GLOBAL CRISIS ISLAMIC FINANCE CAN LEAD TO BETTERMENT

GLOBAL CRISIS: ISLAMIC FINANCE CAN LEAD TO BETTERMENT By Muhammad Ayub Director Research and Training, Riphah center of Islamic Business Riphah University, Islamabad 1

In the Grip of Crises 2008 onward § The most severe since 1930 s’ great depression; § Alan Greenspan: ‘great tsunami’ § Started from the US - other parts of the world - US Dollar and the huge size of the American economy - also owing to the ‘mighty’ US Dollar. § Over $3 trillion of bailouts and liquidity injections to abate the intensity 2

More Advanced: More in grip § 100 s of institutions in USA, UK and Other developed world closed – not even single in countries like Pakistan – had crossed all ethical and shariah based limits. § Sovereign Debt problem – Europe, poor indebted countries 3

CAUSES OF THE CRISIS § Excessive ability to create money and credit §. . carrying fixed charge; creating billions of dollars by simply shuffling the papers and transferring risk; § Adding to wealth of already rich without creating anything of value for use by the mankind. § A large number of investment products, without any underlying real assets by way of selling of accounts receivable and derivatives. § CDOs, interest rate swaps, interest rate futures, forward rates agreement, Forex trade options, 4 warrants and options on futures contracts.

Implications § Increasing poverty and hunger for billions of human beings § World Bank report, January 2010: 64 million more people living in extreme poverty by the end of 2010 than would have been the case without the crisis. § Risk of “currency war” – collapse of the global payments system. 5

NEED FOR NEW F. ARCHITECTURE An ethical requirement– not only Shariah injunction; comprehensive reforms to help prevent chaos and spread of financial crises 6

I. F. Principles can help § Strict moral guidelines for dealing with money, prohibition of debt trading and speculation; § To provide checks for the factors that distorted the system § So, better ability to sustain in the hard times. 7

ISLAMIC BANKING GROWING § Even during the crisis; double digit growth last 20 years in terms of: § Volume § Scope and Assets § Spreading worldwide § Assets held by IFIs worldwide are estimated to be over $1000 billion - figure may vary due to the coverage of institutions; § While the prospective market according to Standard & Poor's is that of $4 trillion, the global assets are expected to hit $1033 billion by the 8 end of 2010.

In Pakistan § Covering 6 % of the banks’ market; expected to rise to 12 % by 2012; § Islamic banks § IBBs § About 600 branches in all major towns of the country § MFIs § Islamic Funds 9 9

Crisis Impact on IFIs § IFIs escaped due to general prohibition of Gharar, Riba and risk-free return on investments. § Dubai debt crisis of 2009 exposed the weaknesses of ‘Islamic banking’ due to a number of objectionable products adopted by the IFIs. § Derivatives – “Islamic” options and swaps. 10

PRINCIPLES TO BE FOLLOWED § Avoiding: § Riba: earning any return from loan and debt contracts or selling debt contracts at discount; § Gharar – absolute risk / uncertainty about the subject matter or the price in sales and financial transactions; § Gambling and chance-based games); § Observing: General Prohibitions /unethical practices 11

PRINCIPLES § Risk & Reward - Owner of an asset has both risk and reward; § Forward trading with strict conditions of delivery and settlement § Possession / delivery - ensuring that risks and liabilities pertaining to an asset are properly taken by the owner; § Public financing: disciplining the fiscal behavior of the governments 12

Possibility of getting real benchmarks for pricing of goods, their usufruct and the services, both in cash /credit markets, reflecting real demand/supply scenario and the strength of the economy 13

IFIs not allowed exposure to CDOs, derivative products and intra-financial counterparty risk that crippled the conventional system; 14

WHY IFIS FAILED TO AVAIL OF THE OPPORTUNITY Financial engineering to mimic the conventional product – derivatives and swaps that crippled the conventional system – beneficial for IFIs? Permitting the haram contracts by use of Wa’d Separating risk from real economic activities and making it traded separately; 15

General Concerns about I. B. § Does not reflect the ethos of Islamic teachings - ; ‘Structured products’ § Strayed from theoretical foundation; § Tawarruq - the predominant instrument; § LIBOR - benchmarks used as a determinant of interest on non-Shariah compliant assets, not only as a pricing 16 tool.

Can Islamic banking in present structure lead to betterment? Not capable to play a significant role in ensuring health and stability of the national and global financial systems PROBLEM OF OPERATION – NOT OF THE SYSTEM 17

Solution lies in: § Observing Shariah and Ethics: § Disciplining the creation of money; § Limiting the self-interest with social interest and the business ethics, and § Transforming the corrupt financial system to make it free of exploitation and games of chance § Thus enabling the mankind to optimally use the resources for benefits at the 18 larger scale.

To Avoid Convergence with Conventional System: § Islamic finance must avoid imitating the practices of conventional banking To avoid § The same fate as faced by the capitalistic system. 19

CHALLENGES § Ensuring the real difference between the two systems - the main key to the stable and long-term growth; § Changing approach of the practitioners that all conventional products should have alternatives; § Developing benchmark based on real performance of the economy- by linking the money and credit expansion to the 20 growth of the real economy

CHALLENGES § Supply of trained human resources having Shariah inspiration and confidence to operate the system ; § Standardization: risk management, regulatory, accounting and market standards - based on AAOIFI Shariah Standards; § Many practitioners -using the dubious structures like that of Ba‘i al Inah and Tawarruq - operating ‘Islamic’ hedge funds based on options and derivatives do not really feel any 21 need for standardization

To Conclude § Islamic banking is in position to play crucial role interrelating finance, economy, community and society enabling the world to avoid crises in future; § To carry out operations according to the fundamental principles of Islamic economics and finance; § To expand their role in the real sector; § AAOIFI’s Standards must be applied for all banks and areas. 22

Thanks 23