The annual meeting of the Board of Governors of the Islamic Development Bank scheduled for June 2-4 in Jeddah is billed to be of extraordinary importance in the wake aggravating global financial crisis particularly in the US and the challenges and the opportunities it offers.

The Bank’s agenda also includes symposia to mull proposals to enhance capital markets co-operation among IDB member countries. Presentations will include such topics as (a) promoting global depositary receipts (GDRs) market in the GCC region (b) promoting Islamic Mutual Funds (c) re-directing GCC-based mutual funds to IDB member countries, and (d) capacity building needs for issuing sovereign ‘sukuks’. Although more than two-thirds of Islamic finance business currently originates in the Middle East, the region looks to international capital markets to finance some prestigious development projects. A 1.5 billion dollar sukuk issue from Dubai Ports World, arranged by London-based Barclays Capital last year, allocated 60 per cent of its bonds to western buyers. The trend of investing in faith-based funds got a major boost after 9/11 when many Muslims began bringing their money back home from the United States.

Since then, big banks such as Societe Generale, BNP Paribas, Deutsche Bank and Standard Chartered have all entered the Islamic banking business. Accounting firms like Ernst Young now offer Islamic financial services. The Islamic Bank of Britain is the UK’s first and only Sharia-compliant high street bank, regulated by the Financial Services Authority, and approved by the Sharia Supervisory Committee.

Now the British government is considering to raise funds by issuing Shariah-compliant bonds in the Middle East, which would be the first time that a western country would do so, but many British banks already provide Islamic financial services. There are at present some 23 conventional banks, including Lloyds and HSBC, offering Islamic products.

The most popular Islamic bond is sukuk. The global sukuk market grew by 75 per cent to reach $85 billion in the first half of 2007. The $24.5 billion raised in the first half alone nearly surpassed 2006 new issuance of $26.8 billion, according to the Islamic Finance Information Service. The potential of the commercial sukuk market was demonstrated in December by the launch of a $300 million convertible bond for Tamweel, the second largest mortgage lender in the United Arab Emirates. Tamweel said its bond issue, managed by Barclays Capital, was oversubscribed within hours.

The international Islamic bond market is divided into sovereign and corporate sukuk markets. These bonds of medium-term maturity have been issued internationally by sovereign and corporate entities. The Abu Dhabi Investment Authority is the largest sovereign fund with $875 billion dollar assets. The Islamic equity funds in the Gulf have swelled to $30 billion.

In 2001, the Bahrain Monetary Agency was among the first central banks to issue sukuks. And in 2004, the German State of Saxony-Anhalt became the first non-Muslim issuer to tap the global Islamic debt market, raising some 100 million euros via a sukuk issue in an effort to appeal to a broader range of investors.

Islamic finance has come of age during the last three decades and has gone global. A generation ago, an Islamic bank was just a simple investment house that instead of paying interest on deposits created dividends by buying and renting out property. Ten years ago it was simply unimaginable that a Muslim could buy a home in the United States or Singapore by applying Islamic methods. Today, he has more and better riba-free (halal) financial opportunities. The key centre in this industry is Malaysia.

Then, it is amazing to see western banks accepting the logic of Islamic finance because of profits it offers and choosing to play a leading role in a market where financing is required to comply with Islamic laws. Citibank’s Bahrain subsidiary was the first to go into the market in 1996.

The United States is the only other country that comes close to Britain, with around 20 Islamic banks, but their main focus remains on domestic retail operations instead of high finance. As the fallout from the US credit crisis continues to take its toll on conventional banking, considerable interest is shifting to the banking based on Shariah.

The volume of Islamic mortgage transactions in the US grew to approximately $250 million per annum in 2006 from less than $20 million per annum in 2000. Since Islamic instruments require deals to be based on tangible assets, they have provided some insulation from credit turbulence across the country. The operations are monitored and guided by a board of religious scholars affiliated with a bank.

The Islamic banking has gone from almost nothing to an industry with assets of hundreds of billions of dollars. Today, it is growing at 15 per cent rate a year and the western financial markets cannot afford to ignore it. Islamic bond, or sukuk, market is estimated to eventually reach $4 trillion according to Standard & Poor’s.

In 1973, seven Arab nations had joined together to form an Islamic bank on the pattern of World Bank to promote Islamic finance, banks and financial markets. Many Muslims who were not using banks for financial services because they opposed the concept of interest needed to be brought into the banking fold. So, the Islamic Development Bank was launched in 1975.

It is not clear whether Islamic banking took off from entrepreneurial drive of bankers or some governments’ efforts to obtain ‘halal’ funds or was it just revival of religious zeal. Most likely, all the three factors could have contributed to it. For instance, Pakistan banned interest-based banking in 1974 with a view to take much of government financing operations as well as private banking activities away from the western banks. Since then, a number of banks and financial institutions have come up which offer Sharia-compliant products.

The challenge Islamic finance faces is in applying the principles of traditional Islamic legal scholarship to modern financial services. Malaysian bankers have done an amazing job in this respect. They have come up with multiple innovations in the field of Islamic finance which are now applied in the global Islamic market. Perhaps the most important innovation to come out of Bank Negara Malaysia is sukuk.