May 27, 2012 (PDF)
During the week, I read a proposal for a replacement for the diminishing musharaka (musharaka mutanaqisah) home finance product (see the basics, and a numerical example). The basic argument given against the diminishing musharaka structure is that it is identical to a conventional mortgage because it incorporates compound interest, which is avoided by the alternative.
However, upon closer examination, the alternative, which INCEIF’s Dr. Zubair Hasan calls the Zubair Diminishing Balance Model (ZDBM), misses a key feature of the musharaka agreement it is based upon. Instead of joint-ownership, the ZDBM assumes a fixed rate of return on the financier’s invested capital in the property being financed and equal payments to reduce the financier’s invested capital (with return on that capital paid out as rental income).
The buyer pays an equal amount each period to reduce the financier’s stake, plus a percentage of the outstanding balance (8% per annum in the example). The relationship between the parties is not one of a partnership, but a lending relationship with non-compounding interest.
The basis for a diminishing musharaka is supposed to be a structure similar to a joint venture, where each party has an ownership stake in a venture, which owns an asset that is leased with the lease payments split between the parties according to ownership. To see the difference, think of the diminishing musharaka as venture between two investors who buy a building and lease it for 10 years to a third party. They will charge the tenant a fixed amount per month for the right to use the building, and will split the proceeds amongst themselves according to the share of capital contributed.
If one party wants to acquire over time the interests of the other, he could use the rental income he receives to pay for a portion of the other partner’s ownership and would, in future periods, be entitled to receive a greater portion of the rental income (corresponding to his ownership share).
The same relationship could be done if the renter is the same person as the owner with the smaller ownership share. The real question, in my mind, is not about whether this builds in compound interest; it is whether the minority owner/tenant should be entitled to have the value of the building reassessed periodically and the buy-out amounts adjusted accordingly.
May 20, 2012 (PDF)
In the 37 years since the first formal Islamic bank opened, the industry has thrived. Despite some criticism about the reliance on debt-based products, much work has been done offer new products to meet customers’ financial needs. However, the Islamic finance industry has so far been limited to focusing on the financial screens, and avoiding financing activities where there is a specific prohibition (e.g. pork, gambling, alcohol production).
Much less attention is focused on avoiding activities where there is not a clear line dividing permissible and impermissible. There are almost no situations where investments are favored based on their positive impact apart from the bottom line. One area with a particular lack of attention in Islamic finance is environmental impact.
Islamic finance is supposed to work for the benefit of all of humanity. One area where Islamic finance should do more is by including both positive screens and additional negative screens that overlap with sustainable finance. This could include environmental impacts, discussed here, or other areas like poverty reduction.
A post on Business Insider summarizes many examples where scholars and organizations with a specifically Islamic focus have laid out the case for environmentalism within Islam, which was significantly broader than I expected. When the Muslim 7 Year Action Plan on Climate Change (see the link to the left) was released in 2009, the Assistant Secretary General of the UN Development Program, Olav Kjorven, said: “The role of Islam could be one of the decisive factors tipping the planet towards a sustainable future.”
The significant potential identified for Islam in moving the planet towards environmental sustainability will rely in many ways on the involvement of Islamic finance. Incorporating Islamic finance into a broader move towards sustainability will connect it with another rapidly growing area of finance that focused on many of the same goals, even though it is not based on Islamic principles.
Islamic and sustainable finance have each gone through a process of evolution to compete with the mainstream conventional finance industry, but each have developed differently, and each is likely to benefit from more cooperation, and a more conscious incorporation of environmental screens (both positive and negative) within Islamic financial institutions can start the discussion.
May 13, 2012 (PDF)
The Islamic finance industry has a problem. It is a problem of replicating conventional finance. However, in this case, I am not talking about the similarities of murabaha to interest-based finance. Instead, the issue is the gender gap, the idea of finance as a “boys club”. Rushdi Siddiqui highlights the issue in an opinion piece in the Business Times (Malaysia) where he interviews two women, one Muslim, one non-Muslim, who work for ThomsonReuters about their experience in Islamic finance.
The critics of the Islamic finance industry view it as a part of an expansionist Islamic project and expect to hear about misogyny rooted in what they perceive as a general hostility in Islam towards women. Instead, what you get is the same type of quotes you could find among women working on Wall Street or elsewhere in the corporate world:
- “Even though there are very talented women, only a few reach senior management positions.”
- “Working in male-dominated markets got me used to being underestimated by male colleagues in the beginning”
- “Women will have to continue to prove that they are just as qualified as their male counterparts”
The challenges facing women in Islamic finance are, in contrast to the critics of the industry, in line with the problems facing women across the corporate world. They are viewed as not being as competent and forced to work harder (often to earn less than men).
As everyone who has worked in a corporate environment knows, there are an equal number of qualified women as men, and gender does not play a determining factor in skill.
Studies have found that women are more focused on risks, and one of the few financial firms that survived the Icelandic collapse during the financial crisis without needing government assistance was one founded by women.
In the wake of a financial crisis which nearly took down the financial system, and whose impact led to the downfall of several Islamic financial institutions, it is imperative that Islamic financial institutions recognize that the Wall Street ‘boys club’ as much as its reliance on overly complex financial instruments nearly took down the financial system.
Can Islamic finance avoid the trap of replicating a Wall Street ‘boys club’?
May 6, 2012 (PDF)
The latest developments in the Arcapita bankruptcy center around Arcapita’s wish to continue using their internal cash management system, hardly a compelling question at first glance, but one which is important (particularly for creditors). When Arcapita filed for bankruptcy, it only filed for some of its entities: Arcapita Bank in Bahrain and several holding companies in the Cayman Islands.
Absent from the list were the US subsidiary, Arcapita Inc, and the various portfolio companies. This is important to the creditors because if Arcapita is allowed to continue to use its internal cash management system and is successful in getting a final order allowing them to make inter-company transfers as a part of the “ordinary course” of its business, the creditors could find all the liquid assets moved away to companies that were not part of the bankruptcy process.
Shifting assets away from creditors is not allowable in bankruptcy, but it is much easier to prevent the movement of cash up front rather than try and recover it later. In order to reduce the likelihood that assets are transferred out, the committee of unsecured creditors has requested greater oversight over inter-company transfers. In their motion, they cite Arcapita’s sale and leaseback of the Lusail property project in Qatar with QIB two weeks before the bankruptcy filing, and other transactions.
Creditors contend this was an attempt to move assets away from the creditors in the $1.1 billion murabaha that matured on March 28th, and they raise questions about links between Arcapita and QIB through Jassim bin Hamad al-Thani, the son of Qatar’s prime minister, who sits on the board of both QIB and Arcapita. Arcapita replies that the transaction is permissible and was simply a loan to Arcapita for $200 million secured by the property and allowable under the maturing murabaha.
In other developments, Arcapita continues to battle with Commerzbank over whether the latter can deliver a claim notice to Arcapita for a guarantee on a €125 million line of credit to portfolio company profine GmbH, which was recently sold to Hidden Peak Capital, a German private equity company. Arcapita claims that Commerzbank is trying to step around the bankruptcy process to collect on its debts, while Commerzbank says that it is just a ministerial act and that Arcapita is trying to invalidate a claim using the bankruptcy process as a “shield and a sword”.