Business | Analysis

Alternative to the western finance model gains favour

The sector is a growth story across asset classes and geographies

  • By Rushdi Siddiqui, Special to Gulf News
  • Published: 00:00 October 2, 2011
  • Gulf News

Dubai: From September 19 to 23, Toronto hosted the massive Swift International Banking Operations Seminar (Sibos) event from Society for Worldwide Interbank Financial Telecommunication (Swift), where I was involved in the session called ‘Islamic Finance 2.0: Growth Opportunities for All'.

There were a number of interesting takeaways from the session that may provide insights on the marketing and positioning of Islamic finance in ‘open minded' western countries, such as Canada and the Arab spring countries.

While presenting Islamic finance in non-Muslim countries, it is described to be ‘similar' to conventional finance in terms of the economic objectives and benefits while de-emphasising the Arabic terminology (form). This is a diametrically opposite approach of positioning it in Muslim countries where it appears to be hyper-sensitive to the linkage and similarities to conventional finance.

Investing

For example, Islamic equity investing falls within the same category of faith-based offering that includes Catholic, Christian or Lutheran funds, i.e., sharing common values. Faith-based funds are a subset of social-ethical or socially responsible investing (SRI) funds.

The screening for Sharia compliance is currently negative in nature, that in turn makes Islamic investing prohibition-oriented. Put differently, Islamic investing is about ‘doing good by avoiding the bad.'

Obviously, an opportunity exists for positive screening, such as environment, sustainability and governance (ESG) and Sharia compliant investing. ESG compliant investing is important because it shows the evolutionary progress on screening, and builds bridges with like-minded communities for possible deployment of their excess liquidity.

One of the most important takeaways from the credit crisis is that the investment information model failed miserably. It did not show the actual risk investors were exposed to in their investments.

The discipline of Sharia-compliant equity investing, emphasis on the debt screen ratio, and quarterly or monthly review for continued compliance constitutes risk measuring, monitoring and management. When combined with prohibitions against derivatives and leverage to turbo-charge returns, compliant investing actually sells itself.

All the screening, talk of disciplined investing and monitoring risk is an acad-emic exercise if performance is not led by recognised compliant companies. Thus, Islamic equity investing has a high correlation to conventional counterpart investing, even with a reduced universe of companies, and led by blue-chip companies such as Google, IBM, Pfizer and ExxonMobil.

Whether such companies provide a pulse for an Islamic equity capital market could be the argument of another article.

Islamic finance is a growth story across asset classes and geographies. It's very much like the categorisation of rapidly developing economies (RDEs). A good example of RDEs is Brics countries (Brazil, Russia, India, China and South Africa). A Muslim Brics could be Sami, including Saudi Arabia, Ankara (Turkey), Malaysia and Indonesia.

The asset-backed and asset-based nature of Islamic financing now has a greater appeal to the non-Islamic finance industry looking for possible alternatives. The Islamic banks' financing model entails focus on customers and ability to meet obligations on fin-ancing real activities tied to the real economy GDP with recourse to the collateral in case of default that is marked to market.

From the customer's perspective, it makes him fin-ance within one's means because the contract is about risk sharing and not shifting.

With the interests better aligned, between the bank and the customer, the moral hazard argument associated with asymmetric information is minimised. Obviously, Islamic finance cannot eliminate market risks and so there have been non-performing loans and provisioning among the Islamic and conventional banks in the UAE, Bahrain, Qatar, etc. However, it's better to write off loans than be written off like, say, Lehman Brothers.

Risk concentration

According to www.failedbankreporter.com there were 25 US bank failures in 2008, 140 in 2009, 157 in 2010 and 97 so far this year.

The issues of risk concentration to a sector or single borrower and lack of securitisation regulations for Islamic banks are now recognised and regulators, led by the UAE Central Bank or Saudi Arabian Monetary Agency have made it a priority to contain such risks.

The final point is the political will to have Islamic finance on the shores of non-Muslim countries as part of financial inclusion, wholesale or retail. In the United Kingdom it was led by Prime Minister Gordon Brown and former finance minister Christine Lagarde, now IMF managing director, in France. To date, no sovereign sukuk has been issued in the post-Brown period and fewer headlines about Islamic finance in France after Lagarde joined the IMF.

The Sibos event in Tor-onto provides a hope for Islamic finance in the western world. Boring is the next excitement.

 

The writer is head of Islamic Finance at Thomson Reuters. Opinions expressed are in his personal capacity.

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