Islamic finance rides the storm

A thriving financial sector sounds like an oxymoron these days. Even Australia's banks - among the most profitable in the world - kept a fifth of this week's interest rate cut to cushion their margins. But there is one sector that has tongues wagging in the hubs of commerce: Islamic finance.

While the Western world's financial system has been imploding, this small but rapidly growing share of world capital has weathered the storm.

Islamic finance takes its guidance from sharia.

The biggest markets are in the Middle East and Muslim countries, but global banks have opened sharia-compliant branches. Locally, the Muslim Community Co-operative is one of a few lenders offering the service.

Justice, partnership and opposition to excessive risk are the main principles guiding Islamic banks. Outright speculation and dealing with any party that has a balance sheet more than a third of which is debt are forbidden, as are investments deemed unethical by Islamic scholars, such as casinos.

But if these rules sound tough, the biggest difference is a ban on interest.

Charging interest is immoral because it does not take into account how changes in the value of the loan's security can affect the borrower, sharia says. Home owners who bought near the peak are now experiencing this harsh reality: interest gives banks a steady payment from the borrower, regardless of the property market's state.

However, profit is fine, and Islamic banks have devised ways to make money from lending. Instead of demanding interest, they buy the asset outright on behalf of the borrower. The borrower pays off the loan (the principle) and a fee for using the asset (rent, for example) until the amount is repaid and ownership transfers to the borrower. (More in BusinessDay)