3Ps – Products, Placement, Promotion

Experts (in Islamic banking & finance) are saying that in order to effectively challenge and compete with conventional finance, Islamic finance needs more products and a wider distribution channel. It would be difficult to attract liquidity into the industry without adequate products and distribution network. This growing industry also needs to develop more unique financial solutions and not resort to merely replicating conventional finance’s product line.

The wealthy GCC sovereign funds are believed to resort to investing in conventional products due to the lack of Shariah approved investment options.

Shariah based finance and investment is mainly based on partnerships and joint-ventures making it suitable for private equity ventures, venture capital as well as asset management. These sectors will allow the Islamic finance industry to create products according to Shariah values, especially on the prohibition of riba via pre-determined return rates.

According to a report published by Ernst & Young this year, as of 1Q 2009, there are only 14 Shariah compliant funds larger than USD500 million out of the 750 Islamic mutual funds under management. Total assets under management is less than USD50 million.

John Sandwick, an Islamic asset management consultant claims that the supply of Islamic funds is not enough to satisfy the demand. The market needs more products. The advent of the pension fund in the Middle East as well as the growing takaful industry will definitely increase the need for more products.

Experts also pointed out most Islamic funds tend to focus on equities and real estate and not much asset diversification especially into fixed income investments.

Sukuk is a ready made instrument to facilitate the Islamic asset management industry. Ijarah, Murabahah and Istisna based Sukuk will provide asset managers with more fixed income investment options.

Silke Bernard, a lawyer specialising in funds said, Islamic funds lacked access to the large distribution platforms used by asset managers and that Islamic funds often lacked the required minimum size of typically USD100 million and a track record of several years required by large asset managers.

It is often pointed out that there is a sizeable amount of Islamic (GCC) wealth looking for Shariah compliant investments. There have also been claims that Shariah compliant investment is already attracting a global fan base from Europe to Australia and Japan and this augurs well for the industry’s long term growth.

Paranoid Americans?

From IFN Newsletter 5th June 2009

However, it’s a completely contrary picture across the Atlantic. Politicians and special interest groups have been very successful in arousing the ire of Americans over terms such as Islam and Shariah even when they are used innocuously. There were howls of protest when the Treasury co-sponsored a forum on the basics of Islamic finance.

A law firm has created an online presentation that claims to show how Islamic finance poses “a real and present danger not just to our Western financial institutions built on disclosure and transparency but to our very system of governance and our way of life.” (http://www.davidyerushalmi.com/Law-Offices-of-David-Yerushalmi-present-Shariah-compliant-finance--disclosure--seminar-for-online-viewing-b9-p0.html) It’s a sure bet that the presentation never mentions how those in these “Western financial institutions” bilked billions of dollars and caused the system to practically collapse, while the losses were relatively minor in scale for those who used Islamic finance.

What takes the cake is that of a federal judge in Michigan who insists on continuing to hear a lawsuit challenging the federal bailout of American International Group (AIG) simply because it has subsidiaries that sell Takaful. Judge Lawrence Zatkoff contends that the US government’s majority ownership of the group raises the question of whether the government is promoting religion, contrary to the First Amendment to the US Constitution. AIG has stressed that its Takaful policies comply with all US laws. “AIG businesses, like other insurers and organizations, tailor programs for a range of religious organizations,” it said. “While they are desirable to those whose religious convictions preclude them from engaging in traditional interest-bearing structures, Takaful is also increasingly popular among non-Muslims who feel that the excess profit/charitable aspect is a socially responsible mechanism for the purchase of insurance.”

Obviously, education and confidence-building are two aspects that must be seriously undertaken if Islamic finance services, now being provided by a handful of firms, are to expand its beachhead in the US.

It is beyond me how stupid and paranoid some people can be. Shariah based finance is all about undertaking financial transactions according to the rules of Shariah. It has nothing to do with professing Islam. Using financial products which conform to the rules of Shariah does not make one a Muslim. The paranoia attached to Shariah based finance is unfounded, how could it be a funding tool for extremists if the products are offered by banks like HSBC, Deutsche, UBS, Standard Chartered, Citibank, Barclays and BNP Paribas? Are we saying these reputable Western banks are part of the extremist (terrorist) conspiracy?

These attacks on Shariah based finance not surprisingly, is sponsored by CSP (refer to my earlier posting – Someone’s Afraid of Shariah Based Finance) and a lawyer by the name of David Yerushalmi is in the forefront in waging war against Shariah based finance. I’m not sure what he is trying to achieve but one thing for sure is that he and his friends will not stop putting Shariah based finance down.

Let’s not waste time, effort and money trying to market Shariah based financial products in the US.

A short take on Takaful

Takaful is an Arabic word that means “guaranteeing each other”. Takaful can be divided into two types, social and commercial. In this context, we are looking at the commercial model because as the name suggests, a social takaful is purely charitable without the commercial elements.

Takaful, which is often referred to as Islamic insurance, provide mutual financial aid and assistance to the participants in times of need and participants mutually agree to contribute for that purpose. The participants undertake to guarantee against any loss or damage incurred by any of them by providing material assistance in time of a misfortune. Takaful is based on the principle of mutual assistance (Ta’awun) and donation (Tabarru’) therefore; the risk is shared collectively and voluntarily by all participants.

Takaful

• Risks are shared by takaful fund participants
• Takaful funds are owned by participants and operator’s funds are owned by Takaful Institution
• Surplus (or deficit) belongs to (borne by) the participants
• Investments must comply with Shariah criteria
• Two accounts – tabarru’ fund and investment fund
• Investments and policies subject to Shariah Committee’s endorsement
  

Conventional Insurance

• Risks are assumed by the insurer
• Insurance funds are owned by the insurer
• Surplus funds belongs to the insurer
• Investments can be made in non-Shariah compliant sectors
  

Differences in Terminology:

Takaful

• Contributions
• Participants
• Sum covered
  

Conventional Insurance

• Premiums
• The insured
• Sum insured
  

Islamic Finance - a Primer

Islamic finance, as the name implies, is finance based on Islamic laws and norms and is a subset of Islamic economics. The principles of Islamic economics are sourced from the two main sources of Shariah, the Quran and Hadith (sayings of the Prophet pbuh). Contrary to Adam Smith’s theory of self interest, Islamic economics subscribes to the policy of ‘prosper thy neighbour’.

The Western model of finance is based solely on monetary transaction where the bank acts as the middleman between those with excess funds (depositors) and those in need of funds (borrowers). The structure of Western banking is that of a lender-borrower, exchanging money for money. The price of money is interest rates and the determinant of the price is the risk associated with ability of the borrower to repay. The utilisation of the proceeds is of no concern of the bank, only the timely repayments of the loan. Hence, the success of the business does not matter to the bank for as long as loan repayments are met by the borrower. The bank does not assume any risks associated with the utilisation of the funds, even if the economy turns into a recession, the borrowers are still contracted to repay the principal and interest back to the bank within the stipulated period. Failing this will result in further monetary penalty, compounded over time.

Islamic and Western (conventional) finance is akin to Petrol and Diesel engines; they run on totally different platforms. Using the wrong fuel would be very detrimental to the engines. Therefore, how it is conducted; the mechanics and modus operandi, pricing, risk management, repayment, recourse, transaction documentation and marketing and sales must conform to the basic Islamic principle of just and equity.

The most significant difference is the basic concept of Islamic finance – risk sharing partnership instead of a borrower-lender relationship. What this means is that all transacting parties must enjoy equal benefits from the transaction and in a case of a loss, all must share the loss equally. The transactions must be conducted in such a way that none of the parties have an unfair advantage over the others.

Being just and equitable does not mean at the expense of profits. Islamic law requires debts to be paid, contracts to be honoured and promises to be kept. However, there is also a need to be compassionate, when the debtor is facing financial distress, it would be the duty of the creditor to understand and not make matters worse. An alternative arrangement must be made to ensure the debt is repaid. Loans per se are not an Islamic financial instrument. Borrowing and lending money is not encouraged unless in times of distress. Debts or obligations to pay only arise in trade transactions where the payment terms are deferred. The only type of loan recognised under Islamic law is the “benevolent loan” or qardhul hasan. This loan does not carry any interest rate nor does it carry a fixed repayment period. The debtor is expected to repay as soon as he is able and the creditor is not encouraged to demand repayment. The elements of trust and responsibility play a fundamental role in this transaction.

Money according to Islamic law is not a commodity. They are merely the intermediary to facilitate a transaction and therefore on its own cannot be traded.

The main characteristics of Islamic finance include;

• Prohibition of interest (riba / usury).
• Prohibition of elements of gambling and uncertainty.
• Partnership instead of lender-borrower relationship.
• Full transparency and disclosure
• Transaction must not involve prohibited goods and services such as pork, alcohol, gaming, armaments.
• Profit and loss sharing instead of fixed returns on the part of financiers.
• Shariah compliant asset backed financing.
• No short selling, i.e. full ownership must be obtained prior to selling.

Islamic finance can be used to facilitate any kind of financial transactions such as;

• Project financing
• Working capital financing
• Leasing
• Trade financing
• Liquidity management
• Sukuk (investment certificates)
• Takaful (insurance)
• Mortgages
• Asset management
• Hire purchase
  

Common contracts / concepts used in Islamic finance include:

• Murabahah (cost plus sales)
• Ijarah (leasing)
• Musharakah (joint venture)
• Mudharabah (trustee profit sharing)
• Istisna (project financing)
• Salam (forward sales)
• Wadiah (trustee safekeeping)
• Wakalah (agency)
• Kafalah (guarantee)
• Hibah (gift)
• Ibra (rebate)
• Qardul Hassan (benevolent loan)
• Tawidh (penalty)
• Ujr (fee)
• Wad (promise)
• Rahnu (collateral)