GLOBAL CRISIS: ISLAMIC FINANCE CAN LEAD TO BETTERMENT

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GLOBAL CRISISISLAMIC FINANCE CAN LEAD TO
BETTERMENT
By Muhammad Ayub Director Research and
Training, Riphah center of Islamic
Business Riphah University, Islamabad
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In the Grip of Crises- 2008 onward

• The most severe since 1930s great depression
• Alan Greenspan great tsunami
• Started from the US - other parts of the world -
  US Dollar and the huge size of the American
  economy - also owing to the mighty US Dollar.
• Over 3 trillion of bailouts and liquidity
  injections to abate the intensity

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More Advanced More in grip

• 100s of institutions in USA, UK and Other
  developed world closed not even single in
  countries like Pakistan had crossed all
  ethical and shariah based limits.
• Sovereign Debt problem Europe, poor indebted
  countries

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Causes of the Crisis

• Excessive ability to create money and credit
• ..carrying fixed charge creating billions of
  dollars by simply shuffling the papers and
  transferring risk
• Adding to wealth of already rich without
  creating anything of value for use by the
  mankind.
• A large number of investment products, without
  any underlying real assets by way of selling of
  accounts receivable and derivatives.
• CDOs, interest rate swaps, interest rate futures,
  forward rates agreement, Forex trade options,
  warrants and options on futures contracts.

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Implications

• Increasing poverty and hunger for billions of
  human beings
• World Bank report, January 2010 64 million more
  people living in extreme poverty by the end of
  2010 than would have been the case without the
  crisis.
• Risk of currency war collapse of the global
  payments system.

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Need for New F. ArchitectureAn ethical
requirement not only Shariah injunction
comprehensive reforms to help prevent chaos
and spread of financial crises
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I. F. Principles can help

• Strict moral guidelines for dealing with money,
  prohibition of debt trading and speculation
• To provide checks for the factors that distorted
  the system
• So, better ability to sustain in the hard times.

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Islamic Banking Growing

• Even during the crisis double digit growth last
  20 years in terms of
• Volume
• Scope and Assets
• Spreading worldwide
• Assets held by IFIs worldwide are estimated to
  be over 1000 billion - figure may vary due to
  the coverage of institutions
• While the prospective market according to
  Standard Poor's is that of 4 trillion, the
  global assets are expected to hit 1033 billion
  by the end of 2010.

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In Pakistan

• Covering 6 of the banks market expected to
  rise to 12 by 2012
• Islamic banks
• IBBs
• About 600 branches in all major towns of the
  country
• MFIs
• Islamic Funds

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Crisis Impact on IFIs

• IFIs escaped due to general prohibition of
  Gharar, Riba and risk-free return on investments.
• Dubai debt crisis of 2009 exposed the weaknesses
  of Islamic banking due to a number of
  objectionable products adopted by the IFIs.
• Derivatives Islamic options and swaps.

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Principles to be Followed

• Avoiding
• Riba earning any return from loan and debt
  contracts or selling debt contracts at discount
• Gharar absolute risk / uncertainty about the
  subject matter or the price in sales and
  financial transactions
• Gambling and chance-based games)
• Observing General Prohibitions /unethical
  practices

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Principles

• Risk Reward - Owner of an asset has both risk
  and reward
• Forward trading with strict conditions of
  delivery and settlement
• Possession / delivery - ensuring that risks and
  liabilities pertaining to an asset are properly
  taken by the owner
• Public financing disciplining the fiscal
  behavior of the governments

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Possibility of getting real benchmarks for
pricing of goods, their usufruct and the
services, both in cash /credit markets, -
reflecting real demand/supply scenario and the
strength of the economy
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IFIs not allowed exposure to CDOs, derivative
products and intra-financial counterparty risk
that crippled the conventional system
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Why IFIs failed to avail of the Opportunity

• Financial engineering to mimic the conventional
  product derivatives and swaps that crippled the
  conventional system beneficial for IFIs?
• Permitting the haram contracts by use of Wad
• Separating risk from real economic activities and
  making it traded separately

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General Concerns about I. B.

• Does not reflect the ethos of Islamic teachings -
  Structured products
• Strayed from the theoretical foundation
• Tawarruq - the predominant instrument
• LIBOR - benchmarks used as a determinant of
  interest on non-Shariah compliant assets, not
  only as a pricing tool.

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Can Islamic banking in present structure lead to
betterment? Not capable to play a significant
role in ensuring health and stability of the
national and global financial systemsPROBLEM OF
OPERATION NOT OF THE SYSTEM
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Solution lies in

• Observing Shariah and Ethics
• Disciplining the creation of money
• Limiting the self-interest with social interest
  and the business ethics, and
• Transforming the corrupt financial system to make
  it free of exploitation and games of chance
• Thus enabling the mankind to optimally use the
  resources for benefits at the larger scale.

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To Avoid Convergence with Conventional System

• Islamic finance must avoid imitating the
  practices of conventional banking
• To avoid
• The same fate as faced by the capitalistic
  system.

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Challenges

• Ensuring the real difference between the two
  systems - the main key to the stable and
  long-term growth
• Changing approach of the practitioners that all
  conventional products should have alternatives
• Developing benchmark based on real performance of
  the economy- by linking the money and credit
  expansion to the growth of the real economy

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Challenges

• Supply of trained human resources having Shariah
  inspiration and confidence to operate the system
  
• Standardization risk management, regulatory,
  accounting and market standards - based on
  AAOIFI Shariah Standards
• Many practitioners -using the dubious structures
  like that of Bai al Inah and Tawarruq -
  operating Islamic hedge funds based on options
  and derivatives do not really feel any need for
  standardization

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To Conclude

• Islamic banking is in position to play crucial
  role interrelating finance, economy, community
  and society enabling the world to avoid crises in
  future
• To carry out operations according to the
  fundamental principles of Islamic economics and
  finance
• To expand their role in the real sector
• AAOIFIs Standards must be applied for all banks
  and areas.

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• Thanks