FAQ on Islamic Finance

1. What is the big fuss about anyway? Finance should look the same in whatever form-ultimately the objective is to earn money That is correct-although the Shariah prohibits interest, banks still get their way around it by artful structuring/'sale and buyback' etc. But still, the main prohibitions are respected-no explicit interest, no investment in banned sectors etc
2. Why has it become so important all of a sudden? Because the wealthy Middle East/African investors are there(many of them conservative Muslims) seeking Shariah Compliant investments. So like in any free market, supply follows demand
3. But why are banks so fascinated with this market? One because of the lesser(so far) competition. Two because in this world of capital starved banks, Islamic finance with its primarily asset backed nature(thus low Risk Weighted Assets requirements for banks) is very attractive. Three because this allows entry into previously untapped markets, and at good profit margins AND to depict themselves as good corporate citizens
4. Give some examples of Islamic finance:- Suppose you need a loan but are prohibited from paying interest. No problem. Just arrange with a bank to sell it a commodity X and buyback at X+Y(Y represents the 'profit'-effectively interest. Or else you want to earn interest on a deposit. Just deposit the funds with a bank, which will give you close to market rates voluntarily to preserve its own reputation.
5. But why are you so cynical? So many people cannot be so absurd at the same time:- Well, like socially responsible investing, Islamic Finance has certainly helped society. But it is an open question whether the investors are better off in this mode or not. Certainly, the noble objective of investors sharing risk is diluted with investments in microfinance, subordinated debt, embedded options etc.
6. If this is so attractive, there would be risks also:- Yes there are. The same structure may be approved by one Islamic scholar but another may issue a fatwa against it. The sale and buyback transactions prevalent here may lead to indirect tax consequences for banks and/or make them residents for direct tax purposes. Or like in the Dubai bonds case, some structures have been legally untested, and may hold unpleasant surprises for investors.