Newswise — What distinguishes Islamic finance from Western finance, and how do those distinguishing characteristics manifest themselves in Islamic financial instruments and practices? It was these questions that distinguished speakers Dr. Zamir Iqbal and Mr. Michael J.T. McMillen addressed during the First UVA Islamic Finance Forum, held Nov. 21, 2011, at the McIntire School of Commerce. The event was sponsored by McIntire’s Center for Financial Innovation and hosted by the University of Virginia’s new Islamic Finance Association.
Cultural Context “If you pick up a popular journal or magazine article on Islamic finance, the primary message you’ll come away with is ‘no charging interest,’” said Iqbal, the Lead Investment Officer in the Quantitative Strategies, Risk, and Analytics Department of the World Bank Treasury and a highly regarded scholar of Islamic finance. “But there’s more to it than that.” Indeed, he explained, the rules governing Islamic financial practices find their roots in the core values laid out in the Koran, and include, broadly speaking, the promotion of community, social, and human unity, as well as the promotion of economic justice.
Operating in accordance with these values leads to financial transactions characterized by profit- and risk-sharing among the parties involved; the pursuit of reduced informational asymmetry and speculation in contracts; the use of asset-backed securities (securities must be directly tied to tangible assets); the pursuit of ethical investments and transactions (not only must the transactions themselves be conducted in an ethical manner, but the businesses involved in any investment must be Sharia-compliant—no investing in firms engaged in the production of things like alcohol, tobacco, or pornography); and, indeed, the wholesale avoidance of charging or paying interest.
Interest Interest
It’s the prohibition on charging interest, Iqbal said, that seems to flummox Westerners the most. In the early 1970s, as an Islamic financial sector began to emerge, “people laughed” at the notion of creating a debt-free financial system, he told the audience. “They said, ‘How can a financial system be designed without the use of interest?’” Iqbal pointed out that the answer is actually extremely simple. Essentially, he explained, Islamic finance uses money as a vehicle by which to make investments in and earn returns on real assets. That is, an Islamic investor could, for instance, invest in a real estate development project, and happily collect whatever profits the project generated. What an Islamic investor could not do, however, is lend his money to a real estate developer, who would complete the project, then pay the investor back with interest.
Iqbal pointed out that the prohibition on interest leaves Islamic financiers free to use a number of financial structures—including partnerships and leveraged leases—that are deeply familiar to Westerners. “It’s not a matter of Islamic versus non-Islamic,” he told listeners. “It’s a matter of financial engineering.” Islamic Finance in Practice
Iqbal’s presentation was followed by that of McMillen, a Managing Director at Riverstone Capital LLC and a leading legal expert in Islamic finance. Recognized as a key figure in the industry, McMillen has twice received Euromoney magazine’s award for best legal adviser in Islamic finance. McMillen, too, was eager to stress the deep commonalities between Islamic and Western methods of finance. In many ways, he said, Islamic financial practices are little different from those espoused by the West’s increasingly popular “ethical” investment funds.
“You know more about Islamic finance than you think you do,” he told the audience. “There are more similarities to Western finance than there are differences.” McMillen, who has helped design scores of Islamic financial deals in such industries as electricity, petrochemicals, and mining, helped bring to life some of the key elements of structuring deals based on risk-sharing (as in the example of the real estate investor, above), the necessity of the presence of tangible assets throughout the investment process, and the absence of interest. As a starting point, McMillen offered the example of an aspiring but undercapitalized merchant seeking to buy, for instance, 100 pounds of sesame seeds. Rather than taking out a loan (at interest) from the bank, the bank itself might buy the seeds and then sell them at a profit to the merchant, who would in turn pay the bank back through a series of deferred payments.
Islamic-compliant financial structures, McMillen pointed out, also preclude the use of short-term investment funds, commercial paper, derivatives, and secondary markets.
McMillen’s talk was followed by a question-and-answer session during which he and Iqbal took queries from the audience. Asked about opportunities for working in Islamic finance, McMillen responded that the industry is growing dramatically not only in the Middle East, but also in European capitals such as Luxembourg, Paris, and London. Although American law makes the United States particularly amenable to the establishment of Sharia-compliant financial structures, McMillen said that America must, on the whole, bolster its efforts to understand Islamic finance and culture. “The problem,” he said, “is education. There are a whole lot of people who have no clue.”
RSS