The turmoil sweeping the world’s financial markets would not, according to one Kuwaiti investment house, have happened under a Shariah-compliant system. Rasameel Structured Finance Company (Rasameel) has issued a challenging and eminently readable analysis detailing the mechanics of the meltdown that comes to the conclusion that securitization is the solution, not the problem.
A major component of today’s capital markets, Rasameel’s report contends, is securitization. This is the process of turning cash producing assets into securities and has been an important part of the capital markets since the early 1970s. Securitization has, the analysis runs, provided lower rates to borrowers and better security for lenders, increased liquidity and provided alternative funding sources in the capital markets. However, in the current financial crisis, securitization has often been mentioned as one of its problems, mostly because of subprime mortgages.
“But it is very important to realize that it is only the speculative, over-leveraged excesses that have crept into securitization during the last 10 years (such as collateralized debt obligations, subprime mortgages, asset backed credit default swaps) that have contributed to the financial meltdown, not the securitization process itself,” the report says.
The very nature of Shariah finance discourages or prohibits the speculative excesses that are the root cause of the current global financial crisis.
The standard Islamic prohibitions against high levels of debt, unsecured debt and speculation result in a high level of financial prudence. Moreover, an obligation for fairness requires that Shariah-compliant investors share in the risk and rewards, and prohibit guarantees to some investors that would come at the expense of others.
“The lack of these concepts and principles in conventional finance results in the greed, volatility, and devastation that we are witnessing,” the report says.
The very nature of securitization is Shariah-compliant, says Rasameel. In securitization, investors own the profit generating assets. The investors’ profit is derived from the cash flow of real assets and the investors are subjected to the risk of the assets that generate the return. All of these features of securitization are requirements of Shariah-compliant finance.
Therefore, securitization under Shariah finance has an ethical component and a moral directive that is missing in conventional finance. Securitization under Shariah finance is used to fund productive activities to finance the purchase and sale of real assets and generally to produce socially useful financing opportunities.
The very hard-hitting report fingers the speculators, whose alleged excesses and cavalier actions brought about the subprime bubble in the first place.
“Shariah-compliant securitization has no attraction for those very shortsighted, irresponsible speculators who are alternately driven by greed and fear. Shariah-compliant securitization actually discourages investors who speculate without engaging in a useful transaction and seek a return with any real economic purpose to the undertaking.”
Focusing on what many see as the root of the current problems, the report says: “Over-leveraged transactions are forbidden (in Shariah) as are unsecured, speculative lending. If only conventional finance had a similar ethical basis, the current worldwide financial crisis would have been prevented or at least reduced.”
Whether that is true or not, we may never know. But there is an attractive logic to the contention for the average citizen who cannot quite get his understanding around how selling debt and promises you cannot keep can make vast profits that you then lose.
As one commentator trenchantly observed: “The whole situation is as if a group of people you do not know held a party you were not invited to, trashed your house, and sent you the bill.” The bill of course is what you will pay from your taxes, also known as “bailout”.
The markets’ non-transparency to the average investor also draws the report’s undivided attention.
“Shariah-compliant investors must realize that, in addition to prohibitions against “Maysir” and “Gharar,” Shariah-compliant securitizations are forbidden to engage in “Ghish,” concealment of information, “Jahalah,” misrepresentation, and “Taghrir,” deception. In a Shariah-compliant securitization, the investor knows he is bound to the fate of the enterprise being financed. If these restrictions and principles were required in conventional finance, the world would be a much better place.
The report goes on to list what Rasameel see as the various benefits of Shariah-compliant securitization to the originators of the schemes, the investors and the consumers. In brief, they stem from ready concluded deals and shared risk.
The report makes an attractive counterpoint to the egregious nationalization of banking systems — or “bailout” as the euphemism has it and offers a very different perspective on a financial genie that once out of the bottle will prove impossibly difficult to control or return to captivity in the rarefied world of the money market.
