Islamic finance body eyes standardised common deals

By Mohammed Abbas

An Islamic financial standards body on Thursday said it had created standard documentation for one of the booming industry's most common transactions, which it hopes will make such deals quicker and cheaper.
Lack of standardised documentation and practices has been repeatedly highlighted by the Islamic finance industry as one of the key constraints on the rapidly growing sector.

Islamic law is open to interpretation, which leads to differences in banking practices depending on the financial institution's advisors.
The Bahrain-based International Islamic Financial Market (IIFM) hopes its Master Agreement for Treasury Placement, which is in the final stages of gaining approval by Islamic scholars, will become a standard document.

"Each bank takes its own different decisions. What we are trying to do is put together a document which is a benchmark document that the industry can use," IIFM Chief Executive Ijlal Alvi told a conference on the future of Islamic finance.
Assets invested according to Islamic guidelines have been growing at roughly 20 percent a year worldwide, reaching $900 billion in 2007, and are set to $2 trillion by 2010, accountants Ernst & Young estimated.

By far the most common Islamic financial transaction is commodity murabaha, which involves a bank buying a commodity for a client, and the client paying the bank back the cost of the commodity plus a bank charge or "profit rate" at a later date.
The contract helps banks manage liquidity, and can be used by the client to secure cash by selling the commodity on again, effectively buying money from the bank for the cost of the profit rate.

Islam bans interest, and stipulates that deals must be based on tangible assets -- money cannot be made from money alone.

Alvi and other bankers at the conference said the response to the standard document had been positive, and expected widespread acceptance. However, the document is not mandatory as the IIFM is not a regulator with punitive powers.

"Standardisation of Islamic finance has been raised as a bottleneck for the fast growing industry. It makes sense that it's commodity murabaha that is being standardised because it's the agreement that is used most widely," Safdar Alam, head of Islamic structuring at JP Morgan said.

Alvi said the new contract would be finalised soon, without giving a timeline.
Commodity murabaha deals have come under criticism in recent years on fears that it is just a paper trail to circumvent Islamic law, with no real prospect of a physical commodity changing hands.

Others say the practice of clients effectively "buying" money for the cost of the profit rate by selling the commodity on is simply interest by another name.
IIFM's new contract does not tackle these issues, but bankers say they are working on an alternative to commodity murabaha.