Friday, May 08, 2009

IFSB summit, Moody's weighs in on sukuk form versus substance, Sheikh DeLorenzo on Islamic home finance in the US

Moody's released a report looking at the future of the sukuk market with a suggestion that investors look not just at the form of the structure, but the substance as well. Although many sukuk use standard forms (as approved by AAOIFI), they can vary significantly across different individual sukuk using the same form. This is particularly important, Moody's notes, because "The assets in the structure are commonly there for Shari'ah compliance purposes only, and ultimately have no bearing on the risk or performance of the sukuk investments, particularly in a distress situation." This is an important point because it raises questions about whether the sukuk market has focused too much on structuring transactions to receive Shari'ah-compliance and too little on creating a different asset class.

There is an interesting opinion article written by Shari'ah scholar Sheikh Yusuf DeLorenzo describing the benefits from the Islamic home finance product in the US for both Muslims and non-Muslims. These benefits are due to the participatory structure of many forms of Islamic home finance in the US and the non-recourse nature of the loans. The combination of these two factors, according to Sheikh DeLorenzo, leads to a lower rate of foreclosure following delinquency because the Islamic finance companies can only take the house in a foreclosure and if this value is below the outstanding amount owed (the mortgage is 'under water'), the bank faces a loss. Although this is the case in many states for all mortgages, it is not always the case in conventional mortgages.

The IFSB says that Islamic finance regulators need to focus on the entire system instead of having a narrow focus on individual institutions to prevent a repeat of the current crisis facing the conventional financial industry in the Islamic finance industry. I think this is very important because there are fewer safeguards on the industry to prevent contagion from spreading from one troubled institution to healthy institutions, like inter-bank money market and a 'lender of last resort'. The president of the Islamic Development Bank Dr. Ahmad Mohamed Ali said at the IFSB summit that the industry still has a significant amount of innovation needed to continue its rapid growth. The head of the IFSB was also quoted speaking to the Straits Times: "It all comes down to risk management. You've to have proper risk management and proper governance and practices so that an institution doesn't fall down".

Bank Negara deputy governor is quoted speaking about two critical issues that the Islamic finance industry needs to deal with to become more resilient in the future:
"There are a lot of issues that need to be addressed, for example the link to economic activity also has got its shortcomings because they are too focused on real estate for example. The absence of a money market that is also a source of risk."

Other News

No comments: