With Iran now closer than ever to an agreement with the West over its nuclear energy program, local financial institutions are poised to regain access to international markets but Iranian banks face serious challenges in mobilizing their Islamic finance potentials, a report says.
Iran has been one of the pioneers of Islamic finance since 1983 after the government passed the Usury-Free Banking Act, forcing local banks to rebuild their business around Sharia-compliant products. The Iranian banking industry remains completely regulated by Sharia and is by far the world’s largest center of Islamic banking, The Diplomat, an international current-affairs magazine for the Asia-Pacific region, reported this week.
However, there are differences between Iranian banking system and the system in other Muslim nations like Saudi Arabia and Qatar, according to the report.
“[Should an agreement with the West really happen] Iran will still remain segregated, because its concept of Islamic finance is not exactly similar to the concept of Islamic finance in other Muslim countries,” the magazine quoted Monzer Kahf, a Sharia scholar and professor of Islamic finance and economics at the Qatar Faculty of Islamic Studies, as saying.
Islamic finance forbids the use of a predetermined fixed interest rate, also known as riba or usury, in banking and financial transactions, as well as investing in businesses that provide goods or services considered contrary to its principles. Financial interests are not banned altogether; they are accepted as long as they represent a ratio of the profit generated by the use of capital. Usury-free banking thus translates into contracts like mudaraba, which literally identifies a profit-sharing agreement between the bank and its clients, either in the form of deposits or loans.
Over the last 20 years, the development of the Islamic finance industry has accelerated. Global Islamic banking assets stood at roughly $1,560 billion by the end of 2014, according to figures from the Islamic Financial Service Board.
At the same time, outstanding sukuks, or Islamic bonds, grew by an annual 20.7 percent between 2008 and 2013, amounting to $294.7 billion at the end of September 2014, IFSB figures show. Both Islamic banking and bond assets are expected to continue growing at double-digit rates in the coming years, as estimated by international observers such as consultancy firm Deloitte and credit rating agency Moody’s.
Iranian Finance
Iran, the only Muslim country besides Sudan where the entire financial industry is obliged to be consistent with the principles of Sharia law, accounts for more than 40 percent of the world’s total Islamic banking assets.
Trailing far behind is Saudi Arabia with 18.5 percent, Malaysia with 9.56 percent, and the UAE with 7.36 percent. However, years of sanctions against the Iranian economy have prevented the country’s bonds from reaching the international markets, leaving the leadership of the global sukuk market to Saudi Arabia, and above all, Malaysia.
However, the report said, things may be approaching a turning point as the Islamic Republic and the P5+1 (China, France, Russia, the UK, the US plus Germany) appear closer than ever to a deal over Iran’s nuclear development program. A deal would trigger a removal of western sanctions and reinstate Iran as a member of the global financial community.
“This Iranian government led by Hassan Rohuani is very keen to integrate the country into the global economy,” Ishrat Hussain, former governor of the Central Bank of Pakistan said.
“They have to catch up with the rest of the world. Now that the sanctions may be over, the government and the private sector have to do a lot to rebuild the economy.”
Challenging Way
Years of sanctions and a different approach to Islamic finance have left Iran at the margins of the growing global Islamic finance industry, the report noted.
Even the fact that the country may be close to staging a financial comeback went largely unnoticed at the last Islamic Financial Service Board summit, one of the most important events on the annual calendar of the Islamic finance industry, held in Almaty, Kazakhstan, in May.
Saudi Arabia, Malaysia and the UAE shared the spotlight as the industry’s trendsetters while Indonesia and Turkey were repeatedly pointed out as its next big thing, although Sharia-compliant assets remain just a fraction of total assets in both countries. Only a handful of delegates represented Iran.
“Unfortunately, the Iranian banking system has so far failed to maintain a constructive cooperation with pioneer countries in the field of Islamic banking,” Farhad Nili, head of the Monetary and Banking Research Institute within the Central Bank of Iran, wrote in a 2014 research report. “Hence the international community knows little about the theoretical foundations and practice of riba-free banking in Iran.”
According to the report, other Iranian officials tend to downplay the existing differences between Iran and other major Islamic finance centers and focus on the financial appeal of Iranian products instead.
“It’s like buying a smartphone, there is no Shia or Sunni smartphone, it’s just the same,” Mohammad Fetanat, chairman of Iranian market regulator Security and Exchange Organization, told The Diplomat on the sidelines of the IFSB summit.
“In terms of profits, Iran is one of the [most] profitable countries in the world. Midterm yields on bonds and deposits range between 20 percent and 30 percent in local currency, and many of these returns are adjusted to inflation and foreign exchange variations.”
Iran and the P5+1 have time until June 30 to follow up on the framework agreement they announced on April 2. Iranian financial authorities and institutions are already gearing up to stage their comeback in the international financial community. The SEO itself is working at a conference—to be held in Tehran in September—specifically aimed at attracting foreign investors into the Iranian capital market.
