Dubai's debt crisis

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What's behind the fall of Dubai World? Some say Dubai's Islamic banks may have abandoned their principles for Western-style investing. The World's Aaron Schachter explains.

MARCO WERMAN: Around the Middle East, Islamic financiers stood by and watched as the Western financial system imploded last year. They thought that what's known as Sharia-compliant investing would keep their money safe. Then came word last week of the collapse of Dubai World. It revealed that some Islamic financing wasn't quite as safe as it was cracked up to be. The World's Aaron Schachter reports.

AARON SCHACHTER: Put simply, Sharia-compliant financing is any kind of monetary transaction in accordance with the laws of the Koran. The most basic of those laws forbids people to buy, sell or invest in products that are haram, forbidden like alcohol, gambling or pornography. But the biggest financial sin in Islam is usury, or charging interest. So Islamic financiers had to come up with something else. John Foster is former editor of Islamic Banking and Finance magazine.

JOHN FOSTER: And so, instead of just giving money to somebody, okay, to go away and then charging interest, what Islamic finance tries to do is, it tries to go into joint ventures with people. So the risk is shared between the person who is borrowing the money and the person who is providing the capital, and they both share in the profit. Today it's called private equity, or even venture capital.

SCHACHTER: To ensure that financial transactions or products are halal, the Muslim equivalent of kosher, financial institutions hire religious authorities to review and approve each product. One of those authorities is Sheikh Zaher Nsouli, with the Lebanese Islamic Bank in Beirut. Nsouli says sharing risk is intended keep financiers honest. He says Islamic finance isn't against making money, on the contrary. But it is against taking risk with someone else's money.

SHEIKH ZAHER NSOULI: You'll not invest in anything except if you know the business risk is good, it's healthy for the economy, it's [INDISCERNIBLE]. You're much more involved in the real economy.

SCHACHTER: Nsouli says Islamic banks have on average outperformed conventional ones because when people deposit money, they're buying shares of real projects that are Sharia-compliant. But Islamic financing as a whole isn't immune from Western troubles.

MOHAMMED SAID RAHMAN: If you put a chimpanzee behind a Rolls Royce, is Rolls Royce still a good car or is chimpanzee still a bad driver?

SCHACHTER: Mohammed Said Rahman is Chairman of the Institute of Halal Investing, based in Portland, Oregon. He says in Dubai, greed got the better of some Islamic financial institutions, the chimpanzees .

RAHMAN: So what happened is that the chimpanzees that were loaning the money out to the people, their eyes were focused towards quick flip over of profits. So Dubai was a casino.

SCHACHTER: The problem was something called a "sukuk," or an Islamic bond. In theory, a sukuk should equal the cost of a project, so assets equal liability. But in Dubai, that wasn't the case. They was just as much speculation there as anywhere else. But John Foster, formerly of Islamic Banking and Finance Magazine, says the Islamic finance industry has lost its way.

FOSTER: What a lot of the modern Islamic banks have done is they've tried to recreate conventional finance, except with an Islamic wrapper. So a lot of the banks would find a sheikh for hire. But the problem which Islamic finance has got at the moment, it needs to have a good look at itself; it needs to address where it is and what it's trying to achieve. It shouldn't try to be Wall Street, it should be Main Street, and it should be for the good for the whole of humanity.

SCHACHTER: Islamic banker Zaher Nsouli says that's why the crisis in Dubai may actually be a good thing, at least for Islamic financing.

NSOULI: Dubai World's crisis will lead to a shift in the way of structuring the sukuk, the way of imitating conventional models. You need corrections from time to time.

SCHACHTER: Nsouli and others says modern Islamic finance is in its infancy. Give it a few years to catch on, and for the mainstream to realize that their form of ethical finance is not just something for the world's billion Muslims. For The World, I'm Aaron Schachter, Beirut.