Iqbal Khan: Islamic Finance: Past, Present, Future - IslamicMarkets LIVE Briefing Note

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1. Leadership Series Tuesday - 16 June 2020 Islamic Finance : Past, Present, Future Interviewed by: Daud Vicary, Chairman of Advisory Board, IslamicMarkets.com Islamic Finance stands on the shoulders of pioneers, such as Sheikh Saleh Kamel and Prince Mohamed Al Faisal Al Saud, who envisioned a values-based industry that serves communities as well as markets. While Islamic Finance has made significant progress in recent decades, we must advance the industry towards the next stage of its evolution by achieving greater authenticity, reach and mainstream relevance. The time has come for Islamic Finance to create a demonstration effect to move from financing-based to equity-based intermediation. Islamic asset management, for example, is an exciting growth opportunity for the industry. T he early years: With more than three decades of experience in the Islamic finance industry, Khan started off the discussion with the development of the industry over time, and the key milestones that have occurred. According to Khan, Islamic Finance in its modern form was built around the intention to focus on equity-based intermediation. In the late 1970s and early 1980s, Islamic Finance institutions such as Dar Al-Maal Al-Islami Trust (DMI) and Al Baraka established a series of Mudaraba and Musharaka investments in the OIC world, around a theme of real economy, interconnected investments. However, these noble efforts were made during a time of major weaknesses within the industry, such as the absence of an enabling framework for equity linked investments through Mudaraba- and Musharaka-based contracts. As a result, many of these initial ventures were not profitable, which led to the industry shifting from a Musharaka mode of risk sharing contracts to financing short-term, self-liquidating trade and commodity finances. In the early 1980s, the industry faced a crossroad of either going to the banking route or asset management route – it eventually chose the banking route for self-preservation which led to the evolution of what is now called Shari’a-compliant banking system. As a result, the equity-based intermediation and the equity-based wealth management platforms lagged behind. Khan notes that this gap is what is now reflected in the significantly lower alpha returns generated by the non-banking related industry institutions, such as Takaful companies, Hajj funds, endowment funds and pension funds. The COVID-19 opportunity: Khan highlighted the work of Dr Edward de Bono, the famous psychologist and thinker, who once famously claimed that “the human mind is brilliantly uncreative.” Khan stated that the human mind needs provocations to create and to be creative. Khan was confident that COVID-19 is already provoking the human to think and act in ways we are not naturally accustomed to, and will create opportunities for the Islamic Finance industry to adapt and improve. As a first step, Khan stated that it was vital for the banking system to slowly re-orient towards an equity-based intermediation model. Islamic finance providers must have an open dialogue with the central banks of their countries, as well as with the relevant finance ministries and other regulatory authorities to establish an enabling rule-book with guidelines in relation to the issuance of equity-based instruments. Once established, the focus would need to switch to building and developing dynamic asset allocation and focused asset management capabilities, to ensure the creation of sustainable alpha returns. Khan stated that governments should play a stronger role in this new equity-based financial intermediation as allocators of capital and by prioritising specific real economy sectors, and allowing banks to have a cost of capital in line with debt instruments so as to level the playing field. Whilst financing-based intermediation models have worked well in the past, there was a large gap created with regards to the authenticity, democratizing savings and investments . Khan believes that equity-based financial intermediation should allow for the creation of financial institutions that are role-models within the Financial Services industry, thereby encouraging more firms and financial institutions to choose equity-based funding options. Going forward: Khan is confident that both commitment-based sukuk and Mudarabah-based equity instruments would help mobilise cross-border funding. This can be a catalyst for Islamic Finance’s future growth and can kick-start the flow of capital between the Organisation of Islamic Cooperation (OIC) nations, stimulating economies, promoting value-based and impact-focused investing, and by doing so, highlighting the true essence of the Islamic finance system. In order to realise the vision that was set out by our pioneers, the industry must attract world-class talent and retain the best people. Khan stated that we need more institutions such as INCEIF to nurture and enable talent especially women working in the industry and we need our institutions to provide them a platform to learn and become future leaders. Watch interview on IslamicMarkets.com
2. Islamic Finance Development : Going Global Development of Products Development of Industry Development of theoretical framework Muslim-majority nation independence 1950s Structured Products Egypt and Malaysia pioneering institutions Establishment of OIC (1969) Islamic Development Bank (1974) and DIB One country-one bank setup Advancement of Islamic products Full “Islamization” of Pakistan, Sudan and Iran 60s 70s 80s Debt Issues 00s Tipping point reached in some markets Development of industry-building institutions 10s Islamic finance worth more than USD 2 trillion First Shariah governance framework in the world Present Commercial Banking 2010s Private Equity Entry of global institutions e.g. HSBC 90s FinTech Project Finance Insurance 2000s 1970s 1990s 1980s Syndications Structured and Trade Finance Equity Emergence of Islamic FinTech initiatives Incorporating Maqasid Al Shariah and Sustainability An alternative banking model in development Shariah-based mindset is crucial direction for product development Shariah-based solutions • Income-sharing products • Shift from debt-based product offering Deposits Profit, not interest, becomes the basis for financial intermediation Liabilities Investments Assets Debt Financing Ijarah, Murabaha, Salam, Isrisna’ Equity Financing Productive economic actors with capital needs Mudaraba & Musharaka Savings & Investments Indebtedness X Shariah-compliant products • Letter of the law • Replicating conventional credit service offering Shariah-based industry is the new vision Key Enablers Dedicated People • Greates intangible to enable Islamic finance and build its future • Human capital development: bankers and Shariah scholars Committed Sponsorship • Academic input to formulate visionary framework and development • Capital sponsorship to bring plans to life Change in mindset • From Shariah-compliant to Shariah-driven products and services Education on all key stakeholders • To build understanding and awareness Proactive engagement • Regulators, Practitioners and Shariah Scholars to set a common agenda Digital Infrastructure • To create more jobs and enable more FinTech initiatives Maqasid-driven and Sustainability-focused • To enjoin responsible finance and create environment and social impacts Power of authenticity and collaboration to create role model Islamic financial institutions