Islamic tenets can restore market discipline: manager

GENEVA (Reuters) - Islamic Finance could broaden its appeal well beyond its traditional base in the wake of the global financial crisis and could help restore discipline to the financial system, says one asset manager.

"Sharia principles would help asset managers to step back from financial engineering and shift toward risk and profit sharing, which is much healthier," Toby Birch, head of Guernsey-based asset manager Birch Assets Ltd, told Reuters.

He said many investors are attracted to sharia-based investments because they avoid esoteric products and focus on the tangible. "Real assets are harder to destroy than complex financial products," he said.

Birch, whose company applies Islamic finance principles to western portfolios, said applying sharia principles to global finance would bring economic equilibrium at much lower levels of leverage than currently present in the financial system.

"On the banking side, Islamic banks can only lend what they have on deposit, which avoids credit creation with all the effects we have seen during the financial crisis. Lending becomes far more disciplined," Birch said.

Birch said fractional reserve banking, where banks lend out many times what they have on deposit, lay at the root of the financial crisis, adding that this system ultimately leads corporates to leverage up too.

"In western finance, companies have had to gear up in order to avoid being taken over by highly geared competitors or private equity companies," he said.

"You weren't allowed to be conservative in the new millennium, where the idea of creating efficiency actually had the ultimate effect of creating systemic risk."

WHY ISLAMIC FINANCE?

Birch's concern that excessive leverage was a major threat to the global financial system led to his publishing the book "The Final Crash" in early 2007, where he discussed the ramifications of the looming credit crisis.

"I was wondering how we could learn something from what I believed was an impending financial disaster, and avoid creating the same conditions again," Birch said.

"When I looked at the principles underlying Islamic finance, the answers were all there."

Nor is Western finance new to such principles.

Birch cited the 'Guernsey experiment', a system developed in the early 1800s where the Guernsey government created its own interest-free money with an expiry date in order to finance infrastructure projects.

"The system enabled the Guernsey government to fund project after project over a period of 100 years without creating inflation or deficits. It is the same principle that underlies Islamic finance -- money has no time value, and therefore no cost attached," Birch said.

In June Birch is preparing to launch the SALAM fund, whose name is an acronym for "sustainable alternative from Lanesborough Asset Management" and also means "peace" in Arabic.

The fund will invest in assets such as property, gold, some venture capital and also what Birch terms "sustainable equity investments with minimum gearing."

(Editing by Jon Loades-Carter)