drawing room

Islamic Finance and Venture Capital

It’s not difficult to see how Islamic banks turn Islamic finance into a charade. Since Koran prohibits interest, all financing must be done on a profit and loss sharing basis. In practice, no more than 5% of Islamic financing is done this way.

Instead, Islamc banks use a structure called murabaha, or cost plus predetermined profit. Remarkably, the “profit” in a murabaha transaction and the interest a conventional bank would have charged on the same transaction happen to be exactly the same (imagine that!). Indeed, Islamic banks often quote their “profit” as a margin over Libor. Sounds dubious? It is.

What Islamic banks should do is to move away from the deceptive modes of financing they currently use and step towards venture capital. The venture capital groups who favor profit and loss sharing over interest are real islamic finance, the genuine thing. Moreover, by providing funds to entrepreneurs with bright ideas, the banks can assist in promoting innovation, invention and creation of new jobs and industries the Middle East desperately needs.

At one time - from AD750 to about AD1100 - it was the Muslim world that was making advances in science and technology, because of the availability of risk capital. But nothing of consequence has been invented in the Islamic world for thousand years. By becoming more like venture capitalists, Islamic banks can practice authentic and genuine sheria compliant financing while helping the Islamic community to rediscover its tradition of invention and innovation.

The next Forum on Islamic Finance should be in Silicon Valley, not Dubai.

private equity

A $100bn LBO no longer seems unthinkable. Home Depot, which is rumored to be a target, has an enterprise value of about $90 billion. Add a premium, and you are close to that number. If a deal goes through, it is feasible that private equity groups could find, say $25 bn equity, and raise a further $75 bn in today’s extraordinarily generous markets.

But what about the exit?? A trade sale is virtually impossible for any $100 bn+ company (there are only 60 non-financial public companies worldwide with that size). Financial engineering has its limits (given the risk of tougher market conditions). And, an initial public offering for a 15-20 per cent float will be extremely difficult (Bank of China aside, the biggest IPOs ever - Enel, Deutsche Telekom, AT&T Wireless - raised between $10bn and $15bn). Even with a successful IPO, a complete, staged exit from the remaining stake could take very long.

With ever-increasing amount of capital chasing bigger and bigger deals that seems to reach a plateau, expect returns on private equity investments to go down.