KUALA LUMPUR: Despite the relative infancy of the global Islamic banking industry, certain steps need to be taken now to ensure that Islamic banking institutions can weather the cyclical movements of financial markets.

Mohieddine Kronfol, the managing director of Algebra Capital, an asset management company based in the Dubai International Financial Centre, Dubai, UAE, told The Edge Financial Daily in an interview that the industry needed to develop its investment universe and risk toolbox if it was to flourish.

Founded in 2006, Algebra Capital is 40%-owned by US-based Franklin Templeton. It specialises in asset management in the MENA (Middle East, North Afica) region, focusing on attracting foreign institutional investors to the region.

Kronfol said that the Islamic banking industry was not immune from economic downturns, even if Islamic banks emerged from the current economic crisis with fewer battle wounds than their conventional counterparts.

Although the common refrain today is that the conservative practices of Islamic banks have generally insulated the industry from the effects of this crisis, the jury is still out whether this has been the case.

At a Reuters Islamic Banking and Finance Summit last month, industry executives were less bullish on the fortunes of the industry, especially if liquidity remained tight. “There is a real threat to the business of Islamic banking. If the liquidity does not return, we will not be able to continue doing our business,” Sohail Zubairi, head of consultancy Dar Al Sharia, was quoted as telling Reuters.

Kronfol provides a similar assessment, saying that while Islamic banks had been relatively unscathed thus far by the crisis, other Islamic investing institutions were not as fortunate. “(The limitations) meant that the Islamic banks weren’t aggressive in their investments, the amount of leverage was lower and they were able to deal with this crisis a little better,” Kronfol said. “This applies to the banks but a lot of Islamic investment companies have really suffered, especially those that borrowed from the short-term market to invest in long-term projects.”

Eventually, those Islamic investment companies developed liquidity problems in trying to service their short-term debt, and needed government help to survive. In short, no one is immune, Kronfol said. “We need to continue to work with one another to develop and increase the size and scale of the sukuk market.

“I think we also need to continue to improve the toolbox available to Islamic institutions, continue to work on standardisation, and continue to strive to  make Islamic markets more authentic. As long as we progress along those four channels Islamic finance should continue to strengthen and attract more participants.

“Financial Islamic institutions still face risks. There is a tendency among them to rely excessively on structured Islamic products, which if not regulated, could cause problems down the line,” he said.

“These structured products are negotiated contracts, and are not on an open exchange; they are not transparent, they are not priced publicly, and so could over time present problems for the system.”

Unlike Malaysia, the Middle East banking system does not have a sufficiently developed debt market, and depended on external investors for the flow of funds.

This article appeared in The Edge Financial Daily, May 4, 2009.