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Sunday, 22 February 2009

Crisis presents ‘golden opportunity’ for Islamic finance

FEB 16 – The global economic crisis has handed the proponents of Islamic finance a “golden opportunity” to show that it is a better alternative to Western-style capitalism. That, at least, was what Malaysian Deputy Prime Minister Najib Razak told participants at an Islamic economic conference in Kuala Lumpur last month.

Islamic finance, argued Datuk Seri Najib, could become a model for change because it prohibits many of the risky activities that triggered the current crisis. He may have a point.

Islamic banking complies with syariah (Islamic) law by using returns on assets to pay investors instead of interest.

Most Islamic scholars also agree that derivatives and hedge funds are haram (forbidden), as is short-selling and speculation. As a result, argue its supporters, the US$1 trillion (S$1.49 trillion) global Islamic banking industry has emerged largely unscathed in the credit crunch.

Whether this will result in further growth in the industry as Western capitalism declines, however, is another matter entirely. The rapid growth of retail Islamic banking and services in Asia is still limited by a variety of regulatory impediments. Arabic terms such as Mudharabah (profit sharing) and Wahdiah (safekeeping) are also unfamiliar to most Asians, including many Muslims.

Some believe that all this is about to change. Celent, a Boston-based financial research and consulting firm, released a report last month on the Islamic banking industry in the Asia-Pacific region that suggested that the global financial crisis had made the Asia-Pacific region seem far more attractive to Middle Eastern investors than the West.

With assets valued at US$43 billion by the end of 2007, Malaysia already has the third biggest Islamic banking market in the world after Iran and Saudi Arabia. Investors from Saudi Arabia, United Arab Emirates, Bahrain and Qatar, said the Celent study, were beginning to channel their funds to developing countries like China, India, and Indonesia. The report identified Pakistan, Bangladesh, and Indonesia as having particularly good potential for growth.

Interestingly, non-Muslim majority nations in the region have already begun to recognise the potential significance of Islamic financial instruments. Singapore, for example, launched its first Islamic bond programme last month.

Similar plans to sell Islamic debt have been announced by Thailand and Japan. The Hong Kong government has also expressed an interest in promoting the territory as an Islamic finance hub. And financial institutions in South Korea have reportedly been lobbying the government to adopt the necessary legal and regulatory framework to enable Islamic financial transactions in the country.

But to suggest that Islamic banking is set to grow strongly despite the global financial crisis may be stretching things a little too far. Last year’s credit crunch hit Islamic bonds much harder than other forms of debt as sharply lower international oil prices deprived oil-rich Middle Eastern investors of cash.

According to rating agency S&P, corporate and government sales of sukuk (syariah compliant bonds) reached US$30.8 billion in 2007, but plunged 56 per cent last year to just US$13.6 billion. By comparison, conventional international bonds and emerging-market debt dropped 5 per cent and 15 per cent, respectively

Not surprisingly, Indonesia delayed its first sukuk sale twice last year.

Targeting mostly local investors, it eventually issued the bonds in January. Japan is also holding back on its plans, while Thailand has yet to set a date. As in the case of Singapore, the Indonesian move is probably best seen as an indication of the fact that the sukuk market is still active rather than ready for a resurgence.

That said, the fact that many governments are trying to spend their way out of the current economic downturn suggests that interest in Islamic finance will remain strong for some time. This is because tight global credit markets are forcing cash-strapped regional governments to seek out alternative sources of funding.

The new global order that emerges from the current economic downturn is unlikely to involve the wholesale replacement of Western financial systems with Islamic ones. But historical watersheds such as the one we are now entering do tend to be accompanied by important systemic changes.

If the new dispensation to emerge from the current crisis involves fresh ways of discouraging speculation and attempts to tie the global financial system more closely to the real economy, Najib may perhaps regard himself as at least partly vindicated. – The Straits Times

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