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  • 1. Islamic Financial Movements: Midwives of Political Change in the Middle East? by Clement M. Henry University of Texas at Austin Department of Government BUR 536 Austin, TX 78712-1087 A paper prepared for the 2001 Annual Meetings of the American Political Science Association, Hilton San Francisco and Towers, August 30 to September 2, 2001. Copyright by the American Political Science Association.
  • 2. Clement M. Henry, Islamic Financial Movements, page 1 Abstract Islamic banking has acquired a degree of acceptance, institutionalization,and small but significant shares of the commercial banking markets in a number ofMuslim countries. It is allowed greater freedom than Islamist political movementsin most of these countries. Relationships are complex, however, between therespective governments, Islamist oppositions, and Islamic banking establishments.This paper discusses conditions under which the Islamic financial movementsmight effectively mediate between governments and oppositions and therebyencourage tendencies toward more political pluralism within the incumbentregimes. The regimes in question are all "authoritarian," with the exception ofTurkey, but they tolerate pluralism in varying degrees, depending largely on therelative strength of their respective private sectors that underpin civil society. Insome of the Muslim countries the Islamic banks associated with Islamic businesscommunities constitute significant parts of these private sectors. This paper seeksto discover the thresholds of private sector activity that may be needed underdifferent political conditions for Islamic finance to moderate Islamist politicalmovements and encourage greater political pluralism. Below the threshold,however, Islamic finance may still indirectly encourage political pluralism bysupporting those elements of the regime that are committed to economic reform.
  • 3. Clement M. Henry, Islamic Financial Movements, page 2 Like social movements, Islamic finance mobilizes resources (deposits, many of whichmight otherwise stay under peoples mattresses) and "frames" the identities of theparticipants in common, specifiable, distinctive practices. It also enjoys better access inmost MENA countries to government and business elites than other "Islamist" socialmovements. The world of Islamic finance may appear at first glance to be far removed fromthe rough and tumble politics of most MENA states. Its apparent marginality, however, alsooffers some protection. In illiberal states the financial field still enjoys a degree of autonomythat is not accorded to political parties, formal NGOs, and other bodies associated withofficial decision-making. Most, although not all, of the MENA states are illiberal, but theytend to be less closed financially than they are politically. Some of them tolerate Islamicbanks as part of a strategy to legitimate themselves. By "Islamist" here is meant a determination to transform the present state of the world orsome aspect of it to accord more closely with the principles of Islam. Financial practicesmay be a very limited aspect - and rather less provocative for some Muslim and Westernaudiences than wearing beards or veils. Dress codes attract attention and, rightly orwrongly, may be taken to express more radical, totalistic aspirations for social change thanarcane financial practices. As Vogel and Hayes observe, however, "the surge in Islamicbanking and finance is part of the much larger phenomenon of Islamic reassertion" (1998:21). Finance, indeed, gets to the root of social and economic change by articulatingrelationships between states and business communities. It is often forgotten, as a recentstudent of Mexican banking laments, that markets and power are fungible (Auerbach p. 23).Max Weber once explained how in his native Germany at the turn of the last century bankeroligopolists converted their market power into seats on boards of directors (Weber 1978:943-944). Rockefellers oil monopoly was another of his favorite examples, but Webernever carried the analysis further to buttress with structures and institutions his ideationalarguments about the affinities of the puritan ethic for capitalist development. This paper willpursue the inquiry, since Islamic finance offers a ready-made and recent set of institutions. As the late Ernest Gellner observed, following Max Weber, Islamism is indeed a form ofpuritanism. In Muslim Society (1981) and in earlier essays he argued that there werestriking parallels between orthodox urban Islam and Christian puritanism. Each traditionwas scripturalist, enabling any literate individual direct access to divine revelation without anyintervening earthly or spiritual hierarchies. The major difference between Islam andChristianity is that Islam was born puritan whereas the Christian puritans emerged much laterto attack a central church hierarchy. Puritanism is part of Islams mainstream orthodoxwhereas it is a deviant protest movement outside the Christian Church. Martin Luther, JohnKnox et al attacked the priests, icons, and angelic intermedaries - all part of a great chain ofhierarchical being adapted from Aristotle. The zealous puritans transformed the chain ofbeing into a chain of command (Walzer 1965) and generated the first mass political partiesin England and Holland in the seventeeth century. If we follow Gellners analogy, Islam was born reformed and has constantly re-experienced puritan uprisings to rid the cities of corruption and religious slacking off.Modern Islamism fits into this tradition of revolt against corrupt authorities, including ulamawho collaborate with illegitimate rulers. In Algeria, for instance, Gellner perceived thereligious reformist movement of Ben Badis to have been the driving force behind the Front
  • 4. Clement M. Henry, Islamic Financial Movements, page 3of National Liberation (FLN) that fought the French and ruled independent Algeria untilrecently. This sort of radical Islamism, in his view, was progressive and perfectly compatiblewith - indeed the principal moral force behind - Algerian industrialization. Very self-consciously in the tradition of Max Weber, Gellner viewed lslamic reformism - what we call"Islamism" today - as sharing the same affinities for capitalist development as the Protestantethic. To follow up on this analogy, however, we need to identify an Islamist bourgeoisierather than just let the state do it, as Gellner seems to have expected of Algeria. Islamicfinance offers the requisite marker to fill in the missing structural link in the Muslim traditionthat neither Weber nor Gellner ever identified for Protestant business in the Christiantradition. While politically Islamist bourgeoisies do not necessarily work with Islamicfinanciers, these bankers offer a politically neutral definition of Islamism that is more likely toprosper in illiberal regimes than more overt forms of political Islamism. They carry. too. adistinct set of business practices that may resonate better than conventional finance withMuslim publics. This paper also addresses the broader question of the conditions needed for anautonomous bourgeoisie or business community to emerge. Can it exercise influence eitherindirectly, reflecting structural power, or by real voice and regime change? Some businesscommunities have occasionally exercised decisive influence. In South Africa, for instance,big business backed the referenda that abolished apartheid. In Brazil business tired of thegenerals pushed for the "decompresion" of the late 1970s. Ultimately the progress ofIslamic finance may require further political liberalization, but to what extent, conversely, canit be a catalyst for such political change? We will see that the movement has progressedfurthest in the Sudan and in relatively liberal monarchies. But it is also tolerated in militarybunker states such as Algeria and, by most recent reports, Syria. The Islamic finance movement Islamic bankers and economists would hesitate to call themselves a social movement butthey appear to share a financial world view in which riba -- interest or usury -- is abolishedwhile the time value of money as understood in contemporary financial theory is respected.Unconvinced Muslims as well as other critical outsiders observe that Islamic banks in realitykeep interest but just call it by another name, such as commissions or profits (ribha). Andindeed a principal form of credit extended by an Islamic bank, the murabaha, involves asimple markup on a sales price. The bank buys you a car for $30,000 and you owe thebank $33,000 a year from now, for example. This arrangement is perfectly acceptable fromthe standpoint of Islamic financial theory but looks to the outsider like a simple loan at 10%interest. Repaying by 5 yearly installments of $7913.92 would be equally acceptable andalso implies an interest rate of 10%. Islamic bankers use financial calculators just like otherbankers to compute present and future values of investments. Financial transactionsmodeled on the murabaha constitute well over half of the assets of Islamic banks. Contractsengaging clients to return fixed payments to Islamic banks apparently constitute from 80 to95 per cent of the latters credit facilities, or "investments" (Warde 2000: 133). Since anyfixed return can be understood as implied interest, there seems little to differentiate Islamicfrom conventional banks. Indeed, as Ibrahim Warde observes, no definition of an Islamicbank is entirely satisfactory (2000: 5). He proposes a bank to be Islamic if run by Islamic
  • 5. Clement M. Henry, Islamic Financial Movements, page 4principles and, one might add (at least in most cases), a Sharia Board of religioussupervisors to vet the banks policies. The movement is hardly monolithic. From its origins in the mid-1970s there werephilosophic disagreements between one of its pioneers, an Egyptian, the late Dr. Ahmad al-Najjar, who sought wider financial participation among the poorer classes, and his Saudisponsor, who was deploying substantial capital to compete with other commercial banks.Commercial forces may have eased out the idealists, but there is still indeed somequestioning about the Islamic legitimacy of the murabaha, though more so by Islamiceconomists than by the jurists who actually make the decisions about what is legally binding.Some of the more "purist" economists argue that the distinctively Islamic financial instrumentsare mudaraba and musharika, both of which involve profit-sharing. Mudaraba is a contractwhereby the bank provides funds to an entrepreneur in return for a share of the profits, or allof the losses, whereas musharika - participation - is more akin to equity financing. AnIslamic bank can also be conceived as a mudaraba whereby the depositors invest in thebank - or entrepreneur mudarrib - that in turn funnels investments into other mudaraba orother Islamically acceptable placements. Profit-sharing with variable returns and risk-takingare the distinctive characteristics of the Islamic financier. The purists criticize existing Islamicfinancial institutions as deviating from an Islamic ideal of venture capitalism. They note thatIslamic banks currently allocate less than 10 per cent of their credit facilities or investmentsto these distinctively Islamic profit-sharing instruments. Some argue that any contractoffering a fixed return is just like a loan at a fixed interest rate and hence is not Islamicallyacceptable. The jurists, on the other hand, tend to think less theoretically and deductively than theeconomists. They reason case by case, on the basis of precedents and prior rulings in theirrespective juridical schools. The consensus is that murabaha is just as permissible,Islamically, as mudaraba or musharika, as long the contract meets certain conditions. Thekiller, in the above example of a murabaha, is that the bank actually has to own the car andsell it to the client, rather than merely advancing him or her the funds to pay the car dealer.The Fiqh Academy in Jeddah went on record in 1988 against the "artificial" murabahawhereby the bank never really owns the car (Vogel and Hayes 1998: 143). Islamic banksare hence caught in a dilemma. Commercial banks in many countries, especially under thosehistorically influenced by British or American banking practices, are supposed to restrictthemselves to the financial business of taking deposits, lending them out, and trading only infinancial instruments. Yet the Islamic jurists insist that they be involved in the trading of therange of goods financed by their portfolios of murabaha. Otherwise they would be engagingin the "ruse" of artificial murabaha that is now forbidden. At least one Islamic bankapparently takes these injunctions quite seriously. The Jordan Islamic Bank for Finance andInvestment inaugurated a bonded warehouse in 1999, just as it was celebrating its twentiethanniversary (21st Annual Report, p14). Almost half (45.7%, p. 56) of its financing andinvestments then consisted of murabaha (while mudaraba and musharika came to less than3%). Evidently the Islamic financial movement is attempting to adapt Islamic instrumentsoriginally designed for pre-industrial trade and handicrafts to a post-industrial globaleconomy. Commercial banking already became a specialized industry in the nineteenthcentury, and European banking systems penetrated the Muslim world as well. Driven by
  • 6. Clement M. Henry, Islamic Financial Movements, page 5new technology and favorable deregulation by the United States and other industrializedcountries, banking and finance became ever more specialized and relatively autonomous. Inthe latter half of the past century the growth in international financial assets has faroutstripped that of any underlying investment and trade in goods and services. In this highlyspecialized world of international finance, with its dizzying rates of product innovation,conventional banks could not afford to build warehouses as well, even if commercialbanking legislation permitted them to. The business of modern finance and banking issufficiently challenging in its own right, and there are few synergies with other industries thatthe "real" non-financial one, such as the car manufacturer-dealer, is not better positioned tobenefit from. The Islamic finance movement developed under the impetus of bankers, notcar dealers - though at least one of the latter engaged in a phoney sort of "Islamic" finance inEgypt in the 1980s. The movement may be at a serious competitive disadvantage with commercial banks,then, not least because of its lack of consensus on murabaha and many other matters. Eachof the 186 or so Islamic banks (as indicated by the Directory of the International Institute ofIslamic Banks) has its own advisory committee of Islamic jurists, and they issue rulings thatare not always mutually consistent. Conventional banks like Citibank that have openedIslamic windows also have their religious advisory committees. Standardization is a majorproblem. For the movement to survive in the competitive financial world of the 21st century,the banks must be able to innovate and develop new instruments for both short-term liquidplacements and long-term investments. Innovators need to know what is Islamicallyacceptable, yet any innovation faces a wide spectrum of legal opinion. If options (adiscretionary contract to buy a good at a future time and price) are Islamically acceptable,for instance, then Islamic financial engineering can mimic virtually any instrument that aconventional financial institution can devise. Highly restrictive rulings, by contrast, couldconceivably outlaw virtually all of the bread and butter murabaha trade financing in which thebanks presently engage and preclude any significant innovation. This paper cannot enter into the details of what might or might not be legal to varioussharia boards. Indeed, as Warde suggests, "legalistic concerns are only aspect, andprobably not the most crucial one, of the real world of Islamic finance" (Warde 2000: 11).Eventually the financiers and their religious boards will make compromises with financialmarkets because these banks enjoy one major underlying competitive advantage, populardemand among pious Muslims for an alternative to interest-based savings accounts. Assetsunder Islamic financial management, currently estimated to be in the range of $200 billion(Abdullah Kamel, Chairman, Saudi Dallah al Baraka Group, to Al-Hayat, December 5, -1999; cf. Warde 2000: 6), continue to grow by an estimated 10 to 20 per cent, especially inthe wealthy Gulf states. Whether or not they build warehouses, the Islamic banks will ndoubt muddle through despite inconsistent rulings and other obstacles to financial innovation.While few of them have become big enough "not to fail," the Muslim host governments willnot let them. Accounting practices vary widely but the Accounting and AuditingOrganization for Islamic Financial Institutions (AAOIFI), established in Algiers in 1990 andnow based in Bahrain, finally issued its first set of standards in June 1998. In addition to theFiqh Academy in Jeddah there are various other institutions engaged in the dialogue betweenbankers, economists, and jurists that are articulating a broad agenda for Islamic banking andfinance.
  • 7. Clement M. Henry, Islamic Financial Movements, page 6 First, at the core of the movement are two transnational groups that conduct their owndialogues: the Al-Baraka Group and the group of banks affiliated to Dar al-Mal al Islami, a -holding company controlled by Prince Mohammed Al Faisal, son of the late King Faisal.The Faisal group is also heavily represented in deliberations of the International Associationof Islamic Banks, founded in 1977 under the auspices of the Islamic Bank for Developmentowned by the member states of the Islamic Conference. Outside the umbrella organization,Al-Baraka has held annual meetings since the mid-1980s to develop commonunderstandings of proper banking practices among its affiliates. In addition many researchinstitutions, in Europe and the United States as well as in the Muslim world, promote anacademic discourse about Islamic financial institutions. In the United States the HarvardIslamic Finance Information Program, launched in 1995, has sponsored impressivepublications and developed an important database. It also convenes annual conferences thatcontribute to the ongoing dialogues between academics and practitioners, jurists andbankers. The most significant guarantee of Islamic finances future may be the large westernmultinationals that have opened Islamic windows for receiving deposits from their wealthyGulf clients and for financing a variety of projects in the Muslim world. The French, led bythe Banque Nationale de Paris, have lately joined the many American and British presencesheaded by Citibank and Kleinworth Benson. The World Banks International FinancialCorporation has encouraged cofinancing infrastructure projects with Islamic investmenthouses. Prominent multinationals, including oil companies, have joined in project financing insome of the GCC states with Islamic financial instruments. Islamic finance, in short, isbecoming respectable in international business circles. One commentator recently went sofar as to suggest that even if existing Islamic banks were to stagnate or fail, their distinctiveset of financial templates would survive as a dynamic segment of global financial markets(Monzer Kahf 1999: 459). On the ground, however, these banks are gradually expandingtheir shares of deposits in the commercial banking sectors of many MENA countries.The growth of Islamic market segments The Islamic banking movement includes both publicly and privately owned commercialbanks. The Islamic Development Bank, founded in 1973 and owned by a consortium thatby 1998 included 52 Muslim states, eventually assimilated some of the novel Islamicfinancial practices devised by the private sector. The first modern privately owned Islamicbank opened in Dubai in 1975. The Dubai Islamic Bank practiced interest-free bankingalthough it did not establish a religious supervisory council until 1998, when a managerembezzled funds and the bank needed a government rescue package. After 1979 Iran,Pakistan, and Sudan all "Islamized" their banking systems from above, but thesebureaucratically induced changes are less interesting than the evolution of privately ownedbanks, including those in the Sudan that were "Islamic" before the official Islamization of the1980s. In MENA countries where privately owned Islamic commercial banks competewith conventional public and privately owned ones, it is possible to compare their respectivefinancial performances. Their respective shares of commercial bank deposits can becompared across countries, and in some countries their returns on capital and total assetscan be readily compared to those of their conventional competitors. Jordan and Turkey areespecially convenient countries to study because they publish aggregate data about thefinancial performance of their respective banking systems.
  • 8. Clement M. Henry, Islamic Financial Movements, page 7 Table 1 pieces together the progress of these privately owned banks in the MENAregion, including Turkey, with the available data. For comparative purposes Malaysia isalso included because its experience is often cited as exemplary in Islamic banking circles.The countrys only exclusively Islamic Bank, Bank Islam Malaysia Berhad (BIMB), hasmobilized less than 2 per cent of Malaysia sight and savings account deposits (measured bylines 24 and 25 of the IMFs International Financial Statistics) in almost two decades as anofficially recognized commercial bank (cf. Warde 2000: 127). At the time of its officialfounding BIMB already had established a Muslim clientele by collecting funds to finance thepilgrimage to Mecca. Relations between BIMB and Malaysias Central Bank may havebeen more constructive over the years than the experiences of a number of Arabcounterparts with their central banks, but Malaysia has not experienced the surge in Islamicbanking of Sudan and the Arab Gulf states. (Table 1 about here) A number of observations are in order. In theory all banks in the Sudan operateaccording to sharia principles, but those that were consciously self-styled Islamic banksbefore the system was Islamized seem to have increased their market share at the expenseof the newer converts. In Saudi Arabia, the spiritual center of the Islamic world, a singleIslamic bank, Al Rajhi Banking and Investment Corporation (ARABIC) has captured over10 per cent of the market, and in some of the smaller GCC states the Islamic sector isapproaching 20 per cent. The GCC seems to be the principal area of growth, possibly tobe joined by Jordan, where Arab Bank has opened a new totally owned Islamic subsidiary,the Islamic International Arab Bank. Until this recent development - the bank opened forbusiness in 1998 - the movement in Jordan appeared to have flattened out at less than 10per cent of the market. Egypt has apparently experienced a slight decline since Islamic banking reached itspeak in 1986. Table 1 does not include the so-called Islamic fund management companiesthat used Islam as a marketing technique for money-changers who expanded theirbusinesses to manage their clients remittances. These companies were, with one or twoexceptions (Sherif and possibly Saad; see Galloux 1999: 488-489), fly-by-night"investment" companies that simply funneled Egyptian workers remittances from the Gulfcountries to hard currency accounts outside Egypt. They doubly harmed the officiallyrecognized Islamic banks. They competed for deposits and slowed the growth of the officialIslamic sector in the mid -1980s. Subsequently they discredited the entire idea of Islamicfinance (even though they did little to practice it other than pay publicity fees to a few Islamicscholars) by going bust after 1987, when an agreement with the IMF to liberalize Egyptianforeign exchange rates destroyed their real competitive advantage. Meanwhile, however,the Egyptian government encouraged conventional banks, led by state-owned Banque Misr,to open Islamic finance windows to mobilize deposits from interest-averse Muslims. Table1 includes only Banque Misr and possibly understates the total Islamic share of deposits bya percentage point or two. In the rest of the Arab world, however, Islamic finance remainsmarginal.
  • 9. Clement M. Henry, Islamic Financial Movements, page 8 Islamic banks are altogether absent in Iraq, Libya, Morocco, Syria, and they ekeout a very marginal presence in Algeria, Lebanon and Tunisia. Conventional or Islamic,private sector banks no longer exist in Iran, but the situation may change. Some Iranianfactions favor development of the private sector, and legislation authorizing the incorporationof private sector banks was passed in the spring of 2000. The most dynamic private Islamicbanks outside the Arab world are found in Turkey. Three of the five private Turkish banksare partly owned, respectively, by the Al-Baraka group, the Faisal group, and the KuwaitFinance House. In fifteen years these banks have not collectively achieved even 4 per centof the market, but they seem established, having recently been integrated officially intoTurkeys commercial banking system instead of standing apart under special legislation asfinance houses. They are clearly growth oriented, as they methodically extend theirbranches networks into the provinces as well as in Istanbul and Ankara. From this brief panorama it is possible to draw some conclusions. With theexception of the Sudan, Islamic banking has flourished the most in the prosperous Gulfregion of the MENA. Indeed, it originated during that brief moment of apparently limitlessprosperity, the 1973-74 oil boom, as an ingenious way of recycling an infinitesimal fractionof the petrodollars into pious activities. In the MENA per capita income seems a fairpredictor of the penetration of these banks into commercial markets. Figure 1 graphs theIslamic shares of commercial bank deposits presented in Table 1 against per capita GDP in1998. Sudan is an obvious outlier, whereas the richest Gulf Cooperation Council states ofKuwait and Qatar lead the rest of the pack. Excluding the GCC, however, the relationshipcould run the other way, with the poor of Sudan, Yemen, Egypt, and Jordan outdoingwealthier states such as Tunisia, Turkey, Libya, and Malaysia. Obviously wealth is not theonly factor that may attract Islamic finance. (Figure 1 about here) Another factor that encourages Islamic banks, or at least does not positivelydiscourage them, may be the relative weight of the private sector in banking. Wheregovernment banks are in control, as in Iraq, Libya and Syria, there is no room for privatefinancial enterprise, whether Islamic or conventional. The private Islamic banks would seemto stand a better chance of developing in relatively liberal economic climates featuring strongprivate sectors and a plurality of competing banks across both public and private sectors. (Figure 2 about here) Figure 2 graphs the Islamic shares of commercial bank deposits presented in Table1 against government ownership of a countrys commercial banking sector. Governmentownership measures the percentage of tota l assets of the system controlled by banks thatare at least 20 per cent government owned. It is assumed that a 20 per cent stake puts thestate in full command. Thus countries like Egypt and Tunisia may practice a veneer ofeconomic liberalism and tolerate private sectors in their banking sectors. However, theirstates remain in pretty full control of their respective systems, as is evidenced by the huge
  • 10. Clement M. Henry, Islamic Financial Movements, page 9proportions of total assets that their banks deploy. Figure 2 situates Bahrain, Jordan, SaudiArabia, Kuwait, and Qatar in the potentially most fertile climate for Islamic banks, the topleft quadrant of predominantly privately owned banking systems. Clustered in the bottomright are Iraq, Algeria, Libya, and Syria, whose banking systems still reflect their stateplanned economies, currently undergoing some adjustment but displaying very littleprivatization in the strategic banking sector. Independently of per capita wealth or government ownership, Islamic banks wouldseem to have better opportunities to expand their shares of the market in relatively open,liberal economies than in closed ones. Since 1995 the Heritage Foundation, a rightwingAmerican foundation, has published an Index of Economic Freedom in cooperation with theWall Street Journal. Figure 3 presents each MENA countrys average score on 9 of the 10indicators (excluding low taxation rates that may attract foreign investment but do notnecessarily indicate a liberal economic climate). The more open the economy is perceived tobe, the lower its score. The average scores of Jordan, Morocco, and Oman all cluster justbehind Turkey and ahead of Tunisia and Saudi Arabia. Morocco, Oman, Tunisia, andLebanon all appear to have much less Islamic banking presence than their Index ofEconomic Freedom might predict. Indeed, it seems surprising, in view of Jordans positiveexperience with Islamic banking, that Morocco and Oman have yet to permit Islamic banksto operate in their respective kingdoms. Their rulers (and the Saudis as well) insist onretaining an ideological monopoly on what is Islamic. It is less surprising the most closedeconomies of Syria, Iraq, and Libya have no Islamic banking presence, although this may bechanging now in Syria. The supreme irony is that these countries, along with Algeria, are under-banked.They display exceptionally low ratios of contract-intensive money, or the percentage of themoney supply (M2) that is kept in banks rather than at home under mattresses. Figure 4shows that little over half of Syrias money supply is kept inside the commercial bankingsystem. (Figure 4 about here) Most business transactions in Syria, for instance, are for cash, not checks much lesscredit cards. The banking systems of these "bunker regimes" also display exceptionally lowproportions of GDP allocated as credit to the private sector (Henry and Springborg, 2001,chapter 3). Conventional banks have failed to mobilize savings in Algeria, Iraq, Sudan,Syria, and Yemen, much less lend them out to private businesses. These countries wouldtherefore appear to be fertile territory for institutions that might appeal to pious Muslims.Except in the Sudan, however, their banking systems are dominated by concentrated, state-owned (Figure banks (Figure 2) that have discouraged privately owned Islamic banks untilrecently. Some of these financially underdeveloped countries, however, have engaged in IMFstructural adjustment. Coincidentally or not, those that underwent reform are the ones thatalso tolerate Islamic banking - Algeria, the Sudan, and Yemen. In Algeria and Yemen theIslamic market shares are small but growing. Less than 1% of Algerias commercial bankingdeposits were with Al-Baraka in 1998, but new private banks, including Islamic ones, are
  • 11. Clement M. Henry, Islamic Financial Movements, page 10being formed, and Algerias future trajectory could well surpass Turkeys, which resembledAlgeria in 1986. Bahrain and Kuwait, situated in upper left of Figure 3, get the highestmarks from Wall Streets Index of Economic Freedom, but Yemen, Sudan, and Algeriaappear best to combine relatively open banking with relatively large proportions of theirmoney under the mattresses. Islamic banks may therefore have the greatest potentialmarkets in these countries. One explanation for the relative stagnation of Islamic banks inEgypt and especially Tunisia, by contrast, may be their restrictive commercial bankingclimates. These, at least, were the only two banking environments in the MENA that WallStreet downgraded (or possibly simply corrected) by a point since 1996 - whereas theothers remained unchanged. An earlier market study suggested that Tunisia, like most otherMuslim countries, had a substantial potential for Islamic banking (Barbulesco 1989: 11). The biggest anomalies seem to be Morocco and Oman, countries that appear to berelatively well positioned for Islamic banking but that have steadfastly refused entry to suchbanks. Each of these banking systems is relatively oligopolistic and concentrated, but nomore so than Kuwaits or Bahrains. If Omans system is relatively restrictive (Figure 3),Moroccos is about average. As Commander of the Faithful, however, King Hassan (1961-99) was unwilling to permit an Islamic alternative to the banks he indirectly controlledthrough various conglomerates. An Islamic alternative might challenge the Commandersreligious authority as well as discredit his conventional financial institutions. In reality Saudi Arabia may be an even greater anomaly despite the respectable11.5% showing of its single Islamic bank, Al Rajhi Banking and Investment Corporation(ARABIC). Islams two big transnationals, Al Baraka and the Faisal group, also have theirmain offices in Saudi Arabia and have tried for over a decade to obtain commercial bankinglicenses in Saudi Arabia. As in Morocco, one reason for their failure may be that monarchy,so reliant on Islam for its legitimacy, does not wish to run the risk of delegitimating itself byassociation with the rest of the banking system. Al Rajhi received a license only becausenew laws prevented money-changers from accepting deposits after one of them (headed byanother member of the Rajhi family) collapsed. The big well established firm was given itslicense as a normal commercial bank but then claimed on its own, backed by a religiousadvisory board, status as an "Islamic" rather than conventional commercial bank. Itsastonishing success may be the real reason why the other transnationals have not been givenlicenses. The conventional competitors, now including major royal investors like PrinceWalid al-Talal, do not wish to see their profitable enterprises undermined. Some, like theprinces Saudi Arabian American Bank (SAMBA), have established Islamic windows tocapture some the growing Islamic sector of the market. As pious, profit-seeking customersgradually shift their funds from non-interest bearing accounts to Islamic investments,conventional banks are devising new Islamic products to satisfy their depositors. By oneestimate the non interest-bearing deposits are shrinking by 1 to 2 per cent annually, and thenew type of banking is growing by 15%. In 1999 SAMBA was estimated to have 4% ofthis new market (Glossman 1999: 17-18). Financial performances With monotonous regularity ARABIC heads the list of GCC banks in total profits,over competitors almost twice its size, such as Saudi Arabias (with Prince Walid and
  • 12. Clement M. Henry, Islamic Financial Movements, page 11Citibank) Saudi American Bank, and the even larger but poorly managed NationalCommercial Bank. In profitability, the ratio of net income to total end-of-year assets,ARABICs 3.5% tops most of the worlds commercial banks and beats everybody in theMENA except a handful of nimble investment banks - half of which are also Islamic(MEED, June 23, 2000, 40). The reason is obvious. ARABIC pays no interest on itscurrent accounts and enjoys a loyal clientele. Unlike most Islamic banks, it pays out none ofits profits at the end of the year to the depositors - or "investors" as they are called, who inother banks hold "investment deposits" or "investment savings accounts." ARABIC doescarry a relatively small proportion of funds deposited by other banks on its balance sheet.Arab National Bank regularly publishes the interest rates for the Saudi interbank market, butthere is no evidence on its income statement that ARABIC incurs any interest expenses.Clearly ARABIC benefits - much more than SAMBA - from the Saudi propensity for noninterest-bearing accounts. Remove SAMBAs interest expenses - which amounted to over3% of its total assets in 1998, and it would have been earning 5.4% on them compared toARABICs 3.7% (SAMBA 1999: 16-17). SAMBA would appear to be the more efficientmoney machine, but ARABIC has a far lower cost of funds. Similarly the Bank of Riyadhwould have earned 4.7% rather than 1.7% on its end-of-year assets. Arguably, however, the recent momentum in the GCC favoring Islamic bankingendangers ARABIC as much as the conventional banks because depositors seem to bebreaking away from their habit of parking funds in non-interest bearing accounts. Data forall of the Saudi banks are not available, but Riyadh Bank indicates in the notes to its 1999Annual Report that about one -third of its deposits are still "non-commission sensitive." In thisrespect Saudi Arabia may be a backwater compared to more demanding publics thatexpect to earn profits - not interest, of course - from their savings. But Saudi Arabia ischanging. The future of the Islamic movement may depend on its ability to compete inprofits distributed to shareholders with the interest offered by conventional banks or theprofits offered through their Islamic windows. In the more financially sophisticated climatesof the MENA, such as Kuwait, Jordan, Egypt, and Turkey the fertile fields of non-interesting bearing deposits may be smaller than in Saudi Arabia, though they do exist. In1998 and 1999, for instance, the Jordanian National Bank (Ahly) reported non-interestbearing accounts amounting to over 15% of its total deposits (Annual Report, 1999). Butnon-interest bearing accounts constituted only 0.1% of the deposits of Kuwaits leadingconventional bank, the National Bank of Kuwait( and about 10% of the CommercialBank of Kuwaits ( Obviously more systematicdata would be useful but most banks do not yet disclose such matters online or even in theirwritten annual reports--pending stronger regulations about financial disclosure.Kuwait The other large established Islamic bank in the GCC in the Kuwait Finance House.Its depositors expect "profits," and indeed the KFH regularly posts the annual rate of returnson its various types of investment accounts at the end of the year. No Islamic bank canpromise a specific rate of return but, like track records of mutual funds for small investors in
  • 13. Clement M. Henry, Islamic Financial Movements, page 12the United States, they try to gain reputations for profitability. Table 2 compares the interestrates offered by conventional banks for various kinds of time deposits with the informationposted by the KFH in a recent annual report. The latters categories unfortunately do notspecify the required time periods and are therefore not strictly comparable, but the fact thatits profit rates uniformly increased in 1997 over 1996 suggests that the KFH did not simplytrack the Central Banks interest rates. These tended in most categories of KD deposits todiminish in 1997. Despite paying customers for their deposits, KFH outperformed all the rest ofKuwaits big commercial banks in 1998 and 1999. Its return on assets reached 2.51% atthe end of the century -- well above the norm of 1.53% collectively achieved by the top 65banks in the GCC states (MEED, June 23, 2000, p. 40). KFHs consistent profitability -with steady returns above 2% in the late 1990s - suggest that Islamic banks can survivecompetition with conventional banks even when depositors combine piety with financialacumen. A closer examination of its balance sheet and income statement, however,indicates that KFH may have enjoyed special advantages. It is 49% owned by thegovernment, and some ministries deposit their employees salaries in the bank, assuring it asteady stream. It is instructive to compare its financial statements with those of the NationalBank of Kuwait, the countrys flagship conventional bank that in 1999 performed almost aswell as KFH, with a 2.46% return on total year-end assets. Since the KFH web site is stillunder construction, its 1998 and 1999 statements were unavailable. Consequently Table 3compares its ratios for 1996 and 1997 with those of 1997, 1998, and 1999 calculated fromthe online data provided by the National Bank of Kuwait. What the NBK and otherconventional banks call "interest paid to depositors" can be translated into the KFHlanguage of "d istribution of profits to depositors." They are the banks cost of funds. "Spreads" earned by conventional banks are the difference between the interestgenerated from loans and the cost of funds. For an Islamic bank, then, spreads are simplythe difference between the revenues earned on murabaha, musharika, etc., and the cost offunds. The comparative ratio analysis in Table 3 shows that KFH (in the left hand columns)earns substantially greater spreads, measured as a percentage of total assets, than NBK.The reason for KFHs competitive advantage is its inexpensive cost of funds. Despite itspublicity about the profits to depositors - cast so as to suggest the banks was keeping upwith prevailing commercial interest rates - it was paying them 1.1% less, on average, thanNBK. This may be Islams competitive edge in Kuwait: pious Muslims can accept slightlyless -- as long as it is not too much less. On the revenue side the KFHs gross earningsroughly equaled those of NBK, but its earnings after paying off the depositors were muchgreater. Turning to page 2 of Table 3, KFHs competitive advantage was reflected in thebottom line, net income as a percentage of total assets. In 1996 and 1997 KFHs bottomline was substantially greater for its size than NBK. It is interesting to see how NBKmanaged by 1999 to catch up with KFH. It did not cut back on its administrative expenses- these remained slightly higher than KFHs, despite the complexities in an Islamic bank ofselling goods for a mark-up (murabaha) rather than simply charging interest. The biggerbank deliberately gave up market share, contracting its deposits and possibly paying less forthem than market rates (although short-term interest rates on KDs also declined by about0.5% in 1999 - see Table 2). By 1999 NBK was earning about as great a return on itsassets as KFH, although its cash flow (when depreciation expenses and provisions for bad
  • 14. Clement M. Henry, Islamic Financial Movements, page 13debts are added back to net income) was not as strong. By MEEDs reckoning it hadbecome as "efficient" as KFH, converting about as high a proportion of gross earnings to thebottom line of net income. KFH still displayed a higher return on capital (NI/Cap), evenafter becoming more capitalized (in the sense of Cap/TA) than its competitor in 1998. KFH had a relatively stronger base of customer deposits than NBK, which reliedmore heavily on the deposits of other banks for its funds. But KFH also had to work harderfor its returns than NBK. A substantially greater proportion of its total assets was tied up invarious forms of Islamic financing, risk assets comparable to NBKs loans and advances tocustomers. KFH generated about as much gross revenue as NBK, but it did so bydeploying an extra quarter of its total assets in risky transactions. This difference is onlypartly explained by netting out a bizarre liability on KFHs balance sheet, "deferred revenue."KFH appears to have a riskier profile than NBK, yet it was also less capitalized until 1998and is still so with respect to risky assets. That is, its capital to risky assets ratio is still muchlower than NBKs. KFH also carries more provisions for losses (as a percentage of riskyassets) than NBK, but capital and provisions constituted only 21% of KFHs mudaraba andleasing assets in 1996 and 1997, compared with NBKs 35% to 37% in 1998 and 1999.The Islamic banks 49% government ownership perhaps offsets the added the risk. KFHcan be relatively confident that the government would bail it out in any emergency. Indeed, inthe wake of the Souk el Manakh crisis of 1982, the KFHs return on assets plummeted fromover 2% to 0, and the government rescued it in 1984. Today, despite its higher return oncapital, it distributes slightly smaller returns to the shareholders in the form of dividends. Good government connections and loyal customers have enabled the KFH tocompete successfully with Kuwaits flagship conventional bank. Like ARABIC in SaudiArabia, KFH is a success story. Elsewhere in the Gulf the Islamic commercial banks haveperformed less brilliantly but kept their substantial market shares. The pioneer, DubaiIslamic Bank, had to be bailed out in 1999 because of an internal embezzlement scandal buthad survived over two decades with returns on assets of less than 1%. In Bahrain andQatar the financial performances were better -- usually over 1% -- but hardly earthshaking.Despite its mediocre return of 1.14% in 1999, however, the Bahrain Islamic Bank rankedfifth in MEEDs efficiency index, converting 45% of its gross earnings into net income(MEED, June 23, 2000, p. 38). Like ARABIC, BIB seems to have benefited from the lowcost of funds acceptable to pious depositors. Other small Islamic investment banks,however, did much better. Not only were the International Investor, First IslamicInvestment Bank, and BMB Investment Bank among the top six in efficiency; they alsoranked among the top five in returns on assets, earning from 4.6 up to 17.8% in 1999.There was clearly much money to be made from devising new Islamic instruments for apious and financially sophisticated clientele disenchanted with non interest-bearing depositsin conventional banks. The wealthy can perhaps afford to satisfy their consciences by taking more risks forslightly less returns in Islamic banks than in interest-bearing accounts. Those who are pious,in the sense of refusing interest, have no alternative except to store their funds in noninterest-bearing accounts or avoid banks altogether. The affluent depositors of the GCCcountries are a relatively easy target for Islamic banks. But in the rest of the MENA, withmuch less per capita wealth, Islamic banks enjoy less competitive advantage. There willalways be a pious minority ready for an alternative to non interest-bearing accounts, but the
  • 15. Clement M. Henry, Islamic Financial Movements, page 14less wealthy and more risk-averse potential investors may prefer to keep those small savingsunder the mattress if they do not earn competitive market returns. The case of the JordanIslamic Bank for Investment and Development (JIB) illustrates some of the dilemmas ofIslamic finance in the less affluent countries of the MENA.Jordan An affiliate of the Al-Baraka group, JIB opened its first branch office in 1979 andsustained its momentum until the mid-1990s. There is clearly strong demand in Jordan forIslamic banking. JIB claimed over 600,000 depositors in 1999 - quite a substantial numberfor a country of only 4.6 million men, women, and children. The highly respected ArabBank, the oldest privately owned bank based in the Arab world as well as one of its largest,opened up a new Islamic bank in 1998 to compete with JIB. It also has plans to extend toother developing Islamic finance nuclei in Egypt, Yemen, and the GCC countries, whereArab Bank owns conventional branches or affiliates. There are clearly markets to be won,but little Islamic banks that do not enjoy either strong government protection or a major allylike Arab Bank may be in trouble. JIBs financial statements reveal serious weaknesses. In its earlier years JIB did fairly well, keeping up with and even in 1985 and 1989surpassing the average returns on equity of businesses in the financial sector. Table 4suggests that it may have been benefiting from tax breaks in the earlier years, but in 1989-1992 its net income before taxes clearly outperformed the average. Even in these halcyonyears, however, its returns on total assets (NI/avTA) were mediocre, never even reachedthe 1% attained in 1982. During these years, moreover, JIB does not appear to have beenas fully capitalized as the average bank. Table 4 indicates, for instance, that in 1989 thebanks share of capital, reservations, and allowances to cover investment losses (provisionsfor non-performing loans in other banks) was only 5.6% of the total recorded by the CentralBank of Jordan. Yet JIB held 6.4% of the total assets. It also held a full 8.3% of the totalrisk assets - loans and other forms of financing outstanding to private and public entitiesexcluding the central government. Like KFH, it had to work harder for its revenues thanconventional banks. Arguably, then, the bank should have been more fully capitalized thanother banks to cover the additional financing risks. Islamic banks like to claim that theirdepositors are in fact like stockholders sharing in the banks profits, but the depositors, likebank regulators, may see it differently. Table 4 pieces together what happened to JIB over the years. Despite an infusionof capital in 1993, it could not sustain its ambitious efforts to mobilize ever greater shares ofcommercial bank deposits. It continued in the latter 1990s to add more branches but theirproductivity declined after 1994: each branch generated fewer deposits and revenues. JIBseems not to have enjoyed any special advantage like KFH of cheap sources of funds.Table 4 compares the rates of profits it gave its customers with the interest paid to thedepositor of conventional banks. The two banks, Cairo-Amman and Ahli, were selectedbecause of their comparable medium sizes and relatively mediocre financial performances.Cairo-Ammans return on assets never exceeded 1% in the early and middle-1990s, andAhli did only marginally better before falling into the red in 1999 after an expensive mergerwith another bank. Table 4 shows that Cairo-Amman was paying its depositors even less
  • 16. Clement M. Henry, Islamic Financial Movements, page 15than JIB - possibly because of low market rates on the West Bank, where Cairo-Ammanenjoyed a virtual monopoly until 1995. Ahli was paying out substantially more than JIB after1994. In 1999 it lost part of its own capital but still paid depositors 6.6% on average -more than twice as much as JIB. Of course this "flexibility" of Islamic banks is cited as oneof their strengths: in hard times they are less likely to go bankrupt. But then they are likely tolose depositors. In 1995 JIB reached its high point in deposits: its share of the marketwould then steadily decline, even before the Islamic International Arab Bank entered themarket in 1998. From Table 4 it seems that JIB simply could not pay depositors well enough to keepthem. The number of them grew but the average size of deposits declined, suggesting thatJIBs expanding branch network might be tapping into small savings that would otherwisestay under the mattress. But most of the depositors probably expected to earn at least asmuch as they would from a savings account at a commercial bank - 4 to 5% in the late1990s (Central Bank of Jordan, Monthly Statistical Bulletin, Table 21, August 28, 2000). JIB diminished its returnsroughly in tune with market rates, but its savings accounts earned only 2.13% in 1999(Annual Report 1999, p. 30) compared to the national average of 4.19%. JIB simplycould not generate the revenues need to meet the going rates. The explanation was simple: either JIB was undercharging customer for Islamicfinancing or growing proportions of those risky assets were not being paid off (or hadperhaps been lost). Table 4 shows that JIBs returns on risky assets plunged in the late1990s; by 1995 they were already lower than the interest rates received by the mid -sizedcommercial banks. Although these were second -tier banks, with relatively anemic returnson assets, they were generating substantially greater gross earnings in the mid-1990s. In itsworst year, 1999, Ahly generated twice as much as JIB, and the islamic bank seemed again,as in the early 1990s, to be undercapitalized and overweighted with risk assets, though it stillheld more deposits for its size than most Jordanian commercial banks. Perhaps competitionwith the Islamic International Arab Bank would oblige JIB to contract further, write off anynon-performing assets, and regain profitability. A number of other Islamic banks have facedsimilar problems. For years, for instance, Faisal Islamic Bank of Egypt (FIBE) has stagnated, losingmarket share and generating scarcely enough revenue to pay off its depositors. In the mid-1980s it was so desperate to generate revenue that it lent hard currency to the Central Bankof Egypt for importing commodities; then, when Egypts foreign exchange situationimproved, it lent out funds to the Bank of Credit and Commerce International (BCCI),which offered it higher than market rates. The collapse of the BCCI in 1991 initially costFIBE some 20% of its balance sheet. Most the funds were eventually recovered, and in1999, for the first time in almost a decade, FIBE claimed a small profit (0.3% of its totalassets). But meanwhile its deposits did not keep up with inflation between 1995 and 1998,and FIBE held on to barely 3% of the market (down from 9.7% in 1986, see Table 1).Like JIB, it simply could not generate enough earnings to distribute adequate "profits" todepositors, much less to shareholders of the bank. The problem of generating revenue may be political as well as technical. It is tooearly to say whether the Turkeys five islamic finance houses are falling into a similar trap ofinsufficient earnings to finance their expanding deposit bases. Since the Turkish military
  • 17. Clement M. Henry, Islamic Financial Movements, page 16obliged Prime Minister Erbaken to resign and outlawed his (Islamist) Welfare Party theIslamic banks have continued to grow at a slightly more rapid rate than Turkeys othercommercial banks. In 1999 they increased their share of deposits to 3.8% but theircollective return on assets diminished from 1.5 to 0.9%. (Central Bank of the Republic ofTurkey, Quarterly Bulletin, various issues). These average returns, however, althoughroughly comparable to those of Turkeys big public sector banks, fall far short of the privatesector bank averages of 3.5 to 4.5% (Banks Association of Turkey, 2000: I-58 - adjustingfrom BATs returns on average assets). Further research might examine the locations in the provinces, such as Konya, thatattract branches of the special finance houses. How do they correlate with the implantationof Islamist parties? Do the finance houses track islamist neighborhoods? How can thesefinance houses move from trade financing to more profitable ways of raising revenue? Mightthey develop profitable long-term relationships - mudaraba and musharika - with Islamicallycommitted businesses in these regions?Political opportunities and constraints As Figures 2 and 3 suggested, Islamic banking tends to be better off in liberalized,less restricted commercial banking environments than in heavily state controlled ones. Infact Islamic banking requires the liberalized climate advocated by international financialinstitutions - the so-called Washington Consensus - more than conventional commercialbanks. In order to generate better earnings, the Islamic banks need to engage in moreequity-like financing that requires clear standards of accountability and transparency of thesorts advocated by the IMF and the World Bank. Since they will need to engage in moreequity-like financing than conventional banks, they stand to benefit more from financialstructural adjustment programs. In some states, however, we have seen that Islamic banks carry a political handicap.Goverments that declare war against political Islamists, such as Algeria, Egypt, and Tunisia,do not have thriving Islamic financial establishments. In most MENA countries the principalopposition to the incumbent regime is Islamist - even in Saudi Arabia where the dynastyposes as a purified Islamic regime. To the extent, then, that Islamic banks are confoundedwith political Islamism, they will be better off in a more liberal political climate. Most Islamicfinancial institutions deny any political associations - just as conventional bankers also try toappear to be above any "politics." But just as state bankers in many state-owned bankingsystems manage patronage machines for those in power, so Islamic bankers may find itdifficult to avoid political associations. In Kuwait the KFH enjoys close ties with certaingovernment ministries and pro-Islamist deputies in parliament. In Egypt the state acts as ifautonomous Islamic banks must be contained - by blocking their expansion and trying tochannel their market into state-controlled banks. It is reasonable to expect that Islamicbanks will be better off in the relatively more liberal political climates where regime andIslamist opposition have learned to coexist than in the MENAs more repressive settings. By these standards the most favorable settings for Islamic banking in the Arab worldare probably Bahrain, Jordan, Kuwait, Turkey, Lebanon, and Morocco. Bahrain is favoredby minimal banking restrictions other than the necessary ones of an experienced regulatoryauthority, and it is also undergoing significant political reform. Morocco, which has no
  • 18. Clement M. Henry, Islamic Financial Movements, page 17Islamic banking, might offer the most promising field, after Jordan, for these institutions todevelop. Certainly in highly illiberal climates, such as Saudi Arabia and arguably in Algeria,Egypt, and Tunisia as well, Islamic banks have to avoid any hint of association with politicalIslamists (unless, perhaps, with Algerias tamed ones displayed in parliament). Only in the politically more permissive climates might Islamic banks directly developties with political Islamists. Whether or not they do so is an empirical question worthy offuture research in Jordan, Turkey, and possibly the Sudan (where Turabis political Islamistscoexist with the military, and Turabi himself used to be associated with the Faisal IslamicBank of the Sudan). In theory the political movement might help monitor the uses to whichIslamic finance is put and extend the ability of the banks to engage in profitable musharikaand mudaraba operations. By reducing the banks monitoring costs, they would renderthem more profitable. Bankers and politicians would share an interest in the success of theIslamic financial experiment, and the politicians, enjoying financial support, might strengthenbusiness interests in the political movement and further moderate opposition to theincumbent regime. This grounds-up approach suggests a gradual increase in the power ofpolitical and business Islam, operating in a relatively stable pluralistic political environment.It assumes that political liberalization is a gradual process and that money can soften up theopposition by bringing it into the moneyed establishment. But it runs against the grain ofrecent political development in the MENA. In the 1990s the political trend has been one ofdeliberalization and reinforced authoritarianism, especially in Egypt and Tunisia. Politicsremain too turbulent and frightening to business and banking interests in much of the region The alternative for the Islamic financial movement is to work closely withgovernments, even when they repress political Islamists. In reality there may be few affinitiesbetween the timid Islamic business and banking interests, on the one hand, and radicalIslamist opposition politicians, on the other. Political Islamists tend to be more concernedwith culture than with economics, and opinion seems divided on Islamic banking. Whenfounded in 1989, the Algerian Front Islamique du Salut (FIS) advocated market reforms inits party program -- including aligning the dinar at international market rates as the IMF wasinsisting at that time -- and Islamic banking. But the FIS may be an exception. Manypolitical Islamist movements view structural adjustment to be yet another imperialist plot topollute their countries with more western businesses and consumption patterns. They areusually ready to join in populist protests against any painful reforms. The mainstreamexponents of the Islamic finance movement, on the other hand, urge structural adjustment,open and transparent markets, and accountable (though not necessarily democratic or evenliberal) government. By making alliances with economic reformers within the government - for mostMENA states are divided between the globalizers and their antithesis, moralizing elementswithin the government that reject structural adjustment for various reasons - the Islamicbanks can gradually gain market share. Protected by their governments, they can offermodest "profits" to their depositors and lure more of them away from non-interest bearingaccounts in conventional banks. The financial returns of these Islamic banks can beexpected to remain weak as long major structural adjustment does not occur, because theyare at a structural disadvantage in generating revenues even if they can gain more deposits.But no matter: they are protected. The major competitive threat then comes fromconventional banks that open Islamic windows to prevent the hemorrhaging of their non-
  • 19. Clement M. Henry, Islamic Financial Movements, page 18interest bearing deposits. But then the conventional banks, too, may acquire a greaterinterest in structural adjustment, market reforms, better accounting procedures and the like.Under this top-down approach the Islamic banks serve the government as a cover forfurther engagements with international financial institutions and the Washington Consensus.Even where, as in Algeria, their market share is miniscule, their approval can contribute tothe (sorely deficient) legitimacy of a government embarked on structural reforms. However,the public sector banks of countries like Egypt and Tunisia may oppose any globalizingalliance that takes deposits away from their weak balance sheets and endangers their statepatronage machines. In the coming five years Saudi Arabia is likely to be the major battleground forIslamic finance. Substantial non-interest bearing deposits seem ready for redeployment intoIslamic financial markets. Were Al-Baraka, the principal owner of JIB, to be allowed entryinto the Saudi market, it would grab market share from ARABIC as well as the NationalCommerce Bank and SAMBA, to mention Saudi Arabias two largest banks, both of whichhave set up Islamic windows. Some ulama and Islamic bankers argue that these windowscannot really work in accordance with the shariah because their funds cannot be separatedfrom the others based on riba. In Jordan the Arab Bank was required to build up an entirelynew bank for its Islamic operations. Were such a ruling to take effect in Saudi Arabia, therecould be a major shake-up in the commercial banking system. An influx of Islamic bankingmight then tip the scales within the government for those in favor of accelerating economicreform. Paradoxically, however, the risk of rapid economic change in Saudi Arabia is thatits principal beneficiaries would be members of the royal family like Prince Walid al-Talaland other less professional uncles and cousins, Saudi equivalents of the nomenklatura insingle -party regimes. The potential political fallout from Islamic banking differs widely from state to state in theMENA. The grounds-up view of synergies between political and financial Islam seems lesslikely today, however, in this era of deliberalization (except in the smaller GCC states), thanthe top-down approach. Whether further structural adjustment will lead to greater politicalliberalization in the long run is yet to be seen, but so far, in the MENA at least, neitherprocess has been linear and uni-directional. Meanwhile Islamic finance, despite its smallshares of the market to date, may incrementally acquire greater shares in many MENAmarkets. Self-consciously Islamic financiers seem bound to prosper, irrespective of theregimes treatment of political Islamists.Conclusion In conclusion we have identified self-consciously Islamist bourgeoisies and tried todiscover the conditions under which they best thrive. Distinctive financial practices seem tobe mobilizing capital that would otherwise stay hidden in mattresses in much of the MENA.We have also seen new Islamic financial ventures in the countries that have been closed inthe past to most other forms of private capital, whether local or foreign. Will these verylate-late comers be more susceptible to a "third" way of Islamic finance than the MENAsearly adjusters? We have seen that Islamic finance is perfectly compatible with the variouseconomic adjustment measures, notably financial reform, that international financialinstitutions insist upon. Indeed, the Islamic banks have more of an interest in transparencyand a suitable domestic environment for lending than conventional banks. Quite possibly,then, countries like Algeria and Syria, which must undergo financial reform, may use Islamic
  • 20. Clement M. Henry, Islamic Financial Movements, page 19finance as a vehicle for legitimating these reforms. The fact that the Islamic Salvation Front(FIS) was ready tacitly to endorse Algerias structural adjustment efforts of 1989-1991suggests a more general strategy of reform with support from nascent Islamist bourgeoisies,with or without Islamist political parties. In Syria the Al Dallah (Baraka) group is part of aSaudi investment venture that may benefit from new legislation permitting a private bankingsector. It is also possible that other regimes that currently repress their political Islamists,such as Egypt and Tunisia, will attempt to coopt their Islamist oppositions by allowingIslamic finance more space and influence, as the pressures build upon their respectivegovernments to privatize their public sector banks. To return to Ernest Gellner, some of his later work belied his earlier enthusiasm forpuritan Islam. In his Conditions of Liberty (1992) he explicitly conludes that Islam is tooideologically monolithic, like the world of Stalinism, to support any meaningful civil society.This paper, building on Gellners earlier work, has tried to show that Islamist puritans inbankers suits may indeed be building civil societies in the form of Islamist businesses.Gellners earlier essays suggesting an Islamic puritan ethic are indeed seminal for theunderstanding of contemporary Islam and politics, as it points to the economic foundationsof Islamist civil societies. Islamic finance offers the structure for articulating the new workethic.ReferencesFuad Al-Omar and Mohammed Abdel Haq, Islamic Banking: Theory, Practice, and - Challenges, London: Zed Books, 1996.Nancy Neiman Auerbach, States, Banks, and Markets: Mexicos Path 6to Financial Liebralizaitoni n Comparative Perspective, Boulder CO: Westview, 2001.Luc Barbulesco, Léconomie islamique dans ses rapports avec léconomie globale, D Working Paper 89-1, Les Cahiers du C.E.R.P., Département de Droit, Université de Droit dEconomie et de Gestion, Centre dEtudes de Recherches et de Publications, Tunis, 1989.Michel Galloux, "The States Responses to Private Islamic Finance Experiments in Egypt," Thunderbird Review of International Business, Special Issue: Islamic Banking ed. Clement M. Henry, 41:4-5 (July-October 1999), pp. 481-500.Ernest Gellner, Muslim Society, Cambridge University Press, 1981_____, Conditions of Liberty : Civil Society and Its Rivals, London 1994.Diane B., Glossman et al, "Citigroup: Saudi Arabia - A Special Case," Lehman Brothers 1999, October 7, 1999.Clement Henry and Robert Springborg, Globalization and the politics of development in the Middle East, Cambridge University Press, 2001.Monzer Kahf, "Islamic Banks at the Threshold of the Third Millennium," Thunderbird Review of International Business, Special Issue: Islamic Banking ed. Clement M. Henry, 41:4-5 (July-October 1999), pp. 445-460.
  • 21. Clement M. Henry, Islamic Financial Movements, page 20Saudi American Bank (SAMBA), Saudi Arabia - Investors Guide, Meedmoney, 1999.Frank E. Vogel and Samuel L. Hayes III, Islamic Law and Finance: Religion, risk, and return, The Hague: Kluwer Law International, 1998.Michael Walzer, The revolution of the saints : a study in the origins of radical politics, Harvard University Press, 1965.Ibrahim Warde, Islamic Finance in the Global Economy, Edinburgh: Edinburgh University Press, 2000.Max Weber, Economy and Society [1922], edited by Guenther Roth and Claus Wittich, 2 volumes, University of California Press, 1978.
  • 22. Figure 1 Islamic share of commercial bank deposits by per capita GDP, circa 1998 .3 SDN .2 QAT KWT SAU JOR BHR .1 YEM EGY ARE Islamic Bank Deposits TUR MYS DZA TUN LBN LBY SYR OMN 0.0 -.1 0 10000 20000 30000 Per Capita GDP 1998Notes: Iraq and Morocco, very slightly poorer than Syria, were omitted because they clustered besideSyria, without any Islamic banking. Algeria, Lebanon, and Tunisia also cluster together withminuscule Islamic bank market shares of deposits.
  • 23. Figure 2 Islamic share of commercial bank deposits by government bank ownership .2 QAT KWT SAU BHR JOR .1 ARE EGY TUR Islamic Bank Deposits MYS TUN DZA LBN OMN MAR IRQSYR LBY 0.0 -.1 0 20 40 60 80 100 120 Govt Ownership (>20%)Note: Government Ownership is the percentage of total assets of thecommercial banking system held by banks owned at least 20% by thegovernment.
  • 24. Figure 3 Islamic share of commercial bank deposits by a countrys degree of economic openness .3 SDN .2 QAT KWT SAU BHR JOR .1 ARE EGY YEMIslamic Bank Deposits TUR MYS TUN DZA OMN LBN MAR SYR IRQ LBY 0.0 -.1 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 Index of Economic Freedom
  • 25. Figure 4 Islamic share of commercial bank deposits by Contract-Intensive Money .3 SDN .2 QAT KWT SAU JOR BHR .1 YEM EGY AREIslamic Bank Deposits TUR MYS DZA TUN OMN SYR LBY MAR LBN 0.0 -.1 .5 .6 .7 .8 .9 1.0 Contract Intensive Money 1998
  • 26. Table 1: Evolution of Islamic banks share of commercial bank deposits by country, 1980-1998 Year 1980 1986 1989 1995 1996 1997 1998 first establishedAlgeria 1991 0.4% 0.5% 0.8%Bahrain 1979 1.0% 6.7% 7.7% 9.8%Egypt 1977 2.4% 9.7% 7.3% 5.1% including Banque Misrs Islamic branches deposits 8.1%Iran 100.0% 100.0% 100.0% 100.0% 100.0%Iraq no Islamic banksJordan (JIB) 1978 1.6% 7.4% 7.9% 9.7% 9.4% 9.2% including Islamic International Arab Bank 10.2%Kuwait 1977 5.7% 18.0% 19.0% 16.2% 16.3%Lebanon 1991 0.1% 0.0% 0.1%Libya no Islamic banksMorocco no Islamic banksQatar 1982 10.4% (missing) 17.8% 18.1%Saudi 1988 11.3% 11.1% 11.5%ArabiaSudan 7.0% 17.0% 19.4% 27.9%Syria no Islamic banksTunisia 1983 0.2% 0.4% 0.6%Turkey 1985 0.8% 1.8% 3.6% 3.6%UAE 1975 1.3% 3.2% 3.8% 7.9%Yemen 1996 4%Malaysia 1983 1.6% 1.6% including Islamic windows of conventional banks (rough estimate) 2% 2%Sources, IMF International Financial Statistics, Harvard Islamic Finance Information Program, various annual reports of banks,authors data set.
  • 27. Table 2: Interest rates in Kuwait and Returns on Islamic Investment Accounts, 1996-1997Central Bank of Kuwait, Quarterly Statistical Bulletin - (1) Average Interest Rates on Customer Time Deposits with local Banks in both KD & US Dollar Percent Per Annum) 1-Week 1-Month 3-Month 6-Month 12-Month Period KD US $ KD US $ KD US $ KD US $ KD US $ 1996 4.8 5.15 6.34 5.17 6.49 5.24 6.6 5.31 6.67 5.49 1997 4.39 4.9 5.72 5.18 5.96 5.26 6.12 5.35 6.22 5.55 1998 4.45 4.79 5.64 5.05 5.87 5.08 6.12 5.07 6.24 5.1 1999 4.07 4.35 5 4.73 5.27 4.86 5.53 4.96 5.66 5.1Kuwait Finance House, Annual Report of 1997 Investment savings accounts Investment deposit accounts for limited period Investment deposit accounts -unlimited 1996 4.667 6.22 7.00 1997 4.75 6.33 7.125
  • 28. Table 3: The Financial Performances of the KFH and the NBK 1996 1997 1998 1999 1996 1997 1998 1999Kuwait Finance House National Bank of KuwaitTotal Assets (KD mm) 1425 1581 1634 1748 3918 4118 3835 3797capital 110.3 128.4 165.6 189.8 352 368.6 381.3 397Customer deposits 1130 1185 1235 1318 2240 2434 2360 2287Due to banks 1154 1137.3 919 931Provisions for risky assets 82.59 94.03 90.9 87.3Cash in banks 97.9 93.2 520 503 648 557Receivables (murabaha) 880.4 952.2 1529 1609.4 1344.5 1292Leased assets 22.8 85.4 Treasury bonds 497 577 487.3 809Govt debt bonds 224.6 176.4 442 376.6 355.3 310Investments 150.3 221.1 240 302.1 236.1 378Earnings 108.7 122.2 Earnings before interest expense 329.9 313.25 298.4 from murabaha, leasing 76.94 90.445 294.7 282.9 257 gov bonds subvention 14.8 10.54 investment income 9.03 15.03Deferred revenue 120.2 139.4Net income 34.36 36.54 41 43.8 68 73.47 80 93Cost of Funds 47.1 52.2 196.9 181.7 149.8Depreciation 3.61 3.86 3.713 4.053 4.295Provisions expense 7.55 13.72 12.95 0.513 2.174Administrative expenses 16.075 15.506 42.587 46.391 44.256Dividends: cash 11.9 16.18 62 55 66 76 bonus shares 2.86 3.03 7Spreads 61.6 70 97.75 101.1 107.2
  • 29. Kuwait Finance 1996 1997 1998 1999 National Bank of 1996 1997 1998 1999 House KuwaitSpreads/TA 4.3% 4.4% 2.4% 2.6% 2.8%COF/Deposits 4.2% 4.4% 5.5% 5.5% 4.7%NI/TA 2.4% 2.3% 2.5% 2.5% 1.7% 1.8% 2.1% 2.45%NI/cap 31.2% 28.5% 24.8% 23.1% 19.3% 19.9% 21.0% 23.4%Cap/TA 7.7% 8.1% 10.1% 10.9% 9.0% 9.0% 9.9% 10.5%Cash Flow/TA 3.2% 3.4% 2.2% 2.2% 2.6%Gross Earnings/TA 7.6% 7.7% 8.0% 8.2% 7.9%NI/Earnings 31.6% 29.9% 32.8% 22.3% 25.5% 31.2%Customer Deps/TA 79.3% 75.0% 75.6% 75.4% 59.1% 61.5% 60.2%Risk assets/TA 63.4% 65.6% 39.1% 35.1% 34.0% net of deferred revenue 54.9% 56.8%Cap/Risk assets 12.2% 12.4% 23.0% 22.9% 28.4% 30.7%Provisions/Risk assets 9.1% 9.1% 6.8% 6.8%Profit rates of 8.5% 8.5% 9.6% 10.0% 8.7%murabaha and leasing 8.5% 8.7%investments 6.0% 6.8%govt bonds 6.6% 6.0%Shareholders return 13.4% 15.0% 17.6% 16.8% 17.3% 19.1% Cash dividends/Equity 10.8% 12.6% 17.6% 14.9% 17.3% 19.1% Bonus shares/Equity 2.6% 2.4% 0.0% 1.9% 0.0% 0.0%Administrative expenses/TA 1.1% 1.0% 1.0% 1.2% 1.2%
  • 30. Table 4: Jordan Islamic Bank for Finance and Investment (1980-1999) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991JIB NIBT/Capital 13.6% 7.9% 8.3% 13.0% 27.6% 25.7% 23.4%average NIBT/Capital (financial sector) 19.9% 20.0% 17.5%JIB NI/Capital 13.6% 7.9% 7.1% 11.7% 18.7% 15.4% 12.9%average NI/Capital (financial sector) 13.3% 11.9% 10.4% 13.5% 14.3% 15.6% 13.4%NI/avTA 0.9% 1.2% 0.8% 0.9% 0.6% 0.5% 0.4% 0.6% 0.9% 0.8% 0.5%JIB share of deposits 1.6% 3.0% 3.4% 4.7% 5.7% 6.6% 7.4% 8.1% 8.2% 7.9% 8.1% 8.0%JIB share of total assets 1.4% 2.4% 2.9% 3.8% 4.8% 5.3% 6.1% 6.8% 6.8% 6.4% 6.0% 6.4%JIB share of capital, reserves and allowances 5.7% 5.6% 5.8% 5.8%JIB share of risk assets 1.2% 2.0% 3.0% 3.6% 5.3% 5.6% 6.8% 7.2% 7.6% 8.3% 8.0% 9.8%Cost of funds/deposits JIB 2.2% 2.1% 3.5% 2.8% 3.3% 3.6% 3.5% 3.3% 3.9% 5.3% 6.2% 4.7% Cairo-Amman Bank Ahly BankEarnings on Financing JIB 4.4% 3.9% 5.1% 8.2% 7.4% 7.6% 6.8% 7.1% 7.8% 9.5% 10.9% 10.0% Cairo-Amman Bank Ahly BankGross earnings/TA JIB 1.9% 1.8% 3.0% 4.3% 4.6% 4.3% 4.0% 3.9% 4.3% 5.7% 6.6% 5.4%Sources: Al-Omar and Abdel-Haq 1996, Annual Reports of banks.
  • 31. 1992 1993 1994 1995 1996 1997 1998 1999 22.4% 11.0% 14.4% 13.8% 12.8% 6.9% 8.7% 5.0% JIB NIBT/Capital 18.7% 18.1% 18.9% 16.2% 21.3% 15.2% average NIBT/Capital (financial sector) 14.0% 6.0% 7.9% 7.5% 8.8% 4.8% 6.1% 3.5% JIB NI/Capital 14.1% 13.2% 13.5% 11.1% 15.1% 11.0% average NI/Capital (financial sector) 0.5% 0.5% 0.6% 0.5% 0.6% 0.3% 0.5% 0.2% NI/avTA 8.6% 9.6% 9.7% 10.0% 9.7% 9.4% 9.2% 8.9% JIB share of deposits 6.9% 7.8% 7.6% 7.4% 7.0% 6.7% 6.8% 6.6% JIB share of total assets 6.6% 10.1% 8.9% 8.2% 7.8% 6.2% 6.1% 5.7% JIB share of capital, reserves and allowances 11.0% 11.9% 11.5% 11.8% 11.7% 11.5% 11.2% 11.1% JIB share of risk assets Cost of funds/deposits 4.4% 4.2% 4.8% 4.0% 3.9% 3.7% 3.7% 3.1% JIB 3.6% 2.0% 2.6% 3.5% 4.1% Cairo-Amman Bank 4.6% 4.9% 6.5% 6.5% 6.8% 6.6% Ahly Bank Earnings on Financing 9.3% 9.1% 9.5% 8.0% 7.7% 6.7% 7.1% 6.0% JIB 8.9% 9.5% 9.2% 10.4% 11.8% Cairo-Amman Bank 9.1% 10.3% 11.1% 10.5% 10.4% 10.6% Ahly Bank Gross earnings/TA 5.2% 5.3% 5.9% 5.4% 5.5% 4.7% 4.9% 3.9% JIB 5.0% 4.8% 5.2% 5.9% 7.1% Cairo-Amman Bank 6.6% 6.4% 7.8% 7.2% 8.3% 7.7% Ahly BankSources: Al-Omar and Abdel-Haq 1996, Annual Reports of banks.