Unmask the World’s Financial
System in the Light of Islamic Finance
Today, the Islamic financial system is being viewed with a
measure of envy and respect. There is growing appreciation
of its symbiotic link to real economic activities. As the
financial crisis reaches out to even more areas around the
globe, some Islamic financial and related institutions are
being affected, though not to the extent that has crippled
many of their conventional counterparts.
This naturally means that the Islamic finance community
should not be complacent; rather, it must continue to
critically evaluate itself. Malaysian Prime Minister
Abdullah Ahmad Badawi asks: “Have we truly established an
alternative system, or are we still very much mimicking the
established conventional system?” His challenge: Prove to
the global market that the Islamic financial system is truly
a robust and viable alternative to the conventional system.
(Islamic Finance News)
The current financial crisis provides that opportunity.
As it is, despite the crisis, new Shariah compliant banks
continue to emerge in various places (Sudan, the Gulf and
Malaysia); they continue to record strong profits (ABC
Islamic Bank’s net profit for the first nine months of 2008
increased by 60% over the same period last year); Britain,
despite being in the thick of the crisis, remains committed
to launch the first Sukuk by a western government; and Gulf
Finance House is embarking on its latest Energy City
project, in Libya, worth US$5 billion. Additionally the
International Swaps and Derivatives Association is to launch
standards for over-the-counter (OTC) Islamic derivative
contracts early next year that will be a key tool in Shariah
compliant risk management.
As part of efforts to add depth to Islamic finance, the
International Shariah Research Academy for Islamic Finance (ISRA)
has been set up to foster collaboration between Muslim
scholars in different countries to develop knowledge in
areas of specific interest to the global Islamic finance
community. In particular, it will help find a middle ground
for the standardization of Islamic finance practices.
At the same time, Malaysia has embarked on an initiative to
promote a more consistent application for Islamic financial
contracts. The central bank’s “Shariah parameters” project
is aimed at determining the essential features of Islamic
financial products derived from underlying Shariah contracts
such as Murabahah, Istisna, Mudarabah, Musharakah, Ijarah
and Wadi’ah. These features will serve as a guide for
Shariah contracts pertaining to Islamic financial products,
and can be applied when designing new products or enhancing
existing ones.
Even as these moves take shape in bringing about a certain
level of standardization and uniformity in Islamic finance,
a debate is ongoing: According to some scholars, binding
legal standards for the industry would challenge the Islamic
concept of Ijtihad, or reasoning, that continuously
re-assesses Shariah law. Standardization, they argue, will
also limit the diversity of Islamic finance products. On the
other hand, regulators and industry practitioners contend
that legally enforced standards are required to enhance
investment certainty and reduce transaction costs.
Finally some of the largest pension plans in the US are
reported to be restructuring their entire portfolio to
venture into infrastructure investment in a major way.
Experts estimate that infrastructure spending will average
US$2 trillion a year through 2015 as emerging markets build
and expand rapidly while developed markets are upgrading
their existing infrastructure.
What’s obvious now is that capitalism is no longer governed
by democracy. Rather, it exploits democracy. Incoming US
president Barrack Obama says one of his priorities is making
sure the plumbing works, meaning stabilizing the financial
system. In the face of what has been said to be the darkest
economic outlook for the US since the Great Depression,
voters said the economy was overwhelmingly the most
important issue in the election, and this was clearly an
advantage to Obama. This is a crisis of capitalism and the
reality is that when capitalism fails it has to be bailed
out by the state. It is capitalist when it goes up and
socialist when it comes down.
Sovereign funds were considered dirty money just a couple of
months ago, but they are now being eagerly sought as a
savior. Barclays is banking on them to get out of the
quicksand. But these sovereign funds are being extra
cautious, especially after they were derided when they
attempted to move in a few months ago. It appears that US
officials now realize what is needed to lure the sovereign
funds from the Gulf: Islamic finance.
Hence the statement by the US Treasury Department that it is
looking into the important features of Islamic banking that
could help in tackling the current financial crisis. Deputy
secretary Robert Kimmitt said: “Islamic banking is an
important issue being discussed right now by experts both in
the public and private sectors.” And this week, the
department organized, together with Harvard, a forum on
“Islamic Finance 101” for the public and private sectors, as
well as Congress personnel.
The consequence of the crisis could be that as Gulf
sovereign funds become more important, Islamic banking could
play an increasing role in global financing, its expansion
relatively unaffected by the financial crisis. This, of
course, does not mean that Shariah compliant finance can
suddenly present itself as a comprehensive alternative to
capitalism. Instead, the current shift in perspective in
Washington ought to be viewed as an opportunity for Islamic
financial institutions to have joint investments with
governments and other financing sources, including
multilaterals, in funding the public works program that
Obama has in mind to help generate economic activity in the
US .
The point is that Obama is inheriting, as one report put it,
an economic estate that has been pillaged by his
predecessor. US public sector debt is well over US$1
trillion, equivalent to around 80% of US economic output.
The nonpartisan Committee for a Responsible Budget estimates
all the government economic and rescue initiatives, starting
with the US$168 billion in stimulus checks issued earlier
this year, total even more — US$2.6 trillion.
Obama faces the nation's worst financial crisis in 70 years.
The US presidency is powerful, but the economy is in such a
mess that no one leader will be able to change things
dramatically any time soon. However, he has had an
electrifying effect not only on Americans but also the rest
of the world. Banking on this impact, and driven by the
pressing situation, will he be bold enough to accept the use
of Islamic finance to help salvage the US economy?
While
global markets struggle to pick up the pieces from what has
been dubbed “the worst economic crisis in decades”, the
Islamic finance industry was dealt a blow when Standard &
Poor’s revealed that more than US$5.6 trillion had been
wiped off the value of Shariah compliant equities worldwide
during the third quarter of 2008.
However, it added that Shariah investors had benefited from
their lack of exposure to financials, which have been the
focus of the market selloff. Its Index services vice
president Alka Banerjee said: “While equity markets around
the world have experienced a tumultuous quarter, Shariah
investors continue to be shielded to some extent by the
exclusion from their portfolios of financial stocks and
other highly leveraged companies, which do not satisfy the
strict compliance criteria associated with Islamic law.”
Standard & Poor’s Ratings Services had also revised its
outlook on six banks in Gulf Cooperation Council (GCC)
countries to stable from positive, which included Islamic
banking giant Kuwait Finance House, citing the less
supportive environment in which they operated from as a
factor. (Islamic Finance News)
The financial turmoil has boosted perception of Islamic
finance, which is now being considered by many Western
countries including the US and even Australia . It was
reported that the US government was studying the salient
features of Islamic banking to ascertain how far it could be
useful in fighting the ongoing world economic crisis.
Prominent Egyptian-born , Qatar -based cleric Sheikh Yussef
al-Qaradawi told participants of a recent conference to take
advantage of the financial crisis to create a Shariah
compliant economic system.
“We have all the wealth... the Islamic nation has all or
nearly all the oil and we have an economic philosophy that
no one else has,” he said, alluding to the fact that Saudi
Arabia holds a substantial portion of the world’s proven
crude oil reserves.
The head of theological studies at Doha University shares
Sheikh Yussef’s view, saying the global economic meltdown
shows the need for a radical and structural reform of the
global financial system. He says the system based on the
principles of Islam offers an alternative that can reduce
risks.
On the flip side, others say that although interest,
derivatives and short selling are forbidden under Shariah
law, which means that Islamic financial institutions were
not burdened any subprime loans, hedge funds or credit
default swaps, investing in halal finance would not be a
shield against a global financial or even economic crisis.
Our country reports focus on Japan , where the private
sector has shown its full commitment to the growth of the
Islamic finance industry. The government has now realized
the potential of attracting petrodollars from Middle Eastern
investors and government officials and industry
practitioners are diligently studying Islamic finance.
The first of two market reports paint a dreary picture for
Islamic investors saying they were not immune from stock
market crashes while Monem Salam, in the other, urges the
industry to avoid similar disasters by analyzing the
failings of conventional finance instead of displaying a
false sense of pride.
British Prime Minister Gordon Brown’s admission that the
global economic downturn is “likely to cause recession” in
the UK saw markets slump. Bank of England governor Mervyn
King said that not since the first world war has the
international banking system been so close to collapse.
Brown said: “Having taken action on the banking system, we
must now take action on the global financial recession which
is likely to cause recession in America, France, Italy,
Germany, Japan and — because no country can insulate itself
from it — Britain too.”
The upside is that genuine interest is emerging in Islamic
finance as an acceptable alternative. UK Trade & Investment
is supporting a briefing to give financial companies a
better understanding of Islamic finance by explaining whom
it applies to, how it can complement existing financial
services strategy, and what the benefits are. Chief
executive Andrew Cahn said: “In these tough times, it’s more
important than ever that we make the most of growing sectors
like Islamic finance.”
The Islamic Bank of Britain has reported a growth of 5% in
customer numbers and 13% in customer financing. The reason
is that the bank “has been better protected from the credit
crunch affecting mainstream banks”, said its commercial
director, Sultan Choudhury. He attributed the rise to people
“looking for a safer option for their money”. In Australia ,
financial institutions and the government are considering
introducing Islamic banking and its principles.
Indeed, Islamic banking has largely escaped the crisis, but
according to experts, because of its heavy reliance on
property investments and private equity, the industry could
be hit if the turmoil worsens and real assets start to
crumble. Still, Kuwait Finance House reports that the
outlook for Islamic financing is bright and it will likely
take the lead in terms of providing funding for major
projects as the conventional banking system reevaluates its
business model.
Islamic Banking fares well in the Credit Crunch
Islamic Banks do not face the same liquidity problems
(problems of getting cash) as conventional banks as:
Islamic Banks do not rely on wholesale fundingfrom other
banks as its assets are funded in one of three ways
i. Islamic banks use its own capital to fund asset products
ii. They have Islamic contracts with its savings customers,
and that money can be used to finance low risk activities in
return for offering the customer a target profit rate with a
Mudaraba contract.
iii.
They also offer its savings customers deposits based on the
principle of Murabaha and in doing so can also offer the
customer a fixed rate for his investment. Conventional banks
have suffered from poor and risky lending decisions
Partnership - The principle of partnership underlying
Islamic finance
means Islamic banks would never enter into the
subprime-style agreements currently affecting the current
crisis. For the benefit of the customers and the bank
themselves, they enter into a partnership agreement. Islamic
banks don’t just enter into any agreement, they make sure
the agreement is right for both partners.
Transparency - Long before consumer legislation came into
play, Islam said that there must be no deception involved in
a transaction, that a transaction must be transparent for
the consumer. Many of the investments that led to large
losses were not transparent.This is a good example where
Islamic principles help in Treating Customers Fairly, and
ensuring any deal is right for the customer also.
Conventional banks have suffered from complex derivative
products ‘going bad’.
Islamic Banks do not engage in complex derivatives as
Islamic
stipulations that you must own the asset you are
trading in also mean practices such as short-selling are not
a feature of Islamic banking. Banks
that are now in crisis effectively traded in paper, whereas
Islamic finance deals have to be underpinned by tangible
assets
The
explosion in complex derivative products over the last few
years has left Western banks reeling from exposure to ‘toxic
assets’ (increasingly worthless assets) often far-removed
from their everyday activities. In contrast the more
risk-averse Islamic finance system did not embrace this kind
of deal. |
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