Whither Islamic Finance? Part II

Abu ‘Arqala (AA) at Suq Al Mal raised a few valid questions after reading my earlier post on the topic. Below I have copied his questions and my answers to them.

AA: There have been objections to your point of view – by some who I would characterize as serious parties. While they have a variety of arguments, there are three related topics that I would be interested in your thoughts on:

(1) Putting aside the qard hassan, can there be debt in Islamic finance? Or is Islamic finance equity only? With all the implications these imply.

My Answer: It depends on how you define debt. Leasing provides a very good example of conventional asset backed financing that is very close to islamic financing. Simplistically speaking, in a conventional lease, the lease originator or lessee owns the equipment and lends it to lessor. The transaction documents however mention the equipment value as loan and charge interest on it. In Islamic Finance, this will be replaced by Ijara and transaction documents would show the lessee renting out the equipment. From financial perspective (cashflow/IRR/NPV calculation) the effect would be the same to the extent that the rent amount would be equal to interest amount. However, if things go wrong, the Islamic finance lease/ijara should be decided as a rent transaction as opposed to conventional leasing transaction where it might be treated as a money loan.

It all boils down to your definition. Though in both cases lessor owns the property, but from accounting perspective one may be treated as debt and other equity.

The question here is not whether there can be debt in Islamic Finance. The question is are we allowed to charge interest on debt and the answer is NO.

(2) “Ease” and “The Middle Way” As I understand the teachings of Islam, a Muslim may eat pork if there is no other food and he is starving. Is there an analogy in financing? In order to build up an Islamic finance alternative, are IF practitioners allowed to engage in non Shari’ah compliant structured transactions? If so, is that temporary? Or if we can get partially to IF is that better than remaining stuck in conventional (non Shari’ah) financings? And so the partial state of true IF could be longer term.

My Answer: Till sometime back (when I did not have a chance to work in Islamic banking) I was a strong proponent of “middle way” using the argument that it took almost 500 years for conventional banking to reach from its roots in streets of Italy to where it is today. We should give Islamic Finance at least 50 years if not half that or more to reach maturity.

However, from my working, dealings and the information that is being posted about Islamic banks (most recent being the ADIB case highlighted by you) I have realized that the most of the sponsors behind Islamic banking do not have sincere intentions (niyyah). Large number of Muslims are reluctant to bank with conventional banks hence it presents a huge untapped potential/market. So by labeling conventional products as Islamic or structuring them to appear as such, they are trying to reach this market.

We have a saying that most islamic banks structure the products so that it follows the letter of the law but not the spirit of the law.

Recently National Bank of Kuwait (largest and most profitable bank of Kuwait) has acquired Boubyan Bank (islamic bank). NBK and its shareholders do not and should not care about Islamic banking and from what I have been hearing, changes are coming in Boubyan bank in terms of kind of products being preferred that do not follow the spirit of the islamic law. NBK has no mandate to promote islamic banking. They are interested in profits (and they should be) and intend to make maximum profits in Boubyan Bank by just following the letter of the law.

Most islamic banks have stopped after reaching mid-way. One could justify it as half is better than none at all. True, but that would have held if you are on your way to full islamic banking and in transition. The way banking is being done at the moment, they have stopped completely at midway and most of them are moving backwards.

The example of ADIB LC transaction is a case in point. If this is midway, I say lets stick with conventional banking. At least we are not fooling ourselves or the shariah board this way.

How can one consider a transaction to be kosher if the approval was obtained by misleading the Shariah board.

(3) Practicality – The IF you describe requires a great deal of due diligence. Can the depositor do the work necessary to evaluate where to place his funds? Primarily I’m thinking about the average Abdullah on the street with a relatively small amount of money. How does he find a way to invest and make a return? Especially in the era of paper money where inflation may erode the measure of value. My dinar today might buy a qantar of dates. But ten years from now only .9 qantar. (Which I suppose leads to the interesting topic of Islam’s view about paper money, inflation etc).

My Answer: I was implying that an IF should do extra due diligence when making investments compared to conventional institutions because in addition to ensuring that investment generates a decent return, they have to ensure that the investment meet the islamic finance criteria in terms of nature of business etc. Till couple of years ago, it would have seemed absurd for an average person to carry out due diligence for depositing his money even in a conventional institution but the credit crisis has put those all those notions to rest. However, I am not sure what benefit would have accrued had he done due diligence. With Chuck Prince dancing, nobody would have a reason to doubt that Citibank or others are as good as dead.

Take the example of Gulf Bank in Kuwait. On paper, it was a sound bank. Derivative transactions with one party was enough to bring it down. Even a highly sophisticated investor would not have any idea what is in store for her if she deposits her funds in Gulf Bank.

I can suggest that we should have islamic rating agencies, islamic audits etc to help an average investor but it has been proven time and again that the bank could easily maneuver transactions/accounts and get the ratings/approvals required.

To answer your question, he is expected to do at least that level of due diligence that he would do when placing money in conventional bank.

Will get back to you some other time with respect to inflation and paper money etc as my replies have already become very long.


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