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Islamic Banking Back on Track |
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Written by Philip Bowring
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Thursday, 04 November 2010 |
 Are they better than money?
A year after Dubai's monster debt problems sent shockwaves though the
sukuk (Islamic bond) world, sukuks are thriving again and with them
Malaysia's role as the center of gravity of international Islamic
finance.
Although Islamic banking, investment and insurance
activity are again gaining global ground, is still relatively small and
mainly concentrated not in the most populous Muslim countries but in
those such as Malaysia and the United Arab Emirates, which are able to
use local liquidity and government help to promote it outside their
borders.
The Malaysian role is being further enhanced by the
establishment of the International Islamic Liquidity Management Corp
(IILM) being set up by a several central banks, mostly from
Muslim-majority countries but including Luxembourg, location of many
listed funds. The IILM will be based in Kuala Lumpur and is expect to be
operational sometime in the first half of 2011, issuing short term AA
paper to provide liquidity to enhance international trade in Islamic
instruments.
The sukuk issue bounce-back has been the Dubai
crisis and the preceding global financial meltdown has been
characterized by a growing variety of instruments and sources,
indicating an acceptance of them among investors such as sovereign
wealth funds in non-Muslim countries as well as non-Muslim company
seeking Muslim funds.
Thus the Japanese financial giant Nomura
made a US$100 million issue while half of a US$500 million one by the
Islamic Development Bank (IDB) was sold to European and East Asian
investors. Meanwhile Malaysia's state holding company Khazanah created a
first for the Singapore sukuk market with a S$1.5 billion issue. Total
outstanding sukuk issues are now over US$100 billion from almost nothing
five years ago.
Proponents of Islamic products claim that,
notwithstanding the problems in Dubai and others in Kuwait in
particular, they have proved more resilient than conventional ones
during the crisis. They point to the fact that they avoid complex
derivatives and all issue must be driven by an underlying economic and
commercial purpose, not by pure speculation. Islamic equity funds also
outperformed conventional ones over the crisis period, albeit only
marginally.
However, skeptics suggest that other factors are at
work. Although Islamic finance is supposed to be about sharing risk and
reward, the Dubai bailout by its richer neighbor Abu Dhabi contradicted
that principle. Others point out that in the case of Malaysia, the
leader in sukuk issues, almost all were by state entities including the
government itself, Cagamas the mortgage institution, Khazanah and state
oil company Petronas, and that most of the buying was by local Islamic
banks and the state-managed pension funds. Without the impetus provided
by the huge current account surpluses of (mostly Muslim) oil exporters,
international business could not have grown at anything like the pace of
recent years. And local business could not have grown without tax
breaks and official incentives.
Islamic banking is still a
minority business in Islamic countries other than Iran and Saudi Arabia.
Seven of the top 10 Islamic banks are Iranian – not a factor which
enhances the global industry. In Malaysia Islamic banking continues to
gain market share, but even with much official support is still only 20
percent of the system. In countries such as Indonesia and Turkey it is
also growing but from a very low base.
Islamic micro-finance has
recently been quite successful in Indonesia but the Muslim heartland of
micro-finance, Bangladesh with its Grameen bank, has stuck with
conventional forms. Nor is there much evidence, the IDB apart, that
Islamic finance has become a way in which rich Islamic countries could
help poorer ones such as by buying their sukuk issues.
Many in
the Islamic as well as non-Islamic worlds continue to claim that there
is scant practical difference between Islamic and conventional forms,
the former merely mimicking the latter with similar rates of return but
adding, at some administrative cost, a veneer of shariah risk/reward
respectability.
Be that as it may, there has been a significant
narrowing of gaps in interpretation of shariah. These had a particular
impact on cross border trade with shariah scholars in the Gulf not
accepting the legitimacy of some compliance decisions made in other
jurisdictions. Disclosure standards are often weak, providing investors
with inadequate knowledge of structures, or of the reasons for decisions
on compliance made by shariah scholars.
Convergence and
disclosure are however increasing and will probably continue to do so as
Malaysia in particular forms a body of codes and practices, in English,
which others can follow.
The global crisis also showed up some
problems of dispute settlement and in both realizing ownership of
security for sukuk issues. Gaps between civil law and its shariah
counterpart also present potential dangers. For non-Muslim issuers there
is also a problem of showing that funds raised are used in ways
compatible with shariah.
But again, Malaysia itself has largely
avoided such problems because of its orderly compliance system and the
efforts made to align Islamic products both with civil law and with
internationally accepted accounting standards. But not many Islamic
countries are as organized as Malaysia where Bank Negara has been
successful in developing Islamic finance mechanisms while running a
tight ship for all forms of banking and finance.
In fact
non-Islamic countries have sometimes paid more attention to making
provision for it either to serve local Muslim communities or enable
Islamic instruments to become part of their financial centre role – as
in the case of the Britain. Other countries have or are moving in the
same direction leading to suggestions in some quarters that Islamic
finance should, at least in non-Muslim countries, be re-named "ethical"
and make it more appealing to non-Muslims. Whether it is more ethical in
practice as well as theory is another issue.
But at least for
now Islamic finance will continue to grow, helped by its acceptance by
non-Muslim central banks of its global role. The IILF itself stems from
the creation of the Islamic Financial Services Board, which plays a role
similar to the Basel committee of the Bank for International
Settlements. The liquidity facility coupled with an increased number of
issues will gradually enable the development of yield curves and other
mechanisms which provide more benchmarks for comparisons with
conventional yields.
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Economics/Business 
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