Islamic finance: exotic or expansive?

Tammer Qaddumi, Private equity analyst, Abu Dhabi

Sitting in a room full of energy bankers and lawyers one evening, I listened to an esteemed Ivy League professor explain how he was able to bridge two disparate academic fields on his way to becoming one of the pioneers of Islamic finance. Working alongside respected Islamic theologians in order to convince a wealthy Muslim investor to put his money into a particular deal, the working team repeatedly hit walls in their efforts to reconcile the concepts of risk, credit, security, and cost of capital with the documented words and actions of the Prophet Mohammed. As a last resort, the professor and the scholars tossed out their case studies and scriptures and drew up a simple analogy:

Say you've got a camel. Now say you lend that camel to your neighbor. You charge your neighbor to use the camel. Now say that the camel gives milk while the neighbor is using it. Who does that milk belong to? What if the camel gives birth? What if the camel dies? Who gets the benefit of that camel, and who bears the risk if that camel goes down?

The simplicity of the analogy should by no means imply a simplicity to the Islamic texts themselves. On the contrary, the texts are some of the most sophisticated religious documents ever recorded. And those who abide by these documents are equally knowledgeable. The Islamic texts carefully explain the logic against interest (to prevent the practice of usury), describe the importance of trade, and outline the principles of sharing risk and reward, among countless other commercial topics.

However, in the pioneering days of Islamic finance, by phrasing the issues in these simplified terms, the ideas behind modern high finance were much easier to relate to the Quran and the Hadith (the documented actions of the Prophet Mohammed). This translation provided the scholars with a level of comfort in a variety of structures that are now the backbone of Islamic finance. What this professor had pieced together is that Islam did not require a re-writing of financial theory, but rather a defendable link to principles already embedded in the religion. With that established, all that was needed to get the deal done was a bit of word-smithing.

The people of the Muslim world are historical traders, commercially-minded people, and they are proud of that fact. No one gets the better side of a deal with a Turkish soap dealer or a Lebanese shopkeeper. But the Islamic religion has a problem with charging money on money. Value cannot be ascribed to something that does not have intrinsic value. Money doesn't have intrinsic value, so charging someone for money is tantamount to theft. When it comes to something that does have value, however, it is religiously permitted (and dare I say culturally encouraged) to charge as much as you can.

What underlies any Islamic transaction or financial product, therefore, is the simulation of a sale and purchase. A loan becomes a discounted sale to a lender with a put option at the back end, for example. Preserving the sale/purchase concept and the appropriate sharing of risk and reward, Islamic finance practitioners have been able to Islamify almost any financial product, mimicking the commercial costs and returns on all sides.

In the same way that conventional financial products spawned where opportunities subject to constraints existed, Islamic finance has evolved rapidly through creative structuring. Now you can get equities, bonds, derivatives, JVs, funds, sale-leasebacks, mortgages, asset-backed financings, fixed rate, floating rate, whatever you want. Last week I got a call from a particularly persuasive Pakistani salesman who convinced me to take an Islamic credit card which offered a better 'profit rate' than the interest rate I get on my conventional card.