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DUBAI — The emergence and growth of the Islamic finance industry is a phenomenon that has generated considerable interest in the financial world in recent years according to a recent report by the National Bank of Dubai.

Given its ability to offer innovative financial solutions to an under-served market, it is seen as a community banking niche with considerable growth potentials. In the Muslim world, and increasingly in the West, significant segments of the institutional and retail markets are actively considering this alternative for their financing and investment needs.

However, the general availability of information remains limited for what is still a young and evolving industry. The current Muslim population of the world is at least one billion. It is estimated that the Middle East houses around 15 per cent of the world's Muslims. This explains why the greatest concentration of Islamic financial activities is in this region.

Today, more than 250 Islamic banks (90 institutions of them are in the Middle East) are operating from China to the US. Western banks, through their Islamic Units in U.K, Germany, Switzerland, Luxembourg, and others countries also practice Islamic banking.

Growth prospects of Islamic financial institutions

Pure-play Islamic Banks and financial institutions manage over $250 billion of assets and a further $200- 300 billion is managed by the Islamic windows and subsidiaries of international banks. The GCC region has been the hotbed of activity as far as the Islamic Banking industry is concerned, where 41 Islamic financial institutions are currently operating in the GCC countries (of which 18 are banks). Qatar and Bahrain are the leaders and hold a 70 per cent share of the assets, while the UAE accounts for 19 per cent of assets. The growth in assets is estimated at 15 per cent and expected to remain so for several reasons. One is the growth in overall wealth in the Middle East. Two, is growing awareness about the Islamic products. Three is the fact that Islamic products are becoming more competitive compared to conventional products. Four, is the wider availability and variety of Islamic financial products.

In addition, the Equity / Asset ratio of Islamic banks stands at 13.10 per cent compared to 11.30 per cent for conventional banks in the GCC region. This indicates underutilization of capital and provides a lot of scope for taking on additional risk on the balance sheet.

Basic instruments in Islamic banking

Contemporary Islamic finance revolves around the following core instruments derived from Islamic commercial law.

Ijarah: Islamic leasing: Unlike capital itself, fixed payments can be determined for assets or rentals. An Ijarah contract is where the financier buys and leases equipment or other assets to the business owner for a fee or more often called rental income. The duration of the lease as well as the fee must be set in advance and mutually agreed. Sometimes there are two contracts involved in this concept.

The first contract, Ijarah contract (leasing/renting) and the second contract, Bai' contract (purchase) are undertaken one after the other. For example, in a car financing facility, a customer enters into the first contract and leases the car from the owner (bank) at an agreed rental over a specific period. When the leasing period expires, the second contract comes into effect, which enables the customer to purchase the car at an agreed price.

Mudarabah: investment partnership: The contract is between a financier and an entrepreneur or investment manager, where risks and rewards are shared. Both receive an agreed share in the case of profits. In the event of incurring a loss, the financier bears any loss of capital while the entrepreneur loses his time and effort.

Murabahah: purchase and resale: Instead of lending out money, the capital provider purchases the desired commodity (for which the loan would have been taken out) from a third party and resells at a predetermined higher price to the capital user. By paying this higher price over installments, the capital user has effectively obtained credit without paying interest.

Musharakah: profit and loss sharing: An equity financing arrangement widely regarded as the purest form of Islamic financing, where partners contribute capital to a project and share its risks and rewards. Profits can be divided up in any agreed ratio, while losses must be in proportion to the capital invested.

Differences between Islamic and conventional financial institutions

Although Islamic finance has generated substantial amount of literature coverage in the press and academic journals,