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“Islamic finance is a medicine for economy” | Linar Yakupov in Tatarstan

I continue to be fascinated by product design in western banks and the sheer lack of innovation despite a clear permanently different business and consumer environment.  By innovation I don’t mean higher or lowers fees and interest rates.  What about the substantive design of products? 

The tile of this post is a provocative statement I located at Islamic Finance Expert that will likely meet mostly deaf ears in the US however when we dig beneath the surface , there is merit to the statement when we appreciate it speaks to the methodologies and product design employed by banks to fund business and retail loans.  So US readers, please bear with me.

The western capitalist and financial approach is naturally designed to be one of animosity.  It is a highly one-sided affair whereby the debtor has only one approach available to them which is maintain all the terms and conditions of the debt.  In contrast the creditor owns all the terms and conditions and is always in charge, particularly when the circumstances change and those new circumstances always add to the rights of the creditor.  Whereas there is no change in circumstances that could arise whereby the debtors position could be advantaged over the creditor. 

The opposing capitalist argument would be that positive changes in asset values or profits from business ventures all accrue to the debtor, with no advantage to the creditor.

The very design of this structure is designed to become animus immediately upon a change in circumstances.

What is it about Islamic Finance that it different?

The source of the statement in the title of this post came from someone I was listening to on BBC news.  Linar Yakupov is a financier in the central Asian country of Tatarstan, a state that is part of the Russian federation.  Most Tatars are Sunni Muslims.  The point of the BBC piece was to point out the dramatic shift in commerce here since the opening of Russia and the dramatic increase in importing and consumption of Halal foodstuffs.

The piece continued on to note the increase in consumption of Shariah or Islamic Finance – the financial version of Halal. 

I have noted here before some of the aspects of Islamic Finance back in the 2006 – 2008 period, and it fell off my radar during the credit crisis.  But my approach back then was merely noting the demographic shifts in western countries and the opportunity that created for western banks.  I see now this was a limited view of the opportunity.

Is the economy really that bad that we need innovation in product design?

This is a new normal.  I just do not see how traditional approaches to financing can be the only means to an end in this environment. 

The newer and deeper message promoted by Yakupov and others is that Islamic Finance is a better alternative and one that could navigate the gyrations of capitalist economies particularly as we look out at probably 10 – 20 years of economic re-engineering caused by:

  • western business & consumer deleveraging and the impact on asset values
  • unemployment absorption & geographic reshaping (think Detroit & Pittsburg)

These shifts are enormous and US, Canada, UK and Europe are all being impacted.  History tells us that post crisis periods create genuine industrial and business innovation.  This occurred in 1870’s and 1930’s.  Richard Florida points out that there is nothing like severe downturns to generate innovation in The Great Reset.  The 1870’s created heavy industry and railroads.  This was a dramatic change.  Innovation such as the assembly line and large factories really took hold post 1930 and the resultant consumer boom lasted until now based on continual growth.  Those innovations in the 1870’s and 1930’s were more than simply the equivalent of a new web model.  They involved systemic shifts in commerce and business.

Financial design worked well so long as everything grew reasonably steadily and bank product design followed along and supported that path.  But what happens now that that bubble is burst.  Does current product design support consumers and business effectively in times of continual doubt and the working out of structural unemployment and the new value of assets particularly housing which have average new price variances across the US of incredible proportions.  (Saginaw-Saginaw Township North, MI $59K to San Jose $630K).  The important note is that the average prices have taken a new form as industry and business changes produced dramatic unemployment where economies were strong prior to the economic breakdown.  I also note that the link where I located the average prices above notes NA for Detroit.  Seems a bit ostrich like of them. is closer to the mark displaying homes in the between < $28K up to >$65K ranges.

It is hard to imagine how banks can operate rationally with such shifts occurring.  The results are neither good for banks nor consumers.  Banks will simply exit the Detroits of the world and that sticks with the one-side model referred to above.

Some specifics on Islamic finance that could work for the post crisis world

Interview with Linar Yakupov.

Principles of investment that support local and infrastrucure: 

  • Firstly, according to Shari’ah principles – TIIC doesn’t participate in business connecting with gaming, alcohol and pork production etc. Yet another important moment, to which I would like to draw attention is the fact that TIIC will maximally distance itself from the oil patch. Generally, the investment company will be the additional lokomotive for the diversification of our economy – not only in Tatarstan but in other regions of Russia. 60% of investment will be for our Republic, the remaining is planned to be invested in projects of other regions of Russia.

Helping people help themselves:

  • In the Halal Industrial Park the facilities for successful completion of the cycle are provided in order to solve this problem – from the farmer to the consumer. HIP will unite the whole circulation of production flow: from the small and medium-sized businesses’ employers, engaging in manufacturing, to the consumer. Linova-Trade, the special company promoting the production of HIP, has been setted up yet. It will start the activity from the next year.

The main point:

  • Moreover, exactly the slant to the speculative instruments in the traditional finance sphere led to the grave crisis. On that score Islamic finance and banking, or ethical banks, how they started to be called nowadays, don’t allow to produce speculation and are turned out to be a sort of  anti-crisis instrument. We don’t say that Islamic finances are the panacea, but they could be the revitalizing factor for the whole economy. If this objective implements, we will be very pleased.

Sharing of risk is a core aspect within Islamic finance from International Shari’ah Research Academy for Islamic Finance (ISRA).

The nature of contracts, which requires that risk be shared by the contracting parties, exemplifies the principle of fairness and justice in Islamic Finance. For instance the partnership contract (musharakah) specifies that all the parties that share the capital in a particular venture will share the profit in proportion to their capital contributions. On the other hand, if there is any loss, all have to share the loss according to the portion of the capital contributed. This equity-based contract will also help to generate greater economic activities through the principle of profit-and-loss sharing; and the clearly defined risk-and-profit-sharing characteristic serves as an additional built-in mechanism to avoid any disputes and economic uncertainties.

Relevance to Bankwatch:

We are in changeable economic times, and everyone expects that to last for many years to come.  Today on Fareed Zakaria his topic was ideas as he seeks to understand what it will take to operate and thrive in this new world.  He interviews Robert Kaplan, Clay Shirky and Richard Florida.  (It is an hour that knocks it out of the park if the future interests you)

What struck me about the methodology espoused by Islamic Finance is not the adoption of Islam or Halal.  Rather it is the adoption of sound principles that avoid the bad and focus on the good (Umair would like that).  It is not a rhetoric argument to argue that gaming and alcohol business will not generate the innovation required to move us through these times.  Rather what struck me is the focus on non-speculative core business which in the case of Tatarstan happens to he Halal but there is no reason these finance principles cannot be applied to core businesses that operate in western economies. 

A core aspect of product redesign that banks can learn from Islamic finance is shared risk.  What if mortgages made during the period 2003 – 2007 had a proportion based on shared risk and benefit.  This would have limited the home ATM phenomenon, speculation would have been reduced, and frankly less risks would have been taken.  A product designed this way where the bank shared in the appreciation on homes would have had no interest in 2006, but what of such a product in the 2010 – 2020 timeframe?

Back in 2008 I noted the proposal by Niall Ferguson for a Jubilee as the only solution because he believes the deleveraging necessary is too large to absorb.  Jubilee means (amongst other things) debt forgiveness and Niall noted the many times this has been used in history to get past a bubble.  Islamic finance uses shared risk as a method of producing a softer landing than absolute debt forgiveness but achieves similar results.

It just strikes me that there are serious lessons to be learned from the world of Islamic Finance that can be applied to genuine innovation of western financial products that would work not just for Muslims for for western consumers, business and economies. 

Written by Colin Henderson

August 29, 2010 at 12:20

Greece ponders the unthinkable

There is likely a little grandstanding for the benefit of the Euro leadership in Michalos comments, yet as a technocrat it only makes sense to consider the implications of all alternatives.

Athens rehearses the nightmare of default |

On Friday afternoon, Constantine Michalos, president of the Athens chamber of commerce, sat in his office – around the corner from where protesters were hurling chunks of marble at riot police – and contemplated what was once unthinkable:

“All hell would break loose,” Mr Michalos said, sketching a society that would quickly run short of fuel, food, medicine and necessities. “You would have social upheaval.”

Written by Colin Henderson

February 18, 2012 at 14:10

Posted in Uncategorized

Another example seeking better ways for the modern economy

Continuing along the theme of ‘medicine for modern finance’ here is another pointer that better approaches are sought, but not before we can understand what is wrong with the current system. You only have to look at Cleveland to understand something is not right.

On the recent interview of Premier Wen of China by Fareed Zakaria. Fareed asked his usual final question of which books Wen recommended. One of the choices was the unusual one of The Theory of Moral Sentiments, by Adam Smith. In the interview it came out that ‘Moral Sentiments’ was written 17 years earlier than Wealth of Nations, that bastion of modern capitalism. Yet Moral Sentiments was written first and provided Smiths moral backdrop to the eventual ‘Wealth’. This is yet another example of how we might learn from those who are apparently at odds with our beliefs, when he has picked the very author of modern capitalism as his regular read.

University of Chicago Press

Influential economist Deirdre N. McCloskey is in the midst of a multi-volume revisionist history of the whole of Western economics. In the first volume of the project she returns to Adam Smith and his largely overlooked discussion of moral sentiments. What is the moral code of capitalism? Is the free market moral? What are the virtues of the bourgeoisie? McCloskey takes on centuries of capitalism’s critics with her erudition and sheer scope of knowledge, affirming capitalism without ignoring its faults. The Bourgeois Virtues: Ethics for an Age of Commerce is fiercely contrarian intellectual history at its finest.  And—virtues of capitalism—it’s free.


(Incidentally if you sign up at UofC Press site, you can get the opportunity for free ebooks including one of the McCloskey volumes)

All this to say Deirdre N. McCloskey has written two volumes (one
two) on the topic of ethics for the age of commerce, and ‘Why economics cannot explain the modern world’. There over 1,000 pages to the two volumes, so this might take a while, but the premise is encouraging, and I am hoping may offer additional insight for different and alternative approaches to commerce that get closer to both sides winning, versus the winners and losers approach that currently exists in finance, and is beginning to look like 2 steps forward, one step back when viewed over longer time periods.

What I liked about this approach is that it goes back in history and to the very theory that forms the basis of modern capitalism and questions what we thought we know about what Adam Smith meant.

Written by Colin Henderson

November 1, 2010 at 16:14

Posted in Uncategorized

The worries about Sharia are getting in the way of common sense regarding better opportunities in finance

When I wrote up the piece on the sensibility of the concepts contained in Sharia finance I knew there were undercurrents everywhere that would react to the words Sharia and Islamic which would blind folks to the concepts that exist underneath those apparently inflammatory words. 

Sense about sharia | Economist

Contrary to some hysterical talk, nobody seriously suggests the use of Islamic penalties in any democracy. Nor is there any reason to fear Islamic finance: a campus discussion about zero-coupon bonds does not mean usurers will be flogged in Harvard Yard. Nor can anybody object if two citizens settle a commercial dispute on Islamic lines, or any other principles to which both freely adhere. In the English-speaking world there is a custom of arbitration, which has created a space in which religion-based arbitration services are accepted, offering Jews, Christians and Muslims a simple, cheap (and from their point of view, divinely blessed) way to settle disputes.

This week we have also seen Germany come out with comments about racial integration.

The Economist piece refers to the work at Harvard since 1994 on Islamic Finance.  The matters of concern about Islam and Sharia law are for another day and another blog.  Here i do want to separate the embedded values about finance contained in Islamic Finance and how they can help us Westerners see new ways to approach finance that will help us.  It is clear the approaches we have been taking are not working and just look here which includes the latest fraudclosure scandal to see the results. 

The promise of the Sharia approach is to share risk between lender and borrower.  This concept allows for future changes in circumstance that is inevitable.  This is not the only new approach available, but there are no others being presented so here is the first.  Western economies are in bad shape with a new structural unemployment in existence that will ensure consumer deleveraging and lack of purchasing capability.  This is an important addition to the debate about the future of consumer finance.

We can keep doing it the old way and expect different results (the definition of insanity) or we can seek different models.

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Written by Colin Henderson

October 17, 2010 at 23:27

Posted in Uncategorized

Emergency Economic Stabilization Act of 2008, and the word that is missing

I would have posted this earlier this evening, but the US House Committee on Financial Services site was down due to the overwhelming response to download the act.

Here is the full proposed Act emergency-economic-stabilization-act-2008-ayo08c04_xml (EESA)

Here is the more useful part for most their one page summary – emergency-economic-stabilization-act-2008-summary-ayo08c04_xml

There are five parts:

  1. Stabilizing the Economy
  2. Homeownership preservation
  3. Taxpayer Protection
  4. No Windfall for Executives
  5. Strong oversight

I took away a few thoughts:

Much of the rhetoric in the bill worded to protect the US taxpayer and punish the big bad banker, will do much of neither.  There is a general theme to the Act that bankers have engaged in predatory lending on poor people with bad mortgage terms that pressed those poor people into losing their home.  Sensitive issue.  One thing that does make sense in the Act is the ability of the Treasury to alter the terms of the mortgage to make it more affordable.

EESA requires the Treasury to modify troubled loans – many the result of predatory lending practices

This provision is of course unfair to the average middle class with mortgages who happen to be able to afford them.  That same middle class were also not complicit in questionable information practices between mortgage brokers and banks.  Nonetheless this provision makes sense, if for no other reason than some locations will lose their ability to have a consumer credit market otherwise, eg. Detroit.

However we are where we are, and finding ways to make the mortgages affordable for those people will bring back some semblance of stability to the real estate market.

The issue I have with this legislation, and the one dead moose on the table <sorry, Canadian expression> that no-one has spoken of is Bank debt.  The notion of managing bank executive pay is ludicrous.  Stupid banks will always find ways to remunerate stupid executives.  Has no-one heard of forgivable loans?  Take a dig on financial statements and see the size of those for junior growing executives.

No, the way to harness Banks is to increase their capital requirements.  This is the one ting that makes banker cringe.  Banks are over-extended with debt, and in a normal bank to customer negotiation, if the bank were applying for credit, the bank would not qualify for debt.  {for non-bankers:  debt = customer deposits}

Some examples:

Bank Debt (deposits) Equity (Capital) D/E ratio
Bank of America 1,554,184 162,691 10 : 1
Wells Fargo 561,110 47,964 12 : 1
JP Morgan 1,642,494 133,176 12 : 1

We could continue but the results would be similar.  This is also little different in other countries;  its not an American thing.  Why is it important?  If one of those Banks loses an amount equal to or more than their capital base, they are bankrupt.  Capital is the basis for solvency in a company, the protection against rainy days.

Thats the dead moose.  Banks have no room to manoeuvre.  The banking system works so long as everyone trusts each other, and money can move freely between qualified institutions; banks that are organisations with banking charters.  Thats why the situation in the last two weeks has gone critical.  Banks have refused to lend to each other, and instead have been forced to borrow from their respective Central Banks.  This is borne out by treasury bill being bid higher and higher until reaching close to par.  In layman’s terms that means the interest rate on T-bills reached close to zero twice in the last couple of weeks.  Thats not a good thing.  Its a sign the economy has come to a standstill, and that’s why this EESA is required.  Banking cannot be compartmentalised from the rest of the economy.  The influence of banking transactions is a reflection of the entire economy.   This is a partial nationalisation of banks, and there is little alternative because government regulations permitted the banks to get into this predicament.

This is recognised in the Act on page 13, wherein they note that financial assistance to Banks will be necessary:

In exercising the authorities granted in this Act, the Secretary shall take into consideration—

(6) providing financial assistance to financial institutions, including those serving low- and moderate-income populations and other underserved communities, and that have assets less than $1,000,000,000, that were well or adequately capitalized as of June 30, 2008, and that as a result of the devaluation of the preferred government-sponsored enterprises stock will drop one or more capital levels, in a manner sufficient to restore the financial institutions to at least an adequately capitalized level;

Relevance to Bankwatch:

The word capital exists once in the act.  Capitalization exists twice.  The thing that is missing from EESA is the requirement for Banks to recapitalise.  That is the final test that would penalise bankers, and bank investors, but so be it.  It would be tough medicine with far reaching consequences, for banks and for the economy, but its time has surely come.


Written by Colin Henderson

September 28, 2008 at 21:02

Posted in US

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