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
chenry@mail.la.utexas.edu

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.
 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 of
Muslim countries. It is allowed greater freedom than Islamist political movements
in most of these countries. Relationships are complex, however, between the
respective governments, Islamist oppositions, and Islamic banking establishments.
This paper discusses conditions under which the Islamic financial movements
might effectively mediate between governments and oppositions and thereby
encourage tendencies toward more political pluralism within the incumbent
regimes.

The regimes in question are all "authoritarian," with the exception of

Turkey, but they tolerate pluralism in varying degrees, depending largely on the
relative strength of their respective private sectors that underpin civil society. In
some of the Muslim countries the Islamic banks associated with Islamic business
communities constitute significant parts of these private sectors. This paper seeks
to discover the thresholds of private sector activity that may be needed under
different political conditions for Islamic finance to moderate Islamist political
movements and encourage greater political pluralism. Below the threshold,
however, Islamic finance may still indirectly encourage political pluralism by
supporting those elements of the regime that are committed to economic reform.
 Clement M. Henry, Islamic Financial Movements, page 2

Like social movements, Islamic finance mobilizes resources (deposits, many of which
might otherwise stay under people's mattresses) and "frames" the identities of the
participants in common, specifiable, distinctive practices. It also enjoys better access in
most MENA countries to government and business elites than other "Islamist" social
movements. The world of Islamic finance may appear at first glance to be far removed from
the rough and tumble politics of most MENA states. Its apparent marginality, however, also
offers some protection. In illiberal states the financial field still enjoys a degree of autonomy
that is not accorded to political parties, formal NGOs, and other bodies associated with
official decision-making. Most, although not all, of the MENA states are illiberal, but they
tend to be less closed financially than they are politically. Some of them tolerate Islamic
banks as part of a strategy to legitimate themselves.
By "Islamist" here is meant a determination to transform the present state of the world or
some aspect of it to accord more closely with the principles of Islam. Financial practices
may be a very limited aspect - and rather less provocative for some Muslim and Western
audiences than wearing beards or veils. Dress codes attract attention and, rightly or
wrongly, may be taken to express more radical, totalistic aspirations for social change than
arcane financial practices. As Vogel and Hayes observe, however, "the surge in Islamic
banking 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 articulating
relationships between states and business communities. It is often forgotten, as a recent
student 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 banker
oligopolists converted their market power into seats on boards of directors (Weber 1978:
943-944). Rockefeller's oil monopoly was another of his favorite examples, but Weber
never carried the analysis further to buttress with structures and institutions his ideational
arguments about the affinities of the puritan ethic for capitalist development. This paper will
pursue 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 of
puritanism. In Muslim Society (1981) and in earlier essays he argued that there were
striking parallels between orthodox urban Islam and Christian puritanism. Each tradition
was scripturalist, enabling any literate individual direct access to divine revelation without any
intervening earthly or spiritual hierarchies. The major difference between Islam and
Christianity is that Islam was born puritan whereas the Christian puritans emerged much later
to attack a central church hierarchy. Puritanism is part of Islam's mainstream orthodox
whereas it is a deviant protest movement outside the Christian Church. Martin Luther, John
Knox et al attacked the priests, icons, and angelic intermedaries - all part of a great chain of
hierarchical being adapted from Aristotle. The zealous puritans transformed the chain of
being into a chain of command (Walzer 1965) and generated the first mass political parties
in England and Holland in the seventeeth century.
If we follow Gellner's 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 ulama
who collaborate with illegitimate rulers. In Algeria, for instance, Gellner perceived the
religious reformist movement of Ben Badis to have been the driving force behind the Front
 Clement M. Henry, Islamic Financial Movements, page 3

of National Liberation (FLN) that fought the French and ruled independent Algeria until
recently. This sort of radical Islamism, in his view, was progressive and perfectly compatible
with - 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 Protestant
ethic.
To follow up on this analogy, however, we need to identify an Islamist bourgeoisie
rather than just let the state do it, as Gellner seems to have expected of Algeria. Islamic
finance offers the requisite marker to fill in the missing structural link in the Muslim tradition
that neither Weber nor Gellner ever identified for Protestant business in the Christian
tradition. While politically Islamist bourgeoisies do not necessarily work with Islamic
financiers, these bankers offer a politically neutral definition of Islamism that is more likely to
prosper in illiberal regimes than more overt forms of political Islamism. They carry. too. a
distinct set of business practices that may resonate better than conventional finance with
Muslim publics.
This paper also addresses the broader question of the conditions needed for an
autonomous bourgeoisie or business community to emerge. Can it exercise influence either
indirectly, reflecting structural power, or by real voice and regime change? Some business
communities have occasionally exercised decisive influence. In South Africa, for instance,
big business backed the referenda that abolished apartheid. In Brazil business tired of the
generals pushed for the "decompresion" of the late 1970s. Ultimately the progress of
Islamic finance may require further political liberalization, but to what extent, conversely, can
it be a catalyst for such political change? We will see that the movement has progressed
furthest in the Sudan and in relatively liberal monarchies. But it is also tolerated in military
bunker 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 but
they appear to share a financial world view in which riba -- interest or usury -- is abolished
while 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 reality
keep interest but just call it by another name, such as commissions or profits (ribha). And
indeed a principal form of credit extended by an Islamic bank, the murabaha, involves a
simple markup on a sales price. The bank buys you a car for $30,000 and you owe the
bank $33,000 a year from now, for example. This arrangement is perfectly acceptable from
the 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 and
also implies an interest rate of 10%. Islamic bankers use financial calculators just like other
bankers to compute present and future values of investments. Financial transactions
modeled on the murabaha constitute well over half of the assets of Islamic banks. Contracts
engaging clients to return fixed payments to Islamic banks apparently constitute from 80 to
95 per cent of the latter's credit facilities, or "investments" (Warde 2000: 133). Since any
fixed return can be understood as implied interest, there seems little to differentiate Islamic
from conventional banks. Indeed, as Ibrahim Warde observes, no definition of an Islamic
bank is entirely satisfactory (2000: 5). He proposes a bank to be Islamic if run by Islamic
 Clement M. Henry, Islamic Financial Movements, page 4

principles and, one might add (at least in most cases), a Shari'a Board of religious
supervisors to vet the bank's policies.
The movement is hardly monolithic. From its origins in the mid-1970s there were
philosophic 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 Saudi
sponsor, who was deploying substantial capital to compete with other commercial banks.
Commercial forces may have eased out the idealists, but there is still indeed some
questioning about the Islamic legitimacy of the murabaha, though more so by Islamic
economists 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 instruments
are mudaraba and musharika, both of which involve profit-sharing. Mudaraba is a contract
whereby the bank provides funds to an entrepreneur in return for a share of the profits, or all
of the losses, whereas musharika - participation - is more akin to equity financing. An
Islamic bank can also be conceived as a mudaraba whereby the depositors invest in the
bank - or entrepreneur mudarrib - that in turn funnels investments into other mudaraba or
other Islamically acceptable placements. Profit-sharing with variable returns and risk-taking
are the distinctive characteristics of the Islamic financier. The purists criticize existing Islamic
financial institutions as deviating from an Islamic ideal of venture capitalism. They note that
Islamic banks currently allocate less than 10 per cent of their credit facilities or investments
to these distinctively Islamic profit-sharing instruments. Some argue that any contract
offering a fixed return is just like a loan at a fixed interest rate and hence is not Islamically
acceptable.
The jurists, on the other hand, tend to think less theoretically and deductively than the
economists. They reason case by case, on the basis of precedents and prior rulings in their
respective juridical schools. The consensus is that murabaha is just as permissible,
Islamically, as mudaraba or musharika, as long the contract meets certain conditions. The
killer, in the above example of a murabaha, is that the bank actually has to own the car and
sell 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" murabaha
whereby the bank never really owns the car (Vogel and Hayes 1998: 143). Islamic banks
are hence caught in a dilemma. Commercial banks in many countries, especially under those
historically influenced by British or American banking practices, are supposed to restrict
themselves to the financial business of taking deposits, lending them out, and trading only in
financial instruments. Yet the Islamic jurists insist that they be involved in the trading of the
range of goods financed by their portfolios of murabaha. Otherwise they would be engaging
in the "ruse" of artificial murabaha that is now forbidden. At least one Islamic bank
apparently takes these injunctions quite seriously. The Jordan Islamic Bank for Finance and
Investment inaugurated a bonded warehouse in 1999, just as it was celebrating its twentieth
anniversary (21st Annual Report, p14). Almost half (45.7%, p. 56) of its financing and
investments then consisted of murabaha (while mudaraba and musharika came to less than
3%).
Evidently the Islamic financial movement is attempting to adapt Islamic instruments
originally designed for pre-industrial trade and handicrafts to a post-industrial global
economy. Commercial banking already became a specialized industry in the nineteenth
century, and European banking systems penetrated the Muslim world as well. Driven by
 Clement M. Henry, Islamic Financial Movements, page 5

new technology and favorable deregulation by the United States and other industrialized
countries, banking and finance became ever more specialized and relatively autonomous. In
the latter half of the past century the growth in international financial assets has far
outstripped that of any underlying investment and trade in goods and services. In this highly
specialized world of international finance, with its dizzying rates of product innovation,
conventional banks could not afford to build warehouses as well, even if commercial
banking legislation permitted them to. The business of modern finance and banking is
sufficiently challenging in its own right, and there are few synergies with other industries that
the "real" non-financial one, such as the car manufacturer-dealer, is not better positioned to
benefit from. The Islamic finance movement developed under the impetus of bankers, not
car dealers - though at least one of the latter engaged in a phoney sort of "Islamic" finance in
Egypt 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. Each
of the 186 or so Islamic banks (as indicated by the Directory of the International Institute of
Islamic Banks) has its own advisory committee of Islamic jurists, and they issue rulings that
are not always mutually consistent. Conventional banks like Citibank that have opened
Islamic windows also have their religious advisory committees. Standardization is a major
problem. 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 liquid
placements and long-term investments. Innovators need to know what is Islamically
acceptable, yet any innovation faces a wide spectrum of legal opinion. If options (a
discretionary 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 a
conventional financial institution can devise. Highly restrictive rulings, by contrast, could
conceivably outlaw virtually all of the bread and butter murabaha trade financing in which the
banks presently engage and preclude any significant innovation.
This paper cannot enter into the details of what might or might not be legal to various
shari'a boards. Indeed, as Warde suggests, "legalistic concerns are only aspect, and
probably 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 financial
markets because these banks enjoy one major underlying competitive advantage, popular
demand among pious Muslims for an alternative to interest-based savings accounts. Assets
under 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 in
the wealthy Gulf states. Whether or not they build warehouses, the Islamic banks will n
doubt 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 will
not let them. Accounting practices vary widely but the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI), established in Algiers in 1990 and
now based in Bahrain, finally issued its first set of standards in June 1998. In addition to the
Fiqh Academy in Jeddah there are various other institutions engaged in the dialogue between
bankers, economists, and jurists that are articulating a broad agenda for Islamic banking and
finance.
 Clement M. Henry, Islamic Financial Movements, page 6

First, at the core of the movement are two transnational groups that conduct their own
dialogues: 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 Association
of Islamic Banks, founded in 1977 under the auspices of the Islamic Bank for Development
owned by the member states of the Islamic Conference. Outside the umbrella organization,
Al-Baraka has held annual meetings since the mid-1980s to develop common
understandings of proper banking practices among its affiliates. In addition many research
institutions, in Europe and the United States as well as in the Muslim world, promote an
academic discourse about Islamic financial institutions. In the United States the Harvard
Islamic Finance Information Program, launched in 1995, has sponsored impressive
publications and developed an important database. It also convenes annual conferences that
contribute to the ongoing dialogues between academics and practitioners, jurists and
bankers.
The most significant guarantee of Islamic finance's future may be the large western
multinationals that have opened Islamic windows for receiving deposits from their wealthy
Gulf clients and for financing a variety of projects in the Muslim world. The French, led by
the Banque Nationale de Paris, have lately joined the many American and British presences
headed by Citibank and Kleinworth Benson. The World Bank's International Financial
Corporation has encouraged cofinancing infrastructure projects with Islamic investment
houses. Prominent multinationals, including oil companies, have joined in project financing in
some of the GCC states with Islamic financial instruments. Islamic finance, in short, is
becoming respectable in international business circles. One commentator recently went so
far as to suggest that even if existing Islamic banks were to stagnate or fail, their distinctive
set 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 expanding
their 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 commercial
banks. The Islamic Development Bank, founded in 1973 and owned by a consortium that
by 1998 included 52 Muslim states, eventually assimilated some of the novel Islamic
financial practices devised by the private sector. The first modern privately owned Islamic
bank opened in Dubai in 1975. The Dubai Islamic Bank practiced interest-free banking
although it did not establish a religious supervisory council until 1998, when a manager
embezzled funds and the bank needed a government rescue package. After 1979 Iran,
Pakistan, and Sudan all "Islamized" their banking systems from above, but these
bureaucratically induced changes are less interesting than the evolution of privately owned
banks, including those in the Sudan that were "Islamic" before the official Islamization of the
1980s. In MENA countries where privately owned Islamic commercial banks compete
with conventional public and privately owned ones, it is possible to compare their respective
financial performances. Their respective shares of commercial bank deposits can be
compared across countries, and in some countries their returns on capital and total assets
can be readily compared to those of their conventional competitors. Jordan and Turkey are
especially convenient countries to study because they publish aggregate data about the
financial performance of their respective banking systems.
 Clement M. Henry, Islamic Financial Movements, page 7

Table 1 pieces together the progress of these privately owned banks in the MENA
region, including Turkey, with the available data. For comparative purposes Malaysia is
also included because its experience is often cited as exemplary in Islamic banking circles.
The country's only exclusively Islamic Bank, Bank Islam Malaysia Berhad (BIMB), has
mobilized less than 2 per cent of Malaysia sight and savings account deposits (measured by
lines 24 and 25 of the IMF's International Financial Statistics) in almost two decades as an
officially recognized commercial bank (cf. Warde 2000: 127). At the time of its official
founding BIMB already had established a Muslim clientele by collecting funds to finance the
pilgrimage to Mecca. Relations between BIMB and Malaysia's Central Bank may have
been more constructive over the years than the experiences of a number of Arab
counterparts with their central banks, but Malaysia has not experienced the surge in Islamic
banking 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 operate
according to shari'a principles, but those that were consciously self-styled Islamic banks
before the system was Islamized seem to have increased their market share at the expense
of the newer converts. In Saudi Arabia, the spiritual center of the Islamic world, a single
Islamic bank, Al Rajhi Banking and Investment Corporation (ARABIC) has captured over
10 per cent of the market, and in some of the smaller GCC states the Islamic sector is
approaching 20 per cent. The GCC seems to be the principal area of growth, possibly to
be 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 for
business in 1998 - the movement in Jordan appeared to have flattened out at less than 10
per cent of the market.
Egypt has apparently experienced a slight decline since Islamic banking reached its
peak in 1986. Table 1 does not include the so-called Islamic fund management companies
that used Islam as a marketing technique for money-changers who expanded their
businesses to manage their clients' remittances. These companies were, with one or two
exceptions (Sherif and possibly Saad; see Galloux 1999: 488-489), fly-by-night
"investment" companies that simply funneled Egyptian workers remittances from the Gulf
countries to hard currency accounts outside Egypt. They doubly harmed the officially
recognized Islamic banks. They competed for deposits and slowed the growth of the official
Islamic sector in the mid -1980s. Subsequently they discredited the entire idea of Islamic
finance (even though they did little to practice it other than pay publicity fees to a few Islamic
scholars) by going bust after 1987, when an agreement with the IMF to liberalize Egyptian
foreign 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. Table
1 includes only Banque Misr and possibly understates the total Islamic share of deposits by
a percentage point or two. In the rest of the Arab world, however, Islamic finance remains
marginal.
 Clement M. Henry, Islamic Financial Movements, page 8

Islamic banks are altogether absent in Iraq, Libya, Morocco, Syria, and they eke
out 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 Iranian
factions favor development of the private sector, and legislation authorizing the incorporation
of private sector banks was passed in the spring of 2000. The most dynamic private Islamic
banks outside the Arab world are found in Turkey. Three of the five private Turkish banks
are partly owned, respectively, by the Al-Baraka group, the Faisal group, and the Kuwait
Finance House. In fifteen years these banks have not collectively achieved even 4 per cent
of the market, but they seem established, having recently been integrated officially into
Turkey's commercial banking system instead of standing apart under special legislation as
finance houses. They are clearly growth oriented, as they methodically extend their
branches networks into the provinces as well as in Istanbul and Ankara.
From this brief panorama it is possible to draw some conclusions. With the
exception of the Sudan, Islamic banking has flourished the most in the prosperous Gulf
region of the MENA. Indeed, it originated during that brief moment of apparently limitless
prosperity, the 1973-74 oil boom, as an ingenious way of recycling an infinitesimal fraction
of the petrodollars into pious activities. In the MENA per capita income seems a fair
predictor of the penetration of these banks into commercial markets. Figure 1 graphs the
Islamic shares of commercial bank deposits presented in Table 1 against per capita GDP in
1998. Sudan is an obvious outlier, whereas the richest Gulf Cooperation Council states of
Kuwait and Qatar lead the rest of the pack. Excluding the GCC, however, the relationship
could run the other way, with the poor of Sudan, Yemen, Egypt, and Jordan outdoing
wealthier states such as Tunisia, Turkey, Libya, and Malaysia. Obviously wealth is not the
only factor that may attract Islamic finance.

(Figure 1 about here)

Another factor that encourages Islamic banks, or at least does not positively
discourage them, may be the relative weight of the private sector in banking. Where
government banks are in control, as in Iraq, Libya and Syria, there is no room for private
financial enterprise, whether Islamic or conventional. The private Islamic banks would seem
to stand a better chance of developing in relatively liberal economic climates featuring strong
private 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 Table
1 against government ownership of a country's commercial banking sector. Government
ownership measures the percentage of tota l assets of the system controlled by banks that
are at least 20 per cent government owned. It is assumed that a 20 per cent stake puts the
state in full command. Thus countries like Egypt and Tunisia may practice a veneer of
economic liberalism and tolerate private sectors in their banking sectors. However, their
states remain in pretty full control of their respective systems, as is evidenced by the huge
 Clement M. Henry, Islamic Financial Movements, page 9

proportions of total assets that their banks deploy. Figure 2 situates Bahrain, Jordan, Saudi
Arabia, Kuwait, and Qatar in the potentially most fertile climate for Islamic banks, the top
left quadrant of predominantly privately owned banking systems. Clustered in the bottom
right are Iraq, Algeria, Libya, and Syria, whose banking systems still reflect their state
planned economies, currently undergoing some adjustment but displaying very little
privatization in the strategic banking sector.
Independently of per capita wealth or government ownership, Islamic banks would
seem 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 rightwing
American foundation, has published an Index of Economic Freedom in cooperation with the
Wall Street Journal. Figure 3 presents each MENA country's average score on 9 of the 10
indicators (excluding low taxation rates that may attract foreign investment but do not
necessarily indicate a liberal economic climate). The more open the economy is perceived to
be, the lower its score. The average scores of Jordan, Morocco, and Oman all cluster just
behind Turkey and ahead of Tunisia and Saudi Arabia. Morocco, Oman, Tunisia, and
Lebanon all appear to have much less Islamic banking presence than their Index of
Economic Freedom might predict. Indeed, it seems surprising, in view of Jordan's positive
experience with Islamic banking, that Morocco and Oman have yet to permit Islamic banks
to operate in their respective kingdoms. Their rulers (and the Saudis as well) insist on
retaining an ideological monopoly on what is Islamic. It is less surprising the most closed
economies of Syria, Iraq, and Libya have no Islamic banking presence, although this may be
changing 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 the
money supply (M2) that is kept in banks rather than at home under mattresses. Figure 4
shows that little over half of Syria's money supply is kept inside the commercial banking
system.

(Figure 4 about here)

Most business transactions in Syria, for instance, are for cash, not checks much less
credit cards. The banking systems of these "bunker regimes" also display exceptionally low
proportions 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 would
therefore 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 until
recently.
Some of these financially underdeveloped countries, however, have engaged in IMF
structural adjustment. Coincidentally or not, those that underwent reform are the ones that
also tolerate Islamic banking - Algeria, the Sudan, and Yemen. In Algeria and Yemen the
Islamic market shares are small but growing. Less than 1% of Algeria's commercial banking
deposits were with Al-Baraka in 1998, but new private banks, including Islamic ones, are
 Clement M. Henry, Islamic Financial Movements, page 10

being formed, and Algeria's future trajectory could well surpass Turkey's, which resembled
Algeria in 1986. Bahrain and Kuwait, situated in upper left of Figure 3, get the highest
marks from Wall Street's Index of Economic Freedom, but Yemen, Sudan, and Algeria
appear best to combine relatively open banking with relatively large proportions of their
money under the mattresses. Islamic banks may therefore have the greatest potential
markets in these countries. One explanation for the relative stagnation of Islamic banks in
Egypt and especially Tunisia, by contrast, may be their restrictive commercial banking
climates. These, at least, were the only two banking environments in the MENA that Wall
Street downgraded (or possibly simply corrected) by a point since 1996 - whereas the
others remained unchanged. An earlier market study suggested that Tunisia, like most other
Muslim countries, had a substantial potential for Islamic banking (Barbulesco 1989: 11).
The biggest anomalies seem to be Morocco and Oman, countries that appear to be
relatively well positioned for Islamic banking but that have steadfastly refused entry to such
banks. Each of these banking systems is relatively oligopolistic and concentrated, but no
more so than Kuwait's or Bahrain's. If Oman's system is relatively restrictive (Figure 3),
Morocco's 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 controlled
through various conglomerates. An Islamic alternative might challenge the Commander's
religious authority as well as discredit his conventional financial institutions.
In reality Saudi Arabia may be an even greater anomaly despite the respectable
11.5% showing of its single Islamic bank, Al Rajhi Banking and Investment Corporation
(ARABIC). Islam's two big transnationals, Al Baraka and the Faisal group, also have their
main offices in Saudi Arabia and have tried for over a decade to obtain commercial banking
licenses 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 by
association with the rest of the banking system. Al Rajhi received a license only because
new laws prevented money-changers from accepting deposits after one of them (headed by
another member of the Rajhi family) collapsed. The big well established firm was given its
license as a normal commercial bank but then claimed on its own, backed by a religious
advisory board, status as an "Islamic" rather than conventional commercial bank. Its
astonishing success may be the real reason why the other transnationals have not been given
licenses. The conventional competitors, now including major royal investors like Prince
Walid al-Talal, do not wish to see their profitable enterprises undermined. Some, like the
prince's Saudi Arabian American Bank (SAMBA), have established Islamic windows to
capture some the growing Islamic sector of the market. As pious, profit-seeking customers
gradually shift their funds from non-interest bearing accounts to Islamic investments,
conventional banks are devising new Islamic products to satisfy their depositors. By one
estimate the non interest-bearing deposits are shrinking by 1 to 2 per cent annually, and the
new type of banking is growing by 15%. In 1999 SAMBA was estimated to have 4% of
this 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 Arabia's (with Prince Walid and
 Clement M. Henry, Islamic Financial Movements, page 11

Citibank) Saudi American Bank, and the even larger but poorly managed National
Commercial Bank. In profitability, the ratio of net income to total end-of-year assets,
ARABIC's 3.5% tops most of the world's commercial banks and beats everybody in the
MENA 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 its
current accounts and enjoys a loyal clientele. Unlike most Islamic banks, it pays out none of
its profits at the end of the year to the depositors - or "investors" as they are called, who in
other banks hold "investment deposits" or "investment savings accounts." ARABIC does
carry 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, but
there 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 non
interest-bearing accounts. Remove SAMBA's interest expenses - which amounted to over
3% of its total assets in 1998, and it would have been earning 5.4% on them compared to
ARABIC's 3.7% (SAMBA 1999: 16-17). SAMBA would appear to be the more efficient
money machine, but ARABIC has a far lower cost of funds. Similarly the Bank of Riyadh
would have earned 4.7% rather than 1.7% on its end-of-year assets.
Arguably, however, the recent momentum in the GCC favoring Islamic banking
endangers ARABIC as much as the conventional banks because depositors seem to be
breaking away from their habit of parking funds in non-interest bearing accounts. Data for
all of the Saudi banks are not available, but Riyadh Bank indicates in the notes to its 1999
Annual Report that about one -third of its deposits are still "non-commission sensitive." In this
respect Saudi Arabia may be a backwater compared to more demanding publics that
expect to earn profits - not interest, of course - from their savings. But Saudi Arabia is
changing. The future of the Islamic movement may depend on its ability to compete in
profits distributed to shareholders with the interest offered by conventional banks or the
profits offered through their Islamic windows. In the more financially sophisticated climates
of 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. In
1998 and 1999, for instance, the Jordanian National Bank (Ahly) reported non-interest
bearing accounts amounting to over 15% of its total deposits (Annual Report, 1999). But
non-interest bearing accounts constituted only 0.1% of the deposits of Kuwait's leading
conventional bank, the National Bank of Kuwait
(http://www.nbk.com/nbktoday/data/annualrep99.pdf) and about 10% of the Commercial
Bank of Kuwait's (http://www.banktijari.com/index_ht.html). Obviously more systematic
data would be useful but most banks do not yet disclose such matters online or even in their
written 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 returns
on its various types of investment accounts at the end of the year. No Islamic bank can
promise a specific rate of return but, like track records of mutual funds for small investors in
 Clement M. Henry, Islamic Financial Movements, page 12

the United States, they try to gain reputations for profitability. Table 2 compares the interest
rates offered by conventional banks for various kinds of time deposits with the information
posted by the KFH in a recent annual report. The latter's categories unfortunately do not
specify the required time periods and are therefore not strictly comparable, but the fact that
its profit rates uniformly increased in 1997 over 1996 suggests that the KFH did not simply
track the Central Bank's interest rates. These tended in most categories of KD deposits to
diminish in 1997.
Despite paying customers for their deposits, KFH outperformed all the rest of
Kuwait's big commercial banks in 1998 and 1999. Its return on assets reached 2.51% at
the end of the century -- well above the norm of 1.53% collectively achieved by the top 65
banks in the GCC states (MEED, June 23, 2000, p. 40). KFH's consistent profitability -
with steady returns above 2% in the late 1990s - suggest that Islamic banks can survive
competition with conventional banks even when depositors combine piety with financial
acumen. A closer examination of its balance sheet and income statement, however,
indicates that KFH may have enjoyed special advantages. It is 49% owned by the
government, and some ministries deposit their employees' salaries in the bank, assuring it a
steady stream. It is instructive to compare its financial statements with those of the National
Bank of Kuwait, the country's flagship conventional bank that in 1999 performed almost as
well as KFH, with a 2.46% return on total year-end assets. Since the KFH web site is still
under construction, its 1998 and 1999 statements were unavailable. Consequently Table 3
compares its ratios for 1996 and 1997 with those of 1997, 1998, and 1999 calculated from
the online data provided by the National Bank of Kuwait. What the NBK and other
conventional banks call "interest paid to depositors" can be translated into the KFH
language of "d istribution of profits to depositors." They are the bank's cost of funds.
"Spreads" earned by conventional banks are the difference between the interest
generated from loans and the cost of funds. For an Islamic bank, then, spreads are simply
the difference between the revenues earned on murabaha, musharika, etc., and the cost of
funds. 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 KFH's competitive advantage is its inexpensive cost of funds. Despite its
publicity about the profits to depositors - cast so as to suggest the banks was keeping up
with prevailing commercial interest rates - it was paying them 1.1% less, on average, than
NBK. This may be Islam's competitive edge in Kuwait: pious Muslims can accept slightly
less -- as long as it is not too much less. On the revenue side the KFH's gross earnings
roughly equaled those of NBK, but its earnings after paying off the depositors were much
greater. Turning to page 2 of Table 3, KFH's competitive advantage was reflected in the
bottom line, net income as a percentage of total assets. In 1996 and 1997 KFH's bottom
line was substantially greater for its size than NBK. It is interesting to see how NBK
managed by 1999 to catch up with KFH. It did not cut back on its administrative expenses
- these remained slightly higher than KFH's, despite the complexities in an Islamic bank of
selling goods for a mark-up (murabaha) rather than simply charging interest. The bigger
bank deliberately gave up market share, contracting its deposits and possibly paying less for
them than market rates (although short-term interest rates on KDs also declined by about
0.5% in 1999 - see Table 2). By 1999 NBK was earning about as great a return on its
assets as KFH, although its cash flow (when depreciation expenses and provisions for bad
 Clement M. Henry, Islamic Financial Movements, page 13

debts are added back to net income) was not as strong. By MEED's reckoning it had
become as "efficient" as KFH, converting about as high a proportion of gross earnings to the
bottom line of net income. KFH still displayed a higher return on capital (NI/Cap), even
after 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 relied
more heavily on the deposits of other banks for its funds. But KFH also had to work harder
for its returns than NBK. A substantially greater proportion of its total assets was tied up in
various forms of Islamic financing, risk assets comparable to NBK's loans and advances to
customers. KFH generated about as much gross revenue as NBK, but it did so by
deploying an extra quarter of its total assets in risky transactions. This difference is only
partly explained by netting out a bizarre liability on KFH's balance sheet, "deferred revenue."
KFH appears to have a riskier profile than NBK, yet it was also less capitalized until 1998
and is still so with respect to risky assets. That is, its capital to risky assets ratio is still much
lower than NBK's. KFH also carries more provisions for losses (as a percentage of risky
assets) than NBK, but capital and provisions constituted only 21% of KFH's mudaraba and
leasing assets in 1996 and 1997, compared with NBK's 35% to 37% in 1998 and 1999.
The Islamic bank's 49% government ownership perhaps offsets the added the risk. KFH
can be relatively confident that the government would bail it out in any emergency. Indeed, in
the wake of the Souk el Manakh crisis of 1982, the KFH's return on assets plummeted from
over 2% to 0, and the government rescued it in 1984. Today, despite its higher return on
capital, it distributes slightly smaller returns to the shareholders in the form of dividends.
Good government connections and loyal customers have enabled the KFH to
compete successfully with Kuwait's flagship conventional bank. Like ARABIC in Saudi
Arabia, KFH is a success story. Elsewhere in the Gulf the Islamic commercial banks have
performed less brilliantly but kept their substantial market shares. The pioneer, Dubai
Islamic Bank, had to be bailed out in 1999 because of an internal embezzlement scandal but
had survived over two decades with returns on assets of less than 1%. In Bahrain and
Qatar 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 ranked
fifth in MEED's 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 low
cost of funds acceptable to pious depositors. Other small Islamic investment banks,
however, did much better. Not only were the International Investor, First Islamic
Investment Bank, and BMB Investment Bank among the top six in efficiency; they also
ranked 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 a
pious and financially sophisticated clientele disenchanted with non interest-bearing deposits
in conventional banks.
The wealthy can perhaps afford to satisfy their consciences by taking more risks for
slightly 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 non
interest-bearing accounts or avoid banks altogether. The affluent depositors of the GCC
countries are a relatively easy target for Islamic banks. But in the rest of the MENA, with
much less per capita wealth, Islamic banks enjoy less competitive advantage. There will
always be a pious minority ready for an alternative to non interest-bearing accounts, but the
 Clement M. Henry, Islamic Financial Movements, page 14

less wealthy and more risk-averse potential investors may prefer to keep those small savings
under the mattress if they do not earn competitive market returns. The case of the Jordan
Islamic Bank for Investment and Development (JIB) illustrates some of the dilemmas of
Islamic 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 and
sustained its momentum until the mid-1990s. There is clearly strong demand in Jordan for
Islamic banking. JIB claimed over 600,000 depositors in 1999 - quite a substantial number
for a country of only 4.6 million men, women, and children. The highly respected Arab
Bank, 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 to
other developing Islamic finance nuclei in Egypt, Yemen, and the GCC countries, where
Arab 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 ally
like Arab Bank may be in trouble. JIB's financial statements reveal serious weaknesses.
In its earlier years JIB did fairly well, keeping up with and even in 1985 and 1989
surpassing the average returns on equity of businesses in the financial sector. Table 4
suggests 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 halcyon
years, however, its returns on total assets (NI/avTA) were mediocre, never even reached
the 1% attained in 1982. During these years, moreover, JIB does not appear to have been
as fully capitalized as the average bank. Table 4 indicates, for instance, that in 1989 the
bank's share of capital, reservations, and allowances to cover investment losses (provisions
for non-performing loans in other banks) was only 5.6% of the total recorded by the Central
Bank of Jordan. Yet JIB held 6.4% of the total assets. It also held a full 8.3% of the total
risk assets - loans and other forms of financing outstanding to private and public entities
excluding the central government. Like KFH, it had to work harder for its revenues than
conventional banks. Arguably, then, the bank should have been more fully capitalized than
other banks to cover the additional financing risks. Islamic banks like to claim that their
depositors are in fact like stockholders sharing in the bank's profits, but the depositors, like
bank regulators, may see it differently.
Table 4 pieces together what happened to JIB over the years. Despite an infusion
of capital in 1993, it could not sustain its ambitious efforts to mobilize ever greater shares of
commercial bank deposits. It continued in the latter 1990s to add more branches but their
productivity declined after 1994: each branch generated fewer deposits and revenues. JIB
seems 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 the
depositor of conventional banks. The two banks, Cairo-Amman and Ahli, were selected
because of their comparable medium sizes and relatively mediocre financial performances.
Cairo-Amman's return on assets never exceeded 1% in the early and middle-1990s, and
Ahli did only marginally better before falling into the red in 1999 after an expensive merger
with another bank. Table 4 shows that Cairo-Amman was paying its depositors even less
 Clement M. Henry, Islamic Financial Movements, page 15

than JIB - possibly because of low market rates on the West Bank, where Cairo-Amman
enjoyed a virtual monopoly until 1995. Ahli was paying out substantially more than JIB after
1994. 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 one
of their strengths: in hard times they are less likely to go bankrupt. But then they are likely to
lose depositors. In 1995 JIB reached its high point in deposits: its share of the market
would then steadily decline, even before the Islamic International Arab Bank entered the
market in 1998.
From Table 4 it seems that JIB simply could not pay depositors well enough to keep
them. The number of them grew but the average size of deposits declined, suggesting that
JIB's expanding branch network might be tapping into small savings that would otherwise
stay under the mattress. But most of the depositors probably expected to earn at least as
much as they would from a savings account at a commercial bank - 4 to 5% in the late
1990s (Central Bank of Jordan, Monthly Statistical Bulletin, Table 21,
http://www.cbj.gov.jo/docs/bulletin/21.html August 28, 2000). JIB diminished its returns
roughly 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 simply
could not generate the revenues need to meet the going rates.
The explanation was simple: either JIB was undercharging customer for Islamic
financing or growing proportions of those risky assets were not being paid off (or had
perhaps been lost). Table 4 shows that JIB's returns on risky assets plunged in the late
1990s; by 1995 they were already lower than the interest rates received by the mid -sized
commercial banks. Although these were second -tier banks, with relatively anemic returns
on assets, they were generating substantially greater gross earnings in the mid-1990s. In its
worst 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 still
held more deposits for its size than most Jordanian commercial banks. Perhaps competition
with the Islamic International Arab Bank would oblige JIB to contract further, write off any
non-performing assets, and regain profitability. A number of other Islamic banks have faced
similar problems.
For years, for instance, Faisal Islamic Bank of Egypt (FIBE) has stagnated, losing
market 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 Bank
of Egypt for importing commodities; then, when Egypt's foreign exchange situation
improved, 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 cost
FIBE some 20% of its balance sheet. Most the funds were eventually recovered, and in
1999, for the first time in almost a decade, FIBE claimed a small profit (0.3% of its total
assets). 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" to
depositors, much less to shareholders of the bank.
The problem of generating revenue may be political as well as technical. It is too
early to say whether the Turkey's five islamic finance houses are falling into a similar trap of
insufficient earnings to finance their expanding deposit bases. Since the Turkish military
 Clement M. Henry, Islamic Financial Movements, page 16

obliged Prime Minister Erbaken to resign and outlawed his (Islamist) Welfare Party the
Islamic banks have continued to grow at a slightly more rapid rate than Turkey's other
commercial banks. In 1999 they increased their share of deposits to 3.8% but their
collective return on assets diminished from 1.5 to 0.9%. (Central Bank of the Republic of
Turkey, Quarterly Bulletin, various issues). These average returns, however, although
roughly comparable to those of Turkey's big public sector banks, fall far short of the private
sector bank averages of 3.5 to 4.5% (Banks Association of Turkey, 2000: I-58 - adjusting
from BAT's returns on average assets).
Further research might examine the locations in the provinces, such as Konya, that
attract branches of the special finance houses. How do they correlate with the implantation
of Islamist parties? Do the finance houses track islamist neighborhoods? How can these
finance houses move from trade financing to more profitable ways of raising revenue? Might
they develop profitable long-term relationships - mudaraba and musharika - with Islamically
committed 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. In
fact Islamic banking requires the liberalized climate advocated by international financial
institutions - the so-called Washington Consensus - more than conventional commercial
banks. In order to generate better earnings, the Islamic banks need to engage in more
equity-like financing that requires clear standards of accountability and transparency of the
sorts advocated by the IMF and the World Bank. Since they will need to engage in more
equity-like financing than conventional banks, they stand to benefit more from financial
structural 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 principal
opposition to the incumbent regime is Islamist - even in Saudi Arabia where the dynasty
poses as a purified Islamic regime. To the extent, then, that Islamic banks are confounded
with political Islamism, they will be better off in a more liberal political climate. Most Islamic
financial institutions deny any political associations - just as conventional bankers also try to
appear to be above any "politics." But just as state bankers in many state-owned banking
systems manage patronage machines for those in power, so Islamic bankers may find it
difficult to avoid political associations. In Kuwait the KFH enjoys close ties with certain
government ministries and pro-Islamist deputies in parliament. In Egypt the state acts as if
autonomous Islamic banks must be contained - by blocking their expansion and trying to
channel their market into state-controlled banks. It is reasonable to expect that Islamic
banks will be better off in the relatively more liberal political climates where regime and
Islamist opposition have learned to coexist than in the MENA's more repressive settings.
By these standards the most favorable settings for Islamic banking in the Arab world
are probably Bahrain, Jordan, Kuwait, Turkey, Lebanon, and Morocco. Bahrain is favored
by minimal banking restrictions other than the necessary ones of an experienced regulatory
authority, and it is also undergoing significant political reform. Morocco, which has no
 Clement M. Henry, Islamic Financial Movements, page 17

Islamic banking, might offer the most promising field, after Jordan, for these institutions to
develop. 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 political
Islamists (unless, perhaps, with Algeria's tamed ones displayed in parliament).
Only in the politically more permissive climates might Islamic banks directly develop
ties with political Islamists. Whether or not they do so is an empirical question worthy of
future research in Jordan, Turkey, and possibly the Sudan (where Turabi's political Islamists
coexist with the military, and Turabi himself used to be associated with the Faisal Islamic
Bank of the Sudan). In theory the political movement might help monitor the uses to which
Islamic finance is put and extend the ability of the banks to engage in profitable musharika
and mudaraba operations. By reducing the banks' monitoring costs, they would render
them more profitable. Bankers and politicians would share an interest in the success of the
Islamic financial experiment, and the politicians, enjoying financial support, might strengthen
business interests in the political movement and further moderate opposition to the
incumbent regime. This grounds-up approach suggests a gradual increase in the power of
political 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 the
opposition by bringing it into the moneyed establishment. But it runs against the grain of
recent political development in the MENA. In the 1990s the political trend has been one of
deliberalization and reinforced authoritarianism, especially in Egypt and Tunisia. Politics
remain 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 with
governments, even when they repress political Islamists. In reality there may be few affinities
between the timid Islamic business and banking interests, on the one hand, and radical
Islamist opposition politicians, on the other. Political Islamists tend to be more concerned
with culture than with economics, and opinion seems divided on Islamic banking. When
founded in 1989, the Algerian Front Islamique du Salut (FIS) advocated market reforms in
its party program -- including aligning the dinar at international market rates as the IMF was
insisting at that time -- and Islamic banking. But the FIS may be an exception. Many
political Islamist movements view structural adjustment to be yet another imperialist plot to
pollute their countries with more western businesses and consumption patterns. They are
usually ready to join in populist protests against any painful reforms. The mainstream
exponents of the Islamic finance movement, on the other hand, urge structural adjustment,
open and transparent markets, and accountable (though not necessarily democratic or even
liberal) government.
By making alliances with economic reformers within the government - for most
MENA states are divided between the globalizers and their antithesis, moralizing elements
within the government that reject structural adjustment for various reasons - the Islamic
banks can gradually gain market share. Protected by their governments, they can offer
modest "profits" to their depositors and lure more of them away from non-interest bearing
accounts in conventional banks. The financial returns of these Islamic banks can be
expected to remain weak as long major structural adjustment does not occur, because they
are 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 from
conventional banks that open Islamic windows to prevent the hemorrhaging of their non-
 Clement M. Henry, Islamic Financial Movements, page 18

interest bearing deposits. But then the conventional banks, too, may acquire a greater
interest 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 for
further engagements with international financial institutions and the Washington Consensus.
Even where, as in Algeria, their market share is miniscule, their approval can contribute to
the (sorely deficient) legitimacy of a government embarked on structural reforms. However,
the public sector banks of countries like Egypt and Tunisia may oppose any globalizing
alliance that takes deposits away from their weak balance sheets and endangers their state
patronage machines.
In the coming five years Saudi Arabia is likely to be the major battleground for
Islamic finance. Substantial non-interest bearing deposits seem ready for redeployment into
Islamic financial markets. Were Al-Baraka, the principal owner of JIB, to be allowed entry
into the Saudi market, it would grab market share from ARABIC as well as the National
Commerce Bank and SAMBA, to mention Saudi Arabia's two largest banks, both of which
have set up Islamic windows. Some ulama and Islamic bankers argue that these windows
cannot really work in accordance with the shariah because their funds cannot be separated
from the others based on riba. In Jordan the Arab Bank was required to build up an entirely
new bank for its Islamic operations. Were such a ruling to take effect in Saudi Arabia, there
could be a major shake-up in the commercial banking system. An influx of Islamic banking
might then tip the scales within the government for those in favor of accelerating economic
reform. Paradoxically, however, the risk of rapid economic change in Saudi Arabia is that
its principal beneficiaries would be members of the royal family like Prince Walid al-Talal
and other less professional uncles and cousins, Saudi equivalents of the nomenklatura in
single -party regimes.
The potential political fallout from Islamic banking differs widely from state to state in the
MENA. The grounds-up view of synergies between political and financial Islam seems less
likely today, however, in this era of deliberalization (except in the smaller GCC states), than
the top-down approach. Whether further structural adjustment will lead to greater political
liberalization in the long run is yet to be seen, but so far, in the MENA at least, neither
process has been linear and uni-directional. Meanwhile Islamic finance, despite its small
shares of the market to date, may incrementally acquire greater shares in many MENA
markets. Self-consciously Islamic financiers seem bound to prosper, irrespective of the
regime's treatment of political Islamists.
Conclusion
In conclusion we have identified self-consciously Islamist bourgeoisies and tried to
discover the conditions under which they best thrive. Distinctive financial practices seem to
be 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 in
the past to most other forms of private capital, whether local or foreign. Will these very
late-late comers be more susceptible to a "third" way of Islamic finance than the MENA's
early adjusters? We have seen that Islamic finance is perfectly compatible with the various
economic adjustment measures, notably financial reform, that international financial
institutions insist upon. Indeed, the Islamic banks have more of an interest in transparency
and 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
 Clement M. Henry, Islamic Financial Movements, page 19

finance as a vehicle for legitimating these reforms. The fact that the Islamic Salvation Front
(FIS) was ready tacitly to endorse Algeria's structural adjustment efforts of 1989-1991
suggests 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 a
Saudi investment venture that may benefit from new legislation permitting a private banking
sector. 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 allowing
Islamic finance more space and influence, as the pressures build upon their respective
governments to privatize their public sector banks.
To return to Ernest Gellner, some of his later work belied his earlier enthusiasm for
puritan Islam. In his Conditions of Liberty (1992) he explicitly conludes that Islam is too
ideologically monolithic, like the world of Stalinism, to support any meaningful civil society.
This paper, building on Gellner's earlier work, has tried to show that Islamist puritans in
bankers' suits may indeed be building civil societies in the form of Islamist businesses.
Gellner's earlier essays suggesting an Islamic puritan ethic are indeed seminal for the
understanding of contemporary Islam and politics, as it points to the economic foundations
of Islamist civil societies. Islamic finance offers the structure for articulating the new work
ethic.

References

Fuad Al-Omar and Mohammed Abdel- Haq, Islamic Banking: Theory, Practice, and
Challenges, London: Zed Books, 1996.
Nancy Neiman Auerbach, States, Banks, and Markets: Mexico's Path 6to Financial
Liebralizaitoni n Comparative Perspective, Boulder CO: Westview, 2001.
Luc Barbulesco, L'économie islamique dans ses rapports avec l'économie globale, D
Working Paper 89-1, Les Cahiers du C.E.R.P., Département de Droit, Université de
Droit d'Economie et de Gestion, Centre d'Etudes de Recherches et de Publications,
Tunis, 1989.
Michel Galloux, "The State's 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.
 Clement M. Henry, Islamic Financial Movements, page 20

Saudi American Bank (SAMBA), Saudi Arabia - Investor's 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
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Max Weber, Economy and Society [1922], edited by Guenther Roth and Claus Wittich, 2
volumes, University of California Press, 1978.
 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 1998

Notes: Iraq and Morocco, very slightly poorer than Syria, were omitted because they clustered beside
Syria, without any Islamic banking. Algeria, Lebanon, and Tunisia also cluster together with
minuscule Islamic bank market shares of deposits.
 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 IRQLBY
SYR
0.0

-.1
0 20 40 60 80 100 120

Govt Ownership (>20%)

Note: Government Ownership is the percentage of total assets of the

commercial banking system held by banks owned at least 20% by the
government.
 Figure 3
Islamic share of commercial bank deposits by a country's degree of economic openness

.3 SDN

.2 QAT
KWT

SAU
BHR JOR
.1 ARE EGY YEM
Islamic Bank Deposits

TUR
MYS
TUN LBNDZA
MAR
OMN 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

 Figure 4
Islamic share of commercial bank deposits by Contract-Intensive Money

.3 SDN

.2 QAT
KWT

SAU
JOR BHR
.1 YEM EGY ARE
Islamic 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

Table 1: Evolution of Islamic banks' share of commercial bank deposits by country, 1980-1998

Year 1980 1986 1989 1995 1996 1997 1998

first established
Algeria 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 Misr's Islamic branches' deposits 8.1%
Iran 100.0% 100.0% 100.0% 100.0% 100.0%
Iraq no Islamic banks
Jordan (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 banks
Morocco no Islamic banks
Qatar 1982 10.4% (missing) 17.8% 18.1%
Saudi 1988 11.3% 11.1% 11.5%
Arabia
Sudan 7.0% 17.0% 19.4% 27.9%
Syria no Islamic banks
Tunisia 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,
author's data set.
Table 2: Interest rates in Kuwait and Returns on Islamic Investment Accounts, 1996-1997

Central Bank of Kuwait, Quarterly Statistical Bulletin - http://www.cbk.gov.kw/publc.htm

(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 5.1

Kuwait 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
Table 3: The Financial Performances of the KFH and the NBK
1996 1997 1998 1999 1996 1997 1998 1999
Kuwait Finance House National Bank of Kuwait
Total Assets (KD mm) 1425 1581 1634 1748 3918 4118 3835 3797
capital 110.3 128.4 165.6 189.8 352 368.6 381.3 397
Customer deposits 1130 1185 1235 1318 2240 2434 2360 2287
Due to banks 1154 1137.3 919 931
Provisions for risky assets 82.59 94.03 90.9 87.3
Cash in banks 97.9 93.2 520 503 648 557
Receivables (murabaha) 880.4 952.2 1529 1609.4 1344.5 1292
Leased assets 22.8 85.4 Treasury bonds 497 577 487.3 809
Govt debt bonds 224.6 176.4 442 376.6 355.3 310
Investments 150.3 221.1 240 302.1 236.1 378

Earnings 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 15.03
Deferred revenue 120.2 139.4
Net income 34.36 36.54 41 43.8 68 73.47 80 93
Cost of Funds 47.1 52.2 196.9 181.7 149.8
Depreciation 3.61 3.86 3.713 4.053 4.295
Provisions expense 7.55 13.72 12.95 0.513 2.174
Administrative expenses 16.075 15.506 42.587 46.391 44.256
Dividends: cash 11.9 16.18 62 55 66 76
bonus shares 2.86 3.03 7
Spreads 61.6 70 97.75 101.1 107.2
 Kuwait Finance 1996 1997 1998 1999 National Bank of 1996 1997 1998 1999
House Kuwait
Spreads/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%

Table 4: Jordan Islamic Bank for Finance and Investment (1980-1999)
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

JIB 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 Bank
Earnings 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 Bank
Gross 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.
 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 Bank
Sources: Al-Omar and Abdel-Haq 1996, Annual Reports of banks.