Project Director, Islamic Economics Project
Islamic finance industry over the past three decades has diversified itself from banking to other sectors as well and now it comprises institutions such as Islamic banks, Islamic insurance companies and Islamic mutual funds. Growth has been impressive during the last decade despite the crisis that had hit global financial markets during that time period.
Islamic mutual fund industry has also enjoyed success in attracting investment funds from Muslim investors and also from non-Muslim investors due to their impressive performance. Islamic mutual fund industry has grown by leaps and bounds globally and in Pakistan as well. Currently in Pakistan, there are 15 AMCs (Asset Management Companies) managing Islamic mutual funds. There are 29 open ended funds that are Islamic in the open ended funds category. Besides, there are 18 voluntary pension funds and 1 closed ended fund.
However, despite growth and profitability, since these institutions have a mandate to work as per Islamic principles and philosophy, it allows us to question and study their performance in upholding Islamic ideals, principles and philosophy, especially with regards to promoting productive and real sectors of the economy and entrepreneurial culture. In this context, below, we present few observations on their performance and operations so far.
Increase in financial instruments through issuance in primary market does not add to ‘Gross Fixed Capital Formation’ unless they are used in a way which increases the productive capacity of the economy. Islamic principles compliment the growth in ‘Gross Fixed Capital Formation’ or productive capacity of the economy by encouraging entrepreneurship in productive sector. Taking on entrepreneurial risk is at the heart of Islamic economics. This risk can only be eliminated at the cost of compromising the basic distinctions of Islamic economic principles. Effective institutions are required to perform financial intermediation that promote entrepreneurial culture rather than circumvent it.
To place short term funds, one investment alternative used is known as ‘Commodity Murabaha’ or ‘Tawarruq’. Basing their actions on the opinion of scholars that ‘Murabaha is allowed, even if not ideal’, the Islamic fund managers took the allowance to the extreme whereby in Commodity Murabaha transactions, the subject matter is not genuinely required by both financial institutions, but each of them takes ownership literally for some minutes and execute a complex sale resulting in a profit for one and fulfillment of liquidity requirement for the other.
Ready buy-future sale is a financial transaction used to circumvent same day trading restriction. By taking unilateral undertaking which is binding, a two-leg transaction is executed which enables the fund to invest funds for very short term by buying and selling on the same day. To circumvent the requirement of possession before sale, rather than executing sale, price is locked through a unilateral undertaking which defers the actual sale transaction, but locks all transaction details and features including price at the time of buying in first leg of transaction. This not only encourages shortsightedness and promotes speculation, but also disregards the concept of meaningful long term risk sharing relationship with the Investee Company.
As of now, there is no Islamic investment bank in Pakistan and there is no Islamic venture capital fund. Mudarabah companies that had been in existence since the 1980s have performed in such questionable ways that even the Shari’ah scholars advising Islamic mutual funds regard investment with these companies as non-compliant from Islamic principles standpoint. In voluntary pension funds, there are as many Islamic funds as the number of conventional funds.
This just goes onto show that apart from banking, there is so much room in alternate financial institutional structure where Islamic institutions can lead rather than follow. But, their philosophy to mimic and follow the conventional trail as deeply as going towards Islamic derivatives and structured finance disappoints those who expected and hoped for a distinctive and egalitarian financial architecture. Key to that is equity based financial intermediation taking over currently debt based financial intermediation which is circularly linked with banking. But, while Islamic banks maintain higher spreads than conventional banks and have most of their products linked with interest based indexes, there is a long way to go still.