The sub-prime meltdown which began in August 2007 has brought down several of the long established and large financial establishments in the US and Europe. Major banks and other financial institutions around the world have reported losses of approximately US$540 billion as of September 2008, and this has continued to increase. Despite concerted efforts by governments and central banks worldwide to cut interest rates and inject massive liquidity into the stock market and the banking system, the global crisis has yet to show any sign of abating. Countries are already experiencing recession while the more resilient economies are revising their economic growth downwards.

Cause and effect

The sub-prime crisis was mainly due to collateralized loan obligations (CLO), collateralised debt obligations (CDO) and mortgaged-backed securities (MBS) which were bundled and repackaged and combined with swap and options (swaptions). They then led to the creation of the sub-prime loans when interest rates were low which then fuelled an artificial mortgage growth, leading to a property bubble. In some cases, the derivatives originated by the investment banks surprisingly found their way back into the originators’ books. Thus, this time round, the investment banks themselves became victims of their own doings. In the early months preceding the crisis, proponents of Islamic finance were quick to point out that the crisis would not affect Islamic banks because Islamic finance transactions are asset based and shuns gharar – excessive risk or lack of transparency. Critics on the other hand say that the reason is simply because Islamic finance has not achieved the level of sophistication of the conventional finance and therefore, not exposed to derivatives.

Impact to the GCC

The Gulf Co-operation Council (GCC) was not spared the spill-over of the sub-prime crisis. The impact of the sub-prime crisis on Islamic finance has become more obvious by the day. The problem however was not from sub-prime loans, although the GCC sovereign funds have stakes in several of the troubled banks in the US and Europe. Instead the causes were a combination of effects from the decline in world oil prices and property bubble burst. In anticipation of the local currencies appreciating against the US dollar, investors in the GCC began withdrawing funds when instead the dollar appreciated thus causing further liquidity problems among the banks. It was reported that one central bank in a GCC country has intervened to rescue a bank. The banking authorities in various GCC countries have begun pumping in cash to ensure the banks can meet liquidity requirements.

Impact to Malaysia’s Islamic finance industry

• The Malaysian Institute of Economic Research (MIER) has revised its growth forecast for 2009 to 3.4% from its earlier forecast of 5%. The government has introduced a multi-pronged economic stabilisation package aimed at mitigating a sharp slowdown in domestic demand given the substantial weak external environment. The contraction is expected to hurt banks’ income and Islamic financial institutions will not be spared.

• Bursa Malaysia lost 40% of its value as at 31 October 2008. Shariah-compliant stocks (SCS) also took a beating. The impact on the Islamic indices, in most cases, was less severe compared to the overall index because finance counters, being the most adversely affected were precluded from SCS. However, in some cases the off-set effects were the absence of non-SCS but defensive large market cap stocks such as tobacco, gaming and brewery companies.

• The value of sukuk approved until September 2008 was RM24.6 billion, down from RM121.3 billion at end–2007. In the near future, it is expected that prospective issuers may reconsider issuing sukuk as they face higher yields, and the fact that the economic slowdown would require them to reexamine their financing requirements.

• It is rather fortunate that we have not fully liberalized our banking and financial infrastructure. Despite recognising that foreign participation is necessary to help accelerate growth and improve consumer choice, Malaysia operates on a gradual and phased approach to liberalisation based on the framework set out in the Capital Market Masterplan. At each stage of phased liberalisation, an assessment is conducted on the impact and benefits of proposals. By adopting these measures, Malaysia will meet its agenda of building a resilient core of domestic financial institutions and preserve financial stability.

• It is rather fortunate that we have not fully liberalized our banking and financial infrastructure. Despite recognising that foreign participation is necessary to help accelerate growth and improve consumer choice, Malaysia operates on a gradual and phased approach to liberalisation based on the framework set out in the Capital Market Masterplan. At each stage of phased liberalisation, an assessment is conducted on the impact and benefits of proposals. By adopting these measures, Malaysia will meet its agenda of building a resilient core of domestic financial institutions and preserve financial stability.

When reality bites

Islamic finance does not operate in a vacuum as it coexists and interacts with the global financial market and economies. It will, therefore, be affected, albeit perhaps to a lesser extent:

• Where Islamic finance is asset-based, it will be susceptible to a property bubble burst, i.e. when the value of the security falls and becomes inadequate to cover the capital, e.g. the mortgage failures in the US.

• For Islamic financial centres which are highly liberalised and where the foreign/conventional players are market dominant, capital flights will have a more serious impact on the market.

• A bank run (triggered by external factors) does not differentiate between Islamic or conventional finance.

• There are other factors such as currency trades and contingent liabilities (involving counter-party risk) which may impinge on an Islamic bank’s performance.

Challenges for Malaysia

Malaysia’s challenge lies in the following areas:

• Demands from rising inflation which put pressure on the low interest rate regime when savings cannot meet the demands;

• Capital flights and repatriations, which have occurred;

• Since the Asian financial crisis, Malaysian banks too have been aggressively extending retail credit in the form of credit cards and refinancing of mortgages with higher margins. How banks manage the NPL during the contracting economy will be of concern; and

• Property overhang is already evident by many unsold commercial and high-end units with developers deferring launch of new projects indefinitely.

Conclusion

Events like the sub-prime crisis provide important lessons to Islamic finance. The Islamic market is not independent of the financial markets and is, therefore, not totally insulated from any financial crisis – regionally or globally. Thus, the Islamic finance fraternity cannot afford to be complacent. Moving forward, Islamic finance has to truly apply the Shariah spirit not only in form but in substance as well. Hopefully this will make Islamic finance more resilient to economic crises.

The article above was retrieved from the freely distributed Malaysian Securities Commission’s Islamic Capital Market Quaterly Bulletin.

While bankers in Europe and the US face new waves of mass lay-offs, downsizings, mergers and acquisitions and even bankruptcies as a result of the sub-prime crisis, the Gulf region sees no let-up in double-digit growth.

‘The need for highly qualified executives in emerging financial hubs such as Dubai, Qatar or Riyadh is enormous,’ says Thomas W. Hofer, Managing Partner of Dubai -based executive search firm Taylor Hofer Partners.

‘The impact of the global credit crunch on Arab and international banks in the oil-rich region has been insignificant,’ he adds.

Lack of knowledge

However, for most high-potential bankers the shift to the Middle East is not a smooth career path.

They face a lack of knowledge of Islamic Finance, which is not only the fastest growing and most innovative banking segment in the region, but has also become a key part of the mainstream industry.

‘This is why Western bankers should apply for a study programme in Islamic Banking, in order to become familiar with Shariah-based vocabularies, from ‘A’ for Amanah (‘to have faith or trust in somebody or something’) to ‘Z’ like Zakaht (the Muslim duty of donating 2.5% of the profits).

There are various curricula world-wide which are most helpful to obtain the theoretical basis for the business around the Koran and capital.

Some examples of these are:

• DIFC Academy, the educational arm of the DIFC, in cooperation with the London-based Securities and Investment Institute (SII) offers five-day-courses in ‘Islamic Finance Qualification’ as well as online-study curricula. An online-exam is taken at the end of the course.

• At CASS Business School in the DIFC, bankers can opt for an Executive MBA Islamic Finance course which can be taken through a 25-month-curricula run alongside the day job. CASS Business school at London University runs its own branch in the DIFC where the entire programme is taken.

• At the Bahrain Institute of Banking and Finance in Manama a 16-week-long study session leads candidates to obtain an Islamic Banking Diploma.

• Most convenient for most employees is the long-distance learning curricula of the Institute of Islamic Banking and Insurance in London. On successful completion of the course, students are awarded the Institute’s Post-Graduate Diploma in Islamic Banking and Insurance and are also made an Associate Fellow of the Institute. The programme was designed and endorsed by Durham University, UK.

Cecile Hofer, Managing Partner of Taylor Hofer Partners, advises Western women in business not to shy away from opportunities in the Islamic Banking world.

‘In Dubai,’ Cecile adds, ‘we constantly see that women climb the career ladder faster than in Europe.’ The statistics speak for themselves: 45% of all bank employees in Dubai are female.

The partnership brings together two institutions with great reputations for education focused on the financial markets.

In a statement, ICMA Centre said the the MSc is the first in the UK to use Islamic material taught by Islamic specialists and aims to capture the increasing demand for the subject with an academic base and practical orientated views on issues such as Islamic Finance, Economics and Law. Students will benefit from having the opportunity to spend three months studying in Kuala Lumpur and study alongside Islamic Finance professionals. The MSc will not require any previous knowledge of Islamic Law or concepts but will explain the current issues within their overall Islamic economic and legal context.

Overall, graduates will benefit from a thorough understanding of Western banking practices that are allied to the principles of Islamic Finance. They will be well qualified to join specialist Islamic financial institutions, investment managers and finance divisions of multinational companies. In addition, participants of the course will also cover the materials necessary to qualify for INCEIF?s Chartered Islamic Finance Professional (CIFP). This professional qualification certification aims to give participants a better insight on worldviews and also cross-cultural perspectives for a robust Islamic Finance industry.

INCEIF President & CEO Mr Agil Natt, in his speech at the signing, said “We are indeed honoured to be chosen by the ICMA Centre at the University of Reading to develop its Masters Programme.”

The ICMA Centre has an international reputation for providing quality undergraduate, postgraduate and professional programmes tailored to the capital markets industry. The Centre is the result of Europe’s first active collaboration between industry and academia. Its success is based not only on the integration of applied finance theory and industry specific training but also its considerable professional and academic expertise, and strong links with companies and trade associations in the global finance industry. Established in 1991 with funding provided by the International Capital Market Association (ICMA) in Zurich, the Centre houses state-of-the-art facilities including two dealing rooms using software similar to those found in major investment banks.

In this joint effort, the first of the three parts of CIFP, the candidates will have the opportunity to spend three months in Kuala Lumpur, studying alongside with Islamic finance professionals. While they are in Kuala Lumpur, they will go through the learning process that includes case studies, problems solving, restructuring exercise, simulation and management games, product conversion exercise as well as Shariah and audit compliance testing.

INCEIF’s relationship with Reading started since last year when both parties jointly organised a continuous professional development programme in Kuala Lumpur that conferred participants the Certificate in Comparative Capital Market.

Mr Agil said Islamic finance is an area where Malaysia and the UK are pre-eminently well placed to work together as both countries have built up significant experience and industry practice.

“The British Government is also doing its bit to strengthen London?s position as a gateway for Islamic finance. The Chancellor, who is now the Prime Minister announced a series of measures aimed at facilitating and encouraging Islamic finance, including taxing Sukuk on the same basis as conventional securities. In April last year, the Economic Secretary announced that the Treasury and Debt Management Office would undertake a feasibility study into the opportunities for the UK Government to issue Sukuk. The legal fraternity is indeed well trained to handle the documentations in Islamic finance. This clear support from the British government, together with the City of London’s deep and liquid capital markets, expertise and innovation, will enhance Britain’s position as Europe’s leading centre for Islamic financial services,” he added.

The UK has also considerable strengths in training, qualifications and standards, in international financial services in general as well as Islamic finance in particular. Other institutions have also started offering courses in Islamic finance. The Securities and Investment Institute in London has developed an Islamic finance qualification that is being offered around the world. The Cass Business School in the City of London has developed an Islamic finance MBA.

Durham, Reading and Surrey Universities meanwhile have highly respected academics working in this area.
Professor John Board, Director of the ICMA Centre said: “We are delighted to launch this programme in partnership with INCEIF. We are already receiving a great amount of interest in this degree and our other new Masters degrees such as Financial Engineering and Corporate Finance.”

Source: INCEIF’s website (http://www.inceif.org)