Sustainability and challenges 2007


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Sustainability and challenges 2007

  1. 1. Sustainability And Challenges - Dr. Sliamslmd Aklitar In the closing session for this event gaps and requirements of growth, given its current size ai.J on Islamic Finance, I propose to reflect development and society at large and composition it is still a niche market on the growth and trends in Islamic as such its demand would be robust in the overall global financial Finance, its size and dimensions and going beyond religious grounds. industry. Prospect for the industry prospects which are now evolving Islamic Finance has to be recog- are quite bright given strong demand from regional to global scale and nized as a parallel system which will for financial ser-ISS3 vices from a impacting the private capital flows. augment and be augmented by the large segment of about 1.4 billion The renewed interest and hype in deeper knowledge and experience of Muslim populations and need to Islamic Finance is unprecedented. the conventional financial system. As channel effectively rising foreign Since it coincides with commercial such, the key challenge going forward savings and high net worth interest of Western financial to its growth and sustainability would individuals. institutions to attractflows generated lie in how it interfaces and benefits from oil revenues and other savings, from complementing and sup- The growth, level, interest and there is a degree of skepticism plementing the conventional system motivation to promote this industry regarding sustainability of interest and how it adapts and conforms to vary across the globe. The growth inand trends in Islamic Finance the international regulations and Gulf Cooperation Council has been industry within and outside Muslim supervision adequitely refined in line exceptional with Bahrain emergingjurisdictions? Also there are concerns with the technicalities and nuisance as a main centre adopting andechoed on whether the industry will of the Islamic financial instruments implementing Islamic bankingpersevere the competition from the and their associated risks. Exploiting regulation, being the firstcentral baiKglobal financial world nurtured by properly theunique features of Islamic to issue Sukuk and establishing centrethe conventional system backed by finance with appropriate adapt- for Islamic finance education, etc. Iranstrong legal, policy, regulatory and ability, without compromising and Sudan declared sometime backinstitutional framework. Shariah principals, will be critical to 100% conversion to Islamic banking.In my assessment, the Islamic Finance the growth and promising future of Within South East Asia, Malaysianow seems to be a reality and is on its Islamic industry. stands out with $31 billion Islamicway to be institutionalized, albeit at banking assets, $1.7 billion Takafuldifferentlevels in different countries, Touching on some of these debates, industry and has the largest Islamicand tbe Western world is also now I propose to firstdiscuss the trends in dedt market which constitutes 45.5%selectively and cautiously Islamic Finance, lay the case for of total Malaysia debt market. Otherpositioning to invest in this system. sustainability of Islamic Finance and countries in South East Asia haveThere are promising signs that Islamic finally discuss some of the key smaller Islamic financial markets andFinance trends are sustainable. It is challenges facing the industry which Singapore has positioned to offerentrenched in a well conceptualized the Islamic financial community at strong wealth management potential.Islamic economic system whose large is now addressing. Within South Asia, Pakistan standsmysteries are being unfolded with out for its proactive and systematicrenewed academic interest in the Global and Regional Growth stance to evolve Islamic financesubject. While undeniably faith and Trends industry. In all these countries, asstcjdriven, the Islamic finance system has Spread across 70 countries, of Islamic banking grew faster thangreat potential to meet the financial Islamic Finance has grown to almost the overall banking assets and scope a $ trillion industry. Despite its and coverage of financial services ECONOMICREVlEW-9/lO, 2007 43
  2. 2. extended to retail and consumer While motivations and drivingfinance, private equity, structured factors for this industry vary across Sustainability and Challengesproducts, insurance and project the world, this round of wave in of Islamic Financefinance etc. Islamic finance industry is there to Prospects for sustainability of stay there. What lends one confidence Islamicfinance appear promising, but Distinct from Islamic countries, is is the large investments by financial there are associated challenges whichthe interest of few global financial industry across main hubs in GCC/ need to be concurrently addressedcenters such as London that now Middle East/South East and South while one exploits and maximizesprovide policy and tax incentives to Asia, both within countries and the opportunities created by thispromote Islamic finance industry to growing foreign ownership and joint discipline.attract funds from high net worthclients. Same motivation seems to have ventures across borders, in infrastruc- First, the sustainability of Islamicdriven global banks such as HSBC, ture development in this industry be finance stems from recognitionl thatStandard Chartered, Deutsche Bank, it by way of Islamic economic and financialCitibank etc. to set up special hubs to (i) Issuance of holistic banking architecture has a lot of appeal and structure Islamic finance products. licenses or opening of special win- depth going beyond Muslim coun- dows or creation of hubs/dedicated tries. While initially conceived to be In reality, while current hype in solely anchored on Riba free interestindustry may be partially driven by Islamic asset management funds, private equity funds and hedge funds rate regime, there is now appreciationavailability of surpluses generated that advocacy to move to Islamicby oil revenues, Islamic banking is etc. accompanied by Dow Islamic business and finance structure whileemerging as an alternate financing Index to which all such transactions be on religious or social grounds isoption that coexists alongside the subscribe too are large; not a "slogan" or mere religiousconventional financial industry. (ii)Development of Shariah pronunciation or condemnation ofMoving from traditional Islamic knowledge and understanding and Riba but is supported by a completeproducts, now the industry is offering engagement of Shariah advisors and and deep Islamic ideology. Whenconsumer financing for residential scholars which together are studied carefully it has its logic andpurposes and structuring financing providing required consensus, guid- basis in a comprehensive Islamicvehicles for supporting infrastructure ance and legitimacy to Islamic economic system which deals with and housing finance projects etc. industry, products and structures; allocation of resources, production Product innovation is emerging with and and exchange of goods and services several different types of hybrid (iii) Development of Islamic and distribution of wealth - all too Sukuks and other combination of standard setters such as the Islamic familiar debates in conventional structures which involve different Financial Supervisory Board and economic textbooks. forms of Musharikas with other Accounting and Auditing products. Notwithstanding these Organization for Islamic Financial Second, the confidence in sus- developments, increasing share of Institutions (AAOIFI) and tainability of Islamic economic sys- equity based credit products, such as Internationa] Islamic Financial tem emerges from the better under- Murabaha and Ijara, remain the Market (IIFM) etc. by the central banks standing that this economic system is dominant form of Islamic financing as well as a range of Multilateral a well conceptualized, consistent and across the Islamic financing Development Agencies including the integrated framework. More institution. Islamic Bank Development. The interestingly, it is accompanied by a combined efforts have helped develop rich and an elaborate set of tenets These trends are expected to which, among others, recognize the and initiate implementation of Islamic persist and the industry is set to grow. right to property supported by elab- prudential regulatory, accounting Standard & Poor Services Rating orate obligations for stakeholders, and auditing frameworks, and Agency estimates that industry has principles and rules of conduct, a inspection and supervision of potential to grow to $4 trillion over contract system and institutional financial institutions; medium term. As highlighted above, framework and procedures for the exceptional growth in Islamic All these regional and global efforts are serious long term initia- enforcement of rules which al! Finance, particularly since 2000, together lay the foundation for Islamic which has coincided with growth in tives which are irreversible though maintaining and building momen- business and financial architecture. oil revenues, has raised questions It is this substantive Islamic whether interest in Islamic Finance is tum on these fronts would be critical to address the questions of sus- ideological and legal framework, one time phenomena? And what the governed by Shariah injunctions and future prospects and sustainability tainability and challenges facing this industry. principles that have translated into of the industry are? ECONOMIC REVIEW-9/10,2007 44
  3. 3. defining the public and private edge of conventional economics and with appropriate asset backing and economic and social affairs that financial engineering and learn to legal structures. Diversifying into eventually help frame the business apply this to the Islamic economics bank assurance through and financial relations. The core of and finance discipline without establishment of associated Takaful these relationships is backed by solid diluting its ideological underpin- institution and appending insurance principles of contracts, rights and nings. sweetener is also a wave, though slow obligations of parties to the Fifth, flexibility and innovation to to take off. Islamic housing finance contractual arrangements. structure different types of financial for acquisition and other purposes Third, the sustainability of this products which augur well for Islamic has evolved to be a natural and system is reinforced by the business Finances sustainability. What promising market to cater for huge and financial relations that are guid- distinguishes Islamic finance is its home financing demand in Muslim ed by the logically defined emphasis emphasis on trading of goods and countries. This market is gaining on the preferred modes of transaction services and its advocacy for profit momentum following some which advocates profit sharing and and risk sharing in businesses interesting facilitation/ incentives as such relies on "ex-post" variability supported by a variety of partnership offered by some countries: for instance rather " than ex ante" fixity in returns arrangements - this is in sharp US has facilitated Islamic lease-to-and consequently has built in risk contrast to loan based financing in own relationship by allowing bank tosharing as a central element of conventional banks. By virtue of these take title to property and in the UKtransactions. Relevance of contracts characteristics Islamic finance offers Bank of England abolished doubleis at the core of Islamic transactions prudent financing options being asset stamp duty on Islamic mortgages,which define the rules of game for backed or equity based; particularly Ijarah I and Murabaha transactions,sale and purchase/trade/exchange linkage of assets with financing and rationalized of legal service feesof goods and services. Financing ensures that transaction is less prone and risk weightage etc. and Australiacontracts are then structured around to debt crisis and funds are used for and Canada allowed adoption ofthe nature of transaction which could their prescribed purpose minimizing declining balance partnershipbe either in the form of trade financ- defaults resulting from improper use concepts to facilitate structuringing; asset based financing or different of borrowed funds. Diminishing Musharaka contractetc.forms of partnerships. Under Islamic Concurrently it offers promising In some jurisdictions momentum forfinance preference is given to trading potential for offering alternate tapping retail market has beenof physical assets as well as trading avenues for saving and investment accelerated by partial or full conversionof rights. for all segments of population. of conventional to Islamic banks such Fourth, the confidence in sus- as Saudi Arabia - challenges of which Sixth, market surveys confirm that cannot be underestimated as it involvestainability emerges from the frame- the potential for retail, housing andwork of enforcement implicit in converting the loan book to Shariah project finance and innovation compliant modes of product. StandIslamic system. The main driver of emerging in these markets is signif-enforcement of contracts and rules- alone Islamic banks have a challenging icant and augurs well for economic task of competing with the conventionalcompliance in Islamic system is and financial services development.ideology and faith which is in turn players who have an edge of longevity Islamic banks have registered double and customer loyalty and economies ofinfluenced by Islams emphasis on digit growth in retail markets.establishing a equitable, ethical, just, scale. High level of customer service, Penetration has occurred faster where offeringfullproductrange, introducingand fair socio-economic system. It is personal banking solutions have beenthis feature which shapes up Islamic a level of transparency in transactions, structured well for saving and devising unsecured personal loanfinance and also distinguishes it from investment account offering range ofthe conventional finance. Although products (a wave emerging with products and where information adoption of Tawarruq product),one can argue that sustainability of technology is used to offer online,interest in Islannic Finance is tied in troducingShariah compliant credit ATMs and telephone banking cards, handling properly thesolely to the response of Muslim services. By and large products arepopulation to their religious values unfunded businesses and improving structured on Murabaha principles efficiencies are some of responses toand beliefs, but it has to be recognized where funds are allocated forthat attraction in this discipline is challenge of competition. Large scale particular projects or finance an, asset business opportunities however lienow widely emerging as there is better (such as home ownership and understanding of Islamic economics in exploiting project finance. automobiles) in which depositor Successful application andand finance and mechanisms are shares in the project rather than bankbeing found to juxtapose the knowl- integration of Islamic instruments profits and to structure Ijara (leasing) ECONOMlCREVlEW-yiO, 2007 45
  4. 4. with the conventional financing has industry ranging from religious fervor and apply legal, regulatory servicehelped in this area while facilitating to the opportunities that exist in Islamic standards at par with conventionalclosure of large and complex multi finance for broadening and deepening products and standards has alsosource financing deals. Project the process of financial intermediation helped encourage confidence in thefinancing, backed by asset and equity which augurs well for financial system.and structured using combination of innovation and engineering, enhancing Going forward, the sustainability ofIjara, Istisna, Sukuk and Musharika etc. the financial services penetration in Islamic Finance would rest in howhas offered opportunities for risk national jurisdictions and for cross the international community buildsdiversification, avenues for resource border capital flows. While the size of on the momentum achieved thus far.mobilization and revenue sharing and Islamic financial industry is still quite This would require performance of services between small as a proportion of the total worldscontractual parties. These deals have financial assets, the current growth (i) Further deepening the efforts illustrated how conventional and trends and the investments in to enhance the legal and Islamic financing can blend and coexist infrastructure in development of its regulatory framework of Islamic finance consistent under common legal and regulatory Islamic Finance networks and its regulatory and supervisory systems, with the international prac- arrangements. tices. Finally, more than conventional lend confidence that this industry has (ii) Continued strive to conform finance, Islamic finance emphasize just promising potential. Prospects for this industry appear and align the structures and and equitable financial system. Among products in line with the others, Islamic finance offers a financial comforting because of variety of factors Shariah principles would inclusive option to Muslim who have - most significant being the strengths help Muslim populations excluded themselves from financial of Islamic ideology and economic motivation to turn to this services inabsenceofRiba free service. system which offer a complete alternative mechanism of Since a number of Muslim countries framework for the Islamic finance financing, while attracting suffer from low financial services industry laying down rules of others to product and risk penetration, bringing in the appeal of conduct and contractual arrange- management and mitigation Shariah complaint financing ments and feasible financing struc- innovation and additionally mechanism could turn out to be a ture which emphasize trade and that this window offers, powerful tool for erhancing access to equity financing that together will (iii) Recognizing that Islamic development finance and empowering help the much needed financial finance has perpetuated and the poor and vulnerable groups. diversification in Islamic countries. changed the dynamics of It is important to recognize that Islamic finance further has poten- cross border private capital Islamic finance confines itself to largely tial to blend economic and social flow this industry has great socially and development projects and objectives and address the ethical potential to augment the institutioris are not permitted to invest aspects of financing effectively. As such process of globalization and in prohibited or socially undesirable it is generally more acceptable in financial integration, but this investments. Emphasis on ethical populations with moderate to strong requires more cooperation issues and rigorous self-regulation inclinations toward managing their and vigilance on the part of in terms of Shariah supervision financial relationships in line with their home and host regulators, ensures fair play and justice and offers beliefs. This can thus help in poverty (iv) Launching aggressive effort superior consumer protection model. alleviation through inclusion of a larger to implement the evolving Furthermore it induces higher proportion of population into the Islamic financial regulatory financial discipline and places strin- banking system giving them access to and supervisory standards gent ethical standards for all stake- credit and mobilizing their savings and capturing the different holders that offers a strong and unique effectively. types of risks associated with model of governance. The emerging solutions and Islamic finance, while application to structure Islamic finance launching consumer Conclusion innovatively have helped cater for all protection frameworks, In conclusion, encouraging types of markets and financing (v) Promoting more financial developments and trends in Islamic requirements ranging from retail to diversification by Finance lend confidence that this project and home financing to equity encouraging financial industry has taken off. However, there funds and products and insurance innovation and Islamic are varying motivation and driving offers a full array of financial options. capital market development. factors for the development of this Industry effort to benchmark pricing • ECONOMlCREVlEW-9/10,2007 46