ANALYSIS

A new order

Shariah banking has been trying to market itself to investors, businesses and the general public as a credible alternative to conventional western banking. At first blush, the exponents of Islamic finance certainly have a bullet-proof argument—that the reckless risk-taking and bad decisions that tipped global banking into meltdown could not happen under the wise leadership of the Shariah sector.
     If only it were that simple. While international finance suffered humiliating government bailouts, there is little evidence that Islamic banking has stepped in to fill the void. But Shariah banking’s secular cousin, the ethical banking sector, has clearly benefited.
Are the men at the top of the Islamic finance tree engaging in self-criticism and calls for rejuvenation? Is there even much call from outside this elite group for a revolution that could bring success?

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FINANCE

Colour of money

Money has become the common denominator in all economic transactions. The commodity serves as a medium of exchange and as payment for goods and services. It can, therefore, be used as a standard of market value and store of value. If man had no means to store value, or save, neither long-term planning nor exchange would be possible.
     Before the concept of money, man had to use primitive barter or be forced to be self-sufficient. Imam Al-Ghazali, an 11th century scholar, explained the logic behind our need for money—he gave the example of a saffron owner in need of a camel and the owner of a camel in need of saffron. That this encounter could only be coincidental rendered barter extremely unattractive.
     Before either party could achieve their goal, the barter would involve an arduous search, sometimes involving a series of intermediate barter exchanges; for example, saffron for wheat, wheat for rice, rice for clothing and clothing for camel. This practical experience prompted a need for a high demand object readily exchangeable against goods and services.

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SUKUK

Building for a solid future

Sukuk are considered the most sought-after financial instruments in Islamic finance. Western investors view them as debt-like fixed-income instruments, whereas Muslim investors buy them because they pose less-risk than equities or real estate and are Shariah-compliant.
     Sukuk have recently been in the spotlight with high-profile defaults that helped to create a new perspective on how these instruments should be legally structured. In this article, three sukuk issuances will be examined: the asset-backed Tamweel rmbs; the asset-based Tamweel Sukuk Limited (tsl); and the asset-backed issuance of East Cameron Gas (ECG), which has defaulted.
     Before we examine the underlying assets of these issuances, we need to clarify a highly controversial subject—the ownership of the assets underlying sukuk. Like most bonds, most sukuk issuances are asset-based, which grants the certificate-holder rights on a portion of the cashflow. There are often no direct links to actual assets, which are a condition of Shariah. One rationale behind asset-based sukuk is the likelihood of obtaining higher ratings, as such sukuk are linked to the credit of the originator that raises the funds, not to physical assets.

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PROPERTY

Seller-financed mortgages

The sub-prime mortgage crisis and economic recession have changed the housing market fundamentally. Buyers can no longer rely on price appreciation to build equity. They need to be clear that whatever kind of financing they take has to pay down the principal in the shortest period, because that’s where the equity will come from—not from price appreciation.
     Shariah-compliant finance houses can expand their deal-flow by acting as mortgage service providers for sellers interested in financing their properties interest-free. As these finance houses do not need to bring cash from a funding source to the closing table, they could process considerably more transactions and lower their operating costs. This could eventually lower transaction costs for all of their other Shariah-compliant products.
     As the US Congress and the us Department of Housing and Urban Development (HUD) regulate the seller-finance activities through their respective Mortgage Reform and Anti-Predatory Lending Act and safe Act by requiring the sellers to go through mortgage licensing, the potential for interest-free seller financing will increase further. It is as if the Congress and the HUD are working together to encourage interest-free real estate financing.


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