Islamic finance resists equity shift, may stunt growth

ANALYSIS – Islamic finance resists equity shift, may stunt growth

By Liau Y-Sing Available at: http://in.reuters.com/article/businessNews/idINIndia-48026020100427?sp=true

KUALA LUMPUR (Reuters) – When Kuwait Finance House Malaysia helped develop a $1.3 billion real estate project in the country in 2005 as a partner in the deal, Islamic equity property ventures were a rarity. Five years on, the bank is embarking on its fourth building project using a similar equity concept but few others in the industry want to follow the same path, reflecting Islamic finance’s slow and difficult shift away from debt instruments.

Debt funding’s dominance of sharia finance has earned the $1 trillion industry the tag of “copycat” and limited its growth as critics question its ability to offer a fairer way of sharing risks and rewards that truly distinguishes it from conventional banking. “Profit-sharing or equity structures are the true way of doing Islamic financing,” said Siti Mariam Mohd Desa, Kuwait Finance Malaysia’s real estate advisory director. “It is a different concept because if you were to give out straight loans, you may as well go to a conventional bank.”

As the global financial system emerges from the debt crisis and banks shy away from assuming added risks, practitioners want Islamic finance to rely more on partnership structures and less on straight financing which they say has created a brand of finance which is sharia compliant in form, but not in spirit. They say equity financing such as musharaka and mudaraba are closer to the sharia’s aim of ensuring gains and losses are shared equitably and a shift back to it would help banks win new business beyond its traditional markets.

While Islamic finance has flourished in Muslim markets such as the Middle East and Malaysia, many non-Muslims are unconvinced, saying the industry differs from conventional banking only in name. “We cannot add value in markets which are mimics of conventional markets. At the moment, it’s difficult to see the value-added,” said Safdar Alam, head of Islamic structuring at JP Morgan in Bahrain. “It’s a real opportunity, with the increased awareness globally of Islamic finance, to demonstrate this value and the difference and benefits. This is a chance that we might miss if we don’t do this well quite quickly.”

But banks’ reluctance to bear the risk of projects funded, companies’ unwillingness to share profits and scarcity of banking capital make equity financing an unappealing proposition. The recent property slump in the Gulf, where equity financing is more common, badly hit Islamic firms such as Bahrain’s Gulf Finance House and could compound banks’ fears of becoming project partners.

Kuwait Finance Malaysia, which uses the musharaka equity structure to develop real estate, had a non-performing financing level of 6.73 percent in September, more than thrice the industry average. Its parent Kuwait Finance House, the Gulf state’s top Islamic bank, posted a 24 percent drop in net profit in 2009 to 118.74 million dinars.

NO RISK, NO REWARD

Equity financing models were born out of a belief in Islam that the financier must share the risks if he wants the rewards and that profits should be earned through enterprise. While equity funding is commonly associated with higher returns, bankers say it may not necessarily be more profitable than debt as the latter allows for higher leverage.

Traditionally, popular Islamic debt-based instruments such as istisna and murabaha have been likened to interest-based loans where banks take limited risks and are guaranteed a return. But as Islamic finance grew beyond traditional roles such as agriculture financing to funding government budgets and billion dollar real estate projects, some banks began leaning more towards debt instruments to limit their risks.

As banks’ capital grows scarce, they will be wary of parting with large sums to back equity ventures, said Mohammad Faiz Azmi, PriceWaterhouseCoopers’s global Islamic finance leader. “On the demand side, the issue is are there enough corporates who are essentially willing to give up the upside?” Faiz said, referring to profit-sharing structures. “The reality is that the people that would want to have equity forms of financing are usually the ones that you want to avoid lending money to anyway.”

Some practitioners say the push for more Islamic equity financing is ill-conceived.

“From the sharia’s perspective, there is no such evidence to support (the view) that Islamic banks or whoever wants to do business should do profit-sharing more than debt-based,” said sharia scholar Aznan Hasan, who advises Barclays Capital London and Malaysia’s stock exchange operator Bursa Malaysia. “Whether it is debt or equity that suits you better, it depends on commercial and business decisions, not sharia matters.”

Best Regards
ZULKIFLI HASAN
DURHAM, UK

  • The Empire State Building, New York

    One thought on “Islamic finance resists equity shift, may stunt growth

    1. MOHAMAD HALIM BEN OTHMAN says:

      Salam to all,

      Basically there are two modes of Islamic financing ( in Malaysia )
      1.Shariah compliant
      2.Shariah based.

      Shariah compliant refers to products akin,likened or as some will want to say’mimicking ‘ the interest based products .But essentially they are shariah compliant, halal, acceptable,workable and approved by the country’s highest authority on Islamic banking and finance.Global and domestic financial infrastructure and conditions compel the usage of these alternatives until new alternatives can take its place.

      Shariah based products are those with equity, profit sharing ,non debt instruments such as rent and leasing that are thought to be in line with ‘no pain no gain ‘maxim.With the constraints as highlighted
      in the article above particularly on owners of thriving business ‘s reluctance to share profit but ever willing to share losses and coupled with the existing financial and legal structure that inhibits their application, we will have to be contented with shariah compliant products , for now.It’s better than not having shariah products at all!

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