The Dubai Financial Crisis - Essay Example

? How has the Dubai financial crisis impacted the investors’ confidence in Sukuk? INTRODUCTION Islamic finance is an important component of financialsystems around the world, and it provides many products and services, such as loans, sukuk (Islamic bonds) and mortgages. Many professionals believe that Islamic finance can help the problems in the current global financial crisis. According to Chapra (2008), ‘One of the most important objectives of Islam is to realise greater justice in human society’. This leads to the knowledge that all products or services will be based on justice which means that both the investors and financials share in the risk so the entrepreneur does not carry the entire burden of losses. Also, Aljarhi (2008) mentions that sukuk can be a good solution to help the sub-prime crisis, but what happened in Dubai with Nakheel’s sukuk perhaps changes all previous concepts because investors have been informed that Nakheel cannot pay off its profit. Research Objectives and Questions Objectives 1 Analyze Islamic financial instruments and research the mechanisms of Nakheel Sukuk 2 Research the factors that caused the Dubai financial crisis 3 Analyze how the Dubai crisis impacted the Sukuk investing in Islamic Financial institutions Questions What factors influenced investors’ confidence in Islamic financial instruments? For this questions to be answered a research and analysis of corner Islamic finance principles as well as performance of Islamic finance institutions as for Islamic instruments effectiveness will be carried out. The data will be majorly based on financial and other statements of Islamic financial institutions. 1 What is Sukuk and their elements that have added to the popularity of Financial investing instruments? 2 What are the mechanisms for Nakheel Sukuk to work effectively in financial markets? Sukuk instrument will be analyzed and against its performance. 3 What were the causes of the Dubai financial crisis? To answer this question an extensive research of data in regard to economic states, economic activities and other factors will be undertaken to learn and analyze events that caused the Dubai financial crisis. 4 What was the role of sukuk in the Dubai financial crisis? Analysis of Nakheel Sukuk in 5 How did the Dubai crisis impact Islamic financing? Analyze the use and performance of Islamic finance in aftermath of the critical times in Islamic finance. Literature Review The literature reviewed in this proposal critiques many writers who have written about Islamic bonds - sukuk. The research aims to show the gap of knowledge concerning confidence in Islamic bonds (sukuk) after the Dubai financial crisis. There are three types of literature that have been discovered: firstly, literature about the causes of the financial crisis which has happened in Dubai; secondly, literature about the impact on sukuk after the Dubai financial crisis; and finally, literature concerning the theory of sukuk which is based on the Islamic financial system. Klomp (2009), in his journal about the significant causes of the banking crisis, says that the absolute important factors that affect directly on a financial crisis are: 1) High credit growth 2) Negative GDP growth 3) High real interest rates. Lewis (2010) has other points in his journal that say that the causes of the financial crisis include individual and cognitive psychology, social influences, psychology used by economists, the good society, and culture and human agency. Rotheli (2010) believes that the causes of the financial crisis can be summarised as risk misperception, policy mistakes, and banks’ bounded rationality. He agrees with Klomp (2009) in a credit cycle in which banks increase their credit supply and stop lending during recessions. That puts banks in a troubled situation in the future, where investors can pay their debts. The financial crisis of Dubai, as mentioned by Bassens, Derudder and Witlox (2010), started in November 2009 when the latest news informed that the largest development agency in Dubai, Dubai World, needed to restructure its soaring $59 billion debt. Its real estate subsidiary, Nakheel, particularly should have paid $4 billion for the maturity of Islamic bonds (sukuk) on December 12, 2009. Nakheel have been facing challenges to control this crisis. According to Anwar (2009), Abu Dhabi is the first city to help Dubai in the financial crisis as it provided $10 billion to help Dubai World. Bakar and Rabiah (2008), explore and analyze the foundations of Islamic finance are explored in their relation to certain corner-stone principles. First, it is the accountability factor and moral or religious conscience, which emphasizes the concept of wealth as a trust from God. Secondly, unfair or oppressive practices like interest and usury (riba), gambling, cheating, and ignorance or uncertainty in contract (gharar) are prohibited. Third, honesty, transparency, justice and fairness in commercial dealings are promoted. And fourthly, establishment of measures to safeguard the contracting parties’ interests in the contract or transaction is undertaken. The underlying reasons for Islamic finance and banking development are stated as follows. Firstly, the original impetus for Islamic finance comes from its religious and ethical concerns. Secondly, Islamic finance has great commercial viability and business potential and, subsequently, wider acceptance due to 1) wider consumer and investor base from both Islamic and conventional banking customer pool; 2) potential ethical appeal as a result of ethical features; 3) strong fundamentals that rest on asset-based and real economic activities; and 4) proven track record of competitive return on investment. In their article El-Hawary, Grais and Iqbal (2007) discuss the features of Islamic banking in their elation to the rules of Islamic law. According to the authors, the undermining feature of Islamic finance and banking echoes the principles of Islamic law – Shariah – and its application to the Islamic economics. Shariah grasps not only religion-based rules and laws, but also those governing economic, social, political, and cultural aspects of Islamic societies. Although Shariah principles prohibit interest payments and acceptance as well as sale of and investment in some businesses that provide products or services that are not accepted in Shariah, its principles were taken to form distinct basis for flourishing economic activities and financial institution formation. Thus, Islamic finance and banking follow the Islamic Shariah rules on transactions called fiqh muamalat that came from the Quran and the Sunnah, and other secondary sources of Islamic law such as opinions collectively agreed among Shariah scholars (ijma’), analogy (qiyas) and personal reasoning (ijtihad). As it was said before one of the main principles of Islamic banking is the prohibition of giving and receiving interest. Of course it does not mean that establishing banks to earn revenues is prohibited too. They are allowed if only they do not include interest of any kind. Here, it is easy to notice how important following of the Law is for Muslims. That is why the establishment of Shariah committees is mandatory under Isalmic banking principles. These committees are necessary to confirm that services, operations and activities of a bank are performed with the correspondence to Shariah (Islamic law) norms. In Malaysia, for example, there is an institution called National Shariah Council. This institution regulates and advises Malasyian Bank Negara on different activities and services that it provides to people. Because Islamic banking system is of great concern of keeping the law and act accordingly to it the establishment of Shariah committees became a really usual phenomenon. Many private advisory firms (not only in Islamic countries) appeared to provide service of helping institutions to act righteously according to Islamic law. In his article on Nakheel sukuk and Dubai Crisis, Omar Salah explains the way how Nakheel Sukuk works in a very comprehensive manner. Essentially, the structure of Nakheel sukuk is quite similar to conventional lease-and-lease-back transaction, in which two parties of the originator, the individual in need of financing, and Special Purpose Vehicle (SPV) are involved. Thus, the originator who is in need of financing starts the transaction by setting up an SPV and selecting tangible assets for the transaction. Then the originator leases the chosen tangible assets to the SPV based on a Head Ijarah Lease Agreement, which is usually for a long lease period. The whole lease sum is paid up front of the lease transaction, which is financed by the SPV by the means of sukuk issuance. Sukuk holders gain beneficial ownership of the underlying tangible assets as the SPV holds the assets in trust for them. Later the tangible assets are leased back by the SPV to the originator in compliance with a Sub Ijarah Lease Agreement for a comparatively short period, e.g. three years. The originator makes periodic lease payments to the SPV since it holds the assets in trust as trustee for the beneficial owners – sukuk holders – during the entire lease period. As sukuk holders are the beneficiaries of the underlying tangible assets, they are entitled to the lease payments received from the originator, which the SPV pays on sukuk to the sukuk holders on periodic basis. The Head Ijaraj Lease Agreement is terminated when the Sub Ijarah Lease Agreement matures. At the maturity of the Sub Ijarah Lease Agreement the originator pays the amount, which is equals to the major amount of money obtained from the sukuk holders according to the original Agreement. However, the money upon Lease Agreement maturity is paid to the SPV, which then repays principal amount to the sukuk holders (Salah, 2010). The study by Ebrahim and Joo (2001) provides useful data on specific features of Islamic banking. Specifically, it is argued that islamification of conventional commercial banking industry underpins a new stage of within the Muslim community. Islamic finance and banking industry cater to both Muslim and non-Muslim clientele and its potential has already drawn attention of western conventional financial institutions such as Citibank and Hong Kong & Shanghai Banking Corporation (HSBC), which have already, in their turn, opened special subsidiaries to attend to the demand for these kind of services. Bassens et al (2010) explore the causes and important features of the financial crisis of Dubai (2010), started in November 2009 when the latest news informed that the largest development agency in Dubai, Dubai World, needed to restructure its soaring $59 billion debt. The author informs that the company is its real estate subsidiary, Nakheel, particularly should have paid $4 billion for the maturity of Islamic bonds (sukuk) on December 12, 2009. Nakheel have been facing challenges to control this crisis. Aljarhi (2008) summarised the conference in Bahrain on 18 March 2008 which attracted more than 200 experts to discuss many issues about sukuk, where many experts found that sukuk could be the true solution for the crisis. Wigglesworth (2009), on the other hand, said in a special report about the future of Islamic banking in the Financial Times, that many bankers and lawyers believe that sukuk are unsecured, and the financial crisis in Dubai with sukuk may damage the good image of Islamic finance. Jones (2009) said that, ‘consternation among bondholders whose repayments were postponed by the emirate this week has spread through the world's debt and equity markets and seen a near-evaporation of confidence in the desert state’. There has been an argument about who believes that sukuk are a good product but, after the financial crisis in Dubai, confidence in sukuk has evaporated. Research Design and Methodology Such types as desk based using data, desk based using theory, and case study analyses are used within the research. These types of research are chosen since they are most suitable to perform the analysis of the topic and to provide thorough analytical results of the issue. Since it is impossible to reach top investing in Sukuk and other Islamic finance instruments, the methodology to be eployed within the research is major secondary data analysis. The data under consideration of analysis within present includes academic articles, relevant analytical and business reviews, comments on Islamic finance instruments and their performance from industry specialists, financial and other statements of Islamic financial institutions. The major purpose of the research it to identify how the Dubai financial crisis influenced the investors’ confidence in Sukuk, one of Islamic financial instruments. In order to understand the real implications of the crisis for Sukuk, it is essential to grasp how Islamic finance works in general as well as to analyze the importance of Sukuk within the Islamic finance framework. Although Islamic finance and Sukuk specifically will be analyzed in theoretical framework, a better understanding of the investing instrument of Sukuk is supposed to be gained from the case study of Nakheel Sukuk, which is to be analyzed within the scope of the Dubai financial crisis. An appropriate analysis of Islamic finance and Nakheel Sukuk combined with a thorough analysis of the Dubai crisis causes and consequences will provide the basis for developing possible remedial actions to restore the investors’ confidence in both Islamic finance and Sukuk in general as well as in Nakheel Sukuk specifically. Research Design and Methodology (continued) In order to reach research objectives and answer research questions secondary research method, which implies an in-depth literature review and case analysis, will be applied. Thus, academic articles, books as well as authoritative business reviews will be used within the research in order to develop a grounded understanding of the topic. Furthermore, analytical business statistics, perceptions, and forecasts will be taken into account while investigating the subject. All of the relevant within the scope of the research sources will be considered to produce a comprehensive research observation and conclusion. The observations obtained from the research will be also used to develop possible remedial action needed for restoration of investors’ confidence in Sukuk. Further some of the works that have fully or partially informed the methodology of the research are discussed. Barbour, R. (2008). Introducing qualitative research: A student guide to the craft of doing qualitative research. London : Sage. Barbour provides a thorough coverage of all the core areas of qualitative research practices, which is helpful in choosing most appropriate research methods. Creswell, J, W., 2003. Research design: qualitative, quantitative, and mixed method approaches. UK: Sage Publications Qualitative, quantitative and mixed research methods as well as the mechanisms how the methods work for various types of research are explained by Creswell (2003) in his work, which informs the methodology of current research. Khairul Baharein Mohd Noor. Case Study: A Strategic Research Methodology. American Journal of Applied Sciences 5 (11): 1602-1604, 2008. In the article Khairul Baharein Mohd Noor reviews the literature on case study as a strategic qualitative research methodology, which will be applied within the research on impact of Dubai crisis on Sukuk. Yin, R, K., 2003. Case Study Research: Design and Methods, Third Edition, Applied Social Research Methods Series, Vol 5. UK: Sage Publications, Inc. This book offers a very complete and detailed guide into conducting case study research, which is very helpful in designing the case study of Nakheel Sukuk within the present research. Zaidah Zaina, 2007. Case study as a research method. Jurnal Kemanusiaan bil.9, Jun 2007. In the article, several aspects of case study as a research method are discussed. The aspects discussed include the design and categories of case studies and how their strength can be achieved. The author also provides discussion on the advantages and disadvantages of case study as a research method, which will be helpful in crafting the appropriate methodology for current research. No quantitative data will be obtained within the research. However, quantitative data from other analytical studies might be taken into consideration in order to provide more comprehensive picture of the issue. The source of the statistics on Nakheel Sukuk performance will be taken from business and investors’ reviews of Sukuk instrument. The qualitative data on Nakheel Sukuk and its performance as well as other Islamic financial instruments will be used. Although involvement of Sukuk holders would be of a great benefit to the research, the time and resources to obtain necessary information from Sukuk holders would go far beyond the limits of the research. Thus, more analytical summaries and overviews of Sukuk holders’ opinion will be used in the research based on the analysis of secondary sources. Thus, the research includes a case study in combination with qualitative desk-based using data and desk-based using theory research. References AAOIFI Shariah Board, Resolutions on Sukuk, February 2008, Bahrain: AAOIFI 2008, available at: [accessed 2 March 2011] Aljarhi, M. (2008), Emirate Islam Bank ‘Economic report [online], available at : [accessed 25 February 2011] Anwar, H. (2009), Abu Dhabi bails out Dubai World with $10 billion [online], available at :< http://bloomberg.com/apps/news?pid=20601087&sid=axQkSZJa0xKY> [accessed 25 February 2011] Bassens, D., Derudder, B., & Witlox, F. (2010), The making and breaking of Dubai: The end of a city–state? [online], available at : [accessed 11 February 2011] Chapra, U. (2008). The global financial crisis: Can Islamic finance help? [online], available at: [accessed 25 February 2011] El-Hawary, D., Grais, W. & Iqbal, Z. (2007), Diversity in the regulation of Islamic financial institutions [online], available at :< http://elsevier.com/locate/qref > [accessed 11 February 2011] Jones, S. (2009), Nakheel's creditors dash to limit damages [online], available at : [accessed 11 February 2011] Klomp (2010), Causes of banking crises revisited [online], available at : [accessed 10 February 2011] Lewis, A. (2010), The credit crunch: Ideological, psychological and epistemological perspectives [online], available at :< https://elsevier.com/locate/soceco> [accessed 11 February 2011 Rotheli (2010), Causes of the financial crisis: Risk misperception, policy mistakes, and banks’ bounded rationality [online], available at :< https://elsevier.com> [accessed 10 February 2011] Salah, O. (2010). Dubai Debt Crisis: A Legal Analysis of the Nakheel Sukuk. Berkley Journal of International Law Publicist, Vol. 4, Spring 2010. [online] Available at: [accessed 2 March 2011] Wigglesworth, R. (2009), Defaults destabilise a reviving market [online], available at :< https:/ft.com/reports/islamic-finance-2009> [accessed 10 February 2011] Read More