Saturday, February 02, 2008

Stir over Islamic finance study in Canada, criticism of commodity murabaha

Reuters has an article that describes the success of Islamic finance in growing rapidly with a discussion of some of the challenges it faces in the next few years. The main challenge, which has been enumerated many times, is the shortage of skilled practitioners in the field, particularly Shari'ah scholars who are instrumental in adding legitimacy to the industry by certifying products as Shari'ah-compliant.

One area which is not as frequently mentioned is the need to spread awareness of the industry as it moves out of majority Muslim countries in the GCC and Asia into Western countries where Muslims are in the minority. This challenge has been accepted by the Institute of Halal Investing, which is working to demystify Islamic finance globally, with a particular focus of spreading knowledge and understanding of Islamic finance within the United States. The Reuters also mentions an informal poll of Islamic finance practitioners who pick Indonesia, Pakistan and the U.K. as the next significant growth opportunities for Islamic finance.

A further challenge to the industry is the wide use of murabaha, particularly commodity murabaha, by Islamic banks to invest surplus cash. Recent criticisms from within the Islamic finance industry have focused on repurchase agreements in ijara sukuk but Ruggiero Lomonaco, of ABN Amro and Aznan Bin Hasan, an assistant professor at the International Islamic University Malaysia both made strong criticisms of commodity murabaha at the recent Islamic Finance Forum in Dubai.

Mr. Lomonaco suggested that because the commodity murabaha often doesn't involve the delivery of the metals involved, it may reduce the legitimacy of Islamic finance and could "cause the fall of the industry in a very short period of time". Mr. Bin Hasan, in addition to criticizing the practice, suggested that where other options are not available, Islamic financial institutions could use commodity murabaha out of necessity. One alternative, using a wa'ad swap where the returns are determined by external benchmarks that was suggested by Mr. Lomonaco was the subject of a forceful criticism in a paper by Sheikh Yusuf DeLorenzo, a prominent Shari'ah scholar.

Moody's warns that Islamic financial institutions face significant risk if they are not seen as being fully Shari'ah compliant. In addition, the use of new products with different risk profiles from conventional financial products makes it difficult for Islamic banks to know the true risks. The presence of Islamic finance predominantly in emerging economies also means there is greater systemic risk to the industry as a whole because regulatory systems are less developed than in Western nations.

Disagreements over whether Islamic finance is beneficial to Muslims in Canada has lead to open disagreement over a Canadian Mortgage and Housing Corporation study about Islamic banking. Critics like Tarek Fatah, founder of the Muslim Canadian Congress call Islamic finance a "con job". Islamic financial institutions like UM Financial, headed by Omar Kalair, disagree and say that Islamic finance is not being forced upon Muslims in the country and provides a valuable tool for those Muslims who would not otherwise participate in the financial industry or purchase homes because of the interest charges in conventional mortgages. The Canadian Mortgage and Housing Corporation, stuck between the opposing groups, says the study is needed to understand the growing industry. CMHC vice president in charge of policy and planning Douglas Stewart says that the CMHC "wanted to get a better understanding of the nature of this type of lending and what some of the implications might be for the Canadian housing system."

Despite the credit crunch spreading across the world financial system, most bankers and analysts in the Islamic finance industry expect a similar volume of sukuk issues in 2008 as 2007, about $12 billion.

The growth of Islamic finance outside of the GCC along with it reaching 'critical mass' in places like Dubai is a significant development for the industry says Majid Dawood, the CEO of Yasaar Research, Inc.

Yasaar Research recently worked as independent Shari'ah consultants for the FTSE Shari'ah Indexes. The new indices, in addition to being overseen by an independent Shari'ah organization, are also using financial ratios calculated using total assets, rather than 12 month trailing market capitalization. The use of the latter as the denominator in the financial ratios has attracted criticism that it forces Shari'ah-compliant investment managers to buy high (when the market capitalization is large enough to drive the ratio lower) and sell low (when falling market capitalization increases the value of the ratios above the level allowed by the Shari'ah screens.

In another development for indices based upon religious and ethical principles, Dow Jones Indexes, the creator of the Dow Jones Islamic Market Index, one of the most commonly used benchmarks for Shari'ah-compliant funds, has launched the Dow Jones Dharma Indexes. The Dharma indexes use screens that aim to appeal to Hindus, Bhuddists, Jains and Sikhs. Briefly, the screens exclude companies that create violence and do not promote sustainable stewardship.

The Harvard Business Review included a paper on Islamic finance in its list of breakthrough ideas for 2008.

A website critical of the World Bank and IMF has a description of how the multilateral organizations approach Islamic finance.

The Islamic Development Bank is moving forward in the development of an anti-poverty fund called the National Islamic Fund. The board of directors are scheduled to meet in Tehran on February 17th.

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