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Monday, 17 November 2008

Islamic finance can restore investor trust

Islamic financial institutions can play a vital role in restoring trust among consumers as they offer a greater degree of financial stability and resilience compared to conventional investment systems, say experts.

"In terms of rebuilding investor confidence and ensuring that funds are invested in a prudent and transparent manner, Islamic financial institutions could play a leading role in restoring trust and supporting the integrity of the financial system," Amin Al Arrayed, General Manager, First Bahrain, told Emirates Business.

Peter Panayiotou, Acting CEO at Gulf Finance House, said: "Shariah prefers that we invest in hard assets that should be easier to understand and allow us to evaluate the risks posed. Although this fact alone does not fully insulate us from the type of fallout from what we have seen in the West, the source of which was sub-prime mortgages, it is true that substantial investment in paper assets such as credit default swaps has been avoided by the Islamic banking industry.

"The Islamic form of investment can help reduce risk, particularly through the avoidance of more complicated non-vanilla derivatives trading. Indeed, Islamic investment is very pertinent right now at a time when investment in infrastructure is needed to stimulate the world's economies."

However, experts are quick to point out that the system is not completely immune to global trends.

Al Arrayed added: "It is true that Islamic financial institutions, by their very nature, are prohibited from investing directly in many of the riskier financial instruments.

"They are nonetheless part of the financial system and will no doubt be affected by the general slowdown in economic activity that has defined the global economy over the past few months.

"It is expected that the economy will continue to experience weakness well into the coming year. Markets as a whole will remain volatile as investors continue to be driven by emotional buying and selling. I expect that the financial sector will witness increased consolidation as weaker institutions are bought up or liquidated.

"This will hold true for both Islamic and conventional financial institutions. On a positive note, over-speculation on the part of financial institutions will be checked as inflation-driven profits start to disappear, providing the market with a more accurate representation of true value."

R Lakshmanan, CEO of Sakana Holistic Housing Solutions, is more optimistic.

"Though the value of sukuk deals has fallen during the year, the Islamic finance industry will continue to grow as many nations worldwide are reviewing the Islamic banking model for implementation, particularly as Islamic banks have not been directly affected by the sub-prime crisis," he said.

He believes a high level of corporate governance has protected the system.

"The level of corporate governance is certainly higher than in conventional banking as there are reviews by the Shariah boards. This layer of governance significantly protects the institutions."

Al Arrayed, on the other hand, thinks that measuring the level of corporate governance is not easy.

"I do not believe it is possible to state definitively that the level of corporate governance is higher within Islamic banking. Islamic banks may be susceptible to the same corporate governance lapses that have plagued conventional banks.

"It is true, however, that Islamic banks have the additional checks of their Shariah boards to help ensure their transactions are consistent with the strict guidelines of Shariah."

A reflection of the importance of Islamic finance is the fact that earlier this month the US Treasury Department held a forum on the subject for US banking regulatory agencies.

A Treasury spokesman said: "The Islamic Finance 101 forum is designed to help inform the policy community about Islamic financial services, which are an increasingly important part of the global financial industry."

Lakshmanan said: "The decision to teach Islamic finance to US banking regulatory agencies is a testimony to the fact that the world in general is looking at Islamic finance and this will further pave the way for the growth of the industry."

Al Arrayed added: "Islamic banking is a growing phenomenon that has come to define banking in the Gulf region. I believe it is very prudent for Western economies to undertake programmes to better understand and incorporate this model."

Malaysian Prime Minister Abdullah Ahmad Badawi has predicted a very bright future for Islamic finance. He said the segment would end its perceived position as a niche or boutique service and lead the financial fraternity into a new era of growth.

"Many observers are increasingly considering the Islamic financial system with renewed respect and admiration," he said. "Islamic finance must be prepared to take on a new dimension to meet the changing demands of business in an increasingly globalised environment."

The Islamic Financial Services Board says the industry controls assets worth $700 billion (Dh2.57trn) and could hold $1 trillion by 2010. The UAE, Malaysia, Kuwait, Pakistan and Turkey have emerged as hubs for Islamic finance. Countries with minority Muslim populations are expanding into the field as well, notably the UK, France and, more recently, Germany.

Sukuk market growing

Despite gloomy market conditions, sukuk issuance is rapidly approaching the symbolic $100 billion (Dh367.36bn) mark. It is likely to pass that figure sometime in 2009, according to a report by Standard & Poor.

This means the sukuk segment has established itself as a niché in the international capital markets and is on its way to becoming more than that.

After a very slow start in the first quarter of 2008, with less than $3bn issued, the sukuk market resumed rapid growth but at a lower pace than in 2007. S&P expects continued significant growth in the next 12 months.

The sukuk market is attracting issuers from a larger number of countries than ever and this trend is set to continue. Entities in more than 15 predominately non-Muslim countries have expressed interest or announced their intention to issue sukuk.

Several Asian countries, including Indonesia, are launching sukuk or reviewing their options to do so, and S&P expects the market to continue to expand globally.

(Emirate Business)

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