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Islamic financial institutions and the shortage of investible products

Summary

6 June 2012

The magazine Islamic Finance News in its edition of 6 June 2012 posed the following question to its forum of experts:

"In the short, medium and long-term, how can Islamic institutions flush with liquidity address the problem of a lack of Islamic products in which to invest?"

The full responses are only available to readers of the magazine. However I have reproduced my own response below.

The challenges faced by Islamic financial institutions are fundamentally the same as those faced by conventional financial institutions, whether they be banks, insurance companies (takaful operators) or asset managers. All of them need to find investible assets which have the right characteristics in terms of yield and risk.

There are two factors which increase the challenge for Islamic financial institutions compared with conventional financial institutions:

  1. Islamic financial institutions are often smaller than their conventional counterparts. This matters for Islamic banks and takaful operators, and means that they have lower equity which in turn means that they are less able to take on financial risk. As a concrete illustration, the only stand-alone retail Islamic bank in the UK has been ‘deposit rich’ for many years, but unable to provide much customer finance, for example house purchase finance, due to its low level of shareholders’ equity.
  2. Islamic financial institutions are unable for religious reasons to invest in many assets which are available to their conventional counterparts. At its simplest, interest-paying assets are excluded, but also the equity of many quoted companies is also excluded, either because they carry on prohibited businesses or because they earn or pay unacceptable levels of interest.

To address the first issue, Islamic banks and Takaful operators need to increase in size, for example by merger. The Islamic banking industry contains too many banks for its overall size, and regulators should encourage mergers.

To address the second issue, Islamic financial institutions need to become more innovative at structuring investible financial assets which can be issued by companies regardless of whether the issuing companies are owned by Muslims or by non-Muslims. Provided they can offer finance at attractive terms, they will find people willing to issue the investible assets required.

 

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