Friday, September 5, 2008

The whys and wherefores of Islamic finance

A short introduction

Faith-based finance

Sep 4th 2008
From The Economist print edition

The whys and wherefores of Islamic finance

THE modern history of Islamic finance is often dated to the 1970s, with the launch of Islamic banks in Saudi Arabia and the United Arab Emirates. But its roots stretch back 14 centuries. Islamic finance rests on the application of Islamic law, or sharia, whose primary sources are the Koran and the sayings of the Prophet Muhammad. Sharia emphasises justice and partnership. In the world of finance that translates into a ban on speculation (or gharar) and on the charging of interest (riba). The idea of a lender levying a straight interest charge, regardless of how the underlying assets fare in an uncertain world, offends against these principles—though some Muslims dispute this, arguing that the literature in sharia covering business practices is small and that terms such as “usury” and “speculation” are open to interpretation.

Companies that operate in immoral industries, such as gambling or pornography, are also out of bounds, as are companies that have too much borrowing (typically defined as having debt totalling more than 33% of the firm’s stockmarket value). Such criteria mean that sharia-compliant investors steer clear of highly leveraged conventional banks, a wise choice in recent months.

Despite these prohibitions, Islamic financiers are confident that they can create their own versions of the important bits of conventional finance. The judgment of what is and is not allowed under sharia is made by boards of scholars, many of whom act as a kind of spiritual rating agency, working closely with lawyers and bankers to create instruments and structure transactions that meet the needs of the market without offending the requirements of their faith.

Non-Muslims may find the distinctions between conventional finance and Islamic finance a trifle contrived. An options contract to buy a security at a set price at a date three months hence is frowned upon as speculation. A contract to buy the same security at the same price, with 5% of the payment taken upfront and the balance taken in three months upon delivery, is sharia-compliant. Then again, winning over non-Muslims is not really the point.

There is no ultimate authority for sharia compliance. Some worry that this may hold the industry back. Malaysia has tackled this by creating a national sharia board. Some industry bodies, notably the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) in Bahrain, are working towards common standards. That a few scholars dominate the boards of the big international institutions also helps create consistency. But differences between national jurisdictions—between pious Saudi Arabia and more liberal Malaysia, say, are likely to remain.

Both of these countries feature in the top three markets for Islamic finance, measured by the quantity of sharia-compliant assets (see table). Top is Iran, although international sanctions keep its industry isolated. The Gulf states, awash with liquidity and with a roster of huge infrastructure projects to finance, are the most dynamic markets. Britain is the most developed Western centre, although France, with a much larger Muslim population, wants to close the gap.

Savings and souls

Islamic finance

Savings and souls

Sep 4th 2008 | MANAMA
From The Economist print edition

Muslims have a lot of money to invest. But it is a constant struggle to reconcile faith and finance

Gillian Blease

TO SEE Islamic finance in action, visit the mutating coastline of the Gulf. Diggers claw sand out of the sea off Manama, Bahrain’s capital, for a series of waterfront developments that are part-funded by Islamic instruments. To the east, Nakheel, a developer that issued the world’s largest Islamic bond (or sukuk) in 2006, is using the money to reorganise the shoreline of Dubai into a mosaic of man-made islands.

Finance is undertaking some Islamic construction of its own. Islamic banks are opening their doors across the Gulf and a new platform for sharia-compliant hedge funds has attracted names such as BlackRock. Western law firms and banks, always quick to sniff out new business, are beefing up their Islamic-finance teams.

Governments are taking notice too. In July Indonesia, the most populous Muslim country, said it would issue the nation’s first sukuk. The British government, which covets a position as the West’s leading centre for Islamic finance, is also edging towards issuing a short-term sovereign sukuk. France has begun its own charm offensive aimed at Islamic investors.

Set against ailing Western markets such vigour looks impressive. The oil-fuelled liquidity that has pumped up Middle Eastern sovereign-wealth funds is also buoying demand for Islamic finance. Compared with the ethics of some American subprime lending, Islamic finance seems virtuous as well as vigorous. It frowns on speculation and applauds risk-sharing, even if some wonder whether the industry is really doing anything more than mimicking conventional finance and, more profoundly, if it is strictly necessary under Islam (see article).

Sukuks in the souk

As the buzz around the industry grows, so do expectations. The amount of Islamic assets under management stands at around $700 billion, according to the Islamic Financial Services Board, an industry body. Standard & Poor’s, a rating agency, thinks that the industry could control $4 trillion of assets. Others go further, pointing out that Muslims account for 20% of the world’s population, but Islamic finance for less than 1% of its financial instruments—that gap, they say, represents a big opportunity. With tongue partly in cheek, some say that Islamic finance should by rights displace conventional finance altogether. Western finance cannot service capital that wants to find a sharia-compliant home; but Islamic finance can satisfy everyone.

Confidence is one thing, hyperbole another. The industry remains minute on many measures: its total assets roughly match those of Lloyds TSB, Britain’s fifth-largest bank (though some firms that meet sharia-compliant criteria may attract Islamic investors without realising it). The assets managed by Islamic rules are growing at 10-15% annually—not to be sniffed at, but underwhelming for an industry that attracts so much attention. Most of all, the industry’s expansion is tempered by its need to address the tensions between its two purposes: to serve God and to make as much money as it can.

That is a stiff test. A few devout Muslims, many of them in Saudi Arabia, will pay what Paul Homsy of Crescent Asset Management calls a “piety premium” to satisfy sharia. But research into the investment preferences of Muslims shows that most of them want products that benefit their savings, as well as their souls—rather as ethical investors in the West want funds that do no harm, but are also at least as profitable as other investments.

A combination of ingenuity and persistence has enabled Islamic finance to conquer some of the main obstacles. Take transaction costs which tend to be higher in complex Islamic instruments than in more straightforward conventional ones. Sharia-compliant mortgages are typically structured so that the lender itself buys the property and then leases it out to the borrower at a price that combines a rental charge and a capital payment. At the end of the mortgage term, when the price of the property has been fully repaid, the house is transferred to the borrower. That additional complexity does not just add to the direct costs of the transaction, but can also fall foul of legal hurdles. Since the property changes hands twice in the transaction, an Islamic mortgage is theoretically liable to double stamp duty. Britain ironed out this kink in 2003 but it remains one of the few countries to have done so.

However, just as in conventional finance, as more transactions take place the economies of scale mean that the cost of each one rapidly falls. Financiers can recycle documentation rather than drawing it up from scratch. The contracts they now use for sharia-compliant mortgages in America draw on templates originally drafted at great cost for aircraft leases.

Islamic financiers can also streamline their processes. When Barclays Capital and Shariah Capital, a consultancy, developed the new hedge-fund platform, they had to screen the funds’ portfolios to make sure that the shares they pick are sharia-compliant. That sounds as if it should be an additional cost, but prime brokers already screen hedge funds to make sure that risk concentrations do not build up. The checks they make for their Islamic hedge funds can piggyback on the checks they make for their conventional hedge funds.

Mohammed Amin of PricewaterhouseCoopers, a consulting firm, says the extra transaction costs for a commonly used Islamic financing instrument, called commodity murabaha, total about $50 for every $1m of business. That is small enough to be recouped through efficiencies in other areas, or to be absorbed in lenders’ profit margins. In addition, bankers privately admit that less competition helps keep margins higher than in conventional finance. “Conceptually, Islamic finance should cost more, as it involves more transactions,” says Mr Amin. “The actual cost is tiny and can be lost in the wash.”

The other area of substantive development has been in redefining sharia-compliance. New products require scholars to cast sharia in fresh, and occasionally uncomfortable, directions. Some investors express surprise at the very idea of Islamic hedge funds, for example, because of prohibitions in sharia on selling something that an investor does not actually own.

“You encounter a wall of scepticism whenever you do something new,” says Eric Meyer of Shariah Capital. “It is no different in Islamic finance.” He says that it took eight long years to bring his idea of an Islamic hedge-fund platform to fruition, applying a technique called arboon to ensure that investors, in effect, take an equity position in shares before they sell them short. Industry insiders describe an iterative process, in which scholars, lawyers and bankers work together to understand new instruments and adapt them to the requirements of sharia.

Differences in interpretation of sharia between countries can still hinder the economies of scale. Moreover, the scholars can sometimes push back. Earlier this year, the chairman of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), an industry body, excited controversy by criticising a common form of sukuk issuance that guarantees the price at which the issuer will buy back the asset underpinning the transaction, thereby enabling investors’ capital to be repaid. Such behaviour contravened an AAOIFI standard demanding that assets be bought back at market prices, in line with the sharia principle of risk-sharing. The sukuk market has enjoyed years of rapid growth (see chart), but early signs are that the AAOIFI judgment has dented demand.

Although Islamic finance has done well to reduce its costs and broaden its product range, it has yet to clear plenty of other hurdles. Scholars are the industry’s central figures, but recognised ones are in short supply. A small cadre of 15-20 scholars repeatedly crops up on the boards of Islamic banks that do international business. That partly reflects the role, which demands a knowledge of Islamic law and Western finance, as well as fluency in Arabic and English. It also reflects the comfort that this handful of recognised names brings to investors and customers.

There are plenty of initiatives to nurture more scholars but for the moment, the stars are pressed for time. That can be a problem when banks are chasing their verdict on bespoke transactions. It takes a scholar about a day to wade through the documentation connected with a sukuk issue, for example. But scholars are not always immediately available. “You’ve got to have the scholar’s number programmed into your mobile phone and be able to get hold of them,” says a banker in the Gulf. “That is real competitive advantage.”

Assets are another bottleneck. The ban on speculation means that Islamic transactions must be based on tangible assets, such as commodities, buildings or land. Observers say that exotic derivatives in intangibles such as weather or terrorism risk could not have an Islamic equivalent. But in the Middle East, at least, the supply of assets is limited. “Lots of companies in the Gulf are young and don’t have assets such as buildings to use in transactions,” says Geert Bossuyt of Deutsche Bank. This limits the scope for securitisation, a modern financing technique that is backed by assets and is thus seen by sharia scholars as authentically Islamic. There are not enough properties to bundle into securities.

Governments have more assets to play with. The Indonesians have approved the use of up to $2 billion of property owned by the finance ministry in their planned sukuk issuance later this year. But oil-rich governments in the Gulf have little need to issue debt when they are flush with cash. That is a problem. Sovereign debt would establish benchmarks off which other issues can be priced. It would also add to the depth of the market, which would help solve another difficulty: liquidity.

It may seem odd to worry about liquidity when lots of Muslim countries are flush with cash, but many in Islamic finance put liquidity at the top of their watchlist. The chief concern is the mismatch between the duration of banks’ liabilities and their assets. The banks struggle to raise long-term debt. In a youthful industry, their credit histories are often limited; they also lack the sort of inventory of assets that corporate sukuk issuers have.

Desert liquidity

As a result, Islamic banks depend on short-term deposit funding, which, as Western banks know all too well, can disappear very rapidly. “Lots of assets are generally of longer term than most deposits,” says Khairul Nizam of AAOIFI. “Banks have to manage this funding gap carefully.” If there were a liquidity freeze like the one that struck Western banks a year ago, insiders say that the damage among Islamic banks would be greater.

Gillian Blease

There are initiatives to develop a sharia-compliant repo market but for the time being the banks have only limited scope for getting hold of money fast. Loans and investments roll over slowly. The lack of sharia-compliant assets and a tendency for Islamic investors to buy and hold their investments have stunted the secondary market. The shortest-term money-management instruments available today are inflexible. Cash reserves are high, but inefficient. Western banks with Islamic finance units, or “windows”, are just as troubled by tight liquidity as purely Islamic institutions are: their sharia-compliant status requires them to hold assets and raise funds separately from their parent banks.

There are other sources of danger, too. Because Islamic banks face constraints on the availability and type of instruments they can invest in, their balance-sheets may concentrate risk more than those of conventional banks do. The industry’s ability to steer its way through stormy waters is largely untested, although Malaysian banks do have memories of the Asian financial crisis in the 1990s to draw on.

None of these tensions need derail the growth of Islamic finance just yet. There is plenty of demand, whether from oil-rich investors, the faithful Muslim minorities in Western countries or the emerging middle classes in Muslim ones. There is lots of supply, in the form of infrastructure projects that need to be financed, Western borrowers looking for capital and ambitious rulers eager to set up their own Islamic-finance hubs. The industry is innovative; new products keep expanding the range of sharia-compliant instruments. And as in conventional finance, the economics of the Islamic kind improve as it gains scale.

But further growth itself contains a threat. The AAOIFI ruling on sukuk earlier this year neatly captured the contradictory pressures on the industry. On the one hand, bankers are worried that the narrow enforcement of sharia standards is liable to stifle growth; on the other some observers fear that Islamic finance is becoming so keen to drum up business that its products, with all their ingenuity, are designed to evade strict sharia standards. This presents a dilemma. If the industry introduces too many new products, cynics will argue that sharia is being twisted for economic ends—the scholars are being paid for their services, after all. But if it fails to innovate, the industry may look too medieval to play a full part in modern finance.

Balancing these imperatives will become even harder as competition grows fiercer. Anouar Hassoune of Moody’s, a credit-rating agency, believes that unscrupulous newcomers could harm the reputation of the entire industry, “like the space shuttle undone by something the size of a 50 cent coin”. Islamic finance serves two masters: faith and economics. The success of the industry depends on satisfying both, even if the price of that is a bit more inefficiency and a bit less growth.

Wednesday, September 3, 2008

King Abdullah Opening address at the World Conference on Dialogue

Opening address at the World Conference on Dialogue
King Abdullah bin Abdulaziz

On 16 July 2008, Saudi King Abdullah bin Abdulaziz opened the World Conference on Dialogue in Madrid with a speech highlighting the opportunities for a more tolerant future among the followers of the world’s religions.
(Source: Saudi-US Relations Information Service, 16 July 2008)

In the name of God, most merciful, most compassionate.

Praise be to God Almighty, who revealed in his Holy Book: "O mankind! We have created you from a single (pair) of a male and a female, and made you into nations and tribes, that ye may know each other. Verily the most honoured of you in the sight of [God] is (he who is) the most righteous of you."

And peace and blessings be upon our Prophet Mohammad and on all the prophets and messengers.

Your Majesty, my friend, Juan Carlos, King of Spain:

Distinguished friends: I greet you, and I thank you for responding to our invitation to this dialogue. I appreciate the efforts you are making in the service of humanity. I extend my deep appreciation to my friend, His Majesty King Juan Carlos, and the Kingdom of Spain and its friendly people for welcoming the convening of this conference on their land, a land that has a historic and civilised heritage among the followers of religions, and which has witnessed co-existence between people of differing ethnicities and religions and cultures, and contributed, with other civilisations, to the advancement of humanity.

Dear friends: I came to you from the place dearest to the hearts of all Muslims, the land of the Two Holy Mosques, bearing with me a message from the Islamic world, representing its scholars and thinkers who recently met in the confines of the House of God. This message declares that Islam is a religion of moderation and tolerance; a message that calls for constructive dialogue among followers of religions; a message that promises to open a new page for humanity in which – God willing – concord will replace conflict.

Dear friends: We all believe in one God, who sent messengers for the good of humanity in this world and the hereafter. His will, praise be to Him, was that people should differ in their faiths. If the Almighty had so desired, all mankind would have shared the same religion. We are meeting today to affirm that the religions that God Almighty desired for the happiness of man should be a means to ensure that happiness.

It is therefore incumbent upon us to declare to the world that difference must not lead to conflict and confrontation, and to state that the tragedies that have occurred in human history were not attributable to religion, but were the result of extremism with which some adherents of every divinely revealed religion, and of every political ideology, have been afflicted.

Mankind is suffering today from a loss of values and conceptual confusion, and is passing through a critical phase which, in spite of all the scientific progress, is witnessing a proliferation of crime, an increase in terrorism, the disintegration of the family, subversion of the minds of the young by drug abuse, exploitation of the poor by the strong, and odious racist tendencies. This is all a consequence of the spiritual void from which people suffer when they forget God, and God causes them to forget themselves. There is no solution for us other than to agree on a united approach, through dialogue among religions and civilisations.

Dear friends: Most of the past dialogues have failed because they have deteriorated into mutual recrimination focusing on and exaggerating differences in a sterile endeavour that exacerbated rather than mitigated tensions, or because they attempted to fuse religions and creeds on the pretext of bringing them closer together.

This is likewise a fruitless effort, since the adherents of every religion are deeply convinced in their faith, and will not accept any alternative thereto. If we wish this historic meeting to succeed, we must focus on the common denominators that unite us, namely, deep faith in God, noble principles, and lofty moral values, which constitute the essence of religion.

Dear friends: Man could be the cause of the destruction of this planet and everything in it. He is also capable of turning it into an oasis of peace and tranquillity in which adherents of religions, creeds and philosophies could co-exist, and in which people could cooperate with each other in a respectful manner, and address problems through dialogue rather than violence.

Man is also capable – by the grace of God – of vanquishing hatred through love, and bigotry through tolerance, thereby enabling all mankind to enjoy the dignity that the Almighty has bestowed upon all of them.

Dear friends: Let our dialogue be a triumph of belief over disbelief, of virtue over vice, of justice over iniquity, of peace over conflicts and wars, and of human brotherhood over racism.

Thus, with God we began, and through Him we seek assistance. I offer you my sincere greetings and appreciation.

Thank you and peace be upon you.


* King Abdullah bin Abdulaziz is the current King of the Kingdom of Saudi Arabia. The World Conference on Dialogue took place in Madrid from 16-18 July 2008. This article is distributed by the Common Ground News Service (CGNews) and can be accessed at

Source: Saudi-US Relations Information Service, 19 July 2008,
Copyright permission is granted for publication.

The Qur'an as therapy

The Qur'an as therapy
Hisham Adem
Bonn, Germany - Along with his students at the University of Haifa, the clinical psychologist Ofer Grosbard compiled a collection of advice from Qur'anic verses for bringing up children. Journalist Hisham Adem talked to the Israeli lecturer about the practical pedagogy of the Holy Book.

How did you come up with the idea for "Quranet"?

Ofer Grosbard: The project was an idea and initiative of one of my Bedouin students, Bushra. Last year, a group of 15 Bedouin graduate students studying educational counselling attended my course in Developmental Psychology. One day, Bushra came up to me and said, "What you are teaching us is not going to be of help to us."

Bushra said that when she becomes an educational counsellor, a parent may come to her and say, "A demon has entered my child" or something similar. "Do you think that what you have taught us here will be of any use to me then?"

"What would he helpful to you?" I asked her.

She replied, "The Qur'an." She said that, in the appropriate context, the quotation of a verse from the Qur'an has enormous impact on Muslims.

I brought a copy of the Qur'an to our next lesson. I divided the chapters among the students and asked them to locate the educational and therapeutic verses. There are many of these verses in the Qur'an, exhorting individuals to take responsibility, learn the truth, respect others, etc. I also asked them to write a brief story from everyday life for each verse to illustrate how a parent or teacher can utilise the verse to convey a message to their child. Together we collected more than 300 stories, and I added a simple, brief educational-psychological explanation to each one. That was how Quranet came into being.

How exactly does Quranet work?

The user selects a particular issue from the list of contents and receives the relevant Qur'anic verse. He or she can then study a brief description of an everyday event illustrating how the verse can be utilised to convey a message. The session concludes with a brief educational-psychological explanation of the process.

What are the main goals of Quranet?

Quranet transforms the Qur'an into a unique educational tool for parents and teachers, making the beneficial power of the Qur'an widely accessible. Moreover, Quranet reveals the beauty of the Qur'an and its respect for human dignity, providing a resounding response to those who exploit the Qur'an to justify terrorism.

What exactly does it mean to use the Qur'an as an "educational tool", particularly in terms of fighting radical Muslim extremism?

I am a Jew, and although I taught my students psychology, they taught me about the Qur'an, which I had not known before. They showed me its beauty and the way it deals so well with human relations. The essence of the Qur'an is actually human relations and human dignity – the opposite of terrorism. We used it to show parents and teachers what love means in the Qur'an.

Did you cooperate with Islamic theologians?

Although we worked on the material, we did not cooperate with sheikhs or imams. We are only educators, and I would like to emphasise this as strongly as I can. The students do not pretend to be interpreters of the Qur'an. They simply want to bring the Qur'an to the child and the family. A father who reads the Qur'an to his son is not automatically an interpreter of the Qur'an. Quoting a phrase from the Qur'an to a child – that one should tell the truth, for example – doesn't make you an interpreter of the Qur'an.

I emphasise this because we received many responses from the Arab world that talked about conspiracy and our presuming to interpret the Qur'an without actually reading the material – because the book is in Hebrew, and they only saw the website. After we finished our work, we presented it to well-known sheikhs in Israel, England and India and got wonderful feedback.

The project has caused apprehension among Muslim circles inside and outside Israel. They consider it Israeli propaganda and a means of manipulating the Qur'an to suit the interests of Israel.

First of all, the initiative came from Bedouin students, who did most of the work under my guidance, and it did not have any connection to the State of Israel. I know that in non-democratic countries it may be difficult for people to believe that not everything is political and dictated by the government.

It is true that the State of Israel is proud of this project, which presents the beauty of the Qur'an. Why not? Muslims also believe that the Qur'an was given to all humanity. Is it forbidden that I, as a Jew, for example, study it? I would like to encourage everyone who feels that way to read the material and make an honest judgment. Then they will have the right answer. This project is a product of love, not conspiracy.

Do you think your project will be able to establish a bridge between the Muslim world and the West?

For Muslims, the Qur'an is a bridge between the Muslim and the western way of thinking. Non-Muslims may discover the beauty of the Qur'an. That's actually what happened to me. The Qur'an built a beautiful bridge of love between me and my students. They showed me the beauty of their culture, something I will never forget.


* Hisham Adem is a freelance journalist. This article is distributed by the Common Ground News Service (CGNews) and can be accessed at

Source:, 27 June 2008,
Copyright permission is granted for publication

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