Debt, corruption and Islamic banking

In last week’s column, I suggested that a political party like Pakistan Tehrik-e-Insaf should adopt the promotion and implementation of Islamic banking as part of its election manifesto. While Imran Khan may not seem like someone interested in Islamic banking and finance, it (Islamic banking and finance) at times attracts interest from the least expected individuals and institutions. Until recently, I used to deliver a one-day training course in Islamic banking and finance at the London-based Chartered Institute of Securities and Investment. On one such training, I met two individuals from the London Metropolitan Police. On my inquiring, they informed me that they belonged to the financial crime branch and were interested to learn about Islamic banking and finance to see if it was linked to financing of terrorism or any other financial crime such as money laundering. Prior to this I didn’t expect police to be interested in Islamic banking and finance. Today, Islamic banking practitioners come from all ethnic backgrounds (from Americans to the Chinese), nationalities (from Ethiopian to South Korean), and from all faith groups (from Jews to Hindus).
I would not be surprised if tomorrow Imran Khan decided to embrace Islamic banking and finance, perhaps not for his love for Islam or Islamists but certainly because of the potential contribution that Islamic banking and finance can make to the cause of national debt strategy and elimination of corruption from the Pakistani economy. Islamic banking and finance, being asset-based, should in principle be less prone to financial crime, but it would be fair to assert that it is no more or less vulnerable to abuse by those who look for weaknesses in a financial system to exploit in their favour. However, because Islamic financing is always provided for doing business or trading, it is relatively difficult for the recipients of Islamic funds to “run away” with the money. In international transactions, if equity-based tools of Islamic finance are used to bring foreign capital into Pakistan, technically the new injection of foreign capital into the country will not lead to an increase in national debt. Even in the case of the government using sukuk for raising debt-based shari’a compliant capital, the financing will always be tightly linked to an already exiting asset or will be used for creating new assets.
This close proximity with the assets being financed makes Islamic banking and finance less prone to corruption. For large transactions, almost always there exists a double due diligence phenomenon (as part of regular banking practices but also an oversight function by the Shari’a supervisory board).
There are some industry observers who argue that Islamic financial transactions are more prone to abuse, given that they are more complex. For example, sukuk (a Shari’a compliant equivalent of a bond) structures normally rely on a number of offshore companies (called special purpose vehicles or SPVs), which can potentially be used for tax evasion and similar kinds of financial crime. After all, the famous Enron debacle resulted from a complex nexus of SPVs that the company used before it eventually collapsed. While it is true that sukuk-type structures tend to be more complex than conventional bonds, it is primarily because of the lack of legal infrastructure in a number of countries where sukuk have in the past been issued. Malaysia provides a good example of a country that has developed a comprehensive framework for the issuance of sukuk. Therefore, there sukuk structures tend to be less complicated and consequently less prone to dispute, corruption and fraud. There is a need to study that model for the further development of an Islamic capital market in Pakistan. Once a transparent Islamic capital market is developed, fears of misuse and abuse of Islamic financial structures will diminish. It is important that the government develops a comprehensive plan to privatise the existing banks and financial institutions only through their conversion to Islamic financial institutions. The likes of Abu Dhabi Islamic Bank and many Qatari banks and financial institutions are looking for shopping opportunities out of their respective jurisdictions. Creating an upbeat environment in favour of Islamic banking in Pakistan will certainly attract their attention. Bringing an international class of new investors into Islamic banking in Pakistan will also ease out corrupt practices in the banking sector, by making such institutions less exposed.

The writer is a Shari’a advisor to banks and financial institutions and can be contacted at [email protected]