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Wednesday, 5 August 2015

What you need to know about Islamic finance

Cost estimates for implementing the proposed sustainable development goals run into the trillions of dollars. That should be expected of an agenda that includes such ambitions as “end poverty in all its forms everywhere.”
Numerous discussions about where that money will come from — including last month’s Financing for Development conference in Addis Ababa, Ethiopia — tend to gravitate toward the same answer: It must come from everywhere.
Social impact bonds, crowdfunding, cash transfers and remittances, and a slew of other mechanisms to make financing available in places underserved by traditional banking models are attracting attention and gaining popularity. One lesson they are all imparting is that financial transactions take place within cultural contexts. Cultural norms and expectations play a big role in promoting — or inhibiting — access of an individual, family or community to financial services.

For Islamic financial institutions, values are baked into their identity — and operations. Islamic financiers emphasize inclusion and prohibit charging interest. And as the global development community looks hard for additional sources of finance to fill the gaps in an ambitious, universal development agenda, it may be time to get to know the “moral economy” of Islamic finance a little better.While financial and value systems often appear to operate in separate spheres, sometimes efforts to build financial inclusion do better when they start from a shared moral sensibility.

Mohammed Kroessin, head of the Islamic Microfinance Unit at Islamic Relief Worldwide, shared with Devex his thoughts on the role Islamic finance plays today — and its potential to contribute in a post-2015 world of development cooperation.
Is there really a big role for Islamic finance to play in financing the SDGs? Is this a source of financing that the broader development community needs to be paying attention to, or is Islamic finance likely to remain on the periphery of a global development agenda?
The truth of the matter probably lies somewhere in between the two. To make the ambitious SDG agenda a reality, the international community will have to use all available resources. There has been tremendous growth of the Islamic finance industry, which now has around $1.5 trillion to $2 trillion worth of assets under management, and nontraditional donor countries such as the [United Arab Emirates] and Saudi Arabia are making a greater contribution than some long-established aid donors. This means it’s a good time to bring Islamic finance toward the center of the global development agenda.
This will of course require a change in the way aid is officially recorded to allow non-[Development Assistance Committee] countries to play a greater role. It will also need more Islamic financial literacy from the new aid architects in order to mainstream Islamic finance instruments. These Islamic financial instruments include the International Finance Facility for Immunization’s pioneering $500 million Islamic bond or sukuk.
Who are the key players in this space, with the power and influence to mainstream Islamic finance within development funding? Is there anything on the near-term agenda we should be looking to as a signal for how these institutions and the broader community are positioning themselves as actors post-2015?
A key player is the Islamic Development Bank, which seeks to foster economic development and social progress of its 56 member countries. It is an international financial institution established by the Organization of Islamic Cooperation, which also plays a significant role in development policy. The World Islamic Economic Forum, a private foundation headquartered in Malaysia, seeks to play a similar role as its conventional counterpart, the World Economic Forum. It is doing so with increasing success, especially by bringing non-Arab perspectives on economic growth and development on board.
Unfortunately these key institutions tend to be quite introspective, as they are working with large and very diverse constituencies spanning from West Africa to Far East Asia. Also the Islamic finance industry is still concentrating on providing more and better financial services in its key markets. Getting the vast majority of citizens in Muslim majority countries to understand and use Islamic finance is still a work in progress. This means that the Islamic banking private sector appetite for development financing is still limited, as is its involvement in policy.
At the same time other development actors, such as the World Bank, have taken a great interest in Islamic finance. There has been a flurry of policy publications recently that demonstrate that they both take Islamic finance seriously and also want to be seen as an active key stakeholder.
Looking to the near future, the next WIEF in Kuala Lumpur in November 2015 might be an interesting forum. It could act as a bridge between tiger economies and BRICS, and hopefully we’ll see a meeting of sustainable development ideas and Islamic finance.
As Islamic financial institutions look to partner with other development actors, is there risk that “moral economy” principles might be diluted?
In Kenya, Islamic Relief is working closely with a leading Kenyan Sharia-compliant bank, in a project funded by the U.K. development agency [Department for International Development]. This project aims to deliver easily accessible financial services to poor, marginalized pastoral communities in northeastern Kenya. This is a good example of the Islamic moral economy in action: the bank’s involvement will impact its bottom line by building future customers, while Islamic Relief is providing vital financial services to people who can’t get ordinary bank loans, bank accounts and so on.In my opinion there are clear areas in which the mission of aid and development organizations and the values of Islamic financial institutions overlap.
While it appears to be an obvious pairing between aid organizations and Islamic finance, it is not always made: The language of development talks about exclusion, while Islamic banks talk about complex financial instruments. Mediators such as Islamic Relief can help to make this connection work in the real world.
Are there gaps that Islamic finance can fill that aren't otherwise served by development finance institutions? Is there a role for Islamic institutions to play in financing for conflict-affected states, for example?
Islamic finance works from the premise of partnership and equity rather than purely making profit from people. To make this work, trust and cooperation between all partners is required as returns are generated often more slowly and will need to be accrued over time. While in conflict situations this trust can be disrupted, equitable partnerships between Islamic financial institutions and their customers tend to be more resilient. But the problem with conflicts is that usually they attract the wrong kind of investors and on the whole positive private sector investors tend to avoid unstable environments.
However, Islamic finance has got a role to play in conflict mitigation and transformation. It has some advantages over other forms of finance. Its participatory nature can assist community relations and it offers asset-based investments that are more resilient to external shocks. At the state and interstate level, development institutions such as the Islamic Development Bank should have an important role to play to inject capital and support economic recovery in post-conflict states. I’d like to see this happen a lot more that it does currently.
As a whole, what does the Islamic financial industry need to do to ensure its influence over development funding decisions is most strongly felt?
The main issue for the Islamic finance industry is “image” — the view that these financial products are for Muslims only. This is incorrect, for example we have seen the U.K. government issue a sovereign sukuk or Islamic bond.
This image problem is further compounded by the one-dimensional Sharia screening of funds. They primarily look at excluding areas prohibited in Islam, such as gambling or pornography, rather than also searching for positive effects that will help poor countries to develop.
Another issue is that the Islamic finance industry still operates in a bubble. This is despite quite high levels of capital, for example the Islamic Development Bank’s assets were $150 billion in 2014. There is also considerable bilateral aid between OIC countries, which has member states as varied in terms of [gross domestic product] as Saudi Arabia and Bangladesh. Much bilateral aid from wealthy Muslim-majority countries uses Islamic finance instruments but is channeled outside the [Organization for Economic Cooperation and Development’s] DAC system and therefore not recognized in mainstream policy circles.
There’s an important role for the OIC in making Islamic finance more visible beyond the Muslim world. It needs to both recognize non-DAC aid flows by the development community and make these work better with the existing global aid system.
Given the win-win situation, both traditional and newer development donors would be well advised to embrace Islamic finance.

(Devex / 31 July 2015)
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