Archivo de octubre/2009

Brendan Quirk (IMBA 2009 class) has written this blog on Islamic Finance. I hope you enjoy it as much as I did.

Last week, IE had the pleasure to have Dr. Ibrahim S. Aboulola, from the Islamic Economic Research Center at King Abdul Aziz University in Saudi Arabia. Dr. Aboulola came to speak to the students about Islamic Finance.

Given today’s current banking crisis. Recently, there has been a lot of interest in Islamic Finance these days because it is not only a widely used and proven method of financing but has an ethical component as well, which has been lacking in the current system used in the west.

For that and many other reasons Islamic Finance is being used more and more in the west. According to Ernst & Young in this year’s Islamic Funds and Investment Report, there have been significant increases over the passed few years with the number of 700 funds and now reaching almost US$ 50 billion in fund assets under management.

So what is Islamic Finance? Well what we learned from the Dr. Aboulola’s lecture is that Islamic Finance is a form of financing used in Islamic banking institutions that work in accordance with Islamic Law, or Shari’a. It is understood broadly to be asset based and not currency based because it does not use interest on money lending. This is the idea known, as Riba is that money has no intrinsic value and is only a means of payment. Therefore, Islamic Banking is linked and directed to real activities like buying physical assets like a house on behalf of a borrower. Then the borrower pays the bank payments that are previously agreed to. I know what you’re thinking. Same as western finance, right? Wrong. These payments are fixed and there is no interest on the money. It’s based on ownership and exchange of real assets and not money. Therefore, it avoids potential injustice by unfavorably enriching one party at the expense of another.

Therefore, each bank has a Shari’a board that serves as an oversight committee of Muslim scholars from many different parts of the community to ensure the integrity of the investment as well as its religious sanctity. They serve as a control and review all investments to make sure they are in line with the laws of Islam and issue a fatwa or ruling on each and every investment that the bank is considering to invest in. In that concept at the core is that ethics is considered in the business deal. Yes, I know this is hard to understand from a western point of view. Therefore, gambling, alcohol, and pornography are prohibited. And so is interest on the assets or currency. This is because money has no intrinsic value, and is only a measure of it and therefore believes that one should not charge for its use. Now this makes sense and is a total rethinking of western finance, however it has been around a long time.
Being based on real assets avoids some risks because it shares the risk between the borrower and the lender and does not get out of hand. That means in the event of a default the losses are shared and then it is done. There is no interest that keeps accumulating or overwhelming debt trap that is becoming all too common in western society. Therefore, you could imagine that there is a lot of credit risk assessing before a deal is made in Islamic Finance.

The truth is that putting ethics in finance has been long overdue and it is about time that this is making news. I really tip my hat to the Islamic world for having done so and for their success with it. A true testament to what the Islamic world can teach the west.

As all the derivatives participants know, this measure is more a populist advertisement than an effective measure because it is very difficult to value exotic swaps. So once again, I strongly doubt that a bunch of public servants can do it.

See below for an excellent article by Bloomberg.

Legislation tightening oversight of the $592 trillion over-the-counter derivatives market would give regulators authority to ban so-called abusive swaps.

The Securities and Exchange Commission and Commodity Futures Trading Commission would get the power to “prohibit transactions in any swap” that regulators determine “would be detrimental to the stability of a financial market or of participants in a financial market,” according to a 187-page draft measure released yesterday by House Financial Services Committee Chairman Barney Frank.

Opaque financial products, including some derivatives, have contributed to almost $1.6 trillion in writedowns and losses at the world’s biggest banks, brokers and insurers since the start of 2007, according to data compiled by Bloomberg. Among fallen companies are Lehman Brothers Holdings Inc., the investment bank that filed for bankruptcy, and insurer American International Group Inc., which has been surviving on government loans.

“Lacking and lagging regulation of OTC derivatives was a major contributing factor to last year’s crisis, including the highly leveraged credit-default swaps at AIG that prompted government intervention,” Representative Melissa Bean, an Illinois Democrat who serves on Frank’s committee, said in an e- mailed statement.

The legislation offered by Frank, a Massachusetts Democrat, would require the most common and actively traded over-the- counter derivatives contracts to be bought and sold on exchanges or processed through a regulated trading platform.

‘Clear Window’

“We can’t effectively protect American consumers — and make sure they are paying fair prices for food, gas and other commodities — unless we have a clear window into the trading that affects commodity pricing,” Bart Chilton, a CFTC commissioner, said in a statement that described Frank’s proposal as helping “to move this discussion down the road.”

The measure also would give the Treasury Department the final say if the SEC and CFTC couldn’t agree on joint regulations, including setting position limits or the treatment of products that are economically similar, such as stock options and stock futures. A three-page proposal released by Frank in July would have given that power to a new Financial Services Oversight Council.

Derivatives are contracts used to hedge against changes in stocks, bonds, currencies, commodities, interest rates and weather. Credit-default swaps are derivatives that were created primarily to protect lenders and bondholders from company defaults. Some lawmakers and regulators have said they may have been used to spread false rumors about financial companies to drive down stock prices.

‘Naked’ Swaps

Frank’s proposals stopped short of barring “naked” credit-default swaps, where the buyer doesn’t own the underlying asset being hedged. The lawmaker had said he was considering such a ban.

The draft by Frank won praise from potential opponents in the New Democrat Coalition. The group, which includes Bean and describes itself as moderate and “pro-growth,” had offered competing legislation that would have given Treasury veto power over regulations enacted by the SEC and the CFTC.

“Chairman Frank’s draft provides a solid start to discussions about reforming the derivatives market,” said Representative Michael McMahon, a New York Democrat who was lead sponsor of the competing measure.