Friday feature

ISLAMIC finance signifies financial services, mechanisms, practices, transactions, and instruments that comply with provisions given in the fundamental Islamic texts. Thus, Islamic finance not only includes banking, but also capital formation, capital markets and all types of financial intermediation.

In recent years, Islamic finance has not only increased in size. It has also become complex as finance professionals compete furiously to produce new shariah-compliant transactions and instruments. Becoming a segment within the global financial market, it has gained considerable interest as an alternative model of financial intermediation.

However, in the 80s and most of the 90s, Islamic finance did not have much of this dynamism. On the asset side, activities of Islamic financial institutions mainly involved ijara, mudaraba, and musharaka. The need for liquidity, portfolio and risk management tools, and derivative instruments was strongly felt, and there were numerous calls for the promotion of financial engineering and introduction of new products.

Along with other developments, this resulted in the introduction of Islamic equity funds (IEFs). Overall, IEFs have been the most popular among all Islamic investment funds. According to FTSE, IEF assets are projected to increase from $15.5 billion to $53.8 billion by 2010. According to other reports, the assets have already reached $20 billion. The industry is dominated by Saudi Arabian funds and fund managers, accounting for more than 70 funds out of about 300 IEFs globally.

In fact, Saudi British Bank`s Amanah GCC Equity Fund was reported as the best performing Islamic equity fund in 2007. On the other hand, Bahrain is becoming the centre for IEF registrations because of the Kingdom`s efficient regulatory system. International investment firms with Islamic divisions are focusing on Dubai.

Islamic Equity Funds are different from conventional equity funds because they select their placements on the basis of their compatibility with the shariah. In order for a stock to be considered sharia-approved, it must satisfy certain requirements set by Islamic scholars. These standards may differ in different jurisdictions depending upon how strictly the shariah is interpreted.

However, the basic condition is the same throughout the Muslim world an enterprise must not conduct business activities prohibited by Islamic texts. These include gambling, alcohol, pornography, etc. Financial ratios (debt-to-equity ratio, cash and interest bearing securities-to-equity ratio, and cash-to-asset ratio) and cleansing mechanisms (to purify investments that are tainted by forbidden activities) are also used by various shariah boards and authorities.

It must be mentioned that a country may or may not have a national screening body. For instance, in Malaysia, it is done by the Securities Commission; whereas, in the Middle East, financial institutions prepare their own list of shariah-approved stocks.

One of the factors that gave an immense boost to IEFs was the introduction of the Dow Jones Islamic Market Index (DJIM), in 1999, as a subset of Dow Jones Global Indexes (DJGI). DJIM Indexes intend to measure investable equities that fulfil shariah requirements. At present, with more than seventy Islamic indexes (which include regional, country, industry, and market-cap-based indexes), it is one of the most comprehensive family of Islamic market indexes. Other conventional index providers have also entered the field. In 2000, FTSE launched the FTSE Global Islamic Index. Unlike Dow Jones that has an independent Shariah Supervisory Board, FTSE indexes are evaluated by Yasaar Research Inc. In 2006, Standard & Poor`s (S&P) introduced the S&P Shariah Indices, followed by, in 2007, the S&P GCC Shariah Indices and the S&P Pan Asia Shariah Indices. S&P has contracted with Ratings Intelligence Partners (RI) to provide the shariah screens and select the stocks based on these standards.

As reported by the Financial Times, these indexes do not enjoy complete acceptance by the Muslims. The screening principle allowing total debt ratios of up to 33 per cent is considered objectionable by some scholars. They claim that it is akin to declaring a food as halal that has a small quantity of pork in it. The indexes maintain that their legitimacy comes from the concerned shariah authorities. In other words, as long as their shariah supervisors agree with these practices, the indexes need not change them.

The future of IEFs looks bright. However, Muslim scholars need to be careful while interpreting and applying the shariah. They need to make sure that Islamic principles are properly observed and that they don`t present or accept an un-Islamic idea as Islamic just because there is more profit in it.