Malaysia- Mahathir projects steady future for Islamic finance

Mahathir Mohamad, former Malaysian prime minister, has warned the Islamic banking industry that it has to learn about the mistakes of conventional finance if Islamic finance is to avoid the same fate. Mahathir, now the elder statesman of Malaysian politics, is as outspoken as ever and remains arguably the most popular politician of "the Muslim man and woman in the street".

In Istanbul, Turkey recently Mahathir was the star attraction giving a special address on the theme "The Future of Islamic Finance Creating Global Linkages and Connectivity to the Growth Real Economy to Promote Financial Stability Economic Growth, Employment and Prosperity" at the opening session of the business seminar on Islamic finance which was organized by Bank Negara Malaysia in collaboration with the Malaysia International Islamic Financial Centre (MIFC) and which was aimed at promoting linkages between Malaysia and Turkey in the field of Islamic finance.

Mahathir, prime minister of Malaysia for over 18 years and who recently published his long-awaited memoirs titled "A Doctor in the House", suggested "there be more resort to Islamic banking systems and principles in order to prevent greed and abuses from taking over. Islamic banking should stay free from gambling and speculations, from the Invention of financial products, and unlimited freedom to create money and leveraging which have all contributed to the downfall of the riba (interest)-based financial system."

He painted a sober if not spectacular future for the Islamic finance industry which contrasts sharply with the hype of the conference circuit where utterances of spectacular 40 to 50 percent year-on-year growth of the Islamic finance industry is all too often too common. There definitely is a future for Islamic finance, he maintained. "It would not be spectacular; It would not be the cause of booms and busts. It would be steady and would not cause the kind of social and economic upheavals that we are seeing today," he added.

In the absence of all the speculative practices, Islamic banking would probably be slow in growing, but then the growth in wealth that are prevalent in the countries which are based on the Western financial system is not real. It does not create jobs, nor increases in trade, nor spin-offs into other businesses, nor help to spread wealth equitably and profitably.

Islamic banking, without Interest and subjected to high moral codes, on the other hand would or should not yield the aforesaid results. It would however slow growth and wealth creation, but the wealth created would be real, would be more fairly distributed, would spin-off into real economic activities, creating jobs, increasing trade domestically and internationally.

Mahathir predicted that Islamic banking and the wealth of the Muslims will cause the rest of the world to link up with Muslim countries. "Muslims will feel comfortable doing business without going against the injunctions of Islam provided that the abuses of the riba banks are avoided there will not be the periodical collapse of the Islamic financial system. We are seeing how the Islamic banks have remained unaffected by the current crisis," he said.

Mahathir knows a thing or two about steering economies out of financial crises. His government successfully steered Malaysia out of the 1997-98 Asian financial crisis, without going cap-in-hand to the International Monetary Fund for bailout funds. In the process he successfully restructured corporate debt and the banking sector debt in Malaysia while at the same time modernized the country and generating economic prosperity. That modernization included the early development of Islamic financial system.

Indeed one of the first actions that Mahathir took when he came to office in 1981 was to set up a National Steering Committee to implement Islamic banking in Malaysia. The report of this committee on the viability and strategy of Islamic banking, was the impetus for the creation and robust development of the Islamic financial industry in Malaysia.

Mahathir emphasized that the Islamic finance industry can learn about the mistakes of conventional finance if it is to avoid the same fate. The conventional banking system has served the developed economies very well by financing industry and services thereby enriching themselves through doing real business.

However, these economies could not compete any longer with the emerging economies of the East and Latin America in the post-war years. This necessitated a switch to the financial markets with the promise of huge capital gains from investments in the share markets of the world. This also spurred on financial innovation in derivative products including collateralized debt obligations (CDOs), short selling, hedge funds and currency speculation, which bore no relation to real economic activities.

Huge profits and greed was the order of the day which fuelled a boom that in reality was unsustainable, only for the financial system to come down like a house of cards, which is what happened in reality and which precipitated the financial crisis in 2008.

"Capitalism has given many nations prosperity," advised Mahathir, "but when capitalism is combined with unbridled greed, the result is what we are seeing today. In the western financial system the abuses are made possible because the system allows unlimited money to be created by the banking system. Loans by the banks have a guaranteed return. There was no risk for the banks, but new ways of guaranteeing returns were invented so that more money could be created and lent by the banks. The greedy played on the greed of people."

He acknowledged that the Western banking system has served the developed countries very well. With the money created by the riba banks the countries of Europe and North America grew rich, they manufactured goods and provided services to themselves and the world. In other words they enriched themselves through doing real business.

The loss of empire and colonies; the emergence of the developing economies especially in Asia and the decline of manufacturing, construction, trade and service industries in the West led these countries to their switch to the financial markets beginning with investments in the share markets of the world.

What followed was a spate of financial innovation of products that bear no relation to the real business done by the companies and corporations concerned.

"It is not the dividends which attracted their investments in stocks and shares. It is the possibilities for capital gains; repeated and sustained purchases of shares would push up the share prices. Once appreciated, the shares would be dumped by them and capital gains collected. First the huge pension funds then the hedge funds got into this. The huge size of their investments influenced market behavior. They were not concerned about whether the actual businesses are doing well or not. On a dollar share the dividend might be just 10 cents, but if the dollar share is pushed up to 5 dollars, the investment in one share at 1 dollar could yield 4 dollars in capital gains," explained Mahathir.

He decried the practices of margin calling, short selling and speculation in commodities and currencies, and the hedge funds, which through leveraging by 20 or 30 times could assure their investors and the managers huge returns.

Greed knew no bounds, he added. "The banks began to lend money for housing and other assets even to borrowers who could not possibly repay their loans. If the borrowers fail to pay the loans, their properties can be seized and sold. They believed they could never lose on the loans made. To be doubly sure, the loans were bundled and sold to Insurance companies or to mortgage companies such as Freddie Mac and Fannie Mae. According to the lenders, their loans have been securitized through Insurance and secondary mortgage. They just could not lose even If the loans become non-performing.''