Innovation and the ensuing needed authenticity are the pre-requisites to move Islamic finance to US$2 or US$2 trillion (RM6 or RM6 trillion) by 2015.
But, how best to describe innovation in Islamic finance? Famous quotes often capture succinctly the essence of the issue, and, for innovation in Islamic finance, the below quotes are a good beginning.
“Sometimes when you innovate, you make mistakes. It is best to admit them quickly, and get on with improving your other innovations.” – Steve Jobs.
“Innovators are inevitably controversial.” – Eva Le Galliene.
“Innovation is the ability to see change as an opportunity – not a threat.” – Unknown.
So, from the three quotes, come three questions: Are Islamic hedge funds a mistake? Is sitting on 80 syariah boards controversial? Are Islamic derivatives an opportunity to bring meaningful risk management tools to bring “authenticity of change”‘ to Islamic finance?
It took the murabaha-centric Islamic finance nearly 40 years to reach US$1 trillion (RM3 trillion) benchmark, and projections are that it will cross the US$2 trillion threshold by 2015.
Obviously, innovation will play a large part, but I would hope that its “outside the box” thinking on innovation that results in inclusion of the financially disenfranchised, funding and financing non-traditional areas, and human asset capacity building to build knowledge based economies in the economically established Muslim countries like Malaysia, Indonesia, Turkey, Saudi Arabia and UAE.
Today, innovation in Islamic finance seems to mean better product structuring. A recent email shot campaign from the respected UK’s IIBI, Institute of Islamic Banking & Insurance, about a workshop stated: Innovation in product structuring is far more important to Islamic financial institutions than their conventional counterparts to keep the momentum of growth and development, and to effectively meet the needs of their clients with diverse risk/reward profiles.
Islamic finance should not be mainly about product pushing, even if it means more efficiently priced products.
Innovation in Islamic finance should also be about inclusion of the non-bankable, Muslims and non-Muslims. To date, Islamic finance has reached, at best, 2-3 per cent of 1.6 billion or 48 million Muslims, while the halal industry has not only great reach, including non-Muslim countries, but deeper penetration.
Query: what can Islamic finance learn from halal industry?
There are many areas in Islamic finance requiring innovation, and the emphasis will be on the following five: One, Islamic micro-financing and, my preference, micro-funding, are important part of impact investing. The “man on the street” financing/funding needs to be prioritised at a policy level for those (Muslim) countries that have declared themselves Islamic finance hubs. Yes, there are challenging initiating, implementing and monitoring costs, but this would start to address the (1) moral and justice (public good) argument for Islamic finance, (2) build bridges to the non-Islamic entities involved and (3) establish the foundation for future Islamic finance customers.
Two, Innovation in Islamic finance is about financing areas that contribute to building a knowledge based economy based upon and linked to real tangible and intangible/usufruct assets. For example, in a number of Muslim majority countries there are the 2020 and 2030 Visions Plans, which entails pushing for higher per capital income, migration towards service based economies, and focus in areas like food security, alternative energy, healthcare, and so on.
Obviously, these are all syariah-compliant/friendly areas and some, like food security, are ideal opportunity for the US$640 billion (RM1.9 trillion) halal industry to contribute, if not lead, the development. In Abu Dhabi, the world’s first zero-carbon, zero-waste city, Masdar, is being built, one wonders how much, if any, is done via sukuk or Islamic syndicate loans. Yes, it’s a real estate project, but the technology is world class, and it will have a spill-over effect locally.
Islamic private equity and venture capital needs to become a priority amongst the thought leaders of Malaysian Islamic banking. It’s about providing meaningful patient seed capital that is professionally managed for selected sectors resulting in technology acquisition/transfer, incubated in the tech parks or the work in progress halal parks and eventual IPO on Bursa Malaysia. One success story will have the Islamic banks in the GCC, presently sitting on mountain of liquidity, knocking on the Malaysian corridors.
Third, Islamic finance needs its own innovative financial indicators that establish blueprints for understanding the pulse of the industry and starts the de-linking from conventional finance. For example, from syariah-compliant equity indexes to syariah-based, from using Libor as a reference rate in pricing credit to a Syariah-Compliant Inter-Bank Offering Rate (Scibor) based on murabaha/wakala, and so on. The Islamic cost of capital may be different, but it needs to be confirmed.
Fourth, consolidation is innovation as it would bring economies of scale efficiencies and reach to better compete with conventional banks, not just their Islamic windows/subsidiaries. It is well acknowledged that Malaysia, like UAE, is Islamically overbanked, and it may result in destructive competition. For example, Malaysian bank holding companies need to be encouraged to spinoff the Islamic subsidiaries and list them on Bursa Malaysia, as it will entice international Islamic investors, start process of syariah-based index, and possibly result in market led consolidation.
Finally, human skill development in the Islamic finance chain from the bank to scholars to intermediaries to customers is probably the most important innovation-cum-authenticity. It begins the process of focusing on the merits of the offering that would satisfy a “conventional” financial user, i.e., the cross sell, rather than the continued emphasis on its “Islamicity.” Thus, in removing the “premium” from Islamic offering, it will make it conventionally efficient.
To quote Steve Jobs again, “Innovation distinguishes between a leader and a follower.” Innovation implies taking a holistic and inclusive approach that focuses on shifting the paradigm to a new level, now, will Malaysia innovate or product push towards Islamic finance 2.0?
The writer is Thomson Reuters’ Global Head of Islamic Finance and OIC countries.