The mega-bank talk surfaces from time to time and as I mentioned a month ago, I am a bit tired of writing about it because it has so far been just talk (despite optimistic predictions by Saleh Kamel in 2007 that by now an Islamic mega-bank called Emaar would have $100 billion in assets by now).
However, in the last couple weeks, there have been reports that Bank Negara Malaysia, the central bank in Malaysia, would be sponsoring such an institution in Malaysia by acquiring Asian Finance Bank. BNM poured cold water on such speculation today saying that applications for mega-bank licenses in Malaysia would be "market-driven" and "private-sector led". Malaysian Insider, which wrote an article saying that not only would BNM take a lead role, after Petronas and the state pension fund KWAP declined to invest $100 million each, it would hand 9% of the equity to Dr. Rifaat Ahmed Abdel Karim, the former head of the Islamic Financial Services Board, and other people they described as "promoters".
As I cautioned on Twitter when linking to earlier stories, "it is always dangerous to rely too heavily on "industry sources" and anonymous "bankers"; may have their own agendas." With that caveat, there are recent precedents where Malaysian government-linked organizations have attracted criticism for their interactions in Islamic finance markets. KWAP recently bought the entire RM1 billion perpetual sukuk offering from the Malaysian national airline, MAS.
I am not an expert on the Malaysian government, its central bank or its government pension systems and their investment focus. But when there is such a degree of activity and rumored activity to lend an extra hand to the Islamic finance industry in ways that are not typical (neither BNM or Petronas are natural start-up investors in banks, Islamic or otherwise) it raises questions for me.
For example, I wonder, whether the government support for Islamic finance--a long-standing goal of the government--hasn't gone too far. There are a number of very laudable ways the Malaysian government has encouraged Islamic finance in the country since the early 1980s that have created a very dynamic environment, even attracting GCC-based Islamic financial institutions (and possibly the Kazah government) who raise money in the more liquid sukuk markets in Malaysia.
However, stepping beyond the bounds of providing a supportive environment by taking a direct stake in a particular bank--particularly one so big with a planned $1 billion in paid-up capital--could lead to questions from existing market participants. In addition, if either the mega-bank (if the reporting is true) or the MAS sukuk went sour, it could harm the overall image of Malaysia in the Islamic finance industry.
Tuesday, June 26, 2012
Sunday, June 24, 2012
Tax neutrality, tax equality and Islamic finance
While writing this week's newsletter, based on an IMF paper released recently focusing on the differences between conventional and Islamic finance in Malaysia, I was surprised to read the following about the tax treatment of Islamic finance in Malaysia: "partnerships formed under the Shariah concept of a joint venture entailing the sharing of profits and/or losses are not recognized as partnerships from the tax perspective".
After doing some very cursory research on the tax rates in Malaysia (helped out by a fact sheet (PDF) from Deloitte), the reason for this peculiar tax treatment of a joint venture is based on the difference in tax rates between income (the corporate tax rate is 25% and the highest personal tax rate is 26%) and tax rate on interest income, which appears to be 15%.
Clearly, the tax treatment was designed to provide tax neturality for Islamic finance, compared to conventional finance. Taking a step back from the example of Malaysia, one of the underlying ideas for Islamic finance from a theoretical perspective (mostly articulated by Islamic economists) is that Islamic finance benefits society as a whole by shifting the burden of risk onto those with more wealth. Instead of lending with interest, they are supposed to be bearing a higher degree of risk in line with the rewards they expect to earn. This will, other factors being equal, result in a lower level of income and wealth inequality (zakat will also provide for lowering wealth inequality).
From the theoretical view, Islamic finance should differentiate itself from conventional finance by focusing on a macro level at lowering income and wealth inequality, and on the micro level at generating income from Shari'ah-compliant sources. However, subsidizing Islamic finance by providing preferential tax breaks to products which effectively shoehorn Shari'ah-compliant products into structures that are equivalent in economic effect to interest-based lending will provide incentive for Islamic finance to move more towards replication of interest-based products.
One of the ideas with the current structure of Islamic finance is that it uses replication of conventional products as a stepping-stone to facilitate the growth of Islamic finance. For example, the regulatory treatment of Islamic finance makes it much easier for banks in particular to use murabaha and ijara, rather than mudaraba and musharaka. Allowing these products to achieve tax neutrality with conventional loans is important for facilitating the competitiveness of Islamic financial institutions with conventional institutions.
From a macro perspective, however, it should be important for Islamic financial institutions to recognize that where interest income is treated in a preferential way compared to regular income (e.g. partnership income or wage income), the incentives will tilt the balance towards debt financing and away from equity finance. It will also tend to provide lower tax rates at the top of the income spectrum and higher tax rates at the bottom, which will increase inequality.
At the same time as Islamic bankers lobby for tax neutrality between interest income and the profits generated from Shari'ah-compliant debt alternatives, they should also push for equal treatment between debt and equity, which will diminish the subsidy of debt finance. They should also support tax equality across income sources, as a way of mitigating increases in inequality that preferential treatment of interest income can cause.
After doing some very cursory research on the tax rates in Malaysia (helped out by a fact sheet (PDF) from Deloitte), the reason for this peculiar tax treatment of a joint venture is based on the difference in tax rates between income (the corporate tax rate is 25% and the highest personal tax rate is 26%) and tax rate on interest income, which appears to be 15%.
Clearly, the tax treatment was designed to provide tax neturality for Islamic finance, compared to conventional finance. Taking a step back from the example of Malaysia, one of the underlying ideas for Islamic finance from a theoretical perspective (mostly articulated by Islamic economists) is that Islamic finance benefits society as a whole by shifting the burden of risk onto those with more wealth. Instead of lending with interest, they are supposed to be bearing a higher degree of risk in line with the rewards they expect to earn. This will, other factors being equal, result in a lower level of income and wealth inequality (zakat will also provide for lowering wealth inequality).
From the theoretical view, Islamic finance should differentiate itself from conventional finance by focusing on a macro level at lowering income and wealth inequality, and on the micro level at generating income from Shari'ah-compliant sources. However, subsidizing Islamic finance by providing preferential tax breaks to products which effectively shoehorn Shari'ah-compliant products into structures that are equivalent in economic effect to interest-based lending will provide incentive for Islamic finance to move more towards replication of interest-based products.
One of the ideas with the current structure of Islamic finance is that it uses replication of conventional products as a stepping-stone to facilitate the growth of Islamic finance. For example, the regulatory treatment of Islamic finance makes it much easier for banks in particular to use murabaha and ijara, rather than mudaraba and musharaka. Allowing these products to achieve tax neutrality with conventional loans is important for facilitating the competitiveness of Islamic financial institutions with conventional institutions.
From a macro perspective, however, it should be important for Islamic financial institutions to recognize that where interest income is treated in a preferential way compared to regular income (e.g. partnership income or wage income), the incentives will tilt the balance towards debt financing and away from equity finance. It will also tend to provide lower tax rates at the top of the income spectrum and higher tax rates at the bottom, which will increase inequality.
At the same time as Islamic bankers lobby for tax neutrality between interest income and the profits generated from Shari'ah-compliant debt alternatives, they should also push for equal treatment between debt and equity, which will diminish the subsidy of debt finance. They should also support tax equality across income sources, as a way of mitigating increases in inequality that preferential treatment of interest income can cause.
Wednesday, June 20, 2012
UM Financial receivership may be nearing an end
During my time writing for The Islamic Globe, one of the stories where I directed a lot of attention was the receivership and bankruptcy of UM Financial, Inc. (and its sister company UM Capital, with the two companies referred to as "UM Financial" for the rest of this post), which offered Islamic mortgages to consumers in the Toronto, Ontario area, funded by the Credit Union Central Ontario, which was later merged with Credit Union Central British Columbia, to become Central 1 Credit Union.
The trigger for the receivership was the decision by the funder, Central 1 Credit Union, to decline to offer additional funding to UM Financial and then requesting the receivership on the basis that UM Financial was in non-monetary default on its credit facility with Central 1. However, the situation moved from typical problems in a messy business separation after a breakdown of the relationship to the bizarre, when Grant Thornton, the receiver discovered $2.1 million missing, having been withdrawn by the CEO of UM Financial, Omar Kalair, in gold and silver in the months before the receivership.
The gold was purportedly in partial payment of an invoice drafted by Kalair and Mufti Yusuf Panchbaya, for Shari'ah advisory services provided by the board, headed by Mufti Panchbhaya since the inception of UM Financial. The timing of the payments immediately before the receivership--when at least Kalair was aware was pending--raised red flags for Grant Thornton, based on statements in a number of court filings. The transfer of the gold, according to Kalair's sworn testimony, occurred in a dark pharmacy parking lot, with $1.8 million and $300,000 in silver being transferred from Kalair's trunk to the trunk of Joseph Adam's car, a shopkeeper who ran an Islamic clothing and bookstore (Adam is also known as Gamal Hegazy).
Shortly after, Adam departed Toronto for his native Egypt with the gold, having returned the silver to Kalair who then gave it to Panchbhaya, who later turned it over to the receiver (it was then sold with a $90,000 loss due to the fall in silver prices). There is considerable confusion on who the gold was intended to be paid to, the local Shari'ah board, Adam, or other consultants who worked with the domestic Shari'ah board. The final story given was that it was paid to unnamed Egyptian scholars who had issued a fatwa for UM Financial, who were introduced through a relative of Adam's, though the only evidence is a one page document with a number of unidentified signatures. Adam admitted in a deposition via Skype that he had taken the gold bars in his suitcase to Egypt, and distributed them, but would not reveal to whom he gave the bars. The gold has still not been located.
During the entire process, many of the homeowners who received financing were left in limbo as the receiver sorted through the paperwork, uncovering second mortgages along the way that increased the confusion about how much had been paid on each property. From the initial 172 clients, a number of mortgages were discharged after being refinanced and 20 were discharged after the customers demonstrated that they had paid UM Financial the remaining balance, which was then not passed along to Central 1.
In the process, the receiver was collecting fees according to the "Musharaka Home Financing Agreement", which included annual 'renewal' fees and prepayment fees of profit for the full year in which the refinance occurred. The receiver has decided to keep the annual fees, but rebate the prepayment penalties on a pro rata basis (based on when the refinance took place), and has asked for court approval to do so. It has also asked for approval to sell the portfolio to Central 1, after bids for the portfolio received during a sales process were rejected because they offered a price that was at a discount to the amount owed by UM Financial to Central 1.
The sale is being done through a credit bid, where Central 1 is bidding the amount it is owed by UM Financial, in exchange for the debt being extinguished, in effect, receiving the portfolio in lieu of any payment by UM Financial. The purchase and sale agreements were signed on June 15th and the court will consider the offer on June 29th, which will likely end the UM Financial saga, although the homeowners affected (through the first and second mortgages) will continue to be impacted, just with a new servicer on the first mortgages, Central 1.
Kalair, Adam and Panchbhaya, according to court filings, face a continuing investigation. Adam told the lawyer for Grant Thornton that he had spent several weeks in the hospital due to stress and the flu. He is seeking a way to return to Canada for medical treatment, but will be arrested and jailed for 6 month for contempt of court unless he can provide the receiver with a return of the gold bars and answer the receiver's questions.
The fate of Kalair and Panchbhaya are murkier still since Grant Thornton reported an ongoing investigation by the Office of the Superintendent of Bankruptcy and the Royal Canadian Mounted Police into alleged Bankruptcy and Insolvency Act and Criminal Code offenses, relating to the receivership and bankruptcy of UM Financial. The investigation also includes allegations of offenses relating to the transfer of gold, which brings the Multicultural Consultancy Canada Ltd, a company formed by Panchbhaya to receive the gold, into the picture. Among the alleged offenses are fraudulent disposition, bankruptcy fraud and conspiracy to defraud creditors, according to a production order served on Grant Thornton as receiver of the 2 UM Financial companies. The investigation does not mention Kalair or Panchbhaya by name, but they are likely to be included in the target of the investigation, "the Debtors [UM Financial Inc and UM Capital Inc] and the operating minds behind the Debtors and MCC".
Whatever the eventual fate of the parties involved with UM Financial, it serves as a reminder that even in Islamic finance, there can be breakdowns of trust between businesses and between a company and its customer and the fact that a business represents itself as being 'Islamic' does not mean that everyone involved will act ethically.
There are specific examples in the UM Financial saga where the management of a company may not be fully independent of its Shari'ah board, which dulls the effectiveness of the Shari'ah board as an independent check for investors and customers. There were also instances where too much control over the handling of money occurs without oversight by either customers, creditors, internal personnel besides management and regulators (UM Financial was unregulated).
At the end of the day, the worst part of the UM Financial saga is that it harmed homeowners, and will limit trust in Islamic financial institutions in Canada, likely for many years to come. It should remain as a lesson for the industry as a whole to remain vigilant to protect the entire industry's reputation, which is much easier lost than it is rebuilt.
Related Documents:
Latest court filing (PDF)
List of all court filings released by Grant Thornton, the Receiver
The trigger for the receivership was the decision by the funder, Central 1 Credit Union, to decline to offer additional funding to UM Financial and then requesting the receivership on the basis that UM Financial was in non-monetary default on its credit facility with Central 1. However, the situation moved from typical problems in a messy business separation after a breakdown of the relationship to the bizarre, when Grant Thornton, the receiver discovered $2.1 million missing, having been withdrawn by the CEO of UM Financial, Omar Kalair, in gold and silver in the months before the receivership.
The gold was purportedly in partial payment of an invoice drafted by Kalair and Mufti Yusuf Panchbaya, for Shari'ah advisory services provided by the board, headed by Mufti Panchbhaya since the inception of UM Financial. The timing of the payments immediately before the receivership--when at least Kalair was aware was pending--raised red flags for Grant Thornton, based on statements in a number of court filings. The transfer of the gold, according to Kalair's sworn testimony, occurred in a dark pharmacy parking lot, with $1.8 million and $300,000 in silver being transferred from Kalair's trunk to the trunk of Joseph Adam's car, a shopkeeper who ran an Islamic clothing and bookstore (Adam is also known as Gamal Hegazy).
Shortly after, Adam departed Toronto for his native Egypt with the gold, having returned the silver to Kalair who then gave it to Panchbhaya, who later turned it over to the receiver (it was then sold with a $90,000 loss due to the fall in silver prices). There is considerable confusion on who the gold was intended to be paid to, the local Shari'ah board, Adam, or other consultants who worked with the domestic Shari'ah board. The final story given was that it was paid to unnamed Egyptian scholars who had issued a fatwa for UM Financial, who were introduced through a relative of Adam's, though the only evidence is a one page document with a number of unidentified signatures. Adam admitted in a deposition via Skype that he had taken the gold bars in his suitcase to Egypt, and distributed them, but would not reveal to whom he gave the bars. The gold has still not been located.
During the entire process, many of the homeowners who received financing were left in limbo as the receiver sorted through the paperwork, uncovering second mortgages along the way that increased the confusion about how much had been paid on each property. From the initial 172 clients, a number of mortgages were discharged after being refinanced and 20 were discharged after the customers demonstrated that they had paid UM Financial the remaining balance, which was then not passed along to Central 1.
In the process, the receiver was collecting fees according to the "Musharaka Home Financing Agreement", which included annual 'renewal' fees and prepayment fees of profit for the full year in which the refinance occurred. The receiver has decided to keep the annual fees, but rebate the prepayment penalties on a pro rata basis (based on when the refinance took place), and has asked for court approval to do so. It has also asked for approval to sell the portfolio to Central 1, after bids for the portfolio received during a sales process were rejected because they offered a price that was at a discount to the amount owed by UM Financial to Central 1.
The sale is being done through a credit bid, where Central 1 is bidding the amount it is owed by UM Financial, in exchange for the debt being extinguished, in effect, receiving the portfolio in lieu of any payment by UM Financial. The purchase and sale agreements were signed on June 15th and the court will consider the offer on June 29th, which will likely end the UM Financial saga, although the homeowners affected (through the first and second mortgages) will continue to be impacted, just with a new servicer on the first mortgages, Central 1.
Kalair, Adam and Panchbhaya, according to court filings, face a continuing investigation. Adam told the lawyer for Grant Thornton that he had spent several weeks in the hospital due to stress and the flu. He is seeking a way to return to Canada for medical treatment, but will be arrested and jailed for 6 month for contempt of court unless he can provide the receiver with a return of the gold bars and answer the receiver's questions.
The fate of Kalair and Panchbhaya are murkier still since Grant Thornton reported an ongoing investigation by the Office of the Superintendent of Bankruptcy and the Royal Canadian Mounted Police into alleged Bankruptcy and Insolvency Act and Criminal Code offenses, relating to the receivership and bankruptcy of UM Financial. The investigation also includes allegations of offenses relating to the transfer of gold, which brings the Multicultural Consultancy Canada Ltd, a company formed by Panchbhaya to receive the gold, into the picture. Among the alleged offenses are fraudulent disposition, bankruptcy fraud and conspiracy to defraud creditors, according to a production order served on Grant Thornton as receiver of the 2 UM Financial companies. The investigation does not mention Kalair or Panchbhaya by name, but they are likely to be included in the target of the investigation, "the Debtors [UM Financial Inc and UM Capital Inc] and the operating minds behind the Debtors and MCC".
Whatever the eventual fate of the parties involved with UM Financial, it serves as a reminder that even in Islamic finance, there can be breakdowns of trust between businesses and between a company and its customer and the fact that a business represents itself as being 'Islamic' does not mean that everyone involved will act ethically.
There are specific examples in the UM Financial saga where the management of a company may not be fully independent of its Shari'ah board, which dulls the effectiveness of the Shari'ah board as an independent check for investors and customers. There were also instances where too much control over the handling of money occurs without oversight by either customers, creditors, internal personnel besides management and regulators (UM Financial was unregulated).
At the end of the day, the worst part of the UM Financial saga is that it harmed homeowners, and will limit trust in Islamic financial institutions in Canada, likely for many years to come. It should remain as a lesson for the industry as a whole to remain vigilant to protect the entire industry's reputation, which is much easier lost than it is rebuilt.
Related Documents:
Latest court filing (PDF)
List of all court filings released by Grant Thornton, the Receiver
Tuesday, June 19, 2012
The potential for growth in Islamic mortgage-backed securities
The GCC does not have a well developed market for mortgage-backed securities, and with the exception of a number of MBS sukuk issued by Cagamas in Malaysia, Islamic finance has seen few MBS sukuk. One notable exception was an MBS issued by Sorouh Real Estate, which I described in a blog post and which was later redeemed (which revealed a limitation for investors since the sukuk was redeemed by the issuer (scroll down to the July 18 newsletter) and not through pre-payment on the underlying assets).
However, with Tamweel considering the issue of $235 million in asset-backed MBS, there is a potential benefit for the sukuk market from more sukuk like this. The estimated redemption date is 2046 according to Moody's who rated the MBS significantly higher than both Tamweel and its parent company, Dubai Islamic Bank.
Before you start commenting on the post and suggesting that Islamic finance shouldn't use any of the products which played a part in the financial crisis, I want to offer a rebuttal. The development of MBS was not at fault in the credit crisis by virtue of their structure. In fact, they offer an asset-backed product which is demanded in the market (with potentially longer maturities for takaful and pension funds). The role that MBS (in contrast to CDO and CDS) played in the crisis was more effect than cause: as home prices fell, many MBS lost value. In addition, the MBS which lost the most value were those backed by bad mortgages that would not have been issued in earlier years.
There are risks to MBS that aren't present in a sukuk. For example, in the Sorouh MBS sukuk, the issuer could refinance and redeem the sukuk early, even before the underlying assets had paid out. But that was more an issue of that structure that gave the issuer a call option on the portfolio but left the risk with the sukuk investors. The structure of the Tamweel may not include a similar provision (I have not seen the documents for the Tamweel MBS sukuk).
Apart from this redemption risk, there is also the risk that the underlying assets are redeemed earlier (introducing reinvestment risk, as the investor is paid out earlier than anticipated and may not be able to find another investment with a similar return).
The benefit for the Islamic finance industry from more MBS issuance is that it can free up more funds for Islamic banks and mortgage lenders, while also offering additional sukuk to the market, potentially with longer maturities than most sukuk issance. This will expand the capacity of Islamic banks to finance other projects and expand their scope, while also offering a more complete fixed income market, which has been so far dominated (particularly in the GCC in recent years) by sovereign issues.
The potential ability of MBS to attract higher credit ratings than their originators is a mixed benefit. It is good, of course, to have a larger supply of highly rated sukuk to fill the portfolios of conservative investors like pension and takaful funds. However, this benefit should always be carefully weighed against the potential to replicate the ills of the MBS market leading up to the crisis where ratings schemes were gamed by originators to get higher ratings so they could push out more and more issuance, the risk of which is largely transferred to investors.
All in all, I think more MBS issuance should be a good thing for the Islamic finance industry and it can offer a way for investors to get Shari'ah-compliant fixed income investments. There are risks to be sure and, given the recent financial crisis, there should be vigilance to ensure that the MBS markets are not flooded with MBS sukuk backed by low quality assets. But if done correctly, it could be a boon to sukuk markets.
However, with Tamweel considering the issue of $235 million in asset-backed MBS, there is a potential benefit for the sukuk market from more sukuk like this. The estimated redemption date is 2046 according to Moody's who rated the MBS significantly higher than both Tamweel and its parent company, Dubai Islamic Bank.
Before you start commenting on the post and suggesting that Islamic finance shouldn't use any of the products which played a part in the financial crisis, I want to offer a rebuttal. The development of MBS was not at fault in the credit crisis by virtue of their structure. In fact, they offer an asset-backed product which is demanded in the market (with potentially longer maturities for takaful and pension funds). The role that MBS (in contrast to CDO and CDS) played in the crisis was more effect than cause: as home prices fell, many MBS lost value. In addition, the MBS which lost the most value were those backed by bad mortgages that would not have been issued in earlier years.
There are risks to MBS that aren't present in a sukuk. For example, in the Sorouh MBS sukuk, the issuer could refinance and redeem the sukuk early, even before the underlying assets had paid out. But that was more an issue of that structure that gave the issuer a call option on the portfolio but left the risk with the sukuk investors. The structure of the Tamweel may not include a similar provision (I have not seen the documents for the Tamweel MBS sukuk).
Apart from this redemption risk, there is also the risk that the underlying assets are redeemed earlier (introducing reinvestment risk, as the investor is paid out earlier than anticipated and may not be able to find another investment with a similar return).
The benefit for the Islamic finance industry from more MBS issuance is that it can free up more funds for Islamic banks and mortgage lenders, while also offering additional sukuk to the market, potentially with longer maturities than most sukuk issance. This will expand the capacity of Islamic banks to finance other projects and expand their scope, while also offering a more complete fixed income market, which has been so far dominated (particularly in the GCC in recent years) by sovereign issues.
The potential ability of MBS to attract higher credit ratings than their originators is a mixed benefit. It is good, of course, to have a larger supply of highly rated sukuk to fill the portfolios of conservative investors like pension and takaful funds. However, this benefit should always be carefully weighed against the potential to replicate the ills of the MBS market leading up to the crisis where ratings schemes were gamed by originators to get higher ratings so they could push out more and more issuance, the risk of which is largely transferred to investors.
All in all, I think more MBS issuance should be a good thing for the Islamic finance industry and it can offer a way for investors to get Shari'ah-compliant fixed income investments. There are risks to be sure and, given the recent financial crisis, there should be vigilance to ensure that the MBS markets are not flooded with MBS sukuk backed by low quality assets. But if done correctly, it could be a boon to sukuk markets.
Using zakat, sadaqa and awqaf for sustainable development
I don't usually use the blog for long quotes with little commentary, but there was an article that I linked to from my twitter account (@sharingrisk) yesterday that that I think is very well written and raises a lot of interesting ideas, so I want to put up the first few paragraphs and suggest you read the rest:
Islam requires Muslims to give 2.5 percent of their wealth to the poor every year. This represents a big potential in aid funding, but much of the money is mismanaged. In search for sustainable forms of aid, some organizations are trying to promote a broader perspective in Muslim giving rather than narrow conceptions of charity.
Every year, somewhere between US$200 billion and $1 trillion are spent in "mandatory" alms and voluntary charity across the Muslim world, Islamic financial analysts estimate.
At the low end of the estimate, this is 15 times more than global humanitarian aid contributions* in 2011.
With aid from traditional Western donors decreasing in the wake of a global recession, and with about a quarter of the Muslim world living on less than $1.25 a day**, this represents a huge pool of potential in the world of aid funding.But Islamic finance experts, researchers and development workers say much of the money spent in 'zakat' (mandatory alms) and 'sadaqa' (charity) is mismanaged, wasted or ineffective."Wealth is growing in the Muslim world. So is the poverty. Where have we gone wrong?" asks Tariq Cheema, president of the World Congress of Muslim Philanthropists (WCMP), an organization which advises Muslim donors - including some of the thousands of millionaires living in the Gulf - on how to increase sustainability and accountability in their donations.Islam requires Muslims to give 2.5 percent of their wealth and assets to the poor every year. Much more is given in voluntary 'sadaqa'. But that money is usually donated in small amounts at local levels to feed the poor, help orphans, or build mosques. Muslims say many of them give, almost without thinking, to fulfil a religious obligation. "Our rituals are there, but often they lack the spirit," Cheema told IRIN. "We just give the money and forget."Very little of the money goes towards sustainable development."Billions of dollars worth of giving in 'zakat' and 'sadaqa' are unfortunately ineffective by and large," he said. "Our giving shouldn't be driven by our desire to prove that we are good people... Our giving should be smart and effective.""We are here to bring that shift in the culture: the paradigm shift from conventional and generous giving to strategic giving... There is a lot of money around that needs to be channelled towards development."
Wednesday, June 13, 2012
Financing food and agriculture through Islamic finance
The Islamic Development Bank's (IDB) Islamic Corporation for the Development of the Private Sector (ICD) announced that it is partnering with fund manger Robeco to launch a $600 million agriculture private equity fund, $350 million of which will be raised by the end of the year. The fund's investment focus is to "invest in projects
that promote steady food supply [by making] private equity
investments in food and agriculture projects as well as companies across
various target countries in a Shariah-compliant way". The CEO of the ICD, Khalid Al-Aboodi, said that the fund would "address the inefficiencies and wastage facing the food and agricultural sector throughout our member countries".
The fund idea sounds to me like a great way to encourage Islamic financial institutions to finance projects which benefit a much larger number of people than building luxury resorts. Food security is one of the most important issues facing many countries with high levels of poverty, so dealing with the issue using Islamic finance would be a way to demonstrate that Islamic finance does "get it" that financing activities that benefit people at all income levels is part of its ethical mandate.
It is important, however, to clearly define the areas where the fund will focus, and identify investments at weak points in the food growing/distribution network so that it will accrue benefits to the investors as well as the people living in countries where financing is directed. In particular, the fund should put a focus on not funding 'white elephant' projects that create a profitable cash flow for investors (e.g. from contracts with local governments to pay for services, but which are unable to provide a benefit to the population because other complementary infrastructure is absent).
Addressing 'food and agriculture' sounds like a simple, narrow area, but it is easy to define investments in other areas that can be instrumental in reducing wastage, for example, in the food distribution process that could lead to significant 'mission creep' for the fund which would dilute its effectiveness. For example, ensuring a reliable supply of electricity in rural areas where food is grown allows for refrigeration and freezing of food, which allows it to be distributed more widely, opening up markets for farmers. From another direction, without a reliable supply of electricity, efforts to increase agricultural productivity in rural areas will accomplish little if most of the expanded productivity is lost to waste since it cannot be refrigerated or frozen and transported to the markets where it will be consumed.
It is good to see the IDB's ICD put a focus on directing investors towards the Shari'ah-compliant financing of an area that can be hugely beneficial for the poor, while also having potential to deliver return to investors if it is done correctly.
Tuesday, June 12, 2012
Lessons from Arcapita
When I was writing for The Islamic Globe, I covered Arcapita and in particular the financial difficulties around its J. Jill portfolio company as that company saw the debt used for the acquisition downgraded several times. It led me to look more deeply into the financial statements of Arcapita and recognize a problem with the upcoming maturity of a $1.1 billion murabaha due in March 2012.
J. Jill was instructive because it was, I believe, the only new investment made by Arcapita after the financial crisis and the speed at which it soured (in terms of credit downgrades) was surprising. At the time, I thought that it might have been a problem of Arcapita not realizing the "new normal" where lenders were much tighter in offering debt financing (the downgrades were due to J. Jill running up against debt covenants, which were likely to be breached since they became more constrictive in future years).
Unfortunately, the Islamic Globe suspended publication and Arcapita filed for bankruptcy (meaning the most current financial statements were from September 2011) before I could finish an article about the firm's problems. Since the bankruptcy, I have followed intensely the filings with the bankruptcy court and have been puzzled that the company did not request permission from the court to sell profine GmbH, which it sold to a German private equity company in late April 2012, more than a month after the bankruptcy filing. The lack of court filings was hard to understand since the profine press release announcing the sale said: "profine GmbH, one of the world’s leading manufacturers of PVC-U profiles for windows and doors, has a new owner. The Frankfurt company Hidden Peak Capital has bought up the shares of the former owner, Arcapita Bank BSC of Bahrain."
There was a good deal of activity in the bankruptcy court concerning a debt guarantee provided by Arcapita to Commerzbank, who provided the financing for the acquisition, but nothing about the sale of the company. I went back then to the original 'first day' filings, and found the story laid out clearly, but must have glossed over on first reading. They detail troubles at profine much earlier, as early as May 2008 (seven months after Arcapita acquired the company).
To be fair, this was months after the failure of Bear Stearns and the credit crisis was just in its early stage, but it matches up quite well with the few details I have about J. Jill, which was acquired after the credit crisis, but with the same leveraged buy-out mentality of Arcapita. In May 2008, Arcapita sunk an additional 25 million euro in equity into profine, and provided Commerzbank with a 125 million euro guarantee, tied to profine's financial performance, which worsened in the financial crisis.
Beginning in 2009, Arcapita and Commerzbank worked on a subsequent financial restructuring of profine, which they finally closed in November 2010 requiring an additional 45 million euro in equity capital by the end of 2011. When that date neared, Arcapita was in dire straights trying to raise the capital to repay the murabaha (the failure to do so earlier was ascribed by Arcapita to the European debt crisis in 2011). They negotiated a one month extension to put up the remaining 13 million euro in equity, but at the end of January, they decided to withhold the funds (whether due to the financial situation of profine or due to their own lack of cash I don't know).
As a result of their decision, their board members were sacked and Commerzbank accelerated the debt due by profine to Commerzbank. As a result of Arcapita's bankruptcy, which was attributed to distressed debt buyers of their $1.1 billion murabaha taking a hard line, Commerzbank now has to wait for the bankruptcy court to approve a restructuring plan in order for them to make good on Arcapita's guarantee of profine's debt. An educated guess suggests that Arcapita's financial guarantee was secured by Arcapita's equity interest in profine, which was likely taken before the bankruptcy filing, and thus Arcapita did not need to request bankruptcy court approval for the sale of profine to Hidden Peak Capital.
At the end of the day, both the J. Jill and profine acquisitions suggest that Arcapita was aggressive with the amount of leveraged used in taking over these companies, and whether that type of leverage is appropriate for an Islamic financial institution should be a topic for discussion in the industry. There will always be some degree of leverage in financial institutions. Islamic banks that issue sukuk are leveraging their equity investors' money also, but with fewer casualties during the financial crisis (Islamic investment banks have taken the brunt of the pain from forced deleveraging and a sharp drop in deal flow and therefore income throughout the financial crisis and its aftermath).
J. Jill was instructive because it was, I believe, the only new investment made by Arcapita after the financial crisis and the speed at which it soured (in terms of credit downgrades) was surprising. At the time, I thought that it might have been a problem of Arcapita not realizing the "new normal" where lenders were much tighter in offering debt financing (the downgrades were due to J. Jill running up against debt covenants, which were likely to be breached since they became more constrictive in future years).
Unfortunately, the Islamic Globe suspended publication and Arcapita filed for bankruptcy (meaning the most current financial statements were from September 2011) before I could finish an article about the firm's problems. Since the bankruptcy, I have followed intensely the filings with the bankruptcy court and have been puzzled that the company did not request permission from the court to sell profine GmbH, which it sold to a German private equity company in late April 2012, more than a month after the bankruptcy filing. The lack of court filings was hard to understand since the profine press release announcing the sale said: "profine GmbH, one of the world’s leading manufacturers of PVC-U profiles for windows and doors, has a new owner. The Frankfurt company Hidden Peak Capital has bought up the shares of the former owner, Arcapita Bank BSC of Bahrain."
There was a good deal of activity in the bankruptcy court concerning a debt guarantee provided by Arcapita to Commerzbank, who provided the financing for the acquisition, but nothing about the sale of the company. I went back then to the original 'first day' filings, and found the story laid out clearly, but must have glossed over on first reading. They detail troubles at profine much earlier, as early as May 2008 (seven months after Arcapita acquired the company).
To be fair, this was months after the failure of Bear Stearns and the credit crisis was just in its early stage, but it matches up quite well with the few details I have about J. Jill, which was acquired after the credit crisis, but with the same leveraged buy-out mentality of Arcapita. In May 2008, Arcapita sunk an additional 25 million euro in equity into profine, and provided Commerzbank with a 125 million euro guarantee, tied to profine's financial performance, which worsened in the financial crisis.
Beginning in 2009, Arcapita and Commerzbank worked on a subsequent financial restructuring of profine, which they finally closed in November 2010 requiring an additional 45 million euro in equity capital by the end of 2011. When that date neared, Arcapita was in dire straights trying to raise the capital to repay the murabaha (the failure to do so earlier was ascribed by Arcapita to the European debt crisis in 2011). They negotiated a one month extension to put up the remaining 13 million euro in equity, but at the end of January, they decided to withhold the funds (whether due to the financial situation of profine or due to their own lack of cash I don't know).
As a result of their decision, their board members were sacked and Commerzbank accelerated the debt due by profine to Commerzbank. As a result of Arcapita's bankruptcy, which was attributed to distressed debt buyers of their $1.1 billion murabaha taking a hard line, Commerzbank now has to wait for the bankruptcy court to approve a restructuring plan in order for them to make good on Arcapita's guarantee of profine's debt. An educated guess suggests that Arcapita's financial guarantee was secured by Arcapita's equity interest in profine, which was likely taken before the bankruptcy filing, and thus Arcapita did not need to request bankruptcy court approval for the sale of profine to Hidden Peak Capital.
At the end of the day, both the J. Jill and profine acquisitions suggest that Arcapita was aggressive with the amount of leveraged used in taking over these companies, and whether that type of leverage is appropriate for an Islamic financial institution should be a topic for discussion in the industry. There will always be some degree of leverage in financial institutions. Islamic banks that issue sukuk are leveraging their equity investors' money also, but with fewer casualties during the financial crisis (Islamic investment banks have taken the brunt of the pain from forced deleveraging and a sharp drop in deal flow and therefore income throughout the financial crisis and its aftermath).
Monday, June 11, 2012
Should Afghanistan issue a sovereign sukuk?
An article in Bloomberg discussed the prospects for Afghanistan to issue a sukuk to fund its budget deficit when international troops in the country leave (along with a lot of aid that accompanies them) in 2014. I have offered a skeptical comment to an earlier Bloomberg article that reported about a proposal to allow Islamic banking in Afghanistan.
A sukuk provides a different set of opportunities and challenges from Islamic banking. It is easier in many ways to issue a sovereign sukuk than it would be to develop a prudently regulated Islamic banking system, because the investors would demand a higher return (whether sukuk or conventional bond) based on the ability to get recourse in case the government defaults in the future. These types of challenges are going to be common to either type of financial instrument. There are also questions about whether the country will be able to repay its debt, which again, will be priced into the yield the government pays.
Biggest challenge unique to issuing a sukuk rather than a conventional bond, is whether the additional costs will be more beneficial to the government in terms of making a statement (and perhaps attracting some buyers who would avoid a conventional bond). To a large degree, the cost-benefit analysis will depend on whether the sukuk is sold mostly to domestic buyers (e.g. banks) or to international investors. The benefits may be higher and the costs lower in the former situation, compared to the latter situation, which may push the balance over the hump in favor of sukuk.
There could also be a benefit if subscribing to the the sukuk were viewed as a politically favorable for the government-owned and government-related Islamic banks in the region (e.g. across the Gulf in the GCC). At the end of the day, if that makes the cost of a sukuk competitive or advantageous compared with a conventional bond, then by all means the Afghan government should do it. However, the government has higher priorities than getting into the sukuk markets, so the trade-off should be weighed carefully, so that it is not paying a nice extra bonus to an Islamic financial institution with funds that could be better used elsewhere.
A sukuk provides a different set of opportunities and challenges from Islamic banking. It is easier in many ways to issue a sovereign sukuk than it would be to develop a prudently regulated Islamic banking system, because the investors would demand a higher return (whether sukuk or conventional bond) based on the ability to get recourse in case the government defaults in the future. These types of challenges are going to be common to either type of financial instrument. There are also questions about whether the country will be able to repay its debt, which again, will be priced into the yield the government pays.
Biggest challenge unique to issuing a sukuk rather than a conventional bond, is whether the additional costs will be more beneficial to the government in terms of making a statement (and perhaps attracting some buyers who would avoid a conventional bond). To a large degree, the cost-benefit analysis will depend on whether the sukuk is sold mostly to domestic buyers (e.g. banks) or to international investors. The benefits may be higher and the costs lower in the former situation, compared to the latter situation, which may push the balance over the hump in favor of sukuk.
There could also be a benefit if subscribing to the the sukuk were viewed as a politically favorable for the government-owned and government-related Islamic banks in the region (e.g. across the Gulf in the GCC). At the end of the day, if that makes the cost of a sukuk competitive or advantageous compared with a conventional bond, then by all means the Afghan government should do it. However, the government has higher priorities than getting into the sukuk markets, so the trade-off should be weighed carefully, so that it is not paying a nice extra bonus to an Islamic financial institution with funds that could be better used elsewhere.
Thursday, June 07, 2012
Why is issuance of bond and sukuk booming in the first half of 2012?
Bond sales in the GCC are at levels for the first half of 2012 that have far outstripped the level of last year and are at a record pace. The amount of issuance is being attributed to the "solidity of the economic environment" according to one bank's asset management group, adding that they have been boosted by "expansion projects and infrastructure plays in the region, the steady maturing of the institutional investment sector and the increased ability of buy-side firms to manage those institutional assets". That may be true, and it is important to consider that they are coming from a "very low base" as a director at Exotix Ltd said.
I agree with some of these projections, even if I don't necessarily link them specifically to the rise in new issuance. Yesterday I was looking to find instances on my blog of a prediction that the move from the GCC to Asia would continue, and I found a post where I had jumped the gun (oops) and predicted that issuance would move back to the GCC based on a combination of a larger GDP (which I had discussed in an earlier post), the need for infrastructure finance and a limit of capacity for the Malaysian markets to absorb all the issuance needed. Long term, this is still likely to happen, but for this post at least, the focus is on the first half of 2012 where there was indeed record bond issuance in the GCC (combined conventional bond and sukuk).
I agree that long-term the factors listed as causes for the surge of issuance in the first half of 2012 are real, but I think there were more mechanistic factors in the bond and sukuk markets that played a larger role in the surge of issuance in the first half. Most of the sukuk issued in the region are issued with a 5-year tenor and I would suspect that most bonds are as well (since sukuk markets tend to take the lead from their conventional equivalent).
The peak year in the global markets was 2007, which just happened to be 5 years ago, and was also near the peak for sukuk issuance in the GCC. Since many issues were 5-year sukuk, they are coming due in 2012 (with a few maturing in 2013 if they were issued in the early months of 2008 before the financial crisis). For the companies that issued these sukuk (if they are still around), 2012 is the year of the refinancing (highlighted so far by the failure of Arcapita to refinance a $1.1 billion murabaha in March). To look to a conventional analogue, Investcorp recently announced that it was refinancing some of its debts due in 2013, likely to avoid running up to a the deadline lest an external financial event like the Euro crisis cause problems.
So, before we start attributing the surge in issuance to the good economy, need for infrastructure financing, and development of the institutional investment sector (while those may in fact be occurring), it is important to separate out the 'inevitable' refinancing activity from maturing bonds and sukuk from the previous peak. If there is still a surge of activity, it will be more correctly attributed to the positive factors that will lead to sustainable growth in issuance as companies (in particular) move away from bank financing for the bulk of their debt issuance.
Monday, June 04, 2012
Don't prohibit Islamic banking!
An article describes the failure of the proposed Islamic bank ZamZam from opening in Ethiopia. I don't know the situation, so I can only offer limited comment on it, but from how this article describes the situation, the National Bank of Ethiopia issued a directive which prohibits the licensing of a wholly Islamic bank, but allows Islamic windows to operate (although I could be mis-reading the analysis of the directive, and it could be only permitting non-banking financial activities by an Islamic financial institution).
The situation resembles the difficulty so far faced in India, where Islamic banking is not allowed under the existing regulatory rules, although recently the National Commission on Minorities weighed in supporting a fresh look at changes which has led the finance ministry requesting the country's central bank, the Reserve Bank of India to reconsider.
The two cases, if I am understanding correctly (and I am not familiar enough with either country's banking laws to say definitively) relate to political questions about whether Islamic banking could fit within the country's banking laws, and potentially other objections to Islamic banking, which highlight the dilemma facing Islamic banking in several countries.
It places on opposite sides of the issue those who say that Islamic banking and finance are fundamentally different from conventional finance with those more pragmatically minded who point to the similarities between conventional and Islamic banking. The former are generally coming from the perspective of Islamic economics, which views Islamic banks as unique entities that are not really 'banks' the way a bank is commonly understood. The latter, are the Islamic finance professionals who view Islamic banking (and finance) as just banking using different products to avoid violating the ban on riba by structuring products to make profit from leasing, or cost-plus sales.
On the issue of where Islamic banks fit into the regulatory framework, I side with the latter camp and think that it is possible to offer banking services in a Shari'ah-compliant way, where the economic outcome is largely the same. That does not mean that this way of doing business is optimal; it may offer the same service at higher cost. But it is taking the regulatory system at its face value and finding a way to work within it to offer products that appeal to consumers who would otherwise be unbanked. That, I think is a positive, as long as the products are not exploitative and the current state of Islamic banking is not viewed as the goal (that is, as long as it is accepted that there is significant room for improvement).
But, Islamic banking should not be quashed just because it is 'Islamic'. I know quite a bit about that living in the US where a substantial portion of the political rhetoric about Islam (representing still a small minority of the population) agitates against Islamic banking and finance on the grounds that it either finances terrorism or is a step on the road to 'imposing Shari'ah'. Those arguments are nonsense, but can hold sway in political circles and can make Islamic banking and finance more difficult to offer by limiting the regulatory flexibility needed to deal with Islamic banking and finance as what it is: an alternative structure for conventional banking services, designed to avoid riba, gharar and the other prohibitions.
While I think Islamic finance offers a compelling promise, I lack the demand for the product as it exists today simply because it is 'Islamic'. But I am not a Muslim, and quite a few million Muslims disagree with me and will choose a product because it is approved as Shari'ah-compliant, and I think they should have that right. If it offers a competitive economic proposition to what I get today from conventional banking (I bank with a credit union), then I will reconsider. However, so long as a banking institution can operate within the rules governing capital adequacy and soundness, I think it should be permitted, and there should be flexibility to regulations to allow for different product structures that accomplish the fundamental business of banking. Prohibiting something just because it is 'Islamic' is a pointlessly retributive exercise.
The situation resembles the difficulty so far faced in India, where Islamic banking is not allowed under the existing regulatory rules, although recently the National Commission on Minorities weighed in supporting a fresh look at changes which has led the finance ministry requesting the country's central bank, the Reserve Bank of India to reconsider.
The two cases, if I am understanding correctly (and I am not familiar enough with either country's banking laws to say definitively) relate to political questions about whether Islamic banking could fit within the country's banking laws, and potentially other objections to Islamic banking, which highlight the dilemma facing Islamic banking in several countries.
It places on opposite sides of the issue those who say that Islamic banking and finance are fundamentally different from conventional finance with those more pragmatically minded who point to the similarities between conventional and Islamic banking. The former are generally coming from the perspective of Islamic economics, which views Islamic banks as unique entities that are not really 'banks' the way a bank is commonly understood. The latter, are the Islamic finance professionals who view Islamic banking (and finance) as just banking using different products to avoid violating the ban on riba by structuring products to make profit from leasing, or cost-plus sales.
On the issue of where Islamic banks fit into the regulatory framework, I side with the latter camp and think that it is possible to offer banking services in a Shari'ah-compliant way, where the economic outcome is largely the same. That does not mean that this way of doing business is optimal; it may offer the same service at higher cost. But it is taking the regulatory system at its face value and finding a way to work within it to offer products that appeal to consumers who would otherwise be unbanked. That, I think is a positive, as long as the products are not exploitative and the current state of Islamic banking is not viewed as the goal (that is, as long as it is accepted that there is significant room for improvement).
But, Islamic banking should not be quashed just because it is 'Islamic'. I know quite a bit about that living in the US where a substantial portion of the political rhetoric about Islam (representing still a small minority of the population) agitates against Islamic banking and finance on the grounds that it either finances terrorism or is a step on the road to 'imposing Shari'ah'. Those arguments are nonsense, but can hold sway in political circles and can make Islamic banking and finance more difficult to offer by limiting the regulatory flexibility needed to deal with Islamic banking and finance as what it is: an alternative structure for conventional banking services, designed to avoid riba, gharar and the other prohibitions.
While I think Islamic finance offers a compelling promise, I lack the demand for the product as it exists today simply because it is 'Islamic'. But I am not a Muslim, and quite a few million Muslims disagree with me and will choose a product because it is approved as Shari'ah-compliant, and I think they should have that right. If it offers a competitive economic proposition to what I get today from conventional banking (I bank with a credit union), then I will reconsider. However, so long as a banking institution can operate within the rules governing capital adequacy and soundness, I think it should be permitted, and there should be flexibility to regulations to allow for different product structures that accomplish the fundamental business of banking. Prohibiting something just because it is 'Islamic' is a pointlessly retributive exercise.
Indonesia can serve as a testing ground for PLS bank financing
The latest figures (from March) show that Indonesia's Islamic banking market continues to expand rapidly (at a 50% year-on-year pace), with a lot of the assets in mudaraba and musharaka financings (roughly 20% of the total assets). As I mentioned at the beginning of the year, "As the market becomes more and more saturated in Malaysia, there is a
huge opportunity within Indonesia, where Islamic finance is at a much
earlier stage of development." There remains a huge opportunity in Indonesia where Islamic banking represents just over 4% of total banking assets (compared to over 20% in Malaysia). This market also seems to buck the trend in the share of assets in mudaraba and musharaka, which many people think are better assets for Islamic banks to hold (or at least more "Islamic").
Indonesia then should be a big test about whether Islamic banks offering mudaraba and musharaka financing can be sustainable on a large scale. There are two prevailing theories about why the profit-and-loss sharing contracts get a much smaller share of total bank assets: 1) Islamic banks have been captured by Western bankers and lawyers who want the banks to operate on similar lines to their conventional counterparts (due to either familiarity or regulatory environment); 2) profit-and-loss sharing contracts are inherently more difficult to operate in a banking environment because of adverse selection and moral hazard.
Indonesia could prove to be a testing ground for both of these theories. I am not an expert on banking regulations of Islamic banks in Indonesia, but by the mere degree to which Islamic banks in the country have engaged in mudaraba and musharaka financing suggests that the regulatory restrictions are diminished compared to other markets. It also seems from my limited research that Indonesian Islamic banks are more focused domestically and on banking in particular (rather than investment banking/private equity/etc). There are also potential regulatory changes that will encourage the domestic focus by limiting new foreign (and domestic) ownership of banks to either 30% or 40% for a single investor, from the 99% allowed now.
Viewing the development of Islamic banks' profitability, and more importantly, the stability of their profits, over time will be a metric of how well the mudaraba and musharaka model can work on a large scale in the context of regulatory systems which allow both conventional and Islamic banks. The key point is whether the internal risk management of the Islamic banks can engage in potentially volatile mudaraba/musharaka financing and either pass that risk through to depositors (mudaraba account holders) or manage their profit-equalization reserves to smooth payouts to depositors without taking large losses for shareholders (either in order to maintain competitive rates of return for depositors, or in the worst case, eating losses to retain depositors' principal amounts).
Indonesia then should be a big test about whether Islamic banks offering mudaraba and musharaka financing can be sustainable on a large scale. There are two prevailing theories about why the profit-and-loss sharing contracts get a much smaller share of total bank assets: 1) Islamic banks have been captured by Western bankers and lawyers who want the banks to operate on similar lines to their conventional counterparts (due to either familiarity or regulatory environment); 2) profit-and-loss sharing contracts are inherently more difficult to operate in a banking environment because of adverse selection and moral hazard.
Indonesia could prove to be a testing ground for both of these theories. I am not an expert on banking regulations of Islamic banks in Indonesia, but by the mere degree to which Islamic banks in the country have engaged in mudaraba and musharaka financing suggests that the regulatory restrictions are diminished compared to other markets. It also seems from my limited research that Indonesian Islamic banks are more focused domestically and on banking in particular (rather than investment banking/private equity/etc). There are also potential regulatory changes that will encourage the domestic focus by limiting new foreign (and domestic) ownership of banks to either 30% or 40% for a single investor, from the 99% allowed now.
Viewing the development of Islamic banks' profitability, and more importantly, the stability of their profits, over time will be a metric of how well the mudaraba and musharaka model can work on a large scale in the context of regulatory systems which allow both conventional and Islamic banks. The key point is whether the internal risk management of the Islamic banks can engage in potentially volatile mudaraba/musharaka financing and either pass that risk through to depositors (mudaraba account holders) or manage their profit-equalization reserves to smooth payouts to depositors without taking large losses for shareholders (either in order to maintain competitive rates of return for depositors, or in the worst case, eating losses to retain depositors' principal amounts).
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