Islamic finance needs original structures, not copycats, says scholar

By BusinessIntelligence-Middle East staff

INTERNATIONAL. Shariah banking needs to develop more of its own products and avoid imitating conventional financial instruments in structures that compromise the spirit of Islam, a leading religious scholar has said.

Shariah instruments have to satisfy Islam’s objective of ethical and equitable investing while retaining a commercial proposition that can draw investors who plough in funds with the aim of reaping returns.

Scholars say Islamic bankers sometimes tailor Shariah instruments according to market demands to ensure they can be more easily sold as Islamic assets vie for investors that also have access to a wider range of conventional banking products.

“People tend to, to a certain extent, dilute some of the principles or objectives of certain contracts in order to accommodate conventional features,” Mohamed Akram Laldin told Reuters in an interview.

For example, in the Mudaraba partnership contract where the bank provides capital finance for a venture, the parties are required to share the profits but the bank bears any monetary loss. However, this is sometimes tweaked as investors demand capital protection, he said.

Akram cited the diminishing Musharaka and Takaful, or Islamic insurance, as examples of pure breed Islamic products that are not derived from conventional finance.

The diminishing Musharaka is a partnership where a bank gradually reduces its equity in a project and ultimately transfers ownership of the asset to the participants.

The US$1 trillion Islamic finance industry is growing 10% to 15% a year mainly because of a deluge of Middle East oil money. But religious scholars are worried that some industry practitioners could be watering down the strict requirements of Islamic law in a quest to broaden the sector’s appeal.

The Accounting and Auditing Organisation for Islamic Financial Institutions, or AAOIFI, a body that sets Islamic financial standards across the Middle East, rocked markets last year when it said 85% of Islamic bonds did not comply with Islamic law because of repurchase agreements.

Most Islamic bonds have been sold with a repurchase undertaking, a promise that the borrower will pay back their face value at maturity, or in the event of a default, mirroring the structure of a conventional bond. AAOIFI said this promise contravenes the obligation to share risk in the case of several types of Islamic bonds. The bonds should be bought at market value at maturity.

Akram, a Jordan and UK-trained scholar who has been involved in religious teaching for about 13 years, said the Islamic industry’s tendency to copy conventional instruments stemmed from a lack of experts skilled in both the Shariah and finance.

“We have this gap in the market, between the Shariah practitioners and market practitioners in terms of knowledge as well as exposure,” said Akram who sits on various Shariah advisory boards including HSBC Amanah.

“The result of this is you can see that there is a lot of conventional products that are being ‘Islamised’ because most of the product development team are people from conventional [markets] which have conventional practice.”

Shariah advisers are a small and influential breed, sitting on the Islamic boards of institutions and ruling on whether or not proposed Islamic products meet the Shariah conditions.