The Korea Herald


[Editorial] Islamic finance

By 류근하

Published : Feb. 18, 2011 - 19:04

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When the Ministry of Strategy and Finance submitted a bill on Islamic bonds to the National Assembly in September 2009, its main motivation was to secure new sources of foreign capital that Korea could tap into when liquidity dries up due to turmoil in the global financial system ― such as the collapse of Lehman Brothers in 2008.

But the bill gained added importance following a Korean consortium’s winning of the $18.6 billion nuclear power plant project from the United Arab Emirates in December that year. The bill, if enacted, would help the Korean consortium raise funds needed to finance the project by issuing Islamic bonds.

But this hope was thwarted in December last year by the Christian community. Church leaders pressured lawmakers to scuttle the legislation as they were worried it might help expand the Islamic presence in Korea.

Now the ministry is giving the bill another try as it seeks to win parliamentary approval during a session that starts today. But the Christian leaders remain as intransigent as ever. One reason for their opposition is that the bill offers, what they see as, too much tax benefits to Muslim investors. But the ministry rebuts this view, saying it stems from a misunderstanding of the mechanism used to issue Islamic bonds, also called sukuk.

Sukuk follows Sharia or the sacred law of Islam that prohibits the charging or paying of interest. As a result, to raise funds through sukuk, a borrower has to follow a procedure similar to a sale-and-leaseback transaction. Under this formula, the borrower has to transfer a property it owns to the lender in return for a loan. Then it leases the property back and pays rents. The lending institution distributes the rents to the bond purchasers. When the bonds mature, the borrower pays back the principal, while the lender returns the property to its client.

As this bond deal involves property transactions between the lender and the borrower, tax issues arise. But these property transactions are perfunctory in nature as they are used simply to facilitate the bond issuance. As such, if the participants in the deal have to pay all the taxes arising from property transfers, their transaction costs will become too high.

Hence the Finance Ministry’s bill calls for removing all taxes on sukuk. The ministry says this measure is exactly the same as the income tax exemption currently applied to the interest on all foreign currency-denominated bonds issued by Korean companies.

The church leaders are also concerned that the bill would help funnel funds to terrorists. They note that sukuk investors are required to donate 2.5 percent of their income to charity under the tradition of zakat. The problem with this practice, they argue, is that there is no way to know to whom the money goes because the investors destroy the names of the recipients immediately after making a donation.

The ministry says zakat is imposed not just on sukuk but all other economic activities. Furthermore, it says, there is not enough evidence that zakat money is used to fund terrorism. The accusation, therefore, is baseless. The Christian leaders, however, turn a deaf ear to the ministry’s explanations.

When seen from an economic perspective, there is little reason to oppose sukuk. The mechanism used to issue it is similar to that used for asset-backed securities. In other words, sukuk is a viable financial instrument. This is why it is used in many advanced countries as a means of tapping into oil wealth.

The Islamic finance market has been growing rapidly amid high oil prices. This market can not only help Korean companies doing business in the Middle East raise funds at a low cost; it can also be a blue ocean for Korean financial firms that seek to diversify their international business. Hence we urge the lawmakers to view the sukuk bill from an economic standpoint without being distracted by its religious or political aspects.