• Muslim investors chose Islamic banking since they feared U.S. freeze

The 2001 September terror attacks in the United States have given rise to Islamic banks worldwide as Muslim investors kept their funds at home in&fear of any U.S. freeze decision, the International Monetary Fund (IMF) has said.

But a stronger positive impact on the mushrooming of Islamic banks was the sharp rise in oil prices, which coincided with the September 11 attacks,&the IMF said in a study on Islamic banks published on its website this week.

"Our results suggest that the September 11th attack on the United States had a positive impact on assets of Islamic banks, perhaps because Muslim&investors, who have traditionally invested in the West, were compelled to keep more money at home for fear of expropriation, for instance," the&Washington-based IMF said.

"However, because those attacks and oil price increases happened at about the same time, we regress them together to see if they have different&effects on the diffusion of Islamic banking....the result is that the significance of the coefficient on the 9/11 attacks vanishes once oil prices are&accounted for. This implies, contrary to conventional wisdom, that the 9/11 attacks did not affect the diffusion of Islamic banking... rather that it&coincides with rising oil prices, which are a major cause of the diffusion of Islamic banking."

The study said that while oil prices have a positive and statistically significant impact on the diffusion of Islamic banking, the effect is likely&to be asymmetric.

"We would not expect a large fall in oil prices to lead to a large decline in the diffusion of Islamic banking, though diffusion rates would&certainly decline. Unfortunately, the use of annual data over a relatively short period (1992-2006) prevents us from testing robustly for asymmetric&effects," the IMF said.

"As expected, terms of trade changes, especially the evolution of oil prices, have a statistically significant impact on the diffusion of Islamic&banks, which tends to increase when oil prices rise....this is to be expected: whether the extra income is treated as permanent or as a transitory&windfall, it will stimulate savings and demand for banking services ranging from mortgages to savings products."

According to the study, inflation has a negative effect on Islamic banking while higher trade largely benefits this banking system.

"Given that Islamic banks are involved in trade finance, this is expected.... interestingly, the impact of imports from the Middle East is larger than&the impact of exports to the Middle East. This may suggest that Middle Eastern exporters favour the use of Islamic banking more than Middle Eastern&importers."

The IMF noted that Islamic banking, which is concentrated in the Middle East and Malaysia, has in a few decades moved from a niche market into the&mainstream.

"Because Muslim populations are under-banked, and given the tremendous need for infrastructure projects like roads and housing across the Muslim&world, development of Islamic banking can spur growth in these regions and can be part of the solution to the slow development process," the study&said.

"We found that the probability for Islamic banking to develop in a given country rises with the share of the Muslim population, income per capita,&and whether the country is a net exporter of oil. Trading with the Middle East and economic stability also are conducive to diffusion of Islamic&banking..... proximity to Malaysia and Bahrain, the two Islamic financial centers, also matters..... we found that rising interest rates hinder the&diffusion of Islamic banking because they raise the opportunity cost for less devout individuals or non-Muslims to put their money with an Islamic&bank."

The study said it believes Islamic banking is a complement to conventional banks, not a substitute. It noted that devout Muslims want Islamic&banking products which conventional banks are not supplying.

"Having a well-functioning conventional banking system already in place, through sharing of common platform and human capital, helps spread Islamic&banking."