ISLAMIC FINANCE SYSTEM SHIELD AGAINST FINANCIAL CRISIS
DR. ANWAR ALI SHAH G. SYED & F. M. SHAIKH
Aug 29 - Sep 11, 2011
Pakistan financial institutions have to learn lot of things from Islamic economic system. At the World Islamic Economic Forum in Jakarta, in March 2009, political and business leaders accentuated the strength of Islamic principles of banking and investments. Islamic banks are generally doing better in today's uncertain economic times than their Western colleagues.
The Koran states detailed regulations and prohibitions concerning the economic system.
First of all, Muslims should not involve in 'Riba' - a word interpreted as interest on loans, credit cards or savings accounts. The prohibition concerns all interest-bearing transactions, whether you are giving a loan or taking it.
The Prophet Muhammad cursed people who pay interest, those who collect it, those who write an agreement based on it, and those who witness such an agreement.
Muslims believe that interest-based transactions are not fair because they give a guaranteed return to the creditor without any guarantees for the borrower. One of the main principles of Islamic banking is the sharing of financial risk and sharing responsibility for profit and loss.
Following this prohibition, Islam banks do not deal in interest-bearing mortgages. As a result, the U.S. sub-prime mortgage crisis and the following recession did not hit Islamic banks as badly as their Western colleagues.
If you want to buy a house and you don't have enough money, Islamic banks offer two types of financing
Murabaha: In this type of financing, the bank agrees to buy the property and then re-sell it to the buyer for a higher price. All costs are fixed at the time of the agreement, so there are no late payment fees. The balance is paid through instalments within a predefined period.
The buyer gains 100 per cent ownership of the property from the beginning. However, transactions must be backed by real assets (gold, land, equipment) or a high down payment in order to protect lender against default.
Ijarah: This type of financing is similar to rent-to-own contracts or real estate leasing. The bank buys the property for you, but it remains the owner as long as the buyer makes instalment payments. Once the balance is paid off in full, the property is registered in the buyer's name.
There are other aspects of Islamic economic system that helped Islamic financial institutions to avoid serious financial difficulties. The Koran prohibits investing in businesses that involve gambling, selling alcohol or pork.
Many Muslims have made a conclusion that investing in stock markets or stock trading (buying shares with the intention to sell them and earn profit) is a form of gambling, so it is prohibited by the Koran. When the stock market crushed, they were immune to its ripple effect.
Financial experts also state that Islamic banks tend to rely on deposit accounts because taking credit from international financial organizations is prohibited (it will make them pay interest). That means that Islamic banks have to ensure their clients that their deposits will not be invested in companies that run un-Islamic business. However, in spite of these facts, Islamic principles are not enough for banks to get the total protection from the financial crisis. Islamic finance is so intertwined with the global financial system that they also cannot avoid problems.
Many Islamic banks invest their funds in equity. When the prices for real estate go down, their portfolios also go down. Countries involved in computer and electronics manufacturing (such as Malaysia) have been hit by competitive devaluation and export reduction.
ISLAMIC BANKS ARE LESS AFFECTED IN GLOBAL RECESSION
Islamic banks were less affected than many conventional banks in the current global recession as they are prohibited from activities that contributed to the credit crunch such as investment in toxic assets and dependence on wholesale funds.
The International Financial Services London (IFSL) report notes that the industry felt the influence of the credit crunch and downturn in the global economy with Sukuk issuance being more than halved and the fall in the value of equity funds.
In 2007, the global market for Islamic financial services rose 37 per cent to US$729 billion but by 2008, the industry began to feel the impact of the credit crunch as it enveloped the world.
Nevertheless, London has been consolidating its position as the key western centre for Islamic finance in 2008. Two Islamic banks, Gatehouse Bank and European Finance House, have been granted licenses bringing to five total number of fully Sharia compliant banks in the UK. Principal Insurance became the first Sharia compliant independent company authorized to offer Takaful to UK residents. In capital markets, four new exchange traded funds and two new equity funds were launched.
IFSL report indicates that the UK offering includes a total of 22 banks, far more than in any other Western country. Professional services are provided by 18 law firms and the big four accounting firms. A cumulative total of 18 Sukuk issues raising $10bn have been listed on the London Stock Exchange, second only to Dubai. With 55 institutions offering educational and training products in Islamic finance, the UK has more providers than any other country worldwide.
Duncan McKenzie, IFSL's Director of Economics said: The UK has benefited considerably from supportive government policies intended to put Islamic services on the same footing as conventional services. Evidence of London's growing role in Islamic finance is shown in the UK being the only western country to feature prominently, 8th with assets of $18bn, in a global ranking of Sharia compliant assets by country. Sir Andrew Cahn, UK Trade & Investment's Chief Executive Officer said: Despite its origin overseas, Islamic finance has found a natural home in the UK. Though no sector is immune to the global financial crisis, Islamic finance has shown great resilience. It is important we continue to work with our Islamic finance partners to maintain our position as the leading western centre for Islamic finance service providers.