Wednesday, April 01, 2009

FT article on the Islamic financial services industry

The Financial Times has a fantastic article about the Islamic financial services industry that includes some very interesting descriptions that, while not new, are described clearer than I have seen in other articles about the industry. A few quites:
"To be clear, many of the Gulf’s Islamic banks have not been immune to the financial crisis – the liquidity squeeze in the region has put pressure on these banks just as much as their conventional counterparts."
"As Emmanuel Volland, analyst with Standard & Poor’s, the rating agency, says: 'Islamic banks were not caught by toxic assets as sharia law prohibits interest. At the same time, you can create and invest in very risky assets and be sharia compliant.'"
"Now, as their profits decline, banks are dipping into “profit equalisation reserves” to keep depositors satisfied. But they will face a dilemma if the economic downturn continues. Devout Muslims have increasingly migrated to Islamic banks in recent years, but will the trend survive if some of them start losing their money?"
"Last year a leading sharia scholar questioned a popular type of sukuk that promised to pay back the face value of the bond at maturity or in case of default. The scholar argued – and others had to agree – that this guarantee ran counter to the spirit of Islamic finance, which stipulates that risk must be shared."

"For those who closely watch the industry, there are more pressing concerns. As a recent S&P report noted, because of a lack of liquid sharia-compliant asset classes, some Islamic banks invested in equities, exposing themselves to the correction of recent months. The leading risk today, however, comes from the exposure to the real estate market. The rating agency estimates that this amounts to 20 per cent of total loans."
"It may have been lucky so far, and perhaps it will learn lessons from the troubles of conventional banks. But Islamic bankers will also have to think harder about how the industry can develop, and how it can resolve the tensions within."

I fully agree that the industry has to some degree avoided problems because of its relative youth. The liquidity management concerns have been a frequent area of concern for me because the global economic crisis is not over yet and the industry, partly because of lack of interbank money markets, has been more cash-rich than conventional banks. The institutions including a few Islamic investment banks and mortgage providers have had difficulties and many in the GCC region have relied upon government capital infusions to shore themselves up as they faced difficulty issuing sukuk.

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