DAVOS, Switzerland, (Reuters) – It’s a myth to assume Islamic finance products are safer than conventional products and underlying risks should be studied more carefully, Qatar’s top regulator said on Wednesday.
Despite being billed as a safer alternative to traditional banking because assets must underpin deals, Islamic bondholders have found they may not have any more legal safeguards than conventional counterparts in the event of default.
Such issues were highlighted after sukuk — or Islamic bonds — had the first ever defaults last year.
Sukuk, one of the flagship products in the $1 trillion Islamic finance industry, are structured as profit-sharing or rental agreements and returns are derived from underlying assets because Islamic laws prohibits paying or earning interest.
Dubai-owned property developer Nakheel narrowly avoided a default last year on its $4.1 billion sukuk thanks to an emergency bailout fund from Abu Dhabi.
“There is some assumption that some of it is cosmetically more comforting, but when so many Islamic instruments are now trying to mimic the effect of conventional products, you need to examine if they carry the same risk profile,” Philip Thorpe, chief executive of Qatar Financial Centre Regulatory Authority, told Reuters.
“It’s a myth for anyone to assume anything about financial products, including Islamic finance,” he said.
“If you go into any form of investment without asking fairly basic questions, you will bear the consequences when things go bad. There was a lot of excitement over Islamic financial products, but not a lot of research…You have to look at underlying risks.”
Thorpe added that recent events in the Gulf, including the debt crisis in Dubai, have raised the tolerance threshold of regulators.
“The role of regulators is to identify risks and in some instances to become a bit more interventionist,” he said.
“If we saw a product that was unsafe for investors, we would not permit it to proceed. Regulation has never been about free markets. Regulation is not a consensual act. It’s a political act…Recent events may have moved the bar up in terms of regulator tolerance.”