Illusions of the 'immunity' of Islamic finance hinder growth and innovation

The governor of Bank Indonesia, during a speech, made the claim that because of the Shari'ah screens, "if implemented properly, we can say that sharia economy and banking pose no risk of a crisis. Amid the ongoing global crisis, the presence of sharia banking is actually a hope." Although there are benefits in reduced risk created by the restrictions on gharar and maysir, the use of Islamic financial products cannot be said to be entirely free of risk of crisis. Islamic finance is still a tool used to finance purchases, including assets that can be inflated in a bubble (see Dubai's property market) and claims that asset price bubbles cannot happen when using Shari'ah-compliant financial services distracts from the real benefits from using these financial products and could, in the extreme, be detrimental if there is a general belief that crisis cannot happen.

One immediate outcome of a focus on the 'immunity' of Islamic finance from crisis is that it distracts attention from a much needed focus on real risk management, particularly whether and what types of derivatives and forwards could be judged permissible to provide a way to hedge exposure to some of the risks that Islamic banks face. In general, derivatives are not permitted because they are judged as gambling, but there is a valuable place for some hedging products to offset the lack of liquidity of some Islamic financial products, the maturity mismatch between assets and liabilities on banks' balance sheets and the lack of an interbank lending market (outside of Malaysia) that could keep a crisis from spreading by providing a buffer against illiquidity becoming insolvency.

The sukuk market shows no signs of improving despite there being over 100 sukuk issues planned because there are doubts about whether there will be buyers. Also, the AAOIFI ruling on sukuk from February 2008 has led to a greater proportion being ijara sukuk, depriving many issuers without the assets needed for the sale-leaseback transaction. Despite this, there are a few companies raising funds to purchase sukuk in the expectation that the lack of demand has made the future returns greater.

Other News

• Asset managers in India are becoming more interested in offering Shari'ah-compliant services. The equity markets in India are deeper than in other countries with larger Shari'ah-compliant asset management companies like Malaysia and some managers expect that over 60% of the total market capitalization in India pass common Shari'ah screens.
  
• Assets under management by Shari'ah-compliant asset managers in Kuwait fell 45.5% in the second half of 2008 to $4.4 billion, a similar percentage fall as seen by conventional fund managers.
  
• Abu Dhabi Islamic Bank will receive AED2 billion in a capital infusion from the government. The government will receive a sukuk paying 6% semi-annually. The structure of the sukuk is not clear.
  
• The merger of Islamic mortgage lenders Amlak and Tamweel into Emirates Development Bank is being rethought and the companies may be nationalized according to an analyst at EFG-Hermes.
  
• Malaysia's central bank, Bank Negara, will issue Ringgit 400 million ($110 million) in ijara sukuk next week.
  
• The size of a Malaysian bank's Gulf aviation fund may be cut in half as a result of the economic downturn.
  
• The State Bank of Pakistan is developing guidelines for Islamic financial products for the agricultural industry.