Islamic finance in Ireland? What is it all about? Well before I go into it today’s post will start with condolences, you see I was meant to be at a seminar at the end of March about Islamic Finance and it had to be put off because several children parishioners of the Dublin Mosque were killed and others extremely injured in a car crash while on a field trip down to the country. My hopes and thoughts are with the children who survived and for the families surviving the ones who were lost. Due to this tragedy the seminar has been postponed but we’ll cover some of the basics of what Islamic Finance is all about and how it may change certain aspects of the Irish Market.
According to the Koran (Qur’an) there are many laws surrounding contract and general dealings. The extent of Shar’ia law is actually quite complex and in many ways you could compare it to British Common Law which was developed using the Bible as one of the fundamental foundations for what is right and wrong in law, for instance, many of the laws in the Ten Commandments are in actual law, for instance ‘thou shalt not kill’ or ‘steal’. Historically religious texts were the moral guidelines of societies so in Europe our laws have a Christian slant and in the Middle East there is an Islamic focus.
One of the fastest growing sectors of finance in the world at this moment in time is Islamic Finance, part of the reason for that is because many commodity rich countries have a Muslim population, and the current boom in Oil prices is giving them the capital to spread their investment net fast and efficiently, CitiGroup was bailed out by the Abu Dhabi Sovereign Wealth Fund, and in general the financial improvement in many Islamic countries along with the financial sophistication of their populations is giving strength to this growth.
Conservatively there is thought to be almost a trillion in assets under management according to Islamic principles. The market in this sector is growing at 10% a year so it doesn’t take long to realise that soon more and more lenders and companies will start to offer products that fit the requirements of such a clientele, in fact, now that Dublin has a Mosque, perhaps it will not be long until we see an Islamic Window appearing.
In Islamic Finance ‘usury’ or the collection of interest is forbidden, and for that reason many of the features of European finance are not suitable to Muslims, usury is also sometimes referred to as ‘Riba’. Devout Muslims are also not allowed to invest in businesses that are considered unlawful or ‘haraam’ (this would be companies or investments that are involved in pork, alcohol, pornography, tabloids/gossip columns, and any other activity which is contrary to Islamic values).
A very interesting thing about our world is just how much of it was based on Islamic business practice, mathematics, while not solely invented in Mesopotamia (modern day Iraq & Southern Iran) was perfected there, and the same nation invented accountancy. Mesopotamia means ‘between two rivers‘, literally the Tigris and the Euphrates. It is also the area credit with inventing writing, and astrology, it must have been chock-a-block with inventors! Their mathematical system was sexagesimal, or units of 60, which is why there are 60 seconds in a minute, 60 minutes in an hour, and 360 degrees in a circle. The calculations that modern physicists use and the standards in much of modern mathematics was all invented in this land between two rivers.
Many international banks recognise this trend and they are opening ‘Islamic Windows’ in their banks, this is literally a ‘window’ much like the foreign exchange window, but one dedicated to servicing Muslim clients. Banks in the UK are creating products that are Shar’ia compliant, however it is the ‘pure Islamic’ banks that seem to be capturing the bulk of the market, and they are the actual Banks from the Middle East.
There are three types of Islamic investor, the ‘very observant’ are people who are not comfortable with international banks who have an ‘Islamic Window’, then the less observant are a group that are very happy that there are any Islamic products available and even though there may not be a price benefit they will conduct business via an Islamic window or otherwise in order to remain compliant to their faith, the last sector are ones that are assimilated in highly Christian countries and they don’t use any Islamic products because there are simply none available.
Islamic financial products are emerging and we are seeing Sukuk’s which are a financial instrument which is best described as an Islamic Bond. These are being used in the Middle East to finance various infrastructure projects and they are not dissimilar in purpose to a Municipal Bond, they differ however in the way they are operated. Sukuk’s are used for trading in, or construction of, specific identifiable assets, such as Dubai’s light rail system.
Sukuk’s (as of 2007 were oversubscribed by five to six times in general). The income must derive from the actual asset as opposed to ‘interest’ and in that instance they are not like many bonds, but it would not be too far off from a Revenue Bond, using the example above, the money would come from people using Dubai’s light rail system.
Under Shar’ia law money is used to measure value and is not an asset in itself the way it is in Western Civilization. So for this reason strict adherents cannot receive or interest either, or any income that comes specifically from money only. In fact standard loans and credit cards are also not allowed. Some people see Sukuk’s as simply being a way around Riba and for that reason the camp is split amongst Muslims as to the merit of Sukuk’s.
Some scholars feel that fixed income from a sukuk is no different than fixed interest from a deposit account, the supporters of them feel that because the bond is based on an asset and not cash that the income is basically rent being spaced out over time.
Islamic finance takes the view that money has no intrinsic value, it is just a tool for measurement of things that do have value, or a way to judge the value of something. On that not I think there is a kernel of genius, as you can’t eat money, you can’t survive on it alone, and the classic story of the dying man who would give all of his wealth for health is often recanted in the saying ‘health is wealth’. The interesting aspect is that this belief points out that ‘a society that trades money for money will eventually have no intrinsic value’ and that is something that we are seeing today in the unwinding of the carry trade and CDO’s as well as SIV’s (see previous posts for explanations of those terms).
Murabaha is a particular type of sale where the seller points out the cost they incurred in bringing something to market, this can be food or a property, mark-up or profit is totally acceptable in Islam, in order to ‘mortgage’ a property this would be the method required. One factor is that the contract price must be fixed otherwise it will fail to work under Shar’ia law.
So in order to do a mortgage for a Muslim you can’t (if you are sticking to Shar’ia law) get a standard mortgage that amortizes (where you are paying off interest and capital), because usury is Haraam (interest collection is forbidden). Instead what would need to happen is that the bank would purchase the property from the seller, in fact this is basically what happens when you get a mortgage, the bank take a first charge or ‘lien’ which means they own the property before the inhabitant until such time as the loan is paid off.
To follow a Shar’ia system though, the bank would buy the property and sell it to the buyer at a profit which they pay in installments, the only thing this doesn’t cover is the changing interest rates, so any European Islamic product would have to be bought off the money markets for the required term. If the market gets big enough we will see this, in the same way as there are Polish newspapers and Russian food shops. Islam is the fastest growing religion in the world so perhaps it’s just a matter of time.
The challenge will be to create compliant products that match western products, having said that, perhaps the focus on performance may be a more western driven concept, and adherents may be willing to accept less in order to remain compliant to their faith. In any case, you can expect to see at least some Islamic Finance products enter the Irish financial market at some stage.