Islamic finance
The last three years have brought the shortcomings of Western banking models into the harsh light of day, prompting many to ask whether other approaches to finance can offer the world any lessons in managing risk and, above all, improving the integrity of the world’s financial markets. As the economic power of the Middle East and Muslim countries elsewhere increases, Islamic finance has caught the attention of banks and governments across the world as a model worthy of consideration. Shari’ah-compliant financial instruments in some ways echo Western structures, but must be judged by religious scholars to be in accordance with the tenets of Islam. The most notable difference is that the payment of interest, so fundamental to Western financial practices, is forbidden. Yet sukuks, for example, can be compared with bonds in their structure and use. The growth of Islamic finance is driven partly by Western banks and governments, but to a great extent domestically by Islamic states. In Saudi Arabia, for example, the retail market is up to 80% Shari’ah-compliant, and Islamic finance is penetrating further into the corporate sector. Opening up a new financial sector also creates new employment and attracts new sources of capital. ‘Another reason is that we have seen how the conventional financial systems have performed and failed in the West,’ says Mohd Daud Bakar, president and CEO of the International Institute of Islamic Finance and Islamic finance specialist for CIMA. ‘This gives a boost to an alternative financial system to be pushed further and appeal to the global community at large. ‘Couple this with the “faith” factor for the 1.6 billion Muslims around the globe, who want to comply with the learned way of doing things, and you have a new source of financial economy and power in the world.’
Banking on integrity Western and global banks such as HSBC Amanah, Standard Chartered and Deutsche Bank are increasingly active in the Middle East and Far East, carving out a significant slice of the Islamic Finance market. A big
draw is the resilience during the global financial crisis of Shari’ah-compliant instruments, which have maintained their integrity when some of their Western equivalents have crumbled. ‘Because they were guided by Shari’ah principles, the scholars prohibited investments in toxic assets or “non-real” assets such as credit default swaps or transfer of risk, so they were not directly exposed to the crisis. They were, however, overexposed to “real” asset classes through excessive funding and financing, but these were not as toxic as in the West,’ says Bakar. In Islamic finance, any investment proposal approved by the management of the bank is passed to Shari’ah scholars, who analyse it from the core principles of Islam and will reject anything deemed to be part of a “non-real” economic sector. Their issue of a fatwa, or judgement, on an
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Islamic banks in Muslim countries are locally focused, though there is growing encouragement for them to become global. In the West, the challenge is not for banks to accommodate the Shari’ahcompliant elements of Islamic finance, but for governments to create legal and tax-friendly frameworks. ‘You have to adapt to the issues of withholding tax, dividend on equity and VAT,’ says Bakar. ‘We need more comprehensive amendment to the relevant taxations laws to put Islamic finance on a level playing field. ‘Hedge funds are sensitive to Islamic finance because it has been deemed as negative in the past. Islamic finance is more about equity, mutual funds, trusts and property funds. The emphasis is on equity not debt, and not on something speculative like a hedge fund where you might have to sell an asset before you own it.’
‘Islamic finance is more about equity, mutual funds, trusts and property funds. The emphasis is on equity not debt, and not on something speculative like a hedge fund where you might have to sell an asset before you own it.’ investment is crucial. To receive a fatwa, investments must be backed by an asset, such as a building or land, by services or by a venture in which the money clearly goes to a specific project. ‘These are what we refer to as the “real” economy or minimum asset-based transactions,’ explains Bakar. ‘Tangible and intangible investments are considered acceptable provided that you can trace your money to the ultimate investment vehicle. ‘In the West it does not necessarily work like this. If you buy a bond issued by Fannie Mae or Freddie Mac out of the securitisation of mortgages, the investor is not able to see the link between their bond and the underlying asset. The missing link of the investment instrument and the underlying asset is obvious in the West.’ Global banks have a prime opportunity to become prominent in Islamic finance.
Preparing the ground Developing Islamic finance skills in the West is one of the simpler challenges to overcome. Finance professionals in Western institutions can build on their knowledge of conventional banking systems, adapting it to accommodate Shari’ah principles. As a professional chartered accounting body, CIMA was the first to issue an Islamic finance certificate, targeting those already working in the conventional banking world. The qualification equips them with a basic level of knowledge, but the advanced diploma that CIMA and the International Institute of Islamic Finance are developing will add insight into the policies and structures that underpin Islamic banking and finance. Building skills in the West will support the efforts of global banks to enter the market and this could see Shari’ahcompliant finance become a major feature of international markets. Excellence in Leadership