Islamic banking offers a different model

Although they command only 5% of the market share in Turkey, “participation banks” see room for growth.

The Istanbul Stock Exchange opened an index on Sharia compliant banks and companies this year. [Reuters]

Earlier this year, the Istanbul Stock Exchange launched an index of Sharia compliant banks and companies. Since then, the emergence of “Islamic banking” — also known as “participation banking” — has garnered considerable media attention.

It has been widely reported that these banks do not charge interest, or “riba”, because it is forbidden according to Islamic law. The actual mechanisms by which the banks operate, however, and the ways in which they differentiate themselves from the mainstream financial sector, remain poorly understood.

Four participation banks are currently operational in Turkey: al Baraka, Bank Asya, Kuveyt Türk, and Türkiye Finans. Like mainstream financial institutions, these banks offer a wide range of services, including savings and checking accounts, house and automobile financing, and even Islamic bonds, or “sukuk”, offered through Kuveyt Turk.

But for each of these services, an alternative mechanism has been developed to make profits without violating Islamic law regarding transactions and trade.

For example, customers with savings accounts at participation banks do not receive monthly interest payments at a certain rate. The banks use funds to supply goods and services directly according to a profit/loss investment model.

Savings funds are invested in tangible goods, real estate, or industry, and at the end of the month profit and loss is shared with the customer. A profit margin is not guaranteed, and no investment is made in companies dealing with pork, alcohol, or other banned commodities, according to the Participation Bank Association of Turkey.

Whereas car financing at a conventional bank entails a loan repaid with interest, Kuveyt Türk buys automobiles on behalf of customers, then sells them in installments at a higher price. Instead of charging interest, they see the transaction as buying and selling at a profit.

Currently, about 5% of deposits, assets and loans in Turkey are held by participation banks, but the Participation Bank Association of Turkey foresees massive growth.

The assistant to the association’s General-Secretary Osman Nihat Yılmaz told SETimes that he predicts participation banks’ market share to double in size, reaching ten percent in the next ten years.

According to Yilmaz, participation banks in Turkey faced the current financial crisis “from a sound position”.

“The banking sector in Turkey is more resilient compared to Western banks,” he says, because of precautions made after the banking crisis of 2001. Moreover, he said participation banks in particular do not “get interest risk because we don’t deal in interest transactions”.

Turkish participation banks now control a very small share of the total assets held in Islamic banks worldwide, approximately ninety percent of which are held in Iran, the Persian Gulf, and Malaysia, according to The Banker.

Yilmaz says that Islamic banking is aimed primarily at conservative people in Turkey, which he describes as consisting of twenty percent of the Turkish population, adding that “it may rise to 40 or 50”. But he admits that participation banks need to persuade target segments as well other people about the banks’ services

When asked whether or not instability in the Middle East created an opportunity for Turkish banks to increase their market share, Yilmaz told SETimes, “we worry for our neighbours” and don’t want to profit at their expense.

But someday “we want Istanbul to become the centre” of banking in the Middle East, he added.

This content was commissioned for SETimes.com.

via Islamic banking offers a different model (SETimes.com).