KUALA LUMPUR: The rise of Europe's nascent Islamic banking sector will be slowed as paralysed credit markets dampen demand for Sharia bonds and weak property prices hurt the industry, European Islamic Investment Bank said yesterday.

A slowing global economy would also weigh on the sector, the London-based lender said, reinforcing a growing view that Islamic finance - despite its strict lending rules - may prove to be more vulnerable to the global downturn than earlier thought.

European banks, along with U.S. lenders, have been badly hit by the global credit rout. European Union leaders vowed action on Thursday to underpin growth after world governments pledged $3.2 trillion to stabilise the financial sector.

Sharia banks would, however, be spared some of the fallout affecting conventional lenders as they are not exposed to subprime loans, European Islamic Investment Bank chief executive John Weguelin said.

"Islamic financial institutions should be no different from other institutions to the extent that they operate in the money markets and the money markets have been impacted - both Islamic and conventional - in the same way with the tightening of liquidity," Weguelin said.

"Clearly one of the areas that have been impacted is the sukuk market because of the credit crunch and the lack of demand within the sukuk market for those products," he said.

The industry's "concentrated exposure to limited asset classes particularly real estate" means it would not escape the global fallout unscathed, he said.

Islamic financing deals are backed by assets, commonly real estate and commodities, due to the Sharia requirement that transactions must involve real economic activity.

The $1 trillion Islamic finance sector has flourished in recent years, helped by huge reserves of Gulf oil earnings and growing demand for ethical investments.

Some industry experts argue that the industry's conservative lending principles have helped it avoid the complex and opaque lending structures that brought down the conventional banking system.

Weguelin said troubled financial markets presented opportunities for the Islamic industry.

"We think the valuations are going to make it very interesting in the coming months for people with cash to acquire assets at very attractive valuations," he said.

In Europe, demand for Islamic products is expected to be led by the UK, France and Germany due to the size of their Muslim populations, he said. About 20 per cent of Europe's population, including Turkey, are Muslims, he added.

"Islamic finance is starting to become mainstream in terms of the financial markets and therefore should become, over time, a viable alternative to conventional finance particularly the potential attraction of being able to tap into new pools of liquidity," Weguelin said.