Is Islamic Finance a Catalyst for Inclusive Growth & Sustainable Development?

Transcription

1 Key Messages from the World Bank INCEIF seminar: Is Islamic Finance a Catalyst for Inclusive Growth & Sustainable Development? April 18, 2013 Washington, D.C. H.E. Mr. Ali Babacan, Deputy Prime Minister Republic of Turkey Key Note Speech More than 70 countries use these instruments, not only in the Islamic world but also in the Western world now. More and more countries and states are using the instruments. Success was achieved was by industries strong financial infrastructure, robust institutional framework, and also keen participation from both Islamic and non-islamic institutions. Islamic finance is not just own, managed, or invested by Islamic or Islamic-oriented investors, institutions, and so forth, but it really has a global nature and we should really look at this subject with a global scope. The understanding of partnership and risk-sharing are two of the very important concepts in the scheme. Another important aspect is that financial transaction and the real sector activities are matched one-for-one, so it is not just finance for finance, but it is the real sector, something really going on, whether that s trade, or investment, or infrastructure project, and the financing associated with that is Islamic finance. This brings a lot of prudence to the system, and compared with traditional finance schemes, the risks involved are slightly less. We believe that more and more countries and companies should be utilizing Islamic financing methods and also participation banks or bank based on non-interest banks, should have larger ground to work on. The outcomes are win-win because the system is more risk-adverse, it s good for financial stability so it s good for the state, so the state wins with the Islamic financial system. It s good for projects or companies and investors because costs are lower and the risks are shared. Dr. Ibrahim Turhan, Chairman & CEO, Borsa Istanbul and President, Federation of Euro-Asian Stock Exchanges (FEAS) During the last crisis, we learned that the worst thing you could do in financial services industry is to break the direct monitoring between the borrower and the lender. Islamic finance is perhaps the only mechanism which ensures the durability of the direct monitoring between the lender and the borrower, and could serve as a cure for a better, sustainable and safe international financial system. Once risk is created, you can change the place, change the form, but you cannot eliminate it completely. This was the mistake made by the financial services industry.

2 When it comes to Islamic finance, you acknowledge the risk and both parties are aware of the risk level. While dealing with Islamic finance, we should be aware of the developments in the conventional financial services industry as well. The existence of IFSB is very important because it creates a direct link between conventional finance and Islamic finance. We should be aware of the risks of Islamic finance which can be easily diverted from its origins, as well as be prudent as Islamic financial services expand very quickly. Session I: Islamic Economics and Finance: Linkages to Growth and Development 1 st Speaker: Prof. Dr. Abbas Mirakhor, First Holder of INCEIF Chair of Islamic Finance Topic: Conception Of Development From The Traditional Economic Approach And The Islamic Approach The Islamic conception of development has three dimensions: one, the focus is on the development of the individual s non-material self; second, the development of the earth; and third, the development of collective society as a whole. All of these are inter-dependent. Rules for behaving in an economic framework reduce uncertainty, reduce demand on cognitive ability of individuals, promote coordination of economic activity, and create an environment where transaction costs are reduced and therefore promote efficiency. The economic theory of Islam is that there are rules that are prescribed for behavior of individuals vis-à-vis other individuals within an economic and financial environment, that compliance with these rules has consequences, and that compliance with these rules anywhere will have the consequences presumably attached to observance of the rules. There are only 3 ways of dealing with risk: transfer, shift, or share it. The entire conventional system is based on risk transfer, when we don t know when it will move into risk shifting to a third party. (15:25) What the risk-sharing system does is to ensure there is skin in the game by everybody involved in transactions, ensuring that those who are taking the risk will partially have to pay for the failure of the risk taking project. If you want a robust system, there must not be debt, there must be not be concentration of risk, and there have to be some skin in the game sharing risk in society.

3 2 nd Speaker: Tan Sri Andrew Sheng President of Fung Global Institute For Islamic finance to be a serious competitor in the world of finance today, there are serious theoretical and practical issues that need to be clarified. Islamic finance has to demonstrate that the goals are practical, and also the journey of getting there is also pragmatic. If Islamic finance is to succeed, it must generate liquidity as good as those in conventional finance, protect property rights without moral hazard, needs to avoid imbedded nontransparent leverage in the derivative markets, and it must comply with Shariah. The real challenge of Islamic finance is misalignment between the shareholders expectations of Islamic finance institutions and community expectations, fundamentally between theory and practice. We go into the crisis because there was flawed regulation, based upon flawed financing, including flawed monetary policy, based upon flawed theory which assumed that risk could be measured, but we now know that there s a huge chunk of risk or uncertainty that is difficult to measure. Islamic finance is only just beginning, there s a lot of work to do. It s not just about the supply and demand of Islamic finance but between theory and practice. For Islamic finance to move to the next stage, it needs a risk-management model that incorporates uncertainty. Exercising discipline of the finance in relationship to the real sector is the heart of whether Islamic finance will prove to be a superior system compared with conventional finance. 3 rd Speaker: Dr. Zamir Iqbal, Lead Investment Officer Risk and Analytics, Treasury, World Bank Topic: Islam s Concept Of Development And How It Can Contribute To Enhancing Access To Finance And Financial Inclusion The promise of Islamic finance is a comprehensive pro-development financial system, featuring risk-sharing and emphasising on redistributive aspects for social and economic welfare. Financial inclusion could be enhanced by promoting risk-sharing, which could lead to entrepreneurship, and by institutionalizing Islam's redistributive instruments such as Zakat. Islamic finance is a system which is meant to be more inclusive if these are applied and implemented properly. There is sound theoretical base for the system but the real challenge is how to take it from the theory to the actual realization. There are pockets of excellence which we can learn from and expand upon.

4 Session II: Innovative Islamic Structures: Catalysts for Economic Development and Sustainability Mr. Ahmed Rostom, Financial Sector Specialist, East Asia and Pacific Region, World Bank Topic: Opportunities And Challenges For SMEs In Islamic Finance One of the main challenges for developing Islamic finance is the lack of accurate data from proxies and estimates. However, the data does show dominance in the industry of banking activities. Islamic finance has a long way to on financial inclusion. Outreach of Islamic financial services will foster financial inclusion and ensures liquidity and healthy growth of the industry. Despite the potential, entrepreneurial activities for SMEs in OIC are constrained by the lack of access to finance or high cost of financial instruments. The entrepreneurial potential can galvanize growth and development through risk sharing inherent in Islamic finance. SME loans are being denied access to financial services due to the structure of the debt-based system. We need a paradigm shift to equity-based investment partnership which is willing accommodate for risk-sharing with SMEs. Islamic finance has potential to fill a portion of global - around USD 0.5 trillion - SME s financing gap. A risk-sharing friendly environment requires an accommodating institutional capacity. Prof. Dato Dr. Mohd Azmi Omar, Director General, Islamic Research and Training Institute (RITI), Islamic Development Bank Topic: Share Activities Of IDB In Context Of Risk-Sharing And Support For Islamic Finance, Brief Description Some Of The Financing Products And How They Link Up. Important components of SME and micro-financing are equity funds, lines of financing, and technical assistance, which comprise a comprehensive solution rather than a purely financing or purely technical assistance. Latest model: IDB provides the equity fund to the microfinance or SME institution under the profit-sharing model. The institution would provide profit-loss sharing with the client. IDB ensures the end client will have the training and expertise because this venture carries higher risk. IDB also ensures that institutions have the right capacity and capability to manage this new type of venture. There is no one single instrument to solve the risk-sharing issue; have to use a combination of financial instruments from exchange-based to equity-based instrument.

5 This model was able to create 485,000 jobs from various microfinance and SMEs. Policy recommendation - propose rather than having a credit-rating agency, who only looks at ability to pay, is to have a business-rating agency to evaluate the whole expertise of the client, in terms paying ability, managing business, skills, in order to fully implement the equity-based model. Prof. Dr. Obiyathulla Ismath Bacha, Professor of Finance Head of Graduate Studies Department INCEIF Topic: How Islamic Finance And Risk-Sharing Can Change The Debt/Equity Trade Off Mudarabah and Musharakah contracts, because they are hybrid instruments with features of both debt and equity, the profile and substantially reduce the advantage of debt, making debt less attractive. With Risk-sharing financing, the SME gets the benefit of equity issuance without the dilution of concentrated ownership structures. Yet, like equity issuance, there is reduce cash flow volatility while financial flexibility is intact. The implication is reduced risk premiums because you are a safer entity Linking sukuk returns to GDP performance would allow governments to then issue sukuk to raise development financing for need development expenditure (traditionally financed by debt instruments), thus avoiding vulnerability to the issuing country and removing bottleneck from limited funds- no loss of ownership, currency risk is minimized. Risk sharing framework has promise especially for development financing for less-developed countries. What risk-sharing promises is change in trade-off profile, making debt less attractive, broader participation of the population in development, dissipation of the risk, thereby minimizing macroeconomic vulnerability, returns that are anchored to real assets. Islamic finance based on goodwill and trust will require the strengthening of governance structures. Dr. Mahmoud Mohieldin The World Bank President s Special Envoy Special Address So we have now the Islamic Economic and Finance working group, that is not going to be solving the problems of the world, but at least it s a recognition by the World Bank Group that finance alone is not enough and the economy alone is not enough, you need to put that in an overall system of governance and institutional framework and other principles of getting things done within the society.

6 The profit and loss sharing paradigm is making the most important link that we sometimes ignore between finance and the real economy. There is a fundamental link between finance in the Islamic financial structure and the real economy that cannot be ignored, ever, because it always assumed that every financial transaction has an underlying transaction in the real economy or a real asset behind it. So you cannot have finance for finance, you cannot see finance growing while the real economy is having a dive and not preforming, this strong link between financial development and economic growth is there in the framework. The main difficulty is that you don t really have in practice so far a kind of a complete version of what could be considered an Islamic economy, you have good progress as mentioned in the previous sessions, the financial transactions have been there, the variety of financial innovations have very much been there, (13:17) But actually to have this kind of a system that is based on the principles of the aims of Shari'ah and translate that into practice is the real challenge. The growth [of Islamic finance] is not important. It s basically about the quality of growth, about the discipline, about the demonstration effect. Because if anything goes wrong at this stage of development it s going to be very counterproductive. That s why I celebrate the work by INCEIF, by Bank Negara Malaysia, by the IFSB, for this kind of emphasis they have on prudential regulation, on the quality of supervision, on training those who are working those who are working in the industry and training the supervisors and the regulators, and equally important for the public seminars that they are doing for spreading the word of Islamic finance and financial literacy as part of the enhancement of knowledge in dealing with financial institutions. Then you get into inclusive growth. The arguments here if Islamic finance manages at least in the economy that has a significant number of Muslims and equally important, as mentioned by Governor Zeti, for some people who believe in the quality of the service so they would come and subscribe to it and deal with it, even if they are not of the believers of Islam, that would be the good thing here it s about inclusion, that you are going to provide a service for some people who are preventing themselves from engaging in it because it does not really addressing their own cultural constraints. (21:46) but this does not mechanically mean inclusiveness in the economy and inclusiveness in the society, but this is a good starting point, you don t need to stop again in the financing part. There is a very big challenge as far as sustainability is concerned, with the challenge of climate change and of the environment. And here I think you are not just going to be using Islamic finance as a tool, but you can use it as part of the incentive structure to provide discipline to a system that really recognizes the rights of all of the people in the whole world, in all generations, those who are living today and those who are living in the future because this is part the development of the Earth that should be recognized that any kind of harm caused to the environment and its resources is forbidden, so this is part of the ethical issues and the values.

7 The challenge of Islamic finance and Islamic financial institutions and those who are working in it is much bigger than those who are working in conventional finance, not because conventional finance has there for ages, not because it has more financial institutions, but conventional finance, despite its problems, crises, ups and downs, it has an economic system with articulation, with a well-defined political economy, with all its problems supporting its work. I m afraid that this is not the case for Islamic finance and Islamic financiers, because they are leading the way in matters for many others, from the legal, social, and economic development perspectives, from the whole governance structure, who are not really doing their part in it. So this question then, I have the answer or an attempt to answer with all of the deficiencies that could come with this answer-- Is Islamic finance a catalyst for inclusive growth and sustainable development? Yes, with modesty, with humility (25:58) As far as the role of finance here, it should be put in context, as it is with conventional finance, there are limits, there are liabilities, there are advantages. Yes it s a catalyst, but you need to solve the other bigger questions of political economy.