Nathaniel
The Azerbaijan Diplomatic Academy's Fuad Aliyev writes on Islamic banking practices, which are expanding under the noses of regulators who attempt to ban these practices. A case study in how local culture can make issues of regulation and transparency fiendishly complex.
"Guerrilla Islamic Finance:" Islamic Banking the Azerbaijani Way
By Fuad Aliyev
Project Manager & Research Fellow, Azerbaijan Diplomatic Academy
Despite government suspicions about the threat any religion-based activities may have for secularism, an increasing number of Azerbaijanis are exploring ways to introduce Islamic banking into the country, within the existing legal and normative framework, however unfriendly to such efforts those arrangements are. This article considers some of the challenges these efforts face and analyzes what some call “Guerilla Islamic Finance” as a possible harbinger of future trends.
At the present time, there are two levels in Azerbaijan’s banking system, a central national bank (NBA) and a number of commercial private banks. Both are regulated by national legislation, with the banks performing most of the functions familiar to students of banking in Western countries and banned from getting involved in trade, manufacturing and other businesses as owners or operators. The system has suffered on occasion through the lack of sufficient prudential regulation and supervision, but the government has gradually moved to tighten its monitoring of liquidity and liabilities in line with Basel principles and thus improved public confidence in banks.
Could Islamic banking fit into this system? In principle, yes, because Islamic banking represents a system of financial intermediation that avoids interest-based transactions based on Islamic teaching concerning halal and haraam and intended to ensure justice and equity. By so doing, such banking makes use of profit and loss sharing (PLS) transactions, an arrangement that can allow Islamic banks to function alongside non-Islamic ones.
Although there were attempts to set up such banks as early as the late 1950s in Pakistan and in Egypt in 1963, the beginning of the period of modern Islamic banking dates to 1975 when the Islamic Development Bank (IDB) was established to provide development financing. That bank and its successors use a number of banking “modes,” many of which are unfamiliar to those who know only about Western banking system.
These include Ijara, a form of leasing, which involves a contract where the bank buys and then leases an item to a customer for a specified rental over a specific period; Mudaraba where there is a contract between two parties, one of which provides the funds and the other provides the expertise while both agree to the division of any profits made in advance; Murabaha which takes the form of a contract for purchase and resale and allows the customer to make purchases without having to take out a loan and pay interest; Musharaka which is a partnership that involves placing one's capital with another person and both sharing the risk and reward; and Qard ul-Hassana, a kind of loan free from profit but where service fees may be involved.
There are currently four kinds of modern Islamic banks: first, Islamic banks and financial institutions that operate in a fully-fledged Islamic banking system such as Iran, Sudan and Pakistan; second, Islamic banks and financial institutions that work in a dual banking system; third, Islamic banking activities undertaken by conventional banks; and fourth, international financial institutions such as the IDB which operate on the basis of Islamic principles.
Islamic banking is spreading in many post-Soviet states, but it faces some particular obstacles in Azerbaijan. Among them are the absence of any regulatory-legislative basis for Islamic banking, the NBA's unfriendly attitude, the lack of the necessary legislative and supervisory framework, the absence of an interest-free financial marketplace, and the lack of linkage institutions to provide those entering this sector with information and support.
Nonetheless some progress in this sector has been made, progress that we can call “Guerilla Islamic Finance” – banking activities “hidden” under the forms of conventional banking and thus accepted by the regulators. Of four above-mentioned types of Islamic banks two are in principle possible in Azerbaijan: Islamic banks and financial institutions that work in a dual banking system and Islamic banking activities undertaken by conventional banks.
Some elements of Islamic finance have been introduced into Azerbaijan via the activities of the Kovsar Bank, which positions itself as an Islamic bank; the collaboration of local banks, including the International Bank of Azerbaijan with the Islamic Development Bank (IDB), and the activities of the Caspian Invesment Bank.
The Kovsar Bank uses mudaraba and musharaka, and also from the sale of bills of bank analogous to sukuk. But it remains unclear how this bank is able to do this given existing regulations, because the bank is not open to the public and because it releases little information. Consequently, just how much of a contribution it has made in this direction is uncertain.
The situation regarding collaboration of local banks with the IDB is clearer. Several Azerbaijani banks work with the IDB. According to the project coordinator Mr. Behnam Qurbanzadeh under this project IBAR allocated six million USD through ijarah, ijara thumma al bai' and installment sale. These operations do not contradict the Azerbaijani legislation and could be “hidden” under the accepted terms of conventional banking. Local banks can thus open “Islamic windows” and render bank services and products to the client segment, but such a partial Islamic banking does not cover so called “passive” banking operations dealing with deposit accounts.
And finally there is the case of the joint Caspian Investment Company set up in November 2007 by the Azerbaijan Investment Company and the Islamic Corporation for the Development of the Private Sector. Because it is not technically a banking institution it will be easier to implement the investment activities and various projects based on Islamic financial principles although it will not be allowed to render banking services or collect deposits.
There are thus several ways in which Islamic banking may be introduced in Azerbaijan. While the future of any of those remains uncertain even for those prepared to engage in such operations, some local experts drawing on the international expertise suggest that promoting “Islamic windows” within local banks would be the most plausible way to go though this would require greater involvement on the part of the local banking system and deeper collaboration with the IDB.
Bibliography:
Aliyev, Fuad (2007). “Islamic Revival in Azerbaijan: the Process and Its Political Implications,” The Caucasus and Globalization, 1 (2).
Raquib, Abdur (2007). Principle and Practice of Islamic Banking, Dhaka: Panam Press.
Warde, Ibrahim (2000). Islamic Finance in the Global Economy, Edinburgh University Press.
Citation:
Aliyev, Fuad (2008). "'Guerrilla Islamic Finance': Islamic Banking the Azerbaijani Way", "Azerbaijan in the World" Azerbaijan Diplomatic Academy Biweekly, Vol. I, No.13, available at http://www.ada.edu.az/biweekly.
Further Reading:
Global Integrity Report: Azerbaijan
Tuesday, August 19, 2008
Azerbaijan's "Guerrilla" Islamic Finance
Monday, June 23, 2008
Want Good Credit? Watch Where You Shop
Where you shop and what you buy may impact your access to credit -- and that's not a good thing for democracy.
Last week, BusinessWeek.com reported on a lawsuit filed against CompuCredit, a credit card issuer, for failing to disclose that it uses the buying patterns of card users to evaluate how much credit to offer them. The lawsuit (details here) has been filed by a U.S. regulator, the Federal Trade Commission, which protects consumers from fraud.
Global Integrity's work emphasizes fighting corruption in governments through checks and limits on government power -- an approach rooted in the Jeffersonian idea that in a democracy, a citizen's right to speak and act freely must be protected from power-seeking institutions. In Jefferson's day, this meant government institutions. While powerful corporations existed then, the daily engagement between citizens and these institutions was limited -- the East India Company didn't much care what you were reading. But it looks like CompuCredit might.
According to the FTC's complaint, the company uses buying patterns to determine who presents a higher risk of defaulting -- a visit to a marriage counselor might flag you as soon-to-be financially unstable. Any development-oriented microlending organization will argue that access to credit is a key factor in economic empowerment. Given the volume and detail of information that a credit card bill provides about the person using the card, it's not hard to see where this can progress from a debatable to disconcerting to fundamentally undemocratic way to deny that access. Should a person who shops at a university bookstore get better access to credit than someone who uses a laundromat? What about a grocery that caters to immigrants? What can magazine subscriptions tell a lender about a person's financial future? It's not hard to imagine a lender preferring a Forbes reader over a New Socialist subscriber. Or a New Parent subscriber.
If these practices were all publicly disclosed and debatable, that would be one thing -- but they're not. Credit profiling is an occult art; the careful management of who to lend to is one of the few ways that lenders compete with each other. (The FTC complaint is with CompuCredits's alleged lack of disclosure of sales-data profiling, rather than the practice itself.) The end result is a culture of uncertainty and fear -- where self-censorship is common and the financially responsible choice is to stick to the mainstream, even with private acts like shopping online.
Thomas Jefferson was a staunch defender of "the rights of thinking and publishing our thoughts by speaking or writing; the right of free commerce; the right of personal freedom." This is commonly interpreted as a defense of unregulated markets, but I would argue that Jefferson would be horrified by the hold that financial institutions like CompuCredit have over citizens. Using detailed personal histories to determine a person's financial destiny threatens the roots of democracy: freedoms of conscience and association.
The FTC's attempt to enforce existing transparency rules around these practices is a good start. In this case, ensuring "the right of free commerce" may require additional government regulation.
-- by Jonathan Werve --
Sunday, June 15, 2008
Analysis: The Private Sector & Anti-Corruption
Thanks to our friends at the Center for International Private Enterprise for the plug in their recently published paper, "Changing perspectives: how donors can work with the private sector to reduce corruption."
Thursday, June 5, 2008
Nuts and Bolts of a Scandal in Kenya
Global Integrity's Kepher Otieno has been busy muckracking in Kenya. Here he details a distressed company's creative bookkeeping that should be all too familiar to readers familiar with Enron, Worldcom and the like. Corruption & fraud: it's not just a Western-nation problem.
Livelihood threatened at troubled Sony
By Kepher Otieno
The Sony Sugar Outgrowers Company (Soc) in Awendo is in trouble.
This follows massive corruption allegations that have plunged the company into financial crisis. It has been put under receivership.
Other than missing machinery, funds running into millions of shillings cannot be accounted for. In some cases, money that should have been paid to the company directly was paid to individuals.
Parts of a grounded tractor at the Outgrowers Company. Picture: Kepher Otieno.
While the firm has been placed under receivership, what is indicated on the books is completely different from what is on the ground.
Loans running into millions of shillings remain unpaid, leaving the company heavily indebted.
In March last year, Soc was put under receivership by the Kenya Sugar Board (KSB) due to the high amounts of debt.
At the time, the company owed KSB Sh423, 280, 000 from a loan it failed to service over the years.
The principal loan of Sh359, 411, 204 had been used to buy tractors. However things went out of control when the company failed to service the loan accruing to an interest of Sh46, 821, 000.
With Soc unable to honour repayments, KSB had to place it under receivership. This was part of a solution to salvage the company from collapse after suggestions to auction it failed, owing to its low asset value.
Valuers said the company was too indebted to be auctioned and even KSB would not meet the requirements. Auctioneers are paid as per the Auctioneers Act and to auction Soc would require a 21 days notice. The headache in this case has been sourcing for money to effect the services which include putting up an advertisement in the newspapers.
The last option, therefore, was to place the company under receivership. A receiver manager, Mr Maurice Selebwa, was seconded by the sugar board to help revive it.
But Selebwa is not a happy man. The ghost of corruption at the company keeps haunting him.
For instance, tractors bought through a loan have not been operating. They have been parked at the company grounds. Reviving them has proved difficult.
Some of the tractors have been immobile for the last 20 years yet Selebwa’s task as spelled out by KSB was to revive the stalled machineries.
"I hardly sleep as I ponder over the best remedy to pull Soc from its financial troubles. The Herculean task has been to make the company viable and more responsive to the farmers’ increasing needs," says Selebwa.
A spot check by The Sunday Standard within the company precincts revealed grounded tractors with several parts of the machines rusting in the grass.
These include engines, trailers, tyres, shells of motorbikes and scattered parts of the machines and number plates strewn all over the parking yards.
Some parts of the machines are alleged to have been looted by former workers and senior managers. However, investigations are yet to close in on the chief suspects.
"KSB assumed that the machines only needed to be serviced and put back on road but when I called the company from which they were bought to carry out an evaluation, we found out that only 13 out of 41 tractors could be resuscitated," Selebwa explains.
The logbook that Selebwa received indicates there were 41 tractors yet in actual sense, only 13 could be verified. But even these had suffered mechanical breakdown.
Asked about the other tractors, Selebwa says: "I can only talk about what I received. I cannot tell you where the other tractors are although I have the logbooks."
Greatest challenges
While records indicate that former managers handed over intact tractors, Selebwa says he only found scrap metals and assorted parts of the tractors.
"Records show that the tractors are intact, but what is on the ground is completely different," he explains.
When he took over the company assets, KSB gave Selebwa tough terms of reference. One of the terms was to come up with a good business plan in 60 days, which he did. He then brought in a team of evaluators from the Ministry of Public Works.
The total asset value of every single machinery evaluated totalled Sh8.9 million but the company had spent Sh165, 376, 000 million to purchase the machines over the years.
"This is one of the greatest challenges that I had to settle at this giant institution," he says.
The latest audit was done in 1998. An independent audit report conducted by a team of internationally recognised certified public accountants then established massive corruption had taken place at the company.
Unfortunately, the recommendations by Kassim Lakha Sam Vir Abdulla were not exposed.
The report indicates that June 30, 1998, the balance sheet of the company had an excess of current liabilities over current assets amounting to Sh114, 708, 730 million with an accumulated loss of Sh36, 095, 730 million making the company insolvent.
The auditors were unable to verify motor vehicles, tractors, motorcycles and trailers with a net book value amounting to Sh20,184,785 million.
Five tractors and three trailers with a net book value of Sh10,764,732 were registered in the name of a third party, the auditors found out.
The auditors were also unable to verify the absence of a register containing details of trailers with a net book value of Sh25,470,264 million yet their logbooks existed. Also unclear was the Company’s inventories and cash at hand, amounting to Sh6, 256, 937 and Sh116, 256, 607 million respectively.
Authenticity of transactions of payment of Sh2, 625, 444 on discount given by Farm Engineering Industries was capitalised. Donation of Sh3 million by the Swedish Government for feasibility study carried by Agro Systems Limited was not reflected in any of the released financial statements of the company.
Payments of transport sub-contractors amounting to Sh2, 989, 367 could not be traced. Also missing was the listing of loans given to farmers amounting Sh74, 165, 968 million. Further investigations revealed that individual loan accounts were not maintained in the ledger book.
Auditors also reported a fraud by company workers amounting to about Sh10, 460, 000 million while KSB loan was not reconciled with ledger account. A difference of Sh3, 575, 514 was detected in the flawed transaction as per the Audit report. Some cheques payable to the company were paid to individuals.
Farmers now want the auditors report to be acted upon before Soc is handed over to them.
Originally published in The Sunday Standard. Republished with permission of the author.
Read more in the Global Integrity Report: Kenya.
Wednesday, February 20, 2008
Wikileaks Responds to Bank Julius Baer
Wikileaks responds to Bank Julius Baer, which has sued Wikileaks and successfully requested that their website Wikileaks.org be blocked. According to a Wikileaks press release, Baer filed papers for an IPO a mere three days before obtaining the censorship order. Wikileaks points out that the ongoing PR disaster for Baer was not well timed.
The current censorship controversy will now inevitably complicate the IPO deal. Says the Wikileaks press release, which I received via email, "Attempting to censor Wikileaks was a very, very expensive mistake for Baer."
Wikileaks has published documents (earlier coverage) which allegedly implicate Baer in money laundering. Baer claims that Wikileaks published and altered documents stolen by a former executive.
Global Integrity has not confirmed the content of this release. Via email: Wilileaks Press Release
Wed Feb 20 23:03:44 GMT 2008
Wikileaks has discovered Bank Julius Baer was preparing to take their US operation public via an a billion dollar IPO. They filed the prospectus with the SEC on Feb 12, a mere three days before convincing Federal court Judge Jeffery White to order total censorship of the transparency site. ( SEC LINK ): "We are an asset management company that provides investment management services to institutional and mutual fund clients. We are best known for our International Equity strategies, which represented 92% of our assets under management as of September 30, 2007." They were going to call the business "Artio" (ticker symbol ART, to be listed on the NYSE). Goldman Sachs and Merrill Lynch were to underwrite the IPO according to Bloomberg (BLOOMBERG LINK)
So the last thing they needed was to be the subject of a New York Times story and all over the world press, associated with money laundering. Now the deal goes under a microscope. Their underwriters have to take a second look and the SEC may have questions. Julius Baer will probably have to file a "material event" 8-K report with the SEC. Newspaper and magazine reporters will be looking at Baer. The question will be raised that the rather high returns Baer reports may be achieved via money laundering.
All this is happening in a down market, in which it is hard to do an IPO and in which investors are very sensitive to unexpected risk. The whole deal may evaporate, or be repriced downward.
Attempting to censor Wikileaks was a very, very expensive mistake for Baer.
Friday, February 8, 2008
The Resource Curse Revisited
Susan Aaronson examines prospects for trade and accountable government in light of a new initiative to increase transparency around extractive resources. Might the Resource Curse be exorcised?
The promise of free trade to elevate living standards in poor countries has driven international development policy since WWII. Countries rich in oil, gas or minerals sell them to rich countries, and the money goes to desperately needed infrastructure, like safe drinking water. If only it had worked out that way. Instead, the concentration of wealth in oil rich states has often produced profoundly undemocratic nations, a phenomenon known as the Resource Curse.
But is this inevitable? Nearly 200 years after the theory of comparative advantage called for realigning economies around trade, the background institutions assumed to exist by the theory, such as basic transparency and reliable contracts, are -- perhaps -- starting to arrive.
Dr. Susan Aaronson (a Global Integrity Report: 2006 contributor) examines a new initiative to increase transparency in states dependent on extractive resources. Aaronson writes: In 2003, the British government proposed a new strategy – the Extractive Industry Transparency Initiative (EITI), to address these problems. This initiative created a voluntary system to which governments rich with oil or minerals agree to adhere. These states entrust an independent administrator to compare extractive sales and revenues as declared by oil companies and recorded by governments. In addition, “all companies operating in the relevant sectors in countries implementing EITI have to disclose material payments to the government” and then make this information public. Such reporting reduces the ability of policymakers to demand bribes of companies, while increasing the ability of citizens to monitor government.
The analysis: Natural Resources, Often a Curse, Can Also Serve the Public
UPDATE: Susan has kindly provided Commons readers with the source data (with academic citations) for the article cited above.
Aaronson, "Is EITI the Future of CSR because it Aligns the Public and the Business Interest?"(MS Word, 300kb)
Aaronson and Winston, "Extractive Industry Indicators" (MS Powerpoint 1.5Mb)
Monday, February 4, 2008
Nigeria: A study in patronage
Our friends at the Initiative of Public Policy Analysis, based in Lagos, have an analysis of the government's failed efforts to jumpstart the local concrete industry in Nigeria by restricting imports. Reading this, I am struck by how fuzzy the lines between failed-but-well-intentioned economic policy and state-capture can be. However, the analysis concludes:
License-or quota-based importation in whatever form effectively limits the powers of the market to operate efficiently. It creates distortions and diverts resources allocation. Resources that could be used to enhance local output are diverted into political patronage to compete for import licenses. Lifting the ban on bagged cement is at best a short-term remedy, not a long-term measure that can potentially achieve competition and lower prices. Indeed, the history of cement importation in Nigeria suggests that the latest is a familiar tune to reward political patronage...
Read the full analysis: Part One. Part Two.