SHOCKING (BUT TRUE) STATISTICS TO THINK ABOUT.....

I was reading an article from The Forbes.com titled The Enforcers, and was shocked and bewildered to learn of the following statistics :

· Currently, there are only 20 men that act as the gatekeepers of the Islamic finance realm

· There are no more than 260 scholars worldwide that have the necessary knowledge in Islamic finance

Islam has overtaken Roman Catholicism to become the world's largest single religious denomination, the figures for 2006 showed that Catholics accounted for 17.4 % of the world population while Muslims accounted for 19.2 % (figures obtained from United Nations). The Vatican puts the number of Catholics in the world at 1.13 billion people, while the figure for Muslims is estimated at around 1.3 billion.

Look at the numbers – what it means is that there is 1 Islamic finance scholar for every 5 million population worldwide. What happened? What went wrong?

Islamic banking and finance is a very lucrative business and yet only 260 scholars are well versed in the field. Malaysia has done a very good job by coming up with INCEIF (International Centre for Education of Islamic Finance) – another brainchild of Bank Negara Malaysia They are producing CIFP graduates and their Master and Doctorate degrees in Islamic Finance are still in the infancy stage but they are making progress. What about the other Islamic nations?

Islam is the religion which was given to Adam, the first man and the first prophet of Allah, and it was the religion of all the prophets sent by Allah to mankind. The name of God's religion lslam was not decided upon by later generations of man. It was chosen by Allah Himself and clearly mentioned in His final revelation to man. In the final book of divine revelation, the Qur'aan, Allah states the following:

"This day have I perfected your religion for you, completed My favour upon you, and have chosen for you Islam as your religion". (Surah Al-Maa'idah 5:3)

"If anyone desires a religion other than Islam (submission to Allah (God) never will It be accepted of Him" (Surah Aal'imraan 3:85)

"Abraham was not a Jew nor Christian; but an upright Muslim." (Surah Aal'imraan 3:67)

Think about it – think really, really hard. If the Muslims don’t help ourselves, who else will do it for us?

ISLAMIC BANKS COULD ALSO SUFFER AS CRISIS EVOLVES

Political and business leaders at the World Islamic Economic Forum in Jakarta this week have been praising the prudence of Islamic financial institutions. They say Islamic banks have not been hit by the global financial crisis as hard as their Western counterparts because they refrained from investing in toxic assets that were deemed "un-Islamic."

Indonesian President Susilo Bambang Yudhoyono says the financial crisis has proved the strength of Islamic methods of banking and finance. He says Western bankers have a lot to learn from Islamic finance, and he is calling on Islamic banks to take more of a leadership role in the global economy.

The focus on the Quran's prohibitions arguably make it difficult for Islamic financial institutions to work in the same way as a conventional Western bank. For example, Islamic law prohibits investment in businesses that sell alcohol or pork, or that are involved in gambling. That means an Islamic banker must ensure clients that their deposits are not being reinvested in a firm that does business deemed as "un-Islamic."

Another basic rule of Islamic finance is a prohibition against what the Quran calls "riba" -- a word interpreted as the payment and collection of interest on loans or savings deposits. Under Islamic law, transactions must be backed by real assets -- tangible, physical assets such as gold, land, or equipment.

Abdul Gafoor, a Netherlands-based author on Islamic finance, opines that these Shariah-compliant rules prohibited Islamic bankers from dealing in second-hand interest-bearing mortgages -- the financial assets at the root of the U.S. subprime property market crisis which pushed the world into economic crisis. But it didn't prohibit them from investing directly in real estate, which has been losing value in many countries since last year. "[Islamic banks] go mostly for real estate and that kind of thing. And when real estate prices go down, [their portfolios] also go down," Gafoor says. "It depends on whether they invested directly in real estate or through securities. Here, you cannot make a general claim [about the strength of Islamic banking]. It depends on each individual bank -- how they behaved."

In fact, there isn't a fixed set of rules that governs Islamic banking. Like Shari'a law, it's subject to interpretation. Some conservative Islamic scholars have concluded that investing in stock markets is a form of gambling -- and is therefore prohibited by the Quran. But others interpret the Quran to mean that they shouldn't get involved in day trading -- the practice of buying shares one day with the intention of selling that equity soon after for a profit. Those Islamic bankers have invested in equity.

"The thing about Islamic banking, at the end of the day, in some respects, it is going back to banking the way it used to be done," Neil Miller, a prominent Islamic finance expert and partner at the Norton Rose international law firm in London, says. "So it is very much based on relationships, on analyzing risks, and understanding the risk and the relationships in the specific projects or company that you are looking to finance and getting comfortable with that. People need to go back to fundamentals."

But Miller also warns that being an Islamic bank is not enough to guarantee immunity in the long run from the financial crisis. He opines that some Islamic banks still could be hurt as the impact of the crisis spreads across the globe -- sending land and equity prices tumbling. "Islamic banks have certainly avoided the worst excesses of the toxic-asset problem because they were certain asset classes that they could never have invested in. So in that regard, they have been insulated," Miller says. "As the crisis has developed and turned into a credit crunch, I think you have to start looking at Islamic banks in different countries and different parts of the world."

Miller says that in some places, such Islamic institutions are better insulated against adverse affects from the current troubles. "It really depends on exactly what their current asset component is," Miller says. "Many of the Islamic banks hold high levels of real estate and high levels of private equity. So although they have not been badly hit with bad debt through lending, which they can't do, they have been hit by asset valuations -- as some of their portfolios are perhaps not as robust as they had been in previous years."

Duncan MacKenzie, director of economics at International Financial Services in London, says there are other aspects of Islamic finance that have helped Islamic banks fare better as the economic crisis evolved into a credit crunch -- the drying up of credit that has made it more difficult for anyone, including banks, to obtain short term loans.

Experts point out that Islamic banks tend to lean more heavily on deposits, since they can't fund themselves on the interbank market that sustains conventional banks.

Senior analyst Firas Abi Ali, from the Islamic Financial Information Service, agrees that Islamic banks generally are better placed to handle the credit crunch. He also says the turbulence and uncertainty in the conventional banking system is now prompting some non-Muslims to consider the option of Islamic banking. Former Soviet republics in Central Asia also have been taking steps to create a legal framework for Islamic financial institutions.

In February, Kazakhstan's Nursultan Nazarbaev signed amendments into law that are expected to help establish Islamic banking in the country. Kyrgyzstan's parliament last month also approved amendments on the introduction of Islamic financial principles into the country's banking system.

But critics say there are other issues that should make potential investors do their research before investing money in an Islamic bank.

Some say that Islamic finance has become so intertwined with the global financial system that problems in the future are unavoidable -- especially as prices tumble for assets like real estate. Gafoor concludes that there is no real data available to check the claim that Islamic banks are largely protected from the global financial crisis.

The balance sheets being made available to the public by some major Islamic banks are unaudited, which raises questions about the real extent of their exposure to the crisis -- even if their investments are deemed Shariah-compliant.

NEW DOCUMENTATION FOR SHARIAH COMPLIANT DERIVATES IN THE GCC

The International Swaps and Derivatives Association (ISDA) and the International Islamic Financial Market (IIFM) signed a Memorandum of Understanding as a basis for developing a master agreement for documenting privately negotiated Shariah compliant derivatives transactions

ISDA and IIFM aim for the agreement to be accepted by Shariah advisors and to become a standard document used for Shariah compliant privately negotiated derivatives in Gulf Cooperative Council member states and beyond. As part of this understanding, ISDA and IIFM have formed a joint working group open to members of both organizations, which will meet every four to six weeks. IIFM's Shariah Supervisory Committee will be charged with evaluating the Shariah compliance of the master agreement.


Unlike their conventional counterparts, Islamic financial institutions (IFIs) have at their disposal a limited range of 'allowed' investment instruments, particularly hedging instruments, a key use of derivatives. This constraint has hindered the development of an efficient and active Islamic financial market. The limited risk management options available to IFIs makes them less competitive and, most importantly, affects their profitability.

DERIVATIVES - ARE THEY SHARIAH COMPLIANT?

The ever-increasing application and innovation of the methodologies associated with derivative instruments have revolutionized the global financial industry over the past two decades. Simultaneously, document standardization in transacting derivative based transactions has reached the point of uniform application in conventional markets and products, thus removing an immense amount of uncertainty and risk previously associated with these types of transactions. In this day and age, it can safely be said that derivatives have become de rigueur in the international financial arena.

Yet the doubt associated with the permissibility of derivative instruments under Islamic finance generally remains. Derivative instruments also still remain an enigma to many, mostly due to the unfamiliarity with their basic mechanics and the highly technical language in terms of which explanations are often attempted. This is a hindrance in trying to get across a proper understanding and appreciation of the matters at hand.

What is a derivative?

A derivative is any financial instrument, whose payoffs depend in a direct way on the value of an underlying variable at a time in the future. This underlying variable is also called the underlying asset, or just the underlying. Usually, derivatives are contracts to buy or sell the underlying asset at a future time, with the price, quantity and other specifications defined today. Contracts can be binding for both parties or for one party only, with the other party reserving the option to exercise or not. If the underlying asset is not traded, for example if the underlying is an index, some kind of cash settlement has to take place. Derivatives are traded in organized exchanges as well as over the counter [OTC derivatives]. Examples of derivatives include forwards, futures, options, caps, floors, swaps, collars, etc

Here's one example: A miller and grain farmer conclude an agreement today for the delivery of a specified quantity and quality of grain on an agreed future date, let's say six months ahead. The important element of this transaction is that the price to be paid for the grain is fixed on today's date. The primary reason for the immediate price determination is to remove the uncertainty for both parties of what the actual spot price for grain would be six months from now. Either party may stand to lose or gain a great deal from this uncertainty if the price movement is against him or in his favour but it does not bode well for one's financial planning. Since the parties face risk in the opposite directions of price movement, it will make financial sense for them to meet and agree on a price, which will suit both of them, to eliminate the price movement risk in the commodity (called "hedging the price"). The grain farmer then knows what input costs he can safely invest in his harvest to still turn a profit; the miller, on the other hand, knows at what price he can sell flour into a competitive market six months into the future and can plan and market his product accordingly.

What has been explained above is a basic forward contract. The derivative element present in this simple set of facts is that, from the first day subsequent to this contract being concluded, the contract itself gains a value derived from the underlying price movements and future expectations of the spot price of grain on the agreed delivery date.

How does this work? The day the parties agreed the price of grain six months into the future it wasn't a matter of mere guesswork. Both parties probably considered a plethora of elements and contingencies in what they considered to be relevant in determining a fair price of grain six months into the future (e.g. market conditions, micro and macro economic indicators, price volatility, weather patterns, quality considerations and many more). Every day thereafter, the input data on these elements and contingencies will vary constantly to the extent that had the parties known about the changed conditions at the time they contracted on the price of the grain, they would have come to a different conclusion. For example, it does not rain in many farming areas during the early planting season and a bad harvest is forecasted, thus increasing demand and the expected future price of grain with it. The farmer who agreed on a price with normal weather patterns and rain forecasted now realizes that he is selling his bumper crop probably cheaper than he would have, had he known about the coming drought in certain areas.

This process of constantly monitoring the variations in the contingencies pertaining to the forecasted spot price of grain on the delivery date of the grain in our example (called "marking to market") can give the contracting parties an indication whether the contract is in their favor ("in-the-money") or not in their favour ("out-of-the-money"). If drought prevailed, as in our example above, the grain farmer would most probably have found his contract's mark-to-market value to be out-of-the-money. However, receiving a price lower than the expected market price was a risk he was willing to take at the outset, to hedge his position. Things might just as well have turned out the other way. It is this mark-to-market value (i.e. derived from translating present market conditions into an expected future price of the commodity on a future date) that represents the derivative value of the contract in question. It should be clear by now that this a value independent of the underlying commodity but at the same time it exists only because of changes in the variables determining the future price of the underlying commodity.

The objections of the scholars of the Shariah

From an outsider's perspective (i.e. not schooled in the Shariah and only having access to English papers written on the subject), the prevailing impression one gets is the inconsistency in arguments and opinion from the learned scholars regarding these instruments. Here are a few examples:

Futures

Mufti Taqi Usmani of the Fiqh Academy of Jeddah in an article answering a set of posed questions on the topic (New Horison, June 1996, pp 10-11), argues that futures contracts are invalid because:

"Firstly, it is a well recognized principle of the Shariah that purchase or sale cannot be effected for a future date. Therefore, all forward and futures contracts are invalid in Shariah; secondly, because in most futures transactions delivery of the commodities or their possession is not intended. In most cases the transactions end up with the settlement of the difference in price only, which is not allowed in the Shariah."

Conversely Fahim Khan (Islamic Futures and their Markets, Research Paper No.32, Islamic Research and Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia, 1996, p.12) states that:

"we should realize that even in the modern degenerated form of futures trading, some of the underlying basics concepts as well as some of the conditions for such trading are exactly the same as were laid down by the Prophet (PBUH) for forward trading. For example, there are clear sayings of the Prophet (PBUH) that he who makes a Salaf (forward trade) should do that for a specific quantity, specific weight and for a specified period of time. This is something that contemporary futures trading pays particular attention to." (Fahim Khan does go on, however, to criticize the modern futures contract for its exploitation of small farmers.)

Options

A number of scholars have found option contracts objectionable (Ahmad Muhayyuddin Hasan, Abu Sayman and Taqi Usmani to mention a few notable ones). However, in perhaps the most comprehensive study of the subject thus far, Hashim Kamali (Islamic Commercial Law: An Analysis of Options, 1995), concluded that:

"there is nothing inherently objectionable in granting an option, exercising it over a period of time or charging a fee for it, and that options trading like other varieties of trade is permissible mubah and as such it is simply and extension of the basic liberty that the Quran has granted."

It appears that most scholars agree that, in principle, futures and option contracts may be compatible with Shariah principles. What makes them worth objecting to, is the manner in which they have found application in the marketplace in certain instances, such as with speculation and exploitation of certain counterparties. The objections of the learned scholars differ in accordance with their individual interpretation of the Shariah and their understanding of the instruments under discussion.

As this deprives businesses from an array of benefits and advantages that, if understood and appreciated properly, appear to be halal in many instances, a concerted effort may be necessary to address the social disadvantages it is placing on such businesses in today's global economy.

(Note : Some parts of this post is extracted from Iqtisad al-Islami)