, he said.

“We will have global banks, and institutions, but there’s also a need for strong local institutions." London, Hong Kong, Singapore are not competing directly with Islamic-compliant institutions in the Middle East, he said. “They’re offering products and opportunities to invest in Asia. That’s how we see our role. Hong Kong is not looking to provide competition, but products, for Gulf investors”.

In the medium to long term, Khan suggested, the road may be smoothed for Islamic banks to expand into markets whose current laws now force them into a regulatory strait-jacket. Islamic banks have been holding talks with central banks and with each other, he said.

“As a new financial architecture emerges after this crisis, Islamic finance can be presented as a model, one based, not on debt, but equity. There are meetings going on. It may happen."

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