Islamic institutions prove their resilience

Citation

Shubber, K. (2009), "Islamic institutions prove their resilience", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 2 No. 1. https://doi.org/10.1108/imefm.2009.35202aaa.001

Islamic institutions prove their resilience

Article Type: Editorial From: International Journal of Islamic and Middle Eastern Finance and Management, Volume 2, Issue 1

Can anyone claim that they have not been impacted by the current financial melt-down and associated recession? A rather naïve question, one might say!

A more serious – and certainly more searching – matter relates to the origins and causes of this pervasive malaise. While many continue to maintain that the seeds of the problem were sown by excessive credit to sub-prime borrowers in the US housing market, others have put forward explanations which pre-date the difficulties in that market, including the system of financial regulation.

During these interesting-cum-challenging times, we have seen the collapse or near-collapse of some major conventional financial organisations. Yet, the ripple effects on Islamic financial institutions (IFIs) have been limited. Plainly, IFIs have been affected by such variables as the returns on their equity and property portfolios, as well as the levels of earnings of their depositors/investors. Nonetheless, IFIs have not suffered anything like the acute liquidity shortages encountered by their conventional counterparts.

Owing to their special nature, IFIs have not relied on wholesale money markets for their funding, as they need to avoid the payment of fixed interest. Instead, they continue to depend heavily on retail deposits/investments, while also attempting to vet the financial status of their partners in a fairly concrete manner.

Role of credit within the conventional system

Clearly, the critical issue of credit and its price (i.e. the rate of interest) pose problems for conventional financial institutions. In essence, the years preceding the onset of the prevailing crisis were characterised by easy credit, whereby these institutions competed vigorously to offer loans and other facilities one easy terms.

With the benefit of hindsight, it is the considered view of many experts that a large number of these firms had not been sufficiently prudent in assessing borrowers and ensuring a reasonable degree of credit-worthiness. Hence, when the trigger was ignited, panic spread like bush fire, and confidence was damaged far beyond the confines of the financial-services sector.

In modern economies, the financial-services sector is intricately intertwined with other parts of the economy, and therefore mutual effects and counter-effects are abundantly obvious. Brokers get commissions for arranging home loans and other financial facilities; fund mangers obtain performance-related bonuses on the portfolios they manage; top executives are entitled to benefits (and re-election) when they maximise profits via cutting costs and enhancing revenues.

All in all, the flight to safety has become a distinctive feature of our times, so much so that yields on US Government debt fell to record lows, while the US Fed lowered rates to virtual zero! Over certain periods, nervous investors actually paid for the privilege of owning US treasury bills, driving down their yields, and even pushing them to negative levels for the first time in post-war history!

A report in the London-based Financial Times on 10 December 2008 indicated that the implied yield for three-month US treasury bills “briefly traded at a negative 0.01 per cent – the first time that has happened since 1940” (p. 17). The glaring interpretation of this is that holders of the security were paying to own the paper, rather than being paid. This only shows how far confidence in Western financial markets has really sunk.

A principle of Islamic finance

All this touches upon a central principle of Islamic finance, namely that financiers cannot demand a fixed return on the loans they advance. Parties who provide capital for any project or business venture must not expect a pre-specified rate of return, irrespective of the actual performance of those projects or ventures.

Based on certain basic axioms, Islamic scholars have evolved a raft of financial-cum-business instruments that are in tune with the Sharia (Islamic law). Chief among these is Musharaka (i.e. participation), where relevant parties (financiers and entrepreneurs) put up the requisite capital, and share the profits or losses on a pro rata basis. Another is Mudharaba (speculation), where all the capital is provided by the financing party, but any profits are shared according to a pre-agreed split among the parties. A third is Murabaha (profit mark-up), which translates into the imposition of a profit mark-up by the financing party.

Furthermore, it can be said that the instruments of Islamic finance are not – and need not be – confined to adherents of the Muslim religion, as the appeal of these approaches can be appreciated by others. Indeed, the head of a new UK-based Islamic bank once remarked that the first customer to step into their first branch was not a Muslim!

Kadom Shubber