By Romen Bose

KUALA LUMpUR, Apr 20, 2010 (AFp) - Islamic finance has emerged relatively unscathed from the global economic crisis and Dubai's turmoil, but experts say the dramas have exposed the need for tighter regulations and higher standards.

The Sharia finance industry, which abides by religious laws that prohibit the payment and collection of interest, is worth an estimated 800-950 billion dollars and expanding rapidly in the Muslim world and in the West.

Moody's Investors Service said earlier this month that the sector has a market potential of 5.0 trillion dollars.

However, the global economic turmoil which felled some mainstream banking institutions, and Dubai's financial fallout late last year, has highlighted the need for the industry to shore up areas where it may be on shaky ground.

Dubai stunned financial markets last November when it said it might need to freeze debt payments by its largest conglomerate Dubai World. Last month it announced a debt restructuring plan with a 9.5 billion dollar funds injection.

"What happened in Dubai is affecting both the conventional market and the Islamic market because the players in the market totally forgot proper risk management," says Badlisyah Abdul Ghani, chief executive of CIMB Islamic, a pioneer Islamic bank in Malaysia.

"A lack of framework regulations are the single biggest threat to Islamic finance growth today," he told AFp at a recent conference on Sharia finance held in the Malaysian capital Kuala Lumpur.

In Islamic finance, the customer and the institution share the risk of any investment and also divide any profits between them.

"There's nothing wrong with the Sharia structure, it's the law of the land and the regulatory framework that needs to be sorted out to ensure an Islamic financial transaction can be done effectively," Badlisyah said.

Malaysia has the world's largest market in Islamic bonds, known as "sukuk", but it is facing rising competition from Singapore and European banking centres.

Badlisyah said Malaysia has got it right, with laws governing the types of Islamic products issued and a national Sharia council whose financial edicts are enforced throughout the industry.

However, Islamic financial advisers say most countries offering Sharia-compliant products have problems with basic elements like having enough scholars to form effective councils to guide financial dealings.

"There is fundamentally a shortage of trained Sharia scholars for the field and a means to properly integrate their views into law," says Abdulkader Thomas who runs SHApE, a US-based Sharia financial structuring consultancy.

Criticism has also emerged that some Islamic products on offer have strayed from their roots, and increasingly mimic conventional profit-driven financial instruments.

As well as the laws which ban interest, seen as a form of gambling, Islamic financial transactions must be backed by real assets -- not, for instance, the wobbly repackaged subprime mortgages which triggered the global meltdown.

Risks are shared between the bank and depositor so there is an incentive for institutions to ensure the deal is sound.

"It's going back to basics but it's very difficult," the International Monetary Fund's former executive director professor Abbas Mirakhor told AFp.

"The entire fiscal, monetary policy, regulatory system in Islamic countries with Islamic finance is pro-debt and anti-equity, so we have to change that, otherwise how are you going to have a system which is risk-sharing?"

The future direction of Islamic finance, says professor Habib Ahmed who teaches Islamic law and finance at pitain's Durham University, is still uncertain despite the lessons learned from the recent turmoil.

"The first challenge is to come out with products that reflect the spirit and form of Islamic finance and this is a challenge to financial institutions and governments to have the right laws and systems in place," he said.

"Only when this is done can we have confidence in these bankers on the supply side and educate investors on the demand side and provide them with truly Islamic financial products that will be of real benefit to all."

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