ISLAMIC FINANCE COULD HAVE SAVED THE WORLD

(Article was extracted from International Financial Law Review - author : Simon Crompton)

Lawyers in Islamic finance firmly believe that if company financing had been done entirely along shariah lines, this financial crisis would not have happened.

A session at the Middle East Financial Law Congress in Doha, Qatar on 17 - 18 February 2009 saw passionate disagreement on the subject.

Panelists from western banks argued that there was nothing wrong with the due diligence that went into local companies when they issued conventional debt. Islamic debt would not have fared any better.

The argument for shariah was put by one speaker particularly strongly, who said: "Islamic finance has been mixed and matched with conventional debt in companies’ financing, with the result that none of them are really Islamic. Even the Islamic parts of their debt have been watered down and adapted to conventional structures."

When asked whether he really thought that the world would not have had a financial collapse under Islamic financial law, he replied: "Yes, absolutely. Islamic debt is about investment; conventional debt is about trading money for its own sake. Islamic law would have prevented the kind of leverage ratios we saw in Dubai."

Dubai real estate company Nakheel became the focus for the discussion, as it had both Islamic and conventional funding and has seen its spreads widen dramatically as investors refuse to buy the debt for fear of it going bust.

A speaker from a western bank disagreed with the Islamic lawyers. "Let’s get this straight," he said. "Everyone that invested in Nakheel knew they were exposed to big real estate risk. They knew the projects that Nakheel had lined up. They knew how it was plowing the profits of one project into another; it was all over the papers.

"There was big real estate risk in a market obviously driven by expectations. But they did their due diligence and took the gamble. They weren’t stupid." He carried on the point out that given the growth predictions for Nakheel at the time it issued most of its debt, the leverage ratio was no higher than any other real estate company anywhere else in the world.

No one disagreed that Islamic finance has become disconnected from its foundations. Rather than being involved from the very start of a deal, it is sometimes brought in at the last minute for a rubber stamp. One straightforward Islamic structure is not picked at the beginning – instead the company’s needs are shoehorned into a tweaked or adjusted structure.

One speaker referred to it as Islamic beer. "You go to the imam and get ask him whether it is compliant with shariah to tie a rope to a door handle. Then you ask him whether it is compliant to lie on the floor. Then to tie a beer bottle to the rope. When someone walks in, the bottle tips over and you happen to be lying there with your mouth open. That is Islamic beer."

He continued: "We must give Islamic finance a chance. We must keep it pure and start over again with companies, making sure all financing is compliant. The rest of the world has a lot to learn from shariah, but only if it remains consistent."

A speaker from the floor agreed. He argued that local investors in the Gulf had just become capitalistic, picking whichever type of financing happened to give greater returns. There was no concern over shariah compliance.

With the number of companies in trouble in the Gulf, particularly in Dubai, this could be the perfect opportunity for Islamic lawyers to get their way and restructure corporate debt along entirely Islamic lines.

My comment :

Islamic finance despite having its origins 1,400 years ago, was only commercially practiced in the last 3-4 decades ago. Yes, we must give it a chance - to purify and start again, while ensuring its compliance to shariah rom the very beginning and safeguarding it against manipulation and intervention from its conventional counterparts. This time around, there should be control and standardization - after all, Islam is one religion and there should only be one shariah guide (that should be obtained by consensus by all jurists) for the interest of the ummah.