Booming Islamic bond market embroiled in debate over religious compliance: Mufti Taqi Usmani’s criticism of contemporary sukuk issues
The booming market for financial products that comply with Islamic law was thrown for a loop recently by criticism from a leading scholar, who has set off a debate about whether the industry has sacrificed religious principles for the sake of growth at a time of surging Mideast oil revenue.
Shariah, or Islamic law, prohibits charging or paying interest, so bankers and lawyers have developed a rapidly growing financial market by restructuring conventional products like bonds to make them compliant with Islam. Shariah-compliant products attempt to replicate the concept of interest through cost-plus transactions, leasing arrangements or by linking payments to returns on underlying assets. The process is normally blessed by a board of religious scholars affiliated with a bank.
However, one of the world’s leading Shariah finance scholars recently rattled the market by saying 85 percent of Islamic bonds, or sukuk, are not Shariah-compliant. Sheik Mohammed Taqi Usmani argued that, in essence, they were structured too much like conventional bonds.
Many industry participants say Shariah scholars knew the bonds had structural issues but approved them to jump-start market growth — raising questions about how the gatekeepers of the Islamic banking industry weigh potential profit versus religious principles.
Others downplay the controversy, saying debate was expected given the rapid evolution of the market and the nature of Islamic law, which encourages multiple viewpoints from different scholars.
The influential Shariah board headed by Usmani at the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions, one of the leading groups trying to establish standards for the market, is scheduled to meet Jan. 15 with the hope of resolving the dispute and mitigating its impact on the industry.
Some say the race to grow the market has led to questionable religious rulings — a problem that is hard to police because of the lack of standardization across Shariah approval boards and the shortage of Islamic scholars well-versed in finance.
“Increasing the market in volume or numbers with false product that is against Islam is not a big success. It should be according to Shariah, that is the main thing,” said Sheik Saleh Abdullah Kamel, chairman of the Bahrain-based General Council for Islamic Banks and Financial Institutions, one of several organizations attempting to monitor the industry.
Islamic banking assets outside Iran totaled $400 billion to $450 billion in 2006 and are projected to rise to $1 trillion by 2010, according to a recent report by McKinsey & Co. Total assets, including those in Iran, totaled $750 billion in 2006, a small fraction of global financial assets, but one that is growing quickly.
Experts say growth has been driven by booming Persian Gulf oil revenue, Muslims’ growing preference for an expanding range of Shariah-compliant products and increasing acceptance of Islamic banking practices by financial regulators around the world.
The development of the sukuk market has been particularly important because previously there was a scarcity of Islamic products that could provide mid- to long-term investment and potentially be traded in the secondary market.
Sukuk issuance has grown almost 85 percent per year since 2001, with the total value of Islamic bonds issued in 2007 reaching $39 billion as of October, according to McKinsey.
“There has been this perception in the past that Islamic finance doesn’t lend itself to overly complicated structures, but sukuk rebuts that view,” said Nadim Khan, a Dubai-based lawyer who specializes in Islamic banking.
“It’s a real demonstration from the perspective of the Islamic financing industry that it is possible to structure widely acceptable, quite sophisticated Sharia compliance structures,” he added.
Islam prohibits interest based on the belief that money alone should not be used to generate profit and the returns are seen as riskless gain. So most sukuk are structured with a profit-sharing arrangement where returns are based on the value of the assets purchased with the initial investment.
However, many sukuk have been sold with a repurchase agreement, stipulating the borrower will pay back the face value at maturity, mirroring the structure of a conventional bond.
Usmani, the Shariah scholar, estimates 85 percent of sukuk have been sold with these repurchase agreements and believes the promise to pay back the capital runs counter to Islamic law.
“This is against the risk sharing principle of Shariah,” said Usmani.
Sheik Nizam Yaquby, another renowned scholar on the Shariah board chaired by Usmani, agreed that bonds with repurchase agreements should be made more Shariah-compliant.
“We need enhancement, improvement, innovation and we need more risk taking,” said Yaquby. “Many scholars have reluctantly approved such (sukuk) structures to take us away from the conventional bond market, but that stage has ended, so we should start creating more innovative structures.”
Kamel, who monitors the market, criticized this willingness to approve sukuk structures based on the assumption that they could be made more Shariah compliant once the market had grown, saying it was dangerous for the industry.
“The golden rule of Islamic banking is if you want a profit, you should accept the losses,” said Kamel. “If this rule is broken in any of the product, it is not according to Shariah.”
However, Afaq Khan, the head of Saadiq, Standard Chartered Bank’s Islamic banking arm, does not believe sukuk currently in the market can be considered counter to Shariah because they were blessed by their respective approval boards.
“Nobody comes to the sukuk market without a Shariah fatwa (religious ruling), so at least some Shariah scholars approved it,” said Khan.
Nevertheless, Khan said the current debate was productive. “Anytime a new industry evolves, it will try to test the boundaries,” he said.
“It is very healthy for the industry to take a breath, review and then move on,” said Khan. “Hopefully some consensus will evolve and it will be beneficial for the industry.”