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This figure depicts the striking development of Islamic investment funds as a share of Malaysian investment funds, with rapidly rising Net Asset Values (NAV), standing close to 25 percent in 2004. The importance of Islamic banking to the overall economy is increasing.

Background: The Established and the Upcoming

Currently, there is a concerted effort, globally, to establish Islamic financial centres. From Malaysia and Hong Kong to London , this effort is gathering pace as we speak. Lets look at some of the key players in this race.

Described by PricewaterhouseCoopers (PwC) as an “Islamic finance powerhouse”, with assets of $31 billion and insurance (takaful) market of $2 billion, Malaysia is at the forefront of development and innovation in the industry. The country has a strong history of supporting the development of Islamic banking, with the earliest institution being established in 1969 to facilitate the Shariah compliant investments for Muslims intending to perform Hajj. This rich history of being a pioneer in Islamic banking was rewarded recently with strong interest in the domestic market by international Islamic finance players, namely: HSBC, Qatar Islamic Bank and Kuwait Finance House.

During the 1970s oil price boom, many countries in the Middle East vowed to make the dessert bloom. This lofty aim was unsurprisingly, not achieved. However, more recently, Dubai – the financial powerhouse of the Middle East – is aiming for another kind of blooming: the biggest and fastest redevelopment in the region, with some of the tallest and most extravagant buildings being erected with remarkable regularity. It can be stated that there is something similar happening in the Islamic finance space. Almost from nowhere, Dubai has muscled its way into Islamic banking, competing with the established centre: Malaysia . This is demonstrated by the $3.5 billion, Dubai Ports sukuk.  

Witnessing its smaller rivals in Asia and Middle East embrace Islamic banking, London has also realised the potential. With New York ’s lukewarm response to the developments in this industry, London realises that this opportunity can cement its position as the leading global financial centre. Moreover, with strong support from the British government, many analysts contend that London is the sleeping giant of Islamic banking.

Can the recent success of Islamic finance be attributed to the development of these regional centres? Alternatively, can this performance be explained by other factors, namely: trade liberalisation; high oil prices; and links that the Muslim world has established with leading practitioners around the world?

The Clusters of Islamic Banking

In his analysis of clusters, Porter makes many important contributions, such as: clusters can expand into different regions and states. This is particularly relevant for the Islamic banking industry, where we can argue that the growth has been fuelled by very productive relationships that Islamic banks have formed with their counterparts in Malaysia and the United Kingdom . Indeed, one of the key variables in the success of clusters is competition. In addition to this competition, there is a desire to work together for the benefit of the industry, which can be confirmed in Malaysia by first the creation of Association of Islamic Banking Institutions Malaysia (AIBIM) and secondly, by the growth in AIBIM's membership.

What is interesting here is that the traditional organisation of the value chain is being questioned. That is, traditionally it was argued that access to inputs and scales of organisations were key determinants of successful businesses. This point is clearly articulated by the Organisation for Economic Co-operation and Development (OECD, 2007), which states “the pace and scale of today’s globalisation is without precedent and is associated with the rapid emergence of global value chains as production processes become increasingly fragmented geographically.” On the contrary, Porter returns with the contention that successful businesses need to focus on competition, which will increase productivity. Porter does add one caveat to his argument, admitting that the quality of the geographical business environment was also important giving the example that companies could not compete on complex service industries if they did not have educated workforce. Therefore, it is questionable how two respected authorities in this field can, find such different conclusions? This is an interesting area to explore.   

Although it is convenient to separate the opinions made by OECD and Porter into two distinct groups, it is important to note that there areas of grey. For example, Porter (like OECD) recognises that access to inputs is significant and goes on to say clusters ensure that companies can gain access to the right inputs at a productive level. In the case of the Islamic banking industry, this point is clearly shown by the access to qualified Islamic bankers. In order to train bankers in Islamic finance, some key qualifications have been launched, with Islamic Finance Qualification (IFQ), offered by the SII and CIMA Islamic Finance Certificate, leading the way. The development of the MBA Islamic Finance programme by the renowned CASS Business School in Dubai and London, is a testament to this focus of cluster theory.

If the cluster is mature, then there can be a productive supplier base. In the case of Islamic banking, the supply base (inputs) include: qualified Islamic bankers; experienced Islamic scholars; and trained Islamic lawyers and accountants. This will ensure that organisations can source locally and as a result lower their transaction costs. This in turn makes the Islamic banks more competitive in the market place, particularly with their conventional counterparts.

On the other hand, it could be argued that companies can achieve these advantages by establishing formal alliances. For example, an Islamic bank acquiring a London based law firm to provide legal insight (a form of vertical integration). However, this will entail bargaining risk and potentially introduce greater inflexibility. Therefore, Porter (1990) openly rejects vertical integration labeling it “inefficient, ineffective, and inflexible”. The opposite view is provided by OECD (2007): “ various stages are optimally located [i.e. vertical integration] across different sites as firms find it advantageous to source more of their inputs globally.

What is the OECD’s argument and how does it relate to the Islamic banking industry? The main point revolves around greater choice between domestic and international supplier, hence more competition. This is supported by the below table, which shows the level of poverty among Muslims in Thailand. The level of poverty in these provinces is excessive, with the pattern being repeated in many countries around the world, with the potential of having significant impact on the growth of Islamic banking, due to the challenges of attracting local deposits. Indeed, this is an important area, which is touched on more thoroughly on research paper: Sukuk your dreams, at Islamicbanker.com.