BLOG OF KNOWLEDGE

Quoted from Islamic Finance News

What’s obvious now is that capitalism is no longer governed by democracy. Rather, it exploits democracy. Incoming US president Barrack Obama says one of his priorities is making sure the plumbing works, meaning stabilizing the financial system. In the face of what has been said to be the darkest economic outlook for the US since the Great Depression, voters said the economy was overwhelmingly the most important issue in the election, and this was clearly an advantage to Obama. This is a crisis of capitalism and the reality is that when capitalism fails it has to be bailed out by the state. It is capitalist when it goes up and socialist when it comes down.

Sovereign funds were considered dirty money just a couple of months ago, but they are now being eagerly sought as a savior. Barclays is banking on them to get out of the quicksand. But these sovereign funds are being extra cautious, especially after they were derided when they attempted to move in a few months ago. It appears that US officials now realize what is needed to lure the sovereign funds from the Gulf: Islamic finance.

Hence the statement by the US Treasury Department that it is looking into the important features of Islamic banking that could help in tackling the current financial crisis. Deputy secretary Robert Kimmitt said: “Islamic banking is an important issue being discussed right now by experts both in the public and private sectors.” And this week, the department organized, together with Harvard, a forum on “Islamic Finance 101” for the public and private sectors, as well as Congress personnel.

The consequence of the crisis could be that as Gulf sovereign funds become more important, Islamic banking could play an increasing role in global financing, its expansion relatively unaffected by the financial crisis. This, of course, does not mean that Shariah compliant finance can suddenly present itself as a comprehensive alternative to capitalism. Instead, the current shift in perspective in Washington ought to be viewed as an opportunity for Islamic financial institutions to have joint investments with governments and other financing sources, including multilaterals, in funding the public works program that Obama has in mind to help generate economic activity in the US.

The point is that Obama is inheriting, as one report put it, an economic estate that has been pillaged by his predecessor. US public sector debt is well over US$1 trillion, equivalent to around 80% of US economic output. The nonpartisan Committee for a Responsible Budget estimates all the government economic and rescue initiatives, starting with the US$168 billion in stimulus checks issued earlier this year, total even more — US$2.6 trillion.

Obama faces the nation’s worst financial crisis in 70 years. The US presidency is powerful, but the economy is in such a mess that no one leader will be able to change things dramatically any time soon. However, he has had an electrifying effect not only on Americans but also the rest of the world. Banking on this impact, and driven by the pressing situation, will he be bold enough to accept the use of Islamic finance to help salvage the US economy?

Best Regard
ZULKIFLI HASAN

Tour De Desert, Dubai

Quoted from http://www.bnm.gov.my/index.php?ch=8&pg=14&ac=1701

Despite the increased volatility in the global financial markets, Malaysian financial institutions remain resilient . Several years of reforms, institutional development and capacity building, continuous efforts to enhance corporate governance and risk management standards and practices have significantly strengthened the banking system. The level of non-performing loans has also improved to 2.5%. In addition, the standardised approach of the Basel II capital adequacy framework was implemented effective January 2008. There is also ample liquidity in Malaysia ’s financial system to facilitate the orderly functioning of economic and financing activities. As at end-August 2008, net interbank placements with Bank Negara Malaysia by the banking system amounted to RM198.5 billion.

The banking and insurance industries are therefore operating with adequate capital and liquidity buffers that have been accumulated over several years. Malaysia ’s financial institutions also have negligible exposure to both sub-prime related securities and to the affected financial institutions of other countries, with more than 90% of total assets of the banks and insurance companies in ringgit denominated assets. In addition, all foreign financial institutions in Malaysia are locally incorporated and have a high level of capital that is committed to support their domestic operations. As at end-August 2008, the risk-weighted capital ratio for these foreign financial institutions was at 12.6%.

The banking system’s leverage position remains manageable and continues to record strong risk-weighted capital ratio of 13.2% as at end-August 2008, exceeding the minimum 8% capital requirement by RM42.3 billion. The insurance industry also recorded high solvency surplus of RM16.5 billion. The strong capital position combined with ample liquidity provides adequate capacity to the banking system to continue to perform its intermediation function and to meet its financial commitments as well as the demands for financing and financial services in supporting domestic economic activities. The aggregate domestic household sector continues to exhibit stable level of indebtedness and wealth where total financial assets are more than two times of total debts. Overall, corporations also continue to exhibit sound financial position and manageable leverage position with debt-to-equity ratio of 48% in the first half of 2008.

The Central Bank has a fully developed supervisory and surveillance system. It continuously monitors all financial institutions under its purview and will take appropriate action to safeguard the soundness of the financial system. The Bank stands ready to provide liquidity, whenever necessary, to financial institutions under its purview. The Bank is also closely engaging with the other monetary authorities in the region to monitor and respond with co-ordinated measures in managing the current challenging environment.

Best Regard
ZULKIFLI HASAN
DURHAM UNIVERSITY

Times Square, New York.

A policy success amid the disaster. Quoted from the Financial Times By Martin Wolf

Will the UK government’s scheme for rescuing the financial system work? The answer to this question depends on the meaning of the word “work”. I can identify three issues: will the scheme rescue banking? Will it cost too much? Will it prevent a recession?

The eight eligible UK banks are to raise £48bn in new capital, of which £12bn will be in preference shares paying a dividend of 12 per cent. The government is making capital investments in Royal Bank of Scotland and, upon merger, HBOS and Lloyds TSB, totalling £37bn. The guarantee on new debt for maturities of up to three years will carry a fee of 50 basis points, plus the median credit default swap rates, over the year to October 7 2008. So charges will end up at 110-150 basis points.

Recapitalised banks must maintain loans to the non-financial sector at 2007 levels, help people struggling with mortgages and accept a governmental say on compensation, board membership and dividends.

Will this scheme rescue the system? Overall, the answer has to be “yes”, though it may not promote much new lending. Evidently, the government must also trade protecting the interests of taxpayers against promoting lending. Knowing where to draw the line is hard. But the scheme looks a bit harsh.

First, it is tougher than that of the US, where preference shares pay only 5 per cent, guarantees are free for the first 30 days and subsequently charged at a flat 75 basis points and there is no requirement to halt dividends. At the same time, accepting government capital is – rightly – voluntary in the UK. Nevertheless, the assisted UK banks will be at a competitive disadvantage and their spreads on lending larger.Second, the scheme will create an incentive for assisted banks to pay the government back quickly. This also makes it more likely that banks will try to limit the size of their balance sheets, to reduce the capital they need. This militates against the new lending the government wants. Third, while restrictions on pay and dividends are understandable, the government has an interest in the quality of banks’ staff and their ability to raise capital privately.

Finally, the government needs an exit strategy. Private banking has indeed disgraced itself. But a politicised banking system, run by bureaucrats with an interest in a quiet life, would be a horror. Crisis-prone private banking is bad; state monopoly banking is still worse. Will the scheme cost too much? On the face of it, the answer is “no”. In fact, the current income of the government should rise, with fees on its guarantees exceeding the interest cost of additional debt. Its gain should be some 0.2 per cent of GDP. Meanwhile, the direct cost of the recapitalisation should add less than 3 per cent of GDP to public debt. If the scheme limits the recession, as it should, it will be cheap at the price.

The fiscal risks the government is taking on, as financial-sector insurer of last resort, are substantial. The guarantees on new lending might end up at £250bn (18 per cent of GDP), or even more. If this money were to be lost, UK net public debt would still be below 60 per cent of GDP (if one ignores the effect on the public finances of the recession itself). But the UK might end up relatively highly indebted, though that would depend on what happened with the similar schemes now emerging in other high-income countries. In any case, the idea that the UK government will lose a great deal on these guarantees seems almost inconceivable. The programme looks quite affordable.

The fiscal position will depend far more on the severity of the recession. The International Monetary Fund forecasts the economy will stagnate next year, after 1 per cent growth in 2008. Tight credit, the collapse of house prices and global weakness make a far worse outcome likely. Public sector net borrowing could hit £70bn this year and £100bn (7 per cent of GDP) in the next two. This would raise public indebtedness swiftly. But a collapsed financial system would have made the outcome vastly worse. Opposing the scheme on cost grounds would be a superb example of being penny wise and pound foolish.

This recession cannot now be prevented. But its impact can be minimised. Saving the financial system is part of the answer. But, with inflation threats dwindling and recession looming, the case for substantially lower interest rates is overwhelming. Another half a percentage point cut is the least I would expect at the next meeting of the monetary policy committee. I would argue for more. The UK also needs a renewed fiscal framework if fiscal credibility and sterling’s acceptability are to be preserved. Without these, all will be lost.

The costs of decisive action were, in short, vastly less than those of inaction. The fiscal burden should prove quite manageable, provided the UK remains a country with credible policies, where people want to invest. Much will depend on the exit strategy from these crisis measures. Much will depend, too, on how far monetary and fiscal policymakers continue to respond sensibly to events. These are, in short, extraordinary times, in which governments must take big gambles. But they seem to have made the right bets this time.

Best Regard
ZULKIFLI HASAN
UNIVERSITY OF DURHAM

Quoted from the Financial Times

US stock prices suffered their worst weekly loss in history on Friday, prompting a pledge from global policy makers to implement an aggressive but broad-brush plan to combat the financial crisis.Finance ministers and central bankers meeting in Washington said they would use “all available tools” to prevent the failure of any systemically important banks after a day of virtually indiscriminate selling in Asia and Europe and unprecedented volatility in the US. The Dow Jones Industrial Average fell as low as 7,882.51 and rose as high as 8,901.28 before closing down 1.5 per cent at 8,451.19. For the week, its 18.2 per cent fall was the worst ever.

Policymakers from the Group of Seven nations said they would take “urgent and exceptional action” to stem the financial crisis, though stopped short of adopting a specific and uniform set of policies that would individually bind all its member countries. The communiqué also did not include a wholesale adoption of a common policy such as the UK plan to guarantee interbank lending. “Different countries have different financial systems,” Hank Paulson, US Treasury secretary, said after the meeting.

The G7 said its tools to prevent failure of “systemically important financial institutions” would be tailored for each country, including recapitalising banks, ensuring strong deposit insurance to protect savers and restarting frozen credit and mortgage markets. Mr Paulson firmed up the US intention to invest directly in troubled financial institutions, announcing a “standardised programme” of purchases of non-voting stock that would be designed to encourage private capital also to come forward.

The G7 communiqué followed a stomach-churning day on Wall Street that saw measures of volatility reach unprecedented levels. The main volatility gauge, the Chicago Board Options Exch-ange’s Vix index, rose above 75, having never even breached 50 before this week. At its low point yesterday, the Dow was down as much as 23.64 per cent for the week. During the week of the Great Crash of 1929, the Dow lost 23.62 per cent at its worst point before ending the week down 9.2 per cent. Losses in other major markets were more severe than in the US. The UK’s FTSE 100 lost 21 per cent, the FTSE Eurofirst 300 22 per cent and Japan’s Nikkei 225 24.3 per cent.

“The events we’ve seen this week represent a once-in-a-generation increase in risk aversion and total lack of faith in the financial system surviving in its current state,” said Graham Secker, equity strategist at Morgan Stanley in London. Confidence was shaken when investors bid 8.625 cents on the dollar for credit derivatives linked to the debt of the Lehman Brothers, which sought bankruptcy protection last month. Trading was halted in several stock markets, including Russia.

Best Regard

ZULKIFLI HASAN

With the Mayor of the City of Durham, Mr. Granville Holland

Quoted from the Financial Times By Ralph Atkins in Frankfurt

Germany, the UK and Spain all face recessions this year, the European Commission forecast on Wednesday, dashing finally any remaining hopes that Europe would avoid a sharp economic downturn. France and Italy would fare little better, it said.The steep downward revisions in growth forecasts by the European Union’s executive arm showed it had accepted that tumbling business and consumer confidence was hitting economic activity – even though the European economy had been “generally sound” prior to the credit crisis . Joaquin Almunia, economics and monetary affairs commissioner, described the environment as “difficult and uncertain”. As well as financial turmoil and a near doubling of oil prices over the past year, significant housing market corrections in some countries were taking their toll, he said.

The Commission expected the 27-country European Union economy to expand by 1.4 per cent this year, and the 15-country eurozone by 1.3 per cent, below the 2 per cent and 1.7 per cent it expected in its last forecasts, released in April. Germany’s economy is projected to contract by 0.2 per cent in the three months to September, taking it into technical recession – two quarters of contraction – after a fall of 0.5 per cent in the second quarter. The UK and Spain were expected to contract in both the third and fourth quarters.But France and Italy, which both contracted in the second quarter, were expected to see flat growth in the current quarter.

Jean-Claude Trichet, European Central Bank president, struck a more upbeat tone, telling the European Parliament that the “current episode of weak economic growth is expected to be followed by a gradual recovery”.But he reinforced expectations that ECB interest rates would remain firmly on hold by warning of a pick-up in eurozone unit labour costs that “has to be countered”. The ECB, which increased its main rate to 4.25 per cent in July, is particularly worried about wage indexation, which it fears increases the risk of current high inflation rates becoming entrenched. The Commission forecast eurozone inflation would average 3.6 per cent this year – above the ECB target of an annual rate “below but close” to 2 per cent.

Mr Trichet also complained about the “cartel” among oil producers. “Stabilisation of prices might be a good thing but stabilisation at a very abnormally high level is not a good thing.”The ECB president warned financial markets would not return to conditions that had previously been considered normal, with three-month interest rates likely to stay elevated. The economic outlook would also depend increasingly on the financial system’s fate. “The financial market correction could be gradually changing its nature and scope and evolve into a more traditional credit-cycle downturn.”

In similar comments – echoing the fears of US policymakers – the Commission said that, “a deceleration in real economic activity could amplify problems in the financial sector by decreasing the capacity of companies and households to service their debt-repayment obligations.” That could trigger a further tightening in bank lending standards.

ZULKIFLI HASAN
UNIVERSITY OF DURHAM

As a panelist together with Associate Professor Dr. Asyraf Hashim for the Capetonian Radio Station’s Talkshow, Cape Town, South Africa.