1 GLOBAL CRISIS: ISLAMIC FINANCE CAN LEAD TO BETTERMENT By Muhammad Ayub Director Research and Training, Riphah center of Islamic Business Riphah University,

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GLOBAL CRISIS:GLOBAL CRISIS:

ISLAMIC FINANCE CAN ISLAMIC FINANCE CAN LEAD TO BETTERMENTLEAD TO BETTERMENT

ByBy

Muhammad AyubMuhammad AyubDirector Research and Training,Director Research and Training,

Riphah center of Islamic BusinessRiphah center of Islamic BusinessRiphah University, Islamabad Riphah University, Islamabad

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In the Grip of Crises- In the Grip of Crises- 2008 onward2008 onward

The most severe since 1930s’ great depression;

Alan Greenspan: ‘great tsunami’ Started from the US - other parts of the

world - US Dollar and the huge size of the American economy - also owing to the ‘mighty’ US Dollar.

Over $3 trillion of bailouts and liquidity injections to abate the intensity

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More Advanced: More in gripMore Advanced: More in grip

100s of institutions in USA, UK and 100s of institutions in USA, UK and Other developed world closed – not even Other developed world closed – not even single in countries like Pakistan – had single in countries like Pakistan – had crossed all ethical and shariah based crossed all ethical and shariah based limits.limits.

Sovereign Debt problem – Europe, poor Sovereign Debt problem – Europe, poor indebted countriesindebted countries

CAUSES OF THE CRISIS Excessive ability to create money and credit ..carrying fixed charge; creating billions of

dollars by simply shuffling the papers and transferring risk;

Adding to wealth of already rich without creating anything of value for use by the mankind.

A large number of investment products, without any underlying real assets by way of selling of accounts receivable and derivatives.

CDOs, interest rate swaps, interest rate futures, forward rates agreement, Forex trade options, warrants and options on futures contracts. 44

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ImplicationsImplications

Increasing poverty and hunger for Increasing poverty and hunger for billions of human beingsbillions of human beings

World Bank report, January 2010: 64 World Bank report, January 2010: 64 million more people living in extreme million more people living in extreme poverty by the end of 2010 than would poverty by the end of 2010 than would have been the case without the crisis. have been the case without the crisis.

Risk of “currency war” – collapse of Risk of “currency war” – collapse of the global payments system. the global payments system.

NEED FOR NEW F. ARCHITECTURE

An ethical requirement– not only An ethical requirement– not only Shariah injunction; Shariah injunction;

comprehensive reforms to help comprehensive reforms to help prevent chaos and spread of prevent chaos and spread of financial crises financial crises

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I. F. Principles can helpI. F. Principles can help

Strict moral guidelines for dealing with money, prohibition of debt trading and speculation;

To provide checks for the factors that distorted the system

So, better ability to sustain in the hard times.

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ISLAMIC BANKING GROWING Even during the crisis; double digit growth Even during the crisis; double digit growth

last 20 years in terms of:last 20 years in terms of: Volume Scope and Assets Spreading worldwide

Assets held by IFIs worldwide are estimated to be over $1000 billion - figure may vary due to the coverage of institutions;

While the prospective market according to Standard & Poor's is that of $4 trillion, the global assets are expected to hit $1033 billion by the end of 2010.

In PakistanIn Pakistan

Covering 6 % of the banks’ market; Covering 6 % of the banks’ market; expected to rise to 12 % by 2012;expected to rise to 12 % by 2012;

Islamic banksIslamic banks IBBsIBBs About 600 branches in all major towns of

the country MFIsMFIs Islamic FundsIslamic Funds

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Crisis Impact on IFIsCrisis Impact on IFIs

IFIs escaped due to general prohibition of IFIs escaped due to general prohibition of Gharar, Riba and risk-free return on Gharar, Riba and risk-free return on investments.investments.

Dubai debt crisis of 2009 exposed the weaknesses of ‘Islamic banking’ due to a number of objectionable products adopted by the IFIs.

Derivatives – “Islamic” options and swaps.

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PRINCIPLES TO BE FOLLOWED

Avoiding: Riba: earning any return from loan and

debt contracts or selling debt contracts at discount;

Gharar – absolute risk / uncertainty about the subject matter or the price in sales and financial transactions;

Gambling and chance-based games); Observing: General Prohibitions /unethical

practices

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PRINCIPLES Risk & Reward - Owner of an asset has

both risk and reward;

Forward trading with strict conditions of delivery and settlement

Possession / delivery - ensuring that risks and liabilities pertaining to an asset are properly taken by the owner;

Public financing: disciplining the fiscal behavior of the governments

Possibility of getting real benchmarks for pricing of

goods, their usufruct and the services, both in cash /credit

markets, - reflecting real demand/supply scenario and the strength of the economy

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IFIs not allowed exposure to CDOs, derivative products and

intra-financial counterparty risk that crippled the conventional system;

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WHY IFIS FAILED TO AVAIL OF THE OPPORTUNITY

Financial engineering to mimic the conventional product – derivatives and swaps that crippled the conventional system – beneficial for IFIs?

Permitting the haram contracts by use of Wa’d

Separating risk from real economic activities and making it traded separately;

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General Concerns about I. B.General Concerns about I. B.

Does not reflect the ethos of Islamic teachings - ; ‘Structured products’

Strayed from the theoretical foundation;

Tawarruq - the predominant instrument;

LIBOR - benchmarks used as a determinant of interest on non-Shariah compliant assets, not only as a pricing tool.

Can Islamic banking in present Can Islamic banking in present structure lead to betterment?structure lead to betterment?

Not capable to play a significant role in ensuring health and

stability of the national and global financial systems

PROBLEM OF OPERATION – NOT OF THE SYSTEM

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Solution lies in:Solution lies in:

Observing Shariah and Ethics:Observing Shariah and Ethics: Disciplining the creation of money; Limiting the self-interest with social

interest and the business ethics, and Transforming the corrupt financial system

to make it free of exploitation and games of chance

Thus enabling the mankind to optimally use the resources for benefits at the larger scale.

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To Avoid Convergence To Avoid Convergence with Conventional with Conventional System:System:

Islamic finance must avoid imitating the practices of conventional banking

To avoid

The same fate as faced by the capitalistic system.

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CHALLENGES

Ensuring the real difference between the two systems - the main key to the stable and long-term growth;

Changing approach of the practitioners that all conventional products should have alternatives;

Developing benchmark based on real performance of the economy- by linking the money and credit expansion to the growth of the real economy 2020

CHALLENGES

Supply of trained human resources having Shariah inspiration and confidence to operate the system ;

Standardization: Standardization: risk management, regulatory, accounting and market standards - based on AAOIFI Shariah Standards;

Many practitioners -using the dubious structures like that of Ba‘i al Inah and Tawarruq - operating ‘Islamic’ hedge funds based on options and derivatives do not really feel any need for standardization 2121

To ConcludeTo Conclude Islamic banking Islamic banking is in position to play crucial

role interrelating finance, economy, community and society enabling the world to avoid crises in future;

To carry out operations according to the fundamental principles of Islamic economics and finance;

To expand their role in the real sector; AAOIFI’s Standards must be applied for all

banks and areas. 2222

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