The US economic health is waning. Credit crunch, bankruptcy, bailout, recession and Ponzi schemes were the infections. Thankfully, parties ‘inoculated’ with the Shariah vaccine have survived. Although they didn’t escape unscathed, neither did they succumb to the financial maelstrom. AYU AZIZ is convinced the US needs the Islamic finance vaccine.
Islamic finance is relatively new to the US. Save for the minority Muslims and those involved in the global banking and finance sector, its existence has barely been acknowledged by the masses. But the scenario is changing. The spotlight recently turned on Islamic finance when the world’s so-called most formidable economy was brought to its knees by the global financial meltdown, which led the entire nation to re-examine its economic foundations.
Free market and deregulation which were believed to be the solid basis of the capitalist economy became brittle not with time but through a blend of greed and poor regulation. The government is desperately trying to fix the problem but until now, no clear remedy has been found. In a desperate search, the US is now exploring alternative “cures” for its ailing economy, including the feasibility of Islamic finance.
In November 2008, the Department of Treasury in Washington, DC, and Harvard University’s Islamic Finance Project organized a seminar on Islamic finance. The aim of the seminar — labeled “Islamic Finance 101”, fittingly enough — was to help inform the community of policymakers on Islamic financial services.
The event hosted speakers from the academia and industry, and was attended by staff of the US banking regulatory agencies, Congress, Department of Treasury and other parts of the Executive Branch. It was inaugurated by Neel Kashkari, the interim head of the new Office of Stability who was in charge of the US government’s US$700 billion financial stabilization program proposed by the previous Bush administration. And it attracted a lot of attention from the public.
“The seminar generated quite a bit of negative press from right-wing groups in Washington who held a press conference on the same day, condemning the US Treasury for falling victim to Islamic finance, which, in their opinion, is a covert conduit for terrorism,” said Yusuf Talal DeLorenzo, chief Shariah officer of Shariah Capital, who was one of the speakers.
After 9/11, resistance toward anything Islamic was to be expected. It came as no surprise, therefore, when FOXNews.com, a major media player, published an article headlined “US Interest in Shariah Finance Opens Dangerous Doors” not long after the tragedy. And to think this was only a low-key seminar. One can only imagine the response of the Americans if the US Treasury were to launch a sovereign Sukuk.
Despite the rebuff from certain quarters of the community, Islamic finance has taken off in the US in a small way. Shariah-based banking is being offered to Muslim communities and there are Shariah compliant funds available for investment.
Small doses
The country has experienced small doses of Shariah-based finance in areas where there is a significant concentration of Muslims. In Detroit, Islamic finance has taken root in a small but significant way. University Bank started offering Shariah-based banking when it saw demand for such services a few years ago. Stephen Lange Ranzini, president and chairman of the bank, has no regrets over the decision.
“University Bank is performing above average compared to our peer group of banks because we have avoided many of the risks that other banks have taken. Many US banks, in contrast, are losing money or have had at least one unprofitable quarter,” said Ranzini.
He added that the bank continues to grow rapidly and was recognized locally as one of the 12 fastest-growing businesses in the area, having grown revenues from US$6.5 million to US$11.5 million from 2004 to 2007. The performance in 2008 shows further rapid growth because the bank avoided engaging in toxic or exotic mortgage products that had caused the housing crisis, which saw many homeowners lose their homes because they were unable to service their loans.
“As a percentage of outstanding financings, our Muslim customers have settled their payments as agreed much more often than non-Muslim customers. Only a handful of Muslim customers have defaulted so far, and these are due to death of the family breadwinner, loss of a job or leaving the country, where there was a low down payment from the customer,” Ranzini explained.
“Since the deals with low down payments all had mortgage insurance, so far the depositors have not taken many losses and the rates of return on Islamic deposits have been good.”
Although upbeat, Ranzini remained wary because the credit crunch has had tremendous effects on the economy and he recognizes that this is a test for Islamic finance as well. “We cannot guarantee we won’t have some setbacks because the US economy is in such bad shape, but the Mudarabah profit sharing structure of our deposits and Islamic deposits insulates the bank from some of those risks,” he said.
“At the moment, because the US Federal Reserve has manipulated the cost of short-term money to close to zero, the profit sharing deposits offered by the bank (Mudarabah) offer superior returns to depositors than conventional deposit account products. The cost of home financing and commercial real estate financing are now comparable in cost,” Ranzini explained.
Another financial institution that offers Islamic products is Devon Bank based in Chicago, where the Muslim population is fairly broad based from new immigrants to native born. What’s unique about Devon is that it offers a few faith-based financial services, not just Islamic.
“There are a variety of investment funds targeting ethical investors, but they are largely not structured to avoid interest. We have provided some financing to the observant Jews who do not deal in interest, but we have not seen strong demand for these products as we have had for our Islamic financing products,” said David Loundy, vice president and corporate counsel of the Islamic finance division at Devon.
Loundy did not deny that the bank was affected by the credit crisis. However, he described the impact as minimal. “We are affected, as is every US bank, but not badly so. Our watch list is growing, as is our volume of delinquencies and foreclosures, but we have always been conservative lenders and believe our actual losses will be fairly small. A delinquency is not necessarily a loss,” he said. Devon’s Muslim customers are multicultural and made up of various races. Loundy described it thus: “It is probably most heavily Indo-Pak, but with some Arab, some African, some Eastern European and a variety of others including Indonesian and Malaysian in the mix. They range from taxi drivers to neurosurgeons.
“For 2009, we anticipate continued digestion of the fallout from 2008 as the economy stabilizes. We expect deposits to grow somewhat, for portfolio loan growth to remain slow, but for off-balance-sheet loan originations to remain fairly strong.
Our major Islamic finance investor has just renewed and extended its commitment for 2009, and we have brought a new investor online in the last month. If things line up properly, we hope 2009 will be a year of growth in both footprint and product set,” he revealed.
Shariah-based investments
Retail banking isn’t the only segment to feature Shariah-based structures. On the investment side, Dow Jones introduced the Dow Jones Islamic Market International Titans 100 Index Fund in 1999. The fund lists a group of Shariah compliant stocks for ethically inclined investors.
The fund is said to be the most stringent in terms of its Shariah screening process with minimal tolerance ratios for things that are banned in Islam — alcohol, conventional financial services, gambling, pornography, tobacco, pork-related products and weapons manufacturing. But the screening has no negative effect on the performance of the fund. Since it was launched, the fund has been one of the most preferred globally with good returns for investors.
Before 9/11, the US was the destination of choice among Gulf investors, who showed little concern over whether their investments were Shariah compliant or not. Post-9/11, the trend changed. Now, with the emergence of Shariah compliant stocks and funds, the money is coming back in.
According to Isam Salah of legal firm King & Spalding, “There are new investments coming from the Middle East, but not at the same level as earlier in the year or last year. Given the lower prices for assets in the US, we do expect a pick-up in new investment activity in 2009.”
In addition, Shariah investment funds have been recognized as among the few that have performed well in an economy that’s spiraling downwards. Morningstar, a US-based independent investment research provider, listed two funds from Shariah compliant Amana Mutual Funds Trust among the top three best-performing faith-based funds in the country in January 2009.
The Amana Trust Income Fund topped the list with losses of only 25.8% of its value for the year, while the Amana Trust Growth Fund was third, losing 30%. The losses incurred by were minimal compared to the average 44% losses reported for US stock funds.
In another development, the first Shariah compliant exchange-traded fund (ETF) will be launched in the US soon by Javelin Investment Management. Known as the Javelin Exchange Traded Shares (JETS), it is the second to track a Dow Jones index after the Dow Jones Islamic Market International Titans 100 Index.
According to media reports, the company chose an Islamic portfolio to kick off its family ETFs because of the lack of competing products and it wanted to leverage on an existing Islamic investor base spread across institutional, high net worth and retail. As for Islamic papers, there is only one corporate Sukuk that was issued in the US. The East Cameron Gas Sukuk, launched in July 2006 to raise US$165.67 million, was issued by East Cameron Partners using the Musharakah structure, which will mature in 2019. The lead arrangers were BESC and Merrill Lynch.
The initial rating by Standard & Poor’s was “CCC+” but in January 2009, this was downgraded to “CC” and placed on credit watch with negative implications. The Sukuk was downgraded because East Cameron Partners, the originator of the East Cameron Gas Company securitization, had filed a voluntary petition for bankruptcy, or Chapter 11.
Although Islamic finance has seen minor advancements in the US, the potential for growth is tremendous. “The future for Islamic finance in the US, like its future around the world, is bright.
“In modern society, it is the upper and middle classes that require financial services; and I believe that in countries where the middle class is growing —whether in Muslim-majority countries like Malaysia, Indonesia, the GCC or Pakistan — or in Muslim-minority countries like the US, the UK, France, India and Sri Lanka, we will see a real growth of Islamic banking and finance,” said DeLorenzo of Shariah Capital.
He explained that the world is already beginning to see real demand for Islamic finance from middle-class consumers. “I believe that it is the middle-class consumer who will drive the future of this industry.