There are two developments in Islamic finance that motivate this post. First, as I discussed on the blog (and in greater depth in my newsletter, which you can sign up for on the right side of the blog), the Qatar Central Bank's directive requiring conventional banks with Islamic windows went into effect, with the added stipulation that conventional banks are prohibited from investing in sukuk in the country. Secondly, the controversy around Goldman Sachs' sukuk program has led to questions about whether sukuk issuance by conventional banks leads to the financing of non-Shari'ah-compliant activities.
A recent article quotes Badlisyah Abdul Ghani, the chief executive of CIMB Islamic, a large Malaysian Islamic bank (an Islamic window at CIMB Bank), who said: "A conventional bank, with the exception of multilateral development banks like the World Bank and the Asian Development Bank, should not be allowed to issue sukuk". I have heard from other people in the industry, contrary explanations that the issuer's activities are not relevant for whether they can issue a sukuk, because investors are not investing in the equity of the company, and therefore they are not generating income from non-Shari'ah-compliant activities. While I accept the premise of the latter argument, I find it a bit too cynical to be convincing to many people not involved in the day-to-day activities of the industry.
But, back to Mr. Ghani's comments, I think that limiting issuance to Islamic banks and other companies (would a company be allowed to issue sukuk if one of its subsidiaries provided conventional financial services) is counterproductive because it limits the potential for growth of the industry. However, that is not the only consideration. The main point of contention with the Goldman sukuk was that there was no separation between the proceeds from the sukuk and the rest of the bank, nor were there specific assets which would be financed by the sukuk proceeds. Had there been a building that was owned by Goldman sold to an SPV and an ijara sukuk were issued (assuming Goldman has buildings it owns that house other businesses that are not conventional banking), there would probably be little in the way of criticism.
However, this comparison raises another issue: how can it be Shari'ah-compliant to finance a conventional bank by buying one of it's buildings and renting that building back and not by selling a commodity to the bank, with repayment of principal plus profit deferred? There is merit to this question because money is fungible (i.e. once the proceeds from the sukuk go into the company, they become indistinguishable from the other money held by the company). However, the whole way that Islamic finance has developed--right or wrong--is by separating investor's money from non-Shari'ah-compliant activities (using an SPV, for example). The criticism that Islamic finance is just adding layers (with added cost) is a criticism of the industry (for example, from Mahmoud El-Gamal).
The discussion at this point does not have a clean conclusion that I can point to and say X is ok, but Y is not. It is, instead, a starting point for further discussion about what Islamic finance is meant to achieve and whether the idea of strict literalism in viewing the construction of sukuk and other Islamic finance products. I think strict literalism is not useful, because it allows people to rely entirely on the form of a product and removes any grounds for intent to be considered by Shari'ah scholars (which, it has been pointed out widely, is an important consideration in terms of whether a product is Shari'ah-compliant or not). Hopefully now, we can get beyond the mechanical arguments about whether a product like Goldman's sukuk is Shari'ah-compliant or not and look deeper into how Islamic finance should be developed.