Islamic Finance: Global Identity Problems and Prospects
By Clement M. Henry, The University of Texas at Austin
Islamic finance is giving rise to a new transnational space in which a distinctively Islamic dialectics of globalization can be articulated. Even as the Bush Administration’s responses to 9/11 have intensified Muslim perceptions of a clash of civilizations and provoked defensive jihad among growing numbers of Islamists, other Islamists are redefining globalization in the financial sphere. Since the year 2000, responding in part, perhaps, to high oil revenues flooding the economies of the GCC states, Islamic financiers have devised an array of controversial new securities. Secondly, they have also in these years completed an institutional architecture designed to regulate the industry with common standards. Thirdly, international concerns about the stability of the international banking system led in 2004 to the Basel II Accord issuing new guidelines concerning the capital adequacy requirements of banks. Meeting the new guidelines poses special challenges for Islamic banks. By successfully competing with conventional banks and harmonizing their practices to meet the demands of markets and regulators, they also appear to some critics to be losing any distinctively Islamic identity.
Islamic finance can be viewed as one of many efforts on the part of Muslim activists or “Islamists” to break out of the colonial closet of personal status legislation and to extend shari’a principles to other domains, notably to the international economy. But unlike more radical activists, the innovative financiers preferred in most Muslim countries to align themselves with Islam’s moderate mainstream, as expressed by the established ulama. It is still difficult even to define an “Islamic” bank except by the fact that it supports a board of religious advisors who are schooled in Islamic jurisprudence and are generally respected by their scholarly peers. It is they who define what is riba (forbidden forms of interest), as contrasted to Islamically acceptable ribha, or profits. Islamic finance represents, in other words, a moderate mainstream of Islamic activism rather than the more rigorist “puritan” variety of radical movement.[1]
In addition to the normal aversion of bankers for risky politics, Islamic financiers are ideologically opposed to political extremism. They may derive material as well as ideal benefits, however, from cooperating with the moderate Islamists enjoying government support in countries as diverse as Kuwait, Malaysia, and Turkey.[2]
Islamic banks faced growing problems of excess liquidity and mismatched maturities in their first quarter century of operations (1975-2000).[3]
They could not by definition park funds in conventional interest-bearing financial instruments unless they were ready to commit financial suicide by foregoing the interest payments. They were in need of functional equivalents of T-bills and other tradable securities, overnight inter-bank instruments, and other facilities available as a matter of course to their conventional commercial bank competitors. Finally, in 2000, the Bahrain Monetary Agency introduced the first Islamic T-bill, a non-tradable sukuk al-salam. The following year Bahrain pioneered a way of bundling Islamically acceptable leases into the first tradable Islamic debt security, a sukuk al-ijara. Malaysia followed suit in 2002, this time creating an internationally tradable sukuk that met U.S. regulatory requirements for conventional global bonds and was rated by Standard & Poor’s and Moody’s. The Islamic Development Bank, Qatar, Kuwait, Dubai, and the German state of Saxony-Anhalt subsequently issued a succession of Islamic bonds. Dubai formally launched its $750 million sukuk al-ijara on October 10, 2004, in partnership with the Hong Kong Shanghai Banking Corporation (HSBC) and other major international and regional banks. Finally, encouraged by Citigroup, which had opened the first Islamic window of a major international bank in 1996, a Dow Jones Citigroup Sukuk Index began on April 2, 2006, to track seven outstanding Islamic bonds,[4]
with expectations of encouraging a secondary market in them. With only $35 billion worth of new issues in the past three years, however, secondary markets remain problematic.[5]
Without greater standardization and transparency, the markets for these and other products of Islamic finance remain limited. Project finance also features some Islamic components in large and complex packages, but we cannot even quantify their dimensions for lack of adequate data.[6]
Estimates of the total assets of Islamic finance vary from $250 to $750 billion, with ritual estimates usually echoed in symposia and conferences on the subject since 1995 of an annual growth rate of 15 per cent.[7]
Islamic finance remains a boutique industry; for comparative perspective the total assets of one major international bank, Citigroup, amounted to $1.5 trillion in 2005.
The thirty-year old Islamic finance industry is gradually developing an international regime to reduce its cumbersome transaction costs. While institutions with sufficient authority to make universally accepted definitions do not yet govern Islamic finance, recent efforts to build a regulatory framework for Islamic finance are a significant step forward. The Islamic Financial Services Board (IFSB), established in 2002 with sponsorship from the International Monetary Fund (IMF), is in effect mandated to define the industry by standardizing its products, and the International Islamic Rating Agency, established a year later and soon to open its offices in Bahrain, is to offer, with the help of a panel of nineteen Islamic scholars, shari’a quality as well as credit ratings of both Islamic banks and other institutions that produce sukuk, along with corporate governance ratings.[8]
These regulatory institutions have materialized just in time – amid an explosion of markets for new securities in response to booming demand from investors. But they are young, under-staffed and under-funded, more an expression of aspirations for Islamic financial order than an established industrial authority. The hope is that the IFSB can set and disseminate international standards for Islamic financial institutions. Its 88 members include sixteen central banks of predominantly Muslim countries, a variety of Islamic banks, and, as associate members, the IMF, the World Bank, the Bank of International Settlements, the People’s Bank of China, and the Central Bank of the Philippines.[9]
The standard-setter behind the scenes that successfully lobbied for the creation of the IFSB is the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), founded in Bahrain in 1991. To date it has issued fifty-six standards on accounting, auditing, governance, and ethical and shari‘a standards, most of them within the past two or three years.[10]
Meanwhile, too, the exuberant growth of Islamic banks and Islamization of existing giants like Saudi Arabia’s National Commerce Bank are generating ever-greater interests in standardization. The recent launching, in particular, of an Islamic mega bank, Al-Masref, licensed by the Bahrain Monetary Authority and capitalized at $10 billion – almost four times the capital of the largest existing Islamic bank, Al Rajhi of Saudi Arabia, although less one tenth that of Citicorps – may generate consensus across the Muslim world among its prospective clients.
Were the IFSB to gain the full international authority required to define Islamic banking practices, however, they would still be subject to religious or ethically inspired objections to their “Islamic” identity. Their efforts to join the mainstream of international finance and accommodating with the Basel II banking standards further expose them to charges of simply mimicking conventional banks and selling out the essence of Islam to dubious marketing strategies that play on people’s piety.
It is hardly the fault of Islamic
financiers, of course, that they have severely curtailed their most
distinctive, equity-like means of financing (Mudaraba and Musharaka)
in favor of contracts for fixed profits, from markup pricing (Murabaha)
and leasing (Ijara). Equity
financing presupposes a culture of transparency that, as former Deputy Prime
Minister Anwar Ibrahim recently observed, depends on political transparency
that is denied in most Muslim countries.[11]
As one critic and authority on Islamic finance has observed, however,
… By approving and eventually codifying (through
AAOIFI, IFSB, OIC Fiqh Academy, etc.)
legal stratagems to replicate conventional financial practices, jurists and
bankers eventually drown the substance of Islamic law in their contemporary
reconstructions of medieval forms of classical jurisprudence. …By focusing on
medieval juristic forms rather than eternal legal principles of Islam, the
industry may in fact violate those principles and become less Islamic than
prudent utilization of conventional financial products.[12]
One way to escape this dilemma may be to promote more business friendly environments in Muslim countries, so that Islamic finance will engage in local equity financing rather than continuing to serve, like other more convention financial vehicles in the region, primarily as a conduit for investment outside the Middle East and North Africa.[13]
The Islamic financial community tends indeed to share the interest of the international community in current reform efforts in the region. It may assist Muslims in articulating a distinctively Islamic form of capitalism that will equally appeal to Muslim communities in Europe, especially the United Kingdom, and the United States. While coexisting with conventional international finance, it may place a distinctively Islamic imprint on globalization among the quarter of the world’s populations that are Muslim and, by joining global finance, alter the widespread perception that it is a new form of imperialism.
[1] For the distinction between “moderate” and “puritan” forms of contemporary Muslim thought, see Khaled Abou El Fadl, The Great Theft: Wrestling Islam from the Extremists (New York: HarperCollins, 2005), pp. 16-25.
[2] In Kuwait and the UAE special laws for Islamic banking regulate the Islamic banks and thus protect them from the competition of conventional banks, whereas in Turkey the special finance houses were integrated in 2001 into the Banking Law that regulates all commercial banks. In Malaysia the Central Bank operates a centralized shari’a board for supervising both Islamic banks and Islamic windows of conventional commercial banks. The board is selected to represent various political currents of the ruling party as well as the intellectual establishment.
[3] The Dubai Islamic Bank, which opened its doors for business in 1975, was the first privately owned “Islamic” commercial bank to survive through the twentieth century, after earlier failures of banking efforts in Pakistan and Egypt. The Dubai Islamic Bank did not acquire a shari’a supervisory board until 1998, however, after it fell victim to mismanagement and required rescue by the government.
[4] The seven bonds to be
selected were the sukuk of the Islamic Development Bank, the sukuk of Solidarity Trust Services Ltd, BMA
International Sukuk, Qatar Global Sukuk, Malaysia Global Sukuk, Sarawak Global
Sukuk, and Dubai Global Sukuk. To be listed, a bond must qualify to be shari’a
compliant, as determined by the Dow Jones Shari’a Board consisting of Muslim
scholars from a number of countries, and the Bahrain-based Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI). See “First
Islamic bond index to set global industry standards,” March 20, 2006, by
Al-Bawaba Reporters (retrieved from Lexis Nexus, April 26, 2006). The Dow Jones Citigroup Sukuk Index is
available online at http://www.djindexes.com/mdsidx/?event=Sukuk.
[5] Michael J. T. McMillen, “Sukuk and Islamic Bonds: Toward Viable Secondary Markets,” presentation to Seventh Harvard University Forum on Islamic Finance, April 23, 2006.
[6] Mohammed El Qorchi, “Islamic Finance Gears Up,” Finance and
Development. December 2005, p. 49, http://www.imf.org/external/pubs/ft/fandd/2005/12/qorchi.htm
(retrieved April 28, 2006). The central banks of Bahrain, Malaysia, and Turkey
publish aggregate data about Islamic banks, but Qorchi observes that “the lack
of adequate data makes it virtually impossible to compare Islamic banks across
countries.” I give it a try in the
appendix to this paper, taken from Clement Henry and Rodney Wilson, editors, The
Politics of Islamic Finance (Edinburgh Unievrsity Press, 2004), p. 7, with
additional data kindly provided by Javier Jopart, “The Impact of Regulation on
the Future of Islamic Finance,” presentation to Seventh
Harvard University Forum on Islamic Finance, April 23, 2006.
[7] As observed by Samuel L. Hayes III, chairing the Governors and
Institutions Roundtable, Seventh Harvard University Forum on
Islamic Finance, April 22, 2006. On
Lexis Nexus I retrieve $500 billion from “Global Islamic banks
must consolidate to be competitive, says industry group,” Associated Press
(Eileen NG), Kwala Lumpur, November 15, 2005.
[8] Paul McNamara, “The Islamic International Rating Agency,” Islamic
Business and Finance, March 2006, pp. 38-40.
[9] The 88 current members are listed on the IFSB website at http://www.ifsb.org/index.php?ch=3&pg=7&ac=10 (last visited April 29, 2006).
[10] See the AAOIFI website at http://www.aaoifi.com/ (last visited April 28, 2006).
[11] Keynote Address of Anwar
Ibrahim, Seventh Harvard University Forum on
Islamic Finance, April 22, 2006. For a more rigorous exposition of the theme,
see Tarik M. Yousef, “The Murabaha Syndrome
in Islamic Finance: Laws, Institutions, and Politics,” in Clement Henry and Rodney
Wilson, eds., The Politics of Islamic Finance (Edinburgh University
Press, 2004), pp. 63-80.
[13] Rodney Wilson, “Capital Flight Through Islamic Managed Funds,” in
Clement Henry and Rodney Wilson, eds., The Politics of Islamic Finance (Edinburgh
University Press, 2004), pp. 129-152.