More on Shariah screening parameters
In the last article, I embarked upon elucidating to readers the importance and effectiveness of the Shariah screening parameters for listed and traded shares for investors.
I also provided examples of live crashes for the companies which failed to clear the Shariah filters. It does not mean that these companies cared for the Islamic screening parameters but it surely proves their importance and efficacy looking at the 2001 bloodbath.
The next Shariah screening parameter I would like to write about is the interest-based lending ratio of a listed company, which must not also be more than 30% of its 12-month trailing average market capitalization value.
It was easy to make out the interest-based borrowing ratio described by me in the last article; however, what is the interest-based lending ratio in a company’s financial statement? Do companies lend on interest similar to the banks and financial institutions? Do they have a central bank license to do so?
No, the companies do not need a central bank license to keep funds in a commercial bank’s term deposit scheme, or buy treasury bonds and bills, municipal bonds, corporate bonds, etc, where they get paid the interest. Also included are conventional securitization based on collateralized debt obligations or conventional mortgages.
The Shariah position for all of them is that these are interest-based placements by the company and hence akin to lending. It will be naive to think that the public joint stock companies operating in the western world, or the developed countries in the eastern side of the hemisphere, will not indulge in putting surplus liquidity to work by investing in all of these tempting offerings.
Some quarters argue that this screening parameter is redundant in the presence of the Haram income threshold, which checks the non-permissible income more effectively. They say that the interest income earned by the company out of such interest-bearing placements is anyway included with the other non-permissible income while ascertaining the extent of the Haram income. As such, applying these measures in addition to the barrier of impermissible earnings unnecessarily makes the screening exercise cumbersome.
I will explain the Haram income criteria a little while later. However, I strongly believe in the effectiveness of the lending filter. My reason is that it discourages a company from excessively indulging in making easy money by channeling liquidity to such avenues rather than expanding the existing Shariah compliant activity from where the Halal income is generated.
As such, my view is that the management of a successful and vibrant listed company should always look out for the opportunity to get a greater market share by diverting any available liquidity for expansion or acquisition.
While the interest income is earned without going through the hassle of investing in bricks-and-mortar business premises, staff, inventory, vehicles, marketing, research and development to improve the sales, etc, there can be no comparison to the joy of an entrepreneur when, after all the trials and tribulations, he sees the bottom line in the financial statement.
It is not only genuinely earned, but is also way above the paltry interest income the banks and bonds pay. Based on the above, I would prefer to keep the lending threshold unchanged.
The next to cross in the hurdle race by a company to enter the Islamic index is that all types of its receivables and cash at hand and in the bank put together must not exceed 70% of the 12-month average market capitalization value of the stock.
This ratio deals with discouraging the situation where the company’s assets turn from tangible to cash and debt. I have written a long way back in this series that Shariah principles do not allow making money out of money as well as making money by selling debt.
Imagine a company having more than 70% of its assets either in cash holdings or in the shape of receivables and its stock is traded at a premium and it is also paying a decent dividend. The profit earned by the shareholders by investing in such type of stock shall be considered impermissible even if its activities are Shariah compliant. This is because the majority of the company’s assets are liquid whereas Islamic principles demand investing in real trading activities, which requires investing the liquidity in inventory and trading, rather than making placements with financial institutions.
It is important to make clear that if the company’s receivables are in the shape of investment in Sukuk and term deposits with Islamic financial institutions, these will stand deducted from the total amount while applying the filter. This is because the Sukuk are either asset-based or asset-backed whereas the Islamic financial institutions invest depositors’ money in financing the trade and investment as the Mudarib.
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.
Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at sazubairi1979@gmail.com.
Next week: Discussion on Shariah screening parameters to continue.
