The GCC is at the heart of the Islamic world, with the two holiest shrines under the guardianship of Saudi Arabia, a kingdom that prides itself on being governed under shariah law. It would therefore be expected that the GCC states would be at the centre of the rapidly expanding Islamic finance industry, which encompasses retail and investment banking, insurance, fund management and the issuance and trading of shariah compliant securities known as sukuk.
Yet it is countries elsewhere, notably Malaysia and the United Kingdom, that have played a leading role in Islamic finance, with Kuala Lumpur the most active centre for Islamic securities trading and London the centre for Islamic investment banking and cross border treasury management. The main aim of this paper is to examine why the GCC states have failed so far to provide leadership in Islamic finance and what can be done to rectify this situation.
Legislation, regulatory issues and shariah compliance
Five out of the six GCC states host Islamic financial institutions, Oman, for political reasons, refuse to award any Islamic banking licences. The Islamic Republic of Iran passed legislation in 1983 abolishing interest based transactions and making it mandatory for all internal financial dealings to be shariah compliant, but similar legislation has not been adopted in any of the GCC states.
Kuwait adopted legislation in 1976 to allow the establishment of Kuwait Finance House, for many years its only Islamic bank, but this legislation was superseded in 2004 by an amendment to the Central Bank Law 32 of 1968 allowing Islamic financial institutions to function alongside conventional banks, but with no special privileges for the former. The law does however provide a framework for Islamic financial governance, especially articles 86, 87, 93 and 96, including a stipulation that each institution should have a shariah board with at least three members.
There is no similar legislative provision in any other GCC state, where Islamic finance is dealt with at the regulatory level only, with Bahrain having the most detailed rule book. The extent to which statutory and regulatory provision is an obstacle to Islamic finance development in the GCC will be investigated in the study.
Standards for shariah compliance are problematic in the GCC where each institution has its own shariah board but apart from in Bahrain, there are no national boards. Consequently there are conflicting fatwa reflecting different interpretations of shariah. In contrast in Malaysia both the Central Bank and the Securities Commission have shariah boards which alone have the power to issue fatwa. Banks in Malaysia have their own shariah boards, but there role is to ensure the agreed fatwa are implemented rather than making independent pronouncements. Furthermore all those appointed to the shariah boards of the banks have to apply to the Central Bank and obtain accreditation. There is no comparable system in the GCC, where the lack of standardisation has caused confusion and uncertainty and hindered Islamic financial development.
GCC financial centres
Bahrain has functioned as a regional financial centre since 1976, keeping its market open to foreign banks, while Saudi Arabia and Kuwait only licensed majority locally owned institutions. Bahrain has more than thirty Islamic financial institutions, including banks and takaful insurance companies, most of which serve the regional rather than the local market. It is very dependent on Saudi business however, and as the latter opens up its financial sector, there are competitive challenges to Bahrain, including in Islamic banking.
Qatar has also a financial centre, with a detailed rulebook covering Islamic finance, including criteria for shariah supervision. A higher proportion of bank deposits are shariah compliant in Qatar than in any other GCC state. The Dubai Financial Centre has the highest international profile in the region, but Islamic finance is somewhat marginal to its interests. In this study the implications of the proliferation of financial centres for Islamic finance in the region will be analysed.
Competition can of course be helpful to financial development, but the emergence of rival centres in the Gulf has fragmented the Islamic finance industry and resulted in many very small institutions being licensed which cannot benefit from economies of scale or scope.
None of the Islamic banks in the Gulf is in the top 100 world banks in terms of assets, and as a consequence it is the major international banks such as HSBC, Deutsche Bank and Citibank that have moved into Islamic finance to fill the void, especially in investment banking, where capacity and capability are of critical importance. Although HSBC has based much of its Islamic banking operations in Dubai, the other investment banks conduct their Islamic finance business from London, where it is easier to recruit skilled professionals, rather than the GCC.
Islamic retail banking
The popular preference for Islamic banking in the GCC indicates that it is more of a bottom-up than a top-down movement. Al Rajhi Bank in Saudi Arabia has more branches than any other bank in the kingdom, and despite the reluctance to grant it a licence in the 1980s, it has become the largest stock market listed Islamic bank in the world. Like the Dubai Islamic Bank, the oldest Islamic commercial bank, which dates from 1975, Al Rajhi has successfully developed a range of deposit and financing products that has attracted millions of clients. The aim of these institutions is to provide as wide a range of facilities as conventional banks, but through shariah compliant products.
Critics of these institutions argue they are simply imitating conventional banks, and focusing on more affluent clients rather than playing a social role and assisting the poor. They are also accused of encouraging consumer indebtedness through their highly popular vehicle and home finance, but most GCC citizens take cars for granted and want to own the homes they live in, and indeed acquire additional property to rent to expatriates to enhance their current income. The poorest in the GCC are mostly migrant labourers rather than local citizens, and labourers only use banks for remittances.
GCC Islamic finance diversification
A major limitation of the GCC market is its small population size, even though admittedly the region has more than its share of high net worth bank clients. As GCC markets have become saturated with Islamic banks, the leading institutions have expanded by establishing networks abroad. The Kuwait Finance House opened a branch network in Turkey in the 1990s and has subsequently opened a Malaysian subsidiary, while Al Rajhi Bank has twenty five branches already established in Malaysia. Dubai Islamic Bank has a presence in Pakistan and has bought a Sudanese Islamic bank, and Abu Dhabi Commercial Bank has bough a significant stake in RHB Bank of Malaysia in order to strengthen its Islamic banking presence in South East Asia.
Investors concerned with shariah compliance in the GCC are increasingly looking to Asian markets, with particular interest in real estate and equity funds. Singapore and even China are increasingly willing to accommodate shariah compliant finance from the GCC, and India has a shariah compliant infrastructure fund.
This internationalisation of GCC Islamic finance will be examined, a two way process, as although GCC based institutions are influencing public perceptions in ASEAN and elsewhere, they are also been influenced by their Malaysian and Indonesian counter-parties, not least by Malaysia, where there are a number of high profile female shariah scholars, in contrast to the GCC where it is an exclusively male preserve.
It is clearly a tough challenge for the GCC to regain the initiative in Islamic finance that many would expect. Greater financial integration would certainly help, as would cross border mergers of Islamic financial institutions, although these have not been successful in the past. Establishment of consistent shariah standards would also be helpful, although even this seems problematic given the differences of opinion amongst the shariah scholars in the GCC and the lack of any central authority.
The author
Rodney Wilson
School of Government and
International Affairs, Durham University
r.j.a.wilson@durham.ac.uk