100% Islamic financing: What could go wrong?

What could go wrong?

By Blake Goud: Available at: http://investhalal.blogspot.com/2012/04/what-could-go-wrong.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+sharingrisk+%28Sharing+Risk+dot+org+blog%29

When I saw the headline “Emirates Islamic offers 100% financing for UAE homes”, I thought I had traveled back in time to a bygone era (specifically 6-10 years ago in the United States). I looked at the date on the article, April 14, 2012, and it surprised me that an Islamic bank would have stumbled upon a product that had so recently led to havoc in the conventional financial markets. Sure, the US housing boom was fueled by other factors (securitization and re-securitization of mortgages into complex securities), but one of the reasons the problem spread into the real economy was that a fall in home prices pushed many homeowners into a position of negative equity (owing more on their homes than it was worth).

The way that Islamic home finance works today would not insulate an Islamic bank offering this type of product from problems down the road, and since the product offered here is only for 5 years, it creates a potential refinancing risk, since most people cannot afford to pay for a house in just 5 years. A 5 year loan requires that either refinancing will be a available five years from now, or a rise in home prices (and thus a buyer expects to sell within 5 years). Both assume that the home will either remain the same price or increase, which the financial crisis and recession following it has demonstrated is a dangerous assumption.

The difference between a 100% financing product and an 80% financing (e.g. 20% down payment) is that the former incentivizes greater speculation on home price rises because it doesn’t require they buyer to have ‘skin in the game’. The incentive problem is made more complicated by the potential for buyers who default to be threatened with arrest. However, while this might limit the number of defaulters (in an non-optimal way), the incentive problem remains. It is a frequent refrain that Islamic finance was spared some damage during the credit because it is different from conventional finance, but if Islamic banks start moving into the same types of products that caused problems in the financial crisis, will this hold true in the future, or are we on the road to Islamic CDOs?

Regards
Zulkifli Hasan

Langkawi Island, Malaysia

SUBSCRIBE

Get the latest posts delivered to your mailbox:

Page Reader Press Enter to Read Page Content Out Loud Press Enter to Pause or Restart Reading Page Content Out Loud Press Enter to Stop Reading Page Content Out Loud Screen Reader Support