Shadows over syariah banking

Syariah banking shows two contradictory trends. First it insists it is different. But second, it wants to compete with Western banking in terms of financial services offered, but without imprudent risks to provide them.

The difference must lie in the adequacy of regulations based on applied theology, enforcement, and transparency.

Ahmad Riawan, chairman of the Indonesia Sharia Bank Association, noted in a recent Jakarta seminar on the sharia economy, that the central bank was confident it could contribute to Indonesian development without inflationary pressures.

This, he said, was because it forbade transactions involving derivatives and high leverage.

Derivatives, collateralisation

But Indonesia just hosted the third Asean annual meeting of syariah economic experts in Jakarta, which syariah-compliant currency exchange swaps and trade support mechanisms.

The issues discussed and highlighted precisely those derivatives, hedging and collateralisation that caused problems for Western banks during and after the October 2008 crash.

The crash necessitated complex concepts like simultaneous term and reverse back-to-back 'murabaha' to try to avoid 'riba' (interest), 'gharar (uncertainty of value of underlying assets) or 'maisir' (speculation).

A website based survey of IFIs or Islamic Financial Instruments in 2006 (of the Arab Banking Corporation site) showed one-third were registered in Western countries.

More than half of Islamic equity funds were run by Western management companies and one third of these were based on Western banks, as were 10 percent of the IFIs registered in the six key high income low population Muslim countries.

Since then, many large Western banks have formed syariah banking subsidiaries.

Yet paradoxically, only 11 percent of IFI registrations were based in the poorest Muslim countries with the highest populations, whilst 42 percent of registrations were in upper income countries with mostly lower populations.

Well deployed in oil, gas

Islamic finance is well deployed in oil and gas and up market property development but less well deployed in support of social capital investment for the poor (rural electricity, water and sanitation, and support for small business).

This discrepancy in volume and emphasis reflects harder targets and less short-term profitability.

But the Organisation of Islamic Conference and the World Islamic Economic Forum want global development, as well as stronger Islamic finance.

Whilst Islamic banking and finance is fully integrated into the global banking and financial system, it operates under different rules, based on different values.

However, if the Western banking and financial system sneezes, then the Islamic banking and financial system still catches a cold.

So when Kuwait-based Investment Dar Co, the owners of half of Aston Martin Lagonda Ltd, missed a payment on US$100 million of debt due on April 27, it became the first major Gulf company to default on an Islamic bond.

Drop in earnings

It was recently confirmed that earnings of some Gulf syariah banks have dropped up to 40 percent while "companies like Investment Dar of Kuwait and Tamweel and Amiak Finance of Dubai are trying to restructure".

The Islamic bond market ballooned from almost nothing in 2002 to US$90 billion in 2008 as surging oil prices spurred borrowing in the Gulf and Asia.

But 'sukuk' sales dropped 56 percent in 2008 from a record US$30.8 billion in 2007.

The Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions or (AAOIFI), led by its secretary-general Dr Mohamad Nedal Alchar, sets accounting, auditing and governance standards for the US$1 trillion plus Islamic finance sector.

The chairman of its board of scholars shocked markets in 2007 by declaring that 85 percent of Islamic bonds were not syariah compliant as they included repurchase undertakings.

These remarks reportedly contributed to the big drop in issuance of Islamic bonds in 2008

Now, AAOIFI says it will launch a global study to see how Islamic financing markets are adhering to benchmarks, with a view to standardising products.

Consolidation, prudence and strengthening of regulations and enforcement would seem to be the order of the day for Islamic banking and finance.

But to travel down which road?

---

TERRY LACEY is a development economist who writes from Jakarta on modernisation in the Muslim world, investment and trade relations with the EU and Islamic banking.