Sharia Banking
Category: Economy & Business... Thinking Allowed...
Posted Tuesday, June 19, 2007 at 06:36 AM [GMT-6]

I bought a copy of The Economist last week, enticed by the cover story, Apple and the art of innovation. Imagine my surprise to find that the article was a one page essay which, while mildly interesting – especially the contention that much of Apple's success is due to its willingness to bring in ideas from outside the company, and then build on them – was hardly worth the $5.99 cover price. (To be fair, there was another three-page profile of Steve Jobs elsewhere in the magazine, but it didn't plow any new ground.)

Fortunately, The Economist is chock-full of interesting tidbits that almost justify the steep single-issue price, especially if you can get a post or two out of it. One that caught my eye was a profile of Hussein Hamid Hassan, a resident of Dubai who has the highly specialized profession of issuing financial fatwas, which are essentially Islamic seals-of-approval certifying that the instruments or arrangements in question are sharia compliant.

The sharia financial system prohibits, among others things, the charging or paying of interest (although, apparently, returns from equity investments are permitted; you're just supposed to not make money from money. This Wikipedia article clarifies the concept somewhat.). Financial instruments that skirt this prohibition are called sukuk, the equivalent of an Islamic bond. I don't purport to understand the intricacies of such an instrument, but it appears that the main distinction between sukuk and traditional bonds is that the former is more closely tied to a specific tangible asset, a technicality that presumably qualifies it for Mr. Hassan's fatwa.

A lot of this seems to be financial sleight-of-hand, semantics, or playing loose with the facts, but the real significance is that the Islamic financial system is rapidly gaining strength. Mr. Hassan is quoted in the article as predicting that "...in a few years all the Gulf states will move to an Islamic financial system." And, in fact, last year East Cameron Partners, based in Houston, issued a $166 million sukuk, making it the first American company – and an oil company, at that – to do so. This PDF describes in detail that instrument, which was used to finance the acquisition of overriding royalty interests in some offshore GOM production. It's interesting to note that the transaction was scrutinized by not one but two shariah advisers, one in the US and one in Bahrain. The final instrument was actually a "Sukuk al-Musharaka", which is a joint venture arrangement.

It remains to be seen whether sharia-compliant banking is another sign of an Islamic conquest of the world. The issuance of significant numbers of sukuks and other shariah-compliant instruments by non-Islamic entities seems to be a double-edged sword, and raises some interesting questions, such as whether US companies should engage in business practices that are explicitly Islamic in nature.

In the attitude of "if you can't beat 'em, join 'em," some might argue that one might as well make the best of things, and make money in the process. In addition, there's an argument to be made that investment decisions surrounding sharia-compliant financial instruments are not substantially different than those made in keeping with other ethical or moral guidelines (e.g. the decision to buy stock in cosmetic companies that don't do product testing on animals).

There are some equally interesting peripheral issues, as well. If sharia banking grows as predicted, business schools will be forced to adjust their curricula accordingly. Tufts University's Fletcher School of International Affairs has a course entitled "Islamic Banking and Finance," which is an overview of the subject; it has similar courses for finance in China, Latin America, and East Asia. However, at some point the business school curricula will have to move from the overview into the practical, training accountants, economists, bankers, financiers, and so on in the hands-on issues related to such things. That transition may not be smooth. It took decades of corporate abuse to convince MBA programs of the need for beefed-up ethics training; what will it take to make them create a curriculum that is explicitly rooted in a specific religion?

And, finally, the new instruments could present challenges to analysts and potential investors who are trying to assess the financial status of companies who have issued (or invested in) them. Should a sukuk be treated as traditional debt in computing liquidity or leverage ratios? How does one assess the risk associated with such instruments? Clearly, these are issues that require new thinking for professional training and investor education.

An excellent overview of this topic is found here, Islamic Finance - The New Mainstream Alternative, via InvestorsOffshore.com.

Technorati tags: Islamic Finance | Islamic Banking | sukuk