The current COVID-19 pandemic has sent shockwaves around the world, both humanitarian and economic. Coupled with the collapse of oil prices, these two ‘black swan events’ have resulted in governments having to re-evaluate their entire economies and redirect spending toward emergency stimulus packages to battle unemployment, businesses bankruptcies and a dangerous drop in GDP.
Islamic finance is no stranger to crisis. During the global financial crisis of 2007–08, Islamic banks fared better compared to conventional banks. An IMF study published in October 2010 revealed that smaller investment portfolios, lower leverage and adherence to Shariah principles precluded Islamic banks from financing or investing in the kind of instruments that had the most adverse impacts on their conventional competitors, and helped contain the impact of the financial crisis on the Islamic banking market.
Borrowers and financial institutions are faced with tough choices when dealing with the effect of the COVID-19 pandemic. In this article, we examine the parallels between the principles of Islamic finance and the measures governments and lawmakers are adopting to combat the effect of COVID-19 on the world’s economy.
Forbearance in Islamic finance
Pursuant to Shariah principles, a transaction must not take advantage of one party at the expense of the other, as reflected in the following Quranic verse: “You who believe, do not wrongfully consume each other’s wealth but trade by mutual consent” (4:29).
Therefore, one should consider forbearance to a debtor who is facing genuine difficulty to meet his obligations.
Not to be confused with ‘welfare’ or ‘charitable’ finance, most Islamic financial institutions accommodate customers who have genuine difficulty to repay debts and exercise restraint in undertaking legal recourse for recovering debts. They also afford Qard Hasan (benevolent loans) as part of their service to society.
Additionally, all Islamic finance products offered in the debt market are based on the principle of risk-sharing. Parties should share in profits and losses to maintain equality and fairness in a transaction. The concept of forbearance is enshrined in Islamic principles, and so creating mindful, responsible and risk-participatory contracts is at the heart of Islamic finance.
Problems as a result of COVID-19
COVID-19 has had a rapid impact on borrowers who in many sectors have seen demand for their goods or services disappear in a manner that is unprecedented in peacetime. Consequently, the financial markets and credit committees of financial institutions all around the world are faced with making decisions in a climate that has an unknown trajectory, adversely impacting any appetite for new or refinanced transactions.
Borrowers may, through no fault of their own, find themselves non-compliant with financial covenants and in default due to non-payment, material adverse change or cessation of business. Financial institutions are reassessing their participation in new transactions and borrowers are asking for COVID-19 carve-outs to the material adverse change clause in commitment letters, term sheets and the definitive financing documents.
Government and legal responses
Governments across the world are scrambling to curtail the effects of COVID-19 on their economy.
The European Central Bank is proposing stimulus, mitigation and quantitative easing, the Bank of England’s interest rates have been slashed and significant measures such as the Covid Corporate Financing Facility and the Coronavirus Business Interruption Loan Scheme have been announced.
In the US, lawmakers have struck a US$2 trillion stimulus deal to provide economic relief to US taxpayers and businesses hit by the coronavirus pandemic, in what stands to be the largest congressional bailout in US history.
The New York Banking Law has been amended so that “it shall be deemed an unsafe and unsound business practice if, in response to the COVID-19 pandemic, any bank [which is subject to the jurisdiction of the Department] shall not grant a forbearance to any person or business who has a financial hardship as a result of the COVID-19 pandemic for a period of ninety days”.
Other governments are following suit and taking similar steps which are all resonant of the same principles that are implemented in Islamic finance transactions. Such measures will provide respite to those in need until the world order is restored in the countries worst affected by the pandemic.
The reaction of governments and lawmakers and the magnitude of the measures introduced show the severity of COVID-19’s impact on borrowers, the state of the financial system and the stability of world economies. These measures may vary from the small banks granting payment holidays to borrowers struggling to meet their debt obligations to the very significant bailout packages granted to large businesses in the retail, service and hospitality sectors. These actions are starkly similar to what is already embodied in Islamic finance principles such as the grant of forbearance and ‘benevolent loans’ in times of hardship.
This article was first published in Islamic Finance News Volume 17 Issue 16 dated April 22, 2020.