Sunday, September 9, 2012

Sharia Compliant Financing Has An Expanding Market

By Kerri Turner

A growing market of Sharia compliant financing instruments is developing. These are meeting the requirements of a niche market catering to investors seeking to invest in financings that are in compliance with Islamic law. Muslim majority countries were the original source of such financial options. But acceptability has now spread to countries with Muslim residents. Of course, the desire to attract wealthy oil rich investors has also led been a source of this acceptance. As a result non Muslim nations are changing their laws and rules to accommodate these customers.

In the U. S, a small industry is growing. Regulators have offered some guidance about the legality of such products. About the active mortgage market, the Office of the Comptroller of the Currency has issued two rules. In 1997, it issued a directive about ijara or lease. In 1999, it recognized the murabaha, a cost plus financing mechanism. Under this arrangement an intermediary purchases an asset with the understanding it will be bought back for a higher fee by the customer.

There has been some effort towards standardization by regulating agencies, but it has been tentative. Hence, variation is the rule in such matters. In part this is because religious scholars do not have a consensus concerning what meets the standard. Since Sharia is interpreted differently, a lack of consensus has not aided standardizing efforts.

If there is no standardization, some worry conformity risks will only rise with further growth in this niche area. The issue of validity variance has been underscored by a dispute between a Lebanese bank and a Kuwaiti investment firm. The question whether a contract was compliant and thus sufficiently enforceable to require it be honored thereunder.

Many observers believe standardizing of regulations is key to increasing marketability and wider acceptance of these products. There have been a number of initiatives over the years to improve regulatory practices. An example is the IFSB publishing of guidelines in 2009 on issues related to governance and capital adequacy requirements of different financial mechanisms. AAOIFI is working on developing risk management and corporate governance standards.

Islam prohibits interest and discourages uncertainty in contracts, profits and sharing of risks is favored thereunder. Increases in the price of oil have given Middle Eastern countries cash looking for investment options. As a result, this specialty market has been booming. New institutions are joining even as those in operation begin offering such products. Five hundred of the leading institutions in a survey indicated a major rise in assets under management. At the same time countries in the West are experiencing economic tribulations. The economy within their borders is in need of investment.

It has been estimated that in 2010 total assets internationally were about 1 trillion dollars. In the financial crisis, risk averse Islamic banks have typically done better than others. But, the industry has not been immune to falling demand and investor insecurity. As a result capital market securities which peaked at 35 billion in 2007, fell to 15 billion in 2008 rising in 2009 to 20 billion.

Innovations have been introduced in the last twenty years to broaden the industry. One example is the market index developed for securities by Dow Jones. Sharia compliant financing in the United States is, however, still dominated by retail investments.

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