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Monday, 20 October 2008

IDB hosts meeting on global crisis

LONDON: The Islamic Development Bank (IDB) is belatedly convening an extraordinary meeting of "leaders and experts of the Islamic financial industry" on Oct. 25 in Jeddah "to discuss the impact of the global financial crisis on the industry".

The subprime crisis and the resultant credit crunch is now into its second year and the contagion has spread like wildfire all over the world with some governments, jettisoning long-held ideology regarding the market and the role of the state, in their rush to bailout their banks through part nationalization, recapitalization and a new-found vigor in favor of tighter regulation of banks, in an attempt to promote financial stability and contain the slide into economic recession.

Only yesterday UK Chancellor of the Exchequer Alistair Darling confirmed that the government is considering spending its way out of the recession in the UK. London is keen to fast-track a 43 billion pounds plan to renovate every secondary school in the UK for instance, thus revitalizing the construction and buildings materials and allied industries and to keep employment in the sector rolling.

The IDB meeting could not have come sooner. The multilateral development bank (MDB) of the Muslim world is notoriously sensitive about tackling issues head-on under the pretext that it does not interfere in the internal policies of member countries. Yet its mandate obliges it to do so. The IDB's major objectives are stimulating intra-Islamic trade; alleviate poverty in member countries; promote Islamic banking worldwide; and encouraging the role of the private sector in member countries.

As such, for this one-day meeting to be effective there has to be some plain speaking. "The IDB, like other Islamic banks, sets itself apart from the financial markets in that its governing and operation is compliant with Shariah principles," stresses the IDB. This may be true, but the record shows that there have been several scandals and frauds in Islamic banks over the last three decades in which senior and middle management have abused their positions and indeed undermined the very Shariah financial principles they were supposed to uphold.

The point here is to articulate the advantages of an Islamic system of financial management without being too strident, complacent and chauvinistic. Some Muslims and Islamic bankers think that because Islamic banking is faith-based, it is automatically immune to the vagaries of the global financial system and the world markets and economies. This could not be further from the truth. As Bank Negara Gov. Zeti Akhtar Aziz has said so many times in the past, the integration of the Islamic financial system into the global financial system and its management in terms of soundness and financial stability is crucial to its global acceptability, development and proliferation.

It is worth remembering that one of the first countries affected by the twin factors of the credit crunch and the spiraling oil prices was Egypt, an IDB member country, where citizens were rioting in the streets against the dramatic jump on basic food and petrol prices. Even in the GCC countries, including Saudi Arabia, the headquarters of the IDB, citizens are complaining of high food prices and huge rises in rents. In an increasing number of cases in Saudi Arabia people can no longer afford to pay their rents.

As events have unfolded in the last year, it is clear the lines between the financial system and the economy per se is increasingly blurred and that the two are inextricably linked. It started off with the subprime mortgages in the US which led to a credit crunch which in turn destabilized the global financial markets which in turn undermined the solvency and capital position of banks - whether large or small - and which in turn is now generating unemployment; homelessness as the economies stagger into recession.

Similarly, the UAE was the first IDB-member country to follow the lead of Ireland to guarantee all banks deposits in the country, a move which has now gain wider prominence. Pakistan, another IDB-member country, too is beset with budget problems with new President Asif Zardari scurrying between Washington and Beijing to get a concessionary loan of almost $1 billion.

Perhaps the IDB meeting should also consider the policy of some of its member countries who continue to insist to peg their currencies with the US dollar.

The IDB should encourage the establishment of a Muslim G-10 which should meet annually to discuss inter alia the Islamic financial system, the Muslim economies, and their integration into the global financial and economic systems. The technical and other aspects can be discussed by the industry standard-setting organizations IFSB (the Islamic Financial Services Board) and AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions), but the policies have to be discussed and agreed at a head of government level.

Some of the market impacts are already evident - the sukuk market says Badlishah Abdul Ghani, CEO of CIMB Islamic Bank, "has effectively dried up". Most of the lead arranger banks have not done one issuance in 2008 so far. This dearth is not because of the actual product, but because of the contagion of lack of confidence in the market and the resultant cautiousness. Pricing and the valuation of assets are other factors which are impacting on the sukuk market.

Similarly, mortgage securitization, which indeed precipitated the subprime crisis, is also affected. An Islamic securitization cannot be affected if there is a lack of transparency in terms of the assets and the quality of the assets; and indeed the structures themselves including ownership and capital guarantees.

It is too early to know to what extent the global financial crisis is impacting on the Islamic mortgage market globally. Apart from Malaysia, the Islamic mortgage market elsewhere is nascent. The good news in the UK at least where the Islamic mortgage market is about $1 billion in size, is that the four major Islamic mortgage providers all report no and very little repossessions, compared to thousands in the conventional mortgage sector.

Perhaps the most important challenge is that of capital adequacy for Islamic banks, some of whom have argued for a lower minimum ratio of the Basel 1 and 11 accords on the grounds that Islamic banks to not have normal deposits which constitute liabilities. Instead they have deposits on the basis of a fiduciary relationship where depositors' funds are invested and any profits shared between the depositors and the manager (the bank) depending on which contract is used. As such in Islamic banks deposits are off balance sheet and therefore are technically not liabilities.

This is a spurious argument given that Islamic banking has risks which are unique to it including fiduciary risks and Shariah compliance risks. Arguing for a different capital adequacy could also promote exclusivity and in fact undermine any attempt to help integrate Islamic finance into the wider global financial system.

by Mushtak Parker | Arab News

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