Dr. Terry Lacey

Development Economist

Sharia 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 the 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, since it forbade transactions involving derivatives and high leverage. (Jakarta Post 29.04.09).

But Indonesia just hosted the third ASEAN annual meeting of Sharia economic experts in Jakarta, which discussed sharia-compliant currency exchange swaps and trade support mechanisms. (Jakarta Post 22.05.09).

These issues highlighted precisely derivatives, hedging and collateralization which caused problems for Western banks during and after the October  2008 crash, necessitating 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 web site based survey of IFIs in 2006 (of the Arab Banking Corporation site) showed one third of IFIs 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 sharia 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.

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 Organization 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 vales.

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

So Kuwait-based Investment Dar Co., the owners of half of Aston Martin Lagonda Ltd, missed a payment on $100 million of debt due on April 27, and became the first major Gulf company to default on an Islamic bond. (Jakarta Post 14.05.09).

It was recently confirmed that earnings of some Gulf shariah 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”. (Jakarta Globe 02.06.09 and Reuters).

The Islamic bond market ballooned from almost nothing in 2002 to $90 billions in 2008 as surging oil prices spurred borrowing in the Gulf and Asia. But Sukuk sales dropped 56 percent in 2008 from a record $30.8 billion in 2007.

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

The chairman of its board of scholars shocked markets in 2007 by declaring that 85 percent of Islamic bonds were not sharia 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 standardizing products. (Jakarta Globe and Reuters 29.04.09).

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 modernization in the Muslim world, investment and trade relations with the EU and Islamic banking.

terrylacey2003@yahoo.co.uk

drterry@c4d-info.org

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