Securitization is the solution not the problem to the Financial Crisis Rasameel Structured Finance Creating alternative Opportunities
Could the disaster that is overwhelming the US, European and other world financial markets have occurred under a Shariah compliant financial system? We do not know but it is very unlikely. Shariah finance, by its fundamental nature, discourages or prohibits the speculative excesses that are the root cause of the current global financial crisis.
The standard Islamic prohibitions against high levels of debt, against unsecured debt and against speculation result in a high level of financial prudence. In addition, an obligation for fairness requires that Sharaih compliant investors share in the risk and rewards and prohibit guarantees to some investors that will come at the expense of others. The lack of these concepts and principles in conventional finance results in the greed, volatility, and devastation that we are witnessing.
A major component of today's capital markets is securitization. Securitization is the process of turning cash producing assets into securities. Securitization has been an important part of the capital markets since the early 1970's. Securitization has provided lower rates to borrowers, better security for lenders, increased liquidity and provided alternative funding sources in the capital markets. However, in the current financial crisis, securitization has been frequently mentioned as one of its problems, mostly because of subprime mortgages. But it is very important to realize that it is only the speculative, over-leveraged excesses that have crept into securitization during the last ten years (such as Collateralized Debt Obligations, Subprime Mortgages, Asset Backed Credit Default Swaps) that have contributed to the financial meltdown, not the securitization process itself.
The basic nature of securitization is Shariah compliant. In a securitization, the investors own the profit generating assets. In a securitization, the investors' profit is derived from the cash flow of real assets. In a securitization, the investors are subjected to the risk of the assets that generate the return. All of these features of securitization are requirements of Shariah compliant finance.
Securitization under Shariah finance has an ethical component, a moral directive which is missing in conventional finance. Securitization under Shariah finance is used to fund productive activities, to finance the purchase and sale of real assets, and generally to produce socially useful financing opportunities.
The structural features of Shariah compliant securitization prohibit those unscrupulous, greedy features of conventional securitization that have resulted in so many problems. In order to conform to Shariah law, Shariah compliant securitizations are forbidden to engage in transactions involving maysir, speculative risk, and gharar, excessive uncertainty. Over-leveraged transactions are forbidden as are unsecured, speculative lending. If only conventional finance had a similar ethical basis, the current worldwide financial crisis would have been prevented or at least reduced.
Shariah compliant securitization has no attraction for those very short sighted, irresponsible speculators who are alternately driven by greed and fear. Shariah compliant securitization actually discourages investors who speculate without engaging in a useful transaction and seek a return with any real economic purpose to the undertaking.
Conventional finance is constantly warned by its regulators to avoid "irrational exuberance". But no matter how many financial crashes can be attributed to speculative transactions that promise huge profits but produce nothing, asset classes that are not only morally corrupt but socially harmful, and appeals to investors' lowest, greediest instincts, conventional finance seems to be doomed to these repetitive cyclical crashes.
Shariah compliant investors should not be afraid of securitization. But they should fear conventional securitization transactions that have allowed speculative excess and unnecessary risk taking to dominate the purpose of the transaction. Shariah compliant investors must realize that, in addition to prohibitions against Maysir and Gharar, Shariah compliant securitizations are forbidden to engage in Ghish, concealment of information, Jahalah, misrepresentation, Taghrir, deception. In a Shariah compliant securitization, the investor knows he is bound to the fate of the enterprise being financed. If these restrictions and principles were required in conventional finance, the world would be a much better place.
Sharia'a Compliant Securitization benefits
Islamic banking faces many challenges when confronted with the competition of conventional banking. Because of the prohibition of charging interest of money, Islamic banking has a strong focus on underlying assets, not just an exchange of money for an assignment of cash flows. Sharia'a compliant finance must involve the funding of geuine economic activities that result in real goods and returns.
Shari'a compliant securitization therefore would not allow the securities generated to have a life of their own or to be synthetic emulations of the underlying assets and what they yield or generate. Nor would it allow an AAA security to be generated out of "high risk" underlying assets.
Additionally, Shari'a compliant securitization offers the necessary safeguards to prevent securitization from being reduced to a mere exercise in the merchandizing of debt labelled as "financial innovation". Shari'a compliant securitization additionally cannot be based on predatory lending practices, made possible by and financed by low quality debt and hedged by credit default swaps.
It is against all of the preceding pitfalls, which in one form or another contributed
to the sub-prime crisis and its derivative repercussions, that Shari'a compliant securitization is meant to guard against.
Securitization Benefits to Originators:
1. Diversification of their funding sources which translates into a number of benefits including:
A. Reducing their funding risk by reducing their reliance on a limited number of funding sources.
B. Reducing their cost of funds through disintermediation and reliance only on banking debt.
2. Enhancing their financial structure which manifests itself through the following benefits:
A. Improving their financial ratios mainly of profitability, debt, liquidity and equity multiplier and the relief obtained from recapturing certain statutory provisions associated with these assets and imposed by their respective Central Banks or any regulatory bodies.
B. Improving their asset and liability management process and reducing the mismatch between the two sides of their balance sheet.
C. Insulating their susceptibility to market rate fluctuation risks induced by potential unfavourable shifts in long term versus short term market rates.
3. Providing for their future growth which is a by-product of the above benefits as well as a product of taking these assets off their balance sheet. This allows originators to concentrate on leveraging their expertise in creating such assets without this being limited by the size of their balance sheets and rather by the size of the market.
Securitization Benefits to Investors:
A. The securitization of the assets by the originators enables investors to make their investment decisions independently of their credit standing, and focus instead on the degree of protection provided by the structure of the securities and the capacity of securitized assets to meet the promised cash flows.
B. It offers them an investment outlet previously restricted to only a few companies.
C. It spreads and diversifies their exposure from that of a single corporate risk to that of numerous obligors numbering in the hundreds or even the thousands.
D. It offers them an opportunity to reap the benefits of investing in already concluded transactions transformed from the phase of consumer finance or other finance operations to the phase of an investment in a security.
E. It offers Awqaf and endowment funds as well as Takaful Insurance companies and pension funds an opportunity to invest in longer term fixed income Sharia compliant securities and thus providing them with alternative investment opportunities which are more attuned to the nature of their long term obligations.
Securitization Benefits to Consumers:
A. The more finance companies or other originators are able to diversify their funding sources, the lower their cost of capital and the more likely that such reduction be reflected in the rates offers to consumers and if not offered voluntarily it is bound to be imposed by the forces of competition due to the increase in the sources of supply.
B. Securitization may contribute to consumers enjoying the benefits of lower prices and longer term financing based on fixed rates which is currently being discouraged for fear of the impact of its risks on financial institutions.
This is achieved by removing the longer term assets generating fixed income from the balance sheet of financial institutions and lodging it where it belongs which is with a wider investor base whose risk appetite, investment horizons and investment objectives and strategies match the securities created and backed by these assets.
C. Satisfaction of consumer needs shall no longer be limited to the size of the balance sheet of a few banks and finance entities which may also be manifested in enjoying the benefits of longer term financing than that provided by banks and financing entities.
Securitization Benefits to the Financial Sector:
A. Securitization contributes to the creation of a more complete market by introducing new categories of financial assets that suit investors risk preferences and by increasing the potential for investors to achieve diversification benefits thus meeting the needs of different 'market segments.
B. It is likely to increase the market potential and growth opportunities since its growth shall not be restricted to the size of the financing entities.
C. It is prone to induce a competitive environment due to the increased sources of supply.
D. It can contribute to the financial health of the current financing institutions by improving their ratios and reducing the mismatch between assets and liabilities and by externalizing maturity profiles which are more suited to the objectives of specific investors rather than the objectives of financing institutions.
E. It will contribute to the dispersion of the funding and credit risk over a wider base and thus reducing the risk concentration currently shouldered solely by financing institutions.
F. It shall help contribute to better ratings by international rating agencies of many of the financial institutions in the Kingdom.
G. It shall provide genuine alternatives through Securitization to "Metal or Commodity Morabaha" transactions or to "Tawarouq" transactions, both of which have stunted the growth, development and creativity of the industry for years.
With all of the aforementioned benefits which can be harnessed through Securitization, only a handful of entities remained dedicated to cater to such benefits and to fulfil such needs, with Rasameel Structured Finance Company, KSCc being the only specialized Company dedicated to Shari'a compliant Securitization.
Rasameel Structured Finance Company, KSCc views Shari'a compliant securitization in the context of what it coined as its "Securitization Continuum" which starts with asset origination and due diligence, to asset Shari'a compliant structuring, to asset pricing, to asset marketing and placement, to asset remarketing, to asset servicing and management to asset administration and reporting. The elements of such continuum are permissible activities under the CMA licensing purview. Asset remarketing however represents a major challenge not only in the context of Saudi Arabia but equally in other GCC countries due to the lack of a viable fixed income component in the capital markets. Capital markets however have tended to emerge organically in response to the existence of buyers, sellers and products and not the other way around. The permeation of securitization throughout the region, of which the establishment of the Company is a significant pioneering effort towards such goal, is the seed that should give rise to a nascent fixed income component to regional capital markets.
Such a pioneering effort is not without its challenges as is further elaborated under "Risk Factors". With such challenges however, comes the Company's opportunity to contribute to the future viability of the regional capital markets and to be at its forefront.
-Ends-
About Rasameel:
Rasameel Structured Finance Company ("Rasameel") is a leading Kuwaiti securitization house with an investment banking mandate established in January 2006 in its Kuwait Headquarter. Rasameel is the result of a successful partnership between a group of independent, well-established companies. Rasameel is supervised by the Central Bank of Kuwait with a paid up capital of Kuwaiti Dinars 30 million and is focused primarily on providing a Sharia compliant portfolio of predictable cash flow generating assets and securities in the form of asset securitization. In addition, it provides asset management, liquidity management solutions, placement capabilities and investment advisory services to a wide array of institutional investors and finance companies. visit www.rasameel.com.
For more information please contac:
Anwar S. Al-Braikan
Assistant Manager - Client Relations
RASAMEEL
Tel: +965 247 8800
Fax: +965 2476600
email: aabraikan@rasameel.com
Kirsten Lange
PR Account Director
BPG Public Relations
Tel: +965 2411676
Fax: +965 2492644
email: kirsten@batespangulf.com
Nancy Nusrally
PR Manager
Tel: +965 2411676
Fax: +965 2492644
email: nancy@batespangulf.com
© Press Release 2008
