London warms to Islamic finance

The land of Adam Smith now teems with a vibrant Islamic banking sector, with even non-Muslims being lured by the model’s promise of transparency and stability.

Shabaz Bhatti is proud to be a devout Muslim – but his plans to remortgage the family home with one of Britain’s new generation of Islamic banks isn’t just about religion.

The 30-something driving instructor wants reliability, and believes Britain’s growing Islamic finance sector offers this in a way that myriad traditional main street banks no longer do.

“It’s simple and straightforward, which is great because … it seems as though interest rates right now could go ballistic,” says Mr. Bhatti, whose parents immigrated to England from Pakistan.

At a time of almost unprecedented financial volatility, Islamic banks are being hailed as bastions of stability. Growing numbers of individuals and companies are now embracing their workings, which are based on Koranic principles.

Using law changes and generous tax breaks, the British government is now attempting to transform London into the Western world’s center for Islamic finance. Conventional banks and financial institutions are also rolling out a range of Islamic finance products.

Globally, the market for Islamic financial services is estimated to have grown more than threefold over the past decade – from around $150 billion in the mid-1990s to $500 billion in 2006.

Keen to tap into this, Britain’s authorities are planning to become the first Western government to issue an Islamic bond – called a sukuk – structured to comply with the sharia law principles of Islamic finance, which forbids all forms of interest payments.

Sharia law also prohibits investing in any enterprises involved with alcohol, gambling, tobacco, and pornography – a fact that nicely dovetails with the growing number of Westerners seeking socially responsible investments.

According to a new study by International Financial Services London (IFSL), an independent organization representing Britain’s financial services industry, Islamic finance will emerge largely unscathed from the current global crisis, largely because its structures make little or no use of many of the complicated instruments blamed for the current problems in conventional finance, such as derivatives and short-selling.

Although Islamic finance does allow for risk-taking, it does not permit excessive uncertainty, known as gharar. All deals to buy or sell are invalid if the object dealt with is not certain and transparent.

When risks are taken, the Islamic financial model insists they are shared. In retail, this involves the customer and their bank sharing the risk of any investment on agreed terms, and dividing any profits between them. Products revolve around principles such as murabaha, a form of credit enabling customers to make a purchase without having to take out an interest-bearing loan. The bank buys the item and then sells it on to the customer on a deferred basis.

Bhatti, who lives in the leafy London suburb of Wimbledon with his wife and young daughter, is currently a customer of Abbey National, a traditional, Western bank. He has had no objection to using conventional Western financial products. However, in the past, the couple were customers of the Bank of Kuwait when they bought a home costing nearly $200,000 in the London district of Croydon.

The Bank of Kuwait valued the house at about $270,000, based on what it was expected to be worth at a later date, and arranged for the family to pay the money back in equal installments over the next 16 years. Now, Bhatti is planning to return to such an arrangement by transferring his conventional mortgage to an Islamic bank.

“With the current economic situation, our plans to go back to Islamic banking are not just about religion, they’re a financial decision. It’s more secure … and it’s clearer for the future,” he says.

More than 26 banks in the UK offer Islamic financial products, including major institutions such as HSBC. Six Islamic banks are wholly compliant with sharia law. A pioneer of Islamic retail banking has been the Islamic Bank of Britain, which has 64,000 account holders and branches in cities including London, Birmingham, and Manchester. The bank recently launched its most competitively priced sharia mortgage to date, offering terms that company executives hope will lure takers beyond its core market of Britain’s 2 million working Muslims.

This country’s growing Muslim community is helping broaden London’s reputation as a financial capital, says Patrick Lamb, an official who joined a British government delegation this week to the World Islamic Banking Conference in Bahrain, where the UK authorities and a range of London-based banks and firms showcased their expertise.

“We have by far the largest concentration of Islamic finance anywhere in Europe,” Mr. Lamb says.

Along with home and retail finance, increasing numbers of companies are also turning to Islamic finance to raise money for expansion, ranging from steel manufacturers to luxury gift firms, which are often owned by Muslims or have Muslim shareholders. Money from wealthy Gulf investors has been pouring into Britain in recent years. There is no more potent symbol of this than the skyline of London’s financial center, known as The City.

A fund from Kuwait spent more than $600 million recently to buy the Willis Building, one of the tallest in the district, while nearly $3 billion is coming from Qatar to finance the building of what will be Europe’s tallest building, a 1,000-foot-tall structure known as the Shard of Glass.

source : csmonitor3259865949_85aa743a0e

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CSR for Islamic financial institutions

Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is developing a governance standard on corporate social responsibility (CSR) for Islamic financial institutions.

The Auditing and Governance Standards Committee consisting of high level executives from the international Islamic finance industry met at the Bahrain Institute of Banking and Finance (BIBF) to finalise the specific details of the standard.

The standard will highlight the importance of CSR from an Islamic perspective and give guidance to Islamic financial institutions in carrying out its CSR functions.

“With substantive provisions on CSR conduct and disclosure, this standard will open the way for Islamic financial institutions to be recognised for their positive ethical and social activities and further differentiate them from other financial organisations as direct contributors to society,” Centre for Islamic Finance R&D manager Sayd Farook said.

The CSR standard complements AAOIFI’s 68 existing international standards on Sharia, accounting, auditing, ethics, and governance.

AOIFI’s standards are adopted in leading Islamic financial centres across the world including Bahrain, Dubai Islamic Financial Centre, Qatar, Qatar Financial Centre, Sudan, and Syria as well as by the Islamic Development Bank Group.

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Is Islamic Finance Panacea for Global Credit Crisis?

“Islamic finance can also reduce the problem of subprime borrowers by providing them loans at affordable terms. This will save billions of dollars that are spent to bail out the rich bankers,” said Chapra, who at present works as adviser at the Islamic Research and Training Institute of the Islamic Development Bank.

Chapra estimated the derivatives market at $600 trillion, more than 10 times the size of the world economy.

“No wonder George Soros described derivatives as hydrogen bombs while Warren Buffett called them financial weapons of mass destruction,” he pointed out. The derivatives include credit default swaps (CDS) worth $54.6 trillion.

The Islamic economist described the present global financial crisis as the worst in four decades. “There is a lurking fear that this might be only the tip of the iceberg. A lot more may come if the crisis spreads further and leads to a failure of credit card institutions, corporations, and derivatives dealers,” he warned.

Chapra urged Muslims to establish a genuine Islamic finance system with proper checks and controls, adding that such a move would encourage others to embrace it.

The Islamic system does not allow the creation of debt through direct lending and borrowing. It rather requires the creation of debt through the sale or lease of real assets by means of its sales- and lease-based modes of financing such as murabaha, ijara, salam, istisna and sukuk.

Spelling out the regulatory regimes in the Islamic system, Chapra said: “The asset which is being sold or leased must be real, and not imaginary or notional; the seller must own and possess the goods being sold or leased; the transaction must be genuine with the full intention of giving and taking delivery; and the debt cannot be sold and thus the risk associated with it cannot be transferred to someone else.”

He said the conditions set by the Islamic system would help eliminate most of speculative transactions. “Financing extended through the Islamic products can expand only in step with the rise of the real economy and thereby help curb excessive credit expansion,” he said.

Chapra emphasized the significance of the condition that prevents a creditor from transferring the risk to someone else by selling the debt. “This will help eliminate a great deal of speculative and derivative transactions where there is no intention of giving or taking delivery. It will also help prevent an unnecessary explosion in the volume and value of transactions and the debt from rising far above the size of the real economy,” he added.

It will also release a greater volume of financial resources for the real economic sectors and, thereby, help expand employment and self-employment opportunities and the production of need-fulfilling goods and services.

The discipline that Islam wishes to introduce in the financial system may not materialize unless the governments reduce their borrowing from the central bank to a level that is in harmony with the goal of price and financial stability, Chapra said.

“In the Islamic system, credit is primarily for the purchase of real goods and services which the seller owns and possesses and the buyer wishes to take delivery. It also requires the creditor to bear the risk of default by prohibiting the sale of debt, thereby ensuring that he evaluates the risk more carefully,” he explained.

He said excessive and imprudent lending by banks was the main cause of the current global crisis.

“There are three factors that make this possible: inadequate market discipline in the financial system resulting from the absence of profit and loss sharing (PLS); the mind-boggling expansion in the size of derivatives, particularly CDSs; and too big to fail concept of banks who believe that the central bank would come for their rescue.”

The false sense of immunity from losses introduces a fault line in the system as banks do not undertake a careful evaluation of their loan projects. This leads to an unhealthy expansion in the overall volume of credit, to excessive leverage, and to an unsustainable rise in asset prices, living beyond means, and speculative investment. Unwinding later on gives rise to a steep decline in asset prices, and to financial frangibility and debt crisis, particularly if there is overindulgence in short sales.

Chapra said the subprime mortgage crisis in the US was also the result of excessive and imprudent lending. “Securitization or the originate-to-distribute model of financing has played a crucial role in this. Mortgage originators collateralized the debt by mixing prime and subprime debt. By selling the collateralized debt obligations (CDOs), they passed the entire risk of default to the ultimate purchaser. They had, therefore, less incentive to undertake careful underwriting.”

Consequently a number of banks have either failed or have had to be bailed out or nationalized by governments in the US, the UK, Europe and a number of other countries.

“This has created uncertainty in the market and led to a credit crunch, which has made it hard for even healthy banks to find financing,” he said.

“When there is excessive and imprudent lending and lenders are not confident of repayment, there is an excessive urge for resorting to derivatives like CDSs to seek protection against default. The buyer of the swap (creditor) pays a premium to the seller (a hedge fund) for the compensation he will receive in case the debtor defaults,” he added.

http://www.arabnews.com/

 

Islamic Finance: Law, Economics, and Practice

Autors : Mahmoud A. El-Gamal
About the Author
Mahmoud A. El-Gamal is Professor of Economics and Statistics at Rice University, where he holds the endowed Chair in Islamic Economics, Finance, and Management. Professor El-Gamal has also served in the Middle East Department of the International Monetary Fund (1995-96), and was the first Scholar in Residence on Islamic Finance at the U.S. Department of the Treasury in 2004. He has published extensively in the areas of econometrics, finance, experimental economics, and Islamic law and finance.

ISBN-10: 0521741262
ISBN-13: 978-0521741262

Publisher : Cambridge University Press

Introduction to Book
This book provides an overview of the practice of Islamic finance and the historical roots that define its modes of operation. The focus of the book is analytical and forward-looking. It shows that Islamic finance exists mainly as a form of rent-seeking legal-arbitrage. In every aspect of finance — from personal loans to investment banking, and from market structure to corporate governance — Islamic finance aims to replicate in Islamic forms the substantive functions of contemporary financial instruments, markets, and institutions. By attempting to replicate the substance of contemporary financial practice using pre-modern contract forms, Islamic finance has arguably failed to serve the objectives of Islamic law. This book proposes refocusing Islamic finance on substance rather than form. This approach would entail abandoning the paradigm of “Islamization” of every financial practice. It would also entail reorienting the brand-name of Islamic finance to emphasize issues of community banking, micro-finance, and socially responsible investment.

Islamic banking course: a first for Australia

life-bundooraLa Trobe University is planning to introduce the first course in Australia dedicated to Islamic banking and finance, joining a handful of universities in the West embracing this fast-growing segment of global finance.

The Master of Islamic Banking and Finance will provide students with postgraduate training in the technical skills demanded by Global Islamic capital markets and institutions.

Associate Professor Dr Ishaq Bhatti, of La Trobe’s Department of Economics and Finance, says the Masters program will appeal to international students from Asia wanting Islamic financial training in English and to local graduates keen to enter the growing sector in Australia. Several local banks – NAB, Kuwait Finance House, HSBC and Muslim Community Cooperative of Australia are active in the field.

The International Centre of Education in Islamic Finance, a training subsidiary of Bank Negara Malaysia, the equivalent to Australia’s Reserve Bank, will provide industry-based certification for graduates of the La Trobe course, opening up employment opportunities throughout the international banking and finance sector.

‘The Islamic banking and finance market has experienced substantial and unexpected growth in recent years, growing at a rate of ten to fifteen percent per year,’ Dr Bhatti says.

‘Today, more than 260 Islamic financial institutions are operating worldwide, which are claimed to manage assets worth no less than A$500 billion, while the assets held by Islamic financial institutions were only A$8.5 billion in 1985.

‘Such immense growth has brought Islamic finance to the attention of the international banking community, prompting the major banks to set up Islamic financial windows to take advantage of demand for Shariah compliant finance.’

Islamic banking has grown from Shariah law which traditionally bans usury – the charging of interest on loans, Dr Bhatti says. ‘Islamic banking is a community activity. It offers equity and security between lender and borrower. If a borrower runs into financial difficulty, it is the responsibility of the lender to help sort out his problems.’

The bank will reduce payments, offer moratoriums, give free financial planning advice and in some cases pay out the loan through the zakah, a fund set up out of the 2.5 per cent annual contribution from accumulated assets required by Shariah law which seeks to encourage the distribution of wealth.

In his recently-published book, Developments in Islamic Banking, Dr Bhatti calls this approach ‘a paradigm of fairness and equity’, contrasting it with conventional economics which has little interest in promoting benevolent behaviour in the market. The lender in Western financial systems enjoys an exclusive right to get back his rented capital with a predetermined interest income, whereas a borrower may bear interest risks out of all proportion to his abilities.

Islamic banking seeks to redress this imbalance by dividing the risk between lender and borrower. In the more intimate setting of the community, the lender will accompany the borrower and purchase the new car or computer on his or her behalf.

Repayments are set according to a formula which includes the purchase price of the item, the rate of inflation, bank costs and a profit margin. This margin is set at the time of the loan and is not subject to variation.

Similarly, in the case of the residential housing market, the bank will buy a house for the customer and rent it back at market value. Any additional repayments will come off the value of the loan. Western financial institutions have acknowledged the stability of the Islamic banking system and invested heavily in its bonds.

Dr Bhatti makes the point that maximising profit is not the major objective of this system.

‘In the conventional system the bank can lend more than their assets. They then issue bonds which are debit-based products to attract investors.’

Islamic banks are not debt-based but asset-based, he says. This makes their bonds attractive to low-risk investors. Western financial institutions such as Citibank have acknowledged the inherent economic stability of the Islamic banking system and invested heavily in their bonds, Dr Bhatti says.

Rhonda Dredge

SPRUCED-UP ISLAMIC FINANCE TACKLES A TURBULENT WORLD

Banks that keep to shariah law could offer a solution to some of the problems facing Western financiers

 

Luke Hunt

 

The global turmoil that has ravaged the international banking sector is breathing fresh life into alternative investments like Islamic finance which has undergone an image makeover in recent years and improved its appeal among conservative investors. 

Behind that appeal is the trillions of petrodollars that arose out of a quadrupling in the cost of crude since 2001 and the sharp increase in the number of Middle East investors seeking to expand their portfolios beyond their traditional oil and construction remits in the desert kingdoms.

 

Saiful Azhar Rosly, the head of Islamic banking at the International Centre for Education in Islamic Finance (ICEIF), said Islamic financing was not without its problems, however, the rigours imposed by shariah law would have prevented the collapse of Wall Street institutions and the $700 billion rescue package that has since followed.

 

“Prudent lending was a root cause of the sub-prime crisis in the United States. The borrower did not have to make a down-payment for a home loan, he was just asked whether he could pay it back, that I can presume will not happen in Islamic banking where you would have to pay much closer attention,” he told Bangkok Post Sunday.

 

Islamic finance in the modern era is a late-comer when compared with the different styles of Western capitalism.

 

Its development first emerged in the early 1970s with the establishment of Gulf banks on the back of an earlier oil boom, however, the philosophies of Islamic finance go far deeper and back to the times of the Prophet Muhammad and the beginnings of shariah law in the 7th century.

 

Under shariah law, speculation, the payment of interest and complicated derivative products like those that brought Wall Street to its knees are prohibited.

 

“You’re not allowed to sell a loan,” Rosly adds, with reference to the re-packaging and selling of bad loans in the US.

 

Companies that are considered heavily in debt are shunned, and those that deal in gambling, alcohol, pornography or illicit products like pork are strictly off limits.

 

As opposed to a mortgage, Islamic finance operates more along a lease basis. Officially, the lender owns the property while the borrower makes a substantial down payment and enters a rental agreement. Ownership is transferred once the total value is paid out.

 

Islamic banks and insurance companies also profit share among customers and are much more geared towards spreading risks when compared with their Western counterparts.

 

It’s for Muslims who are prepared to pay a piety premium, to ensure their investments measure-up to the moral standards imposed by the shariah code.

 

“The growing preference for Islamic financial instruments is all the more meaningful with the spread of Islamic banking into new markets,” Standard & Poor’s wrote in its 2008 outlook on Islamic finance.

 

“Banking customers in the Arab world and a large part of Asia as well as Muslims in the West are increasingly attracted by the Islamic model.”

 

This has resulted in $500 billion worth of shariah-compliant assets around the world which have grown at an average 10 per cent a year for the last decade.

 

Malaysia has invested heavily by pioneering sukuk, or Islamic bonds, which are mainly backed by property assets. Equally important, Malaysia wrote benchmark laws that underpin and secured its Islamic financial market. Coherent regulations have been the biggest issue confronting the industry.

 

Also more and more non-Muslim countries are vying for a share of the market. Governments around the world want to tap Islamic finance particularly if they can raise cheaper funds to finance big ticket projects like electricity, roads and mass transportation projects.

 

The UK and Germany have been prominent while in Asia, Thailand, Hong Kong, Singapore and Indonesia are attempting to follow Malaysia’s lead.

 

Hong Kong has launched an Islamic China Offshore Index on its stock exchange where sharia-compliant companies can list and raise capital to further leverage themselves into Mainland China.

 

Indices that contain shariah-compliant companies are becoming increasingly popular in the West and in non-Muslim Asia. Standard & Poor’s already covers 30 shariah stock market indices and screens close to 30,000 global stocks for potential Islamic investment.

 

But Rosly said uncertainty faced by Western investors, the liquidity crisis and freefalls in global equity markets would rub off on Islamic finance.

 

“The global crisis is creating a lot of uncertainty and this will hurt the issue of sukuks,” he said, adding that sukoks were more suited to governments and sovereign wealth funds as opposed to companies.

 

In July, Thailand – home to six million Muslims – scrapped plans to issue its first $500 million Islamic bond this year due “to several issues”. Although Finance Ministry deputy permanent secretary Sathit Limpongpa insisted “we should see a bond issue in the next fiscal year”.

 

Rosly added that ratings issues would impact on a government’s ability to launch an Islamic bond and this need to be considered.

 

Malaysia, for instance, which is “A” rated and holds about two-thirds of the global sukuk market enjoys slightly stronger ratings than Thailand, where agencies are warning that ongoing political turmoil could lead to downgrades.

 

And this, Rosly says, will challenge Bangkok’s ability to raise cash for its economy whether through a sukuk or a regular international government bond tender.

source : bangkokpost