Thursday, May 11, 2006


A professor once asked me to submit a paper I had written for his Business Ethics class on Islamic Banking to a magazine he co-edited. I was obviously flattered and promised to have another look at it and get back to him but never did submit it finally. Certain reservations I was never able to rationalise left me uncomfortable with the article.

Let me start out by saying that the class was part of the mandatory curriculum in the first year and I chose the topic because it presented a strong fit with the parameters of the assignment. I have neither the religious nor historical knowledge of the details to present a definitive view, but I had read a significant amount on the subject (whatever was available then) and the basic religious principles were quite simple really.

Fundamental to the whole issue is the underlying risk of the transaction. As long as there was some exchange of tangible assets / goods / commodities then you could finance the transaction Islamically and the more market risk you were exposed to, the better. What is not acceptable is a 'done deal' or a back to back paper transaction, i.e., if there was no risk in the transaction or if you were covering your risks through forward sales and just taking your cut, then you ain't kosher (ptp). But what were all these banks to do with the money if they could not place it in short term deposits that would earn interest and provide liquidity when needed.

Early on, I found out that there was a very broad scope of interpretation for what you can and cannot do. Not that people were unscrupulous necessarily, but exhibited varying degrees of pragmatism, reasoning and rationalising. I remember discussing this with an uncle who is both religious and into metal trading who basically turned down a massive contract with one of the banks exactly for that reason. They wanted to park their money in forward contracts on the metal exchange where guess what the rate of return was on the forward sale? Very close to the Interbank Offered Rate, i.e. the rate of interest they would have gotten at a bank.

My issue was not with Islamic banking per se, but the rest of the international financial systems. Ultimately, all money will eventually return to the system because there is no other place for it to go, and somewhere, someone will earn interest off it. And most of the commodities being traded were part of the same system. What was required was to create another system that could provide a short term place to park funds that banks could use to earn some cash off their deposits, but stay within the confines of Islamic jurisprudence. There was an attempt to establish a company whose shares were traded and for which there was a market maker at all time providing liquidity, but the actual company's performance was never that good. What was really required was a basic commodity which was subject to market fluctuations which was in plentiful supply locally and for which there was an enormous demand for…hmmm…let me think here…I think we might have something like that over here, but then again, it isn't really our oil anyway is it.

Enter the era of massive real estate projects. I do agree that private equity is probably the most Islamic of all forms of banking, but not the way it is practiced over here. It is too easy for banks to take their money upfront and leave the investors with dud participations that have already had all the cream taken out. Yes the investor is left with a fundamentally Islamic investment, but the bank that sold it to him has already taken its profits and is sitting pretty while the investor has to sweat.

From my perspective, I am left with the same uneasiness as I did when the question of business ethics was first raised and still have no obvious answer. Otherwise, Islamic Banking to me holds the same appeal as credit cards from your favourite football team.

1 comment:

Anonymous said...

Well written, however, i feel you're only scratching the surface. The educated reader is well aware of Islamic banking and how the money made is deemed kosher (pardon the pun). I would like to understand your reservations about the application of Islamic banking in our markets, the issues with Sukuks (can they be sold in secondary markets?), the limitations (or scope) in terms of how far this type of banking can go.

We are witnessing a trend in which the Saudi Commecial Banks are enjoying astronomical bottom lines due to the fact that they don't have to pay any interest on their Islamic Deposits. Larger "Western" banks are establishing Islamic business arms of their own to capitalize on this trend. Large corporations shunning conventional banking facilities for Sharia compliant ones..

how far do you see this going? is this the new sexy side of banking in the Middle East?