Islamic finance in Australia
Islamic finance is already one of the fastest growing industries on the financial globe, but it has become even more popular after the recent Global Financial Crisis, primarily due to its resilience.
One of the cornerstones of Islamic finance is to legally bind ‘nominal transactions’ with real economic activities. This means money is not treated as a commodity in itself and cannot earn return interest, unless it is legally identified to a real economic activity, in which case it will equitably share the return from that economic activity (profit or loss).
Furthermore, people can only sell what they actually own or what tangibly exists. This is to make sure a nominal transaction is followed by a real/legal delivery.
A key recommendation of advocates of Islamic finance is to restructure the financial system to ensure, at the very least, every nominal activity is backed up a real economic activity. If not, nature will intervene in the form of a crisis, more frequently than otherwise, to cleanse the system (to reduce the gap between nominal and real).
Australia, like many other nations, sees this recommendation as an important segment in its credit market diversification commitment. Australia intends to be a global financial centre in the region where more than 60 percent of the world’s Muslim population resides with a growing demand for Islamic finance.
This together with Australia’s political stability, sizable domestic economy, advance supportive infrastructure and a relatively developed financial system, adds to its chance of becoming a hub for Islamic finance in the region.
Apart from serving the purpose of becoming a major financial centre in the region, introducing Islamic finance will help foster the further integration of more than 265,000 Muslims resident in Australia.
While it is an attractive opportunity, Islamic finance also brings forth some new challenges. First and foremost, it requires the introduction of tax reforms, regulatory and legislative changes to provide a level playing field for all institutions, conventional and Islamic, targeting neutrality in treatment.
For example, purchasing a home via an Islamic mortgage would result in double payment of stamp duty. This is because Shariah-compliance requires the asset to change hands twice. A neutral treatment would require amending the law such that the stamp duty is paid once or an equivalent amount in two installments. The Victorian government has already introduced such changes after working together with the MCCA Group. Other states will have to follow suit.
On the regulatory side, the conventional measure of liquidity cannot be applied to Islamic banks as the composition of an Islamic bank’s assets excludes holding treasury bills, bonds or other interest yielding securities.
Islamic banks tend to hold greater excess reserves than conventional banks, about 40-50% more, and short-term trade finance assets, conventionally regarded as being fairly liquid, are not tradable instruments, and therefore, cannot be transformed into cash until the importer being financed repays.
This will put resource pressure on institutions willing to enter the Islamic finance market. They will have to recruit professionals with expertise in conventional finance and Islamic finance, where numbers are presently limited.
Islamic banks will also have to ensure their product is truly Sharaih-compliant. Shariah-compliance on its own is tricky, given lack of standardization in the industry. This would require approval by an internal Shariah board and/or compliance with standard issued by the Islamic Financial Services Board (IFSB, Malaysia) and the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI, Bahrain).
Shariah-compliance is a sensitive issue and requires some serious thinking. It could be used to gain advantage over others. Understanding its depth and using its skills and expertise to innovate and compete on this front has the potential to fast track Australia’s achievement towards becoming a hub for Islamic finance in the region.
Dr Hayat Khan