OCTOBER 16, 201I usually agree with most of what Rushdi Siddiqui writes, but I think he missed a big point in his article about what takaful needs to thrive. Takaful struggles to grow because it is (generally) a much more retail-focused industry.
Takaful operators offer Shari’ah-compliant alternatives to conventional insurance products, with a focus on health insurance, life insurance, and auto insurance. There are far fewer products available to businesses, and the average size of each product (premium) will necessarily be smaller than in Islamic finance (banking generally being more ‘retail’ than other areas of Islamic finance). It will also require much more reliance on appealing to retail consumers both in convincing them about the need for insurance in general (particularly in developing countries where fewer people have insurance) and in convincing people that takaful is a better alternative.
This is probably more difficult because, unlike banking, there is not as simple of an explanation for why takaful is allowed and conventional insurance is not analogous to the “banking involves interest and interest is prohibited” simplistic explanation for why the alternative exists. The smaller average transaction size also makes it more difficult because larger projects using Islamic finance can spread the costs of development across a larger dollar amount. The development of Islamic financing for large projects (e.g. the development of ijara-istisna’a contract in the US in the early 2000s) absorbs some of the fixed costs with developing new Islamic financial products. With a consensus (more or less) reached on how a product must operate to remain Shari’ah-compliant, future iterations (even in smaller dollar denominations) can avoid some of the additional costs.
Takaful does not have this luxury. The takaful funds are mostly small, and have not yet formed a consensus on the best way for takaful operators to manage their business and get paid for their management services (e.g. the difference between mudaraba and wakala business models). Each new product goes straight to the overall market and cannot have the sticky questions of Shari’ah-compliance (which add costs) ironed out without raising the costs to the insured. Rushdi Siddiqui does address this in the question of what industry body speaks for takaful? An industry body could at least spread the costs of product development across the industry, or have a bulk of it shouldered by one or several countries.
Takaful has many challenges to overcome, but there should be some areas where it can follow the path of Islamic finance. However, it should look much more towards the history of retail banking, and not try to replicate the rapid growth of sukuk. Fixed income-like products can grow much more rapidly than insurance, because the latter needs more focus on not overextending itself, and ensuring that it can manage the risks it takes on when it writes a new takaful product.
OCTOBER 9, 2011
During the last week, I wrote about two different cases where I was put off by the actions of an Islamic bank in one case, and the statements by the Chief Economist of another (see below). Fortunately, I do not have to spend much of my time writing blog posts as critical as the ones I wrote this week, but it does raise a questions: Is it sufficient for Islamic banks to just ensure their products are structured in a Shari’ah-compliant way, or is there a higher ethical standard for transparency that Islamic banks should adopt? Also, should people speaking on behalf of Islamic banks, like the Chief Economist described in one post, be given a free pass when they make overly rosy or just factually incorrect claims about the Islamic finance market?
As the dismay in my posts indicates, I think that Islamic banks should be held (and hold themselves) to a higher standard of ethics and transparency. Islamic banks currently are focused primarily on attracting Muslim customers, mostly those who refuse to use conventional banks, and therefore are somewhat of a “captive” market (i.e. in many respects, Islamic banks do not compete directly with conventional banks, in retail banking this is more likely to be true rather than in investment banking). Relying on a captive market seems to have made many Islamic financial institutions complacent and makes it more likely for banks to become evasive about their derivatives exposure, for example.
If the Islamic finance industry wants to move beyond their primary niche and grow to compete with the conventional banking industry, it would probably benefit by enforcing higher standards of transparency on itself. Rather than an Islamic bank responding evasively to questions about its derivatives exposure, it should be open that conventional derivatives are not permissible for it to engage in, but that it uses Shari’ah-compliant derivatives to manage its risk from its international exposure in full compliance with its regulatory requirements. Instead of claiming that the sukuk markets increased significantly in the financial crisis (when they actually fell), the economist should have stated that although the financial crisis did lead to a fall in sukuk, they quickly rebounded in the years since the financial crisis to higher levels already this year than were issued in the year before the crisis.
If Islamic financial institutions choose to ignore this advice, they will continue to grow and continue to operate much as they do today. However, they will miss out on the chance to set an example for how financial institutions should operate and actually give conventional banks a run for their money. That would be a shame.
OCTOBER 2, 201I was looking into the Nakheel sukuk issued to trade creditors recently to fulfill the remaining 60% of what was owed to them when Nakheel began a restructuring back in 2009 and I came across a Bloomberg BusinessWeek article that began:
Sept. 27 (Bloomberg) — Nakheel PJSC, the builder of man- made islands off Dubai’s coast, said some of the land used as collateral for a $1.31 billion Islamic bond is at the bottom of the Persian Gulf.
“The land has been valued by reputable companies and was accepted by lenders and trade creditors,” Chairman Ali Rashed Lootah said after a press conference today, without saying who evaluated the asset. “What’s the issue?”
Most investors would not be comforted hearing that the assets backing an Islamic bond they hold are located underneath the Persian Gulf, so the first reaction many people was likely surprise. “What do you mean, ‘what’s the issue’?”. However, from the analysis I have read about the legal system in the UAE (which is applicable now that the tribunal no longer has jurisdiction over restructuring issues), whether the assets backing the sukuk are onshore or under the ocean makes no difference because creditors would not be able to take control over either in the event of a default. Of course, this is only based on what I have read; I am no expert on the laws of the UAE (or anywhere else for that matter). Also, the sukuk is unsecured (i.e. asset-based) and so investors would not have any legal recourse on the asset regardless of where it was issued.
More to the point, I think, is that the new Nakheel sukuk serves as further reminder of the incredible real estate bubble which was popped following the global financial crisis. The reason the parcels of land on which the sukuk is based are underwater (both literally and figuratively) is that they were earmarked for one of the three planned palm-shaped series of islands destined to be the home of luxury hotels and condos, but the financial crisis interrupted the development of the final two.
Pre-crisis, Nakheel was ambitious in using sukuk markets to raise funds (a total of $5.25 billion in 3 sukuk) for the projects (sukuk that have since been repaid with assistance from the Dubai Financial Stability Fund). Although the sukuk were large even among contemporaneously-issued sukuk, they were not unique in being raised to finance ambitious real estate projects. In addition to the real estate bubble, which was near its peak when the sukuk were issued, the ease with which tangible assets (either land or buildings, depending on the sukuk) could be used to create a sukuk led to far too many being issued relative to the total volume of sukuk being issued.
The sukuk markets are recovering strongly and it appears that this year will surpass 2007 for the largest volume of sukuk issued. Amidst the joy that the market has bounced back, it would be good if the lessons from the previous crisis could be heeded moving forward. Specifically, it is important that sukuk be designed to support projects which have solid economic fundamentals and to avoid piling into certain sectors that are viewed as “easy” to shift financing from conventional bonds to sukuk. 1