Islamic mega-bank prays for support

LONDON (Reuters) - Islamic finance is about to get its first mega bank if Sheikh Saleh Kamel has his way.

The billionaire chairman of Bahrain-based Al Baraka Banking Group is head of an alliance hoping to launch a $10 billion Islamic bank before year-end. He will have his work cut out. Islamic banks may have avoided the worst of U.S. sub-prime dross, but Islamic banking has risks of its own.

Islamic finance has enjoyed a benign decade. It has been growing at a 20 percent-odd clip since the turn of the century, with assets of $600 billion at the end of 2008. Moreover, Islamic banks avoided the complex collateralized debt polluting most western banks, thanks to Shar'ia restrictions on riba (interest).

Those western banks have been struggling to repair their ravaged balance sheets, with governments often the only (unwilling) investor.

Al Baraka itself has held back from IPO plans that have been in the offing for several years. But Adnan Youseff told a regional TV station this week that Sheikh Kamel is "accelerating the finalization process."

But investors are taking a risk if they assume that Islamic finance is a whole lot safer than its discredited western counterpart. After all, most Gulf banks are heavily exposed to real estate. As Spanish and Irish banks have found to their cost, it is little consolation to avoid complex U.S. sub-prime debt if you are hammered by a local property bust.

More generally, Islamic banks have yet to test the central tenet of Islamic banking-that depositors are co-investors who share in the risks that they take on. In practice, like U.S. money-market funds, they strain every sinew to ensure they don't "break the buck", or give customers back less than they deposited.

But big real-estate write-downs could mean that banks do not have enough to repay deposits in full. That would test depositors' loyalty. And many Islamic banks, like their western counterparts, have lent long. Therefore, if depositors turn away from their local banks, they could face a liquidity squeeze just as acute as when wholesale markets closed to western banks in August 2007.

After all, depositors do have a choice. There is already a mega-bank offering Islamic finance. It's been in the Middle East for more than a century. It's global. And it's about as safe as banks come. It's called HSBC.

-- At the time of publication, Margaret Doyle did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund.