FYI: What is Islamic finance and why is the government so keen to make Hong Kong a centre for it?

PUBLISHED : Sunday, 23 December, 2007, 12:00am
UPDATED : Sunday, 23 December, 2007, 12:00am

Chief executive Donald Tsang Yam-kuen's decision to turn part of his most recent policy address into a plea for Islamic investment came as a surprise to many. After all, Hong Kong attracts plenty of other kinds of wealth, and Muslims make up barely 1 per cent of the population. Besides, officials are already working to make the city a regional hub for everything from art to logistics - do they really need to add Islamic finance to the list?

The simple answer is that the amount of cash involved has grown too big for any self-respecting financial powerhouse to ignore it. By most estimates, the total value of Islamic funds under management worldwide reached about US$400 billion last year and growth is outpacing other segments of the industry.

The stellar performance has been fuelled largely by investors from the cash-rich oil-producing nations of the Middle East, which are benefiting from an extended spell of high fuel prices. Major institutions such as Citigroup and HSBC, and governments from Malaysia to the Maldives, are currently tripping over themselves to offer their money a home built on Islamic principles.

It's clear Hong Kong wants a piece of the action, but the city's financiers will need to get used to doing things differently. The primary characteristic of Islamic banking is that any form of riba, or interest, is prohibited. Unfortunately, interest happens to be one of the main ways banks make money.

Islamic institutions generally circumvent the restriction by applying surcharges to their services. For example, if someone wants to take out a loan to buy a house, an Islamic bank might purchase the property outright and sell it to the borrower at a marked-up price that can be paid in instalments. Similarly, interest on deposits can be replaced by dividends, profit-sharing arrangements or regular hibah, 'gifts' of cash. Critics argue these kinds of practices amount to interest in all but name.

The other major rule institutions have to contend with is a ban on investing or engaging in business with companies that trade in goods or services prohibited by Islam, such as alcohol, pork, pornography or gambling. Given the tangled structure of most corporations, making sure a company doesn't have its fingers in anything sinful is no simple task. Institutions with Islamic offerings usually have a board of religious scholars to ensure they adhere to these and other principles.

It may sound like a lot of work, but it can pay off. Islamic funds not only tap into a wealthy demographic but they also tend to outdo their peers. While the collapse of the US subprime mortgage market has handed many banks and funds one of their worst years in living memory, the Dow Jones Islamic Market Index, which tracks Islamic funds, has risen 13.5 per cent since January. Moral investing can apparently be good for the pocketbook and the soul.

It remains to be seen whether Tsang will burnish Hong Kong's Islamic finance credentials with moves to develop the Islamic bond market and a planned visit to the Middle East next year. The likes of the United Arab Emirates and Malaysia, which boasts Asia's largest Islamic banks and introduced tax incentives for Islamic institutions this year, make Hong Kong look like a late arrival to a party that's in full swing.