What’s next for Islamic finance? Booking Revolution

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Islamic finance has long since reached a point of critical mass. The exuberant innovation of the early 2000s has been replaced by a mood of careful consolidation.

Islamic financial assets were worth $3.6 trillion at the end of 2021, according to the State of the World Islamic Economy Report; Global sukuk issuance was $181bn in 2021, according to Moody’s, while Fitch says Islamic funds were worth $130bn at the end of 2021, before falling with the rest of the market this year.

These are big numbers that are not going to decrease and instead should grow pretty automatically from now on. And now that?

The Islamic finance industry is at a philosophical turning point. It can cement its profits as a credible and important part of the global financial architecture, or try to use its muscle to shake everything up and target a bold new model.

This question was hotly debated at the Global Islamic Finance Forum in Kuala Lumpur this week (October 5-6), which revealed an intriguing range of views on what Islamic finance should do with its hard-earned peso.

Among those who think practical consolidation is the answer is Mukhtar Hussain, best known for his many years at HSBC, including stints as chief executive of HSBC Amanah (the bank’s Islamic finance arm) and HSBC Malaysia. Islamic finance, he says, now represents about 1% of the financial universe.

“One percent may seem like a very small thing, but in the context of an industry that is essentially 50 years old, that’s a lot of progress in a relatively short period of time,” he says. “But clearly there is an opportunity to significantly increase that number in the next few years.”

There are so many vested interests in retaining the fractional reserve system… that it won’t happen as a general architecture. However, seeing it applied in an Islamic jurisdiction would be very interesting.

Hussain advocates continued growth along the same lines as today, although he says there should be more focus on liabilities and liability management, as much as assets.

“What I would say to those who strongly support the idea of ​​turning the financial system to be more Islamic than it is, I would say…it is exactly the right thing to do,” he says.

“But remember, idealism has a place, but the reality of idealism is that it needs to meet realism. And then that realism needs to be translated into practical, pragmatic steps that translate that idealism into some form of commercially sustainable reality.”

For Hussain, the development of Islamic finance has been elusive: “Islamic finance began largely as a price taker”, but its subsequent gains in scale and sophistication meant that it “began to control its own destiny in terms of innovation, in terms of product, in terms of structures”.

He argues that only through continued building of that market share does Islamic finance gain the opportunity for further disruption of the financial system in general.

For others, that’s not enough, including Alaa Alaabed, managing director of Wethaq Capital Platform in Bahrain. She wants nothing less than the abolition of the fractional-reserve banking system, the banking model that operates in most countries around the world through which deposit-taking banks hold a proportion of their liabilities in liquid assets as a reserve and can to loan. the rest.

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Alaa Alaabed, managing director of Wethaq Capital Platform in Bahrain, speaking at the Global Islamic Finance Forum in Kuala Lumpur this week

Alaa Alaabed, managing director of Wethaq Capital Platform in Bahrain, speaking at the Global Islamic Finance Forum in Kuala Lumpur this week

In his opinion, a full reserve banking system, which would mean a 100% reserve requirement for demand deposit accounts, with loans only against time deposits, would be more in line with the principles of Islamic finance in terms of proper alignment of risk and reward.

“There is no denying the fact that the current formation of Islamic banking has emerged from conventional banking and uses many of its techniques and instruments,” he says, including fractional reserve and deposit insurance systems.

“Scholarly efforts have long linked the connection between the fractional reserve system, leverage, credit booms, and busts,” he says, in that they pile up debt in the economy, inflate bubbles, and decouple finance from debt. real economy, aggravating problems.

“Deposit insurance schemes are to blame for misaligning risk and reward,” he says. “Banks can harness the full potential of risky transactions, while the downside is limited. Those who will benefit from the full advantage are covered from the disadvantage”, which incentivizes them to take on risk and debt beyond the best interest of society.

In his proposal, banks would be required to maintain the full backing of demand deposits and, in turn, depositors would not expect monetary compensation for them. However, Islamic investment account holders would fully share both the advantages and disadvantages of the transactions.

On a global level, there is clearly no chance of this happening.

Full reserve proposals come and go from time to time, Iceland and Switzerland being recent examples, and the idea was even pushed in the US after the Great Depression. Such powerful voices as Milton Friedman and Martin Wolf have favored her from time to time.

But there are so many vested interests in retaining the fractional reserve system (and the hope, if not necessarily the proof, that it will spur growth) that it won’t happen as a general architecture.

However, seeing it applied in an Islamic jurisdiction would be very interesting.

In a number of Islamic nations, Malaysia in particular, there is a renewed focus on trying to wring social good out of Islamic finance, rather than simply congratulating one another on having secured such a large asset base: the Securities Based Brokerage Program. Bank Negara Malaysia, for example. , seeks to translate that transaction into a tangible positive impact.

Could Malaysia, Iran, or Saudi Arabia (or Bahrain, perhaps) ever consider trying to require full reserves on deposit accounts, to see how much it affects bank viability (terribly bad for profitability, presumably, since they have deposits ) as consumer behavior? and economic growth?

The debate, which also involved CIMB’s Rafe Haneef on the no change side and Waafi Bank Chairman Mohamed Ashraf Iqbal on the change everything side, was purely academic. It was no surprise to find Alaabed, one of the smartest voices in the industry who twice won Malaysia’s INCEIF President’s Award while pursuing his Ph.D., eloquently arguing for a theoretical idea.

Islamic finance will most likely continue to evolve along the rails it has long laid, cementing its gains and building a voice in individual economies. But questioning the whole thing, and how it could be improved or reinvented, is exactly what the industry should be doing.

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