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Friday, 8 February 2013

Recent Financial Crisis and Opportunities of Islamic Finance

KUWAIT CITY, Feb 7: “Islamic banking has become an alternative to conventional banking after the recent crisis. There appears to be a great potential for growth in the industry. There are challenges associated with developing an industry with a different approach to “risk management.” However, this can be the best time to grow the Islamic financial market, since Basel III can be an opportunity rather than an obstacle. Because in terms of capital adequacy, Islamic banking is already placed well,” stated Dr. Yildiray Yildirim, Associate Professor of Finance, Chair, Finance Department, Whitman School of Management at the Syracuse University in New York, during a lecture on Wednesday evening at the Kuwait Economic Society.

The lecture entitled “Recent Financial Crisis and opportunities of Islamic Finance, organised by the Kuwait Economic Society tackled the simple comparison between conventional and Islamic finance in the context of the financial crisis, challenges, risk management, importance of securitization, what went wrong, how could it be prevented, the current market conditions and the opportunities in Islamic finance.

Dr Yildirim explained that in conventional setting, securitization led mortgage lenders trading excessive risk (gharar). Historically, banks kept on their books the loans they originated. However, he pointed out that over time, they move away from originate-to-hold model with the originate-to-distribute model by selling them in the secondary loan market (structured finance). Corporate loan securitization allowed banks to sell loans off their balance sheets — particularly riskier loans, which have been traditionally more difficult to syndicate.

He cited that in the primary market, the loans are originated and charged with interest (riba). In conventional case, securitized products are removed from the underlying assets and pretty much money made from money.

Meanwhile, In Islamic finance, structured finance products must be based on “real assets.” Risk must be shared between lender and borrowers and trading excessive risk is prohibited. “Gharar is haram that is bundling the risky loans in the name of securitization without knowing who holds the real estate property,” he stressed.

Charging interest (riba) in the primary market is also prohibited. The transaction should be based on the concept of profit-and-loss sharing or “fixed-cost mark-up.”

In his lecture, Dr Yildirim emphasized that risk management should be done before the crisis, not after. “It is the important, not urgent cases that separate success from average performance. The probability of bubble in prices is small but the consequences are huge “ he stated. He cited the example of Blaise Pascal’s bet (17th century mathematician and physicist) on pressure equals force divided by the area.

“The difference between gambling and investment is in investment, you take calculated risk. Risk management is for hedging not speculation,” he explained.

Dr Yildirim outlined that structured finance offers enormous flexibility to create securities with distinct risk-return profiles in terms of maturity structure, security design and asset type providing enhanced return at a customized degree of diversification commensurate to an individual investor’s appetite for risk.

He added that the premier form of structured finance is capital market based risk transfer, whose two major asset classes, asset securitization (which is mostly used for funding purposes) and credit derivative transactions (as hedging instrument).

“Islamic finance falls within the domain structured finance instrument whenever religious constraints require the replication of conventional interest-bearing assets through structured arrangement of two or more contingent claims,” he stated.

Dr Yildirim  attributed the main cause of the crisis to the failure in ill-designed securitization market. He cited that in particular, uncertainty about the true quality of securitized assets exacerbated the impact of asymmetric information, causing the market failure.

“We have to re-establish the securitization market for a healthy economy. However, credit crisis has eroded the market confidence. This may give a window of opportunity to increase new issues of Islamic asset backed securities for all investors around the world seeking Islamic investment as a means of diversification,” he said.

With the recent financial crisis, Dr Yildirim discussed the various opportunities for Islamic finance and one of which is real estate.

“Housing is one of the basic needs. It is linked to many sectors of the economy. Promoting this sector consequently promotes employment, consumptions and investment in the economy. Housing a blessing from Allah (SWT). It is a place of rest and peace of mind,” he explained.

He cited the huge market demand for housing.IDB member countries need around 8.2M houses per year to accommodate poor and low income urban people. He added that world population will grow additional 2 billion by 2030, meaning roughly there would be 40,000 houses in an hour. 

Dr Yildirim pointed out that expanding housing benefits requires a scalable means of delivering new funds from alternative sources of capital. This capital would most likely come from securitization or sukuk programs. In order to deliver additional funding, capital markets rules as well as core investment entities need to be put into places.

The fundamental difference between Islamic finance and Western interest-based finance is based on how risk is allocated and rewarded in these systems. The core premises of Islam look more to profit and loss sharing. “Every transaction must involved a tangible asset, overcollateralization. It is secured funding such as sale-buyback, lease backed, asset backed (sukuk),” he stressed.

There are three basic forms of Islamic finance such as debt- based contracts (synthetic loans/purchase orders (murabahah) and sale-buyback (bai’al’inah), Asset-based contracts (leases (ijarah) and sale-leasebacks (ijarah thumma al-bay) and equity based contracts (profit-sharing/partnership (musharakah) and sweat capital/seed funding arrangements or trust (mudarabah).

Dr Yildirim also presented some of challenges that Islamic finance has to hurdle such as the lack of financial engineers to develop new product for risk management purposes (most Islamic banks operate as retail bank); shortage of scholars to understand and approve products; lack of unified regulatory framework; and lack of demand among Muslims. “No government is in a position to cope with the current housing funding satisfactorily. The housing sector is too large for any financial institution or government to finance alone. We need a depthless in secondary market to create liquidity in the market. We need more structured finance products. There is a window of opportunities of Islamic securitized (structured) products,” he concluded. The lecture was followed by an open forum as attendees asked Dr Yildirim with Saad Al-Khorafi of KES acting as the moderator.

(Arab Times / 08 Feb 2013)

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Takaful is growing faster than traditional insurance

Takaful is growing faster than traditional insurance, which increases the competition to conventional insurers, according to Katsipis. “Very few Takaful companies have actually focussed in developing new offerings, they are competing with a Shari’ah-compliant product for the same type of business,” he explained.
Katsipis explained that a Takaful company’s portfolio doesn’t differ much from a conventional insurer’s. “If you look at the average portfolio of a Takaful company, it’s mainly motor followed by medical and the question is, how do they differentiate? They don’t. There is very little differentiation other than the fact they are Shari’ah-compliant,” he said.
“For that reason, most of what these Takaful players are doing is putting pressure on the market, and they have the same impact as a conventional insurer when they enter a market. They will need to offer something new to add value,” he added.

(C.P.I Financial / 06 Feb 2013)

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Indonesia: Govt encourages sharia banks to take reins in managing haj funds

Performing the haj or pilgrimage is one of the pillars of Islam for Muslims who are physically and financially capable. It is a huge annual undertaking, especially for Indonesia with 90 percent Muslim adherence among its population of 240 million.

The government believes that managing the huge amount of funds must be the responsibility of Islamic banks instead of conventional banks. It was an opinion reiterated recently at a seminar in Jakarta initiated by the Director General of Haj and Umrah (minor haj) Affairs Anggito Abimanyu. 

He said the funds reached around Rp 50 trillion in 2012. “Surely, the huge funds would be very useful to propel the Islamic economy,” he said. In addition, Islamic banks’ responsibility for overseeing the funds was in accordance with a 2008 law on the haj.

The one-day seminar, “Managing Haj Funds with Sharia Economic Principles”, was organized by the daily Pelita and sponsored by Bank Indonesia. Anggito said that efforts were underway to finalize the bill on managing haj funds in which the policy on haj funds will be separated from the haj management. 

“The management of haj funds in public service agency will be conducted in a professional, accountable, transparent and trustworthy manner,” he said. 

The government is striving to provide a direct investment opportunity from haj funds to raise the value, following the calculation of value gained from the placement of the funds in bank deposits and sukuk (Islamic bonds).

Under the 2008 law, haj funds cannot be used for direct investment but are only allowed to be invested in deposits and Islamic bonds. “So the regulation allows us to make a direct investment but in a limited amount,” he said. 

Executive Director of Bank Indonesia’s Islamic Banking Department Edy Setiadi said in his keynote address that the central bank would coordinate intensively with the Religious Affairs Ministry to seek ways to optimalize the haj management system to be beneficial for the public and Islamic banking. 

“The public can take advantage of haj savings deposited in Islamic banks for productive activities through financing by Islamic banks,” he said. The president director of Bank Syariah Mandiri, Yuslam Fauzi, disclosed that Islamic banks have conducted a discussion with the Deposit Insurance Agency (LPS) regarding the replacement of the haj funds in Islamic banks.

“The discussion is aimed to make sure that LPS can provide certainty about the insurance of the haj funds to be placed in Islamic banking institutions,” he said. According to him, the Religious Affairs Ministry drew upon the haj funds for the investment in Islamic bonds in early 2012, which led to the Islamic banking industry experiencing slow growth last year. Starting in mid-2013, the haj funds will be returned to Islamic banking in stages, he said. 

‘Wakaf’ funds

Edy Setiadi also disclosed in his address the significant potential for wakaf (money for religious purposes) as alternative financing to support the fund disbursement in Islamic banking. 

“If 10 million Indonesian people set aside wakaf of Rp 10,000 to Rp 100,000 each per month, then around Rp 5 trillion will be collected within a year,” he said. 

Data in the International Center for Education Islamic Finance (INCIEF) shows that wakaf funds in Indonesia are currently US$1.5 million, or about Rp 11.7 billion. Indonesia lags behind other nations in the sector. 

For example, Malaysia with a Muslim population of 17.3 million, collects wakaf funds of Rp 644 billion, or about 61.3 percent of its Muslim population. Funds in Turkey with a Muslim population of 73.9 million reach Rp 239 billion, or about 98.6 percent of the population. The United Kingdom, with a Muslim population of around 2.7 million, collects about Rp 31 billion in reaching approximately 4.8 percent of its Muslim population.


Edy said that Islamic banking assets in 2013 were projected to grow around 36-58 percent whether the situation was pessimistic, moderate or optimistic. 

A pessimistic scenario happens when the Islamic banking expansion encountered pressures, either from internal or external factors. The internal factors include the failure to collect funding as expected and the decline in the amount of third-party funds. External factor relates to the decline in national economic performance. 

Meanwhile, a moderate scenario takes into account the current acceleration of Islamic banks through continued financing expansion and the increase in third-party funds, he said. 

He further said that a positive scenario happens when, for example, more new Islamic banks are opened; Islamic business units are converted to Islamic banks and conventional banks are turned into Islamic banks

(The Jakarta Post / 06 Feb 2013)

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