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Category Archives: Introductory material
State Street Global Advisers senior vice president and managing director of the Doha Office, Rod Ringrow, tells Business Spectator’s Isabelle Oderberg how Islamic finance works and why it is set for enormous growth amid the meltdown of western style financial systems.
Isabelle Oderberg: I was wondering if just to start with for some of our readers who aren’t familiar with Islamic finance if you could just go through the fundamentals of it?
Rod Ringrow: The underlying principle for Islamic finance is it’s based on Islamic law and there are a number of key tenets that are critical to how the whole thing hangs to together. So, there’s the underlying premise that social and economic justice go hand in hand. There is a ban on interest. There is a ban to the extent possible on uncertainty. There is the promotion and the concept of risk and profit sharing between the provider of the finance and the recipient. Ethical, socially responsible investments.
So for example, nothing in gambling, armaments, alcohol, pork, obviously for Muslims, and in almost all cases there’s an underlying financial and physical asset that go with the transaction, so the concept of money making money is really what’s behind what is prohibited. So, in many ways it appeals to the Muslim community and also I think a great number of non-Muslims, in the fact that it is back to basics almost in terms of Western finance where there’s a physical asset underlying it, there’s not excess of leverage, etc.
IO: So you can’t invest in, for instance, bonds or anything like that because they pay interest. What kinds of investments would an Islamic fund manager be making?
RR: Well, there’s short-term and longer-term and we’ll come to the bond concept later, but a good example of a short-term fund would be a trading transaction, so the promoter buys a shipment of sugar or iron ore and pre-sells it at a predetermined price, so you buy it at 100 and sell it for 120 and that’s considered acceptable, because as I say, there’s an underlying physical asset and you’re pre-financing that shipment. The uncertainty element’s gone, because you know what you’ve bought it at and you know what you’re selling it at. That’s one example.
You’re right in the true sense of a bond not being able to be invested in, but there are some instruments called sukuks, which are really referred to as ‘Islamic bonds’ and there’s been a huge interest in those. In 2007 there were US$47 billion issued. The market took a bit of a tumble in 2008, but there’s a lot of potential demand out there for sukuk issuance.
There are 14 different kinds of sukuks and that creates another problem which we can come back to later, but in the 14 kinds of sukuks, there’s one called an ijara and that’s more like a lease transaction. Again, there has to be a physical asset underlying the financing here, but that ijara is closest probably to a leasing transaction in western finance. So somebody buys the asset then leases it for a monthly fee to the user. There are bonds issued, backed by that kind of structure, and there are a number of fund management houses beginning to look at how to create investment funds using sukuk as the kind of underlying investment. The traditional sort of Islamic investment funds have traditionally been equity based investment.
Principles of Islamic dealings from the sayings of the Prophet (Allah bless him and grant him peace)
Experts in Islamic finance believe their way of doing business has shielded them from the global credit crisis.
But how does it differ from conventional Western finance?
A former executive director of the International Monetary Fund, Dr Abbas Mirakhor, says wider Islamic economics relies on God’s guidance, handed down almost 1,400 years ago.
There is a "consciousness of a supreme creator and a system that he has provided", he says.
What we know as the conventional Western way does not have that, which is "really the major difference between the two", he adds.
One of the central differences between the Islamic and conventional approaches to finance is that our own cults – which may well see a revision before the end of this crisis – ascribe supernatural powers to money. Cult specialists are at great pains to understand and control how it works, but admit that it does so in magical ways that go beyond the effects of human commerce (for the markets, too, have magical attributes, including innate goodness). Whatever we want from money, we suspect, as devotees, that in the end it will always behave as it sees fit. Our awe of it is a bit like a rapt meditation on the way the shower of gold behaves – shimmering and falling – when it cascades over Danaë in her cloister in Argos. In the story, it’s merely the form chosen by Zeus for her seduction, but in our meditation, there is no Olympian in disguise and no intention to seduce, just the metal shimmering and falling, in consummate self-expression, as deity and dogma. Islamic approaches – there are quite a few – are much closer to Nonconformist and Anglican traditions, where the divinity stands to the side of money, reminding the faithful that he is one thing and mammon another. Money, in this view, is an object of caution rather than superstition – and, in spite of its dangers, a useful tool for anyone who wants to build a respectable world, with God’s instructions pinned to the wall above the workbench.
Maybe this is why sharia-compliant products have been gaining popularity among British Muslims, even if they differ only slightly from conventional ones. Take the home-ownership scheme offered by HSBC’s sharia-compliant range, Amanah (amanah means ‘trust’ in the moral and legal sense). Muslims are forbidden to pay or receive interest and troubled by conventional lending, because it appears to put the burden of risk on the borrower not the lender: in the Islamic view, no transaction is ethical unless risk is fairly distributed between the parties. HSBC Amanah’s scheme is based on an Islamic contract known as ‘diminishing musharaka’ and it’s approved, like all HSBC Amanah’s services, by a board of sharia scholars. A would-be home-owner must put up 40 per cent of the cost price (much less before the credit crunch); the property is registered in a trust (amanah) as a jointly owned asset, with the bank’s majority ownership diminishing over an agreed period, as regular payments are made; the customer promises to buy the bank’s share, and the bank promises to sell it to the client. The property is envisaged as a set of units and the customer’s payments as twofold: one part is rental, for the right to live in it, another is a form of unit-acquisition. The trust keeps a tally of the bank’s diminishing ownership and the growing share to the customer. At term, the trust is dissolved and the home passes to the customer.