LONDON: Depending on whom you talk to or which report or statement you read, the impact of the credit crunch and the global financial crisis on the Islamic finance industry worldwide is either very small or very large, with sectors such as the Sukuk market badly affected.

The danger is that officials, bankers and economists are either artificially talking up or talking down the Islamic finance sector as their counterparts seem to be doing in the conventional financial sector, largely based on which economic ideology they espouse. Others will merely follow the latest market moves no matter how narrow and insular they may be. During the dotcom boom, for instance, several Islamic banks invested in a variety of start-ups. One GCC Islamic financial institution invested a tidy sum in boo.com, the fashion and sports goods online company.

When the company crashed and investors lost their money, the CEO of the very Islamic financial institution, when asked why his institution invested in boo.com, nonchalantly replied: “We were simply swimming with the dotcom tide.”

The Islamic finance market like any other can be extremely fickle. At a time when the UKTI was promoting the virtues of London as an Islamic finance and investment hub and the pioneering work of the Treasury in enabling Islamic finance legislation in the UK, at the UK Pavilion at the WIBC conference in Bahrain recently, on the very same day the Treasury was announcing that the UK government had decided “that issuing a sovereign Sukuk would not offer value for money at the present time.” Not surprisingly, the UKTI officials and the sponsors, banks and companies were livid at the timing of the announcement. So much for joined up government in the UK.

Crisis such as the credit crunch may sort out the men from the boys. As the experience in Dubai shows, hype and the semblance of large inward investment flows are no guarantee against failure or crisis. The best strategy is sound fundamentals — good regulation, capital adequacy, quality capital, balanced leverage, judicious gearing and sound management code of ethics.

From an international perspective, the impact of the credit crunch on the Islamic finance sector has similarly been mixed. The United Nations recently convened an international committee which will advise on the financial stability of the international system and which is mandated to come with strategies on how to preempt the current scenarios in the future.

The good news is that Dr. Zeti Akhtar Aziz, governor of Bank Negara Malaysia, the central bank, is a member of this committee and she is keen to include the Islamic system of financial and economic management as part of these deliberations.

This is especially significant in the light of a number of IMF studies in the past which have concluded that Islamic finance may be in a better position to absorb international financial shocks. Malaysia has proven that the Islamic system, because of its very nature of concentrating on financing the real economy as opposed to obscure and very often fictitious bundles of derivatives which have been the bane of the current credit crunch, has something to offer to the world in terms of sound financial management and based on a proven record and not merely on religious sentiments.

The Islamic Development Bank (IDB), at the same time, has set up a financial crisis monitoring team and is reportedly in the process of issuing a program of “Credit Crunch” Sukuk to raise funds to help support member countries to weather the effects of the global financial crisis. The funds raised will be directed to such areas as SME financing, the agricultural sector and other sectors which employ large number of people. “Our (the ISB) funds are invested in secure Islamic portfolios, which are not affected by speculative business,” stressed Dr. Ahmad Muhammed Ali during a recent one-day conference of experts convened by the IDB in Jeddah to discuss the impact of the credit crunch on member countries and the Islamic finance sector.

The IDB however needs to be more urgent, proactive and imaginative on its approach. The organization is notoriously bureaucratic and slow to react to major events and developments. And some Islamic bankers already lament that the IDB is not taking this opportunity to make the case for Islamic finance. The same can be argued for the sovereign wealth funds (SWFs) from the Muslim countries, many of which ironically have invested billions in bailing out the major international conventional banks in their recapitalization drives.

Since the Sukuk market is suffering from a serious lack of market confidence and a perceived lack of good orderliness in terms of which structures are the best to use, now is the time to take measures which would counter these effects.

In fact, the recommendations issued earlier this year by the Bahrain-based AAOIFI regarding Musharaka and Mudaraba Sukuk has unwittingly contributed to this crisis of confidence on the Sukuk market especially by potential non-Muslim issuers such as Japan Bank for International Cooperation; the Hong Kong Airport Authority, the UK Treasury etc. The timing and the process of the statement was indeed unfortunate, and AAOIFI, and one of its main supporters, the Central bank of Bahrain, should in future consider the implications of the organizations methodology and processes especially in matters relating to Shariah compliance of financial products.

There should be a much more in-depth consultation period, not merely of Bahrain-based institutions but those worldwide.

All the above three potential issuers have put their Sukuk issuances on hold and this has further exacerbated market sentiments. This is unfortunate. If sovereign issuers are merely looking at pricing and money-for-value considerations on a pre-credit crunch basis, then of course they would not be justified in doing so. But these are extraordinary times which require more innovative approaches.

As such, the IDB, with the cooperation of the Muslim SWFs should be aggressively courting these potential issuers and encouraging them not to put their plans on hold. If the IDB is going to issue credit crunch Sukuk any way, it might as well divert some of the funds to these potential sovereign issuers, which would go a much longer way to instill confidence in the market. The best way to do this is to underwrite some of these sovereign issuers such as a potential UK sovereign Sukuk in the wholesale sterling market.

Banks including CIMB Group in Malaysia, Europe Arab Bank, ABC, Gatehouse Bank in London and others are looking for leadership from the IDB and the SWFs based on positive survival and strategies.

On a more positive note, South Korea is now also warming to Islamic finance with the first conference being held there by the Islamic Financial Services Board in January 2009. Even in Kenya, according to Hassan Varvani, chairman of First Community Bank, the latest Islamic bank to be authorized by the central bank of Kenya, is keen to establish Nairobi as the Islamic financial hub for east and central Africa.

But the most encouraging news may come from Paris where a major Asian financial institution is in advance discussions with the French Government in structuring the first European sovereign Sukuk.

This follows the initiative of President Nicolas Sarkozy to promote France as a center for Islamic capital markets, investment and other products. Indeed Paris has hosted two Islamic finance conferences in succession in recent weeks.