Wednesday, September 14, 2005

"Islamic Project Finance" and Cheapening the name of Islam

I had an interesting email exchange with a reporter earlier today. I will post the reporter's questions in red, and indented, and my responses thereof in the default color and paragraph style.


Some of the recent large project financings have carried Islamic tranches, but many of the participants seem to be the Islamic divisions of conventional banks. Some banking sources have suggested that the Shari'a boards of some of the Islamic banks, particularly in Saudi, regard these deals as not sufficiently shari'a compliant to permit their participation. I was wondering if you had looked into this matter at all or had any opinions on it?

My reply:

Conventional investment banks in particular have an obvious comparative advantage.
First of all, while every financial procedure can be "Islamized", project finance is an area where Islamization is particularly easy (e.g. BOT structures can easily be called istisna`, ijara and sale, with trivial modifications required, depending on your particular Shari`a board). The ease of Islamization in this area means that the more conservative Islamic banks are at the same disadvantage competing with the larger and more experienced conventional banks.

With regards to whether something is "sufficiently Shari`a compliant", that is a red herring. You can always hire the appropriate scholars, and add degrees of separation to make any structure "Shari`a compliant"... That is a given. The question is one of cost. In this particular area, as I have argued above, the main cost components are the ones for conventional project finance, where the smaller and less experienced Islamic banks are at a distinct disadvantage... (I am repeating myself, am I not :-)


Also, would you like to make any general comments about the growth of Islamic participation in the project finance sector? I'm happy to take on- or off-the-record information depending on your preference.

My reply:

It was a natural: banks know how to do this anyway, and -- as a London lawyer told me recently -- everything "Islamic" is currently the flavor of the month for investment bankers. Every project is now "the first ever" something (e.g. the first ever Islamic BOT to break the $1.5 billion barrier in the Emirate of Sharjah :-). This way, you get a bunch of free publicity (mainly from you guys), and perhaps if some gullible customers think that your product is in fact different from what they could get from conventional providers, you may charge them a little extra.


It seems that you're a bit skeptical (!) about the growth of Islamic finance, but isn't it useful in providing a little bit of extra liquidity?

My reply:

Not a bit skeptical: *very* skeptical and disappointed. What is marketed as "Islamic" is completely void of substance. Name one case where Islamic finance served a function that could not be served by conventional finance! In the meantime, "Islamic finance" experts deride Grameen and others active in micro-finance (which actually do serve a purpose that the HSBCs in the world would only support as part of their public relations, or community banking act type regulations) for not being "Islamic".

I am not sure about increasing liquidity: Islamic finance serves only to bring about market segmentation, which reduces overall liquidity.


...So if Islamic banks are serving a function which could easily be served by convetional banks in project finance and are not offering anything new....What could they do to change this? Do you think they should simply abandon the world of project finance for other initiaves or can they come up with something new that would compete pricewise with conventional banks but also be fully shari'a compliant (and not just massaged to look compliant)?

I guess that's the million dollar question!

My reply:

Allow me to answer in metaphor:

I am not saying that "Islamic restaurants" should not serve vegetarian salads, neither am I saying that their lettuce is not truly Shari`a compliant. I am merely saying that celebrating the launch of XYZ Islamic salad ("the first ever with three types of dark greens and tomatoes") can only be useful for cheap publicity. Its cheapness cheapens the name of my religion, too, but few seem to care.

Saturday, September 03, 2005

New paper on Islamic banking corporate governance and regulation

I have just posted a new paper to my website entitled
"Islamic Bank Corporate Governance and Regulation: A Call for Mutualization".

The abstract follows:

Sheikh Kamel does not fancy the word customer or depositor and prefers to use the term ‘partner’. “Those people who place their money in Al-Baraka bank or any other Islamic bank are considered shareholders of these banks. This means if these banks prosper so will they”.

The Daily Star (Monday, August 15, 2005), by Osama Habib,
“Saudi businessman tackles task of polishing Islam's image”

The rhetoric of Islamic banking – exemplified in this opening quote by one of the industry’s most prominent pioneers – is derived from its historical evolution as a model of two-tier silent partnership. In fact, Islamic banks have mimicked conventional bank assets – from receivables to bonds, with credit sale and lease-backed debt instruments. In the meantime, Islamic banks have continued to rely for the bulk of their liabilities on “investment accounts”, which have a peculiar quasi-equity structure. Contrary to the opening quote, holders of those investment accounts in fact are not shareholders of Islamic banks. In this paper, I analyze different means of reverse engineering a debt-structure for Islamic banks’ liabilities, which would resolve the corporate governance and regulatory problems posed by the investment account structure (wherein holders of those accounts lack internal corporate protection through representation on the board of directors, and lack legal and regulatory protection as creditors and first claimants to the banks’ assets). However, adopting those measures – similar ones having been suggested in the earliest stages of industry development – likely would be rejected by industry practitioners, as they would negate the perceived unique nature of Islamic banking upon which the industry was built. I also suggest that the current mutual-fund model of investment accounts, which is favored by industry practitioners and theorists is fundamentally unsuitable for banking in the narrow sense. I propose mutuality as a solution to the corporate governance and regulatory problems currently unresolved due to the peculiar investment account structure. I show that mutual banking would be closer to the religious tenets enshrined in the prohibition of riba, and thus would strengthen the brand-name of Islamic banking by re-focusing it on the nature of finance and its objectives, and away from formal-legalistic contract mechanics. Moreover, mutual banking is well understood by regulators and economists, and thus the corporate governance and regulatory frameworks for mutuality-based Islamic banking may easily be adopted from western best practices.


As always, comments and suggestions would be greatly appreciated.