SHAFAQNA – Shafaqna decided to conduct a special interview with Usman Hayat the CFA, Director, Islamic Finance & ESG, CFA Institute, London, United Kingdom.
CFA Institute is a global association of investment professionals that offers the Chartered Financial Analyst (CFA) designation, the Certificate in Investment Performance Measurement (CIPM) designation, as well as the Claritas Investment Certificate. One of its core beliefs is that fair and effective financial markets, led by competent and ethically centered professionals, are what drive economic growth. Since its founding in 1947, it has grown to become the largest global association of investment professionals with more than 115,000 members working to shape an investment industry where investors’ interests come first, financial markets function at their best, and economies grow.
Usman Hayat, CFA, is director of Islamic Finance and ESG at CFA Institute, where he focuses on Islamic finance and sustainable and responsible investing. Previously, he worked as an independent consultant in the capital market in Pakistan and earlier as a Joint Director at the SEC in Pakistan. He has earned the Financial Risk Manager designation from the Global Association of Risk Professionals, the Islamic Finance Qualification from the U.K. Securities and Investment Institute and a Certificate in Islamic Finance from the Chartered Institute of Management Accountants. Mr. Hayat holds an MBA from Lahore University of Management Sciences and an MA in development economics from University of Sussex in the United Kingdom. He has been an active columnist on capital market issues.
SHAFAQNA – How would you define Islamic Finance?
Usman Hayat – Islamic finance is about bringing faith based ethics into finance. The term Islamic finance is generally meant to be banking, capital market, and insurance. One way to describe it is to say that it is finance that is not inconsistent with the teachings of Islam. I say “not inconsistent with” instead of “consistent with” because the default ruling in Islamic commercial jurisprudence is permissibility. Everything is permissible unless it is specifically prohibited. In fact, in some cases Islamic finance may well be indistinguishable from conventional finance, such as equity financing.
Personally, I like to think of Islamic finance as morally conscientious and pro-equity finance that takes a more humane view of things. If you look at the debates of mainstream finance, they are about CAPM, efficient market hypothesis, equity premium and so on. You don’t find much content on human welfare and natural environment in these debates. In fact, you can at times go through a whole finance text book and not find any reference to society and environment. Islamic finance literature, like the sustainable and responsible investing (SRI) literature does not disconnect with concerns about human welfare and environment. I cover both Islamic finance and ESG issues in investing at CFA Institute and I see the parallels between Islamic finance and SRI in trying to “avoid harm and do good.”
SHAFAQNA – What distinguishes Islamic Finance from mainstream finance?
Usman Hayat – Islamic finance puts constraints on both the purpose of financing and the structure of financing. To give a simple example, it cannot be used to build a casino through interest bearing loans because gambling (purpose) and lending money on interest (structure) are considered prohibited in Islam.
Here it is worth clarifying that while it is called Islamic finance, it is not meant to be confined to Muslims and the idea is not to be different for the sake of being different. It is an inclusive field where, regardless of your faith, you can participate as an investor, customer or employee. A useful example to illustrate this point is Amanah Growth Fund managed by Saturna Capital in the US. It is the largest equity fund in Islamic finance globally and most of its investors are non-Muslim Americans, and so is its principal portfolio manager, who happens to be a CFA Charterholder. In fact, CFA Institute has members in different countries who are working in Islamic finance, such as Bahrain, Malaysia, Pakistan, Saudi Arabia, UAE, UK and many more.
Some of the core ideas in Islamic finance are closely related to risk-sharing. Islamic finance literature emphasizes that sharing the risk of asset and enterprise promotes distributive justice in the society.Instead of lending money on interest to the resourceful (because they are the best credit risk) or engaging in trading of risk through derivatives, financiers and finances are supposed to participate in asset and enterprise in the real economy, and share the risks and rewards. This normative concern with distributing wealth and opportunity through risk sharing in Islamic economic thought is in contrast to the free market version of capitalism which would prefer that people accept gross inequalities in wealth and opportunity rather than try to do something about it.
SHAFAQNA – Has there been a historical evolution of Islamic Finance? Are there country or regional variations of Islamic Finance?
Usman Hayat: Modern Islamic finance is a young industry based on old ideas. Some of these ideas, such as prohibition on lending money on interest, predate Islam and are frequently traced to Christianity and Judaism. Just about 50 years ago, Islamic finance was mostly theory and little, if any, practice. The institution of Tabung Haji to assist pilgrims in Malaysia and the Mit Ghamr project catering for rural farmers in Egypt in the 1960s represent the first Islamic financial initiatives. Dubai Islamic Bank is reportedly the first Islamic commercial bank which was established in 1975 in Dubai and the Islamic Insurance Company was the first Islamic insurance company founded in 1979 in Sudan. The modern Islamic finance industry gained most of its size and prominence in the decades following the 1990s. For instance, the first Islamic equity index, Dow Jones Islamic Market Index was launched in 1999 and the Central Bank of Bahrain issued the first sovereign sukuk (or Islamic investment certificate) in 2001.
There are variations across countries in Islamic finance. It is well known that Islamic finance in Malaysia tends to be less constrained than Islamic finance in the Gulf Cooperation Council countries. There could also be variations within the country, as different institutions offering Islamic finance may do things a bit differently. The evolution in Islamic finance is very much alive and ongoing.
SHAFAQNA – What are the challenges facing Islamic finance?
Usman Hayat – As a young field that has in its theory ideas which run counter to the established system, Islamic finance faces a lot of challenges. But let me talk about what I consider to be the most important challenge, the form versus substance debate.
Islamic finance structures tend to take the legal form, as per Islamic commercial jurisprudence, of trading and leasing, but their economic substance tends to be of interest bearing debt. Critics question that if profit-sharing is encouraged in Islamic finance and debt is constrained or even discouraged, why does the industry rely pre-dominantly on debt? While the mainstream view in Islamic finance is that it is acceptable to charge a higher price in a credit sale compared to a spot sale, critics find credit sales used in Islamic finance too synthetic to really be a sale. This is most relevant for commercial banking and most of the Islamic finance is indeed commercial banking in emerging markets.
It is difficult do risk sharing within commercial banking because it was not meant for sharing risks of real assets and enterprises but for borrowing and lending money on interest. Reasons such as central bank regulation, commercial pressures and profit motive pressure Islamic banks into acting more and more like conventional commercial banks within the fractional reserve system.
This makes Islamic banking an easy target for critics who continue to assail it for being Islamic in form but conventional in substance. Proponents of Islamic banking tend to argue that it will take time to put genuine risk sharing into practice and what’s being done is what can be done within the global financial system at the moment. The debate between the critics and the proponents rages on, but it affects the credibility of Islamic finance sector and limits its potential.
With the benefit of hindsight, there is a growing realization that Islamic finance better fits investment management rather than commercial banking. It is investment management that has structures like mutual funds which are better suited to genuine risk-reward sharing. In fact, some of the hardest critics of the sector tend to have a softer, if not favorable, stance towards mutual structures.
SHAFAQNA – What is the current size of Islamic Finance? How has it grown during the past decade?
Usman Hayat – Industry estimates tend to put the current size around US $1.5 trillion. Clearly, it is a small industry as some of the largest banks in the world have assets more than that. But hardly a day passes when there isn’t a news item about Islamic finance in the likes of Bloomberg, FT and Reuters. One reason it makes so much news is its explosive growth rate. The estimates of growth of the sector also vary, ranging from 10 to 30 percent, but there is one thing in common among them, they are all in double digit year after year.
But not everyone is impressed with Islamic finance just because it is growing. There is a fairly widespread wish that Islamic finance should not be content with just being business as usual that is “compliant” with technicalities of Islamic commercial jurisprudence. They would like Islamic finance to be more like impact investing based on sharing business risk, making a profit and making a difference. Many eyes are watching the industry to see if will do more to walk the ethical talk and reduce the gap between its theory and practice.
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