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Inequalities of screening

Standardised, transparent screening that accounts for Shariah guidelines will produce more consistent Islamic financial products. Professor Ulrich Derigs and Shehab Marzban dissect the different systems and look at the way forward

Shariah-compliance strategies are based on sector and financial guidelines. Shariah clearly defines activities in which Muslims are not to be involved, such as the consumption of alcohol and pork and activities related to gambling. Consequently, Muslims cannot invest in assets of businesses earning primarily from such activities.
     Sector guidelines are general prescriptions through which all companies operating in specific types of non Shariah-compliant business activities are excluded. Financial guidelines, on the other hand, are used to analyse how deeply an individual company is involved in financial practices that are not Shariah-compliant. For that purpose, Shariah scholars define threshold levels for specific indicators/financial ratios through which the degree of compliance when investing in an asset is measured. If the company that issued the asset is involved in financial practices exceeding the respective threshold, the asset is classified as non-compliant and, as with the sector guidelines, has to be excluded from further investment.
      An example of a common financial guideline using the accounts receivables, cash and short-term investments and total assets figures as published in the financial statements of the respective company is given by: (accounts receivables + cash and short-term investments) / total assets ≤ 50%. This guideline aims to ensure that the liquid assets of a compliant company as a proportion of its total assets are less than or equal to 50%. It stems from the Shariah rule that income is to be gained mainly from illiquid assets and, therefore, the majority of assets has to be of illiquid form.

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CAR needs driving in the right direction

If supervisory authorities and central banks provide regulatory incentives to Islamic banks, true economic returns to investment account holders could follow, argues Syed Farook. One incentive is the capital adequacy ratio (CAR)

Walk into some Islamic banks and you will see that they provide indicative rates of- return based on historical performance, which, ironically, co-relate with conventional banking deposit interest rates. Is there a problem with this? Yes and no. Yes, the problem with this is that Islamic banks engage in a profit-sharing relationship with their investment account holders (the term given for the comparable of depositors). This means that investment account holders (IAHs) should enjoy true economic returns of the bank rather than distributions comparable to benchmark interest rates. There is no problem with this if the asset allocation strategy yields returns for the Islamic bank that are comparable to benchmark interest rates. However, studies have found that some Islamic banks do smooth distributions to IAHs.
     The reasons for this are quite clear in the minds of some Islamic bankers. As an Islamic banker, I would tell you that if we do not provide rates similar to deposits, then our IAHs will move their funds to a bank - Islamic or otherwise - that does. Displaced commercial risk (DCR) is a legitimate concern and it relates to the mentality of IAHs who may desire a stable, low-risk return. This ‘distributions smoothing’, while not generalised to all Islamic banks, could potentially cause the Islamic bank's earnings to be volatile. Why? If pre-distribution revenues are poor in a particular year, Islamic bank shareholders have to sacrifice their profits for that year to subsidise IAHs' appetite for returns.

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Deciphering the secrets of the scrolls

The discovery of the Cairo Geniza provided an important insight into the development of Islamic business transactions, writes Mohammed Imad Ali

Various communities take credit for their contributions to the development of modern business transactions. However, the contribution of Islamic civilisation is not generally well known. In fact, the golden era of Islamic civilisation is termed by some economic historians as the great gap in the history of economics. These writers of economic history are either not aware of the contributions of Islamic civilisation in this area or they just choose to ignore it. A great treasure of records from all over the Mediterranean countries, dating mainly from the eleventh through the thirteenth centuries, has been preserved in the so-called Cairo Geniza. These documents were discovered in the nineteenth century in a synagogue in old Cairo. The Hebrew word Geniza (pronounced gheneeza), like Arabic janaza (which means ‘burial’), is derived from the Persian. In Persian, ganj denotes a storehouse or treasure. In medieval Hebrew, Geniza, or beth Geniza, designates a repository of discarded writings.
     This article is an analysis of the two volumes entitled, A Mediterranean Society: the Jewish Communities of the Arab World as Portrayed in the Documents of the Cairo Geniza, written by S D Goitein, who was one of the pioneers in the study of Jewish Orientals.
     His work is divided into six volumes and there are 10 chapters in total. The work is published by the University of California Press. For the purpose of my analysis, I have used the one published in 1967. The chapter that concerns us is chapter three from the first volume, entitled, ‘The World of Commerce and Finance’. Goitein has done excellent and painstaking work studying these documents and commenting on them.

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Applying Koranic thinking to microfinance

The Islamic finance sector shares with conventional microfinance ethical and moral behaviour that offers real opportunities for the poor and society, writes Alberto G Brugnoni

Although the Islamic financial services industry has experienced impressive growth in the last decade, it has failed to make financial services accessible to the poor. This is in spite of poverty in both urban and rural parts of the 1.2 billion-strong Muslim world being high and that five predominantly Muslim countries—Indonesia, Bangladesh, Pakistan, Nigeria and Egypt—account for more than 500 million of the worldís poor, with incomes below the national poverty line.
     The need to align Islamic finance developments with the Koranic injunction to feed the hungry and help the distressed is increasingly felt throughout the industry as a moral obligation and as natural for its policies. Great attention has been given to microfinance as a well-suited conduit to channel much-needed resources to the Muslim living in deprivation.
     Of particular relevance to this challenge is the notion of financial inclusion gaining wide international acceptance. Major supra-national organisations such as the European Union and the World Bank have repeatedly expressed the views that giving the non-bankable a chance in life is a key element for social stability and sustainable development. The Consultative Group to Assist the Poor (CGAP), the multi-donor consortium dedicated to advancing microfinanceó has, for example, specifically included financial inclusion and the integration of microfinance with the formal financial systems as one of its key principles.

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Institutions try to fill the demand

The need to increase human capital in Islamic banking and finance has been evident in academia. Institutions have been quick to devise their own programmes in the hope of capturing students keen to enter the sector. Roshan Madawela reports

The British have tended to enjoy a reputation of excellence in the realm of conventional higher education and academia, at least since the 20th century. This strength is one of the leverage mechanisms that is being applied as a point of entry into the Islamic finance sector by the UK, consolidating the foothold in the banking and financial services areas in the process. In a recent Research Intelligence Unit survey, it was found that the UK far exceeded all other countries in the number of educational establishments that directly provide courses on Islamic finance or were found to be involved in research and training activities in the sector. The survey placed the number at 55, more than twice the UKís nearest rival.
     London also recently claimed to be the first to launch a formal qualification covering all aspects of Islamic finance with the unveiling of a joint British-Lebanese initiative. The Islamic finance qualification (IFC) was developed by the British industry body, the Securities and Investments Institute (SII), and the Lebanese Business Ecole Superieure des Affaires with the backing of the Lebanese central bank and the British government.
     Capitalising on traditionally strong trade links between the Middle East and the UK, the London-based CIMA also launched the certificate in Islamic finance, which has been developed and authored by a team employed by the International Institute of Islamic Finance Inc. consisting of leading Shariah scholars.
     While also catering to its minority Muslim community by having Shariah-compatible windows within parts of the mainstream banking system, the UK government is actively working to get a larger slice of the global business that can bring in billions of dollars more to its finance sector. Most senior government officials have been spearheading the campaign. As the UK finance sector is a respected standard bearer for conventional financial products, the SII is set to play a leading role in examinations development and introducing professional standards in Islamic finance.

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Complexities of risk outweigh Basel II

Demands on risk managers are greater In Islamic banking with more considerations than Basel II. Johan Lee reports

High fuel and other commodity prices are creating tension within the world economy and could potentially trigger higher rates of defaulting among bank customers. Frameworks such as Basel II were drafted so that banks might be better able to manage these risks by regulating capital requirements and putting in place other risk-mitigating measures. A big sticking point is that Basel II was drafted with conventional banking very much in mind. Islamic financial institutions, on the other hand, face their own peculiar set of risks, such as profit rates that remain fixed even as the cost of funds go up because of rising market interest rates.
     Innovation Associates, a consulting firm in Kuala Lumpur, expects the Islamic banking sector will share the burden. Ling Kay Yeow, a senior manager, says: “While conventional banks have Basel II, Islamic financial institutions may need their own framework to address some of the risks they face but conventional financial institutions do not. The global economy is entering a slowdown phase and Islamic banks have to prepare themselves for customers defaulting, including looking into risk management frameworks as well as legal frameworks.”
     Nora Mohd. Salim, a spokesperson for Kuwait Finance House in Malaysia, says that the Islamic Financial Services Board (IFSB), the body equivalent to Bank for International Settlements (BIS), has helped by developing international guidelines for the Islamic banking industry. “IFSB over the years have been very active in promoting new standards for risk management,” she says. “Essentially, the prudential standards complement the Basel standard to address the specificity of Islamic products. The standards cover capital adequacy, corporate governance and risk management.”