This was quite a surprise. To read what Hussein had to say. Some challenges that I can see right now relate to (1) the Basel II framework that he is talking about - that was a totally wrong reading of what it is supposed to do; (2) the treatment of bond-holders - that is again a wrong reading, you can have differing treatment of bond holders; (3) the management of bankruptcy - if you treat defaulting or bankrupcy as financial suicide, then capital formation will be impacted severely and rentier behaviour will arise as we can see right now with his talk about having lease payments - value is not being generated!; (4) reporting obligations - on what basis does a bank report its risk to the regulator? or what about taxation? ; (5) and finally, how on earth do you value many instruments which do not have a market?
but more on that later when I finish my review of the FSA book, but read this, very interesting.
'All Arabs will prefer Islamic banking'
3 Dec, 2007, 0229 hrs IST,Sugata Ghosh & Mayur Shetty, TNN
Hussein Hamid Hassan is considered as the father of Islamic finance. He received his PhD from the faculty of Sharia at the Al Azhar University in Cairo in 1965 and holds two degrees in law from the International Institute of Comparative Law, University of New York. He chairs the Sharia Supervisory Committee of many Islamic banks in the Middle East, and has advised several governments.
An expert in Law, he had been the attorney general for the government of Egypt between 1969 and 1970. He has advised several governments in the Middle East and CIS countries on establishment of Islamic Finance Institutions. According to Mr Hassan, Islamic financing is the most equitable form of financing since it enables the creation of wealth without fuelling inflation or stoking a financial crisis.
In order to do away with the concept of interest rates, Islamic banking entails structuring products in different ways. If it is primarily to acknowledge that there is a price of money, how is it different?
The function of conventional banks is to receive deposits with fixed interest rates and to lend the same to borrowers at a fixed rate. The difference will be the revenue of the bank to meet expenses and distribute profits to shareholders. Conventional banks are not permitted to invest deposits at all, but can only lend it to investors.
Islamic bank doesn’t receive deposits with fixed interest rates. Rather, the deposits are in the form of equity from depositors to be invested, along with shareholders’ equity in one common pool. On the asset side, conventional banks have, since inception, had only one product, that’s loan with interest.
Sharia has unlimited products to suit every customer and every project under any circumstances. For instance, if you need to buy an aircraft or vessel or plant, you come to me for financing. If you want to buy an aircraft for $300 million, I will buy and transfer it you after 10 years after collecting installments with a profit margin. It can be fixed or floating like any benchmark or any index.
This is called Murabahah, to buy with agreed margin. Then there is Mudarba for financing project, where the businessman has full freedom to invest; the bank has no right to interfere in the project. According to Sharia, if something happens beyond your control, a force majeure event like war than I lose the capital 100% and you will lose your share in this limited liability venture. Your share is the expertise that you bring in.
Conventional banks sell loans through securitisation to raise resources. Can Islamic banks do something similar?
Sharia does not allow trading of loans. But if you have a combine, which has up to 30% tangible assets and 70% receivables, you can securitise the portfolio, where you take the assets from the balance sheet and sell them. This I have done it for Islamic banks in Abu Dabhi, Sharjah, and the UAE which have issued Sukuk bonds for several billion.
There is a real estate company called Amlak, which has securitised its portfolio in this manner. I am working on sukuk bonds for Morgan Stanley for $5 billion, but we are fighting with them. They want to make it Sharia-compliant, but they want bondholders to be pari passu with creditors of the company. But I have said no. This kind of bonds cannot be Sharia-compliant. But Morgan Stanley says that according to the American law, they have to make bondholders similar.
This is also what we have been telling central banks for 25 years on capital adequacy. Central banks treat Islamic banks on par with conventional banks and ask for 8% capital. I have been saying this is not correct because depositors of Islamic banks are equity investors and if you treat their money as equity, capital adequacy of Islamic banks will be 90%.
Today, when people want investment avenues to multiply their wealth, can Islamic products generate same returns?
The Sharjah government had asked me to convert Sharjah’s national bank into Islamic bank in 2002. Before they were paying interest of 1.2 to depositors. On June 30, we closed the conventional bank books. The share of the bank was quoting at three dirhams. Overnight from July 1, the share price went up to seven dirhams. After six months, the bank distributed profit of 3.5% for six months.
A lot of money is going to non-dollar assets, which is reflected in euro’s rise, do you think this shift is permanent or temporary?
I think this will continue, they were waiting for this. They are re-evaluating their currency. Kuwait has already gone from the dollar.
Would you advise others to drop the dollar peg and shift to euro?
For the present circumstances I would. Why? because the dollar is coming down and why should I lose. Business is business. Everyone has a right to protect themselves. If after 25 years, things come back to where they were, we can move back. One should mitigate his risks. For any risk, it is compulsory that you mitigate for yourself. This is not religion. Religion does not prescribe what currency one should select. This means that fortunately, every country should look at its own interest.
Given the rise in revenues of the Arab world, one would have expected Islamic banking to grow faster.
Not everyone invests in Islamic banks. But every week and every day, conventional banks are converting into Islamic banks. This is happening gradually. I can guarantee that all Arabs will move and prefer only Islamic banks. This is my personal belief as I have my own analysis and research on this. When we built the first Islamic bank in 1975, it was easier to say Islamic whisky than Islamic bank. I myself could not imagine that the Islamic banking industry would grow that fast.
Are there bankruptcy laws in Islamic banking for recovery from defaulters?
We have in Egypt a proverb, “giving the keys of the food store to the cat”. Conventional banking does that. In Islamic banking, I am not giving money to you to buy equity in your name or your wife’s name. Instead, I will buy an aircraft and lease it to you for 10 years. In return, I will get fixed rental and I will also get variables as a percentage of your profits. If you default, the lease is terminated and the asset is leased to someone else. Under Islamic financing, default means to commit financial suicide.
All this to be taken with a grain of piquant salt!!!