Which geographic locations represent the best opportunities for Islamic financial services over the next few years?

SIDDIQUI: You have to look at the macroeconomic environment. Islamic finance is an oil related phenomenon. The Gulf Cooperation Council (GCC) is becoming deeper and wider. Oman and Saudi Arabia are part of this widening. There has been consolidation in Bahrain with Islamic banks. There is a migration towards size. Islamic finance is also a documentation led phenomenon. We are seeing Gulf-based banks raising money in Malaysia because of documentation. Malaysia, as a leader in Southeast Asia, will deepen and widen Islamic finance. There are jurisdictions that show potential, such as the Commonwealth of Independent States (CIS), lead by Kazakhstan and Azerbaijan. The Arab Spring countries of Africa are part of this as well. The key issue in these places is the regulatory infrastructure. There is a concept called Sharia Tax and Regulation Standardization (STARS). This has to be in place for Islamic finance to take off.

Will there be harmonization among the different Islamic centers or will there be fragmentation?

SIDDIQUI: Harmonization implies that there is disharmony. There is no disharmony. Like most industries, you begin with fragmentation, followed by coordination, and consolidation. We are still in the fragmentation phase. The Muslim countries that want to take part in Islamic finance, and the non-Muslim countries that want to tap the petrol liquidity, are at different levels of economic development. Their regulatory infrastructure, capital markets, and awareness about Islamic finance, are all different. You have to put this large hodgepodge of different attributes into the mix to say that this is a vertical silo approach. Islamic finance today is a domestic phenomenon. We need to migrate beyond the shores for it to become a regional and international phenomenon. This will have to take place behind the concept of STARS.

How have Islamic products and indexes fared in comparison to their conventional counterparts over the past few years? What do you project for the future?

SIDDIQUI: Islamic finance is a subset of the conventional global economy. What happens upstairs has an impact on what happens downstairs, whether it is by liquidity or by confidence. On the financing side, Islamic finance says that the financial sector has to be linked to the real economy. Everything that is financed must have tangible collateral. The concept of having derivatives on derivatives, speculation, and leverage are not good. This has prevented Islamic finance from blowing up. On the investing side, Islamic screening is essentially low debt, non-financial, social, ethical investing. This is a phenomenon that is coming to the west. Islamic finance today is negative screening. The industry is moving towards positive screening, which is a good thing. Companies like Microsoft, British Petroleum, Pfizer, and Intel are all compliant companies. In a way, they have a link to Islamic finance. The industry has to move to Sharia-based indexes. This will give you the pulse and the health of what is happening in this space. 

In what ways do you see Malaysia playing a leadership role in Islamic finance?

SIDDIQUI: In Malaysia, there is commitment, continuity, and coordination. There is no complacency. This has placed Malaysia at the tip of the spear for Islamic finance. We must figure out what parts of Malaysian Islamic finance is exportable to other countries. The STARS concept exists in Malaysia. It does not exist in many other jurisdictions. You cannot export Malaysia’s robust model to these countries, but you can export bits and pieces of it. This will be a good starting point.

How do you see more sophisticated and consolidated GCC markets impacting Islamic financial services?

SIDDIQUI: Everything is about size. Size mitigates the risks associated with the lack of size. When you have size, the ability to take calculated risks increases. If Islamic finance is liquidity oriented, short term, and risk averse, then size allows you to graduate from risk averseness, towards risk taking. There is a perception that the foundation of Islamic finance is bedrock in the GCC. In reality, most Islamic banks are small in terms of paid up capital. Whether you have a mega-bank like Kuwait Finance House, or a license to become a mega-bank, the perception will start to meet the reality of size. When you have size, you have access to deal with wealth.

How do the Islamic financial service centers need to better educate the general population?

SIDDIQUI: The public relations and marketing of Islamic finance, which is very important in brand building, is not strong. At one level, the industry sees it as a cost. It is an investment in the brand to turn this niche market into a mainstream market. Some of the institutions in Malaysia and the UAE are slowly recognizing the importance of brand building.

Which trends in the macroeconomic outlook for Islamic finance are showing positive signs, and which represent challenges?

SIDDIQUI: Today, Islamic finance is a debt phenomenon lead by sukuk. At one level, sukuk has become the alter ego of Islamic finance. When you have a sukuk default, or bankruptcy, it tells people that there is instability. However, this is simply a young industry going through growing pains. Defaults and restructures show that it is linked to the macroeconomic environment. The industry needs to bring balance to it. We are currently debt biased. You can be conventionally over-leveraged, and you can be Islamically over-leveraged. We know what the consequences are when the optimistic cash flows are not able to meet the profit rate payments. On the equity side, alternative assets need to be built out. The Muslim countries need to have a robust buildup of compliant equities. At one level, Islamic investing is about Sharia-compliant capital flight. We have to look into how we can reduce some of that, and keep some of the money within the Muslim countries. The industry has to move from form to substance. One of the most important parts of the dialogue of form over substance is what we call space. Religion is an emotional issue. When you mix faith and finance, it works well in the Muslim countries, but it may not work as well in the non-Muslim countries. If we re-brand Islamic finance as participation finance, as they do in Turkey, it could be beneficial. The phrase of Islamic finance conjures up certain images, both negative and positive. Participation finance implies that people doing business are partners, and as partners neither person will take advantage of the other. People will be forthcoming with information. There will be an element of transparency and governance. That’s what the essence of Islamic finance is.