THE Finance Bill 2011 allowed a five-year tax holiday for loan-free equity investments. While the overall impact of this incentive is not known, anecdotal evidence provides support to the picking up of debt-free capital spending.

The very fact that the Securities and Exchange Commission recently moved to tighten rules on inter-corporate financing also indicates that the way in which equity investments were growing through, they might not always have had fully complied with required business ethics.

The pace of investment in greenfield projects is slow, as the focus of entrepreneurs has been on industrial consolidation, for which corporate earnings and savings may often suffice, particularly in case of major business groups.

Despite sluggish economic growth in recent years, corporates have made robust profits, which has, to some extent, done away with their need for borrowings for refurbishing existing capacities. Investors are often deterred from bank borrowing by fluctuating interest and exchange rates that tend to impact adversely on the financial viability of their projects.

And banks are shy to lend to the private sector in a situation where industrial capacities are significantly underutilised, and energy — which fuels economic growth — is in short supply. And the failure of the government to provide necessary social and physical infrastructure is discouraging businesses from paying due taxes.

However, looking at the emerging trends in equity investment following the global financial crisis and the Great Recession, some experts have started questioning the mode of conventional banking while comparing it with Islamic banking.

“During the crisis,” says Dr Ishrat Hussain, former governor of State Bank, “Islamic banks didn’t suffer as much as conventional banks because they did not deal with exotic derivatives or artificial money-creation instruments such as collateralised debt obligations. Every transaction in Islamic financing must be backed by real assets in building, structures, factories, machinery etc”.

That is the crux of the difference between the two systems of banking since the time ‘shadow banking’ was developed to postpone the cyclic/systemic crises that hit the financial markets every 30-35 years with regularity, and with widening and worsening consequences.

While policymakers did get some ‘breathing space,’ the problems accumulated over time and became more difficult to resolve. They widened the disconnect between money/bank finance and productive investment.

Conventional banking is being criticised on another count — inequality. Here, it would be relevant to quote Dr Ishrat Hussain again.

“Inequality’s origins can be traced to the nature of conventional banking, where the risk is concentrated solely in the borrower and the fruits of good fortune or adversity are borne by the individual or firms that have borrowed the money. Should the business fail, the underlying collateral is forcibly realised by the bank. The cause of many bankruptcies, business collapses and financial insolvency lies in the inbuilt characteristic of conventional banking.”

The word ‘inequality’ could perhaps be better substituted by ‘inequity,’ as the learned scholar does in the context of Islamic banking, as follows.

“As the risk is shared between the supplier and the user of funds, returns on investment, whether positive or negative, are shared equitably between the two parties in the proportion they had agreed upon. The burden of adversity does not fall on the borrower only — the winner does not take it all, while the loser, i.e. borrower, does not become financially insolvent.”

Here, Dr Ishrat Hussain has treaded a controversial path, as many still do not believe that Islamic financing is fully Shariah-compliant, but for ‘Mushrika,’ which is sparingly used because of the prevalent corporate culture.

He himself drops an indirect hint about it when he says “Pakistan has been too obsessed with making conventional banking products Shariah-compliant”. Leasing is common to both Islamic and conventional banking.

But one would not disagree with him that Islamic banking is restricted to financing of ‘real assets’. That is what is making the difference, with Islamic banking growing at a pace ‘twice that of conventional banks’.

That brings us back to the issue of equity investment (EI) being preferred to bank borrowings. It is not so clear at this point of time whether EI is becoming popular (as indicated by lacklustre bank borrowings by the private sector) in the current phase of market development, or is it the future, taking a long-term view.

But the thoughts expressed by the former SBP governor need to be probed by the government’s appointed committee for development of Islamic banking.

And in the recent damage done by the Anglo-Saxon financial model to the developed world economies, one tends to recall what US President Thomas Jefferson, architect of the American Constitution, once said: the banking system is more dangerous than standing armies.

Currently, it is liberally financing fiscal deficits of the government rather than engaging in productive pursuits in an economy performing much below its potential. Perhaps conventional banks should re-think their lending strategies in the light of rapid development of Islamic banking in Pakistan as well as worldwide.

Opinion

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