Islamic finance, banking and insurance complies with Shariah or Muslim religious laws that ban the earning of interest, or involvement in alcoholic drinks and gambling.

From basic bank deposits and investment accounts, the sector has expanded into complex areas including equity funds, bonds and Islamic hedge funds and swap equivalents, and more new products are in the pipeline.

Japan will be the first major industrialised country to issue Islamic bonds if the Japan Bank for International Cooperation goes ahead with the plan announced yesterday which is aimed at attracting money from oil-rich Muslim countries.

It is working with the central bank of Malaysia, a predominantly Muslim country that has established itself as the Asian leader in Islamic banking after introducing the service in 1983.

The sector now makes up nearly 10 per cent of the nation’s banking system and the government aims to double this to 20 per cent by 2010, but it faces stiff competition from elsewhere in Asia, particularly Singapore.

While aiming to target Muslims, who consider traditional banking as impure, Islamic products have also attracted non-Muslim clients partly because banks operating under Shariah law charge no interest.

And unlike in conventional banking where clients usually bear all the brunt in case of a financial loss, Islamic banks share in absorbing risks.

Funds are also banned from investing in companies associated with tobacco, alcohol or gambling considered as taboo to Muslims — a feature attractive to so-called “ethical” investors.

Major banks like HSBC and Britain’s Lloyds TSB now offer Islamic products, and the US Treasury Department has appointed an Islamic scholar as its principal adviser on Islamic finance in an effort to better understand the market.