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An oriental financial concept conquers the world markets

What happens when the financial markets are confronted to cultural values? The financing structures that conform to Islamic law are at the top of an evolution aiming to integrate cultural values in a globalised economy. Right now, the sukuk (Islamic products on capital markets) are at the heart of this trend.

Article also available in : English EN | français FR

In October 2011, a major bank has announced the launch of a sukuk in order to raise capital on the Islamic financial markets. In the world of finance, this issue, which conforms to the Sharia (the Islamic law), by a Western bank has caused major tremors. Two aspects have significantly caught the attention of watchers: the two billion dollar volume and the date on the launch during full economic crisis. This sukuk could represent the definite breakthrough of Islamic finance on the international stage and could open very interesting perspectives to financial institutions facing difficulties in the current environment.

Interest prohibition, a major principle

Islamic Finance blends financial activities with Sharia. Founded on different legal bases, most notably the Koran and the Sunna, the Sharia is the guiding line for all Muslims. As the sacred book of Islam, the Koran transmits, according to Muslim faith, the words of gods revealed to the prophet Mahomet. The Sunna however describes the way of life of the prophet who is considered as the example to follow for every Muslim. Since Mahomet has been a merchant at one time in his life, the Koran and the Sunna contain a lot of advice and guidelines regarding the behaviour to adopt in terms of economic matters. The central principle of this code is the prohibition of riba, that is interest or usury. Consequently, the main condition that must be applied to all Islamic financing operations is to give up interest.

A characteristic of monotheist religions

This prohibition does not limit itself to Islamic finance. Most of the monotheist religions have at one time or another expressed mistrust towards transactions involving interest. In antiquity, interest charges were considered as a sin by Jews and Christians. Religious conventions have then taken several centuries to sufficiently develop themselves for financial activities involving interest to be socially accepted. In the history of Judaism, this process has been simplified by the fact that that loans with interest were provided to non-Jews and by the fact that the Christians have then entrusted the Jews with the management of their finances. For the Christians however, interest remained prohibited until the end of the middle ages. After that, the change in mentality that took place within the Christian community was mainly based on fundamental thinking regarding the venal value of money. The critical position against interest remains firmly grounded up till this day in several national legislations. In the United States for example, the maximum rate authorised by lending operations is defined in the “usury statutes”, the usury laws.

Speculation and gambling games

Interest prohibition is not the only characteristic which differentiates Islamic finance from the traditional financial sector. The prescriptions are also applicable to risk, speculation and gambling games. They make the distinction between “good” and “bad” activities. Rules concerning risk and speculation aim at favouring durable growth in local economies. The origins of this prohibition applied to merchants linked to gambling games date back to pre Islamic mecca where these highly sought after games were based on agricultural products. Some players were considerably enriching themselves while others were going down in debt. The prophet Mahomet who cared a lot about social cohesion with Islamic society opposed himself to such things since it widened the gap between the rich and the poor.

Dow Jones Islamic Market Index

Islamic finance is also known for its principle of negative selection. Since the emergence of the sector, Muslim intellectuals have divided the sectors between conforming and nonconforming sectors towards Islam. Nowadays, the Dow Jones Islamic Market Index, the most well known reference index for Islamic shares defines as incompatible with Islam the following sectors: alcohol, tobacco and porc based meat production, traditional financial services, entertainment and weaponry. In addition, heavily indebted companies are also excluded since the intellectuals favour capital instead of debt

Progressive development from the 1970s.

In the middle of the 20th century, Egyptian intellectuals spread the idea of taking into account the Sharia principles in order to structure financial transactions. At the time, the Near East is everything but a prosperous region. Consequently the first experiments in Islamic finance did not produce major interest supra nationally speaking. In the 1970s when the concept of financial operations that conform to the Sharia is raised again, the situation has completely changed: The oil crisis provides immense wealth to this part of the world.

Since then, several financial institutions in the Near East and South East Asia have continually invested themselves in the development of an Islamic economic action. The main precursors of this movement are the banks of the Gulf states that are largely supported by the Islamic Development Bank that was founded in 1973.

During the 1980s, Islamic financial services have witnessed a growing success in South East Asia. In this region, financial establishments are more and more focussed on small investors as opposed to Near East markets which are mainly focused on wealthy private banking clients and private equity activities.

Sukuk: A growing demand.

However, until the end of the 20th century, Islamic finance offers possibilities that are relatively limited. Direct interest charges remaining prohibited, clients can only invest their money in shares and must give up the idea of using full range banking services. This situation only changes after 2000 when the Islamic financial institutions start investing more heavily in research and development. In this reorientation path, the market for Islamic capital as well as Islamic real estate loans increase. Credit cards that conform to Sharia are also issued. At the end of the 2000s, the Islamic market players finally benefit from wholly developed Islamic financial services. During the first decade of the new millennium, the sukuk became for the Near East and South East Asian companies a highly appreciated method of obtaining capital on the financial markets.

Net increase in Islamic loans

The term Sukuk – often translated as Islamic Bond – is the plural of the Arab word “sakk” which means “official document”. In an etymologic sense, it has the same origin as the English term “check” and points to the ancient tradition which consisted in establishing an official document in order to certify debts. The word “Sukuk” meaning several “checks” is therefore used to refer to the first attempts at creating Islamic products on capital markets. Little by little, the popularity of the Sukuk increases: from less than 50 in 2002 and 2005, their number grows to 398 in 2010.

Capital mobilisation in the Muslim world

This increase has several reasons. First of all, it originates from the improvement in transparency regarding the manner in which the Sukuk are structured. In order to avoid interest normally generated on classic products of the capital markets, the Sukuk are generally based on extremely complex legal and cash flow structures. After having faced some failures, the Islamic financial market has submitted the framework conditions of the sukuk to a series of tests and has optimized them.

Then, the demand for Sukuk has been stimulated by a growing number of investors in Muslim shares who broadened their religious approach of capital market products. Thirdly, several non-Islamic companies have started issuing sukuks in order to obtain capital from the Muslim world. Muslim investors can therefore obtain capital market products from non-Islamic institutions. The first issuer of non Islamic sukuks was the German land of Saxe-Anhalt in 2004 which by this pioneering act has considerably increased its investor base. Since then, companies such as General Electric, Hewlett Packard or even Petronas have issued sukuks as well.

It is not surprising that even established financial institutions are now considering the possibility of stepping ahead. Indeed, considering the austerity plans and budgetary cuts currently being applied in the United States and in Europe, capital mobilisation from the Middle East and South East Asia could in the future become the only way for some companies to preserve their liquidity.

A new era in globalisation?

Since the end of the 1980s, the term globalization designates the production and circulation on a global scale of goods, services and ideas. While a great deal of goods and services continue being supplied by emerging markets, the ideas generally come from Western political and financial institutions. In this respect, Islamic finance is a notable exception. The fact that non Islamic companies have endorsed Islamic finance does not correspond to the traditional pattern of globalization. This trend is rather the sign of the beginning of a multipolar world. Right now, this evolution is unquestionably accelerated by the persistent financial crisis as well by the need of Western companies to find new sources of capital.

Stefan Leins , March 2012

Article also available in : English EN | français FR

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