Islamic Finance Solution to Global Financial Crisis

                                            Why Islamic Banking Is Successful?  

 Islamic Banks Are Unscathed Despite of Financial Crisis

By  Prof. Rodney Wilson  Professor-Durham University

The collapse of leading Wall Street institutions, notably Lehman Brothers, and the subsequent global financial crisis and economic recession, are encouraging economists world-wide to consider alternative financial solutions.

Attention has been focused on Islamic banking and finance as an alternative model. What lessons can be learnt, and how resilient have Islamic banks been during the current crisis?

ISLAMIC BANKING PRINCIPLES AND SUB-PRIME LENDING

The religious teaching underpinning Islamic finance is concerned with justice in financial contracts to ensure that none of the parties is being exploited.

The bank may advance the clients a n interest-free loan to enable them to continue their payments during the recession in anticipation that they will pay in full when the economy rebounds.

Riba( interest or usury) is one source of exploitation, especially, as in the case of subprime lending, the highest rates were charged to lower earners. Such discriminatory charging by conventional banks was justified as being a reflection of the risks involved.

Those on lower incomes, with poorer prospects of finding new employment in the event of redundancy, were less likely to be able to service their interest payments. Islamic housing finance involves risk sharing between the bank and the client, rather than transferring all the risk to the latter.

Under the most commonly used diminishing musharaka (partnership) contract, the bank and the client form a partnership, with the bank providing up to 90 percent of the purchase price, and the client at least 10 percent. Over a period of usually 10 to 25 years, the client buys out the ownership share of the bank which makes its profit from the rent paid by the client for the share the bank owns.

In the event of a rental or repayments default, the bank may advance the clients an interest-free loan (qard hassan in Arabic) to enable them to continue their payments during the recession in anticipation that they will pay in full when the economy rebounds.

The client retains their home rather than being faced with eviction— like the victims of the sub-prime crisis. Of course Islamic banks have to appraise credit risk, and indeed are more cautious about who they should finance than conventional banks.

The banks in the United States charged high arrangement fees for sub-prime borrowers which were used to pay bonuses for those signing up new clients.

As the mortgages were sold on to Freddie Mac and Fanny Mae, the arrangers were unconcerned that the sub-prime borrowers might be unable to meet their financial obligations.

Indeed, gifts were provided to entice the feckless to sign up, and the mortgages often exceeded the value of the property. The banks in other words became mere booking agents, with no long term commitment to their clients.

THE ISLAMIC BANKING RECORD

Consequently when the credit crunch came and borrowing from wholesale markets was halted, Islamic banks were not exposed.  In contrast to conventional banks, no Islamic bank has failed and has needed government recapitalization which ultimately becomes a burden on hard pressed taxpayers.

All Islamic banks comply with the Basel II capital adequacy requirements and the Islamic Financial Services Board (IFSB)- the body which advises regulators with respect to Islamic finance- has produced detailed guidelines on compliance. The IFSB has an ongoing relationship with the Bank for International Settlements-the institution which developed the Basel standards- and is certain to be consulted as Basel III guidelines are drafted for capital adequacy which are likely to be implemented globally in the coming decade.

The soundness of Islamic banks is accounted for by the fact that they use a classical banking model, with financing derived from deposits, rather than being funded by borrowings from wholesale markets.

Consequently when the credit crunch came and borrowing from wholesale markets was halted, Islamic banks were not exposed. However, Islamic banks are not immune from the effects of the global recession, and the fall in oil prices will inevitably have a negative impact on 2008 results of Gulf-based Islamic banks. The situation will become clearer from February once the audited financial statements start to appear.

Two Islamic housing financial institutions, Amlak and Tamweel are being merged, as both have faced problems given their exposure to the Dubai property market.

In Iran where all financial operations have been shariah-based since the Law on Usury Free Banking was introduced in 1983, banks have been relatively insulated from the financial crisis, ironically because United States sanctions meant they could not deal with institutions such as Lehman Brothers which were trying to place large amounts of toxic debt with Middle Eastern banks.

The sanctions therefore proved to be a blessing in disguise for Iran— although the Islamic banks there have been adversely affected recently by the fall in gas prices.

Nevertheless being state owned, institutions such as Bank Melli, the largest Islamic bank in the world, are well placed to ride out the global financial storm. With assets of over $50 billion, and 2007 profits exceeding $540 million, it has more than adequate resources to cope.

ISLAMIC FINANCIAL STABILITY

Investors seeking shariah compliance have portfolios which are more heavily weighted in sectors such as healthcare or utilities.

Islamic banks enjoy a built-in stabilizer to help them cope with economic downturns, as instead of paying interest to depositors, those with investment mudaraba accounts share in the banks profits.

Thus, if profitability declines in an economic downturn, depositors receive lower returns, but if profits rise they enjoy higher returns.

This profit sharing reduces risk for the banks and means they are less likely to become insolvent. However as the banks build up a profit equalization reserve, which can be used to finance pay-outs during difficult years, depositors benefit from some protection of their returns during economic downturns.

The last year has been difficult, if not disastrous, for equity investors, given the fall in stock market prices globally.

Investors in equities screened for shariah compliance have also suffered, but less than their conventional counterparts, because they have not invested in the shares of riba based banks which have fared especially badly during the global financial turmoil.

Investors seeking Shariah compliance have portfolios which are more heavily weighted in sectors such as healthcare or utilities where revenue streams are maintained even during cyclical down-turns.

PROSPECTS FOR ISLAMIC FINANCE

There are already five wholly Islamic banks in London, and the first Islamic bank will open in France in 2009.

Islamic banking provides a viable alternative to conventional banking and is less cycle prone. The spread of Islamic finance into western markets demonstrates that it now being treated seriously by regulators and finance ministries.

There are already five wholly Islamic banks in London, and the first Islamic bank will open in France in 2009. According to the conservative estimates of the Banker in October 2008, Islamic financial assets globally exceed $500 billion, a figure that could easily double over the coming decade.

The experience of Islamic banking in the United Kingdom has been extremely positive. Islamic Bank of Britain has been operating as a retail bank for over four years, and has attracted over 40,000 customers. HSBC Amanah, the Islamic finance subsidiary of HSBC, has been operating for ten years in London, focusing mainly on institutional clients and business finance.

Alburaq, the Islamic finance subsidiary of Arab Banking Corporation, has become the market leader for shariah compliant home finance in the United Kingdom.

None of these institutions has been affected by the global financial crisis, and their resilience bodes well for the future.

SUKUK ARE REAL ASSETS

The United Kingdom authorities promoting London as a international centre for sukuk issuance to rival Bahrain, Dubai and Kuala Lumpur.  In addition to banking, Islamic sukuk security issuance has enormous potential. Unlike conventional bonds and notes, sukuk are backed by real assets, which provides assurance to investors.

Although global sukuk markets were adversely affected by the global recession in 2008, longer term prospects look promising, with the United Kingdom authorities promoting London as an international centre for sukuk issuance to rival Bahrain, Dubai and Kuala Lumpur.

The Malaysian ringgit sukuk market has been largely unaffected by the global turmoil in securities markets, and issuers such as the Saudi Arabia Basic Industries Corporation, one of the world’s largest petrochemical producers, view sukuk as a desirable instruments to raise funding for plant expansion.

There can be no doubt that Islamic finance has an exciting future, and the quest for a financial system based on moral values rather than greed and fear, is bound to enhance its position in the global system.

http://www.islamonline.net/servlet/Satellite?c=Article_C&cid=1230650190574&pagename=Zone-English-Muslim_Affairs%2FMAELayout

Can Islamic finance save the banking sector

Islamic finance regulations around the world

Ireland, a country of arguably staunch Catholics, is also making a bid to be a global hub for Islamic finance.

 

Ireland, a country of arguably staunch Catholics, is also making a bid to be a global hub for Islamic finance. The global growth of Islamic finance in recent years is, in part, a response to the demand for a more ethical financial system. But is Islamic finance just an ethical “spin” on “conventional” finance? Or can it offer more tangible solutions beyond the Muslim community?

What is Islamic finance?

Just like ethical investment in the standard financial sector, Islamic finance prohibits the use of funds for certain purposes. For example, no investment in activities that deal with alcohol, pornography, gambling and so forth.

The basis for Islamic finance’s code of ethics comes from religious texts and is less arbitrary than secular ethical investment. Admittedly, these texts have to be interpreted, and this can lead to vigorous debates and disagreements. But compared to standard ethical investment, the religious texts serve as a relatively more permanent anchor to guide behaviour.

Islamic finance goes much further than standard ethical investment. Not only does Islamic finance prohibit funding for “unethical” activities, it also bans transactions where people share risks and uncertainty in a disproportionate manner. This is why the use of interest is prohibited.

As you know, if you borrow money from a “standard” bank to run a business, the bank is guaranteed a return (the interest) while you, the borrower, will bear all the risks of making or losing money from the business operation. Islamic finance prohibits such arrangements. Instead of an interest-based banking system, Islamic finance prefers a system where profits and losses are shared. So, instead of lending money in return for interest payments, Islamic banks would lend money in return for an eventual share of the profits or loss generated from the business.

No speculation

The standard financial system permits speculative activity. In fact, this is encouraged as a way to keep the market “efficient”. Unfortunately, speculative activity can also have unwelcome effects, such as when financial bubbles are created and then burst.

Unlike the standard financial system, Islamic finance prohibits financial transactions that involve speculation. According to Islamic texts, financial transactions must have a clear link to an underlying “real” activity. So, you can buy and sell financial assets if you have a genuine interest in its underlying value, not because you want to gamble on changes in its price. [See the paper (paywalled) by Shahnaz and Tony Naughton for a clear and detailed discussion on this point.]

As such, Islamic finance is about more than just ethical investment. It challenges the increasing “gap” that has emerged since the 1990s between the financial sector and what economists call the “real” economy: the part of the economy that is concerned with producing goods and services, as opposed to the financial sector which is less tangible. It seeks to take us back to the days when the role of the financial sector was to serve the “real” economy.

In emphasising the need for financial transactions to have a link to a “real” activity, Islamic finance limits the amount of debt in the system, creates fewer opportunities for speculation and, as a result, minimises the chances of the financial system becoming unstable. Islamic finance would have prohibited the type of products that contributed to instability in the American financial system in 2007.

By prohibiting the use of interest while encouraging the sharing of profit and loss, the approach adopted by Islamic finance will shift some of the risks shouldered by consumers on to financial institutions. Supporters of Islamic finance argue that it offers a safer and more equitable approach to the organisation of finance than the standard system.

A way to a more equitable financial system?

In practice, Islamic finance has so far not been able to perfectly follow what it preaches. Even though interest is prohibited and banks should share in profits and losses, Islamic banks tend to intentionally structure the products they sell so that they achieve outcomes that are very similar to interest-based products. As a result, Islamic financial institutions get more certain outcomes instead of bearing the risks profit and loss-sharing arrangements.

Until now, supporters of Islamic finance have argued that these choices have been necessary in order to compete with the “standard” sector, and that they would be abandoned once Islamic finance becomes more established and sophisticated. But, in mimicking the “standard” financial sector, Islamic finance risks betraying its roots. Such an approach undermines its claims to offer an important and substantially different system.

Despite these criticisms, Islamic finance can still reframe the debate about the role of the financial sector in modern society. It forces us to question our current relationship with finance: should finance be used for speculation, or should it only be used to fund “real” activities?

Given the global financial crisis and the debate about reforming financial sectors, the approach of Islamic finance offers us one way to think about how the financial sector might be reformed to better serve society’s needs.

Jikon Lai is a Lecturer in International Relations at The University of Melbourne and a Visiting Fellow at the School of Politics and International Relations in the College of Arts and Social Sciences at the Australian National University. This article first appeared on The Conversation.

http://www.smartcompany.com.au/financial-services-and-insurance/052267-can-islamic-finance-save-the-banking-sector/2.html

Tweak laws to allow Islamic banking: RBI

The Reserve Bank of India (RBI) has written to the government to “restructure” or “amend” the laws to allow Islamic banking in India . Speaking at a local event,RBI governor D Subbarao said: “Islamic banking is allowed in many parts of the world, but the Banking Regulation Act of India does not conform to Islamic banking because it allows banks to borrow from and deposit money with the RBI on interest. But we are in correspondence with the government on how our laws can be restructured or amended so that they are in conformity with Islamic banking.”

The RBI governor’s statement comes on the back of a rising clamour to allow Islamic banking in India, which would fetch billions of dollars in investments from countries in the Middle East. Islamic banking is an interest-free system that is allowed in many developed economies, including European markets like France, Germany and the UK.

Law minister Salman Khurshid announced recently that he had written to the Planning Commission and RBI on the issue. RBI’s stand on the matter so far has been that it is not possible within the current statutory and regulatory framework.
The entire RBI top brass — including deputy governors Subir Gokarn, K C Chakrabarty , Anand Sinha and H R Khan — are in Puducherry for a board meeting and were interacting with local students at an interactive event. The RBI team also stressed financial inclusiveness and the role that mobile banking can play in expanding the banking footprint in rural India. “Mobile penetration is large in rural India and we can leverage that technology for financial inclusion,” said deputy governor Khan.
RBI is prioritizing electronic payments to reduce the economy’s dependence on cash. “India is the fifth largest in cash-to-GDP ratio and we are taking a series of steps on both retail and wholesale payment’s side to reduce this,” said deputy governor Chakrabarty . One of the interventions , he said, was the decision to reduce merchant discount rates (MDR) drastically on debit cards to encourage usage. The RBI recently capped MDR in debit card transactions to 0.75% up to Rs 2,000 and 1% beyond Rs 2,000 — a sharp cut given that debit and credit card MDRs have been similar in India so far.

 

http://timesofindia.indiatimes.com/business/india-business/Tweak-laws-to-allow-Islamic-banking-RBI/articleshow/16663710.cms

Islamic banking on radar

The Reserve Bank of India (RBI) is in correspondence with the government to look into ways to bring in new rules to accommodate the concept of Islamic banking, said Governor D Subbarao. Speaking at the Jawaharlal Institute of Postgraduate Medical Education & Research, he said: “The current Banking Regulation Act does not allow the model of Islamic banking.

Under the current Act, banks are required to borrow and deposit (and paying interest) with RBI, and to give interest to depositors.”

One of the basic principles of an Islamic banking system is that there should not be collection or payment of interest.

It also includes risk sharing by banks, rather than the risk-transfer method followed by conventional banks.

According to earlier reports, Union law minister Salman Khurshid had written to RBI for a response on the issue. Prime Minister Manmohan Singh had in 2010 itself asked the central bank to look at Islamic banking practices in Malaysia as a possible model. An attempt by the earlier Left Democratic Front government in Kerala to allow the start of a bank based on Islamic principles had met legal hurdles in 2010.

On foreign direct investment (FDI) in multibrand retailing, Subbarao said it would help consumers get better quality products at reasonable prices. At present, around 40 per cent of farm products perish before reaching the market and FDI could bring in a better supply chain, helping producers get more benefit. The apprehensions on FDI were understandable but in the long term, he added, it would be good for the economy.

On food inflation, he said addressing it was largely the domain of the government and it had initiated some programmes which needed to be expanded. Retail FDI would help reduce wastage, thus increasing the supply.

Food inflation in the long term would harden inflation expectations among people and RBI was trying to break those expectations, he added.

http://www.business-standard.com/india/news/islamic-bankingradar/488582/

failed import

Failed to import Media “2 Invest Religious Wealth City Investment Services Stock Market Online Trading Wealth Mangement Real Estate Tax Saving Retirement Sharia Ethical Investment oppurtunity”
Failed to import Media “4 Ethical Shariah Stocks Wealth City Haraam Halal Unethical Company Compliance Compliant Research Islamic Principles Oppurtunity Islamic Investment opportunity”
Failed to import Media “6 Save Tax Shariah Invest Islamic Way WealthCity Bajaj Allainz Pure Stock Pension Fund India Only Sharaih Compliant Fund TASIS Investments Returns Islamic investment”
Failed to import Media “2 Invest Religious Wealth City Investment Services Stock Market Online Trading Wealth Mangement Real Estate Tax Saving Retirement Sharia Ethical Investment oppurtunity”
Failed to import Media “4 Ethical Shariah Stocks Wealth City Haraam Halal Unethical Company Compliance Compliant Research Islamic Principles Oppurtunity Islamic Investment opportunity”
Failed to import Media “6 Save Tax Shariah Invest Islamic Way WealthCity Bajaj Allainz Pure Stock Pension Fund India Only Sharaih Compliant Fund TASIS Investments Returns Islamic investment”
Failed to import Media “2 Invest Religious Wealth City Investment Services Stock Market Online Trading Wealth Mangement Real Estate Tax Saving Retirement Sharia Ethical Investment oppurtunity”
Failed to import Media “4 Ethical Shariah Stocks Wealth City Haraam Halal Unethical Company Compliance Compliant Research Islamic Principles Oppurtunity Islamic Investment opportunity”
Failed to import Media “6 Save Tax Shariah Invest Islamic Way WealthCity Bajaj Allainz Pure Stock Pension Fund India Only Sharaih Compliant Fund TASIS Investments Returns Islamic investment”

Islamic banking is right to better life, says association

The National Old Peoples Association (Glorious Favour) yesterday backed the establishment of Islamic banking in Nigeria, saying it is the people’s right to enjoy a better life.

A statement in Lagos by its Chairman, Primate Ayola Omonigbehin, noted that the right for the religious banking system is in the Constitution and in the Bible.

Quoting Chapter Four, Section 33 of the Constitution and Isaiah 25:6, the group urged “all Christian organisations to supplement this developmental idea of building welfare and eradicating crimes in the country”. Continue reading

Equity Market – An investment option the Islamic way

In order to remain in the main stream of the economy and have equitable investment opportunity, equity stock market (The Islamic way) provides the most cost effective investment solution for the Muslims. Hence they should take advantage of the boom in the equity market of the country so that they are not left behind in the economic growth that is being witnessed throughout..

invest equity market, shariah compliant stocks, islamic investment, equity islamic investment, shariah compliant stocks, shariah compliant, shariah, equity,

On the onset investment in equity market is Islamically a permissible activity since it is based on Musharakah (Partnership) and the profit is earned with risk of loss. However there are some issues for a Muslim to invest in equity market (explained later). With the guidance and approval from Ulama (Islamic scholar) it is now possible to invest in equity market the Islamic way, and this perhaps is the best option available for the Muslim.

We first look in to the inherent advantage investments in equities have over other forms of structured investments. Continue reading

India has enormous opportunity for Sharia-compliant investments – Gulf News

With nearly 200m Muslims, the country could expand sector

By Rushdi Siddiqui, Special to Gulf NewsPublished: 00:00 June 19, 2011

When you consider that there are nearly 200 million Muslims in India, it is surprising that one of the world’s fastest growing economies has little or no facilities for them to invest their money in a Sharia-compliant manner.

Indeed, the total size of 100 per cent Islamic funds registered for sale in India was a miniscule $3.1 million (Dh11.4 million) as of March 2011, according to Lipper, a Thomson Reuters company.

India has enormous opportunity for Sharia-compliant investments

India has enormous opportunity for Sharia-compliant investments

Not that India’s reluctance to embrace Islamic finance is unusual in non-Muslim countries, like so many other places, there is a hostility to the practice based on the incorrect belief that it is a political or religious movement, or that it propagates an ideology that is inconsistent with democratic values.

 

It is fair to say that the Islamic finance industry also shares some of the blame for this perception, it is not yet savvy or sophisticated enough in the realm of public relations and marketing.

But, actually, India is important for the growth of Islamic finance. The country has historical ties to the Gulf, and is not only part of the Bric group of nations (Brazil, Russia, India and China), but it is also categorised as a rapidly developing economy (RDE).

So India presents an obvious opportunity, but the question remains: is India ready for Islamic finance?

Key effect

The recent establishment of an Islamic finance institution in Kerala, with the backing of the local government, has at least gone some way to suggesting that it is. One of the key effects of this has been the revelation that Islamic finance is about business and not religion, it does not favour one religion over another. Islamic finance is “user agnostic”; its door is open to all.

In recognition of this, the local proponents and Indian stakeholders should perhaps think about rebranding Islamic finance.

Turkey has achieved this by renaming Islamic banking “participation banking”. This is an initiative that India could certainly consider.
Soon, as it happens, India will have “participation banking” at its doorstep — Turkey’s Bank Asya, an Islamic bank, announced in March its interest in establishing a representative office in India.

Fourteen of the countries that make up the G20 have some form of Islamic fin-ance, including India. The UK, for example, has been involved in Islamic finance since the early 1980s and it is still a well-functioning inclusive secular democracy.

A more technical question is: if India was to expand its level of Islamic banking, should this be a retail or wholesale approach?

A deposit-taking Islamic commercial bank, that is, retail, will present more challenges, as legislation, regulations, and mindset issues still need to addressed. Second, what is the number of bankable Muslims in India?

How many Islamic funds, with small minimum amounts, have been launched and available to the onshore “man on the street” since the BSE launched their Sharia index in 2010?

It is also worth mentioning that a number of financial scams have been perpetrated on this generally financially illiterate Muslim community, hence, new offerings are viewed with scepticism.

A wholesale approach implies fewer signs-offs from regulatory bodies, because it is not dealing with the public’s money. For example, in 2006, Bahrain-based Islamic investment bank, Gulf Finance House, embarked on the ambitious Energy City India, a $2 billion project in Maharashtra.
Funds

Other areas for consideration for India include Islamic trade finance funds (major bilateral trade with GCC) and Islamic venture capital (VC) funds working with technology parks in, say, the UAE for areas like alternative energy, health care, water and others.

But it does not mean non-bankable Indians would be excluded from Islamic fin-ance. Indeed, some of the recent developments with micro-finance in Andra Pradesh have not left the best impression with recipients and regulators.

I have said elsewhere, unlike micro-finance, which creates a creditor-debtor relationship and interest rates often becomes usurious, we should look at Islamic micro-funding, as an equity approach aligns the interests of the parties and prevents the debt trap.

The amounts to be disbursed would be the same, and the areas for funding will be Sharia-compliant, as micro-finance doesn’t typically involve financing the “sin” sector.

The funding would be for Muslims and non-Muslims, therefore building future customers. Obviously, vetting and monitoring costs are higher, but it should result in more focused investments.

Finally, if Islamic finance is involved in developing local infrastructure, financial enfranchisement and contributing to employment – as it no doubt would be – I imagine that the opposition to it on the part of chief ministers of Indian states would eventually fade away.

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

http://gulfnews.com/business/markets/india-has-enormous-opportunity-for-sharia-compliant-investments-1.823248