Issue 848, 27 February 2009

Islamic finance: a real alternative to boom or bust?

it is not immune to the impacts of the global financial crisis, but scholars and financiers argue that this is a ‘golden opportunity’ to promote the Islamic finance industry as a more responsible alternative to conventional banking.

Just like conventional banks, Islamic financial institutions (IFIs) are suffering from tight liquidity, but if the principles of sharia-compliant financing were followed, we would not be in the current financial mire, scholars and financiers argued at Euromoney’s annual Islamic Finance Summit. With fewer bankers than last year attending the 24-25 February event in London, financiers and scholars present argued that an Islamic-based economy would offer a system that doesn’t practice or promote the weaknesses of capitalism – excessive leveraging, short selling, market manipulation, derivatives, options or swaps. The basic principles of sharia-compliant financing forbid usury and place high ethical standards on the type of investments permitted. In a neat argument to exempt Islamic financiers from any blame for the global crisis, it was argued that the Sharia industry exists within the context of a capitalist system and its market risks.

IFIs have liquidity issues. Qatar Islamic Bank’s chief executive Salah Jaidah said “all banks have been affected by tight interbank lending. We’ve been relying on international institutions for short-term funding – they gave the right price and reacted immediately to demand – but that’s no longer available.” The upside is that Gulf Co-operation Council banks are looking to the region and further east for funding. “We now have to continuously try to get liquidity from the region, and there’s healthy activity between banks, we’ve started getting to know each other for the first time and I think from now on we’ll see increased interaction between Gulf and Asian banks,” Jaidah said.

For Emad Al-Monayea, chairman of Kuwait Finance House subsidiary Liquidity Management House, the issue is one of confidence. “Kuwaiti banks are sitting on tons of liquidity, that’s the issue. There’s a mismatch between short-term and long-term funding. Banks are asking: ‘do I trust that wherever I invest liquidity it is going to come back to me?’.” The concern now is “not a return on capital but return of capital,” Al-Monayea added. The maturity mismatch of short- and long-term funding relates to the fact that IFIs’ main investments are longer-term products such as sukuk, project finance and real estate, while their main source of funding is short-term customer deposits.

According to the not-for-profit International Islamic Financial Market’s chairman Ijlal Ahmed Alvi, the challenges are that “no secondary market trading options are available and liquidity management products are limited.” Another liquidity challenge for Islamic banks is the absence of a central bank lender of last resort; and their returns on liquid assets are low. On the whole, Alvi said, Islamic banks were more liquid than their conventional counterparts – 30% more liquid than last year. Saudi sharia scholar Dr Mohammed Elgari said this was because “it’s not easy for Islamic banks to acquire assets.” The amount of screening involved to make sure their investments were Sharia-compliant and not considered haram – such as investing in gambling, alcohol or pork – means it takes longer to find the appropriate investment.

Each GCC economy and financial market is experiencing the crisis differently, but the underlying message is that government intervention is much needed. In Saudi Arabia, Al-Rajhi Bank’s head of corporate banking Marcus Andrade said, “the size of infrastructure projects are far bigger than bank capacity – without foreign bank lending, large projects cannot be financed.” While local Islamic banks had been lending to projects for the last three to four months, there was still debt that needs to be met. Saudi liquidity will be an issue for another six to 12 months, and eventually the government will have to finance projects.

Many were confident that Islamic finance would flourish once markets started to pick up. Some banks, like Malaysia’s Commerce International Merchant Bankers (CIMB)’s Islamic arm, are using the downturn as an opportunity to expand branch networks. Western countries are still working to develop the Islamic finance industry in their domestic markets. The UK has taken a lead; Australia has committed A$20bn over the next five years; and the Netherlands has set up a working group

Bankers said that, fundamentally, Sharia-compliant finance was a good business model. A completely Islamic-based economy would avoid inflation and deflation, because lending is based on tangible assets – services and goods – there’s no return on money itself. Compliance, and other issues mean the system is far from perfect., but at a time when trust in conventional banking is at an all-time low, Islamic financiers feel their time may have come.