Islamic Finance: Banks Have Their Work Cut Out

AS a regional financial centre, Singapore would be well placed to develop Islamic finance. But that seems unlikely, as bankers here prefer to wait for others to take the risks of being creative. It's a pity, as demand for Islamic products is rapidly expanding in the region, liquidity is plentiful and funds from the Middle East to Brunei are looking for investments that comply with Islamic law.

According to DBS's Greg Seow, Singapore has a natural headstart as an established regional financial centre with a strong and trusted reputation, but will have to quickly increase its critical mass in terms of Islamic counterparties and approved products to establish itself as a regional Islamic financial centre. 'Malaysia is making good headway and Brunei has plans to establish itself as an Islamic financial centre,' Mr Seow says. But Islamic finance is hardly on anyone's radar screen. The reason given is lack of demand, which commercially, means it won't make money. But that is sounding increasingly short-sighted given the size of the region.

Yet this complaint is not peculiar to bankers here. Accusations that banks are reluctant to take on the marketing and development risks of offering more Islamic finance products have also been raised in London - the largest international centre for Islamic finance outside the Muslim world.

Globally, Islamic finance - an ethical and equitable mode of finance that derives its principles from the syariah (Islamic law), with the most distinctive element being the prohibition of interest - is growing at an estimated 15 per cent a year. It is worth an estimated US$250 billion, with funds under management of US$60-80 billion, according to HSBC Amanah Finance, the Islamic financial services division of the HSBC group. The growth rate partly reflects the Islamic world's economic growth, fuelled mainly by oil wealth. This has promoted a middle-wealth niche and made banking a necessary service for a larger segment of the population, says HSBC Amanah Finance.

In Malaysia, Islamic banking is expanding at a rapid pace, and already accounts for 10 per cent of the industry there overall. Islamic finance has broadened to cover almost every aspect of banking in Malaysia, from the retail finance of home purchase to commercial banking such as financing manufacturers.

Unconcerned: But the three Singapore banks - DBS, United Overseas Bank and OCBC - don't seem too worried about not having a serious profile in this ready market.

DBS is taking small steps by launching a second Islamic fund, while the other two, which have full-fledged banking operations with branch networks in the major Malaysian towns, are not known for their Islamic banking offerings. The three often like to boast of their local and regional knowledge when they talk about the competition. The inference is that with their local and regional roots and long experience, they have an advantage in reaching out to customers and offering customised service.

So why the tentative approach towards developing Islamic finance? After all, Malaysia is almost like home to them. The market is not just the Muslim community but also non-Muslims.

According to research released last year by Deloitte Touche Tohmatsu Malaysia, up to 70 per cent of Malaysians who opt for Islamic banking are non-Muslims. They like Islamic banking for its certainty and principles, which prohibit usury, or the charging of interest on loans. For an Islamic housing loan, the contract details the fixed monthly repayments for the loan period. The bank acts by buying the property and reselling it to the customer at a profit. This margin covers what would otherwise be charged as interest.

Since interest rates in the conventional banking system are now low and are only likely to increase in future, many Chinese Malaysians opt for Islamic banking to lock in low instalments, especially for home purchases.

But Singapore bankers seem unconvinced. According to one banker here, there's no need to charge into Islamic banking because other businesses are still profitable. He also notes that local banks prefer to let others develop new products and test the markets before they take the plunge themselves. 'When bankers get creative, you get Enron,' he said in defence of the timidity of his counterparts.