Issue Two

Birds of a feather

Without question, Shariah-compliant instruments are gaining ground in the US, buoyed by consumer demand among Americaís growing Muslim population. Regulations can be obstructive, and ground still needs to be made up, but the financial needs of Muslims are clearly being heard with more attuned ears, says Umar F Moghul. The history of contemporary Islamic finance is quite brief, and its history in the United States is even shorter. Yet the factors leading to the appearance of Islamic finance in the US are quite similar to those that led to its rise in Muslim nations, despite the very different contexts. Islamic finance began as an element of the broad"return to faith" throughout the Muslim world following the end of the colonization era, and as an ultimate means to bring into compliance with Islamic law the overall economies and finances of nations. While the latter goal remains unachieved in any Muslim nation, the former trend continues, stimulated by the rise and success of Islamic finance. In the US, where Muslims constitute a minority, lacking as a whole significant political and economic wherewithal, Islamic finance is only properly beginning to serve the increasing demand of the Muslim community. American Muslims have, thus far, largely relied on themselves to construct Islamic banking and financial products, but efforts of non-US institutions have also proven quite instrumental. Grassroots efforts towards Islamic finance in the US began, at least at an institutional level, during the 1980s. Before that, and even currently, there are informal mechanisms for obtaining financing. Islamically, such mechanisms, as can be expected suffer from numerous shortcomings but nonetheless reflect demand.

An obvious gap in the market

Germany needs to develop Islamic financial products to meet a pressing need, writes Michael Gassner. In the decades since the second world War, Turkish immigrants have helped Germany to prosper again. About 3.5 million muslims reside in Germany, out of which 2.6 million are of Turkish origin and approximately 350,000 have a German passport. Of these, more than 70% have been living here for more than 10 years and around 15% were born and have grown up in Germany. Mummert Consulting, a high-profile German consultancy, analysed this long-neglected market. Its report was upbeat: Turkish residents saved twice that of the Germans—a market size of E1.5bn annually. Isoplan, the Institute for Development Research, Economic and Social Planning, estimates Turkish-origin residentsí assets held inside banks to be around E20bn. And according to a survey of Zft, the centre for Turkish studies, 23.2% of Germany's Turkish population do not consider interest acceptable for religious reasons. Despite this, few Islamic products are available. Turkish Holdings gathered around E4bn-E5bn in assets to be invested in Turkey, but without supervision of competent Shariah boards nor under registration of German laws. The result: tens of thousands of Germany's Turkish muslims invested and lost their money.

The creation of Islamic wealth

Should Islamic banking provide distinctive financial products or simply mimic conventional banking, making adjustments to comply with Shariah law? Professor Rodney Wilson reports on the research and arguments put forward at an academic seminar. In the global economy, wealth determines power and influence, but much of the capital accumulation on which this is based results from debt finance involving interest payments. Such a system brings widely acknowledged injustices, notably problems of developing country debt, corporate insolvency resulting in unemployment, and social hardship where family financial obligations cannot be met. For Muslims, such economic injustices can never be acceptable, hence the need to develop systems of managing finance that are compatible with Koranic teaching and Shariah law. Wealth creation and value preservation are one of the greatest challenges facing Muslims and the Islamic world as a whole. In this regard, there is a need to focus on longer term issues of Islamic capital accumulation and its contribution to the development of Muslim societies, including those in the West. Many of these societies remain poor, yet there is much positive experience to learn from. Wealth creation results from savings and investment, but this is most likely to be successful if the institutions created to harness and deploy funds share the values of the societies they serve. The growing Islamic banking movement has become a global financial force, and it has the proven ability to harness funds that might otherwise be under-utilized. There is much successful experience that demonstrates how adherence to religious values brings social development, and that moral financing is good business sense.

Sustaining long-term growth

The first fund management group in South Africa to offer Shariah-compliant investments was Oasis. The group has since enjoyed success on the international stage, giving high returns compared with similar managed funds. Adam Ismail Ebrahim discusses the strategy that has driven Oasis forward. The one enduring characteristic of equity markets is that, regardless of the return they offer, they are inherently volatile. Markets tend to over-react to both good and bad news and thus short-term returns tend to be either excessively high or low. Creating and sustaining wealth over the long term, therefore, requires that investors are able to realise their investments at any time without having their investments materially reduced by a short-term cycle within the market. In modern portfolio theory there are two sources of return from an investment in the equity market: the return of the market as a whole and the value added/destroyed by the selection of individual stocks within the market. Alpha (a) is a measure of the fund manager's contribution to the performance due to stock selection and Beta (b) is a measure of the sensitivity of a portfolio's rate of return against that of the market, the market risk. Ideally, one should look to have a low b (correlation to the market) when the market is expensive, and a high b when the market is cheap. This would determine the exposure of a portfolio to general (volatile) market movements and unpredictable extraneous market variables. Simultaneously, one should seek to achieve a sustainably high aóthe return obtained through understanding and predicting company specific factors.

Leveraging specialist expertise

'Location, location, location', the old adage applied to all real estate investment, is an overused and outdated cliche. The issues are much broader, write Muhannad M Abulhasan and David Swan. Real estate as an asset class is becoming increasingly popular. The reason is that not only does real estate offer attractive risk-adjusted returns, but also it facilitates the structuring of Islamically acceptable senior financing facilities using sale/leaseback structures. Most of the recent real estate transactions in the Islamic banking industry have been joint ventures with established operators in specific real estate sectors. Publicly traded real estate operators have, in recent years, preferred to access private capital through joint ventures rather than raise funds from the public markets. In the current depressed public markets, where many real estate investment trusts (REITs) are trading at a discount to their net asset value, it is more efficient for real estate operators to raise capital for new developments by partially divesting from existing assets than to raise funds in the public markets. These market conditions have provided a window of opportunity for Islamic banks to act as financial investors and partner with well-established real estate operators to complete real estate transactions previously unavailable to them. Generally, investors construct their real estate portfolio based on where we are in the economic cycle. Consistent with the recessionary economic climate, which has been prevalent in many parts of the world, we have seen that most of the real estate transactions in the Islamic banking industry have been in stabilized income-producing assets. In the current low interest rate environment and weak economy, investors have shown an appetite for real estate investments, especially those providing a regular income stream. Real estate is a very attractive asset class for Islamic investors, especially those in the Gulf, who have a natural affinity to the physical and tangible nature of such assets.

An interest-free commodity currency

Most modern money exists as the balance sheet counterpart to the interest-bearing loans of commercial banking. Tarek El Diwany discusses why the underpinning of paper currency is so precarious and proposes a more reliable and less volatile interest-free alternative The origin of money is a rarely discussed topic in media outpourings on economics and finance. This is rather strange, given that money is the measuring rod by which the worth of so many other efforts are judged. Supply and demand determine price, but this is only part of the story, because the value of money itself helps to determine price. If the measuring rod of economic activity is unreliable, then the conclusions of myriad arguments among economists may themselves be unreliable, as may the commercial decisions of individuals and corporations the world over. While the man in the street typically believes the government alone has the right to create money and regulate its value, the professional economist usually acknowledges that both the state and deposit-taking financial institutions create the monetary medium of the modern nation. Given that commercial banks are the most common form of deposit-taking institution, the following discussion refers to two types of modern money, ìstate money and bank money. In 1935 Professor Irving Fisher proposed the elimination of the power of the commercial banks to create money on the basis that they had consistently used this right to profit at society's expense. The side-effect of their profit-seeking action was, argued Fisher, a boom and bust economy, unnecessary levels of debt, and the needless paying of interest on money that the commercial banking system had, in effect, created out of nothing. The method that Fisher proposed for achieving his objective was the gradual raising of required reserve ratios for commercial banks (that is, the ratio of monetary base to a bankís sight deposit liabilities) to 100%. The entire money supply of a nation would then comprise money issued by the state, from which point onwards the state alone would have the right to create money. Over the years, economists such as Frank Knight and Henry Simons have argued in a similar vein to Fisher, and so the idea is not an entirely novel one.