ISLAMIC banks warned.
That is not the kind of comment one expects to hear from Central Bank of Bahrain Governor Rasheed Al Maraj at the opening of the world's premier Islamic banking event.
But that was the warning he delivered to delegates at the World Islamic Banking Conference (WIBC) at the Gulf International Convention and Exhibition Centre yesterday as he emphasised that both the region and Islamic financing would suffer from the global turmoil.
The quote is from a former head of a conventional bank to explain why Western institutions got embroiled in the subprime market when they should have known better.
And yesterday he warned that following the herd instinct in Western finance was not something that Islamic finance, even with its strict Sharia-compliant principles, was immune to.
The conference's theme is Competitive Strategies for Challenging Times and has attracted more delegates than the organisers expected, given the current global financial crisis.
The consensus from delegates yesterday was that people had turned up in record numbers this year because they felt the need to talk to other industry professionals to work out just where the industry stood in these difficult times.
Setting the tone for conference debate, Mr Al Maraj said, "Until very recently, many commentators and analysts believed that the economies of the GCC were an oasis of calm in the ongoing global financial turmoil.
"Since the collapse of Lehman Brothers in mid-September, it has become clear that no part of the world can be immune to the present crisis.
"We have seen a vastly changed financial landscape, and there is little doubt that the availability of funds and the costs of borrowing are being affected in all parts of the world.
"In recent months as the global financial crisis has deepened, many commentators have pointed out that Islamic financial institutions have escaped relatively unscathed from the severe downturn which is affecting most conventional financial institutions," he said.
"The fact that Sharia-compliant institutions have avoided significant losses resulting from the global financial crisis does not mean that there are no lessons that they can learn from the fallout.
"Let me mention three in particular which I believe are particularly relevant - the risks of herding behaviour, the importance of liquidity management, and the importance of sound corporate governance," he added.
"The first example I invite you to consider concerns the belief by many conventional banks that lending to subprime borrowers represented a viable new business line in which there would be an appropriate risk reward trade-off," he said.
"The first movers in this market might have found a profitable niche - but once many banks tried to become players in the same market, credit standards became lax and loans were made to borrowers who had little chance of repaying them.
"Although some banks recognised the risks they did not do enough to mitigate them at a sufficiently early stage.
"The reason, as the former head of a major bank remarked in explaining his bank's sub-prime related write-offs, is that 'if the music is playing, you have to get up and dance'.
"The subprime episode provides an illustration of the herding instinct which has been a recurrent feature of financial markets since their very beginning," he said.
"Some banks discover a profit opportunity, other banks follow, and before long the oversupply of credit has led to losses.
"Although Sharia-compliant financial institutions have been insulated from direct losses resulting from the recent financial crisis, this does not mean that they are not as much subject to herding as are conventional financial institutions," he said.
Copyright 2008 Gulf Daily News
Provided by Syndigate.info an Albawaba.com company