What the West Can Learn From Islamic Banking

Across the Middle East and South-East Asia, Islamic financial institutions hold aggregated assets estimated to be worth $50 billion. To some, this cash-rich sector represents a huge opportunity for growth and investment. But perhaps, what Islamic banks can really offer is a set of guiding principles that can enhance financial stability, four years after the crisis.

Will centre of gravity of global finance shift from London and New York to the Gulf and Kuala Lumpur?
Photo Credit: creativei images

Given they are barred from charging interest and must abide by a strict religious code, Islamic financial institutions are often dismissed by sophisticated western bankers as living in the dark ages. However, according to a couple of recent major reports, shariah-compliant financial institutions are not only coming of age, but also have much to teach their western counterparts.

In a report, Empowering Risk Intelligence in Islamic Finance: Managing Risk in Uncertain times, Deloitte’s Islamic Finance Knowledge Center said that the approach to risk management used in Islamic finance has more in common with the western approach than is often assumed.

The report – based on a survey of 20 Islamic financial institutions located across the Middle East and South-East Asia, which have aggregate assets of $50 billion – suggested that Islamic finance, a cash-rich sector, has much to teach the west's financial system, which has yet to fully recover from the near-death experiences of 2007-09.

The Empowering Risk Intelligence report found that Islamic financial institutions came late to adopting formal approaches to risk management. 79% of respondents had established their risk-management departments in the past five years, with only 5% having a risk management department prior to 2002. But things are changing, and fast. The report found that 83% of Islamic finance firms today have both a formal risk-management function and a risk committee responsible for overseeing all risks.

Related: Islamic Finance

Related: Islamic Banking and Islamic Banks

Yet Deloitte acknowledged there is room for improvement in the risk management area. Key risk-management and regulatory challenges facing the Islamic sector include that two-thirds of Islamic financial institutions don't have any external credit rating, and that only 25% have considered or received an external rating from a specialist Islamic rating agency such the Bahrain-based Islamic International Rating Agency. The report said:

This constitutes a real challenge posed to industry participants and standard-setters such as the [Kuala Lumpur-based] Islamic Financial Services Board, [Bahrain-based] Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI), [Bahrain-based] International Islamic Financial Market (IIFM) and the Islamic International Rating Agency (IIRA), to enforce best practices.

The report suggested that the main causes of shariah-compliance risks include non-standardized practices, diverse interpretations of shariah law, and the fact shariah laws are unenforced in many jurisdictions. Dr Hatim El Tahir, director of Deloitte’s Middle East Islamic Finance Knowledge Center, said:

One thing is certain – the traditional operations and management of Islamic finance will need to change. Institutions offering Islamic financial services around the globe will not only need to deal with risk management but will also need operational effectiveness and a skilled workforce to empower risk intelligence in Islamic finance.

The Deloitte findings came as an op-ed published by Project Syndicate, The Challenge of Islamic Finance, sang the praises of Islamic finance and suggested it has an important role in counter-balancing the bonus-fuelled procyclicality and morally hazardous nature of western finance.

Authors Andrew Sheng, ex-chairman of the Hong Kong Securities & Futures Commission (and one of the voices of sanity in the movie Inside Job) and Ajit Singh, emeritus professor of economics at Cambridge University, said there is growing convergence between Islamic and western finance.

Despite skepticism regarding accommodation between Islamic and global finance, leading banks are buying Islamic bonds (also known as sukuk) and forming subsidiaries specifically to conduct Islamic finance. Special laws have been enacted in non-Muslim financial centers – London, Singapore, and Hong Kong – to facilitate the operation of Islamic banks and associated financial institutions.

Read the full story by Andrew Sheng and Ajit Singh here on EconomyWatch.  

Sheng and Singh argued that Islamic finance, already a $3 trillion sector, has an important role to play in improving the ethical framework of western-style finance (which, as everyone other than bankers and financiers recognizes, seriously lost its way during the credit bubble of 1999-2007).

They suggested that if the ethical values in Islamic finance, rooted as they are in shariah religious law, could:

"further deter moral hazard and the abuse of fiduciary duties by financial institutions, Islamic finance could prove to be a serious alternative to current models of derivative finance."

The test of any alternative financial system depends ultimately on whether it is – or can be – more efficient, ethical, stable, and adaptable than the prevailing system. For now, there is no Islamic global reserve currency and no lender of last resort. But the Islamic world is the custodian of huge natural resources that back its trading and financial activities.

If the scenario outlined by Sheng and Singh is correct, prepare for the centre of gravity of global finance to shift from London and New York to the Gulf and Kuala Lumpur.

Related Story: Can Consumers & Taxpayers Be Saved From The Bonus-Crazed Financial Sector?

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By Ian Fraser

Ian Fraser, a journalist since 1988, is working on programmes about the banking and financial crisis for the BBC. He writes about business and finance for the Financial Times, the Sunday Times, the Independent on Sunday, the Daily Mail, and the Mail on Sunday.

http://www.economywatch.com/economy-business-and-finance-news/what-the-west-can-learn-from-islamic-banking.16-05.html?

Islamic Finance Offers Good Governance To Conventional Banking

Islamic finance, which borrowed features such as products from conventional banks, can now return the favor by lending its set of principles for good governance and responsibility, the Raja Muda of Perak, Raja Dr Nazrin Shah said on Tuesday.

"To date, Islamic banks have borrowed from conventional finance in terms of products.But, I think, the time has come where the flow of information and knowledge can and should flow the other way as well," he said in his keynote address at the second day of the World Capital Markets Symposium, here.

He said Islamic finance could also help the global finance industry to be more aware of following the rules and curtailing excess as well as create an infrastructure of honesty, fairness and integrity.

"But, I also believe Islamic finance can offer much more than this," Raja Nazrin, who is also the financial ambassador for the Malaysia International Islamic Financial Centre, said.

"At its heart, Islamic finance is an ispiration towards good finance.As we have seen, good finance is about trust, and trust is a cornerstone of stability.

"Therefore, I believe that Islamic finance can help break the vicious cycle of boom and bust that has come to characterise global finance," he said.

Islamic finance is now a truly global market, participating across borders with a vast range of investment alternatives including sukuk, mutual funds, commodity funds, equity traded funds, real estate investment trusts, shariah compliant derivatives and hedge funds.

Recent developments also included the possibility of an Islamic bank in France, the publishing of a book on Islamic finance in Italian and shariah compliant real estate funds in Australia.

There is also news of expected sukuk issuances from the United Kingdom, Australia and Korea.

There have also been a diverse range of issuers of shariah compliant products including the World Bank, the Islamic Financial Centre, the German state of Anhalt-Saxony, Aston-Martin and Shell, which pioneered the sukuk.

"The world is interested and I believe Islamic finance to be up to the challenge," Raja Nazrin said, adding that the industry is growing with more demand seen from non-Muslim investors, not only in Malaysia but also abroad.

He stressed that one of the most important goals of the Islamic finance industry should be to integrate into the global financial system.

Link: http://www.bernama.com/bernama/v5/newsbusiness.php?id=431825

UK: Crossing over to Islamic banking

As the credit crunch has mutated inexorably into a recession, with bankers having eclipsed politicians, lawyers and even journalists as public enemy number one, the growing number of Islamic finance institutions in Britain might just be sitting pretty.

The UK now has five fully Sharia-compliant banks and another 17 financial institutions have set up special branches or firms. They include the Qatar Islamic Bank (QIB), with its London-based European Finance House in Berkeley Square, and the Islamic Bank of Britain, which has headquarters in Birmingham.

Both have answered Gordon Brown’s call of two years ago for Britain to become the global centre for international Islamic banking; a report by the International Financial Services London even says that Britain’s Islamic banking sector is now bigger than that of Pakistan.

Islamic banks, says Steven Amos, the Islamic Bank of Britain’s head of marketing, are prospering. “Our core business will always be Muslims but the numbers of non-Muslims are really picking up. We’ve had massive interest — and that’s down to a number of reasons, all of which have kept us insulated from the credit crunch.”

He alludes to the nuances of Islamic banking — specifically that Islamic finance has to be Sharia, or Islamic law, compliant. Sharia is taken from the Koran, one of whose central tenets — that money has no intrinsic value — might sound alien to the denizens of the City.

One British businessman believes that adopting Sharia principles might be just what the West needs.Roger Smee, a former professional footballer and now businessman, says the West has “lost the plot. All we have as a success guide is a number of rich lists. Instead of looking down on what we are quick to reject as cumbersome legal restrictions, we should take a page out of the Middle East’s book and use the principles of Sharia to begin building real and sustainable economies.”

Smee, who divides his time between the US, Europe and the Middle East on his real estate and office interiors business, realised six years ago that a financial time bomb was ticking. I was offered a controlling stake in a new US mortgage business. The company was involved in the refinancing of huge numbers of house mortgages, lending at 125 per cent of an already overinflated property value to people who obviously did not have the funds to maintain payments. As we now know, these loans were then packaged up and sold on, earning the mortgage business a 7 per cent fee on each transaction. But the underlying finances were totally flawed.”

Smee’s disenchantment with “watching the world of Western finance become a casino” led him to concentrate many of his activities in Doha, Qatar. There he found Sharia principles to be “based on a deep sense of partnership, with your bank or other investors”.

Two factors help to explain his enthusiasm. Under Sharia, the charging or paying of interest is prohibited, something that, he says, has left the Islamic banks and their customers largely unscathed by the credit crisis. “Islamic banks do not borrow or lend on money markets, so they are not experiencing any of the same liquidity problems besetting UK banks.”

Sharia also only allows investment or trade in a tangible, visible asset. Hamid Yunis, the head of the law firm Taylor Wessing’s Islamic finance practice, confirms that while Sharia can permit certain futures and options structures, such as the salaam [sale contract with a deferred delivery] and arboun [sale contract with a non refundable deposit], it prohibits convoluted derivative products. “An asset has to be visible. If you can’t see it, it’s unlikely to be Sharia-compliant.”

Neill Gibson, a partner in Trowers & Hamlins who works on many Islamic finance matters, sympathises with Smee’s belief that Sharia principles might have helped to insulate conventional markets from their current turmoil. “Sharia prohibits investment in anything that can be seen as speculative,” he says. “Because interest is also forbidden, clients can’t burden themselves with highly leveraged interest-bearing debt.” However, Sharia-compliant instruments, such as a murabaha [deferred sale financing], operate, in effect, as a loan.

Gibson says that Islamic finance wouldn’t have touched the sub-prime markets “but it won’t have been protected from other badly hit sectors, such as real estate”.

Hamid Yunis says there should be a return to “back to basics” banking across the board, rather than merely among Islamic banks. “Banks are much more risk averse in the current climate,” he says.

Perhaps it is this, as much as Sharia’s theological strictures, which banking needs. Or, as Elliot Caldwell, chief executive of Colliers Capital and an expert in property investment fund management, says: “If it was an unsustainable business in the first place, it doesn’t matter what means — conventional, Islamic or something altogether different — you used to invest. In the current climate, the chances are that you’d still be feeling pretty uncomfortable.”

(Times Online)

Vatican Says Islamic Finance May Help Western Banks in Crisis

March 4 (Bloomberg) -- The Vatican said banks should look at the rules of Islamic finance to restore confidence amongst their clients at a time of global economic crisis.

“The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” the Vatican’s official newspaper Osservatore Romano said in an article in its latest issue late yesterday.

Author Loretta Napoleoni and Abaxbank Spa fixed income strategist, Claudia Segre, say in the article that “Western banks could use tools such as the Islamic bonds, known as sukuk, as collateral”. Sukuk may be used to fund the “‘car industry or the next Olympic Games in London,” they say.

Pope Benedict XVI in an Oct. 7 speech reflected on crashing financial markets saying that “money vanishes, it is nothing” and concluded that “the only solid reality is the word of God.” The Vatican has been paying attention to the global financial meltdown and ran articles in its official newspaper that criticize the free-market model for having “grown too much and badly in the past two decades.”

The Osservatore’s editor, Giovanni Maria Vian, said that “the great religions have always had a common attention to the human dimension of the economy,” Corriere della Sera reported today.