Islamic banks sheltered from storm, says Moody's

Islamic banking institutions are well-positioned to weather the global financial storm according to Moody's, a ratings agency.

Islamic banking institutions are well-positioned to weather the global financial storm, due to their reliance on religious principles that have given them a conservative investment strategy and prohibited them from investing in mortgage-backed securities, according to Moody's, a ratings agency. Islamic Banks, which prohibit the use of speculation and interest rates, are viewed by depositors as safer because they are less prone to the kind of complicated financial innovations that created the credit crunch.

"Paradoxically, Islamic banks' reputation has benefited from the current crisis... reflecting their conservative approach to business, a close proximity to their domestic and regional deposit franchises, their balanced and ordered appetite for growth and their focus on basics of banking as opposed to innovation, with emphasis on their domestic market first," Moody's said in a report. "All these factors, which used to be perceived as weaknesses before the credit crisis began, are now being used as shields against the potential damage of imported stress."

However, the banks weren't entirely immune to the global credit shortage, and the rapid growth they have enjoyed during recent years was likely to slow next year, the agency said. "2009 is likely to be a tough year for Islamic banks" the agency said, projecting their growth to slow to 10 or 15 per cent in the coming year, after enjoying 27 per cent growth last year and an estimated 20 to 30 per cent growth this year.

According to Moody's, Islamic banks face several challenges in the current environment, including a difficulty managing short-term credit needs and accessing long-term credit, along with their exposure to the property market. However, their "entrenchment" in the retail banking sector, with high customer loyalty and deposit stability, limited the probability of runs on the banks, the agency said. "Islamic banks do not operate in isolation. They are part of the local, regional and increasingly global economy. In this respect, although they are less sensitive to the monetary fluctuations of the West, they remain dependent on the real economic cycle," Moody's said.

"As the financial crisis gradually turns into a real economic downturn, asset quality will ultimately deteriorate and Islamic banks' high exposures to the property sector could turn out to become a curse rather than a blessing," the report said. "It is true that Islamic finance has been more resilient because of the ban on interest, which has resulted in Islamic financiers steering clear of toxic repackaged credit instruments; however, the Shariah-compliant financial model is not a panacea either." [e-mail]