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Sunday, 19 October 2008

Securitization: Solution to ‘pervasive’ financial crisis

JEDDAH - Could the disaster that is overwhelming the US, European and other world financial markets have occurred under a Shariah-compliant financial system? We do not know but it is very unlikely.
Reacting to the ongoing global financial crisis, Rasameel Structured Finance Company, a Kuwait-based specialized company dedicated to Shariah-compliant securitization, said on Saturday Shariah finance, by its fundamental nature, discourages or prohibits the speculative excesses that are the root cause of the current global financial crisis. The standard Islamic prohibitions against high levels of debt, against unsecured debt and against speculation result in a high level of financial prudence. In addition, an obligation for fairness requires that Shariah-compliant investors share in the risk and rewards and prohibit guarantees to some investors that will come at the expense of others. The lack of these concepts and principles in conventional finance results in the greed, volatility, and devastation that we are witnessing.
Rasameel views Shariah-compliant securitization in the context of what it coined as its “securitization continuum” which starts with asset origination and due diligence, to asset Sharih-compliant structuring, to asset pricing, to asset marketing and placement, to asset remarketing, to asset servicing and management to asset administration and reporting. The elements of such continuum are permissible activities under the Saudi Capital Market Authority licensing purview.
Asset remarketing however represents a major challenge not only in the context of Saudi Arabia but equally in other GCC countries due to the lack of a viable fixed income component in the capital markets. Capital markets however have tended to emerge organically in response to the existence of buyers, sellers and products and not the other way around, it said. A major component of today’s capital markets is securitization. Securitization is the process of turning cash producing assets into securities. Securitization has been an important part of the capital markets since the early 1970’s.
Securitization has provided lower rates to borrowers, better security for lenders, increased liquidity and provided alternative funding sources in the capital markets. However, in the current financial crisis, securitization has been frequently mentioned as one of its problems, mostly because of subprime mortgages. But it is very important to realize that it is only the speculative, over-leveraged excesses that have crept into securitization during the last ten years (such as collateralized debt obligations, subprime mortgages, asset backed credit default swaps) that have contributed to the financial meltdown, not the securitization process itself.
The basic nature of securitization is Shariah compliant. In securitization, the investors own the profit generating assets. In securitization, the investors’ profit is derived from the cash flow of real assets. In securitization, the investors are subjected to the risk of the assets that generate the return. All of these features of securitization are requirements of Shariah-compliant finance.
Securitization under Shariah finance has an ethical component, a moral directive which is missing in conventional finance. Securitization under Shariah finance is used to fund productive activities, to finance the purchase and sale of real assets, and generally to produce socially useful financing opportunities.
The structural features of Shariah-compliant securitization prohibit those unscrupulous, greedy features of conventional securitization that have resulted in so many problems. In order to conform to Shariah law, Shariah-compliant securitizations are forbidden to engage in transactions involving Maysir, speculative risk, and Gharar, excessive uncertainty. Over-leveraged transactions are forbidden as are unsecured, speculative lending. If only conventional finance had a similar ethical basis, the current worldwide financial crisis would have been prevented or at least reduced.
Shariah-compliant securitization has no attraction for those very short sighted, irresponsible speculators who are alternately driven by greed and fear. Shariah compliant securitization actually discourages investors who speculate without engaging in a useful transaction and seek a return with any real economic purpose to the undertaking.
Conventional finance is constantly warned by its regulators to avoid “irrational exuberance”. But no matter how many financial crashes can be attributed to speculative transactions that promise huge profits but produce nothing, asset classes that are not only morally corrupt but socially harmful, and appeals to investors’ lowest, greediest instincts, conventional finance seems to be doomed to these repetitive cyclical crashes.
Shariah-compliant investors should not be afraid of securitization. But they should fear conventional securitization transactions that have allowed speculative excess and unnecessary risk taking to dominate the purpose of the transaction. Shariah- compliant investors must realize that, in addition to prohibitions against Maysir and Gharar, Shariah- compliant securitizations are forbidden to engage in Ghish, concealment of information, Jahalah, misrepresentation, Taghrir, deception. In a Shariah- compliant securitization, the investor knows he is bound to the fate of the enterprise being financed. If these restrictions and principles were required in conventional finance, the world would be a much better place.
Islamic banking faces many challenges when confronted with the competition of conventional banking. Because of the prohibition of charging interest of money, Islamic banking has a strong focus on underlying assets, not just an exchange of money for an assignment of cash flows. Shariah- compliant finance must involve the funding of genuine economic activities that result in real goods and returns.
Sharih-compliant securitization therefore would not allow the securities generated to have a life of their own or to be synthetic emulations of the underlying assets and what they yield or generate. Nor would it allow an AAA security to be generated out of “high risk” underlying assets.

-Saudi Gazette

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