Malaysia can lead global Islamic finance reforms
Malaysia can lead reforms in the global Islamic finance industry to avoid future financial crisis, the head of an Islamic investment firm says.
Fajr Capital chief executive officer Iqbal Khan said Islamic financial institutions, which are modelled after the conventional banking system, need to reform their architecture by separating banks with financial intermediary and utilitarian roles.
He said Malaysia could be a role model for the reform across the Organisation of Islamic Conference and Organisation for Economic Co-operation and Development world.
"Malaysia is the best hope for the Islamic banking industry. Malaysia seriously pursue the opportunity to create a model of financial architecture," he said in an interview in Kuala Lumpur recently.
Iqbal said the global financial system - both conventional and Islamic - requires a narrow banking model that comprises two types of banks; one is utilitarian (deposit taking and payment activities) and second, asset manager and investment bank.
"The co-mingling of the two activities - the principal-agent conflict - had created the crisis," he said.
According to Iqbal, there is currently a conflict between the principal and the agency roles of banks, where the bank acts as an agent to transact the foreign exchange but at the same time, it also acts on its own behalf in the foreign exchange.
This way, the bank is trading against its own clients, instead of trading for its clients.
"This agent-principal conflict is a very serious issue, which has to be addressed. Until we can address these two things, we will continue to have crisis after crisis," he said.
Although it is obligatory in Islamic finance to separate between financial intermediary and utilitarian roles, he said Islamic institutions tend to follow the conventional banks.
So far, the crisis has yet to occur in the Islamic finance because there has been no huge losses like in the conventional sector.
He said if the division is not done, the fragility in the banking system and the systemic risks inherit in the banks will continue.
"If there is a separation, in the event of the bank collapse, at least the payment system will not collapse," he added.
He said in utilitarian banks, the clients' money is safe as the banks are not allowed to trade as principals, or involved in financial intermediary and risky assets.
"Simple utilitarian financial institutions can invest their surplus in asset-backed, low risk transactions under the guidance of central bank. So, we are confining the risks of taxpayers," he said.
The banks with financial intermediary roles, meanwhile, manage different funds with various risks and categories under the guidelines of authorities.
These banks are not involved in the payment system or act as a custody of money for the widows, the orphans or the endowment as these are done by utilitarian banks.
"And the only banks should be rescued by taxpayers' money are utilitarian banks," he said.
Iqbal said because the banks currently control the payment system, governments are forced to bail out banks because if the banks collapse, the economy will collapse.
"This is a terrible model, it means in good years, there is a privatisation of profits and in bad years, there is a socialisation of losses. So, the losses go to the state and the profit goes to the shareholders," he said.
He said Islamic financial institutions have to reform their architecture, where those who want to do banking, go for a simple utilitarian model.
"Everything else - Mudharabah-based, asset-based, unit trust and investment fund - goes into separate business. These two, never the twain shall meet, they have to be kept separate."
Iqbal also said that debt cannot be solved by making it cheaper or more abundant. "You need to wean them out of debt situation. We can't out-borrow and out-finance ourselves out of this crisis, we have to save or invest ourselves out of this crisis," he stressed.
Fajr Capital chief executive officer Iqbal Khan said Islamic financial institutions, which are modelled after the conventional banking system, need to reform their architecture by separating banks with financial intermediary and utilitarian roles.He said Malaysia could be a role model for the reform across the Organisation of Islamic Conference and Organisation for Economic Co-operation and Development world.
"Malaysia is the best hope for the Islamic banking industry. Malaysia seriously pursue the opportunity to create a model of financial architecture," he said in an interview in Kuala Lumpur recently.
Iqbal said the global financial system - both conventional and Islamic - requires a narrow banking model that comprises two types of banks; one is utilitarian (deposit taking and payment activities) and second, asset manager and investment bank.
"The co-mingling of the two activities - the principal-agent conflict - had created the crisis," he said.
According to Iqbal, there is currently a conflict between the principal and the agency roles of banks, where the bank acts as an agent to transact the foreign exchange but at the same time, it also acts on its own behalf in the foreign exchange.
This way, the bank is trading against its own clients, instead of trading for its clients.
"This agent-principal conflict is a very serious issue, which has to be addressed. Until we can address these two things, we will continue to have crisis after crisis," he said.
Although it is obligatory in Islamic finance to separate between financial intermediary and utilitarian roles, he said Islamic institutions tend to follow the conventional banks.
So far, the crisis has yet to occur in the Islamic finance because there has been no huge losses like in the conventional sector.
He said if the division is not done, the fragility in the banking system and the systemic risks inherit in the banks will continue.
"If there is a separation, in the event of the bank collapse, at least the payment system will not collapse," he added.
He said in utilitarian banks, the clients' money is safe as the banks are not allowed to trade as principals, or involved in financial intermediary and risky assets.
"Simple utilitarian financial institutions can invest their surplus in asset-backed, low risk transactions under the guidance of central bank. So, we are confining the risks of taxpayers," he said.
The banks with financial intermediary roles, meanwhile, manage different funds with various risks and categories under the guidelines of authorities.
These banks are not involved in the payment system or act as a custody of money for the widows, the orphans or the endowment as these are done by utilitarian banks.
"And the only banks should be rescued by taxpayers' money are utilitarian banks," he said.
Iqbal said because the banks currently control the payment system, governments are forced to bail out banks because if the banks collapse, the economy will collapse.
"This is a terrible model, it means in good years, there is a privatisation of profits and in bad years, there is a socialisation of losses. So, the losses go to the state and the profit goes to the shareholders," he said.
He said Islamic financial institutions have to reform their architecture, where those who want to do banking, go for a simple utilitarian model.
"Everything else - Mudharabah-based, asset-based, unit trust and investment fund - goes into separate business. These two, never the twain shall meet, they have to be kept separate."
Iqbal also said that debt cannot be solved by making it cheaper or more abundant. "You need to wean them out of debt situation. We can't out-borrow and out-finance ourselves out of this crisis, we have to save or invest ourselves out of this crisis," he stressed.
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