Wednesday, December 05, 2012

Islamic financing, a perfect system?

By KHAIRIE HISYAM ALIMAN - NOT FOOLPROOF: Despite the advantages offered by the Islamic financing system over conventional banking, is the system itself foolproof? NST RED talks to Baiza Bain, Managing Director of Amanie Advisors, on the changes necessary in the Malaysian Islamic finance industry Following the US subprime mortgage crisis, various quarters have claimed that application of Islamic principles to international financial markets would have prevented such a crisis, as the trading of trillions of dollars without assets backing the transactions as had happened during the crisis would have been against Islamic law. However, would the practice of Islamic financing principles have prevented the US subprime mortgage crisis or is it really of no consequence? Implementation is key: “It’s a tough question,” muses Baiza. “I suppose it is not down to whether the banking system is Islamic or conventional; rather, it is down to how the banks implement their credit policy.” “Islamic or conventional does not matter, really.” Clarifying further, Baiza explains that the regulation of the system should focus on the people, not the product. Regardless of the system used, the potential for abuse will always be there. “The problem lies with the players in the market because they dictate how the market will run.” “In the US, borrowers really don’t have a choice since not many companies offer Islamic financing,” adds Baiza, pointing out that this leads to borrowers trying very hard not to default as they have few alternatives should they default on their loans. “The bottom line is how the banks implement their credit policies — it should be in line with market practice.” However, Baiza quickly notes that there is no risk of such a crisis in the Malaysian market due to the strict monitoring by the central bank. “Recently banks were instructed to tighten their financial policies and even car loans are not easily attainable anymore since we are going on net pay as opposed to gross pay.” “This was implemented in the market to ensure that the default rate stays low,” explains Baiza. “In other words, only those who can afford to pay the instalments get financing.” More options here: In comparison to the US Islamic financing market, Baiza comments that Malaysian consumers are somewhat “spoiled due to the many choices available whereas in the US, options are quite limited.” “We have many banks offering good products, so people have the option of changing from one product at one bank to a different product at another bank,” explains Baiza. “It is more liberal in Malaysia in a sense that you can move around within the market of Islamic banks that offer mortgages.” “In comparison, you can’t do that in the US because there would probably be just one or two companies at most offering Islamic financing products.” Domestic improvement: However, Baiza sees room for improvement in terms of home mortgages using the Islamic financing system, especially in terms of standardising domestic practices. “It is good that there is some standardisation in the market — you can leave some room for banks to be creative in terms of what they offer, but as far as documentation is concerned, if products are similar then we need to introduce some form of standardisation,” points out Baiza, adding that such standardisation would bring benefits such as reducing legal fees and easing processes. “In fact, the central bank is currently moving towards that.” “They are introducing Shariah parameter references, essentially practice notes to industry players explaining how each type of contract can be used,” says Baiza. “For example, in the case of murabahah — what are its applications, the fatwas supporting its use, the parameters in which the murabahah can be applied, etc.” “So it is basically a guide for industry players — not to curtail creativity, but to ensure that the application is the same,” notes Baiza, clarifying that “this is to avoid misinterpretation and to close the gap on how the contracts are being implemented.” According to Baiza, the parameters cover six types of contracts: Murabahah, Ijarah, Mudarabah, Musharakah, Istisna’ and Wadiah. “Two are in practice now whereas four are still in progress,” says Baiza, explaining that each parameter is worked on with input from industry players until it is completed. Standardising standards: Baiza also highlights that there is a significant difference in how Islamic financing is done in Malaysia as compared to the rest of the world, especially the Co-operation Council for the Arab States of the Gulf, also known as the Gulf Co-operation Council (GCC). “We do have differing standards, although both are heading in the same direction and would eventually merge, so to speak.” “Even equity screening for shariah-compliance was previously unique to Malaysia — no other country did it,” notes Baiza, adding that the screening is done based on our local settings and interpretation of Islamic guidelines. However, the days of different standards and practices are numbered. “Over the years, there has been a lot of dialogue between Malaysia, the GCC parties and the rest of the world,” comments Baiza, explaining that as a result, the Securities Commission is now moving towards adjusting Malaysian standards to be in line with international standards. “It will be implemented next year.” How is the Islamic financing market receiving this development though? “The buzz in the market is good,” answers an upbeat Baiza, sharing further that “we advise quite a number of fund managers and they have problems when going into the GCC region because if they use the Securities Commission’s equity screening methodology, it may not necessarily comply with international standards.” “So after the implementation, Malaysian funds will be more palatable to the GCC market,” concludes Baiza. Read more: COVER STORY: A perfect system? - RED - New Straits Times

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