The 2008 global financial crisis (GFC) had created unprecedented havoc in the global financial markets and almost all traditional financial assets were severely impacted. Traditional diversifiers and safe haven assets such as gold and foreign currencies (i.e. Swiss Franc and Dollar) failed to provide protection to investors during that time, forcing investors to think about alternative assets to protect them from losses caused by the crisis.
Islamic finance drew the attention of researchers and policymakers during 2008 GFC, attributable to its conservative nature governed by Shariah principle. As a result, Islamic finance is witnessing a surge in popularity with an unprecedented growth of 14% per annum in recent years. It was estimated that global Islamic financial assets would grow to $4.0 trillion by the end of 2020. Such growth is supported by both Muslim as well as the non-Muslim world. Even in the year 2020, which was marred by a global pandemic, it has witnessed 11.4% growth on the back of Sukuk issuance which is surprising.
I have recently conducted several studies on Islamic finance and findings of such research show that Islamic markets comparatively perform better than conventional markets particularly in times of crisis and hence, the growth of Islamic finance is inevitable.
In spite of having interest, Muslim investors could not invest in the traditional financial markets, as Islamic law disallows interest (riba), gambling (qimar), and risky transactions (gharar) such as short-selling and speculation.
Sukuk or Islamic bond, a shari'ah compliant bond, has emerged as a big solution to this problem. Unlike a conventional bond, which represents the debt obligation of the issuer, a Sukuk technically represents ownership of an asset. Sukuk refers to undivided pro-rata ownership rights to the underlying assets and income they generate. Sukuk does not represent a claim of debt in a pure monetary sense. At maturity, the issuer is contractually obliged to buy the bond back at face value.
Sukuk is gaining popularity not only among Muslim investors but also non-Muslim ones. Non-Muslim Investors may prefer Sukuk for several reasons.
First, it can offer higher returns than conventional bonds particularly in times of crisis. Similar to previous studies, my recent analyses also support this proposition.
Second, generally, it is assumed that higher returns are attached with higher risk, but Sukuk surprisingly yields a lower risk than conventional bonds. My recent findings suggest that Sukuk generates substantially higher risk-adjusted returns compared to conventional bonds both in normal as well as crisis periods.
Third, Sukuk can offer diversification benefits, as it is likely to be decoupled from conventional bonds. That is, it is believed that Sukuk moves in opposite directions of conventional ones and therefore, it offers an important way for investors to diversify their portfolios and protects themselves against downturns in conventional bond markets. As a result, Islamic finance is often placed in the category of alternative finance, with good potential for risk reduction.
Finally, we have seen several financial crises, e.g. 1997 Asian financial crisis, 1998 Argentine crisis, 2008 GFC, 2010 European sovereign debt crisis and current Covid-19 crisis over the last two decades. These created significant volatility in financial markets, causing substantial losses for investors. Investors are always looking for markets that are less impacted by these shocks. My recent studies along with several earlier studies found that Sukuk was less impacted by global financial shocks and thus can claim the status of a new safe haven, particularly from a non-Muslim investor's perspective.
Sukuk era has begun in Bangladesh with the issuance of the first Sukuk of Tk80 billion through Bangladesh Bank to support funding of a safe water supply project. Although it is initially issued by the government, the corporations can also take advantage of it.
Bangladesh can benefit from Sukuk in two ways:
First, recently, the Bangladesh government has undertaken several mega infrastructure projects which require huge amounts of funds. Besides, a number of other mega projects are in the pipeline. The financial burden of growing infrastructure needs in Bangladesh can no longer be assumed solely by the government or by means of conventional lending. Sukuk can play a crucial role in financing such projects in Bangladesh.
Second, Bangladesh stock market is characterised by high volatility, less liquidity, and less resilience, while investors constantly suffer financial losses. Sukuk can also play a great role in this regard, as it is mentioned earlier that Sukuk provides diversification benefits to investors in financial markets. Also, it can provide shelter to investors from financial losses in the conventional markets during market turmoil.
In addition to these, Sukuk can also play an important role to reduce the burden of the banking sector in Bangladesh. For example, the private sector heavily depends on the banking sector to raise funds to finance their big projects, which can be reduced substantially using Sukuk.
Given the huge demand for Islamic finance in Bangladesh, no other Islamic product has developed except Islamic banking. Although the Islamic Index was launched in 2014, it did not attract much attention due to lack of publicity.
Dr Md Bokhtiar Hasan is the chairman of Finance and Banking Department at Islamic University, Kushtia. He can be reached at [email protected]
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.