Sharia-Compliant Banking and Emerging Markets

Because many emerging markets have large Muslim populations (especially in the Middle East, North Africa, and South Asia), Islamic banking is a growing financial category that offers opportunities for shareholders and depositors. If you’re investing in banks in Muslim countries, you need to know how Islamic religious law, called sharia, affects how banks operate. In most of the world, banking is all about interest. Under sharia law, Muslims may not pay or receive interest, a practice known in Arabic as riba, so financial services operate a bit differently.

Financial services and practices may be significantly different from country to country depending on government regulations and the predominant denomination of Islam practiced.

Financing purchases

For a financing arrangement to be compliant with Muslim law, the institution providing the financing has to have a stake in the asset. A car lease is appropriate, because the person providing the lease has a stake in the value of the car. Two typical types of financing arrangements offered to borrowers are the installment sale (murabaha) and the redeemable lease (ijara). In the installment sale, the bank buys the asset and then resells it to the person who’ll use it but at a higher price that reflects the fact that the buyer has to pay for it over several years. With ijara, the person uses the asset in exchange for a predetermined number of months or years. At the end, he or she can pay cash to own it.

Larger transactions may be arranged as a joint venture (musharaka), where one partner puts up the money and the other puts up the expertise. This is a typical form of financing for real estate and equipment purchases in predominantly Muslim countries. The partner providing the financing is paid out of the transaction’s profits and doesn’t receive any money until the project generates cash.

Deposit accounts

On the savings side, Islamic banks offer accounts that share in the profits the bank makes from its financing activities. Instead of paying depositors money earned from interest on loans or bond holdings, an Islamic bank distributes its profits at a rate agreed to when the account is opened. If the bank doesn’t have profits, it doesn’t pay on these accounts; the depositor (that’s you, as an emerging-market investor) is expected to share in the risk of those receiving the financing. Although these accounts function much like interest-bearing savings accounts and certificates of deposit, the differences are critical to some customers, especially because not all customers qualify for deposit insurance.

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Source:http://www.dummies.com/how-to/content/shariacompliant-banking-and-emerging-markets.html