Sanctity of Islamic bonds questioned

Traders at the Kuwait Stock Exchange

Bonds called sukuks, designed to conform to Islamic rules forbidding interest on loans, have been popular investments the past few years. But now a leading scholar has cast doubt on whether the bonds are truly Islamic, prompting fears of a subprime-like meltdown. Stephen Beard reports.

Traders at the Kuwait Stock Exchange (Yasser Al-Zayyat/AFP/Getty Images)

KAI RYSSDAL: The bond market’s been an interesting place this week. Alisa Roth was telling us some of the money coming out of commodities has been heading over there, as investors are looking for someplace safe to wait out the storm.

But the most exuberant bond market around doesn’t have anything to do with Wall Street. Sukuk — bonds that are designed to conform to the rules of Islam — have been going gangbusters… $47 billion worth were issued last year. That’s a 73 percent increase over a year earlier.

But Marketplace’s Stephen Beard reports the world of Islamic finance could be on the brink of its own credit crunch.

Stephen Beard: Islam prohibits the charging of interest — it’s considered exploitation. Muslims believe that those who provide capital should either take a share of the profits or bear the losses of the enterprise they’re backing. Humayan Dar teaches Islamic finance at the CASS Business School. He says the sukuk, or Islamic bond, cleverly circumvents this rule in a number of different ways.

Humayan Dar: For example, sukuk holders receive ownership of an asset which is then leased to the issuer which offers a rental.

But critics say that’s just interest by another name… that bond is un-Islamic. A leading muslim scholar, Sheik Muhammed Taqi Usmani, says 80 percent of these bonds break the fundamentals laws of Islam. Tarek El Diwany, author of The Problem with Interest, says the sheik is right: The banks have been hoodwinking Muslim investors.

Tarek El Diwany: They are engaging in legal trickery in order to produce a fixed financial rate of return from the outset of the transaction. Many of them are — not all of them.

Special boards of Muslims scholars certify all the sukuk as islamic. The trouble is, says El Diwany, the banks pay those scholars — sometimes handsomely. Rather like an investment bank paying a rating agency, which then gives its conventional bonds a triple-A. Hardly an independent opinion…

El Diwany: At the end of the day, it’s a little bit much to expect a big banking organization to pay a scholar who says the bank’s products are not permitted under Islamic law. It’s not going to happen, is it?

Sheik Usmani’s attack has sent shockwaves through the Islamic bond industry. His influential board has just issued tighter guidelines, and that has made many of the existing bonds look as if they don’t comply with Islamic law. Andrew Hilton runs a financial think tank, the CSFI:

Andrew Hilton: Many institutions around the world who hold sukuk bonds might no longer be allowed to hold them. They might have to sell them because they wouldn’t any longer qualify as qualifying investments for those institutions.

He says what’s happening here is reminiscent of the unravelling of the conventional credit markets, when packages of debt, including subprime mortgages were suddenly stripped of their triple-A rating.

Hilton: It could indeed be the subprime meltdown of Islamic fiance. It’s something that people have worried about for a while — quite terrifying for the institutions which have invested in these bonds.

Other analysts say this is not as terrifying as it seems. The bonds may have been stripped of their religious respectability. But the sheik was right: Many of the bonds do pay healthy and fixed rates of return. There will be plenty of non-Muslims lining up to buy them.

In London this is Stephen Beard for Marketplace.


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