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Friday, 6 April 2012

Egypt: Flirting with Islamic finance

With Egyptian newspaper headlines signalling Islamists' increasing hold on politics, the economy pages are regularly filled with information on all kinds of investment products that adhere to Islamic principles. Sharia law bans both interest and speculative trading.

The Egyptian media echoes the social transformation that is currently underway. Ikram El-Sayed, a 62-year-old housewife, said she is transferring all her savings to Islamic banks, after spending the past 15 years unwillingly investing her money in interest-bearing investment certificates. She feels good making this change, and blames recent life failures on having made investments she considered religiously prohibited. "The certificates' yield that I get every six months is never blessed, as most of it was spent over the years on my late husband's treatment for cancer, as well as on a failed private business for my only son."

El-Sayed said she hates usury. But as her relatives had told her that even Islamic banks in Egypt did not apply Sharia law completely, she and her husband had decided to invest the savings they had made from working in the Gulf in conventional banks. But now, "with Islamists rising to power, banks will strictly abide by Sharia, and I will be sure that my money is 100 per cent halal," or Sharia-compliant.

Banks and other financial institutions have already started to feel the new market beat. Egypt currently has two fully-fledged Islamic banks -- namely Faisal Islamic Bank and El-Baraka Bank. Another handful of banks are applying for licences to open branches for Islamic transactions. They include Ahli United Bank, Audi Bank and the Bank of Alexandria. Moreover, the Central Bank of Egypt (CBE) is planning on setting up a new unit specialised in monitoring Islamic banks.

Participants in a recent conference on Islamic finance in Egypt expected the market share of Islamic banks to increase from the current four to 20 per cent of overall banking.

And in February, the Egyptian Financial Supervisory Authority (EFSA) amended the capital market law to accommodate the issuance of Islamic bonds, or sukuk. Islamic investment funds have achieved the highest yield since the beginning of the year, exceeding 30 per cent in some cases. Starting mid-2011, Egypt added three new Islamic funds to raise the overall number to 11 out of the 60 currently working in Egypt. There is also a keen interest in Egypt for Islamic insurance, ortakaful, which currently makes up five per cent of Egypt's $1.45 billion insurance market. This area is expected to grow dramatically, according to a March report by Islamic consultancy BMB Islamic.

Further, Islamic finance has been gaining much popularity worldwide since the 2008 financial crisis exploded on the back of virtual transactions. Such transactions were based on derivatives and securitisation, both of which are banned by Islamic law and cost the world billions of dollars. Experts believe that one key factor in the expansion of Islamic finance is the fact that it can attract savings by Egyptians working in Islamic Gulf countries, as well as millions of Muslims worldwide.

"In a post-Mubarak era, the urgency of rebuilding and changing things will clash with the absence of resources and lack of money," Ibrahim Warde, adjunct professor at the Fletcher School of Diplomacy at Tufts University recently told Reuters news agency. "Egypt is going to look towards the Gulf for money, and it's going to have to offer Islamic options to maximise investments," he added.

The National Bank for Development, which is currently transferring all its activities to become Sharia-compliant, is owned by the Abu Dhabi Islamic Bank. And the fully Sharia-compliant bank Al-Baraka Misr is entirely owned by the Bahraini Baraka Bank. According to data from Thomson Reuters, Egypt could see Islamic finance assets grow to $10 billion in 2013, from $6 billion in 2007.

Still, the road ahead is full of challenges. Investment expert Hani Tawfiq said the new trend shows that the market is flirting with the Islamists who are now in power, by trying to offer products that might appease them. However, this interest will soon fade when profit and loss calculations prove that the market still lacks much- needed infrastructure.

"Even if there is a demand on anything dubbed Islamic in a religiously sensitive society like Egypt, the market still lacks products that can accommodate the demand," said Tawfiq.

Sukuk is a good example of this. Tawfiq explained that it is a growing industry worldwide, but that it depends on sharing profit and loss. And as most Egyptian individual investors have small savings and are looking for a regular income, investing in sukuk could be risky unless they are used to finance projects with definitive revenues. Such projects might include drilling and oil exploration operations of oil wells with large proven reserves. "Such projects are few in the Egyptian market," he said.

Seeking halal investments in the stock market through Islamic funds, for example, is extremely difficult, according to Tawfiq. This is because investors have to exclude companies working in industries that are not permitted in Islam, such as tobacco, alcohol and gambling. Moreover, some Islamic funds only invest in companies with a maximum of 30 per cent of their assets financed by interest-bearing debt. "You can hardly find good companies to invest in after all those filters," the expert said.

For many years, Egyptians have had reservations against Islamic finance, after firms like Al-Rayan and Al-Saad stripped thousands of Egyptians of millions of pounds in Ponzi schemes in the mid-1980s.

That is one reason why Islamic finance witnessed very slow growth in Egypt, despite the fact that this was among the first countries that embraced Islamic finance. Islamic banking has yet to become a real success here. No new licences are being given out to set up new banks, while there are no incentives whatsoever to encourage banks to open branches for Islamic transactions. They even used to operate under the same regulations that traditional banks are governed with, according to May El-Haggar, deputy head of research and banking analyst at Al-Naeem Brokerage. She also pointed out that demand on Islamic banking products is so far limited. "On the corporate level, what really matters is getting the best terms for credit finance, be it Sharia-compliant or not."

This leaves us with individual bank customers, whose main aim would be to get interest-free loans to buy a car or a house, or obtain a halal credit card. They are likely to be disappointed by the limited available options on these retail services. In fact, retail services in Egyptian banks, Islamic or not, are still very underdeveloped.

El-Haggar added that she talked to senior officials in several top banks, who said they are not considering applying for a licence to offer Sharia-compliant products. Their economic feasibility in Egypt today, they say, is not particularly high.

(Al-Ahram Weekly Online / 05 April 2012)

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Islamic finance solutions for development

Modern finance has played a key role in economic development across the globe. Its impact has varied from country to country depending upon the adopted economic systems, capital mobility, market imperfections and regulatory environment. Contemporary Islamic finance has generally operated within this broader framework of conventional finance and has conformed to globally acceptable conventional rules, prudential regulations and financial standards. Therefore, its impact on development is also expected to be consistent and similar.
Empirical evidence from Muslim majority countries, however, remains mixed. It suggests that gains from Islamic Finance have been limited to only a small segment of the general population. This has to do primarily with how the business and industry of Islamic finance evolved over last forty years and how it has been preoccupied with high net worth individuals. Retail Islamic banking and insurance products have been launched successfully to match the performance of conventional products but they have only taken some market share away from conventional products and have not made any significant impact either on the growth of financial sector or on greater monetisation of economy. In fact, Sharia compliance practices have created additional burdens, inefficiencies and operational constraints. That is unfortunate since Islam is universally acknowledged as an inclusive religion which promotes equality and justice for all. Sharia compliance protocols that industry adopted, however, have led to sub optimal solutions for the economy, thus undermining the original Sharia objectives of fairness, inclusiveness, equity and economic justice.
It is not suggested that classical Islamic jurisprudence principles or underlying traditional Islamic operational contracts such as Murabaha, Ijara, Musharaka, Mudaraba, Wakala, or Salam, have not been correctly applied in the development of either the retail consumer products or the asset/wealth management products for the high net worth individuals. Similarly, Islamic banks have satisfied their liquidity or treasury management needs by supporting the adoption of Sharia compliant equity and fixed income securities that perform exactly like their conventional counterparts. In this process of compliance, they have been aided by all the regulators, rating agencies, a vast majority of investment advisers and the industry-retained Sharia scholars. Thus there has been no additional or supplementary expansion of the financial sector, better access to finance for the masses or deepening of the financial markets simply because of gradual market introduction of Sharia compliant products over the last three decades. This has occurred even with substantial capital infusions from the development banks such as ADB, IBRD, and the Islamic Development Bank.
The conventional character and performance of Islamic finance products limits their religious or inspirational impact on a Muslim society. Central bankers, securities commissions, stock exchanges, and other government regulators have all followed conventional guidelines in approving and standardizing Sharia compliant products without developing a coherent national economic policy that distinguishes or maximises the benefits from such products. Islamic finance industry has remained satisfied in using newly Islamized nomenclature products for sheer profitability and market share gains at the expense of their conventional competitors. It has neither sought nor received any long term comprehensive or strategic plan from any Islamic nation to become an instrument of economic change, development, poverty alleviation, enhanced access to financial services or general social welfare.
The industry has relied heavily on the jurisprudence associated with trading practices of ancient Arabia for the Islamic legitimacy and for operating precedents from the Islamic past. It is a historic fact that classical financial contracts that provide the Sharia compliance rationale for contemporary Islamic banking and insurance products have been instrumental in the past centuries in fostering trade, growth and development all over Muslim lands. They were the pillars and facilitators of economic fairness, equity and justice in all business transactions in these societies and contributed greatly to the well being of common people as well as the emergence of the class of successful global traders and financiers. Unfortunately, internal strife and foreign colonialism destroyed the legal and judicial systems of the land and made these contracts obsolete or irrelevant until they were rediscovered in the post colonial period beginning the middle of the last century.
The pace of new Sukuk launches has picked up after the decline witnessed because of the global financial crisis of 2008 but the supply of new Sukuk still falls short of the demand from investors for fixed income securities. We can review the precedents from the conventional bond market to explore the creation of new classes of Sukuk for institutional investors and consumers alike that will enhance the potential for government projects financing in developing countries. It will not only ensure deepening of the Sukuk driven capital markets but will also provide a mechanism for Sharia conscious consumers to adopt Sukuk as a long term savings tool. Examples and case studies of public utilities financing and municipal bond financing can be looked at as viable basis for new Sukuk ownership certificates as the alternative to widely marketed savings bonds in these countries.
The potential of hybrid Sukuk structures emphasising Wakala principles should not be overlooked. Similarly, recommendations for effective placement of lower yield sovereign Sukuk in foreign currencies should be carefully examined. In the light of 2008 AAOIFI rulings on Sukuk, unique Sharia issues associated with commonly used contracts such as sales, lease, partnership and agency should be contrasted with Sukuk classifications based on commercial functions such as exchangeability and convertibility. The difference in asset-backed versus asset-based Sukuk should be examined with the available data for sovereign issuers who would like to expand the prospects for Sukuk holders in Muslim majority societies that are eager to use Sukuk instruments for economic growth and infrastructure development. Failure of past privatization efforts because of underlying corruption or other moral hazards should be noted along with suggestions for a new class of convertible Sukuk.
The popularity of both sovereign and private Sukuk in major markets such as Malaysia and UAE suggests that large population Muslim countries such as Indonesia, Pakistan and Bangladesh will benefit from the issuance of new fixed income securities in these markets. Development banks such as IDB and ADB should work in collaboration with the World Bank and other multilateral organizations in broadening the base of such Islamic finance instruments that are positioned to create a positive transformation of these economies.

by Malik Muhammad Mahmud Awan, Author is professor of Islamic Finance.
(The Nation / 05 April 2012)

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