Liquidity management challenge for Islamic finance

MUSHTAK PARKER: Addressing the issue on an international basis has been a bane, says Islamic banker.

IN the last instalment of a three-part interview, Mushtak Parker, the leading journalistic voice on Islamic finance, shares his views on the International Islamic Liquidity Management Corporation (IILM), education in Islamic finance, moving the industry to US$2 trillion (RM6.22 trillion), scholars on multiple boards, the late Dr Zaki Badawi and, finally, how he would like to be remembered. The following are excerpts from the interview.

Question: What are your expectations of IILM in addressing liquidity management?

Mushtak: The objective and establishment of IILM is highly commendable. But the process of its conception and perhaps its immediate operational plan is flawed. As with many industry organisations in Islamic finance, it lacks transparency — even the way its CEO was selected was not transparent. We are told that the CEO was head hunted by a top international recruitment agency, but at the same time the powers that be refused to reveal the name of the other candidates involved. 

To be frank, both the industry (at least those I spoke to) and I are concerned that the IILM will not address this vital gap in the Islamic finance system. Addressing short-term liquidity management of IFIs on an international basis has been the bane of the industry. 

The insistence that the IILM will only issue “AAA” rated papers, when the incidence of such issuances in the market is woefully small and most of the countries involved do not have an “AAA” sovereign rating, is inexplicable. There seems to be naïve or perhaps emotional or uninformed reliance on the fact that some of the founder members of the IILM will rush to issue “AAA” sukuk or contribute asset pools which would be the underlying for “AAA” papers under the corporation’s aegis.

Two-Year Anniversary

Approaching the two-year anniversary, the IILM has yet to issue its debut sukuk, which we are told is imminent but in reality has been on the cards for the last six months. The reason was that the rating process of such an issuance has been a drawn-out one by the three major international rating agencies. The pilot issuance will also be a modest one – in the range of US$300 million — which is not exactly going to set the liquidity management task on fire. 

Tan Sri Dr Zeti Akhtar Aziz, governor of Bank Negara Malaysia, a key driver behind the IILM, would ideally like to have an issuance programme in excess of US$2 billion per year. But realistically it will require a Herculean issuance effort to achieve that. The danger is that if the IILM does not meet the above expectations, it could ironically further set back the liquidity management challenge in the Islamic finance industry.

Many countries where Islamic banking is practised do not have a syariah-compliant government issuance programme in place to manage reserves and short term liquidity needs of Islamic banks. When questioned about this, many central bankers have told me they are waiting for the IILM to develop such instruments. 

This outsourced reliance on the IILM is stunting the introduction of sovereign sukuk and government notes in many countries, albeit it initially domestic issuances for domestic local currency liquidity management. I sincerely hope that the IILM can get its act together for any non-issuance of a debut sukuk this side of the end of 2012 will start impinging on its credibility. 

Question: A number of world-class universities have tried make contributions in IF, Harvard, Oxford, etc, and dedicated universities, like INCEIF and research-oriented ISRA. How would you rate them today?

Mushtak: Islamic finance education remains a major enigma, anomaly and challenge. Unfortunately, the education gene has mutated for the worse in most Muslim countries where education has become politicised. 

How do you approach Islamic finance education — from an economics and finance vista? From a market and socio-economic vista? From a faith and therefore Fiqh Al Muamalat vista? Or from a bit of all three vistas? 

The other issue is that a truly Islamic banking theory has not been fully developed and discussed. People such as Dr Abbas Mirakhor, in my opinion the outstanding Muslim economist of his generation, have made invaluable starts in this respect, but as a corpus and intellectual exercise, Islamic economic and banking theory remains woefully inadequate and underdeveloped. 

Codify Fiqh Al Muamalat

There may be a need to codify Fiqh Al Muamalat, and I know several scholars who agree on this, but it is mammoth task that will take decent resources and time. Instead, the industry paid millions to the likes of Harvard to research and publish “definitive books” on Islamic finance and what we got instead is a staid and predictable book on Islamic finance law and issues and a casual attempt at what the late Dr Zaki Badawi suggested was to introduce a new “Harvard Madhab (School of Islamic Law)”. 

INCEIF

INCEIF is a commendable project, but unfortunately a lot of things got wrong from the onset. 

It is inconceivable that a retired conventional banker was heading a prestigious Islamic finance education project with no experience in running an educational establishment let alone in Islamic finance practice, no matter how limited. 

IF Education Future

I tend to be optimistic about the future of Islamic finance education, because it is driven by market demands. However, the future quality of the industry will be reflected by the current quality of Islamic finance education. So there is a lot a stake. Once we get the whole process of global accreditation of universities and courses offering Islamic finance and economic education sorted out then the transformation to a more professional and systemic dispensation may be quicker. 

I know the Malaysian government has granted resources to one of the local universities to collaborate with a major American university accreditation body to develop a global accreditation system for Islamic finance education. I cannot stress the importance of getting this right.

Question: Where does IF need to focus on to get to US$2 trillion? Microfinance? SME? VC/PE? Trade?

Mushtak: This is a challenging question. I can highlight several areas but if the industry is not equipped or unwilling to accommodate those areas or products then there will be no impact or movement. 

Let me approach this question from the three areas of an Islamic economic system — the siasi (public sector); the tijari (private or commercial sector) and the ijtima’I (the social welfare sector). In the public sector, Islamic finance has yet to make deep enough inroads in monetary and fiscal policy requirements. 

This even applies to countries such as Malaysia and Bahrain. Government external borrowing requirements based on Islamic structures would give a major boost to the industry. Similarly, the involvement of sovereign wealth funds (SWF) could be a game changer. The Muslim SWFs are some of the largest in the world and, yet, apart from Khazanah Nasional, their involvement in Islamic finance even in the sukuk sector is paltry. A small percentage shift in the direction of investment of some of the SWFs and so on into Islamic finance portfolios could almost single-handedly meet that US$2 trillion target. 

I do not accept the argument of some of the SWFs that the Islamic finance industry is not capable of absorbing the sheer scale of investment suggested. These SWFs are run by vested interests with a scant understanding let alone commitment to Islamic finance or investment. 

Still on the public sector side, the demand for infrastructure financing; for SME financing and for microfinance because of an increasing awareness of financial inclusion especially in the wake of the global financial crisis, is increasing. The infrastructure spend of the OIC countries alone is estimated to be in excess of a few trillion dollars over the next 20 years. Even if a small percentage is financed on a syariah-compliant basis, it boosts the market size enormously on an incremental basis. 

OIC member countries should adopt a policy as in Malaysia where any major state-funded infrastructure project must have an Islamic finance component. Look at the recent RM30.6 billion PLUS sukuk for the management of national highways in Malaysia. It is the largest sukuk programme to date in the world; it contained a privatisation component; it has employment generation and revenue accruing (through toll roads) components; and it has a direct impact on the real economy.

Takaful Neglect

One area that is hugely neglected is the takaful sector, potentially much bigger than the Islamic banking sector but incapable of taking that great leap forward, This has been due to manifold reasons — lack of regulatory and legal frameworks; low capitalisation therefore underwriting capacities; dispute over which Islamic models to use; misplaced cultural issues over the very acceptability of insurance; and so on. 

The takaful sector has largely concentrated on general and family takaful. Yet there are other market segments begging to be leveraged — commercial and credit risk takaful (to complement those huge Murabaha book business); export credit and investment (political risk) takaful; sukuk takaful and third party guarantees (which would satisfy Justice Taqi Usmani concerns over issuers guaranteeing the principal in Musharaka and Mudaraba sukuk). Institutions such as ICIEC, Eximbank Malaysia, Dhaman, Turk Eximbank, etc, are trying to do something in this space, but once again the export credit agency culture remains underdeveloped in the OIC countries. 

Wealth, Waqf & Zakat

Then there are opportunities in private wealth management — asset management, pensions, and annuities, estate planning and inheritance. In the conventional economy, it is the pension funds that drive investment and other activities. The same should happen in the Islamic finance space. 

Finally in the welfare sector, there are also huge opportunities — zakat and waqf run into a few trillions of dollars according to one estimate and given the fact that there are about two billion Muslims in the world. For example, in the late 1990s it was the Islamic Religious Council of Singapore that issued the first social sukuk against a waqf property. It was a modest S$25 million issuance based on a Musharaka structure. 

Question: With the limited number of scholars on so many boards, does this produce a credibility risk for the industry?

Mushtak: Yes, there is a credibility, reputational and conflict of interest risk. I have said in an earlier answer that the solution is the regulation of the syariah advisory industry. The Malaysian model once again will eventually become the norm. Malaysia’s syariah governance framework which is backed by enabling legislation is the model to follow albeit that the framework may need some updating in one or two respects. 

Question: The late Dr Badawi, May Allah give him Janaah, was an immense contributor to Islamic finance, what is being done to continue his work?

Mushtak: Unfortunately, not much for various reasons. I am not the heir to his book collection, writings, etc. I believe you should put that question to his heirs. Not even his alma mater, Al Azhar University, has done anything to recognise his legacy and contribution. 

Question: Finally, how would you like to be remembered in IF?

Mushtak: Gosh, it sounds that you are trying to write me off already. God willing, I plan to be around for many more years, irrespective of how my health or wealth turns out. 

Perhaps I will like to be remembered as a modest and independent observer of the contemporary Islamic finance movement, whose basic aim is to report, analyse, comment, articulate and inform about the developments, successes, failures and the future challenges of the industry to various stakeholders, especially the man and the woman in the street.

Rushdi Siddiqui is the global head of Islamic finance at Thomson Reuters 

(Business Times / 04 Sept 2012)

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Alfalah Consulting - Kuala Lumpur: www.alfalahconsulting.com
Islamic Investment Malaysia: www.islamic-invest-malaysia.com