The constant evolutions of sophisticated Islamic financial products structured using multiple Shariah-based contracts have resulted in a new wave of creation and innovation globally over the last 50 years since the reintroduction of Islamic finance.
Islamic finance products have become competitive and efficient both in terms of structure and pricing, giving greater choice for this essential public good to consumers. Nonetheless, product development in Islamic finance over the years has always been looked upon with cynicism and suspicion by some people who do not fully understand the workings of Shariah. They forget that in Shariah, everything is allowed unless clearly expressed or stipulated in the Quran and legitimate Hadith as disallowed.
The Islamic banking and finance industry typically contains many types of activities such as banking, asset management, debt capital market, equity capital market, private equity, takaful, etc.
Financial institutions with involvement in the various activities must come out with different products and services to intermediate between the haves and have-nots across consumer segments in different jurisdictions to meet their diverse financial needs in a Shariah compliant manner.
Product development in Islamic finance must be looked at from a demand and supply perspective done in a way that complies with the same universal Shariah principles applied on a jurisdictional basis subject to local parameters in any one country, such as the law of the land, its market conventions, its culture, its customs, etc.
The common market misperception in product development is that each Shariah principle needs to be fitted into a specific product. As an example, there is a thinking that the Shariah principle of Ijarah can only be used for an operating lease product. This is not true at all.
In the industry a singular Shariah principle can be used to facilitate various products. This is what I have labelled as “One Shariah Principle, Many Financial Activities” methodology.
An Ijarah principle can be used to facilitate many products such as operational lease, financial lease, home financing, corporate financing, car financing, project financing, credit cards and sukuk.
SUBSTANCE OVER FORM applies here. The financial product done is the real substance of the activities. The Shariah principles used do not determine the substance of the product undertaken in each activity.
The products are accounted for in the financial report distinctively, as home financing, credit card, sukuk, etc, each carries different risk profile in substance, although the same Shariah principle is used.
How can an operating lease company which leases machines to factories be reporting the same way as an Islamic bank providing credit card to individuals using the same principle? If we account everything as operating lease then there would be a misrepresentation to the different stakeholders when they read a particular Islamic financial institution’s financial and activity report. It is against Shariah to misrepresent.
Some people have also misperceived that a single Islamic financial activity when created or innovated, is facilitated by a singular Shariah principle only. This is again very inaccurate. The same financial product done by the same category of financial institutions could be done using different Shariah principles and even a combination of Shariah principles.
A home financing given by Islamic banks can be facilitated using different principles such as the Bai Bithaman Ajil, Murabaha, Inah, Ijarah, Istisna’ and Musyarakah or a combination of these principles.
The Bai Bithaman Ajil home financing facility, for example, uses Bai Bithaman Ajil (deferred payment sale), Murabaha (sale at cost plus) and Inah (buying and selling between two parties) principles.
Another example is Musyarakah Mutanaqisah home financing, which uses Bay (sale), Musyarakah (joint ownership) and Ijarah (leasing).
In my “One Financial Activity, Many Shariah Principles” methodology, no matter what underlying Shariah principles are used for the financial products, the transaction is in essence a home financing and will be treated as such under tax law and accounting practice.
Such approach is not against Shariah. If we account for something based only on the Shariah principle used, then there will be a lot of confusion in the market. Every Islamic bank will declare different things to stakeholders although they are doing the same product.
Thus making peer comparison difficult and many would be misled on material risks of the activities undertaken.
Both methodologies above are not only pragmatism in its best form available under Shariah but are very consistent with the requirement for transparency and the need to manage systemic risk in the financial market. The government, regulator and the private sector must provide the right product for each activity and must communicate the right information to the public.
Without proper disclosure, the real impact on systemic risk cannot be appreciated and monitored, any market growth and development achieved would come to nought.
In Islamic finance we create and innovate by using trade as encouraged under Shariah. It is not rocket science as the difference is only in the contracts used. Instead of an IOU or a lending contract, Islamic finance uses trade contracts consistent with Shariah that meets the financial needs identified by consumers. It is how these contracts are entered in different jurisdiction that influences how each Islamic financial product is created and innovated.
The Shariah in each Islamic finance product remains the same, only its application differs due to distinct local parameters, thus providing for a very dynamic, sustainable and stable development of Islamic finance for the next 50 years and beyond.
[Badlisyah Abdul Ghani is ED and CEO of CIMB Islamic Bank Bhd]
THE MALAYSIAN RESERVE, 09 December 2013
