Can a credit card truly be Islamic?
Credit cards are so widely accepted that even small kiosks along rural roads routinely ask itinerant customers to type in their PIN or impress their plastic onto old-fashioned carbon sales vouchers. As with every new invention, variety ultimately follows, and Islamic credit cards are gaining momentum in markets like South East Asia and the Middle East. The chief criterion that all issuers must abide by is that they cannot charge interst, says professor Dr Mohd Ma’sum Billah, an international scholar on applied Islamic banking issues. The credit cards that have been devised for Islamic consumers were borne from different views of Shariah principles. Whether Muslims can use credit cards has been a perennial debate. The very notion that a credit card charges interest (riba) on late payment is prohibited under Shariah principles. However, the counterpoint that disciplined behaviour resulting in prompt full payments does not trigger interest charges allows credit card use. Of course, credit cards cannot be used for cash withdrawals as there are interest charges per transaction.
     Some Islamic scholars are quick to point out that the mere signing on the dotted lines of a credit card agreement breaches Shariah law, as an individual can never guarantee his or her future actions. In this instance, the successful repayment at the end of each billing month can never be forecast. Any such agreement that triggers interest is unlawful (haram). The main differences between conventional and Islamic credit cards are twofold. First, there is no element of money-lending when using an Islamic credit card, as the transaction is based on trade. Profit margins are fixed for the whole tenure of the credit card agreement. Second, cardholders will make only halal transactions. The bank will decline transactions for non-halal activities. There are also Islamic credit cards that offer better fixed fees for other services, such as withdrawals, compared with conventional cards.

Speech that guides the industry
Not only with its intricate relationship to Islamic law and with its quest for Shariah compliance, Islamic finance and its study traverses all spheres of intellectual disciplines and scholarly thought. Harvard Law School conti nues to be instrumental in inspiring discussions among the Islamic finance industry through its numerous forums, initiatives, and workshops. Of particular value and success is its role in enhancing the dialogue between Islamic economists and practitioners vis-à-vis Shariah scholars. The active participation and applied reasoning of the Shariah scholars fundamentally kick-starts this banking transformation. Putting all the controversies to the side, one cannot but be impressed by their commendable contributions to this field. Not only for their astute understanding of public demands, but also it is for their advancements within a complex and ever-changing legal and financial regulatory frameworks.
     A dynamic cycle exists within Islamic finance. This cycle starts with the growing consumer demands and levels of financial sophistication, which is analysed and interpreted by the economists, then to the industry practitioners who deal with the reality of testing and structuring products in the market, and finally to the Shariah scholars who provide the Islamic legal analysis and the coveted sanctioning. It must be made clear: Shariah scholars are in no position to invent products. Shariah scholars can only but assess the products’ compliance to Islamic law, while practitioners devise and structure the products. A mutually beneficial relationship, therefore, emerges between the economists and practitioners, being the harbingers of innovation, and the Shariah scholars as the authenticators of that work.

Crisis? What crisis?
The domino effect of this crisis has parlayed into the structured finance markets, especially the mortgage-backed securities industry. What are the major elements responsible for the crisis, and would an Islamic finance model have prevented this?
     A sub-prime mortgage essentially refers to a mortgage granted to a risky borrower, with lenders facing a higher risk of default due to the borrower’s short or poor credit history. This may include a borrower having difficulty in proving the capability to repay the debt due to a less-than-average credit rating or an income that could arguably be unstable. Globally the real estate market enjoyed a boom period for the last five years, especially in middle America. The exuberance was attributable to low interest rates, especially in the USA. At the height of the boom in the US housing sector, banks and other financial institutions were providing interest-only mortgages with variable interest rates. The need to increase liquidity based on the upward trend in housing prices blinded the lenders to ignore the realities of the market in terms of risk of default by certain borrowers.
     However, activity came to a halt as the Federal Reserve, in an effort to combat inflation, slowly increased the prime rate—the benchmark interest rate used for mortgage loans. Many borrowers with sub-prime mortgages were first-time buyers, confident about rising home prices but inexperienced with variable interest loans. As the prime rate climbed, they struggled to make the payments.
     The mounting default rate across US markets led to an escalating number of foreclosures, resulting in major declines in house prices. This structure left the lenders unable to recover their losses in the market. However, the losses were not curtailed to only the mortgage and commercial lending of banks. The bigger impact was felt by the global structured finance markets in addition to lower prices of bank shares due to the linkage of exchanges. The impact of higher borrower default rates across the US affected structured products such as mortgage-backed securities. Investment houses that heavily backed hedge funds involved in real estate or sub-prime mortgages suffered massive losses.

Integration strategy in the Lebanon
Although its market volume cannot be compared with that of oil-rich neighbouring countries, financial institutions in Lebanon have a potential role to play in the Islamic financial industry. In fact, Banque Du Liban (BDL) plans to create a level playing field for alternative finance and enhance the integration of the conventional and Islamic financial sectors. Therefore, BDL is working on the following four strategic fronts: regulatory front; human capital and knowledge platform front; islamic transactions efficiency front; and integration front. Since the promulgation of law no 575 on 12 February 2004, BDL has issued a set of circulars whose major characteristics pertain to the Lebanese Islamic financial sector as stipulated in law and its related circulars are: no Islamic windows—only fully fledged banks; minimum capital of US$20m for banks and $100 for investors; article 3—Islamic banks are entitled to offer and provide all banking, commercial and investment services and operations, including the establishment of companies and participation in established projects or projects in the process of being established; and deposits should have a minimum term of six months.
     In addition, current accounts deposited in Islamic banks in Lebanon are covered by the deposit guarantee law; off–balance sheet investment portfolios must not exceed 20 times the net tier-one capital; provisions for meeting risks related to “result-linked deposit accounts” shall be withheld at a minimum ratio of 12% of net investment profits of the various operations until cumulative provisions reach twice paid capital; investments and placements in Lebanon must account at least for 50 per cent of the assets and rights of the bank; establishment of a corporate governance committee safeguarding the interests of the stakeholders; and an independent Shariah auditor requirement for the disclosure of the Shariah board’s annual report to the public at large, allowing community screening and assessment.

Nothing ventured, nothing gained
The Islamic sharing formulae can be considered one form of western venture capital VC, where the Islamic venture firm accrues its return from profit share not from ownership share, as the Islamic sharing formulae are short-term in nature. They share profits from investment operations only. In the case of diminishing musharaka, full ownership of the business assets passes to the partner after a certain period. Under this type of agreement, the client is given the right to gradually buy as much as he or she can from the bank’s shares until becoming the sole owner of the asset. Because of the congruence between the Islamic sharing formula and conventional VC, it would be logical to argue that, if the Islamic profit and loss sharing formula is taken as one form of venture capital, rather than an ideological concept, it will possibly have a great deal of universal application, especially as a supplement to interest credit financing for small and medium enterprises (SMEs). This is probably what Harper had in mind when he concluded that “the Islamic prohibition of fixed interest lending, which is also reflected in the Jewish and Christian traditions, has led to the evolution of a number of financial innovations from which everyone can learn”.
     Surges in oil prices have created record liquidity in oil-producing countries, particularly Arab Gulf Cooperation Council (AGCC) states. Moreover, the post 9/11 years have witnessed repatriation of capital by Arab investors from the world market. The region’s private wealth is also increasing. Standard and Poor’s estimates that Arab capital available for investment, mostly managed by western private banks, will eventually exceed US$2.3 trillion. A current estimate of the private wealth in the Gulf in 2006 alone stands at US$1 trillion. This figure is expected to rise to US$1.5 trillion this year.

Hard and fast rules
In support of the growth and expansion of the industry, the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has recently issued 12 standards. These have brought the number of issued standards to 68, comprising 25 accounting standards, five auditing standards, six governance standards, two codes of ethics, and 30 Shariah standards. Among the new standards are accounting standard for consolidation, statement on governance principles for Islamic financial institutions, governance standard on independence of Shariah supervisory board, Shariah standard on takaful, and Shariah standard on indices.

Tapping into Islamic finance
In most cases, a rational lender steadfastly conducts a cost-benefit analysis before deciding on what gives the highest return. It is probable that he may discover some arbitrage opportunities and attempt to take advantage of them. In a conventional banking system, these arbitrage opportunities are insignificant, as most of the financing products have approximately the same net effect For example, when the exchange rate between country A and B is 1:2, and country B and C is 1:1.5, and country A and C is 1:2.8, an arbitrageur has an opportunity to take advantage from the anomaly existing in these exchange rates. He could buy currency C with one unit of B and convert it to A for which he would get 0.54. Then, he converts this 0.54 of A to 1.08 of B. Here, he has made a small gain of 0.08 per unit of B. One would only take advantage of this when the transaction cost is lower than the gain generated. In most cases, the opportunities will be arbitraged away, meaning the rate is adjusted until no more arbitrage opportunity exists.
     As a result, arbitrage is deemed to enhance the efficiency of the pricing system. Likewise, the arbitrage opportunities in a dual banking system present a lender with an opportunity to maximise his profitability, although not through a direct buying and selling transaction. It concerns the differences in his profitability when he compares two modes of financing, that is, between conventional and Islamic. The hypothetical situation that will be used here will clearly show that Islamic banking financing products cannot attract quality projects if this form of financing arbitrage is practised in a dual banking system. But there are solutions to overcome these inadequacies.

Issue #15 Business Scope