Friday, May 27, 2005

Muslim middle classes and the truly needed Sukuk

Yesterday on, the structure of a new "Sukuk" issuance (Sukuk is the plural of Sakk, meaning "bond" or "certificate", a synonym of the Arabic word "sanad", which is commonly used for conventional bonds) was shown as follows (almost all of those lease-based structures look alike -- one can discuss juristic problems with those structures, but that is not my purpose in this blog):

Now one can see a benefit in issuing only bonds that are secured by some underlying assets. This would ensure that the issuing agency can only borrow up to the current market value of its assets, which reduces the chances of bankruptcy. Moreover, the lease structure may in fact impose a "marking to market" discipline, by linking the interest rate paid on those bonds to the actual rental cost of comparable properties, thus ensuring fairness and economic sense of all completed transactions of this form.

In reality, however, many governments and corporations that issue those sukuk also issue regular bonds, thus being exposed to potential bankruptcy. Moreover, the interest rate masked as lease payments is benchmarked to LIBOR, with a risk-premium based on the issuing country or agency's credit rating (betraying domination of "Islamic finance" by a group of London bankers, who think of everything in terms of the opportunity cost via London inter-bank loans). Thus, the solvency and marking to market advantages of having a real economic transaction (lease) underlying the bond issuance are in fact squandered.

It is very instructive in this regard to read S&P's analysis of the Qatar Global Sukuk (available on the S&P website), which were also lease based. The S&P analysts showed that the risk structure of the Sukuk is identical to that of conventional bonds -- even destruction of the leased property thorugh an act of God would be a dissolution event requiring the lessee to make the rest of its payments as promised! In other words, there is no lease at all: it's a charade, the only beneficials from which are the lawyers who structured the deal, the investment bankers who collected its fees, and the jurists who gave it its stamp of approval.

This brings me to a much more serious problem with Islamic finance: Are there any deals done in that industry that couldn't have been done otherwise? It seems that everytime one inspects any Islamic finance deal in some detail, one discovers that it merely replicates an already existing financial product or service at a higher cost. Is that all Islamic finance can offer?

Let's look at Muslim societies: Their biggest problem is the striking absence of a thriving middle class (in some countries, no indigenous middle class ever developed, and in others, it has been eroding very quickly). The vast majority of Muslims who can form the middle classes of those countries are in dire need for credit to avoid falling into (or staying in) poverty, and yet banks that are swimming in excess liquidity can't think of any better role to play than investing in various high-yielding bonds... And if the bank is called "Islamic", then let's just create an "Islamic bond" for it, mimicking the same risk and yield structure of conventional bonds... In other words, there is a fundamental crisis of financial disintermediation in Islamic societies, and "Islamic finance" has not -- to date -- done much to solve this problem.

The bond/Sakk needed in those societies is a different one: a new social contract that allows banks not only to serve as depositaries of funds, but also to extend credit to the shrinking and potential middle classes of their respective societies. Micro-lending is not the solution (I'll have to get to that in a separate posting), it is only a stop-gap measure for immediate poverty alleviation. What are needed are networks of intermediary credit institutions to fill the gaps between banks (be they Islamic or conventional) and the general public. I am proposing the use of mutual savings banks and credit unions to fill that gap in my paper under construction: "Mutuality as an Anti-dote to Rent-Seeking Shari`a-Arbitrage in Islamic Finance".

Before anyone objects to this proposal, note that all Islamic banks do at any rate is serve as intermediaries between conventional multinational financial institutions (be they mother banks, as in the case of HSBC, or otherwise) and "Islamic" structures offered to various customers. A similar or better structure can be built to appeal to the increasing religiousity of potential or barely surviving Muslim middle classes, to channel credit to them in Islamically accepted ways (which would also make economic sense by ensuring solvency and fairness through marking to market).

The structure is not yet very clear (more research is needed) but a model of Islamic Credit Unions at syndicates, labor unions, and other structures that are currently dominated by incresingly religious Muslim memberships, seems workable. It would help to formalize the existing informal credit structures used only in emergency situations, and allow the Muslim middle classes to develop a culture of thrift and investment that can make them economically sustainable. In the meantime, larger banks (Islamic or otherwise) can serve as wholesalers for those networks of credit unions, and we have seen how trivial it is to "Islamize" that securitization part of finance... First, however, we need to develop a useful Islamic finance for the betterment of Muslim societies.


Blogger heraish said...

"even destruction of the leased property thorugh an act of God would be a dissolution event requiring the lessee to make the rest of its payments as promised! In other words, there is no lease at all: it's a charade,..."

The Shariah scholars should be confronted with this.

10:08 AM  
Blogger heraish said...

Assalamu alikum brother Mahmoud,

If this could be developed into an academic paper to be published in an Islamic academic journal that would be excellent.

1:04 PM  
Blogger heraish said...


You allege that the Sukuk has the same risk/reward structure of a regular bond. One solution is that the Muslim governments should totally stop the issue of regular bonds. That way the Sukuk would have more meaning in the macro-economic sense and have a different risk/reward structure.

God Knows Best

11:27 AM  
Blogger Adam F. said...

Salam alaykum,

In my opinion the model - we are all looking for - real islamic finance and credit - is set by non-Muslims in Brazil - see their projects with local currency and C3model desrcibed on

Another example is set by Swedish Bank

In Muslim context the most advanced and close to ideal of pure halal finance model was proposed by Shaikh Ahmed in Man and Money

Allah knows best

8:01 PM  
Blogger Muhammad Saeed Babar said...


Is there no other way to alleviate poverty in Muslims than provision of credit?

1:42 AM  

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