Islamic Banking: Answer to U.S. Banking

The banking sector was historically the darling of investors, with stocks offering steady income and high secured yields universally. However, the 2008 global financial crisis laid bare the risky dealings by individual banks and the lack of regulatory oversight that made up leeway for such practices.

In the melee that ensued, regulators finally awakened to the risky dealings by the banks, and stringent regulations became the order of the day. Five long years after the Great Recession, which shattered the economic stability of the U.S. banking sector, banks are still struggling to put the past behind. In the first half of 2013, U.S. banks showed progress, signaling a bright future for the sector.  But it is too early to be confident about the sector’s growth prospects.

Many fear that structural changes in the sector will continue to impair business expansion and investor confidence. Yet, entering the new capital regime will ensure long-term stability and security.

Nevertheless, the sector is still clouded by many dampening factors. Tighter regulations aside, banks face asset-quality troubles, mortgage liabilities and run-ins with the government regulators. U.S. banks are also subject to never-ending lawsuits besides being subject to criminal and civil investigations from authorities. Therefore, five years on, the American banking system is yet to show any dramatic change.

Is There an Alternative?

It is hard to find an alternative to U.S. methods of banking. Risky endeavors and huge profits made these banks the poster boys of the financial world, till the reality check after recession. The resulting endeavor to find a viable option to U.S. banking has paused at an intriguing question: if high debt and inadequate equity were to a certain extent responsible for the financial crisis, might Islamic Banking be the solution?

Islamic principles prohibit financial transactions involving interest rate payment on debt and hence financial institutions rely on profit-loss risk-sharing measures. This culture of shared responsibility has led the think tank to see Islamic banking the answer to the debt crisis plaguing the U.S.

In fact, Wall Street major JPMorgan Chase & Co. (JPM - Analyst Report) operates an Islamic Banking unit in Middle East & North Africa. London-based Standard Chartered PLC and HSBC Holdings plc’s (HBC - Analyst Report) -- HSBC Amanah – also acknowledge that Islamic Banking is fast catching up and growing globally.

Notably, Britain is a world-leader in sharia banking. Evidently, 17 leading financial institutions including Barclays PLC (BCS - Snapshot Report), The Royal Bank of Scotland Group plc(RBS - Snapshot Report) and Lloyds Banking Group plc (LYG - Snapshot Report) have already ventured into Islamic Banking in the past. Taking a cue from these British banking giants, many global banks such as Citigroup Inc. (C - Analyst Report) and UBS AG (UBS -Analyst Report) have also opened their Islamic banking units.

Islamic Banking: An Overview

First the highlight: the core of Islamic economics is a proscription on interest on debt. Almost instantly, a question arises on the profitability of these banks with interest ruled out of the picture. In sharia banking, an organization enters into a partnership with its depositors and invests their money in a sharia-compliant business. The profit from this investment is shared between the depositor and the bank after a certain period of time.

Islamic banking has developed products that bear a striking resemblance to those offered by conventional banks, just leaving out the interest rate payments and excluding fees and conditional payments.

This Islamic concept has fast grown in recent years primarily due to investments in the oil-rich Gulf and Asian regions that were relatively untouched by the global financial crisis. Islamic banking is growing globally at a rate of more than 20% a year, as a larger part of the world’s Muslims seek finance that agrees with sharia laws.

According to Ernst & Young, global Islamic banking assets are set to cross $1.1 trillion  by the end of this year, up from $800 billion a couple of years ago, driven in particular by strong growth in the Middle East and Malaysia.

The Underlying Risks

Beneath the rosy picture of debt free finance is the risk of lower profitability. Many large global banks like Morgan Stanley (MS - Analyst Report), Deutsche Bank AG (DB - Analyst Report) and Barclays have started downsizing their Islamic banking operations. The wider implications of banks shrinking Islamic banking services are doubts on the ability of Western banks to serve Muslim communities with a relatively small customer base and earn profits at the same time.

Pundits see two basic problems. First, is the challenge of expense management, elevated charges due to intricate structuring and legal overheads, constrained demand as well as profits, and the resulting revenue crunch. Second, the integrity of some products is a huge question. In many cases, these financial products have become an Islamic modification of interest-based debt. Therefore, many experts believe that the Islamic model, chiefly in the retail sector, is fundamentally troubled.

Conclusion

The fact that Islamic Banking is gaining popularity in the Western world is a major advantage for the business, which is still in its nascent stage. It is encouraging to see that investors have finally woken up to the advantages of interest-free finance, even though certain headwinds remain. Additionally, the business has to evolve. It is only 40 years old and is competing with a conventional banking system that has survived more than 800 years.

(Zacks / 09 Oct 2013)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Consultant-Speaker-Motivator: www.ahmad-sanusi-husain.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com

Australia: Hockey should put Islamic finance on his Inquiry’s agenda

A topic which warrants inclusion in Joe Hockey’s planned Financial System Inquiry — but probably won’t make it in — is the regulatory and institutional impediments to Islamic finance.

The 2% of the Australian population who want these Sharia-compliant products face significant problems in accessing them.

Islamic finance is different from regular banking for a number of reasons, one of which is a prohibition on interest. Others include acceptable insurance arrangements and restrictions (which look much like socially responsible investment criteria) on acceptable investments.

I don’t see a point to these religious-based constraints –- but in a free society, governments should not be putting unnecessary impediments in the way of those who want to adhere to them.

And it should be a concern that some regulation, like compulsory superannuation, and institutional indifference, force individuals into financial products not compatible with their beliefs.

Among the various problems which exist, two stand out. The first is the question of designing Islamic financial products enabling families to buy homes. Because interest is prohibited, a conventional mortgage loan is not acceptable.

Islamic finance works around these prohibitions with some simple financial engineering. The financial institution buys the house an individual wishes to own, and leases it to the individual on agreed terms in a long term contract.

At the end of the contract the ownership of the house is transferred to the individual.

The main problem with implementing that in Australia is double stamp duty, once on the initial purchase by the financial institution and second when the house is transferred to the owner at the end of the lease.

Under conventional mortgage finance, stamp duty is only levied once when the house is initially purchased.

The Victorian government has removed this impediment, by allowing house purchase under Islamic financing arrangements to only incur one lot of stamp duty, but other State governments have been unwilling to take that step.

Islamic financing of small business enterprises faces similar problems, a compounded by tax and legal issues.

And the government should turn its attention to superannuation. All employees, regardless of their religious faith (or lack thereof) have compulsory contributions paid by their employers into a super fund of their choice.

And there are significant tax advantages for voluntary contributions as well.

But what does the typical institutional super fund’s portfolio allocation look like? Even allowing for a member’s choice between different investment options, the only portfolios generally available will still have a significant fixed interest component.

This is based on the widely held view of trustees that prudent asset allocation involves a significant share of investments paying interest. That doesn’t sit well for fund member wanting only Sharia-compliant investments.

It is possible — in principle — to construct portfolios which don’t have an interest component but which have some “fixed-interest like” investments. Established infrastructure assets are one example. Lease income is another, such as that which might flow from Islamic financing of home ownership as discussed above.

But more relevant is whether conventional institutional norms about what are acceptable portfolio allocations for super, and institutional inertia, should prevent or inhibit Sharia-compliant super options being offered to individuals forced to invest in super.

Self managed super is always an option — but that’s only cost-effective for individuals with substantial super savings.

While it does look as though some institutional super offering of Sharia-compliant super is now emerging, the impediments and lack of interest have apparently been substantial.

Will Islamic finance get an airing in the proposed Financial System Inquiry? Probably yes, but in the context of what is needed to make investment in Australia attractive to wealthy international Islamic investment houses – because that caters to the interests of, and potentially benefits, the financial community.

That may be worthy of attention, but there’s more value in focusing on whether impediments to providing suitable savings and funding vehicles affecting this group of individuals and businesses can be reduced.

(The Conversation / 07 Oct 2013)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Consultant-Speaker-Motivator: www.ahmad-sanusi-husain.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com

Malaysia: Islamic finance laws reviewed

KUALA LUMPUR: The Law Harmonisation Committee Report 2013 released yesterday documents the current phase of the committee’s initiatives since its inception in 2010.

The high-level committee has been set up to review, harmonise and further strengthen the legal infrastructure to facilitate the conduct of Islamic finance in a bid to reinforce Malaysia’s leadership role in building and maintaining a solid foundation for the development of Islamic finance.

The committee has a mandate to recommend legal reforms that will advance the development of Islamic finance and achieve greater certainty and enforceability of Islamic finance contracts domestically.

A total of nine issues concerning 17 laws were reviewed, it said in a press release. And after extensive consultation and research, recommended amendments were made on four issues, which have been escalated to the relevant Government ministries, departments and agencies.

The first recommendation is to introduce provisions in court rules on the imposition of late payment charges on judgement debts in Islamic financial cases as permitted by the Syariah Advisory Councils of Bank Negara and the Securities Commission.

Further, allowing better access to financing, particularly Islamic financing, for consumers where it involves the charging of reserve lands through recommended amendments to reserve land legislations at all states has also been recommended. Next, the committee will look into facilitating Islamic financing involving landed property through the recognition of Islamic finance in the National Land Code 1965.

And finally, it recommends facilitating the introduction and usage of innovative and more globally accepted Syariah-compliant product structures for the Islamic money market through appropriate modifications in the Companies Act 1965 that would enable a more efficient conduct of collateralised commodity murabahah transactions.

The first recommendation has been fully implemented, while the remaining are in the process of being implemented.

The committee is headed by the former chief justice Tun Abdul Hamid Mohamad.

( The Star Online / 08 Oct 2013)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Consultant-Speaker-Motivator: www.ahmad-sanusi-husain.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com