Sunday, January 06, 2013

World Council on Credit Unions may take lessons from Afghanistan to Libya

The World Council of Credit Unions has spent the past 8 years building 34 Islamic Investment and Finance Cooperatives across Afghanistan providing murabaha, ijara and a murabaha-ijara hybrid product to its 92,456 member-owned cooperatives (here's the WOCCU's page on the IIFCs).  Now it is shifting its attention to Libya where there CEO of San Francisco Federal Credit Union said "As the country reconstructs, it is an opportunity for credit unions to participate in rebuilding the economy."

It would be useful to see the development of more Islamic credit unions, particularly in countries where access to finance (of any kind, conventional or Islamic) is low because the credit union model has a seeming overlap with Islamic banking.  Depositors of the credit union are members (i.e. owners) of the credit union and the return they get on the use of their deposits are returned to them as profit.  While there are still aspects where the credit union will replicate how banks work (for example, losses are unlikely to be passed through to depositors unless the credit union fails), there are fewer areas where there are difficult contradictions inherent in the model.

For example, if an Islamic bank goes out and tries to attract deposits using the mudaraba structure, they would be theoretically at risk of loss if the investments made with the deposits lose money.  Yet, how is that different from the equity owners of the bank, who should in theory have the same risk-return profile.  One difference between the mudaraba depositors and the equity investors is that the investors would have the right to participate in some ways in the management of the bank where the depositors wouldn't. 

However, that would make the structure of an Islamic bank more beset with conflicts of interest than a credit union (where members provide deposits and also act as the owners of the bank, which is typically a non-profit).  The equity investors (musharaka partners, essentially, have a right to a portion of the bank's earnings, much of which is made using the funds provided by depositors (the mudarib fee in the mudaraba arrangement).  The depositors are liable for the loss of their deposits if the investments are poorly chosen, and are entitled to the share of the profits accruing to them as the rabb al-maal but have no rights to direct the management of the bank. 

In the actual operation of Islamic banks, depositors are treated as being senior to the equity holders (they will have their deposits paid first if the bank were wound up, with any residual accruing to the equity holders).  That introduces an additional potential conflict of interest where the bank's equity owners would benefit from gains but would not have as much at risk to loss if the bank failed (since they would be investing with their equity capital plus the deposits).  This conflict of interest, of course, is the reason why banks (including Islamic banks) are so highly regulated. 

However, from the perspective of choosing whether an Islamic banking entity would work better using musharaka equity investments alongside mudaraba deposits as a privately held bank or a member-owned credit union, I think there is a lot to be said that the credit union would be better because the potential conflict of interest between the depositors and the equity owners would be eliminated by making the depositors the owners of the credit union.  There remains still, of course, the governance challenge of aligning management and depositor/member interests in a credit union, but using a structure with fewer conflicts to manage seems like a better way to go. 


Elaine Housby said...

I'm interested in this as I have written about the opportunities for convergence between Islamic models and non-Islamic mutual models, particularly credit unions, in the British context. It's in a book I've just finished on the relationship between Islamic and other forms of 'ethical' finance that will be coming out in June 2013 with Edinburgh university press. I'm now trying to write about credit unions in more depth for a conference presentation, and I confess I was not aware that there was such a body as the World Council on Credit Unions, so thanks for that.

Blake Goud said...

Sounds like an interesting book.