An article in Arab News describes the prospects for Islamic finance as seen by Zeti Akhtar Aziz, the governor of the central bank of Malaysia, Bank Negara. Included in the article is a quote from Gov. Zeti which I think does an admirable job at describing the ways in which Islamic finance is affected by the global financial crisis and the recession which followed. She said:
There are some things I think are not necessarily true. IFIs do have some elements of responsible lending because they cannot move risk off balance sheet quite as easily (and in opaque ways) as conventional banks through credit default swaps (which the FT Alphaville blog described in two posts earlier today). But, I am not sure that IFIs are any more linked to the real economy than conventional banks (with the exception of situations like before the credit crisis when some banks were loaded up with CDOs created (synthetically in many cases) from subprime MBS. Most (smaller) banks didn't participate in these instruments, but were still hurt because of tightening credit, falling real estate prices and a slowing economy."The Islamic finance industry was insulated from the first round of the crisis (the global financial crisis). Islamic financial institutions (IFIs) are more resilient because they are closely linked to the real economy, with in-built checks and balances such as profit-sharing and risk-sharing. As such, there are greater elements of responsible lending. As economies slow down and financial markets experience a correction, these will impact financial institutions including IFIs. That is why it is important to have capital buffers, risk management and governance practices that are sound. We are continuing to develop mechanisms, institutional arrangements and financial infrastructures such as greater liquidity management and more so that the Islamic finance industry would continue to be resilient."
However, she is absolutely correct that IFIs are susceptible to a slowdown in the economy, which necessitates a similar level of regulation as other financial institutions. Gov. Zeti is usually a good source for clear statements on the Islamic finance industry and this quote is a good example.
A couple other things in the article caught my eye. First, the 3 applications for Islamic mega banks are not from Western institutions, and are reportedly backed by GCC-based investors, which continues the trend of convergence between the GCC and Malaysia. Second, Governor Zeti is quoted saying: ""The IILM [International Islamic Liquidity Management Corporation] is currently obtaining the required rating, as well as fulfillment of all other parameters for the issuance including high quality underlying assets". This to me suggests that the sukuk will be more likely an istithmaar sukuk, backed by Shari'ah-compliant financial assets from the central banks that are the members of the IILM. Under standard practice, fewer than 50% of these assets will be murabaha and istisna'a if the sukuk are going to be tradable (though I think AAOIFI rules stipulate a cutoff of 33%).