The CGAP microfinance blog highlights the lack of progress in developing laws to facilitate microfinance since the Arab Spring. One point the post makes is that "The irony in all this is that only in Syria and Yemen, two countries still heavily affected by the uprisings, did the governments sanction savings mobilization by MFIs meeting minimum standards."
It is interesting to me that in both these countries where microfinance was sanctioned by the governments there have been Islamic microfinance institutions, in Jabal al-Hoss in Syria and Hodeidah in Yemen. There is still much to do in both countries, and in both countries there are more pressing needs with the departure of Ali Abdallah Saleh from Yemen and the continued fighting in Syria against Bashar al-Assad.
However, despite the continued unrest in both countries, there have been examples of demand for Islamic microfinance which suggests that there is probably demand in other countries where the Arab Spring has run its course. These countries should move forward on both conventional and Islamic microfinance development as a top priority. Some may point out that there are more weighty concerns in the forefront today, but I would argue that the development of programs to provide economic opportunities should be at the forefront because the Arab Spring largely arose out of one man, Mohammed Bouazizi, very publicly died after setting himself on fire due to having his livelihood snuffed out by the police when they confiscated his fruit crates and electronic scale.
It is fair to question whether Islamic microfinance is well developed enough to be moved to the top of the agenda alongside conventional microfinance. However, with so many resources being devoted to developing the (macro) Islamic finance industry, there should be an equivalent commitment to developing Islamic microfinance. Today, two of the biggest Islamic microfinance programs are being facilitated with funding for technical support from the US international aid agency USAID in Afghanistan and Iraq. Where are the Islamic finance institutions who claim to embrace corporate social responsibility, ethical finance and a concern for the poor in laying the groundwork for Islamic microfinance to develop across the MENA region after the Arab Spring?
Showing posts with label ethical finance. Show all posts
Showing posts with label ethical finance. Show all posts
Friday, February 03, 2012
Thursday, September 29, 2011
Is Islamic Finance Ethical?
Islamic finance is ethical in the sense that it conforms with the commonly accepted understanding among Shari'ah scholars of what is ethical. However, the industry markets itself in a different idea of what is ethical. Islamic finance is supposed to be a superior alternative to the current financial system, one which appeals to Muslims as well as non-Muslims and one which takes as a minimum a standard that is more stringent than the 'industry average'.
On this metric, I think Islamic finance has much more work to do. If one thinks that Islamic finance is supposed to meet the baseline standards of financial ethics with an additional set of constraints specific to the dictates of the Shari'ah, than Islamic finance meets the definition of 'ethical'. However, the way Islamic finance is presented, and I would argue also how it views itself, this standard is not sufficient to be 'ethical'.
For example, take socially responsibly investing. It is an 'ethical' framework for investing and it has broad appeal (although there is nothing 'unethical' about disagreeing with the standards under which it operates). However, it operates in an environment with conventional finance is a competitor and where it has to offer something valuable to consumers. Islamic finance, on the other hand, is largely concerned with serving a market where it is not in direct competition with conventional finance.
For Islamic finance to gain consumers--at least until that market is saturated--all it has to offer is the same types of products that conventional finance, but in a way that passes muster of a Shari'ah board. This type of Islamic finance industry does not directly compete with conventional finance because it is targeted towards a consumer who is not deciding between Islamic and conventional financing, but instead is deciding between working with an Islamic bank or keeping his or her money under the mattress. This market is almost entirely Muslim, although not all Muslims use Islamic finance.
There has been a trend in recent years for non-Muslims to use Islamic finance, whether this is Islamic banks in Malaysia or Islamic mutual funds in the United States. This decision is primarily financial: if an Islamic bank or mutual fund offers a better deal than conventional financial institutions, then non-Muslims will use it regardless of the "ethical-ness" of the product. However, being price competitive alone does not make the product "ethical", even if it happens to be designed to fit within an ethical system like the one derived from Islam.
Islamic finance talks a lot about being superior to conventional finance and being an alternative that is attractive to conventional finance to non-Muslims as well as Muslims. While this is admirable, there still remains a disconnect between creating an "ethical" alternative based on the precepts of Islam. Returning to the socially responsible investing example, that industry started (like Islamic finance) by avoiding things that were viewed as "unethical", whether that was weapons or tobacco makers or producers of alcohol or companies that produced other harmful or toxic products. But, the evolution of socially responsible investing did not become an "ethical" alternative until it started offering a product that was defined by what it did, not by what it did not do.
Today, Islamic finance is approaching the point where it too will have to define what it is, not what it is not. This ties back into my earlier post on the debate between the idealists and pragmatists in Islamic finance with the former saying that creating financial products that Shari'ah scholars approve using financial engineering in some cases which fit into the current regulatory environment is sufficient. The latter say, "no", and argue that only profit-and-loss sharing (PLS) products are true to the roots of Islamic finance.
When viewed through the ethical lens, the idealists have the edge because they are offering an idea about what they want, not how they have not done X, Y or Z. However, they promote an idea that I think is incompatible with financial services today because of regulatory barriers, as well as consumer preference. Not every financial consumer's needs can be met with a PLS-based financial product. For example, how would one structure a student loan to pay for college using PLS?
But, I do think their focus on what Islamic finance does that other types of finance do not is useful for the Islamic finance industry. To create an ethical product in Islamic finance, financial institutions should consider not only avoiding what is haram, but also on incorporating ideas of what is encouraged within Islam into financial products. This will make it easier to explain to non-Muslims why they should consider Islamic finance, without either resorting to platitudes about fairness and justice or hoping that the economics of the transaction are more beneficial than a conventional financial product.
Until Islamic finance moves towards this idea, it will be stuck selling its products to the segment of Muslims who will not deal with conventional banks, or those who prefer to deal with Islamic banks, if the cost is similar. There will remain examples that can be tossed out to refute my argment based on the large non-Muslim customer base, but in large part, those will be isolated examples where the economics work out better for the consumer. There will be little progress in making inroads on the non-Muslim market (and also among many Muslims) if there is not something being offered that is not solely based on superior performance.
On this metric, I think Islamic finance has much more work to do. If one thinks that Islamic finance is supposed to meet the baseline standards of financial ethics with an additional set of constraints specific to the dictates of the Shari'ah, than Islamic finance meets the definition of 'ethical'. However, the way Islamic finance is presented, and I would argue also how it views itself, this standard is not sufficient to be 'ethical'.
For example, take socially responsibly investing. It is an 'ethical' framework for investing and it has broad appeal (although there is nothing 'unethical' about disagreeing with the standards under which it operates). However, it operates in an environment with conventional finance is a competitor and where it has to offer something valuable to consumers. Islamic finance, on the other hand, is largely concerned with serving a market where it is not in direct competition with conventional finance.
For Islamic finance to gain consumers--at least until that market is saturated--all it has to offer is the same types of products that conventional finance, but in a way that passes muster of a Shari'ah board. This type of Islamic finance industry does not directly compete with conventional finance because it is targeted towards a consumer who is not deciding between Islamic and conventional financing, but instead is deciding between working with an Islamic bank or keeping his or her money under the mattress. This market is almost entirely Muslim, although not all Muslims use Islamic finance.
There has been a trend in recent years for non-Muslims to use Islamic finance, whether this is Islamic banks in Malaysia or Islamic mutual funds in the United States. This decision is primarily financial: if an Islamic bank or mutual fund offers a better deal than conventional financial institutions, then non-Muslims will use it regardless of the "ethical-ness" of the product. However, being price competitive alone does not make the product "ethical", even if it happens to be designed to fit within an ethical system like the one derived from Islam.
Islamic finance talks a lot about being superior to conventional finance and being an alternative that is attractive to conventional finance to non-Muslims as well as Muslims. While this is admirable, there still remains a disconnect between creating an "ethical" alternative based on the precepts of Islam. Returning to the socially responsible investing example, that industry started (like Islamic finance) by avoiding things that were viewed as "unethical", whether that was weapons or tobacco makers or producers of alcohol or companies that produced other harmful or toxic products. But, the evolution of socially responsible investing did not become an "ethical" alternative until it started offering a product that was defined by what it did, not by what it did not do.
Today, Islamic finance is approaching the point where it too will have to define what it is, not what it is not. This ties back into my earlier post on the debate between the idealists and pragmatists in Islamic finance with the former saying that creating financial products that Shari'ah scholars approve using financial engineering in some cases which fit into the current regulatory environment is sufficient. The latter say, "no", and argue that only profit-and-loss sharing (PLS) products are true to the roots of Islamic finance.
When viewed through the ethical lens, the idealists have the edge because they are offering an idea about what they want, not how they have not done X, Y or Z. However, they promote an idea that I think is incompatible with financial services today because of regulatory barriers, as well as consumer preference. Not every financial consumer's needs can be met with a PLS-based financial product. For example, how would one structure a student loan to pay for college using PLS?
But, I do think their focus on what Islamic finance does that other types of finance do not is useful for the Islamic finance industry. To create an ethical product in Islamic finance, financial institutions should consider not only avoiding what is haram, but also on incorporating ideas of what is encouraged within Islam into financial products. This will make it easier to explain to non-Muslims why they should consider Islamic finance, without either resorting to platitudes about fairness and justice or hoping that the economics of the transaction are more beneficial than a conventional financial product.
Until Islamic finance moves towards this idea, it will be stuck selling its products to the segment of Muslims who will not deal with conventional banks, or those who prefer to deal with Islamic banks, if the cost is similar. There will remain examples that can be tossed out to refute my argment based on the large non-Muslim customer base, but in large part, those will be isolated examples where the economics work out better for the consumer. There will be little progress in making inroads on the non-Muslim market (and also among many Muslims) if there is not something being offered that is not solely based on superior performance.
Monday, September 12, 2011
How do Islamic banks act ethically?
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It is common for people to describe the potential of Islamic finance beyond just Muslims based on its socially responsible or ethical foundations. However, given the structures used and limited screening methodology (focusing only on excluding what is prohibited outright), without any consideration for activities which may not be prohibited outright, but which are socially detrimental, such as environmental and labor standards.
Even beyond this critique, some (myself included at times) focus solely on the "asset" side of the balance sheet and criticize the use of products that are functionally equivalent to conventional lending, but which have been re-structured to be sale or lease contracts instead of ones based on interest. Part of the criticism is that by acting the same way as conventional banks, albeit with different contracts, there is no "ethical" benefit to Islamic finance. However, that does miss the conflicting demands an Islamic bank (like any bank) faces between interest groups which may have different objectives and to which the bank may have different levels of responsibility.
For example, as pointed out in this article, giving additional forbearance on a loan or renegotiating the terms beyond what is required in the contract or under the laws of the country in which it is executed, it may be viewed as more ethical by borrowers (and people whose interests are aligned with that borrower, like other debtors to the bank who may expect similar treatment). However, it will be viewed very differently by the bank's depositors and shareholders, who will see a lower return on deposits or on their shareholdings in the bank. To them, while the action of the bank may have been charitable, it was done not with the bank's money, but at the expense of the depositors or shareholders' return.
As a result, it becomes more of a challenge to decide whether an Islamic bank is 'ethical' simply by viewing how it treats borrowers who are in distress, either because of factors out of their control like an economic downturn, or where they overextended themselves by buying a property they could not afford (in the latter case, some of the responsibility lies with the bank for not analyzing the borrower's ability to pay). In normal times, and where there are no disputes about the bank acting in bad faith, it is perfectly ethical for a bank to demand repayment or to foreclose on the borrower to minimize the loss of depositors and shareholders.
However, in strained times, when there is a general economic downturn, especially when a lot of the bank's assets are exposed to a particular sector that has been hit hard, the Islamic banks should react differently and consider offering payment moratoriums, reducing the amount borrowers owe. However, it should not do these out of charity to the borrowers, it should do so out of the responsibility to maximize the return (or minimize the losses) to shareholders and to protect depositors. It should be a strictly economic decision--if the bank has high exposure to real estate, it cannot hold onto hope that all of the assets it holds will be worth their book value.
By getting in front of the problem and determining what assets are impaired and which are not, it can decide how to maximize the value of its assets. If the Islamic financial contracts and the bank's balance sheet is simpler and clearer than a conventional competitor, then it should be easier to identify losses, supplement capital where needed and move forward than in a conventional bank with a complicated balance sheet where its assets are more difficult to understand and value. This may be more ethical in the end, but only if the bank 's management is willing and able to deal with the problems quickly.
If Islamic banks keep their operations simple and don't get too heavily leveraged with balance sheets filled with assets that are difficult to impossible and the management is honest with itself and its constituencies, then it may be judged to be more ethical. The screens used in Islamic finance (particularly those relating to gharar and maysir) may tie the hands of management in a good way, it cannot be relied upon to keep the Islamic banking system any safer than the conventional banking system, or more ethical and transparent. Combining the limitations on some types of activities may help, but in the end qualified, competent and ethical management has to be in place for the ethical ideas to be translated into practice. Another reason why Islamic banking should not be viewed as inherently better, more ethical or more stable than conventional banks.
Sunday, July 17, 2011
Islamic investing 2.0
Writing in Gulf News, Rusdhi Siddiqui runs through the equity screening criteria for Islamic stock indices and concludes that there is nothing exclusively "Islamic" about the process of "doing good by avoiding the bad". He concludes: "Islamic investing does not have a monopoly on doing good, by avoiding the bad, its common shared values with all investors of conscience".
I would go one step further and say that for equity investing in public companies--which as he notes includes companies like ExxonMobil, Nestle, Microsoft, Johnson & Johnson and Novartis--Islamic investing is far behind the curve in terms of ethical investing.
For example, consider the Calvert Funds, a well known socially responsible investing fund. Their screening criteria is similar in terms of what is excluded: firms engaged in tobacco, weapons, alcohol, gambling, human rights issues and nuclear. These have significant overlap with the Islamic screens used across the industry (with the additional exclusion of companies with poor human rights track records and those engaged in the nuclear industry). From this "doing good by avoiding the bad" strategy, Calvert adds another set of criteria: governance and ethics, environment, workplace safety, product safety, human rights, indigenous peoples' rights and community relations.
These criteria add another level of screening. Calvert not only avoids the companies engaged in socially detrimental industries, it also screens the companies that pass its 'negative' screens to ensure their businesses are conducted in an ethical way. This is something missing today in Islamic finance. All the focus is placed on avoiding companies that generate significant revenue from 'bad' industries, but doesn't ask how the companies generate revenue from the acceptable industries to determine whether they conduct business in an ethical way.
This should be an area where Islamic investing focuses because of the often-stated idea that Islamic finance supports a more ethical economy. How is this verifiable if there is no screening of companies in acceptable industries to see whether they make products that harm people, whether they deal fairly in their employment practices, have adequate corporate governance to ensure shareholders' rights are protected and there are no 'ticking timebombs' of unethical behavior (e.g. the failures of management at News Corp to stop the hacking of individuals' voicemails and bribery of police).
That leads to the final area where firms like Calvert go beyond the Islamic investing standards. When there are problems at firms in the additional criteria, investors' voices should be used to force changes through shareholder advocacy. As far as I know, most Islamic investing companies take passive positions where they could be more active and try to advocate for changes that make the companies they invest in make positive changes like avoiding certain areas of business, avoiding taking on additional debt, improving corporate governance and disclosures.
Yet, they do not. Most Islamic investors are concerned with 'avoiding the bad' but do not widen their screens to favor companies that are leaders in their industry in corporate governance, human rights, or more generally in conducting an ethical business. If Islamic investing does not adopt the 'best practices' for sustainable investing, then it is unlikely that the companies in which they invest will adopt 'best practices' in terms of sustainability.
I would go one step further and say that for equity investing in public companies--which as he notes includes companies like ExxonMobil, Nestle, Microsoft, Johnson & Johnson and Novartis--Islamic investing is far behind the curve in terms of ethical investing.
For example, consider the Calvert Funds, a well known socially responsible investing fund. Their screening criteria is similar in terms of what is excluded: firms engaged in tobacco, weapons, alcohol, gambling, human rights issues and nuclear. These have significant overlap with the Islamic screens used across the industry (with the additional exclusion of companies with poor human rights track records and those engaged in the nuclear industry). From this "doing good by avoiding the bad" strategy, Calvert adds another set of criteria: governance and ethics, environment, workplace safety, product safety, human rights, indigenous peoples' rights and community relations.
These criteria add another level of screening. Calvert not only avoids the companies engaged in socially detrimental industries, it also screens the companies that pass its 'negative' screens to ensure their businesses are conducted in an ethical way. This is something missing today in Islamic finance. All the focus is placed on avoiding companies that generate significant revenue from 'bad' industries, but doesn't ask how the companies generate revenue from the acceptable industries to determine whether they conduct business in an ethical way.
This should be an area where Islamic investing focuses because of the often-stated idea that Islamic finance supports a more ethical economy. How is this verifiable if there is no screening of companies in acceptable industries to see whether they make products that harm people, whether they deal fairly in their employment practices, have adequate corporate governance to ensure shareholders' rights are protected and there are no 'ticking timebombs' of unethical behavior (e.g. the failures of management at News Corp to stop the hacking of individuals' voicemails and bribery of police).
That leads to the final area where firms like Calvert go beyond the Islamic investing standards. When there are problems at firms in the additional criteria, investors' voices should be used to force changes through shareholder advocacy. As far as I know, most Islamic investing companies take passive positions where they could be more active and try to advocate for changes that make the companies they invest in make positive changes like avoiding certain areas of business, avoiding taking on additional debt, improving corporate governance and disclosures.
Yet, they do not. Most Islamic investors are concerned with 'avoiding the bad' but do not widen their screens to favor companies that are leaders in their industry in corporate governance, human rights, or more generally in conducting an ethical business. If Islamic investing does not adopt the 'best practices' for sustainable investing, then it is unlikely that the companies in which they invest will adopt 'best practices' in terms of sustainability.
Tuesday, November 30, 2010
Islamic finance as ethical finance?
An issue that comes up periodically with Islamic finance is that the Arabic terms used to describe the products and the underlying prohibitions driving the industry (e.g. riba, gharar or Shari'ah-compliant). There are many areas where Islamic finance overlaps with ethical finance and, therefore, Moinuddin Malim, the CEO of Mashreq al Islami Bank said that the industry should 'Westernize' the labels: "Why is it Islamic banking? It is ethical banking. A lot of people think that it is only for Muslims, and it is not - it is for everyone. [...] But the problem is that it doesn't appeal to non-Muslim investors in Europe, primarily because they do not understand the various Arabic phrases".
There are many reasons why the industry should use more 'familiar' terms for the products being used and some of the resistance might due to fears that it will move the industry outside of its niche. Not all Muslims are native Arabic speakers so the use of Arabic terms may create a need for more explaining of products than is necessary if they were called by a different name. However, there are differences between the products used and the products they might be called (e.g. ijara versus a lease). If a product is substantively different (for example, in the rights and responsibilities of the two parties as in an ijara compared with a lease), the use of 'lease' instead of ijara could be misleading.
There is a more fundamental reason, I think, that Islamic finance should retain the use of the Arabic terms for products: the industry is created to cater to the specific prohibitions within Islam. It is not in and of itself ethical finance. The industry does not universally adopt an ethical stance that would be expected by many investors, even some Muslims. For example, even within Islam, man is placed as caretaker of the earth, yet many Islamic financial products finance activities that are destructive to the environment. There is not even a delineation between whether the financed companies use industry best practices or are egregiously destructive to the natural environment.
The industry was created and is designed to serve investors who want to avoid that which is prohibited in Islam according to the scholars who advise the financial institutions offering the Islamic financial products. It is not necessarily even created for the needs of all Muslims; there are some Muslims holding a different view of what is permissible in financial services and if those views are outside of the consensus within the Islamic finance Shari'ah scholar community, then the Islamic financial industry may not be suitable for them.
This is not meant to be a critique of Islamic finance. It serves a valuable place in the financial services industry globally by providing an alternative to a significant proportion of Muslims who believe that the way the rules on finance are applied by contemporary Shari'ah scholars is correct. It does a good job at catering to those individuals' needs, even if there remain significant gaps in product offering to actually meet all consumers' needs. However, it would dilute the purpose of Islamic finance and confuse it's methodologies if it were marketed as 'ethical finance'.
There are two things that should happen if my description is accurate. First, the Islamic finance industry would reach out to non-Muslims who can see the ethical features of Islamic finance. For example, using non-Muslims' frustrations with large international banks who are using their deposits to finance either unethical or overly risky products and who present a systemic risk to the financial system (and therefore to the economy as well). An approach to this group of potential consumers would b to explain the terms used in Islamic finance, but emphasize the fact that Islamic commercial banks by and large are much more pure intermediaries. They take in deposits and make loans. Depositors are paid based on the profitability of the financing. This is an approach that has been successfully applied by credit unions (at least, I switched from Wells Fargo to a credit union for a similar reason, but I think others did too).
Another example would be to appeal to other consumers with an Abrahamic background who are looking for the 'basics' in terms of screening. They want to avoid pork, gambling, alcohol and tobacco companies and those producing weapons or distributing pornography. These are areas where Islamic finance has a well developed methodology for more than just investment: from banking to private equity. With a proper understanding that the economic outcome of most Islamic banking products is the same, just with different labels, they could be convinced that an Islamic financial institution would be able to meet their needs. The one area where a change of terminology might be helpful to appeal to new consumers would be by finding an alternative to the 'Islamic' label. Even with Arabic terms, the gap can be bridged by explaining how an ijara works, but some consumers may not even ask the question if they think that the financial institution is working only for Muslims based on its 'Islamic' label. This has been done before: Turkish Islamic banks are called participation banks, for example.
Moving to the second way that Islamic finance could attract more non-Muslims without changing its use of Arabic terms: if the industry wants to take on the broad 'ethical' name, it should widen its restrictions beyond the prohibitions it uses now. Of course the expansion of mandate should be vetted by scholars to ensure that they are Shari'ah-compliant, but with few exceptions, that should be an easy test to pass (for example, the mitigation of excessive environmental damage financed by Islamic financial institutions). This would provide a better base for Islamic financial institutions to credibly claim that they are concerned with the wider 'ethical' ideas, beyond those that are prohibited explicitly within Islam.
There are ways that Islamic finance can be opened to non-Muslims more than it has so far, but just changing the terms used or adopting new marketing approaches that use a broad 'ethical' label are unlikely to be successful. Islamic finance can be ethical finance (in fact, for many people it already is), but it depends on the consumer's view of what is ethical and many people's understandings would find gaps in the screens used by Islamic financial institutions today. Reaching out to non-Muslims is important--in many countries it is essential for Islamic financial institutions to grow. However, just changing the names and hoping people understand the industry better and thus choose to use it is not going to be sufficient.
There are many reasons why the industry should use more 'familiar' terms for the products being used and some of the resistance might due to fears that it will move the industry outside of its niche. Not all Muslims are native Arabic speakers so the use of Arabic terms may create a need for more explaining of products than is necessary if they were called by a different name. However, there are differences between the products used and the products they might be called (e.g. ijara versus a lease). If a product is substantively different (for example, in the rights and responsibilities of the two parties as in an ijara compared with a lease), the use of 'lease' instead of ijara could be misleading.
There is a more fundamental reason, I think, that Islamic finance should retain the use of the Arabic terms for products: the industry is created to cater to the specific prohibitions within Islam. It is not in and of itself ethical finance. The industry does not universally adopt an ethical stance that would be expected by many investors, even some Muslims. For example, even within Islam, man is placed as caretaker of the earth, yet many Islamic financial products finance activities that are destructive to the environment. There is not even a delineation between whether the financed companies use industry best practices or are egregiously destructive to the natural environment.
The industry was created and is designed to serve investors who want to avoid that which is prohibited in Islam according to the scholars who advise the financial institutions offering the Islamic financial products. It is not necessarily even created for the needs of all Muslims; there are some Muslims holding a different view of what is permissible in financial services and if those views are outside of the consensus within the Islamic finance Shari'ah scholar community, then the Islamic financial industry may not be suitable for them.
This is not meant to be a critique of Islamic finance. It serves a valuable place in the financial services industry globally by providing an alternative to a significant proportion of Muslims who believe that the way the rules on finance are applied by contemporary Shari'ah scholars is correct. It does a good job at catering to those individuals' needs, even if there remain significant gaps in product offering to actually meet all consumers' needs. However, it would dilute the purpose of Islamic finance and confuse it's methodologies if it were marketed as 'ethical finance'.
There are two things that should happen if my description is accurate. First, the Islamic finance industry would reach out to non-Muslims who can see the ethical features of Islamic finance. For example, using non-Muslims' frustrations with large international banks who are using their deposits to finance either unethical or overly risky products and who present a systemic risk to the financial system (and therefore to the economy as well). An approach to this group of potential consumers would b to explain the terms used in Islamic finance, but emphasize the fact that Islamic commercial banks by and large are much more pure intermediaries. They take in deposits and make loans. Depositors are paid based on the profitability of the financing. This is an approach that has been successfully applied by credit unions (at least, I switched from Wells Fargo to a credit union for a similar reason, but I think others did too).
Another example would be to appeal to other consumers with an Abrahamic background who are looking for the 'basics' in terms of screening. They want to avoid pork, gambling, alcohol and tobacco companies and those producing weapons or distributing pornography. These are areas where Islamic finance has a well developed methodology for more than just investment: from banking to private equity. With a proper understanding that the economic outcome of most Islamic banking products is the same, just with different labels, they could be convinced that an Islamic financial institution would be able to meet their needs. The one area where a change of terminology might be helpful to appeal to new consumers would be by finding an alternative to the 'Islamic' label. Even with Arabic terms, the gap can be bridged by explaining how an ijara works, but some consumers may not even ask the question if they think that the financial institution is working only for Muslims based on its 'Islamic' label. This has been done before: Turkish Islamic banks are called participation banks, for example.
Moving to the second way that Islamic finance could attract more non-Muslims without changing its use of Arabic terms: if the industry wants to take on the broad 'ethical' name, it should widen its restrictions beyond the prohibitions it uses now. Of course the expansion of mandate should be vetted by scholars to ensure that they are Shari'ah-compliant, but with few exceptions, that should be an easy test to pass (for example, the mitigation of excessive environmental damage financed by Islamic financial institutions). This would provide a better base for Islamic financial institutions to credibly claim that they are concerned with the wider 'ethical' ideas, beyond those that are prohibited explicitly within Islam.
There are ways that Islamic finance can be opened to non-Muslims more than it has so far, but just changing the terms used or adopting new marketing approaches that use a broad 'ethical' label are unlikely to be successful. Islamic finance can be ethical finance (in fact, for many people it already is), but it depends on the consumer's view of what is ethical and many people's understandings would find gaps in the screens used by Islamic financial institutions today. Reaching out to non-Muslims is important--in many countries it is essential for Islamic financial institutions to grow. However, just changing the names and hoping people understand the industry better and thus choose to use it is not going to be sufficient.
Tuesday, May 18, 2010
Future growth in Islamic finance, sukuk news
Future growth in Islamic finance
An article in the National newspaper provides a good summary of the growth areas in Islamic finance, as well as the areas of controversy which remain in these areas. The largest focus is on whether creating Shari'ah-compliant hedging contracts is a help or hindrance for the growth of the industry. In some aspects I can see how it reinforces the view that Islamic finance does nothing but mimic conventional financial products. However, as the article notes, longer term financing like what would be necessary for project finance, would be largely absent were there not a way to hedge against currency, commodity price or interest rate fluctuations.
The article also discusses the lack of Islamic microfinance. Moinuddin Malim, the CEO of Mashreq Al Islami, is quoted as saying "We have not yet reached our real audience. We need to develop microfiannce to enable communities to thrive in their own right and bring living standards to them". I would disagree with his characterization of "bringing living standards to them" and replace that with bring affordable, Shari'ah-compliant financial alternatives, but it is definitely an underserved area of Islamic finance. The CGAP competition which recently closed (and I advised two groups who submitted proposals) is a good effort because it focuses on providing seed money to develop sustainable financial institutions (either non-profit or for-profit). However, outside of this and a few efforts by a couple small efforts by (mostly) global financial institutions in Islamic finance, there has been not much more than lip service paid to the need for Islamic microfinance.
There is a lot more to Islamic finance than just structured products that mimic conventional finance for large corporations and sovereigns. Islamic retail banking fills some of the need with a reach towards a larger number of Muslim consumers, but there are many Muslim (and non-Muslim) 'unbanked'. This is the consumer base that the Grameen Bank was formed to serve and it has now attracted a lot of attention from larger financial institutions. The same need is present for the Islamic financial industry to fill and it should be a quicker transition for Islamic financial institutions to recognize this need (and potential) now that conventional microfinance is well established with participation from the larger financial institutions. It is also ideally suited to the underlying ethics behind Islamic finance, which should feel a greater need to promote economic empowerment based on its ethical foundations.
Another article describes the re-emergence of innovation within the Islamic financial industry which has largely been absent during the recession. There are areas--like liquidity management--where innovation can be a positive development to increase the available investment opportunities (particularly short-term and overnight). However, there are also a lot of 'innovations' during the 2005-2008 period in structured products and especially real estate, where 'innovation' can turn into 'high fees with little other benefit'. One example of this that has been described in detail was Gulf Finance House, which was described in a recent paper by Mohammed Khnifer.
The issue of standardization remains contentious. The debate, however, depends on what standardization means, which Debshis Day of Clifford Chance pointed out, is unclear. "Standardization, what does that really mean? It is very difficult for everybody to agree on one thing. People need to understand that even in a conventional market there is not pure standardization". I would agree with him that complete standardization is neither possible nor probably desirable. There are certain areas (like the ISDA-IIFM derivatives standard and the IIFM standardized murabaha agreement) where standardization can be beneficial by reducing costs associated with replicating the same structure. However, these standardized contracts are not, nor should be, mandatory. There are numerous areas where improvements can be made and leaving the door open to new products or new variations of existing products makes sense for the industry as a whole.
Sukuk News
Unicorn Investment Bank and Standard Chartered report they have mandates to work on issuance of $6 billion in sukuk this year. Reportedly, over $4 billion of this amount will be advised by Standard Chartered. An executive at HSBC, Mohammed Dawood, says that issuance of dollar-denominated sukuk may reach $5 billion, matching the previous year's total. The total issuance may be $8.5 billion, about last year's level, but far below the pre-crisis levels in 2007 and 2008. However, due to the Greek crisis and Ramadan, most issuance will be pushed into the third quarter. Al Rajhi Bank, which has been largely absent from the sukuk market due to concerns by its Shari'ah board over the compliance of the sukuk in the markets, plans to launch a sukuk with Cagamas, the Malaysian housing finance agency, in June. Indonesia recently sold $467.5 million in sukuk to the government-managed Hajj fund.
U.S. issuers could make up part of the issuance in the second half of this year or in 2011. GE Capital, which issued a $500 million sukuk last year (my summary of that sukuk) is planning a 'benchmark' sized sukuk in late 2010 or 2011, which is generally over $500 million. In addition, Unicorn Investment Bank, which has a U.S.-based private equity subsidiary UIB Capital, is working on a $250 million sukuk for a U.S.-based company. The only two sukuk issued by U.S.-based companies so far have been the East Cameron sukuk, which ended with investors owning the underlying asset after the issuer entered bankruptcy, and the 2009 GE Capital sukuk.
Another rare issuer coming to market is Malaysia, which will likely offer its first international sukuk since 2002. The sukuk, expected to be an ijara sukuk with a 5-year tenor is said to be backed by government hospital assets. The issue is reported to be a $1 billion, however, it has not been formally announced and is expected to be announced at an Islamic economic forum in Kuala Lumpur.
Robin Amlot writes an interesting review of an e-book published by Euromoney, written by Parvez Daruwalla and Shahzad Siddiqui, in Islamic Business & Finance. The e-book talks about whether the sukuk structure, and in particular sovereign sukuk, could be done better.
Article by the CEO of Gatehouse Bank
Richard Thomas, the CEO of Gatehouse Bank, an Islamic wholesale bank in the UK, has an article about Islamic finance. While in general, he speaks to the general outlook for Islamic finance globally, he makes two notable points. First, he does not fall into the "Islamic finance is immune from the crisis" trap and secondly, he acknowledges the overlap between Islamic finance and ethical/sustainable finance. He writes:
Other News
An article in the National newspaper provides a good summary of the growth areas in Islamic finance, as well as the areas of controversy which remain in these areas. The largest focus is on whether creating Shari'ah-compliant hedging contracts is a help or hindrance for the growth of the industry. In some aspects I can see how it reinforces the view that Islamic finance does nothing but mimic conventional financial products. However, as the article notes, longer term financing like what would be necessary for project finance, would be largely absent were there not a way to hedge against currency, commodity price or interest rate fluctuations.
The article also discusses the lack of Islamic microfinance. Moinuddin Malim, the CEO of Mashreq Al Islami, is quoted as saying "We have not yet reached our real audience. We need to develop microfiannce to enable communities to thrive in their own right and bring living standards to them". I would disagree with his characterization of "bringing living standards to them" and replace that with bring affordable, Shari'ah-compliant financial alternatives, but it is definitely an underserved area of Islamic finance. The CGAP competition which recently closed (and I advised two groups who submitted proposals) is a good effort because it focuses on providing seed money to develop sustainable financial institutions (either non-profit or for-profit). However, outside of this and a few efforts by a couple small efforts by (mostly) global financial institutions in Islamic finance, there has been not much more than lip service paid to the need for Islamic microfinance.
There is a lot more to Islamic finance than just structured products that mimic conventional finance for large corporations and sovereigns. Islamic retail banking fills some of the need with a reach towards a larger number of Muslim consumers, but there are many Muslim (and non-Muslim) 'unbanked'. This is the consumer base that the Grameen Bank was formed to serve and it has now attracted a lot of attention from larger financial institutions. The same need is present for the Islamic financial industry to fill and it should be a quicker transition for Islamic financial institutions to recognize this need (and potential) now that conventional microfinance is well established with participation from the larger financial institutions. It is also ideally suited to the underlying ethics behind Islamic finance, which should feel a greater need to promote economic empowerment based on its ethical foundations.
Another article describes the re-emergence of innovation within the Islamic financial industry which has largely been absent during the recession. There are areas--like liquidity management--where innovation can be a positive development to increase the available investment opportunities (particularly short-term and overnight). However, there are also a lot of 'innovations' during the 2005-2008 period in structured products and especially real estate, where 'innovation' can turn into 'high fees with little other benefit'. One example of this that has been described in detail was Gulf Finance House, which was described in a recent paper by Mohammed Khnifer.
The issue of standardization remains contentious. The debate, however, depends on what standardization means, which Debshis Day of Clifford Chance pointed out, is unclear. "Standardization, what does that really mean? It is very difficult for everybody to agree on one thing. People need to understand that even in a conventional market there is not pure standardization". I would agree with him that complete standardization is neither possible nor probably desirable. There are certain areas (like the ISDA-IIFM derivatives standard and the IIFM standardized murabaha agreement) where standardization can be beneficial by reducing costs associated with replicating the same structure. However, these standardized contracts are not, nor should be, mandatory. There are numerous areas where improvements can be made and leaving the door open to new products or new variations of existing products makes sense for the industry as a whole.
Sukuk News
Unicorn Investment Bank and Standard Chartered report they have mandates to work on issuance of $6 billion in sukuk this year. Reportedly, over $4 billion of this amount will be advised by Standard Chartered. An executive at HSBC, Mohammed Dawood, says that issuance of dollar-denominated sukuk may reach $5 billion, matching the previous year's total. The total issuance may be $8.5 billion, about last year's level, but far below the pre-crisis levels in 2007 and 2008. However, due to the Greek crisis and Ramadan, most issuance will be pushed into the third quarter. Al Rajhi Bank, which has been largely absent from the sukuk market due to concerns by its Shari'ah board over the compliance of the sukuk in the markets, plans to launch a sukuk with Cagamas, the Malaysian housing finance agency, in June. Indonesia recently sold $467.5 million in sukuk to the government-managed Hajj fund.
U.S. issuers could make up part of the issuance in the second half of this year or in 2011. GE Capital, which issued a $500 million sukuk last year (my summary of that sukuk) is planning a 'benchmark' sized sukuk in late 2010 or 2011, which is generally over $500 million. In addition, Unicorn Investment Bank, which has a U.S.-based private equity subsidiary UIB Capital, is working on a $250 million sukuk for a U.S.-based company. The only two sukuk issued by U.S.-based companies so far have been the East Cameron sukuk, which ended with investors owning the underlying asset after the issuer entered bankruptcy, and the 2009 GE Capital sukuk.
Another rare issuer coming to market is Malaysia, which will likely offer its first international sukuk since 2002. The sukuk, expected to be an ijara sukuk with a 5-year tenor is said to be backed by government hospital assets. The issue is reported to be a $1 billion, however, it has not been formally announced and is expected to be announced at an Islamic economic forum in Kuala Lumpur.
Robin Amlot writes an interesting review of an e-book published by Euromoney, written by Parvez Daruwalla and Shahzad Siddiqui, in Islamic Business & Finance. The e-book talks about whether the sukuk structure, and in particular sovereign sukuk, could be done better.
Article by the CEO of Gatehouse Bank
Richard Thomas, the CEO of Gatehouse Bank, an Islamic wholesale bank in the UK, has an article about Islamic finance. While in general, he speaks to the general outlook for Islamic finance globally, he makes two notable points. First, he does not fall into the "Islamic finance is immune from the crisis" trap and secondly, he acknowledges the overlap between Islamic finance and ethical/sustainable finance. He writes:
"Islamic finance has, however, been met with enormous challenges. It has not escaped the global downturn despite Islamic banks being safeguarded by the nature of their Shariah principles against exposure to subprime mortgages and the other toxic assets that have hurt the balance sheets of so many of the world’s biggest financial institutions. "
[...]
As it is, a substantial amount of business transacted in an ethical or sustainable format may qualify as Sharia compliant. This demand for products and investments, while primarily fuelled by the world’s 1.3 billion Muslims, is supporting interesting crossover products that benefit from the same ethical criteria."
Other News
- Golden Belt Sukuk holders approved the dissolution of the sukuk trust, making the sukuk holders unsecured creditors of Saad Group.
- The Central Bank of Bahrain's sukuk al-ijara issue was oversubscribed by 230%. The sukuk has a maturity of 182 days.
- Dana Gas reset the conversion rate on its sukuk according to JPMorgan Chase & Co., the calculation agent.
- South African investment management firm is planning on launching its products outside of its home country including within Europe.
- Aston Business School will launch an MSc and PhD program in Islamic banking with sponsorship from the CEO of Dubai-based Surgi Tech.
- Al Rajhi Steel Industries, a Saudi rebar manufacturer obtained a $196.5 billion Shari'ah-compliant bank loan to finance construction of a new plant in Jeddah.
- The Iraqi bank Ashur Bank is exploring offering an Islamic banking window, for which it submitted an application six months ago to the Central Bank of Iraq. 7 of Iraq's 42 banks are Islamic banks.
Wednesday, April 28, 2010
Dubai World, Saad Group
The Dubai World debt negotiations hit another potential snag with the repayment of the Nakheel sukuk maturing in May becoming more likely even without a restructuring deal. This compounds the issues caused by the offer of a 1% interest rate for banks who are owed money by Dubai World at the same time that trade creditors are offered 40% cash payment with the remaining 60% paid through a sukuk yielding 10%. A top official at Al Ghurair, which is described as a 'key trade creditor' by Emirates Business 24/7, said the 10% profit was "very generous".
I have previously questioned whether the restructuring would incorporate Shari'ah-complaince and there still has not been a complete reporting of this aspect of the restructuring. However, the use of a sukuk to repay trade creditors indicates that Dubai World remains interested in Islamic finance. The big potential problem is the differential treatment of different creditors, most of which are unsecured creditors. Banks are offered 1%, trade creditors offered 10% on a portion with the remaining being repaid while sukuk holders of the sukuk maturing next month receive full repayment. This differential treatment does no favors to Islamic finance because it reinforces the uncertainty about the rights of creditors in one of the largest geographical concentrations of sukuk issuers. This will make it more difficult for issuers to bring new sukuk to market because although the problems are largely Dubai-related, the uncertainty is generalized to the UAE, if not the GCC. Although the debt holders would suffer delays and would probably come out worse for it, for the Islamic finance industry, it may have been preferable for the whole Dubai World mess to end up in the tribunal in front of internationally recognized judges under DIFC law, which closely resembles English law.
Sukuk holders of the Saad Group have agreed to dissolve the sukuk trust. According to a Reuters factbox, the Saad Group sukuk was an asset-based sukuk, which would mean that the dissolution of the sukuk trust does not provide investors with an avenue to recover their money except through a bankruptcy proceeding as unsecured creditors of Saad Group, where they would be treated equally (pari passu) with other unsecured debt holders and subordinated to any secured creditors.
Khalil Jarrar has an interesting column in the latest Opalesque Islamic Finance Intelligence.
My latest article on the East Cameron sukuk was published by Islamic Business & Finance in the latest issue.
Other News
I have previously questioned whether the restructuring would incorporate Shari'ah-complaince and there still has not been a complete reporting of this aspect of the restructuring. However, the use of a sukuk to repay trade creditors indicates that Dubai World remains interested in Islamic finance. The big potential problem is the differential treatment of different creditors, most of which are unsecured creditors. Banks are offered 1%, trade creditors offered 10% on a portion with the remaining being repaid while sukuk holders of the sukuk maturing next month receive full repayment. This differential treatment does no favors to Islamic finance because it reinforces the uncertainty about the rights of creditors in one of the largest geographical concentrations of sukuk issuers. This will make it more difficult for issuers to bring new sukuk to market because although the problems are largely Dubai-related, the uncertainty is generalized to the UAE, if not the GCC. Although the debt holders would suffer delays and would probably come out worse for it, for the Islamic finance industry, it may have been preferable for the whole Dubai World mess to end up in the tribunal in front of internationally recognized judges under DIFC law, which closely resembles English law.
Sukuk holders of the Saad Group have agreed to dissolve the sukuk trust. According to a Reuters factbox, the Saad Group sukuk was an asset-based sukuk, which would mean that the dissolution of the sukuk trust does not provide investors with an avenue to recover their money except through a bankruptcy proceeding as unsecured creditors of Saad Group, where they would be treated equally (pari passu) with other unsecured debt holders and subordinated to any secured creditors.
Khalil Jarrar has an interesting column in the latest Opalesque Islamic Finance Intelligence.
My latest article on the East Cameron sukuk was published by Islamic Business & Finance in the latest issue.
Other News
- The World Bank and the International Finance Corporation will be in Malaysia to discuss a Shari'ah-compliant fund for green technology investments.
- The relative strengths and weaknesses of using equity vs. debt in Islamic finance acording to an executive at Elaf Bank in Bahrain.
- Arcapita is planning to build a fund management business to reduce the cyclicality of revenues in the private equity business. I believe this is something that more Islamic investment banks and private equity houses will undertake to smooth their revenues and reduce the prospects of being severely harmed in future downturns and this is good for the industry as a whole.
- The Abu Dhabi Stock Exchange may begin to indicate which investments are Shari'ah-compliant and which are not.
- The CEO of a Malaysian invesmtent bank, Alliance Investment Bank, says that sukuk have a promising future.
- Kencana Petroleum Bhd, a Malaysian oil and gas services company, is planning to issue $78 million (MYR250 million) in sukuk sales. Cagamas issued $156 million (MYR500 million) in 5 year sukuk that were rated AAA by MARC because Cagamas is state-owned.
- Indonesia issued $22 million in sukuk, about 20% of its planned offering. Demand was limited, according to reports, because of limited liquidity in the sukuk.
- KPMG in India has expressed support for the development of guidance from the central bank for Islamic financial institutions in the country which have been slow to develop.
- The latest monthly commentary abou the performance of the Dow Jones Islamic Market Indexes for April is now available.
- Dundee University in Scotland will offer a postgraduate degree in Islamic finance.
- AsiaOne has a summary of Islamic finance structures that are commonly used.
- The company offering Salaam Halal, Principle Insurance Holdings, has been sold to a Kuwaiti buyer who was one of the largest shareholders.
- AAOIFI will hold its annual meeting at the end of May.
- The new Christian ETFs will not be a competition to Islamic financial products, but will encourage greater uptake of ethical products, according to an article in the Malaysian Insider.
Sunday, April 11, 2010
What does Islamic finance provide and how can it be improved?
With some of the criticism of Islamic finance as nothing more than a replication of conventional finance, I took a chance to think over what the goals of Islamic finance should be and where the current state of the industry fits within the larger idea.
First, the criticism of Islamic finance as a replication of conventional finance does have merits. The way Islamic finance works today is not one that is seeking to completely overhaul the conventional financial industry. Instead, it seeks to provide the basic financial products like bonds and banking services to Muslim consumers who don't want to work within an interest-based financial system. For the most part, these consumers want to have the same opportunities as those who are comfortable working with the interest-based financial system.
The basic products are replications of conventional financial products and in most cases, that is not a bad thing. Using modified contracts to achieve the same ends as conventional finance will make it more likely that the products are comparably priced with conventional financial services, which is important. That these products are priced accordingly with conventional financial products is a benefit not a cost. There should be a goal within the industry to make the plain-vanilla products equally priced so there is no premium paid for using Islamic versus conventional financial products. The important thing is that the means and the intent by which these products are delivered is that they should be put together in a way that is broadly accepted by scholars as Shari'ah-compliant.
There are limits to how far this replication can proceed. There are financial innovations that are detrimental to society at large and if these are replicated in Shari'ah-compliant forms, then there is clearly a problem. The main deficiency with the Shari'ah review process as I understand it is that there is a focus on the specific contractual form, not necessarily as thorough a review of the social implications of a given product. If a product is created (e.g. in the conventional space, the negative amortization mortgage) which relies upon a continually rising house price to benefit the consumer and in any other case will harm him on average, then it would not be appropriate to create a Shari'ah-compliant version of the product.
It is not certain that the use of murabaha or tawarruq financing necessarily produces this social harm because in its absence, there will be a voluntary decision by many consumers to not receive financing at all. This will avoid some of those consumers from entering into a situation where they endanger their financial health, but it will also create hardship for some consumers who could benefit from receiving credit to finance education, healthcare, or a new business. On balance, there is not enough evidence that the use of murabaha or tawarruq creates net social harm.
Similarly, the use of asset-based sukuk which replicate an unsecured bond may not create anything different from a conventional product, but it provides an investment opportunity, for example, for an investment portfolio managed in a Shari'ah-compliant way for a pension fund or takaful provider that can introduce diversification in the way that a profit-and-loss sharing equity investment cannot. The product will not necessarily create a new type of financial system, but it will provide benefits to the investors who are not able to diversify using a conventional bond allocation. In its absence, there will be overallocation to real estate or equities, which are much more volatile and can lead to significant harm if (read: when) there is another significant market downturn.
That is the 'good' type of replication that I see. There is also some that is negative. The creation of products (particularly some of the structured products) that come with high fees for investors and these fees may leave them worse off than if the products had never existed in the first place (although providing significant income to the financial institutions and law firms which created them). As the real estate boom in some areas of the Gulf turned into a bubble which eventually burst, there were plenty of Islamic financial products which fall into the category of what I described. This distinction should be made clear between the over-structured products that are accompanied high fees from the basic banking products which promote inclusion within the financial systems for Muslim consumers that choose to avoid the interest-based conventional financial system.
However, that perspective alone feels a bit empty in terms of what the Islamic financial system is supposed to provide and the similarities it shares with socially responsible and ethical finance. There is one aspect that is omitted from the above discussion that is key for the Islamic finance industry to live up to its billing as another form of ethical finance. There should be a proactive and positive approach to financing ethical businesses and doing good for the world through its operations. Right now, it is too focused on avoiding that which is prohibited while ignoring doing what is encouraged. There are two areas where I think a start should be made: 1) make an extra effort to finance businesses that are environmentally responsible and those that are focused on making businesses more environmentally friendly (companies that provide products that make more efficient use of energy and those that can help develop and integrate renewable energy); 2) use some of the profits and expertise from creating Islamic financial products to help those who are less well off, through focusing on providing financing to small and micro-businesses.
These two areas are important for Islamic financial institutions because they promote beneficial activities for the world and people in need while not forcing the industry from leaving its core area of expertise, which is in financing businesses and individuals. There are many charitable organizations that can provide other services where they have better skills at how to do this efficiently. In the financial area, Islamic financial institutions can work more closely to use their role as a financial intermediary to improve the state of the world. If they choose not to do this, then it would be fair to accuse them of being little more than a re-structured version of conventional banks without a special feeling of obligation to pursue a more ethically focused form of business.
First, the criticism of Islamic finance as a replication of conventional finance does have merits. The way Islamic finance works today is not one that is seeking to completely overhaul the conventional financial industry. Instead, it seeks to provide the basic financial products like bonds and banking services to Muslim consumers who don't want to work within an interest-based financial system. For the most part, these consumers want to have the same opportunities as those who are comfortable working with the interest-based financial system.
The basic products are replications of conventional financial products and in most cases, that is not a bad thing. Using modified contracts to achieve the same ends as conventional finance will make it more likely that the products are comparably priced with conventional financial services, which is important. That these products are priced accordingly with conventional financial products is a benefit not a cost. There should be a goal within the industry to make the plain-vanilla products equally priced so there is no premium paid for using Islamic versus conventional financial products. The important thing is that the means and the intent by which these products are delivered is that they should be put together in a way that is broadly accepted by scholars as Shari'ah-compliant.
There are limits to how far this replication can proceed. There are financial innovations that are detrimental to society at large and if these are replicated in Shari'ah-compliant forms, then there is clearly a problem. The main deficiency with the Shari'ah review process as I understand it is that there is a focus on the specific contractual form, not necessarily as thorough a review of the social implications of a given product. If a product is created (e.g. in the conventional space, the negative amortization mortgage) which relies upon a continually rising house price to benefit the consumer and in any other case will harm him on average, then it would not be appropriate to create a Shari'ah-compliant version of the product.
It is not certain that the use of murabaha or tawarruq financing necessarily produces this social harm because in its absence, there will be a voluntary decision by many consumers to not receive financing at all. This will avoid some of those consumers from entering into a situation where they endanger their financial health, but it will also create hardship for some consumers who could benefit from receiving credit to finance education, healthcare, or a new business. On balance, there is not enough evidence that the use of murabaha or tawarruq creates net social harm.
Similarly, the use of asset-based sukuk which replicate an unsecured bond may not create anything different from a conventional product, but it provides an investment opportunity, for example, for an investment portfolio managed in a Shari'ah-compliant way for a pension fund or takaful provider that can introduce diversification in the way that a profit-and-loss sharing equity investment cannot. The product will not necessarily create a new type of financial system, but it will provide benefits to the investors who are not able to diversify using a conventional bond allocation. In its absence, there will be overallocation to real estate or equities, which are much more volatile and can lead to significant harm if (read: when) there is another significant market downturn.
That is the 'good' type of replication that I see. There is also some that is negative. The creation of products (particularly some of the structured products) that come with high fees for investors and these fees may leave them worse off than if the products had never existed in the first place (although providing significant income to the financial institutions and law firms which created them). As the real estate boom in some areas of the Gulf turned into a bubble which eventually burst, there were plenty of Islamic financial products which fall into the category of what I described. This distinction should be made clear between the over-structured products that are accompanied high fees from the basic banking products which promote inclusion within the financial systems for Muslim consumers that choose to avoid the interest-based conventional financial system.
However, that perspective alone feels a bit empty in terms of what the Islamic financial system is supposed to provide and the similarities it shares with socially responsible and ethical finance. There is one aspect that is omitted from the above discussion that is key for the Islamic finance industry to live up to its billing as another form of ethical finance. There should be a proactive and positive approach to financing ethical businesses and doing good for the world through its operations. Right now, it is too focused on avoiding that which is prohibited while ignoring doing what is encouraged. There are two areas where I think a start should be made: 1) make an extra effort to finance businesses that are environmentally responsible and those that are focused on making businesses more environmentally friendly (companies that provide products that make more efficient use of energy and those that can help develop and integrate renewable energy); 2) use some of the profits and expertise from creating Islamic financial products to help those who are less well off, through focusing on providing financing to small and micro-businesses.
These two areas are important for Islamic financial institutions because they promote beneficial activities for the world and people in need while not forcing the industry from leaving its core area of expertise, which is in financing businesses and individuals. There are many charitable organizations that can provide other services where they have better skills at how to do this efficiently. In the financial area, Islamic financial institutions can work more closely to use their role as a financial intermediary to improve the state of the world. If they choose not to do this, then it would be fair to accuse them of being little more than a re-structured version of conventional banks without a special feeling of obligation to pursue a more ethically focused form of business.
Sunday, March 07, 2010
Islamic finance restructuring news
The restructuring theme is in full force right now for Islamic finance and related companies. Global Investment House received an award for most innovative deal for its restructuring that included an Islamic tranche. Dubai World is expected to approach its creditors in London which will include Nakheel sukuk creditors and those who provided financing for Limitless, which has a syndicated Islamic facility coming due. The Investment Dar may use a recently passed 'financial stability law' to protect itself from creditors who have not agreed to its restructuring plan.
Other News
Other News
- Gulf Finance House is planning to launch an Islamic bank in Syria called the Syria Finance House.
- An article in a Turkish newspaper discusses Bank Asya, one of the participation banks in the country.
- An article on Mideast fund managers provides some statistics on the distribution of Islamic funds across the world in advance of an Amanie-Failaka conference.
- The CEO of the Badr-Forte bank, an Islamic financial institution in Russia, is starting a new Islamic financial institution, Al-Shams Capital.
- I found this article with an interview with Professor Catherine Cowley about the relationship between ethics and finance interesting.
- Islamic hedge funds have, not surprisingly because of limited offerings, not been a prominent fixture in fund managers' portfolios with only 19.7% of Middle East investors reporting that they invested in Islamic hedge funds.
Sunday, November 15, 2009
Islamic and ethical finance, Nakheel sukuk, sukuk markets
The CEO of Noor Islamic Bank highlighted the opportunity for Islamic banking to compete with conventional banking in the wake of the financial crisis. He suggested that the financial crisis has created additional demand for ethical and more risk averse financial services, which would benefit Islamic finance. I think that Hussain Al Qemzi, the CEO, is making an important point for the Islamic finance industry by recognizing the two selling points for Islamic finance, especially if it is going to be able to attract non-Muslim customers, is the ethical framework (which has many similarities to the ethical/sustainability-focused mindset that goes beyond just Muslims) and the relatively more risk averse structure of Islamic finance. A focus on these areas could assist Islamic financial institutions in expanding outside of the main areas where Islamic finance exists.
The Nakheel sukuk is now trading above the redemption value on maturity, reflecting the additional premium payable to sukuk holders if there is no qualified public offering before the sukuk matures. This also reflects confidence that the sukuk will be redeemed in full upon maturity, which has been a longstanding concern given the property market collapse in Dubai since the sukuk was issued. Nakheel is currently in talks with Dubai World, which has guaranteed the sukuk that mature in December. Bloomberg also has an article on the subject.
The sukuk market has rebounded by about 40% compared to the first ten months of 2008. However, the issuance has been mostly by sovereign or government-related entities (GREs). This means that the credit quality of new issues has improved, which Moody's believes is a positive because it will help develop a "more detailed yield curve" which will benefit corporate issuers in the future. However, the lack of many corporate issuers, besides the most highly rated issuers like Saudi Electric Company (which was forced to pay far more than their sukuk of 2007) is potentially problematic for the market. Without a variety of issuers across the credit ratings scale, there will be few opportunities for companies to enter the market and the continued growth in the market will be limited. Only time will tell whether this persists, but the first signs of a rebound in the corporate sukuk area should come from the secondary markets. If trading of listed corporate sukuk becomes more liquid, it may begin to entice new issuers into the market.
Islamic Finance Resources, another blog, has some great material posted up and one of the recent is a collection of webcasts and podcasts on Islamic finance. This site is definitely recommended as a source of invaluable resources on Islamic finance.
Other News
The Nakheel sukuk is now trading above the redemption value on maturity, reflecting the additional premium payable to sukuk holders if there is no qualified public offering before the sukuk matures. This also reflects confidence that the sukuk will be redeemed in full upon maturity, which has been a longstanding concern given the property market collapse in Dubai since the sukuk was issued. Nakheel is currently in talks with Dubai World, which has guaranteed the sukuk that mature in December. Bloomberg also has an article on the subject.
The sukuk market has rebounded by about 40% compared to the first ten months of 2008. However, the issuance has been mostly by sovereign or government-related entities (GREs). This means that the credit quality of new issues has improved, which Moody's believes is a positive because it will help develop a "more detailed yield curve" which will benefit corporate issuers in the future. However, the lack of many corporate issuers, besides the most highly rated issuers like Saudi Electric Company (which was forced to pay far more than their sukuk of 2007) is potentially problematic for the market. Without a variety of issuers across the credit ratings scale, there will be few opportunities for companies to enter the market and the continued growth in the market will be limited. Only time will tell whether this persists, but the first signs of a rebound in the corporate sukuk area should come from the secondary markets. If trading of listed corporate sukuk becomes more liquid, it may begin to entice new issuers into the market.
Islamic Finance Resources, another blog, has some great material posted up and one of the recent is a collection of webcasts and podcasts on Islamic finance. This site is definitely recommended as a source of invaluable resources on Islamic finance.
Other News
- Sukuk could be the new alternative investment in the wake of the financial crisis which saw risky investments take large hits because of its more conservative structure.
- Indonesia will not pay higher yields on sukuk than conventional bonds. This comes following investor demand for higher yields on several recent sukuk auctions.
- SWIFT is working with Path Solutions on a financial messaging system for the Islamic banking industry.
- Swiss company Sarasin is launching an Islamic wealth management unit.
- QInvest and Fortis Bank are launching a Shari'ah-compliant ship financing fund.
- Indonesian company Mitra is issuing a 200 billion rupiah ($21.4 million) sukuk along with a conventional bond.
- Pakistan is considering issuing a sovereign sukuk.
- Bank Negara Malaysia governor Dr. Zeti Akhtar Aziz gave a speech highlighting the prospects of Islamic finance integrating into the international financial system. She also highlighted in another speech the ability of Islamic finance to deal with the risks to the Islamic financial system.
- UBS is planning to expand to offer Islamic derivatives to help clients hedge risks, reports Reuters.
- DIFC and bankers in London are discussing partnerships and new opportunities. A conference held by UK Trade & Investment will discuss the effects of the credit crisis on Islamic finance.
- France may also look to Malaysia for guidance on developing its Islamic financial industry. Australia may also become a source of sukuk based on its natural resource wealth, according to the deputy governor of the Malaysian central bank.
- Hong Kong continues to move forward on its plans to attract Islamic finance with proposed tax changes to level the playing field for sukuk.
- The FT discusses the attention paid to Islamic finance following the financial crisis.
Thursday, May 14, 2009
State Street report on Islamic finance
The State Street report on Islamic finance that was recently announced (see previous blog post) provides a good overview of where the industry is now and what the primary risks and issues challenges that face it. I would recommend that those interested in the full report request it from State Street at vision@statestreet.com. A few quotes and comments from me are below.
"While Shariah’s faith-based principles continue to hold strong appeal for Muslims, the pragmatic benefits arising from its application are becoming increasingly attractive to non-Muslims as well, particularly during the current economic crisis and the intense focus on risk management we are witnessing."This is a particular interest to me as a non-Muslim that sees the potential benefit from Islamic finance to the ethical finance industry. The latter has been very good at screening investments (and using positive in addition to negative screens which Islamic finance is just beginning to consider). However, the move from investing to finance more generally has been slow in other areas of ethical finance and the tools developed within Islamic finance could provide a good path for ethical finance to move into new areas.
"These [Shari'ah] boards are viewed as both an auditor for the company offering the financial service or product, and a consumer advocate for the company’s clients."I think the idea of Shari'ah boards as 'auditors' and 'consumer advocates' is understated. However, the way the Shari'ah review process is currently structured where Islamic financial institutions pay scholars directly compromises this role in perception if not in reality. The idea of standardization has been widely promoted (including by me) but the easier and just as important area that is coming into its own is external companies that provide Shari'ah review services. The development of this service is a positive development for the industry, but just as with the problems at credit ratings agencies has spurred criticism about their independence (and a similar critique of accountants and auditors in the early 2000s) the Islamic finance industry needs to continue to develop standards to ensure that Shari'ah boards are truly independent and unbiased. This is beginning to develop with IFSB standards on Shari'ah review (ED10, pdf).
"Financial institutions in the Gulf are experiencing widening mismatches between longer-term maturities on the loans they extend and the shorter-term financing that backs them, creating demand for access to longer-term funding."The asset-liability maturity mismatch is one of the greatest problems facing the Islamic finance industry. Secondary markets will help, but as conventional financial institutions are realizing, the mere existence of secondary markets does not ensure that they function efficiently.
"The perception of whether a product or service is Shariah compliant, or whether an institution is engaged in activities that are deemed unlawful under Shariah, leads to reputation risk. Again, the Shariah supervisory board plays a crucial role in conducting due diligence and helping to ensure compliance to mitigate this risk."Reputation risk is one of the areas where Islamic finance is more risky, but also one of the factors that constrains excesses. If institutions are subject to rigorous Shari'ah audits and require this for their continued recognition by consumers as an Islamic financial institution, it should constrain their activities that could lead to a negative audit result.
"Collateral coverage at Islamic financial institutions is often higher for conventional banks since they have an obligation to back any transaction with a tangible, underlying asset. Still, certain transactions carried out by Islamic banks can bear above-average credit risk, namely musharaka (venture capital financing) and mudaraba (trust financing), which can increase the risks carried by the banks. In addition, in murabaha (mark-up financing) and ijara, the existence of full collateral could lead Islamic banks to be less vigilant when assessing the creditworthiness of their borrowers.This outline of the risks (credit, funding and liquidity risks) is very well outlined and really hammers home the issues facing the industry.
Funding and liquidity risk is one of the most critical issues for Islamic financial institutions since only a small secondary market exists to enable them to manage liquidity. Their assets are generally not sellable on a secondary market, and they aren’t able to invest in fixed-income instruments for treasury management purposes.
Liquidity risk is of particular concern with regard to PSIAs, should PSIA holders decide to withdraw their deposits at maturity. Islamic institutions have developed some layers of protection to deal with this, namely profit equalization reserves, mudarib fees and investment risk reserves."
"Opening the door to additional alternative forms of investing, particularly ones that emphasize the sharing of risk and reward, will certainly help to facilitate our goal. Despite an impending market recovery, we are likely to see a continued trend toward risk-averse investments and intense scrutiny of investment practices across the board, which will give Islamic finance a boost for years to come."I wonder whether a recovery will lead to enough introspection for long enough to lead to more sustained attention to Islamic finance, but for the near term, it should provide an opportunity for the industry.
Tuesday, December 23, 2008
Islamic finance running into problems in the GCC, expanding elsewhere
France is considering regulatory and tax changes to allow Islamic banks to compete and enter the market which could be one of the largest in Europe based on the relative share of the population that is Muslim. At least three banks have requested permission to operate in France, the Qatar Islamic Bank, Kuwait Finance House and Al Baraka Islamic Bank of Bahrain. The Islamic banks operating in the UK would also likely be interested in France and would probably face an easier time expanding because of the financial sector harmonization promoted by the European Union.
The Commercial Bank of Kuwait cancelled plans to buy a 19 percent stake in Boubyan Bank from The Investment Dar, something that was part of reported plans by the Investment Dar to raise money.
As a result of the credit crisis, the Turkish government is considering issuing sukuk, although like the Islamic banking sector, it will not be explicitly labeled as Islamic (Islamic banks are called 'special finance houses' in the country).
A Shari'ah-compliant green fund trading carbon credits is being launched, although it is not immediately clear to me how they will engage in 'active trading' in the carbon markets in a Shari'ah-compliant way.
The market for sukuk and IPOs in Saudi Arabia has taken a tumble since the credit crisis spread across the world and out of the financial system into the real economy. The Central Bank of Bahrain's regular ijara sukuk issue was oversubscribed as normal however. The State Bank of Pakistan, the country's central bank, successfully issued Rs. 6 billion ($76 million) in sukuk, providing Islamic banks an investment for their surplus liquidity.
The property market in Dubai is experiencing a squeeze and, although it is not clear which companies bear the greatest brunt of it, there are probably some Islamic finance companies that will be hurt. Dar Al Shari'ah, a consulting subsidiary of Dubai Islamic Bank, believes that publicly traded Shari'ah-compliant securitizations could provide funding for home finance that would allow smaller investors to become involved.
An article compares the zero interest rate policies of the Bank of Japan and the US Federal Reserve to Islamic banking. I think the analogy is entirely incorrect because Islamic finance doesn't actually use a 'zero interest rate', it structures financing differently. Although some of the products may resemble interest-bearing instruments, they are not offered at zero cost. Borrowers are making financing available based on an expected (non-zero) return. I think that many articles miss the real compelling facets of Islamic finance when it is boiled down to 'they don't use interest'.
The Commercial Bank of Kuwait cancelled plans to buy a 19 percent stake in Boubyan Bank from The Investment Dar, something that was part of reported plans by the Investment Dar to raise money.
As a result of the credit crisis, the Turkish government is considering issuing sukuk, although like the Islamic banking sector, it will not be explicitly labeled as Islamic (Islamic banks are called 'special finance houses' in the country).
A Shari'ah-compliant green fund trading carbon credits is being launched, although it is not immediately clear to me how they will engage in 'active trading' in the carbon markets in a Shari'ah-compliant way.
The market for sukuk and IPOs in Saudi Arabia has taken a tumble since the credit crisis spread across the world and out of the financial system into the real economy. The Central Bank of Bahrain's regular ijara sukuk issue was oversubscribed as normal however. The State Bank of Pakistan, the country's central bank, successfully issued Rs. 6 billion ($76 million) in sukuk, providing Islamic banks an investment for their surplus liquidity.
The property market in Dubai is experiencing a squeeze and, although it is not clear which companies bear the greatest brunt of it, there are probably some Islamic finance companies that will be hurt. Dar Al Shari'ah, a consulting subsidiary of Dubai Islamic Bank, believes that publicly traded Shari'ah-compliant securitizations could provide funding for home finance that would allow smaller investors to become involved.
An article compares the zero interest rate policies of the Bank of Japan and the US Federal Reserve to Islamic banking. I think the analogy is entirely incorrect because Islamic finance doesn't actually use a 'zero interest rate', it structures financing differently. Although some of the products may resemble interest-bearing instruments, they are not offered at zero cost. Borrowers are making financing available based on an expected (non-zero) return. I think that many articles miss the real compelling facets of Islamic finance when it is boiled down to 'they don't use interest'.
Wednesday, December 17, 2008
Islamic finance may face challenges from economic slowdown; another call for focus on the ethical basis of Islamic finance
Although there has been a lot of suggestion that Islamic finance is immune to the credit crisis (although it may be hurt by the follow on economic slowdown), the Islamic financial industry has not yet gone through a period where the legal structure has been tested if the issuers of sukuk, for example, default. For example, there has not been a challenge of whether sukuk holders have a claim on the asset used to back sukuk. According to an article in Asian Banker, the IFSB says that they should, but the fallout from the economic slowdown may result in an actual test of whether or not sukuk holders get ownership of the underlying asset in the case of default.
A EFG-Hermes report on the UAE says that the merger of Islamic finance companies Amlak and Tamweel will be a balancing act and that "one thing we can be reasonably confident is that while Amlak and Tamweel may make it to the beginning of the year, they are unlikely to make it to the end".
Farmida Bi argues that focusing too narrowly on specific rules as opposed to the intent of Shari'ah guidelines hampers growth and that "If Islamic finance is seen in its true guise as a form of ethical financing, of interest to all rather than only as a faith-based activity of interest to the Muslim population, it is likely to find favour with a different type of conventional investor who would be potentially willing to consider different types of risk-reward stuctures." I wholeheartedly agree that Islamic finance should focus on the objectives (maqasid) of the Shari'ah and should work to attract non-Muslims. This will ensure that the industry does not just become an exercise in structured finance, but promotes a greater ethical cause that is shared among peoples of all faiths.
Japan's largest bank, the Bank of Tokyo-Mitsubishi UFJ is planning to offer Islamic financial services in the Middle East and Asia. Japanese companies have been exploring growth into Islamic finance and some have started to become involved in the industry.
Islamic finance in India is finally beginning to develop some momentum.
A EFG-Hermes report on the UAE says that the merger of Islamic finance companies Amlak and Tamweel will be a balancing act and that "one thing we can be reasonably confident is that while Amlak and Tamweel may make it to the beginning of the year, they are unlikely to make it to the end".
Farmida Bi argues that focusing too narrowly on specific rules as opposed to the intent of Shari'ah guidelines hampers growth and that "If Islamic finance is seen in its true guise as a form of ethical financing, of interest to all rather than only as a faith-based activity of interest to the Muslim population, it is likely to find favour with a different type of conventional investor who would be potentially willing to consider different types of risk-reward stuctures." I wholeheartedly agree that Islamic finance should focus on the objectives (maqasid) of the Shari'ah and should work to attract non-Muslims. This will ensure that the industry does not just become an exercise in structured finance, but promotes a greater ethical cause that is shared among peoples of all faiths.
Japan's largest bank, the Bank of Tokyo-Mitsubishi UFJ is planning to offer Islamic financial services in the Middle East and Asia. Japanese companies have been exploring growth into Islamic finance and some have started to become involved in the industry.
Islamic finance in India is finally beginning to develop some momentum.
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