A Secular approach to Finance

Issues of Faith in these times tend to get dismissed as awkward moments and are something to be avoided.
This conflict of Spirituality can lead to misunderstandings when the person concerned has a different ‘moral compass’ which sets out the course to be steered when faced with differing values and philosophies.
With the emerging economies in the East and a diverse secular community in this country, it is important there is an understanding of the underlying principles when relating to other Faiths.
Business leaders will talk of Corporate Mission statements of Corporate Culture/values, these are in fact a manifestation of the individual’s faith and their education (in it’s broadest sense) and are based on an infrastructure of Spiritual values.
What is important in business dealings be they transactional or relational is not to get bogged down in the Foundations of Dogma but recognising the respective differences of Islam and Christianity and embracing them rather than confronting them, after all they have at the root similar principles.

We are not talking aggressive secularism but more cultural inclusionism and bridging the gap between Mecca, Jerusalem and Rome.
Some 25% of the world is now Muslim, with demand for Islamic Financial Services in the UK and Europe being fuelled by the growing number of middle-class Muslims in the West.
So, in particular, are there any facets of Islam that we can draw on as common ground and learn to accommodate in our business dealings

Islamic Finance
Islamic banking models are not fundamentally different from Western Models being supported by asset and business ownership; there is a heavy reliance on understanding the general and specific business environments in which they operate. The ‘Business Partnership’ that most western Bankers promote.
Islamic principles insist ons account monitoring to ensure the strict observance of Shari’a law in business activities.
Riba, or interest, is prohibited in Islamic law. Any risk-free or guaranteed interest on a loan is considered to be usury, so there dependence on asset backed investment effectively precludes interest

Banks and Customers do therefore not enjoy interest (Riba) but rather participate in the yield resulting from the use of funds. The Islamic Funder invests in business projects and then profits are shared in a pre determined ratio. There is thus a partnership between the Islamic financial provider and its depositors on one side, and between the Islamic financial provider and its investment clients on the other side.
If we take interest out of the equation, the nearest I can get to this in modern times is that it strikes a chord with Western Accountancy concepts of matching costs and revenues, albeit taking it to the new level of (literally) ownership.
Some of this strikes a note also with the ‘rules of tracing’ so much beloved of Insolvency lawyers.
Very Early western principles of Banking along co operative lines and respect for the borrower were very much in this mentality, but somewhere alomg the way the two models diversified and the business partnership ethos came away from these first principles.

This is very deep here as there are similarity between this and the ‘no man’s an island’ concept and the notion that the consequences of our action has a direct effect on others.
Sharia finance differs from western concepts of finance in that it is based on sharing the yield of the project and takes a more Holistic view of the ‘lending’ proposition.

Some Western banks have taken this principle and adopted there products to suit . HSBC has innovated Amanah, an Islam-compliant services which includes a current account and home financing facilities. Lloyds TSB operates a similar set of services.
Islamic Banks have been largely protected by the ‘Credit Crunch ‘ as they have not lent to the sub prime market and therefore there asset backed security is much more solid. We would not have had a Northern Rock, Lehmans.AIG or ant other big recent corporate collapse if Islamic principles had been followed, so there is a lesson to be learnt.
The funding of house purchasing in Islamic terms is also quite different from the traditional western model
Islamic Insurance (Takaful)
The western notion of Insurance is compensation for losses and includes elements of risk and uncertainty which implicitly involves ‘gambling’, a notion that does not sit comfortably with Sharia law

Takaful employs the risk model of law of large numbers, i.e what is uncertain to one individual will be less uncertain with respect to a very large number of similar individuals
Islam compliant Insurance needs to involve the notion of Partnership and the pooling of resources to help the needy
Insurance products, to remain attractive should therefore consider a departure from traditional (Western) underwriting principles and incorporate one or all of the following concepts

1 refund 50% of all premiums at the end of the year if there are no claims
2 as above but instead of refunding directly the money, radically reduce the following years premium by 50% of the first year
3 In the event of a claim, asking for a 50% contribution from the Insured

(point three would be to damage only, not Third Party personal injury)

There also need to be a principle governing the taking of a deposit, (refundable) front as surety for the 50% and splitting any ‘interest’ earned on this money equally at the end if no claims (or if any surplus left after claims)
Underwriters would have to adopt Islamic Banking rules and concentrate on project yields rather than charge Interest

The operation of the Takaful (Islamic) insurance market, would suggest there is no problem with setting up an insurance policy in any of the 3 ways suggested.. What has been found to work better is rather than just give away rate reductions or no claims 'bonuses', you can try to lock the client into a renewal and a good/ nil claims experience bonus so they only get the rebate if they renew the contract.

All 3 of the options are acceptable terms as part of an insurance policy because they all relate to money being made to work on a particular scheme or plan without interest. However, the insurance company needs to be 'Takaful' compliant so that pure interest is avoided (investment income) and profits from premiums collected (less claims) are shared with the policyholder (after reserves and other financial allocations have been made).

On the concept of up front deposit interest, there should be no problem dividing the profit element if there is a clean or good claims record. But the funds should avoid attracting pure interest whilst held on deposit. In practice, many commercial insurers in the middle east still invest premiums in the normal way but they do not pass on or share any pure interest/ investment income onto policyholders but only the pure 'profit' element left (ie., once the Premium LESS Claims calculations have been done).


It is worth looking at some of the Islamic websites on this, a good one being the Islamic Bank of Britain website which explains things in a simple uncomplicated way. A lot of Takaful insurance companies have committees devoted to establishing what is ethical underwriting and profit taking compliant with Sharia Law and what is not. In the main banks in UK are way ahead on Islamic Finance issues but there is not any Islamic or Takaful ('cooperative') insurance companies in the UK although some of the banks seem to be offering personal lines insurance over the internet from their website.
In a way this business model has come full circle as it is very similar to how Insurance companies used to operate on the old ‘Mutual Companies model’

One thing is drawn from all this is that in some ways these principles have been embodied in Lending and Insurance criteria in UK/US banking for some time and ally closely with the Christian Paternalist ethics beloved of so many Economists. The issue has been that in the drive to find more innovative and complicated lending and Insurance products, sight has been lost of some fundamental principles which Sharia law continues to embody.
As with most walks of life, there is not so much difference between the two cultures, merely a difference in interpretation of fundamental and common values, With the recent collapse of western style banking there are lessons to be learnt from Eastern principles and above all respect for lenders and borrowers alike is probably a principle that should be brought to the forefront of any lending proposition .
Recent Cataclysmic events could have been avoided if the avariciousness of western lenders had been curbed

Islamic finance moves to centre-stage

Funds invested in Islamic finance products at banks in the Gulf now amount to $70 billion - a fifth of the total asset base, and a clear signal of the extent to which a onetime niche activity is moving centre-stage, particularly in the Middle East and parts of Southeast Asia.

What was once seen as marginal is becoming mainstream. Islamic bankers will come to Dubai this week for the International Islamic Finance Conference - timed to coincide with the IMF/World Bank annual meetings - not as practitioners of a marginal sideline but as mainstream players in the financial community.

Top names

Dubai's Bank Street. ©Gulf News
Some of the top global banking names are now in the field. Citibank and HSBC have incorporated Islamic financing businesses. BNP Paribas recently set up a special unit in Bahrain.

And the rationale is clear: Islamic financial assets are now estimated at about $239 billion worldwide. The sector is growing by 15 per cent a year. That is a lot of investment clout.

For a bank that is seeking to maximise its deposit base and access to investment capital, especially in the Gulf, the region's fast-growing pool of Islamic assets is clearly attractive. "It is a source of finance that one can no longer ignore," says Amin Raad, deputy head of Islamic banking at BNP Paribas.

Meanwhile, client demand for Islamic financing is also on the rise, both in the Middle East and further afield, in western markets such as Britain and Germany, and in south-east Asian countries. In Pakistan, the entire financial system is being transformed to make it compliant with Islamic principles.

The Malaysian government's masterplan for the financial sector envisages that Islamic services will account for 20 per cent of the banking system by 2010. The current figure is 9.4 per cent.

"Malaysia's Islamic baking sector has achieved the critical mass needed to further develop the Islamic financial system. Islamic financial institutions must take this opportunity to aggressively market their products and services to put them ahead of competitors," deputy finance minister Shafie Mohammed Salleh argued recently.

Bank Islam Malaysia, a local pioneer, is now 20 years old and it offers a wide range of products, ranging from everyday personal bank accounts through to corporate finance and securitisation. Initially, the sector developed to meet demand from committed Muslims who had chosen to conduct both their personal life and their business activities in full accordance with the precepts of Sharia law.

Malaysia introduced framework legislation for the emerging Islamic finance industry in 1983, with the Islamic Banking Act.

But today, the industry's appeal stretches far beyond the faithful. Many clients in Malaysia are from the local Chinese community, while the established Islamic banks now face competition from conventional institutions that offer Islamic funding and investment windows.

Altogether, more than 40 different products are marketed. It is important to stress that modern Islamic banks, investment houses or insurers are quite distinct from traditional charitable structures.

The US-led international crackdown on terrorism finance has not specially targeted Islamic finance institutions. A huge range of banks and institutions of both Islamic and conventional types have come under increased scrutiny, as have charities and the hawala money transfer system used by migrant workers in the Gulf to send their savings home.

In predominantly Muslim countries such as the Gulf states or Malaysia, many services are tailored to the needs of mass market personal consumers. But Islamic financing is also making itself felt as a force in the big business field. This is what BNP Paribas is concentrating on.

Amin Raad explains that, since the 1980s, different specialist units in the bank had gradually developed Sharia-compliant versions of their products to meet the needs of key Islamic customers. But these were not actively promoted as a coherent range of services. That is now changing with the establishment of the new operation in Bahrain.

Target groups

"We set up the Islamic banking unit to develop our marketing," he explains. The Bahrain office works with the various teams of product experts in Paris and London to promote the services that these specialists have devised for Islamic customers.

"We feel there is an ever-growing demand for products, both from sovereign [government] clients and from private sector clients," says Raad.

In business terms, he maintains, Islamic finance is competitive. But it is also worthwhile for the banks providing the services. "We try to create Islamic products which have the same characteristics as conventional products - both for the client and, in terms of revenue, for us."

However, the development of the Islamic finance sector does pose new management and regulatory challenges. Islamic financing replaces conventional interest rates with the principle of profit and loss sharing by investors depositors. They gain a share of the profit or loss incurred through the bank's use of their money.

But a working paper published by the IMF in November 2002 argued that, while this shifted credit risk from the bank to the depositor, it also added to the overall level of risk to which the bank's balance sheet was exposed.

Another complication is posed by the drawn out nature of profit or loss. There is no exact timetable for repayment - and thus for deciding when default has occurred. A bank that provides funds to an entrepreneur on a profit-sharing basis must wait until the business client generates the profits or losses.

The Fund paper also pointed out that the vast growth of Islamic financing products was making it hard to standardise them. Implicitly, this adds to the workload facing supervisors.
Moreover, the bank has no legal control over the business management decisions taken by the entrepreneur.

The paper highlighted particular risks relating to Islamic "ijara" structures - equivalent to leasing - and purchase-with-deferred-delivery arrangements and noted that the development of hedging and inter-bank money markets had not evolved as far as that of the conventional financing equivalents.

Of course, many of these shortfalls in the depth of the Islamic financing market are likely to be filled as the global banking and investment groups strengthen their presence.

Regulation varies

But the Fund paper also pointed out that regulation of Islamic finance varied from country to country and it argued that there was a "lack of an efficient and reliable Shariah litigation system to enforce financial contracts".

In light of all these factors, the paper stressed the importance of Islamic banks developing their capital and reserves base to offset the risks.

It proposed the development of a new framework for Islamic banks' management of risk and disclosure of information, based on the CAMELS (capital, assets, management, earnings, liquidity and sensitivity) model.

But governments of Middle Eastern and Asian countries where Islamic banking is now a major force had already begun to take action. In talks at the April 2002 IMF/World Bank spring meetings they decided to establish an Islamic Financial Services Board, based in Kuala Lumpur, to promote good regulation and uniform prudential standards.

The new Basel Capital Accord - when it is finally agreed - is also likely to incorporate risk measures better suited to the Islamic finance sector than existing regulatory standards.
Meanwhile, the credibility of Islamic finance as a tool for major business structures is steadily rising, and this has been particularly noticeable in the Gulf, where it has been used in infrastructure deals.

Kuwait Finance House and the Islamic Development Bank led a $55 million Islamic finance tranche for the $255 million Hidd power project in Bahrain. In the UAE, Islamic groups stepped into the breach when the 11 September confidence slump in 2001 threatened to leave funding for the $1.6 billion Shuweihat power project some $350 million short of target.

Islamic institutions, which felt more comfortable with Gulf political risk than some of the more nervous western banks, quickly agreed to provide the necessary resources.

Industry experts believe that in future, international power developers will routinely seek to include a substantial slice of Islamic funding in arrangements for new Middle Eastern projects.