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Interest Ban Saves Islamic Banks From Worst Of Credit Crunch - Moody's

Tariq Sami

28 November 2008

Islamic financial principles, such as the ban on interest, have saved the newly emerging Islamic financial sector from falling into the current crisis, according to a report released this week by Moody’s, the rating agency.

Due to Islam’s prohibition on interest and volatile speculation, the sector has not participated in instruments such as derivatives so Islamic banks have avoided the heavy losses caused by the unwinding of derivative products.

The report, however, stresses that Islamic banks should not consider themselves immune from financial woes. Since no specific Islamic money market exists, where Islamic banks can trade exclusively with each other, the sector remains very much interlinked within the global financial network.

But Islamic banks are facing specific difficulties, as a direct result of their investment policies, the report says. Despite protecting the sector, the prohibitions of interest and speculation have also limited investment choices.

Islamic banks have traditionally favoured real estate investment. However with the global slowdown of the property market - which has been especially steep in the Gulf -  Islamic banks have been left exposed. In one of the worst case scenarios, Moody’s thinks that the fall could halve the equity value of the sector.

Overall though, Moody’s remains optimistic that this doom scenario will not happen and sees the sector as largely stable.

The bank given the strongest financial strength rating is Saudi Arabian based Al Rajhi bank which acquires a C rating, and has a foreign currency rating of A1/P-1. The bank also has a wealth management operation. As well being involved in private banking for its Saudi clientele, it is at the forefront of developing the Malaysian market.

Global Islamic banking assets grew around 27 per cent in 2007 and growth of 20-30 per cent is expected this year. By contrast, 2009 will likely be a tough year for Islamic banks: Moody's expects that the growth rate of their combined assets will decelerate, probably in the range of 10 per cent.