Interview: Tirad Al-Mahmoud
How has the government’s investment strategy, post-economic crisis, impacted the demand for sharia-compliant financial services?
TIRAD AL-MAHMOUD: The characteristics of sharia-compliant services, grounded in limited risk and morality, have become more desirable for consumers in light of the recent global economic slowdown. Increased government investment has also stimulated personal and corporate lending. This has led to a growing demand for Islamic financial services (IFS) in the region, to the extent that it is exceeding that for personal banking.
Islamic banks operate under morally sound principles. This requires transparency, but also carries less risk over time given that all financing is asset-based, sharia compliant and disengaged from speculation. As a result of more predictability and reliability, the consumer market is responding with growing demand for personal Islamic banking services.
What measures should be taken to improve the flexibility of Islamic banks?
MAHMOUD: While sharia-compliant financial services offer advantages such as a low-risk profile, their business model places restrictions on them. A significant barrier to growth for Islamic banks is the absence of flexible forms of working capital finance that can compete effectively with conventional banks.
Given that Islamic banks are asset-based financiers, financing is available through leasing or on a deferred payment basis. Noting that interest cannot be charged, these agreements entail profit- and risk-sharing partnerships. This can unfortunately lead to moral hazard, where entities using Islamic financing enter with the knowledge that they will take a loss which the bank will have to share. At the same time, partners may not want to split a percentage of any profits gained. This has been perceived as unattractive to some borrowers and has restricted Islamic banks to limited forms of financing.
In order to offer more flexible forms of working capital finance, limited partnerships must be provided. Providing an agreement consisting of limited profit and downside would eliminate such financing obstacles and pave the way for further growth. This would require new legislation and a discussion among scholars.
In what way can regulation bridge the gap between Islamic and conventional banks?
MAHMOUD: New government regulation propositions, such as lending caps and loan devaluations, are not only beneficial for the health of the banking sector, but narrow restrictions between Islamic and conventional banks. The UAE market is very competitive, prompting banks to engage in more risk in an effort to gain or stabilise market share, which increases overall risk in the system. Government regulation that creates boundaries to prevent reckless lending practices is therefore welcomed. Prudent, clear measures taken by the central bank will provide long-term stability in the market.
Since sharia-compliant financial services providers already adhere to regulations regarding derivatives, lending and environmental protection, we will see a convergence starting between Islamic and conventional banks. In order to gain confidence from credit agencies and public opinion, conventional banks may begin abiding by the same rules as sharia-compliant banks and engaging in sustainable and green banking.
To what extent do small and medium-sized enterprises (SMEs) provide a new frontier for IFS?
MAHMOUD: SME lending provides new opportunities for growth as it is a relatively untapped segment. SMEs play strong roles in mid- to downstream services and are integral drivers for economic growth. They are currently buoyed by the government’s investment programme in Abu Dhabi, as large investment projects yield vertical benefits for SMEs down the value chain.
However, there are still risks as SMEs do not have the same staying power as larger firms, causing them to be less resilient during a down cycle. Risks must thus be acknowledged for growth potential to be realised.
Read OBGs interview with Tirad Al-Mahmoud in The Report: Abu Dhabu 2015
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