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Monday, January 5, 2009

Islamic Finance: safer than Wall Street?

By David Rocks

I spent the past few days in Kuala Lumpur at a conference on American relations with the Muslim world sponsored by the Brookings Institution, the Asia Foundation, and Malaysia’s Institute of Strategic and International Studies. I was on a panel that looked at economic issues in Muslim countries, and one thing that came up was whether Halal financial instruments had held up better than traditional stocks and bonds. I hadn’t thought about this much, but it makes some sense given that Islamic finance is based on the concept of shared risk. The main instrument is called a sukuk, and any money proffered (it’s not technically a loan) is backed by some collateral held by the person or institution putting up the funds. That would pretty much eliminate the arcane instruments such as collateralized debt obligations and credit default swaps that got the Western financial world into so much trouble.

Since I really didn’t know much about it, I spent some time looking into the question today. I still have to plead relative ignorance, so I’d be grateful for any insights readers might have. But I found this story that said the total money invested in Halal instruments had grown to $1 trillion, five times the level of a half-decade ago.(As it turns out, the story came out of a conference in KL—which has become a center for Islamic finance—on Monday and Tuesday, the same days I was there at the Brookings gathering.)

I also found this story out of Australia that says the Dow Jones Islamic Finance Index rose nearly 5% in the most recent quarter. As I understand it, though, the DJ index measures shares in companies that have been judged to be Shariah-compliant (they don’t sell alcohol, pork products, and the like), not a measure of how well sukuks have fared in the market recently.

So that leaves me still looking for some kind of broader measure of the health of the Islamic finance sector. One of the other panelists yesterday, by the way, noted that while sukuks aren’t subject to the kind of turmoil now facing Wall Street, they have some disadvantages. Since they require collateral, they’re often backed by real estate—not necessarily a smart investment these days. In any event, as I discovered from this story in the Guardian, it appears Asian investors aren’t yet convinced Islamic finance is the right place to invest their money.

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