Islamic Finance: Post 2009 to 2010 and Beyond – A Sustainable Alternative

After three decades of uneven and sporadic growth, the strength and health of the Islamic financial institutions (IFI) as an industry is well articulated by the fact that the industry is 430 IFI strong in 75 countries out of 195, with total assets exceeding US$1 trillion.

The industry continues to enjoy an impressive growth rate that hovers between 15% and 20% for the most part in the last decade when growth was accelerated. The humble start 30 years ago was to serve the Muslim population, which stands today at about 1.4 billion Muslims. The industry growth could have been exponential if each of the 57 Islamic countries established a true Islamic system under its central bank.

The asset management and fund industry has come a long way since it began in the early 90s. Presently, the number of funds exceeds 700 globally, with assets under management (AuM) touching US$500 billion for all asset classes.

In the 10 years of its existence, sukuk has managed to achieve total issuance of about US$24 billion in 2009. This number is expected to climb by 50% in 2010 to reach around US$30 billion, close to 2007 levels, in line with the expected growth in government spending during 2010 and beyond.

Those figures confirm that growth will continue to be the nature of the industry for years to come with plenty of room for even more growth in asset management activities and sukuk issuance. This growth will be parallel to generic growth in IFIs with more countries practicing Islamic investment and finance on a national level instead of being limited to standalone IFIs.

The years 2009 to 2010 will be remembered as landmark years for Islamic investment and finance, as well as the debt and capital markets, where the ordeal of the global financial crisis was overcome.

The crisis confirmed the industry's resilience and strength, regardless of the fact that few IFIs experienced different levels of difficulty during the crisis (whether due to operation problems such as heavy asset concentration, green field projects, valuation and a few with weak risk processes).

Similarly, transactions and in particular sukuk have had its fair share of the crisis. There was also the liquidation of about 30 funds in the same period.

The recent financial crisis and its aftermath presents the industry with a unique opportunity to join forces and resources, come to the forefront and reinstate itself as a global mainstream provider for debt and equity as well as a lawful and genuine alternative that is sustainable and reliable.

As the world becomes more familiar, Islamic investment and finance is for the first time being considered as an alternative to the present structures and schemes in term of products and solutions. Accordingly, we should capitalise on this reality. Islamic investment and finance is no longer a phenomenon or hype, and we should enhance Shari'ahsim system presence globally.

Shari'ahsim system is a term I use to refer to an economic system that continues to evolve and expand based on the collection of fatwas accumulated over the years that stipulate guidelines and rules derived from the main sources of Shariah.

There is a need for the industry as a whole to be segregated from other economic systems as well as develop its character and identity to put things in perspective.

In addition, the system must be identifiable under one unique name when compared or crossed reference with other systems such as capitalism or socialism. Moreover, it falls under the call for standardisation and unification of the industry.

Last but not least, we have one name to consolidate all activities under it including finance, investment, economic, leasing, takaful, capital market sukuk, microfinance, waqf, zakat and funds and such.

In this view, we should label 2009-2010 as the year of rebirth for Islamic investment and finance in the form of a new paradigm – considering we have been through three decades of extraordinary growth filled with ups and down, marked by trials and errors, thus creating a fragmented industry which is natural for the evolution of Islamic investment and finance towards industry institutionalisation, standardisation and globalisation. This new paradigm must evolve under the name Shariahsim System.

With that in mind, the Islamic countries, as well as IFIs operating in non-Islamic countries as a whole, should be turned into the main source for the industry in terms of Shariah, in terms of innovations, development, groundbreaking structures and new funds as well as regulations and standardisation while preserving and protecting the industry reliability and integrity.

This could only be possible if Islamic countries seriously consider the implementation of an Islamic system for investment and finance through their central banks and capital market authorities which will eventually lead to a worldwide regulatory and supervisory structure.

In the same line of thinking, national and international institutions jointly with their regulators, should collectively invest in research and development of Shariah-compliant products and structures including sukuk and funds to foster uniformity and conformity of Shariah-compliant structures and products.

In parallel, this will contribute to the public education and awareness about Shariah-compliant investment and finance.

This new reality is only possible through innovation – as innovation is one of the major drivers of the industry as it will expand the product and service offering and mix. As a result, growth will be ignited in the industry as a whole.

However, innovations should come only from within the Shariah guidelines and not from mimicking or ‘Islamising' conventional structures and products. Also, innovation should be driven by needs and demands and not just for the sake of innovation.

Taking into consideration the future of the global financial industry and its growing regulations and complications, existing Shariah-compliant structures and their fatwas should be revisited, reviewed and consolidated as well as documented.

This will establish a stronger foundation by going back to basics and will pave the way towards standardisation and eventually the globalisation of uniform structures and formats that is Shariah-compliant and acceptable to the critical mass of both Muslims and non-Muslims, without compromising its authenticity and integrity.

We should also concentrate on the fact that Islamic investment and finance have revised new products that should be accepted globally through embracing best international practices in terms of transparency, disclosure, compliance, governance and risk and without compromising the adherence to Shariah guidelines as a threshold to globalization.

Institutionalizing Shariah-compliant products and structures should be a priority at the national level for institutions as well as regulators. This could only become a reality through the creation of a unified Shariah supervisory board under the central banks and capital markets authorities.

This would enhance the standardisation of fatwas and structures while eliminating doubt and suspicion about the industry and its products and structures. It should also eradicate disputes over conformity among practitioners, scholars and investors.

Sukuk is one of the pillars as well as an anchor product of Shariah-compliant investment and finance even though the instrument is only one decade old. Sukuk recently faced a long period of questioning and query that later led to discrepancies and a test of its existence.

In particular, the conflict between sukuk documents and the governing law of the sukuk, besides the transfer of asset to sukuk holders through the trust in case of default. Such setbacks were needed to refine sukuk. Accordingly, the time is right for sukuk to move to the next level of its development and evolution.

Recommendations include:

First, duties of the Shariah supervisory board should go beyond issuing fatwa for sukuk. They must be fully responsible and accountable, from the fatwa to implementation, execution ending with operations and trading. (This role should apply to all related Shariah-compliant structures and products).

Second, sukuk should be introduced at the retail level, thus expanding the trading platform of sukuk to augment accessibility.

Third, the secondary market should be expanded, which will enhance its liquidity and marketability.

Fourth, long-term sukuk of 10 years and beyond should be introduced to increase the diversity and attractiveness of the sukuk.

Fifth, issuance of sukuk should be advanced and encouraged for all three terms (short/medium/long) to expand the depth of the secondary market.

Sixth, sukuk should become a savings instrument option for individuals.

Seventh, the cost of sukuk issuance should be driven down, allowing med-cap businesses to become issuers.

Eighth, more infrastructure and mega project originators and sponsors should utilise sukuk for its financings.

Considering these recommendations will restore confidence in sukuk and attract sizeable liquidity while opening a new window for individual savings while also expanding the secondary market.

Similarly, it will give flexibility to asset managers for better asset allocation as well as developing more innovative products with different tenors and value involving sukuk. At the same time, governments will have additional tools to manage its money supply.

The years 2009 to 2010 will also be remembered for the rediscovery of the importance of risk as well as compliance. Termed Shariah compliance risk, it is the possibility that the financial service or product is not or will not be in compliance with established Shariah principles and standards.

As a term, definition and process, this risk should be incorporated in the risk management for IFIs as well as transactions and funds. This risk should be integrated into every risk assessment and be treated as a standalone risk in the risk management process by every risk officer. It should involve the Shariah internal auditor and the Shariah supervisory board.

The regulators should check this risk for all IFIs as well as their products. The recent troubled transactions and sukuk are a strong testimony for the need of a well identified Shariah compliance risk and mitigation that is usually not found in the fine print.

The impact of non-Shariah compliance on IFIs goes beyond the financial losses to negatively damage credibility and reputation of the IFI.

While waiting for the recovery to accelerate in the financial sector and for the recent euro zone problems to be resolved, the industry should be taking advantage of the abandoned opportunities, which could position them to enjoy the upside of the global economy.

IFIs should rediscover their niche and grow into those untapped segments and products as well as geographic areas as dictated by the needs and demands, not by trends or imitations.

For example, private equity, particularly the med-cap segment, is one of the asset classes that is yet to be tapped by Islamic investors with great potential for growth. In a nutshell, IFIs and asset managers should find the need to fill this niche.

Knowing that strategies are not time oriented but event driven, we need new strategies for new realities, and as a result, strategies must be revisited and reviewed, if not completely revamped.

Both internal and external environments of the IFIs should be involved including clients and service providers. IFIs and asset managers should be ready to bounce back and be transformational.

In closing, going back to basics is not just an option under the present market conditions, it is a must. The process requires us to master our basic products and services while rebuilding our industry future on a solid and sound foundation, thus creating a real economy for the benefit and prosperity of individuals, societies, institutions, businesses and countries regardless of belief and political orientation.

Looking forward, the industry should be categorised and viewed as well as criticised by other camps through transparency and compliance to Shariah guidelines by institutionalisation and standardisation.

This will eventually enable the new Shari'ahsim system to be a worthy contender in the growing global financial market, thus making it a sustainable and consistent alternative.

Dhafer Salih Alqahtani has accomplished over 22 years of experience in Shariah compliance and conventional banking covering asset management, portfolio management, and corporate finance, due diligence, origination and arranging along with advisory.

This article first appeared in Islamic News Finance (Pg 17, Vol 7, Issue 47, 24th November 2010 issue). For more details, please visit