CULTIVATE A CULTURE OF SAVE FIRST, SPEND LATER

Finance-Money

It is certainly true that emphasis on innovation in development of Islamic financial products has receded in the wake of current financial crisis in the developed economies of the world, especially the US and the European countries. It is primarily because of the criticism of irresponsible innovation in conventional banking and finance, which has been blamed for malaise one may observe in the well-developed financial markets around the world.

Financial derivatives and structured products in particular draw a major share of this criticism. Consequently, financial regulators have gone back to drawing boards to redraw regulatory maps to restrict what is being termed as irresponsible innovation.

Given this focus on innovation and the born again urge for regulation, one may ponder over the optimum levels of regulation and innovation to ensure that the growth in Islamic financial sector is not unnecessarily hampered by over-regulation.

One message that one may draw from experience of the last 20 years of financial innovation is that moving the financial sector away from the real economy is not a good idea at all. Islamic economists have for last 30 years been arguing against dichotomy between financial sector and the real economic activity.

Any innovation that involves trading in debt (eg creating debt from debt and buying and selling debt instruments), over-reliance of insurance (ie shifting risk from one party to another in the financial markets, without actually reducing the volume of risk), and creation of money through interest rate mechanism is bound to result in financial bubbles that destabilise an economic system.

Islamic banking has shown impressive growth in Malaysia and the Bank Negara Malaysia has played an instrumental role in ensuring the smooth running of Islamic banks and financial institutions in the country. It will only be a natural expansion of the growth story of Islamic banking, if Islamic banks and financial institutions start promoting a culture of saving first and spending later. This is not only in line with the Islamic emphasis on prudence and living in one’s own means, but also is required for sustainable macroeconomic growth.

On a systemic level, any kind of budget deficit (especially large government budget deficits) is not self-sustainable and, hence, caution must be exercised to over-spend. Any innovation in financial services, which encourages spending first to save later is dangerous, and has adverse implications for future generations. It is, therefore, important to encourage savings with the help of innovative financial products so that the future generations benefits from the savings of their predecessors.

One such model could be based on the idea of micro savings and micro investments.

While microfinance has been used as a tool for promoting financial inclusion in a number of countries, it has rather limited relevance to the Malaysian economy wherein in abject poverty does not pose as big a threat as in many other Islamic countries.

Micro savings and micro investments are on the other hand relevant to the needs of a growing economy. It is, therefore, the time now to develop micro investment programmes that must encourage individuals and households to save small amounts over significantly long time periods.

These small savings and micro investments can be encouraged with the help of strong incentivisation programmes.

Prizes and rewards are one way of encouraging people to save more and for longer time periods. Prize-based saving schemes and loyalty programmes as devised by businesses (eg air miles, reward points etc) may be used to structure innovative financial products.

For long-term micro savings and investments, it is important that strong regulatory frameworks are developed to ensure safety of such savings by way of investing them prudently in long term infrastructure projects.

In most developing countries, including many emerging markets, legal structures and property rights regimes are either non-existent or underdeveloped.

Hence, governments must focus on bringing legal reforms to accommodate such a change. This will indeed give rise to a new range of financial products that will not only deepen financial markets but also create and maintain the desired link between finance and economy.

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