The U.K. government’s decision to issue a sukuk — a bond that complies with Islamic Sharia law — raises an interesting question: What if the U.K. and other non-Muslim countries switched fully to Islamic principles in finance?
I think the world might be a better place.
The U.K.’s planned $323 million issue is largely a political move, meant to establish London as a major Islamic banking center. In an article for the Financial Times, the U.K. finance minister, George Osborne, wrote of the British government’s desire to become “the first sovereign to issue an Islamic bond outside the Islamic world.” It won’t be the first Western government to do so: In 2004, the German federal state of Saxony-Anhalt issued a $123 million sukuk, attracting investors from Saudi Arabia, Malaysia and Bahrain, as well as from the U.S., U.K., Germany, Japan and Hong Kong.
The first ever “Islamic bond” was probably issued in 1775 by the Ottoman Empire, which borrowed against future customs duties on tobacco. The 2004 Saxon bond was a contract known as ijarah, in which investors buy shares in a special purpose vehicle that collects rent on an asset, often a land parcel. Instead of interest payments, which are banned under Islamic law, the sukuk holders receive a portion of the rent. At the end of the contract’s term, the asset is sold to repay the original investment.
In other words, sukuk are always tied to an underlying asset providing a certain revenue stream — a feature that makes them particularly conducive to financial stability. If countries like Greece, Spain and Italy held to Islamic finance principles, they would not have been able to run up enormous unsecured debt burdens. They would only have been able to borrow against streams of revenue, such as taxes and customs duties, that they could reasonably expect to collect.
Such constraints would not necessarily have an adverse effect on growth. There are types of sukuk, such as musharakah and mudarabah, which allow holders to share in profits and even losses much as if they were equity investors. The main difference is that governments would be able to hold onto strategic assets no matter what. In that sense, the deals are akin to Western production-sharing agreements.
In the Islamic financial world, money is not a tradeable commodity, and it has no time value. It is merely a medium of exchange. As time goes by, all that changes is the level of risk: The longer an investor has to wait to be repaid, the greater the chance of an adverse event. Goods that do not exist at the time of the sale cannot be sold. These principles discourage speculation and the creation of derivatives without a deliverable underlying asset. Money is always tied to the real economy. If that relationship were always observed, energy prices, for one, might be much less volatile.
An Islamic mortgage bond, for example, would consist of Sharia-compliant mortgages, in which the borrower makes a large down payment and pays rent to the lender, who owns the property until the term runs out. Subprime mortgage bonds, along with the related derivatives that did so much damage during the 2008 financial crisis, would not be possible.
Islamic finance accounts for only about 1 percent of global assets, but as Osborne pointed out, it is growing 50 percent faster than traditional banking. According to Ernst & Young, the value of Sharia-compliant assets worldwide stands at $1.8 trillion, up from $1.3 trillion in 2011. Non-Muslim investors have a healthy interest in the instruments because of the security they offer. In Malaysia, 80 percent of Sharia-compliant assets are held by non-Muslims, according to a report by Infosys.
Religion notwithstanding, Islamic bankers might have something the world wants after the recent crisis: Finance that people can understand.
(Leonid Bershidsky, an editor and novelist, is a Bloomberg View contributor. Follow him on Twitter.)