Moody’s Report on Islamic Banking

| Friday, August 28, 2009

Riyadh, Asharq Al-Awsat- Moody’s Investors Services recently issued a report on Islamic banking in which the credit-rating agency identified several points of weakness that it believes in future will threaten these Islamic financial institutions and their credit rating.

The truth is that the report brought nothing new to the table with regards to highlighting the points of weakness that Islamic banks suffer from as highlighted by many specialists in this industry. Many of these points have previously been made in this column, as they are no secret to any of the observers who follow the Islamic banking industry.

For example, the report mentioned that Islamic banks suffer from managing excessive liquidity, and this is a fact especially with regards to the management of short-term liquidity, or ‘overnight’ liquidity.

Islamic banks today are suffering from the fact that there is no Islamic-compliant tool that serves as an alternative to the loan that is used in conventional banking and that is prohibited in Islamic Shariaa. The Murabaha is considered too costly in this case and therefore unsuitable, let alone its lengthy documentation procedures. As a result, some Islamic banks resorted to exchanged loans to manage such liquidity. In fact, this tool is ineffective in terms of the way it operates, let alone the fact that several religious figures believe that it is illegitimate. Therefore, in many cases, management of short-term liquidity in these banks is considered inefficient. This problem is not a new one; it is as old as Islamic banking itself.

According to the report, Islamic banks suffer from weak risk management, particularly in terms of the handling of asset-liability maturity mismatches. This is also an old problem, as many Islamic banks rely on current accounts as a major source of deposit, being a short-term source, moreover it is among the most critical kinds of deposits that can be used in finance, especially if it is long-term as in cases of real-estate finance and infrastructure projects, which form the core of Islamic funding.

In order for many of these banks to rely on current accounts as the most important source of their deposits, we find that many of these banks are not interested in covering the risk of changeable interest rates because these accounts are free accounts. In other words, the bank pays no interest to account holders, so it is no cost to the bank.

This may explain to us, as well as to Moody’s, why Islamic banks are not keen on creating products that coordinate between asset-liability discrepancies. However, I think that this situation will not continue as the era of free finance regarding Islamic banks is on the verge of disappearing as conventional banks have strongly entered the field of Islamic banking. Moreover, the number of Islamic banks is on the rise and this increases the heat of the competition over this finance whereby the ways of attracting finance vary. We have seen signs of this competition in Saudi Arabia where the Kingdom’s bank launched a current account that allows the account holder to gain part of the bank’s profits, in addition to the pressures that the credit rating agencies may put on Islamic banks to coordinate between the due dates of assets and liabilities in these banks aimed at limiting the risk they have because of these discrepancies and the effect that these discrepancies will have on the bank’s credit rating. Therefore, Islamic banks must develop products that can achieve such a balance.

What is new in the report is the indication that the Islamic finance sector has maintained stability despite the global financial crisis thanks to ample liquidity, safe debts, and high-profit margins. This is crux of the matter with regards to the effect of the Islamic banking industry on the crisis. This is to silence those who cast doubts on the strength of this industry and to disprove the idea that it has been directly affected by the global financial crisis. This testimony is issued by a notable and a neutral international agency based on accurate and carefully-studied information. Therefore, there is no room for sceptics to contest this or cast doubts.

Link: http://aawsat.com/english/news.asp?section=6&id=17873

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