world islamic eco forum 5th-publication

8/9/2019 World Islamic Eco Forum 5th-Publication

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UNLOCKINGTHE POTENTIAL:

INVESTING IN THEFUTURE OF THEMUSLIM WORLDA World Islamic Economic ForumSpecial Commemorative Publication 2009


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The uture belongsto those who

prepare or it today.Malcolm X (1925 - 1965)


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CHAIRMANSFOREWORD

Tun Musa Hitam

Chairman o WIEF Foundation

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SPECIAL MESSAGESusilo Bambang Yudhoyono

President o Indonesia

11

INTRODUCTION

Small Change,

Big DierenceFazil Irwan Mohd Som

Director o Editorial and

Business Development o

WIEF Foundation

15

Our Future is Now

Dato Johan RaslanExecutive Chairman o

PricewaterhouseCoopers

Malaysia

Contents

A World IslamicEconomic Forum

Special CommemorativePublication 2009

PUBLISHED BY WIEF FOUNDATION

World Islamic Economic Forum Foundation

2nd Floor, Kompleks Antarabangsa

Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia

T: +603 2145 5500 F: +603 2145 5504

E: [email protected] W: www.wie.org

DESIGN BY PRICEWATERHOUSECOOPERS

Level 10, 1 Sentral

Jalan Travers

Kuala Lumpur Sentral

50706 Kuala Lumpur, Malaysia

T: +603 2173 1188 F: +603 2173 1288

E: [email protected] W: www.pwc.com/my


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CHAPTER ONE:

The World in the Wake othe Financial Crisis

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What Went Wrong:

A Retrospective Analysis o

the Power o Yes CreditStructure

A Rushdi. Siddiqui

Former Global Director

Dow Jones Islamic Indexes

36

Banking on Integrity:

The Prospects o Islamic

Finance in a Diverse World

Rae Hanee

Managing Director o

Fajr Capital

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CHAPTER TWO:

Stability in Foodand Energy

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The Food Crisis:

Identiying the Cause,

Rectiying the Present,Hope or the Future

Jacques Diou

Director General o Food and

Agriculture Organization o the

United Nations (FAO)

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The Rise in Biouel:

The Sime Darby Experience

Dato Seri Ahmad

Zubir Haji Murshid

President & Group Chie

Executive o Sime Darby Berhad

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The War Against Hunger:

Building an Ecient Food

System

Joachim von Braun

Director General o International

Food Policy Research Institute

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CHAPTER THREE:

Tackling a Thirsty World

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Blue is the New Green:

A Demand-Side Proposal

on Water

Dr. Mahmoud Abu-Zeid

President o the Arab Water

Council & Minister o Water

Resources and Irrigation, Egypt

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Water:

A Market o the Future

SAM Sustainable Asset

Management AG &

PricewaterhouseCoopers

85

ACKNOWLEDGEMENTS

89

ADVERTORIAL


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CHAIRMANSFOREWORD

W elcome to the 5th World IslamicEconomic Forum in the capital city oJakarta, Republic o Indonesia. It is indeed a

great honour to be able to convene our thglobal orum in this remarkable country. Thisyears orum bearing the theme o Food andenergy security & stemming the tide o theglobal nancial crisis seeks to address someo the most important issues conronting theMuslim world at present. Issues such as theglobal nancial crisis, ood and energy security,the role o SMEs in development, the prospects

o green technology and its job growthtrajectory are among the pertinent subjectsthat will be discussed. Some o these issueswill also be showcased here in this book tohighlight their importance.

The Muslim world is conronting one o themost challenging times in history when theglobal nancial system that provides the

backbone to the worlds various economiesare showing signs o collapse. We are alsoconronting a possible ood crisis when oodproduction in the Muslim world is at an all-timelow, rendering ood prices to be extremelysusceptible to changes in global prices,such as that in the price o oil, which led to adevastating impact on the lives o millions. Thisis compounded by the act that many Muslim

countries are relying heavily on ood imports.Energy stability and the imperative o a moreecient water management system are equally

important issues that the Muslim world, theMuslim governments in particular, need totackle seriously.

I hope that with the rich and thoughtul articlescontained in this book, the reader can betterunderstand the intricacies o the problemssurrounding us and would be able to actaccordingly to address it. I also hope that the

book can contribute to a richer discussion othe topics mooted at this 5th WIEF in Jakarta.I wish the participants o the Forum a greatnetworking and enlightening session. And lastbut certainly not least, I would like to thank thegovernment o the Republic o Indonesia, theIndonesian national organizing committee andthe Indonesian people or sharing our dreamand giving us support to make this Forum anastounding success.

Tun Musa Hitam

ChairmanWIEF Foundation


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SPECIALMESSAGE

T he signicant eeling o proximity betweenpeople and nations is the reality o ourglobalized world. Our challenges have alsobecome global. The destinies o nations havebecome deeply intertwined and interconnected.No matter where in the world we live, we aretouched by the successes and ailures otodays global economy, politics, and socialissues. Islamic countries around the world areas infuenced by these global challenges andcrises as the rest o the world today.

As Indonesia - the ourth most populouscountry and home to the worlds largest Muslimcommunity - continues its ongoing eorts orglobal collaboration, it is with great honor tohost the 5th World Islamic Economic Forum thisyear in Jakarta, Indonesia. Special thanks to theWorld Islamic Economic Forum Foundation toallow us this honor and or all the outstandingeorts and support to assist us in organizingthis event.

It is hoped that the Forum will serve as aplatorm or global dialogue on pressingeconomic, ood and energy security, andenvironmental challenges that conront theMuslim countries as well as or the non-Muslim countries participants. Like all global

challenges, it will take the collaborative eorto all global stakeholders rom government,business, academe, media and society to pre-empt or stabilize any crisis, create alliances andnd solutions.

Touching on all these issues, through the lenso the prominent authors in this book, it is alsohoped the remarkably inormative articles romvarying perspectives will contribute to reinorcethe understanding o the topics addressed atthe Forum.

On a nal note, on behal o the Indonesiangovernment and people, I wish all our esteemedand distinguished guests a pleasurable andmemorable stay with us during this outstandingand momentous event.

Susilo Bambang Yudhoyono

President o the Republic o IndonesiaPatron o 5th World Islamic Economic ForumHonorary Fellow o WIEF Foundation


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INTRODUCTION

Small Change,Big Dierence

Just as a single sick person can startan epidemic o the u, so too can a

small but precisely targeted push causea ashion trend, the popularity o a newproduct, or a drop in the crime rate

Malcolm Gladwell

The Tipping Point, 2000

Fazil Irwan Mohd SomDirector o Editorial and Business DevelopmentWIEF Foundation


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L ittle things can make a dierence. Asrefected in Malcoms quote, it takes oneperson to spur a series o small-scale eventsthat can radically change peoples ate, thecommunitys wellbeing, or the success onations. One single person is all it takes to playa pivotal role in changing the lives o millions opeople.

This years WIEF Special CommemorativePublication is a refection o an idea. An ideathat i we all work together in our own individualcapacity towards a single common cause,regardless o how small the scale o such anactivity, can have the potential o creating apowerul and positive impact on people andcommunities. This is an idea that highlights theimportance o assertiveness and capitalising onopportunities right at our doorstep.

At present, we ace several o theseopportunities at our doorstep. They come inthe orm o the global nancial crisis, the oodproduction crisis, the energy security impasse,and the scarcity o potable water, all o whichare covered in the chapters o this book,albeit in varying depths and perspectives. Theauthors o this book, in their own unique way,seek to bring to our attention these importantevents and to accordingly paint a better pictureo how the world might look like given a set oprescribed measures.

The lessons rom the global nancial crisisteach us the value o nancial accountabilityand the sound evaluation o credit risks.

Islamic nance is thereore poised to be acredible alternative to the current nancialsystem i steps are taken to push it to the ore,particularly in terms o creating awareness andcreating more innovative nancial products thatcan substitute its conventional counterparts. Itis thereore timely or all practitioners, policy-makers and stakeholders to step up eort intheir own respective areas to make Islamicnance a mainstream practice.

The ood crisis provides us with another door oopportunity. At present, despite an overall oodsurplus taking into account ood productiono each and every national economy on theglobe, many o the worlds poor are still gravelymalnourished. The UN Food and AgricultureOrganization (FAO) stated that the number omalnourished people actually increased rom842 million in 1990 to 963 million in 2008.

By any standards, that is an alarming gureespecially when logistics technology andcoordination would have improved throughoutthe same time period. And this is more o acause o concern because a major chunko the abject poor are people o the Muslimworld. As a result, the governments o severalMuslim countries are starting to look intoood as the next major issue and have taken

appropriate steps to boost production capacity.The national ood policies o Kuwait, Qatarand Bahrain are pertinent cases in hand. Butthere are still more to be done especially by theprivate sectors o the Muslim world.


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For a start, investment in agricultural scienceand technology and rural development isway below satisactory levels. This may be agood opportunity or the private sector sinceinvestments into these areas would increaseeciency o ood production by multiples. Thuswith huge nancial backing rom the key GulStates, ood security can indeed be a viablebusiness venture.

The same applies to investments in variousenergy sources especially those that areenvironmentally riendly. Still more needs to bedone in terms o building capacity and creatingjobs to support these green industries. Andthere is ample opportunity or the governmentsas well as the private sector in these areas.Water is another crucial opportunity or theMuslim world. As it is now, the availabilityo adequate drinking water in most parts othe Muslim world is a cause or concern asit has a direct correlation to malnourishment,ood scarcity and ultimately human capitaldevelopment. In some cases, water scarcitycan lead to large-scale humanitarian confictsas in the case o the Sahel Belt. This thereoreprovides a huge opportunity or the privatesector in several critical areas o watermanagement.

As the PricewaterhouseCoopers studyindicated, there are 4 promising opportunitiesup or grabs or the private sector. There is thedistribution and management sector, wherecompanies can pursue the developmento systems to supply resh water and oersolutions or upgrading water mains and sewerinrastructure. Companies can also ventureinto advanced water treatment which involvesdisinection o drinking water, the treatment owastewater or the desalination o sea water.The third sector is the demand-side eciencywhere companies can oer products andservices to boost eciency o water use inhouseholds or industry. The nal sector isthe water and ood production sector wherecompanies may pursue the development oproducts that improve water eciency andreduce the pollution in crop irrigation and oodproduction.

All these events and opportunities point to theplain act that there are so many opportunitiesthat remain unrealized. The onus is thereoreupon every capable entrepreneur in the Muslimworld to pick up a piece o the jigsaw puzzleand put it in its place to complete the biggerpicture. For only when each individual playshis/her role in contributing to the betterment

o society, can there be real changes in thatdirection. Little things do make a dierence.We have to start somewhere.


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Ouruture isnow

Dato Johan Raslan

Executive Chairman

PricewaterhouseCoopers Malaysia


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Our uture is now

Daily, we ace a barrage o news o distressed economies caused by the near collapse o key nancialmarkets, extreme volatilities in oil and gas prices refecting demand/supply mismatches, global savingand spending imbalances, and severe climate change complications - all symptoms o a world incalamity. To say we live in troubled times is an understatement.

However, while many o us struggle to come to terms with the economic storm that grips us, howmany o us recognise the ragility o our world? We ace the unprecedented challenge o three crisesat once - climate change, an energy shortage and the nancial downturn - which directly and indirectlyimpacts business perormance. In the wider scheme o things, this means our worlds sustainability.

Climate change crisis

Growing water scarcity

By 2025, 1.8 billionpeople ace absolutewater scarcityBy 2010, an estimated300,000 deaths

annually rom climate-related diseases

Signiicant reduction inbio-diversity

By 2050, 200 millionpeople may becomepermanently displaced

By 2100, up to 40%

o species aceextinction and morethan 16,000 speciesare threatened

Energy crisis

Looming oil and gas scarcity

Production oconventional oil isprojected to peak around2030Non-OPEC conventional

oil production already atplateau and projected todecline around 2015

Serious mismatch betweensupply and demand

Without energy eiciency,demand would exceed

120% o supply by 2030Most global energyinvestments planned or2007-2030 are just tomaintain current supply

Financial crisis

Near collapse o inancialmarkets

Sharp alls in stock marketsacross global markets,rom New York to Tokyo,with average equity market

losses o 44%

Severe credit crunch

Frozen credit marketssaw interest rate slashesworldwide with US ratesreduced to nearly zerosince mid-December 2008and this trend is expectedto persist

Rising unemployment

Projected 18-50 millionjob cuts worldwide by end2009


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In the ace o adversity, business leadersshould rerain rom an over-ocus on short-termearnings at the expense o long-term valuecreation and security. Otherwise known asshort-termism, this is perhaps one o the mainculprits o the current economic turmoil. Asone-time US Vice President and Nobel PeacePrize winner, Al Gore, said, The investmentmarketplace worldwide is under a strange spell.Short-termism has led to a distortion o valuesand priorities and a seemingly endless string obad decisions.

Many o us could hardly be aulted or makingour business health our top - and only - priorityin the current environment. But short-sightedbehaviour will work against us.

The danger in short-termism is in its appeal- that is, the promise o immediate prots orthose who are able to make the most o the

moment. It is the very thing that got us intothe economic turmoil we now ace that couldplunge us into even greater despair. Leaderswho orsake long-term and sustainabledevelopment do so at their own peril, and thato everyone who depends on them. In act,we should begin measuring our success indecades, not quarters.

1 This proposal was announced the week o 11 Jan 2009. At the time o print, this was still true, however, there may havebeen developments in Obamas economic stimulus package developments since.

The orest or the trees

We might beremembered asthe generationthat saved thebanks and letthe biospherecollapse.George Monbiot,Journalist, columnist &environmental activist

Recognising the faws o short-termism

In the US, which aces its worst recession since World War II, President Barack Obama recently1proposed an economic-stimulus package that included as much as USD25 billion in energy tax credits orrenewable-energy production (doubling his previous proposal). Despite the enormity o the poverty anddebt issues on his plate, this President recognises the urgency o addressing longer-term environmentalissues to ensure America survives.


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At the heart o it

What is thesustainability agenda?

The sustainability agenda begins withmaking a commitment to incorporatingsocial, environmental, economic and ethicalactors into a companys strategic decision-making. It extends to evaluating how these

actors aect the business - including allo its stakeholders - and what risks andopportunities these actors present.

Finally, the sustainability agenda asksbusinesses to adopt measures to mitigaterisks and take advantage o opportunities.

The sustainability agenda: Industry perspectives*,PricewaterhouseCoopers, 2008


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Many o us acknowledge and understand theargument or embedding sustainability thinkinginto the way we do business. The question - adaunting one in spite o its brevity - is, how?

The act is, sustainability issues pose a myriadset o challenges and individual businesssectors require unique solutions. How do weas a business community - so varied in ourindustries, in where we come rom and wherewere headed to - nd a common resolutionthat we can work together on?

At a recent World Business Council orSustainable Development (WBCSD) workshop2in Malaysia, I was heartened to hear theparticipants agree that the answer to thislies simply in people. At the heart o oursustainability woes, the group agreed, it is thevalues and actions o those in leadership rolesand their people, that can make or break the

sustainability cause.

Responsible and sustainable vision -

your baseline

The WBCSD workshop, titled Vision 2050: An Asianperspective, involved Corporate Responsibility/

Sustainability champions rom over 20 Malaysian

corporates, non-prot organisations and regulators. Itsought to gain their insight into Vision 2050 - a project

which looks at the challenges, changes and solution setsor ensuring a sustainable world by 2050.

2

The leaders role is crucial. Leaders set thetone or how businesses achieve success- and the methods they employ to get towhere they want to be. Those who inspiretheir people with a vision ounded onsustainability and responsible behaviour willensure that these values become a part otheir organisations.

At this point in our history (and here I amtalking about the history o the capitalistenterprise), perhaps it is time we returned

to the basics - old-ashioned values likeintegrity, accountability and transparency.Late last year, at the 5th Conerence onEthics in Business: Corporate Culture &Spirituality at the European Parliament,Brussels, a diverse group o leaders agreedthat corporate ethics is the answer to theeconomic crisis: We are at a turning point.This is the time when the world decides i

ethics will simply disappear in the battle orsurvival, or i it will become the oundationon which we build our uture, said Nirj Deva,a British Member o European Parliamentand Chair o the conerences advisorycommittee.

Leaders must recognise that their businessactivities impact the environment,

community, people and marketplace withinwhich they operate: the business world andthe real world are intertwined, and actionson either side impact the other.


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Figure 2: Stakeholders in an interconnected world

Source: PricewaterhouseCoopers

Naturalorces

Government

Role o businessand governmentin achieving

sustainability:

LeadershipCollaborationInnovationCorporateand socialresponsibility

Businesscommunity

Individuals

You

Humanactivities

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Collaboration - your strategic link

Ours is an interconnected and borderless world wheregeographical and societal lines are ast disappearing. Businesseswhich embark upon strategic collaborations are nding that new

doors open up to them. Yet, exploring new relationships andterritories may seem risky to some. Ater all, change never comeseasy. Fortunately, according to PwCs 12th Annual Global CEOSurvey, 2009, more CEOs plan or cross-border joint ventures thanmergers & acquisitions this year (44%), as compared to last year(30%), which is an indication o even higher levels o collaborationin years to come.

Businesses are also in a unique position. On the one hand, they

have the ability and relationships necessary to infuence - or at thevery least, lobby - governments. On the other, they have a directear to the demands and concerns o the ordinary people.

Businesses play a pivotal role in the lives o their people - thecaring employer provides a wider range o employee benetsthan beore. Organisations in this day and age can impact theiremployees (and employees amilies) health, welare, educationand retirement. They have a great infuence on the worlds citizens

in general, sometimes, even more so than governments do.

CEOs believe

that a uniquewindow o timeis now open.Governments andbusinesses havean opportunityto coordinateglobally toaddress globalcrises.

PwCs 12th Annual Global

CEO Survey, 2009

Collaborative winning examples

Co-opetition (US pharmaceutical industry):

The cost o developing a new drug is exorbitant while onlya third o new medications actually make it to market. Bigpharmaceutical companies, like Proctor & Gamble (P&G), oten

work collaboratively to share risk. A decade ago, P&G started aprogramme to evaluate the thousands o innovations emergingevery year rom academia, biotech labs and pharmaceuticalcompanies. Today, P&G reports that its R&D return on investmenthas improved by 60%, and nearly 35% o the companysnew products have elements that originated rom outside thecompany.3

Public-private partnerships:

Coca-Cola has gone intopartnership with the World WildlieFund in Asia to address the

shortage o drinking water in oneo their biggest emerging markets.Such a move makes goodbranding sense and has a positiveimpact on the communities withinwhich they operate.4

Andy McClenaghan, P&G strategy: Connect and develop: Procter & Gamble sees C + D as a strategic evolution rom

the more traditional R&D and grows through collaborative partnerships, The Gazette (Montreal), October 9, 2006.American Perspectives Managing the way we live and work now and in the uture, PricewaterhouseCoopers, 2008.

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4

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People your talent pool

At the recently concluded World Economic

Forum in Davos this year, it was predicted that50 million people could lose their jobs by theend o 2009. Unortunately, organisations willalso continue to grapple with the talent war -97% o CEOs believe that the access to andretention o key talent is critical or important tosustaining their growth but 69% eel there isstill a limited supply o candidates with the rightskills5.

Many o us are or will be caught in a dicultbalancing act in these trying times - strugglingto reduce costs (job cuts being a tried andproven method) while supporting key talentand increasing productivity. Obviously, any costreduction exercise needs to be carried out witha ull understanding o the impact it will have onthe organisation (and inevitably, the countrys

economy).

The risk o not having the right talent in placeis obvious: any strategies, partnerships orvisions developed amount to nothing withoutour people. And in the current environment,this risk is exacerbated. Now is the time ororganisations to relook the way they prole andinterpret or use inormation about their people.

Leaders need to remember that their peoplearent just numbers but are the means to whichthey can ensure their business survival.

Diversity leads to excellence

One last point, but a crucial one. The business

world is increasingly coming to the realisationthat a diverse organisation is better than onemade up o a single type o person. Withinorganisations, teams (including and especiallyleadership teams and boards o directors)perorm better when they are diverse. Here, Iam talking about all types o diversity: ethnic,religious, educational and, o course, gender.

According to a recent McKinsey study,...companies where women are most stronglyrespresented at board or top-managementlevel are also the companies that perormbest.6 With the business case or women morecompelling than ever, companies are rushing todiversiy. In some cases it is cosmetic, in othersit is to beat competition. But the act remains,that a diverse set o people can be that crucial

element to long-term success.

5 12th Annual Global CEO Survey,PricewaterhouseCoopers, 2009

6 Georges Desvaux, Sandrine Devillard-Hoellinger, andPascal Baumgarten,Women Matter, McKinsey &Company, 2007.

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Figure 3: Triple crises call or urgent,smart and bold responses

VISION

CRISIS

Prole

Dato Johan Raslan

Executive ChairmanPricewaterhouseCoopers Malaysia

Dato Johan Raslan is the Executive Chairmano PricewaterhouseCoopers Malaysia. He isa regular speaker on corporate governance,corporate reporting and corporate responsibilityat local and international orums.

Johan is chairman o the Financial ReportingFoundation (FRF), an appointment by the

Minister o Finance. The FRF oversees thework o the Malaysian Accounting StandardsBoard. He also chairs the Institute o CorporateResponsibility, Malaysia, a network ocompanies committed to advancing responsiblebusiness practices.

He is also a Board member and AuditCommittee Chairman o Putrajaya Corporation,a member o the International Advisory Panel

o the Labuan Oshore Financial ServicesAuthority (LOFSA), a member o the Board oKuala Lumpur Business Club and a membero the Board o Trustees o Tun SuanFoundation.

An Eisenhower Fellow, he is Adjunct Proessoro University Malaya, a Council Member othe Malaysian Institute o Accountants, Vice-President o Malaysian Institute o Certied

Public Accountants and a member o theInstitute o Chartered Accountants in Englandand Wales.

Make or break - the uture is ours

A sustainable world is a uture all o us

have a stake in. However, it is a uturewe cannot wait to attend to. Time is nolonger just o the essence - it is a luxurywe cannot aord.

Business leaders have an importantresponsibility to their shareholders.Great business leaders know their roleis to leave behind a better world.

Source: PricewaterhouseCoopers

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CHAPTER ONE:The World inthe Wake o theFinancial Crisis

What Went Wrong:A Retrospective Analysis o the Power o Yes Credit Structure

A Rushdi. Siddiqui



Banking on Integrity:

The Prospects o Islamic Finance in a Diverse World

Rafe Haneef

Managing Director

Fajr Capital

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What Went Wrong:A RetrospectiveAnalysis o thePower o Yes

Credit StructureA Rushdi. Siddiqui



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The captains o capitalism, operating in the

nancially engineered, leveraged enhanced,

speculative, yield hungry, regulators sleeping,

wild west environment, perpetrated the

largest sel enriching/icon institution destroying

scam in the world, the subprime originate-

distribute mortgage cum toxic asset class,

at the expense o the man on the street! In

todays age o instant communication, alleged

best o breed regulation and transparent

governance, how is it possible that trillions

o US dollars o wealth evaporated over-night, established mega-capitalized blue chip

companies bailed out via nationalization, and

(the allegedly non-existent) decoupling carried

the crisis rom US shores to the developed and

emerging markets?

More importantly, as the present day 400 year

old, G-20 led conventional capitalist systemis undertaking sel-introspection to see what,

where and how, it all went wrong, the important

question is- can a 40 year nancial system

provide some guidelines or a new age nancial

system based on ethical nancing o tangible

and usuruct real assets and ethical aligned

and structured investments.

The Public Policy:

Home Ownership

It is an admirable public policy to provide an

inrastructure to encourage home ownership

or a countrys population, as the building

o a house has a positive multiplier eect

on the local economy. It is also admirable

to allow/encourage nancial institutions to

oer novel/exotic alternative asset classes

that support home ownership. However, in

allowing or a deective originator-distributor

model o nancing and investing, it, the

private-public partnership, also eventually

exposed the shortcoming o the model, andthe incompetence and greed o the chain o

stakeholders.

In order or the (wo)man on the street to better

understand the sub-prime cum credit crisis in

everyday language, lets look at the errors o

commissions and omissions o the stakeholders

o the perect nancial storm that brought thenancial palace in the sky down, and how the

screening o a system called Islamic nance

& banking is approaching the originator-

distributor model o nancing (mortgages) and

investing (securitization and sukuks).

How is it possible that trillions o US dollars o wealthevaporated over-night, established mega-capitalized bluechip companies bailed out via nationalization, and (theallegedly non-existent) decoupling carried the crisis rom USshores to the developed and emerging markets?

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The Stakeholders

Home Buyers

There are those potential home buyers that have

the right credit scores rom the credit scoringagencies (Experian, Equiax or TransUnion), make

the right amount o down payments (20% or more

down), obtain the right appraisal o the home, etc.

With these standards, the process o closing on a

home purchase has worked very well or decades.

The mortgages may then be bundled into

securities (via the securitization process) and sold

to Fannie and Freddie, or packaged into securities

as asset backed securities or sophisticated

buyers, etc. The proceeds o these sales are then

recycled or more mortgages, securities, etc. Thus,

those that can objectively aord to be in homes

are in homes, hence, we see about 63% home

ownership in the US beore the exotic mortgages

came several years ago.

Then there are those new class o buyers witheither no, low or troubled credit scores, who

generally do not make any down payment (either

cannot or will not), and where the rst ew years

o interest payments are below market interest

rates, these are the sub-prime market buyers.

The (wrong) assumption was that the value o the

purchased house would keep increasing, to the

point where homeowners were using the houselike a personal ATMs. Mortgages loans such as

option ARMs (adjustable rate mortgages) were

being oered with supporting documentation

requirements that can be best described as no

doc/low doc loans or liar loans, where you (the

potential homeowner) would veriy your own

employment, income and assets, etc. Thus, home

ownership shot up to nearly 68% during the sub-

prime re-sale bonanza!

An example oten cited is that o a vegetable

picker earning $14,000 who was able to nance

an $800,000 mortgage loan. Our mortgageeis ulflling his/her monthly obligationsor the frst ew years because o thelow teaser interest rates, but eventually

the customer runs into trouble whenthe mortgage payment steps up bya ew hundred basis points above thereerence rate, typically the 10 year US

Treasury rates. Put dierently, the paymentswent rom, say, $500/month to $2000/month. Now

multiply the above scenario a ew million times,

and you can see how the subprime scenario

induces the deault and oreclosure crisis.

Builders

The low interest rates and availability o exotic

(unsecured) mortgages encouraged home

builders to build and expand inventory, because

mortgages were cheap and their borrowing on their

construction lines was cheap.

Mortgage Oering Institutions

The most brazen example o a sub-prime

mortgage oering institution was probably Seattle

based Washington Mutual (WaMU). A recent New

York Times article entitled, Saying Yes, WaMu

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Built Empire on Shaky Loans, provides a most

glaring example o unettered greed at the

top gone amok resulting in the Power o Yes

slogan becoming the business strategy!

A recent New York Times articleentitled, Saying Yes, WaMu BuiltEmpire on Shaky Loans, provides amost glaring example o unetteredgreed at the top gone amok

resulting in the Power o Yes sloganbecoming the business strategy!

Mortgage operations o WaMU during the go-

go sub-prime period can be closely compared

to the boiler room sweat shop operations

o penny stock operators. Pressure rom the

compensation driven executives at the top to

sell stocks was equivalent to the comparable

to pressure to sell loans. The riskiest stock

and riskiest loans netted the highest prots or

the company, the biggest commissions or the

brokers, and the attest checks or CEOs.

The compliance oce ocer o these sweat

shop penny stock operators either did not

exist or was pressured to comply in themaleasance, not very dierent than the

pressure on the underwriter to approve the loan

application or to get the right appraisal rom the

independently cooperative (ee hungry) home

appraiser.

Appraisal Companies

These independent entities are requested

by the mortgage giving entities to supposedlyprovide proper valuations on the home to be

purchased. They typically use a variety o

ormulas, say, comparably sold properties in

the neighborhood, to come up with a value. It

should be noted that a mortgagor may also

have in-house appraisers. As mentioned above,

house prices were increasing aster historically

and money was cheap and easily accessible,

i.e., a sellers market, hence, bigger loans

(or the buyer) means larger prots or the

seller, larger commissions or brokers, greater

revenue or mortgagors, and easy ees or

the appraising companies. Thus, you see the

eects o the Power o Yes culture.

Investment Banks

At one time, some o the brightest minds

rom schools went into bio-medical, nuclear,

computer, automotive, civil, entrepreneurship,

engineering, etc. But the extremely attractive

compensation packages rom Wall Street

resulted in the demand o or nancial

engineers, where assets were literally created

out o thin air, and urther led to derivative

assets. Some have said a it was a ee structure

looking or an asset class! In case o sub-

prime mortgage back securities, the mortgage

oering entity wanted to unload some o

these exotic mortgages, and the ee hungry

investment bankers were able to nancially

engineer pools o such mortgages into (rated)

tranched securities or sophisticated investors.

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Rating Agencies

In simple terms, the role o rating agencies

is to provide independent, third party (credit)inormation on a nancial instrument. It sounds

simply enough. But the rating agencies were

perhaps not as careul as they should have

been and allowed packages to be rated more

highly than they should have been. The Power

o Yes? The existing model o rating agencies

being paid by the issuer o paper/securities

creates an inherent confict o interest (actual

or perceived). [The Enron asco exposed

the confict between audit practice o an

accounting rm rom the consulting practice

o the same, yet, no lesson learned here. Its

interesting to note the possibility or potential

o law suits against the rating agencies on

similar grounds as the accounting rms.] One

interesting model proposed by certain rating

entities is that rating agencies revenue could bederived rom institutional investors, instead o

issuers, hence, at least, addressing the confict

o interest issues.

Insurance Companies

The insurance companies were perhaps not

as strong as they should have been based

on the sheer volume o risk. This, in part,

was because they thought they were hedging

their risk (by buying credit deault swaps rom

AIG), hence, ast, easy and sae revenues.

Again, the Power o Yes shows its presence.

The presence o bond insurance raised the

rating o the mortgage backed securities,

hence, lowering the due diligence scrutiny o

supposedly sophisticated buyers.

Yield Hungry Buyers

Sophisticated investors, including pension

unds, hedge unds, muncipalities, towns,

cities, states, and others wanted xed income

securities. But when it came to xed income

securities backed by sub-prime mortgagesit seems, these sophisticated investors were

either not inormed or not careul about what

they were buying. In part, the investors relied

on rating agencies, rather than understanding

what they were buying. They juiced returns

by buying the bonds using borrowed unds,

because, ater all, rates were low and they

could make a nice spread on insured highly-

rated bonds. As the crisis in the sub-prime

mortgages took hold, investors who bought

these bonds with borrowed unds got margin

calls due to the declining bond prices (Bear

Sterns) and had to sell, urther depressing bond

prices and starting another vicious cycle.

But the extremelyattractive compensationpackages rom Wall Streetresulted in the demand oor fnancial engineers,where assets wereliterally created out othin air, and urther led toderivative assets.

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Regulators

Here is where the Power o Yes, or, rather,

Power o Not No, made a home or itsel in

the sub-prime market. Who was lookingout or the best interest o theuninormed, hapless or carelessmortgagee, like the vegetable picker,and the investor o such mortgageback securities? The variable ARMswere high ee generating mortgages, and

were pushed by real estate brokers allegedlyhaving duciary duties to the buyer. These

same brokers were paid reerral ees by WaMu

(mentioned above) or such mortgages, hence,

mortgages that best served the nancial

interest o the broker and bank and NOT the

buyer. Some o underwriters at WaMu were

orced to doctor and approve such high ee

generating mortgage applications.

The leveraging o such toxic securities and

derivatives o o such instruments were or

(those not needing protection) sophisticated

investors, who, in hindsight, were not so

sophisticated.

As the crisis in thesub-prime mortgages

took hold, investorswho bought these

bonds with borrowedunds got margin calls

due to the declining

bond prices (BearSterns) and had tosell, urther depressing

bond prices andstarting another

vicious cycle.

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The Domino Eect

Thus, the perect nancial storm, called

sub-prime mortgages, involved credit score

challenged buyers purchasing and moving into

homes they could not have historically aorded.For this to happen, the sub-prime stakeholders

created high ee generating, non-transparent

exotic mortgages based on smoke and

mirrors. When homeowners could not continue

to make their monthly mortgage payments due

to the step up provision, the dominos starting

to tumble and reached the shores o developed

and emerging countries in the orm o missedmonthly payments (on the purchased asset

backed securities like CDOs), which were an

important part o operating budgets. Thus, the

missed payments by sub-prime mortgagee (in

the aggregate) resulted in missed payments to

the holders o the purchased securities, which

were in turn part o cash fow assumptions or

budgets.

Thus, the perect fnancialstorm, called sub-primemortgages, involved creditscore challenged buyerspurchasing and moving into

homes they could not havehistorically aorded.

Islamic Screening oSub-Prime Mortgage?

Everything is permissiblein Islamic fnance UNLESSthe structure, and/ortransaction has elementso gharar (uncertainty) or itsleads to unjust enrichmentor unair exploitation othe counterparty, or theunderlying asset is haram(impermissible). The

process and procedureso fnancing like the WaMuARM mortgages mentionedabove would have beena non-starter accordingto basic Islamic contract

law without the need oa consumer protectingregulator.

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So, in theory a sub-prime ARM would be

rejected by, say, an Islamic nancial institution

(IFI) because:

ocial documents must support

employment and income o potential buyer

seeking home nancing (i.e., its common to

have salary transers rom employers by, say,

Islamic banks in Dubai, UAE)

the contract must be clear on all the major

terms and conveyed in no uncertain terms

to the purchaser, a major pre-conditionimposed by the Shariah Board o the IFIs

the valuation o the home must be done with

transparency and be able to support the

income o the purchaser

Unlike the board o directors, executives,

regulators and compliance ocers, Shariah

scholars are held to and have an allegiance toa higher authority. Hence, every transacting

contract or a bank client has met the minimum

standards o (Shariah) transparency and

accountability. Thus, Shariah scholars, at one

level, are consumer advocates.

Now, how would such packaged subprime

mortgages be treated as investment and

trading instruments by Islamic contract law?

The Shariah prohibits the trading o debt,

unless at par value, otherwise it (priced at

discount) is an interest based transaction. In

addition, Shariah prohibits the use o leverage

to enhance returns.Furthermore, theShariah prohibits shortselling, as

one cannot sell something that onedoes not own. Finally, the Shariah prohibitsthe use o derivatives (swaps, utures and

options) because o the speculative (maysir)

nature o these transactions. Thus, debt based

instruments, like CDOs or collateralized debt

obligations, using leverage to enhance returns

would be in violation rom the beginning, and

any derivatives based on them would obviouslyalso be prohibited.

Yes, there are Islamic ARMs (adjustable rate

mortgages) where loan to value ratios were

up to 97% (at one time issued by Dubai

based Islamic mortgage oering entities), but

due diligence is done on the buyer (name

o employer, income verication, and salary

transer), appraisal o the home is done in

transparent manner, process and procedure

is signed o by the Shariah board o the bank

(with possibly an on over-site by a Shariah

liaison ocer on-site), and those that can aord

to have residents (nanced Islamically) have

been meeting their monthly obligations.

To the best o my knowledge there have beenNO deaults on Islamic ARMs comparable to

what has happened in the US in the last two

years. However, the sub-prime induced credit

crisis has been exported rom US shores to,

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A commentator best summarized thesub-prime induced credit crisis as,

the whole situation is as i a groupo people you do not know held aparty you were not invited to, trashedyour house, and sent you the bill.

And a comedian best described thesituation as who would have thoughtthat Bubba in Tennessee missing a

couple o mortgage payments wouldlead to the implosion o the centralbank o Iceland?

In the name o unbridled greed, via unjust

enrichment and unair exploitation, a relatively

simple concept o a mortgage became

turbo-charged revolving door approval

o quality challenged applications- moralhazard, anyone- that eventually littered

the world landscape with oreclosures,

unemployment (2.6 million jobs lost in US in

2008), bankruptcies, trillions o dollars o wealth

evaporation and a global recession.

Unlike conventional banks, Islamic banks can

spread the external shocks with risk sharing

depositors (mudaraba), the partnership model

(musharaka) on the asset side, and the paid up

capital. More specically, the risk averse nature

o Islamic bank operations with (uninsured)

depositor money (acting under an Amanah or

Trust) encourages them to oer stable/steady

returns (where depositors tolerate smaller

returns or peaceul sleep at night), larger

say, Dubai, and is impacting the real estate and

nancial sectors. The downsizing o companies

in these sectors has resulted in employee

redundancies, and those (expatriates) withIslamic mortgages are encountering diculties

or deaulting, and, not because they were like

the vegetable picker living in a house he could

not aord, but because an extra-ordinary event,

being laid-o has rendered them unable to

make mortgage payments.

NOTE: This is an opportunity or Islamic nanceto shine and answer the question: whats the

dierence (between Islamic and conventional)

in treating a deaulting mortgagee on an Islamic

mortgage by the Islamic bank?

Conclusion

The Shariah prohibits the

trading o debt, unlessat par value, otherwise it(priced at discount) is aninterest based transaction.

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Rushdi. Siddiqui

Former Global DirectorDow Jones Islamic Indexes

Rushdi Siddiqui is the ormer Global Directoror the Dow Jones Islamic Market Indexes. Inthat capacity he supervises more than 90 DowJones Islamic Market Indexes [equity, sukuk,sustainability, etc.] that underlie hundreds oShariah-compliant mutual unds, exchangetraded unds and structured products with total

Assets Under Management (AUM) o US$7B.He also oversees the Dow Jones IslamicMarket Index Shariah Supervisory Board ointernational scholars.

Mr. Siddiqui introduced the idea o buildingIslamic indexes to Dow Jones in 1998 andsince then has been a vigorous advocate or theIslamic nance through his relationships withOIC global stock exchanges and investmentrms, speaking at conerences, teaching atuniversities, writing articles, and conductingmedia interviews, hence, a rare combinationo practitioners experience with vision o anacademic in Islamic nance. His work hasresulted in over a dozen awards or the DowJones Islamic Market Indexes in Islamic nancesince its launch.

shareholder- small ree foat or

listed banks- (and depositor) keep

a short leash on management to

prevent raud/negligence or estopaggressive risk taking nancing (so

as to avoid lawsuits against larger

shareholders). Also, as access

to liquidity is more challenging

(compared to conventional counter-

part), there is less risk taking and

there is less sector concentration

nancing (lets see how the propertyexposure o Islamic banks plays out

on non-perorming loans (NPL) in

selected GCC markets). Thus, the

moral hazard concerns are relatively

minimized.

The G-20 world order is

examining a new paradigmo real asset fnancingand real asset investing,and Islamic fnance nowhas a once in a lie-timeopportunity to be animportant stakeholder o

the new world fnancialorder in regaining trust andbuilding confdence, whilsteliminating ear.

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Banking on Integrity:The Prospectso IslamicFinance in a

Diverse WorldRae Hanee

Managing Director

Fajr Capital

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The ongoing global nancial turmoil has

prompted many to question the integrity and

the sustainability o the existing nancial

system. The regulators are blaming the bankersgreed as the root cause o the unolding crisis.

The bankers are blaming the regulators or

prolonging a low-interest rate environment that

orced banks to seek riskier assets to remain

protable. The mortgage lenders have been

blamed or booking sub-prime assets and

perpetrating predatory lending. The sub-prime

lenders blame the securitization and creditderivative markets or orcing them to scrape

risky assets rom the bottom o the credit

barrel. Others blame the ratings agencies or

ailing to analyse the risks involved in packaged

securitized products, assigning infated ratings

or risky portolios. Many blame the investors

or demanding high returns even in a low-rate

environment; which prompted investment

managers to assume risky strategies that

yielded high returns. The accountants have

been blamed or the o-balance sheet

treatment o securitization vehicles like the

Qualied Special Purpose Entities (QPSE) that

contributed to the excessively high leverage in

the system.

The present-day system demonstrates that

stability can be ultimately destabilising in the

long run. As expounded by Hyman Minsky, long

periods o stability have lead to complacency inlending practices, causing debt to evolve rom

manageable debts (like amortizing home loans

where the lenders can aord both principal

and interest payments), to speculative lending

(like interest-only mortgage where the lenders

can only aord interest payments and principal

will be payable at the end o the loan term), to

eventually the riskiest Ponzi lending (like sub-prime mortgage, which required no initial down

payment, a reduced xed interest rate or two

years, and an option to pay interest by adding

back to the principal amount). When the Ponzi

gamble ailed, i.e. house prices started alling

and interest rates rising, the loan servicing

became untenable, leading to deaults and

asset sales, which urther brought down asset

prices due to the food o supply on the market,

and causing the start o a downward cycle

and domino eect which rippled through

borrowers deaulting, creditors tightening

and eventually the banking system nearly

collapsing. The world is now in the midst o the

worst nancial crisis and desperately looking

or a viable solution towards a sustainable

nancial system. This article highlights theprospects o Islamic nance providing an

alternative and sustainable nancial system

provided there is a strong political will to reorm

the existing nancial landscape.

The present-day systemdemonstrates thatstability can be ultimatelydestabilising in the long run.

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Time to Replace the

Fractional Reserve Model

Under the current system, risk-averse

depositors place their unds in bank deposits

which usually pay a nominal interest rate. Under

the ractional reserve banking model, the banks

will retain a certain amount (average 8%) o

deposits and deploy the rest through loans at

a higher interest rate to a diversied pool o

borrowers. In reality the risk-averse depositors

(savers) are lending money to banks at low

rates without any orm o security or restrictive

covenants to monitor the lending activities o

banks. In theory, the savers rely on the banks

ability to lend prudently and diversiy their loan

portolio based on the banks ability to gather

and monitor inormation on borrowers; but

given that banks always keep such inormationprivate this oten leads to adverse selection and

moral hazard problems. Banks oten end up

making loans to risky borrowers to earn higher

returns to the detriment o the depositors who

lack the incentive and ability to monitor the

lending activities o the banks.

Following the Great Depression in the 1930s,

a group o economists rom the University

o Chicago presented a banking reorm

plan to President Roosevelt. The ChicagoPlan primarily proposed the abolition o the

ractional reserve model and the separation

between commercial and investment banking

(i.e. payment and capital deployment

activities), among other banking reorms. The

opponents o the ractional reserve system

include prominent economists such as Irving

Fisher, Frank Knight, Milton Friedman, MurrayRothbard and Ludwig von Mises. Unortunately,

the Chicago Plan was only partially adopted

under Roosevelts New Deal programme.

Despite the 1933-35 period seeing one o the

greatest dislocations the U.S. economy and the

collapse o the nancial system, the proposal

to abolish the ractional reserve system was

dropped due to strong lobbying by bankers,

who directly beneted rom the status quo

model. Ultimately, ractional reserve banking

has let the door open or banks to assume

even greater risks and expose the depositors to

bank ailures.

The Chicago Plan primarilyproposed the abolition o the

ractional reserve model and theseparation between commercial

and investment banking

... deposits rom depositors andchanneling them towards even more

risky credits.

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Principle o

No Risk, No Reward

In working to alleviate the systemic banker-

depositor incentive mismatch which, as

currently seen, can spiral out o control, an

Islamic nancial system proposes or therisk-averse savers to deposit their savings in

wadiah accounts (like demand deposits) which

will not generate any returns to savers.Thekey Islamic principle that governs allinvestments is al-ghurm bil ghunm(no risk, no return). Since the savers are

risk-averse they are not entitled to any return.The banks will also not be able to deploy the

unds deposited in wadiah accounts, which

will have to be 100% risk-weighted. The banks

may end up charging a service ee to the risk-

averse savers or keeping their deposits sae

and providing the payment unctions through

branches, ATMs, etc. Further, the depositors

will be liable to pay zakah (a orm o wealth tax)

i the unds kept in the wadiah accounts meet

certain zakah conditions. Interestingly, this is

comparable to the model advocated by the

Chicago Plan and the prominent economists

who opposed the ractional reserve banking.

In the Islamic model, the risk-aversedepositors will have security o

deposit at all times given that theirdeposits will be 100% risk-weighted.As a result, there will be no cause or bank runs

and no need or a deposit insurance scheme

and costly lender o last resort measures.

Deposit Insurance

Scheme Subsidises Banks

Instead o strengthening the banking system

by abolishing the ractional reserve model,

various governments across the globe

introduced deposit insurance schemes thatinsures up to a certain amount, or example

up to $100,000 in the US. Many, includingPresident Roosevelt who establishedthe Federal Deposit InsuranceCorporation (FDIC) during the NewDeal era, have opposed deposit

insurance schemes on moral hazardgrounds. Due to political expediency, theRoosevelt administration ended up introducing

the deposit insurance scheme to strengthen

the ractional reserve system. In reality, deposit

insurance schemes only end up subsidizing

the banks by enabling them to mobilize risk-

ree deposits rom depositors and channeling

them towards even more risky credits. Therisk-averse depositors are content with the

low rate o return as long as their deposits are

insured. Even uninsured depositors are not too

concerned with the excessive risks taken by

the banks given that FDIC have oten protected

uninsured depositors when too big to ail or

systemically critical banks get into trouble.

As pointed out elsewhere, the subsidy in actincreases in value or the banks as they take

on progressively greater risk, providing an

additional incentive or a risk preerence.

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Whilst deposit insurance schemes may prevent

bank runs and contagion eects in the short-

run, they oten encourage excessive risk taking

that in the long-run increases bank ailures and

nancial crises. Since FDICs inceptionin 1934, a total o 3565 bank ailureshave been noted - averaging around10 per year between 1934 and 1981but rocketing to between 100 and300 per year rom 1982-1992 (peaking

at 534 ailures in 1989). There may be evenmore bank ailures in 2009, with already 28

ailures recorded between 2007 and 2008.

Further, deposit insurance schemes always run

the risk o mispricing the insurance premium

payable by banks due to the act that premiums

are calculated on ex-ante basis. For example,

FDICs total pay-out to insured depositors o

ailed banks oten exceeds the total infowrom bank insurance premiums. Even the

newly introduced risk-based premium does not

remove the moral hazards risk. It is very hard

or a deposit insurer to even evaluate the banks

loan book, let alone a complicated portolio o

nancial derivatives.

Debt-based Financial

Intermediationis Unsustainable

Because banks have access to cheap

deposits subsidized by the deposit insurance

schemes, banks are able to oer cheap and

easy credit to their customers. Consumers areincentivized and bombarded through clever

marketing to borrow and live beyond their

means. Corporations invariably resort to high

leverage to improve their return on equity to

appease shareholders. Such excessivelyhigh leverage in the system inevitablyleads to excessive aggregatedemand in the economy whichrapidly builds inlationary pressures.To avoid a nancial crisis, regulators will

usually respond by shrinking the money

supply through interest rate hikes or other

monetary tools with the hope o reducing credit

expansion and aggregate demand. When credit

becomes expensive and scarce, individuals

and corporate will struggle to repay their debts

and bankruptcy, insolvency and unemployment

rates will increase. The process o deleveraging

will begin and increase the severity o the

nancial crisis. Some regulators dread this

painul process and opt or a soter landing

which sometimes leads to a bigger problem.

The current US nancial crisis is a case in point.

When the investors irrational exuberance

ueled by excessive leverage lead to the stock

market bubble in the US in the 1990s and

There may be even more bankailures in 2009, with already 28ailures recorded between 2007and 2008.

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subsequent collapse, the Federal Reserve

decided to cut interest rates to avoid a

nancial crisis. The Fed maintained a low-rate

environment or almost a decade and banksconsequently went on a lending-renzy. The

lower cost o deposits incentivized banks to

oer even more easy credit at even cheaper

rates. Predictably, the corporate and personal

debt levels increased to unprecedented levels.

For instance, the household debt level in the

US and UK increased rapidly rom around

60% o GDP in the 1990s to more than 100%o GDP in 2008. Further, the low-interest rate

environment acilitated prime credit to borrow

at incredibly low rates. Banks were then

compelled to lend to risky credits at higher

rates in order to boost their protability.

Basel II Failed to

DiscourageExcessive Risk-taking

Under Basel II, banks who lend to risky credits

in pursuit o higher returns are required to

allocate higher capital to commensurate with

the higher risks assumed. In theory, bankswill avoid excessive risks in order to avoid

allocating more risk-weighted capital to their

reserves, which in turn reduces their return on

equity. However, due to accounting loopholes

banks were able to devise o-balance sheet

solutions which gave them access to risky

assets and excessive leverage without the

need to commit any capital. The banksincentivized intermediaries--such as mortgage

brokers--to book sub-prime assets which the

banks underwrote and securitized through the

o-balance sheet vehicles in return or a high

ee income. Banks were prepared to extend

loans to risky borrowers given they ultimately

packaged and sold on the risk, rather than

holding on to these risky assets on their own

balance sheet. But, when the o-balance

assets become non-perorming due to the

economic downturn, the banks were orced

to treat them as on-balance sheet due to their

retained interest in the o-balance sheet

assets or due to reputational risks. Suddenly,

the leverage ratio o banks increased multi-old

and lead to high prole bank ailures due to

inability to inject more capital to meet regulatoryrequirements.

Because banks haveaccess to cheap depositssubsidized by the depositinsurance schemes, banksare able to oer cheapand easy credit to their

customers. Consumersare incentivized andbombarded through clevermarketing to borrow andlive beyond their means.

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Shit Towards

Equity-based FinancialIntermediation

It is a well-researched act that the major

cause o the current nancial turmoil and

most o the previous nancial crises is

excessive leverage that is inherentconsequence o the current debt-based inancial system. Islam,thereore, discourages debt ingeneral and in particular incurringdebt or living beyond ones means orto grow ones wealth. Debt should be

the last resort in economic activities.To promote a debt-ree liestyle Islam strictly

prohibits those with surplus unds to loan them

on interest or usury. Instead, Islam encourages

investments through direct risk-participation

ventures like mudaraba (investment trust).

Similar to the conventional investment trust,

i the underlying mudaraba investment

perorms well, investors share in the higherreturn. Conversely, i the investments perorm

poorly they receive a lower return. In the

Islamic model, the nancial institution will not

guarantee a xed rate o return to the investors.

The mudaraba investments will be treated

as o-balance sheet assets and will be 0%

risk-weighted or capital adequacy purposes.

Given that the nancial institution and investorshave to share the risk and reward o the

underlying investments, the nancial institutions

will become more prudent and engaged in

managing their assets. I their portolio is not

perorming well the nancial institutions will not

be able to attract more investments. There is no

deposit insurance to help them attract cheap

deposits. Additoinally, investors may liquidate

their investments in a low-perorming portolio

and re-invest with a better perorming portolio.

It is believed that the Islamic model will ensure

that: (i) nancial institutions are more prudent

in managing the assets and disincentivised

rom taking excessive risks; and (ii) investors

are incentivised to exercise adequate

market discipline on nancial institutions.

Interestingly, a similar approach was

proposed by the Chicago Plan whichadvocated: (i) a 100% reserve or alldemand deposits; (ii) a 0% reserve orinvestment trusts; and (iii) no depositinsurance.Arguably, most savers are risk-averse and may end up placing their deposits in

wadiah accounts which will remain as idle capital

and create a drag on the economy. However,the Islamic model incentivizes the risk-averse

depositors to invest more o their savings in

mudaraba through the ollowing deterrents: (i)

wadiah ee; (ii) zero wadiah return, (iii) zakah

obligation, and (iv) infationary pressures.

Financial institutions will also be incentivized

to create a range o investments with a broad

risk-reward spectrum to attract investors with

dierent risk-reward proles. The nancial

institutions will have to dierentiate themselves

on superior investment and risk mitigation

strategies and superior returns to attract and

retain unds rom investors. They will also preer

investments in productive assets and will avoid

unproductive assets to remain competitive.

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Managing DirectorFajr Capital

Rae Hanee is currently a Managing

Director at Fajr Capital, a new Islamic investmentcompany based in London, Dubai and Kuala Lumpur.

He was previously the Head o Islamic Banking

or Citigroup Asia based in Kuala Lumpur. He was

responsible or developing Malaysia as a regionalIslamic nance hub or Citigroup and spread its

Islamic business ootprint across the region.

Prior to joining Citigroup, he established the Global

Islamic Finance Department at ABN AMRO basedin Dubai and was in charge o the Islamic wholesale

and retail businesses or the group. Prior to that he

was with HSBC Amanah in London & Dubai ocusingon Islamically-structured cross-border transactions

and the Sukuk market. He lead the rst global sukukoering or the Government o Malaysia in 2002.

Rae Hanee read law and Shariah at the InternationalIslamic University in Malaysia. He was admitted to

the Malaysian Bar and was practicing law in Malaysiaspecialising in Islamic nance. He then pursued

his Master o Laws at Harvard Law School and

subsequently qualied to the New York Bar.

The Islamic system will also need to

be regulated to ensure, among others,

that (i) the wadiah unds are sae

and secure; (ii) investors are given

adequate inormation on mudaraba

investments; (iii) there are no scams

or illegal investments; and (iv) the

marketing is not misleading, conusing

or deceiving. To put some skin in the

game, the regulators can require the

nancial institutions to also co-invest

in their portolios (known as musharaka

or partnership nancing). The nature

o regulation, hence, may be a hybrid

between the banking regulation and

the securities industry regulation.Certainly, a lot more research needs

to be conducted to ensure the

gradual transition to the alternative

Islamic model is not disruptive to the

economy. Without such a transition,

Islamic nance will never become an

alternative and sustainable nancial

model. What we need now is a strongpolitical will to initiate and complete

the gradual transition process.

President Roosevelt misseda great opportunity sevendecades ago. Let us not missthis opportunity now.

Given that the inancial

institution and investorshave to share the risk andreward o the underlyinginvestments, the inancialinstitutions will becomemore prudent and engaged

in managing their assets.

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CHAPTER TWO:Stability in

Food and Energy

The Food Crisis:Identiying the Cause, Rectiying the Present,

Hope or the Future

Jacques Diouf

Director General

Food and Agriculture Organization o the United Nations (FAO)

The Rise in Biouel:

The Sime Darby Experience

Dato Seri Ahmad Zubir Haji Murshid

President & Group Chie Executive

Sime Darby Berhad

The War Against Hunger:

Building an Ecient Food System

Joachim von Braun

Director General

International Food Policy Research Institute

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The Food Crisis:Identiying the

Cause, Rectiyingthe Present, Hope

or the FutureJacques Diou

Director General

Food and Agriculture Organization o the United Nations (FAO)

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The world today is in a severe nancial and

economic crisis. It was preceded by a ood

crisis that disrupted the international agricultural

economy and highlighted the ragility o worldood security. It has also showed us that reviving

local ood production is the only viable and

lasting solution to the ght against hunger. We

must thereore invest more in agriculture.

The ood price crisis has had dramatic economic,

social and political consequences. In 2007,

mainly because o high ood prices, the numbero hungry people in the world rose by 75 million

instead o declining by 43 million to achieve the

commitment o the 1996 World Food Summit. In2008, a urther increase o 40 millionpeople is expected, bringing thetotal number o people suering romchronic hunger to 963 million. This meansthat almost one billion people (or 15%) o the 6.5

billion world population is undernourished.

International prices o major ood commodities

have come down since July 2008, but the price

index is still 17.5 percent above the level o 2006.

The crisis is thus ar rom being over. Reduced

ood consumption even or short periods can

have long-term consequences. Further, with un-replenished cereal stocks, unprecedented high

levels o ood prices in local markets, high input

prices, the global credit crunch and the economic

slowdown, ood security continues to be under

serious threat.

In 1996, at the rst World Food Summit

which FAO hosted in Rome, the Heads o

State and Government o 112 countries and

the representatives o 186 Members o theOrganization solemnly pledged to reduce by

hal the number o hungry in the world by

the year 2015 and adopted a programme to

achieve that target. But already in 2002, a

second world summit had to be convened

because resources to nance agricultural

programmes in developing countries were

decreasing instead o rising. At that rate theSummit target would only be reached in 2150.

An anti-hunger programme, with nancial

requirements estimated at 24 billion dollars per

year was prepared or that meeting.

But again, the international community ailed to

live up to its promises and rather than providing

more help, we witnessed a stubborn decline in

nancing to the arm sector: Aid to agriculture

ell rom eight billion dollars in 1984 to 3.4

billion dollars in 2004, representing a reduction

in real terms o 58%. Agricultures share o

Ocial Development Assistance ell rom 17%in 1980 to 3% in 2006. The international and

regional nancial institutions saw a drastic

reduction in resources allocated to the activity

that constitutes the principal livelihood o 70%

o the worlds poor.

... reviving local ood production isthe only viable and lasting solution to

the ight against hunger

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Today, the consequences o inaction speak or

themselves. Soaring prices or ood and inputs

have produced a bitter crop o protests, riotsand deepening global hunger. The situation has

also threatened world peace and stability.

Although in ood prices have allen back rom

2008 record levels, during the year as a whole

FAOs Food Price Index price index averaged

196 points, up 26% rom 2007 and 55% rom

2006. Food commodity prices, notably wheatand maize, showed marked volatility.

The global ood import bill was expected to

top an unprecedented one trillion dollars in

2008 - 23% higher than in 2007 and 64% more

than the year beore. The most economically

vulnerable countries were set to bear the

highest burden, with total expenditures by

Least-Developed Countries (LDCs) and

Low-Income Food-Decit countries (LIFDCs)

anticipated to climb by roughly one third ater

rising by 30% and 37%, respectively the year

beore. The sustained rise in imported ood

expenditures or both vulnerable country

groups constitutes a particularly worrying

development, since their annual ood import

basket is likely to cost our times as much as itdid in 2000.

No doubt, high ood prices do not have to be

bad news or all, and armers normally stand

to benet. But this time the only armers whomanaged to prot rom higher prices were in

developed nations, where cereals production

rose by 11% in 2008. In developing countries,

armers were squeezed by soaring costs and

any increases were marginal. Prices or ertilizer,

seeds and animal eed have risen rapidly

since 2006, hitting small, subsistence armers

particularly hard.

To avert a deepening disaster, FAO launched in

December 2007 its Initiative on Soaring Food

Prices (ISFP).

In essence, the Initiative aims initially at

boosting agricultural production in low-income

and ood-decit countries over the 2008 and

2009 planting seasons by acilitating armers

access to essential inputs. Integrated into

existing programmes and harmonised with

other eorts, measures worth more than 100

million dollars have already been deployed in

95 countries. But this can only be a starting

point and much more will be needed 1.7

billion dollars to develop a substantive and

comprehensive development package or theuture.

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At the High-Level Conerence hosted by FAO in

June this year, more than 4500 delegates rom

181 countries, including 43 Heads o State and

Government and over 100 Ministers, came andrenewed their commitment to ghting hunger

much more orceully than in the past. Some 22

billion dollars were pledged in the ght against

hunger last year, 11 billion o which during the

Conerence. This was more than ve times the

level o all ODA going to agriculture in 2006.

We hope that the very encouraging pledges

will come orward this time to benet the pooraround the world.

Allow me now to look urther ahead into the

uture. In the next ty years, it could become

much harder to eed the world i relevant

actions are not taken immediately. Population

will grow rom 6.5 billion today to 9.2 billion

in 2050, with virtually all o the growth

concentrated in developing countries. Global

ood production will thereore need to double

by the year 2050.

Not only will the entire populationgrowth take place in developingcountries, urban population will grow

while rural population will actuallyshrink. That means that ewer armers willhave to produce nearly twice as much ood

as they do today. This requires much more

research and technology, inrastructure

(i.e. more dams, irrigation and drainage

systems, storage acilities), machinery

(tractors, implements, water pumps, etc.)

and more rural roads.

Land and water resources still lie untapped

in some regions o the world, many others

lack the luxury o unused resources.

Indeed, some regions ace severe and

increasing resource scarcity. South Asia

and the Near East/North Arica regions

have already exhausted much o theirrain-ed land potentials and depleted a

signicant share o their renewable water

resources. Their ood import dependence

is high and could increase urther. But

we will also need better skilled and better

trained armers. Those armers will have

to do the job with ewer resources. More

than 1.2 billion people today live in river

basins where absolute water scarcity and

the trend o increasing water shortages

are serious concerns. Huge investments

will be required or the development o the

necessary irrigation schemes and dams in

these areas.

Expanding land under cultivation is possible

in sub-Saharan Arica and Latin America butwill require adequate arming practices and

increased investment.

Population will grow rom 6.5 billion today to

9.2 billion in 2050, with virtually all o the growthconcentrated in developing countries

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Global agriculture will also have to cope with

the burden o climate change. The Inter-

Governmental Panel on Climate Change

(IPCC) documented these impacts in itsourth assessment report published last

year, which oten makes alarming reading.

I temperatures rise by more than 2 degrees

celcius, the global ood production potential

is expected to contract severely and yields

o major crops like maize may all globally.

The declines will be particularly pronounced

in lower latitudes. In Arica, Asia and LatinAmerica yields could drop by 20-40 percent.

In addition, severe weather events such as

droughts and foods are likely to intensiy

and cause greater crop and livestock losses.

These changes require massive investments

in improving agricultures adaptive capacity

to climate change. Climate change in act

poses a twin challenge or agriculture --

adapting agricultural production systems

to a new agro-ecological environment and

helping mitigate the overall impacts o

climate change on the world as a whole.

Fossil energy scarcity could mean that

alternative energies will become increasingly

important. The energy market is so large

and the demand could be so high that ithas the potential to change our traditional

agricultural market systems completely.

Last year high rising oil prices in conjunction

with massive and oten highly distorting

policy incentives made a growing share

o agricultural produce competitive as

eedstock or the energy sector. This resulted

in a situation where nearly 100 milliontonnes o cereals was siphoned-o the ood

markets and diverted away or energy needs.

Another eature that will remain with us

or an extended period o time is higher

price volatility. The rst and probably most

important reason is that we do not expect a

signicant replenishment o stocks over thenext 10 years, at least not without deliberate

policy action. Second, we nd that demand

is becoming increasingly less sensitive to

price changes as the commodity share

in the nal ood bill alls and as industrial

demand grows; third, weather conditions

and agricultural product supply may become

more variable with climate change; and

nally, we have seen that speculative,non-commercial investment unds enter or

leave agricultural utures markets as prot

opportunities dictate. All this means that the

price swings we have witnessed over the

past two years are likely to be with us or an

extended period o time.

How can we rise to such challenges? Wehave already made a number o proposals

in this respect. In 2002, when I called or

a ollow-up meeting to the World Food

Summit, we presented a comprehensive

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approach designed to reduce the number o

undernourished to the level aimed at by the

WFS in 1996. In this investment plan, which

we called the Anti-Hunger Programme, we

advocated a two-pronged strategy, which

is now oten reerred to as the Twin-track

approach.

When we prepared the Anti-Hunger

Programme (AHP) in 2003, we estimated

that an annual overall investment envelope

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