CHAPTER 1
The Political Economy of Islamic Banking and Finance in the Gulf Cooperation Council Countries
Ashraf Mishrif
Introduction
Perhaps the most challenging question in Islamic finance is whether the current phenomenal growth in the Islamic banking and finance industry is sustainable in the medium and long-term and, if so, how the sustainability of growth in this industry impacts on the political economy of the member states of the Gulf Cooperation Council (GCC), more specifically on their economic diversification and integration projects as well as their trade and investment strategies within the region and with the rest of the world. Though this issue is hard to explore from the perspective of policy, it is evident that industry debates on Islamic finance are no longer based exclusively on religious grounds. Rather, they have latterly concentrated on technological innovation and new banking products to the extent that Islamic banking and finance now competes on an almost equal footing with conventional banking in the global financial system.
The phenomenal growth in Islamic finance has led some scholars to argue that this industry is entering its renaissance period by adapting and changing to meet the needs of modern finance in a way that has gained the attention of large global financial institutions such as Citi Group, HSBC and Barclays Bank. Financial data shows that the Islamic banking and finance industry has developed slowly but surely since the mid-1970s until reaching unprecedented levels, with global Islamic banking assets estimated at US$826 billion in 2010 and expected to reach US$1.8 trillion in 2013. The World Islamic Banking Competitiveness Report 2011-2012 confirms the prominent position of GCC as a global hub for Islamic finance, with the GCC countries collectively accounting for a higher percentage of Shariah-compliant global financial assets than any other region in the world. In 2010, the GCC Islamic banking assets amounted to US$127 billion, almost five times higher than the entire Middle East and North Africa (US$25 billion) and more than three times the share of Malaysia (US$38 billion), the world's leading nation in this industry (Ernst & Young, 2012: 3-5).
To examine the sustainability of the growth of GCC Islamic finance industry and how it impacts on the political economy of the region, this chapter looks at ways in which Islamic banking and finance could enhance the internal markets of the GCC member states, strengthen their financial and economic power and integrate them with the global economy. It begins by focusing on the relationship between the evolution of modern Islamic banking and finance, which originated in the GCC with the creation of the Dubai Islamic Bank and the Islamic Development Bank in 1975, and on the accumulation of wealth resulting from rising oil prices since the early 1970s. Also, it explains the extent to which sustainable growth in the Islamic banking and finance industry can facilitate economic diversification and economic integration among the six member states of the GCC. This is analysed in terms of both the political will and commitment of the GCC governments to boosting Islamic finance, as well as policy measures aiming at economic and financial liberalisation and accumulated wealth through Islamic finance and sovereign wealth funds. It ends by arguing that the increasing size of this industry necessitates a higher degree of harmonisation of financial principles, policies and regulations, which could serve as bases, if not prerequisites, for the creation and success of the GCC customs and monetary unions.
2. The Evolution of Islamic Banking and Finance in the GCC
Although the practice of Islamic finance is well-known to Muslim populations over the past fourteen centuries, modern Islamic banking originated in the Gulf region with the creation of the non-governmental Dubai Islamic Bank and the intergovernmental Islamic Development Bank (based in Jeddah, Saudi Arabia) in 1975. The evolution of this industry has been driven by the rise of pan-Islamism and, most recently, of political Islam across the Muslim world and by the accumulation of wealth in the Gulf region since the early 1970s. Some scholars believe that the roots of this development go back to the 1960s, particularly to the reign of King Faisal (1964-1975), when Saudi Arabia used pan-Islamism as a means to expand its political and economic influence across the Arab and Muslim worlds. The doctrine of Islamic solidarity initiated by King Faisal was, in fact, instrumental in combating President Nasser's pan-Arabism and curbing Egypt's influence in the Arab and developing countries, particularly after Egypt's defeat in the 1967 war, as well as making it possible for the Kingdom to position itself in the leadership in the pan-Islamic movement, which included non-Arab Muslim countries such as Pakistan, Turkey and Iran (Mortimer, 1982: 217). The politico-religious role of Saudi Arabia was further strengthened by the creation of the Organisation of Islamic Conference in 1970. Since then, this organisation has served as a political forum through which the Saudis have been able to exert political influence on other member states through economic and financial aid.
In the aftermath of the oil crisis of the early 1970s, the political and financial power of the Arab Gulf states increased significantly. Historically, the quadrupling of oil prices between October and December of 1973 underscored the ability of these countries to create a linkage between the price of oil and its availability in international markets. Warde attributes this to the shift in the balance of power between the international oil companies and the governments of the oil-producing countries in favour of the latter, which were able to obtain better terms, have greater control over oil policy, set higher prices, secure greater shares of receipts and gradually nationalise the oil companies (Warde, 2010: 95). He also traces the petrodollar windfall in the Arab oil-exporting countries to the uninterrupted global economic growth and strong oil demands during the 1970s and again in the 2000s. The subsequent accumulation of wealth in these countries has resulted in the expansion of their financial sectors in general and the evolution of Islamic finance in particular, with a large number of Islamic financial institutions created in the Gulf region, including the Kuwait Finance House (1977), the Bahrain Islamic Bank (1978), the Islamic Investment Company of the Gulf in Sharjah (1978) and the Bahrain Islamic Investment Bank in Manama (1980). Moreover, Islamic finance has rapidly expanded beyond the Gulf as Egypt created the Faisal Islamic Bank of Egypt (1977), Sudan established the Islamic Bank of Sudan (1977) and Jordan founded the Jordan Islamic Bank for Finance and Investment (1978). In 1983, Iran and Sudan transformed their entire banking and financial systems into Islamic finance, which is based on Shariah Law. Other non-Arab Muslim countries such as Malaysia and Indonesia promoted Islamic finance through legislation, tax breaks and indirect subsidies as means of fostering the role of their Muslin populations in the economic development. In Europe, the UK government has promoted London as a centre for Islamic finance by creating the Islamic Bank of Britain in 2000 and allowing a number of conventional banks such as HSBC and Barclays to operate Shariah-compliant products and services to meet the demands of its growing Muslim population and to facilitate commercial transactions between the UK and its Muslim trading partners, particularly in the Gulf region.
The geographical distribution of the Shariah-compliant banking assets has been significantly widespread in the Gulf region. Recent estimations show that this type of banking assets represents a significant portion of the total banking assets of the GCC countries, with that of Saudi Arabia accounting for 35 per cent of total banking assets, estimated at US$377 billion in 2010. In the same year, the share of Shariah-compliant assets in Kuwait, Bahrain, Qatar, and United Arab Emirates stood at 31 per cent of total banking assets (US$155 billion), 27 per cent (US$46 billion), 22 per cent (US$156 billion) and 17 per cent (US$438 billion), respectively. Oman did not implement Shariah-compliant assets until May 2011, but its financial industry is catching up with the rest of its GCC counterparts. According to Ernst & Young (2012), the GCC Islamic banking market shares have been significantly higher than those of other major regional markets, such as Malaysia and Turkey whose share stood at only 17.3 per cent (US$505 billion) and 4.3 per cent (US$652 billion), respectively (Ernst & Young, 2012: 80).
A number of factors contributed to the growth of Islamic banking and finance in the GCC in the post global financial crisis of 2008-2009. The most notable feature of this evolution is the rapid transition of this industry from a localised to a globalised industry. As explained above, modern Islamic banking, which originated in Dubai (UAE) and Jeddah (Saudi Arabia) in the mid-1970s, is now in operation from as far as New York and London in the west to Hong Kong and Singapore in the east and to Cape Town in the south. Over the past five years strong economic growth in the GCC as well as in the emerging Asian markets has turned this region into a regional and global hub for Islamic finance. This has been accelerated by the rapid increase in the demographic structure and growing population in almost all GCC countries, which stood at 3.4 per cent per year in the decade to 2008 and is currently rising by an average rate of 2.6 per cent per year. The sharp increase in the GCC populations was from 29.63 million people in 2000 to 41.45 million in 2010 and is expected to reach 53.41 million by 2020; not only does this mean that the region requires considerable investment in infrastructure and services, including water, transport, housing, healthcare and education, but also a significant rise in the levels of consumption and consequently trade between the GCC and the rest of the world is occurring (Economist Intelligence unit, 2009: 4-5).
In the post global financial crisis, GCC countries experienced a favourable shift in their economic conditions due to high growth rates in gross domestic product (GDP), oil and gas exports, high oil prices and huge sovereign wealth. The International Monetary Fund (IMF) estimates the value of GCC economies at 2.2 per cent (US$1.56 trillion) of the world's total GDP, which was put at US$71.3 trillion in 2012. The sizeable expansion of the GCC economies has enabled the GCC to boast 35 per cent of global sovereign wealth funds or US$1.77 trillion of US$5.2 trillion as of the start of 2013 (Ali, 2013). Indeed, the earnings from the oil sector are responsible for the accumulation of this wealth; in turn, not only has this provided a cushion for the national and international business communities when dealing with the GCC markets, but they have also contributed to the availability of high levels of liquidity in the Islamic banking and finance industry. Such favourable economic conditions have led some scholars to argue that these conditions created excess demand from Muslims who do not have adequate access to Shariah-complaint financial services (DiVanna and Sreih, 2009: 122). There has also been a noticeable shift in the preference of many Muslim investors and customers to Islamic finance over conventional financial services as they enjoy greater value for money while combining their banking needs with self-re-affirmation of cultural and religious identity.
One could also argue that the Islamic banking and finance industry has benefited from geopolitical factors following the events of September 11 in the US in 2001. The tense political relations between the US and some Arab Gulf states, particularly Saudi Arabia, forced many Middle Eastern investors to retreat from the US and European markets and to invest their capital in home markets as well as shifting their investment to Asian markets with significant Muslim populations. In this context, the rise of political Islam in the Middle East has also enhanced the Islamic finance industry, with some Arab spring countries such as Egypt and Tunisia introducing legislation that allows for the issuance of Islamic sukuk and for the creation and operation of Islamic banks and, hence, increasing the flow of capital and financial transactions between these countries and the GCC. The abundance of wealth and liquidity in the Gulf region, the negative impact of the global financial crisis on conventional banking and the desire to invest in socially responsible investment have all given rise to moral investment, where Islamic banks base their operations on the principles of equality, fairness in transactions and a sense of a higher purpose to the community. The appreciation of these ethical values in Islamic finance may have encouraged many Muslim and non-Muslim consumers to seek Shariah-compliant products and services. The increase in consumer demand has been met with an increase in the supply side, with GCC governments providing vital support to this industry through incentives, institutionalisation, regulations and legal protection; all of these measures aim to enhance the quality and credibility of the Islamic finance industry.
As well as the quantifiable growth of this industry due to the emergence of a large number of market entrants supported by government and private shareholders, the quality of the Islamic banking and finance industry in the GCC has become more innovative and efficient than that of other leading countries, such as Sudan and Iran, whose entire banking system is based on Shariah-compliant assets. Wilson attributes the good performance of the GCC Islamic banking industry as compared to its Iranian counterpart based on its ability to provide a much more attractive range of services because of the need to compete with conventional banks in domestic markets (Wilson, 2009: 2). Not only are they less bureaucratic than Iranian competitors, but Wilson also stresses the capacity of the GCC countries to re-structure and modernise their Islamic banks, making them more competitive due to their access to sophisticated information and communication technology; meanwhile, their Iranian counterparts are struggling with long term economic sanctions imposed by the US and the EU. The existence of most of the ingredients for the evolution of the Islamic finance industry - the accumulation of wealth from oil and gas revenues, huge demographic and population growth, increasing demands of Shariah-compliant banking services and availability of a wide range of innovative Islamic financial products and services - has enabled GCC countries not only to build new Islamic financial centres as a means of stimulating economic development, but it has also allowed cities such as Dubai, Abu Dhabi, Manama, Jeddah and Doha to evolve as natural hubs for Islamic finance, both regionally and globally.
3. Institutionalising and Regulating Islamic Finance in the GCC
The growth of Islamic finance in the GCC underscores a strong relationship between the role of the state and institutions in regulating and supporting this industry. The role of the state in institutionalising Islamic banking has been noticeable in the supportive efforts, legislation and decrees issued by the GCC governments since the mid-1970s. The decree of the Emir of Dubai on 12 March 1975 authorizing the establishment of the Dubai Islamic Bank and the legislation of the Saudi government for the creation of the Islamic Development Bank serving as a development assistance agency for the Muslim world in the same year clearly demonstrated both the desire and capacity of the GCC states to build the institutional structure required for the development of this industry. Kuwait passed legislation to establish the Kuwait Finance House in 1977, while Bahrain and Qatar established Islamic banks in 1979 and 1982 respectively. Most recently, in May 2011 Sultan Qaboos bin Said authorised the establishment of Islamic banking in Oman; this was followed by the publication of the Islamic Finance Regulatory Framework in January 2013, which allows conventional and Islamic banks to market Shariah-compliant products and to govern Oman's Islamic financial sector (Oman Daily Observer, 2013). With the creation of Alizz Islamic Bank and Bank Nizwa and the Islamic Finance Regulatory Framework introduced in Oman, all six member states of the GCC now enjoy the institutional structure required for their Islamic banking and finance industry.
The role of the state in institutionalising Islamic finance in the GCC has manifested itself in the introduction of national regulatory frameworks that oversee and supervise all financial practices. The efficiency of the Malaysian Islamic financial regulatory system may have encouraged GCC countries such as the UAE to develop national councils to oversee their Islamic banks. Wilson outlines the advantages of the creation of a national Shariah council in overseeing the work of the Shariah boards of the Islamic banks and the amalgamation of fatwas, thus eliminating any possible confusion or uncertainty about the legality of some products (Wilson, 2009: 9). The need for regulation in the Islamic finance industry is vital for its growth and sustainability not only because the relationship between civil and religious law varies across national jurisdictions, but also because most legal and regulatory practices governing Islamic banks in the GCC differ from one country to another.
