Islamic bonds in developing countries

Some insights from Professor M. Kabir Hasan

-Reuters file photo -Reuters file photo

Sukuk or Islamic Bonds are a new investment product in Bangladesh for a variety of investors. A financial instrument controlled by Islamic Shariah law is known as a Sukuk. It differs from a traditional investment in that it does not pay interest (i.e.'Riba' in Arabic) and instead offers income in the form of a shared profit.

Islamic financing accounts for approximately 25 per cent of the total market. If Islamic bonds are effectively implemented and utilised, it will benefit the government and the economy in two ways: (a) when the private sector refuses to invest in infrastructure development, the government can generate funds and use them to improve infrastructure development; (b) to cover the yearly budget deficit, the government generally borrows from the banking system. As a result, the government exerts pressure on the financial system. In such a situation, the government can reduce the funding gap by borrowing directly from citizens via Islamic bonds.

The private sector can also borrow from citizens to invest in their businesses, including in various Shariah-compliant enterprises. In the light of this, the decision to introduce the Islamic bond is very positive. Professor Kabir Hasan, an internationally known and prominent Islamic Finance professor from the University of New Orleans, has for long advocated for this proposal. Here are the highlights of recent talk with Professor Kabair Hasan. [the talk was facilitated by Dr. Tonmoy Choudhury, Lecturer at Edith Cowan University]

THE CHALLENGES IN INTRODUCING ISLAMIC BOND: The first challenge is the inadequacy of understanding and lack of technical know-how about Islamic Bond. The lack of comprehension stems not only from the perceptional or conceptual context, but also from the operational paradigm.

The problem is, any product in Shariah-based banking is usually developed using conventional banking products. As a result of current market behaviour, just following the conventional system can be termed as a mimicking industry. For example, the products of Islamic banking are formulated by following the products of other banking systems. These are, of course, Islamic banking products. But in most cases, the structures under which these products are developed do not lead to attaining the greater objectives of Islamic Shariah.

Professor Kabir is concerned that the manner in which Islamic bonds are being introduced will increase the likelihood of mistakes. According to former judge and Islamic scholar Muhammad TaqiUsmani, 85 per cent of all Islamic bonds in the world are not Shariah-compliant.

Professor Kabir is unaware of, and cannot estimate from afar, the structural competency and scope of authority of the Bangladesh Bank and the Bangladesh Securities and Exchange Commission (BSEC) for the types of Islamic bond being introduced in Bangladesh, and these are proceeding in the proper manner.

However, he believes that the country requires the right individuals in the appropriate positions. He expects them to carry out their responsibilities and respond appropriately.

IMPLEMENTION OF ISLAMIC BONDS & OTHER COUNTRIES' STRATEGY: The first dilemma is the fact that those involved in the Islamic bond market and engaged in the development of Islamic bonds are mostly lawyers by profession. They would essentially be careful to ensure that the letter of the law is followed and whether it involves any term of interest, anomaly, or the basic principles are followed or not. But they do not consider the end result or determine whether it is a Project Financing product or a Debt Product.

In most cases, it is not only the lawyers but those working in the credit rating institutions who are also prone to rating it from the perspective of the conventional bond system.

As a consequence, they change the fundamental structure of Islamic Bond instruments. As a result, it ceases to be an Islamic bond in the real sense and becomes essentially another conventional bond.

The first challenge is whether Islamic bonds are asset-backed or asset-based. Asset-based is when the originator is the guarantor of creditworthiness. What is the objective of Islamic bonds? The objective is to receive refinancing. In effect, the intent is to hypothecate and monetise the existing asset. This will increase credit in the economy.

The advocates of Islamic bonds say that there should be direct asset-based hypothecation. We call this an Asset-based Islamic Bond. Of course, this depends on the risk appetite of the government. But an Islamic bond is 'backed' by the assets, and that is what makes it Shariah-compliant.

 Let us assume that there is construction work on the highway in process. The future of this asset can be backed by issuing Islamic bonds. This will create opportunities to procure new materials. So, what do the people who buy these Islamic Bonds get in return? The toll collected from the highway can be used to pay back. Professor Kabir believes that people understand this and are proceeding properly.

We have seen four different mechanisms. The Islamic bond is a bondholder, asset-light, an Islamic transaction has to be a sales contract, and the presence of a guarantee.

Another fundamental precept of Islamic Shariah is that "You cannot rent money for money." As a result, the asset-based model, which is heavily dominated by real assets, does not provide a complete picture of financial resources. It is generally accepted that the asset must be denominated in real assets to the extent of 51 per cent real and the remaining 49 per cent in murabaha, or debt assets. Many Shariah scholars allow it. But it is not Islamic. It has to be highly denominated by a real asset to become an Islamic product. If we want to move on properly, we need to formulate the Asset-backed Islamic Bond structure.

There are some factors and intricate issues involved. But, unfortunately, muftis (Islamic scholars) lack appropriate commercial jurisprudence training. Having an Islamic background does not automatically imply that they are specialists in Islamic financial jurisprudence, and hence their capabilities need to be enhanced.

Mohammad Mushfiqul Haque Mukit is a freelance journalist and researcher.

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