Saturday, March 07, 2009

University Bank featured in the NYT; Can Islamic finance provide a way forward after the crisis ends?

The New York Times has an article about University Bank in Ann Arbor, Michigan describing the phenomenal growth of its Islamic home finance products since it began offering them earlier this decade. The bank, which owns 80% of its Islamic finance subsidiary, the University Islamic Financial Corp started in 2005, is seeing growth increasing rapidly. The article points out that a week in which 11 "mortgage-alternatives" were signed to finance home purchases was "more than twice the weekly average".

A legal magazine article describes the development of Islamic finance in Singapore, which was recently announced as the site of the Islamic Financial Services Board's (IFSB) annual summit in May. The city-state issued its first sukuk earlier this year and has taken significant steps to change laws and regulations to place Islamic finance on equal regulatory ground with conventional financial institutions.

Dr. Umer Chapra gave a speech in which he said that the current global economic condition was worse than it had ever been and that Islamic finance could provide a solution. He noted that Christianity and Islam both provided rules to limit excessive debt and "As long as those religious values were practiced, the society progressed in every walk of life". While Umer Chapra is a respected figure in Islamic finance and I have heard him speak and found it very enlightening, I have to criticize his focus on blaming a lack of religiosity for the economic crisis. It creates a distraction from the work needed to solidify the Islamic finance industry, which is currently being harmed by the worldwide economic slowdown. Instead of assigning blame for current economic problems, I think it is far more constructive to say that Islamic finance has been fairly resilient but the fall in real estate prices in Dubai (to use one example) shows areas of weakness. In that particular case, an over-concentration of investments in property that back financing instruments carried on Islamic bank's balance sheets has led to problems in those banks with the greatest exposure and those whose liabilities are not supported by large amounts of customer deposits and are instead more reliant on wholesale, shorter-term capital markets. Instead of making arguments about how Islamic finance could have prevented the crisis, I think the focus should be on increasing the stability of the Islamic financial industry through regulatory coordination, increased transparency, the development of inter-bank markets to improve liquidity of Islamic banks and the further growth of secondary markets for sukuk.

Dr. Mahmoud El-Gamal criticized the Islamic finance industry and said it bore responsibility as well for the economic crisis which is impacting the global economy. One of his criticisms was:
“In the past 30 years of Islamic banking, no ‘authority’ has been established that can inform the international concerned bodies such as the IMF about their financial and investment products. Hence, no one has a clear picture of the activities of the Islamic banks, the number of their institutions and branches”
Dr. El-Gamal is a frequent critic of the industry's current practices and in this criticism, I think he hits on a very important area of transparency of the industry's size, scope, product mix and other factors that may have an impact on the global financial system.

The official newspaper of the Vatican printed an article suggesting that financial institutions could learn valuable things from the Islamic finance industry: "The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service". The reference to "bringing banks closer to their clients" is a criticism of banks from moving away from their role as intermediaries connecting depositors and borrowers into complex financial institutions and growth in their proprietary trading activities. Islamic banks, because they are limited in the types of products they can offer, are often more focused into the role of being an intermediary. George Bailey would be proud.

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