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12/4/14, 5:09 PMIdentity crisis for Islamic finance | The National
Page 1 of 6http://www.thenational.ae/business/banking/identity-crisis-for-islamic-finance
Adam Bouyamourn
November 24, 2014 Updated: November 24, 2014 04:46 PM
Identity crisis for Islamic finance
Topics: Islamic finance
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Islamic finance is gaining popularity, but there are also several challenges facing the segment. There is a general feelingthat Islamic banks are modelled on conventional banks. Lee Hoagland / The National
Islamic finance is flourishing as corporate and retail demand booms, butsome question whether the industry is abandoning the values that inspired it.
“The industry I work in, am immensely attached to, and want to be a forcefor social good and social change is, in some respects, being hijacked,” saysHarris Irfan, managing director of the European Islamic Investment Bank,and author of Heaven’s Bankers.
“Islamic finance is struggling to differentiate itself both in terms of productand culture,” he said.
Professor Habib Ahmed, Sharjah chair of Islamic economics and finance atDurham University, agrees. “There’s a difference between the theory ofIslamic finance and the practice.
“In theory, Islamic finance is based on Sharia,” Prof Ahmed says. “But whenwe look at the practice, there is a general feeling that Islamic banks aremodelled on conventional banks, with the objective of making profit.”
The prohibition on Riba, or interest earned outside of commercial activity,
12/4/14, 5:09 PMIdentity crisis for Islamic finance | The National
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bars Islamic banks from earning money from increments charged on loansand deposits.
Sharia prohibits Gharar – speculation or gambling – and requires that alltransactions are based on the real exchange of goods and services. It alsosays that individuals should not take advantage of significant informationalasymmetries, or exploit those with weaker bargaining positions.
These principles are alien to most conventional banks.
In 2007, Muhammad Taqi Usmani, chairman of the Accounting and AuditingOrganisation for Islamic Financial Institutions (AAOIFI), based in Bahrainand the closest thing the Islamic finance world has to a central standardsauthority, said that around 85 per cent of sukuk as then designed did notcomply with Sharia.
The problem was that returns on sukuk al musharaka should vary with themarket value of the underlying asset. A musharaka contract sees partiespool money to invest in a profit-sharing enterprise.
But because the sukuk al musharaka behaved like a conventional bond witha guaranteed rate of return, Mr Usmani argued that it was not a genuineprofit-sharing enterprise, and so not Sharia-compliant.
Mr Usmani’s intervention led to a precipitous decline in the popularity of thesukuk al musharaka. Issuers now prefer the sukuk al ijara, where underlyingassets are transferred to a trust, with rental incomes deriving from beneficialownership accruing to the sukuk holder.
While the products have changed, the worries have not.
One paper from the Islamic Sharia Research Academy showed that, of asample of 560 sukuk, only 11 involved the transfer of an asset off the issuingcompany’s balance sheet to the sukuk holder – a necessary step for thetransfer of usufruct, and legal rights.
“If you look at early experiments in Islamic finance, they were as much socialexperiments as economic experiments,” says Mr Irfan. “The hope was thatIslamic finance would be about trading in the real economy, and with asset-backed products.
“Although the products are certified as being Sharia-compliant, you end upwith too many that look like their conventional equivalents,” he says.
Commercial pressures and the need for Islamic equivalents of tools used byconventional banks have forced Islamic banks to compromise, Prof Ahmedsays.
“Islamic banks are modelled on conventional banks, which are debt-basedinstitutions,” he says. “The organisational format is such that you can’t doanything other than debt-based lending.”
“Clients of Islamic banks often don’t see any difference between Islamic andconventional banks.”
Yet Sharia emphasises equity-based transactions. This means Islamic banksshould more closely resemble venture capital firms or merchant banks,instead of modern retail banks, Mr Irfan argues.
12/4/14, 5:09 PMIdentity crisis for Islamic finance | The National
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Commercial pressures force Islamic banks to compromise between principleand the needs of a modern retail bank. For example, Islamic banks cannottap the money market for day-to-day liquidity operations, because mostmoney market products are not asset-based.
Whether Islamic or conventional, retail banks need to make their accountstally at the end of the day – or face technical default.
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