Islamic Finance: Origins, Emergence, and Future

by Scott B. Wilson September 18 2007, 23:35
    One of the most raucous political fights of 2006 involved the takeover of the British ports operator P&O by DP World, which if fully effectuated would have ceded the control over six U.S. ports to a firm owned by the government of Dubai.[1] A principle objection to the deal was that it in effect would have rendered control of U.S. commerce and a main facet of national security to a government of Middle Eastern country that potentially had links to international terrorism. After a lengthy showdown between the Congress and President, DP World conceded to sell the firm to an American interest.[2] However, what went almost unnoticed was that this new deal was financed with a sukuk, a bond-like financial instrument that concurrently remains consistent with Shariah law.[3] Such issues are part of an emerging sector in the financial industry known as "Islamic Finance." This article traces a brief history of the origins of Islamic Finance, its emerging competitiveness, and its prospects for the future. Origins     Islamic Finance is part of a larger unified system known as "Islamic Economics." There is much in common with this system and western economic systems.[4] One overarching difference, however, is that Islam does not distinguish between the secular and the sacred as has been the tradition through much of the Christian West.[5] One author has painted this distinction by characterizing western secular economic systems as being driven by "unbridled profit motive" regulated only by the legislative and democratic processes while an Islamic system recognizes market forces up front but simultaneously requires humanity to submit to "divine authority" and all its commands to correct for the assigned evils emanating from the marketplace.[6]     Thus, "Islam postulates a unique nexus of contracts among the Creator, man and society on the basis of the Divine Law that directly affects the workings of the various social, political, economic, and financial systems."[7] Thus, the foundation of any Islamic economic system will be consistent with Islamic ideology, which encompasses three tenants[8]: Unity and Oneness of the Creator; Mohammed is the last prophet of Allah and was the perfect prototype of a perfect set of rules for living a perfect life in this world; Return of everything in this world to Allah at the Final Judgment     Consistent with this ideological framework, Islam posits a unique law, Shariah, which governs both private and public affairs.[9] The sources of Shariah include the Quran and the writings and acts of the Prophet Mohammed, commonly called the Hadith.[10] These laws are comprehensive, governing all aspects of one's life, and ultimate compliance with these rules leads to not only a harmonious life but also a consequential unified human society.[11] It is important to remember that any Islamic economic system seeks consistency with Shariah not as an end in itself, but its ordering is part of a much larger unified whole. Examples of how an Islamic system based on Shariah challenges the western secular model include[12]: Priority in emphasis on Islam's teaching of Justice and Equity as demonstrated by the enforcement of both distributive and commutative justice A spiritual framework that values human relations above material possessions A balance between individual self-interest and the common good Maximum profit and satisfaction are not the sole objectives, which in effect minimizes waste Recognition and protection of private property rights while encouraging reciprocal responsibilities     One  well-reported feature of Islamic Finance, or rather Shariah, is its abhorrence of interest, or riba. Scholars differ on whether an exact translation exists; however, a suitable definition is that Shariah forbids "the practice of charging financial interest or a premium in excesses of the principle amount of a loan."[13]. The Quran emphasizes the earning of money through trade and commerce rather than the charging of interest.[14] One verse from the Quran, 2:275, specifically distinguishes between the two practices by describing Allah's prohibition against "usury."[15]     Essentially, the prohibition of riba is a prohibition on debt security, but the system permits other forms of financing, such as risk and profit sharing.[16] Thus, instead of return on capital being determined ex ante through a nominal interest rate, the return naturally occurs ex post on the basis of the economic activity for which the funds were invested.[17] Scholars posit that this system avoids the risks, such as bank runs and periodic financial crisis, inherent in a fractional reserve banking system.[18] However, the element of riba does not alone differentiate Islamic Finance; a valid financial contract also must not contain Gharar (ambiguity or deficiency of information in the contract), Qimar (any elements of gambling), and Myisur (deceptive games of chance).[19]      All Islamic banks or traditional banks that provide Islamic financial products are required to establish "Shariah Advisory Councils" that serve the dual purpose of advising clients and assuring that the institution remains compliant with the demands of Shariah.[20] Such councils are composed of religious scholars who are experts in Shariah as well as the financial markets.[21] It is in conjunction with these councils that financial institutions have developed tools that while remaining consistent with Shariah also satisfy the institution's shareholders and customers. The Islamic Finance system is complex, but a nonexclusive list of some of its tools includes: Musharakah: This word literally means, "sharing", and int he business context it means a joint enterprise in which all partners share in the profits and losses.[22] This entity naturally developed out of the riba prohibition, and proponents argue that it is more equitable than the interest model.[23] For instance, in the interest model, if the debtor suffers a loss, a fixed rate of interest is still payable to the creditor which results in an "injustice."[24] Likewise, if a debtor succeeds in his venture, then the creditor only receives the fixed interest rate payment instead of a more proportional sum of the profits.[25] Murabahah: This is financing on a cost-plus basis usually through the form of a sale.[26] For instance lacks the capital to do so. He approaches a bank or financier for assistance, which instead of lending him the funds at interest, the two parties form an agreement whereby the financier purchases the product at its "acquisition cost."[27] Then in accordance with the agreement, the financier transfers the product to the entrepreneur at its acquisition cost plus a certain amount above in the form of profit.[28 The entrepreneur thereby agrees to make installment payments to the financier for the balance of the account. This financial tool remains consistent with Shariah and avoids the use of riba on the ground that the bank actually owns the product and has thereby taken on considerable risk in case the entrepreneur backs out, so the profit is justifiable because it is earned.[29] Likewise, if the entrepreneur defaults, he is only responsible for the balance of the account attributable to the acquisition cost, not for any additional fees or interest.[30] Two allowable exceptions under Shariah to a murabahah include a salam (similar to a futures contract for specific goods that require payment up front and a fixed delivery date) and a istisna (a future contract for something that requires manufacturing).[31] Ijarah: A leasing arrangement to be distinguished from a murabahah in that instead of the sale of a tangible asset, an ijarah is the sale of the right to use an asset for a specific period of time.[32] There are several slight differences between this and a conventional lease such as the lease begins on the date of acquisition instead of the date the contract was signed, the lessee is not responsible for the value of the asset in case of its destruction because the bank is required to take out insurance, and the lessee is not bound to purchase the asset at the completion of the contract.[33] Mudarabah: Contract similar to a venture capital transaction whereby a financier agrees to provide capital to an entrepreneur in exchange for a percentage of future profits.[34] The entrepreneur provides only his labor and expertise in investing in real economic activities, while the financier agrees to bear the full loss of a failure.[35] Hawala: An informal debt transfer system that operates exclusively using the honor system without any formal legal system.[36] The system works through a network of interconnected brokers. For example, if I owe a debt to person X in Cairo but I am currently in Damascus, I can approach a hawala broker and pay my debt to him. The broker in turn calls another broker in Cairo who agrees to settle the debt at a later time for a small commission. The advantage of this system is that it avoids hassles such as national currency manipulation, regulatory regimes, and taxation. More pointedly, because of its informal nature, it does not leave a paper trail.[37]      Above are some of the main contracts and financial tools that compose the emerging Islamic Finance sector. Each developed as a way to remain compliant with Shariah while permitting the flourishing of a functioning economy. Along with understanding what the basic tools of Islamic Finance are, it is also helpful to know of it history, rapid emergence, and prospective future success in the United States and world financial markets.   Emergence & Future      A sketch of the modern history of Islamic Finance would begin sometime in the 19th Century in predominantly Islamic countries then under colonial rule.[38] During this period, especially during the early decades, the indigent peoples gradually lost touch with their traditional practices and heritage.[39] The colonial powers offered new systems and symbols of modern success that led to the de-emphasis of traditional Islamic teachings that informed one's total worldview.[40]      Following the demise of the colonial period, "Muslims began to re-discover their identities and manifested the desire to regain the lost values in all aspects of life, especially concerning the economic system."[41] Most notably in Egypt, opposition grew to the presence of the interest-based Barclays Bank, which was established for the purpose of raising capital for the construction of the Suez Canal.[42] Similar opposition arose in India at the turn of the century where a minority of Muslims established Shariah compliant interest-free loans.[43] Joining this low level opposition was a group of intellectuals and scholars that by 1953 developed a formal Islamic banking system.[44]      As the 20th Century advanced, the Middle East as a whole, but especially the petroleum-rich nations, grew in influence. Increased capital flows resulting from the growing demand for petroleum exports created the need for an integrated financial and banking system. Likewise, in Islamic countries outside the Middle East, such as Malaysia, efforts were made to develop an interest free financial system to assist Muslims performing the Pilgrimage.[45] By the 1970s, the high oil revenues created an incentive for the creation of Shariah compliant investment and financial products. In 1975, the Islamic Development Bank was established, which provided developmental finance in accord with Shariah. This bank and other financial systems used the financial contracts listed above, such as Murabahah, for the placement of the Islamic banks' funds.[47] The countries Iran, Pakistan, and Sudan, at least officially, converted their entire banking systems to an interest-free basis.[48]      By the 1990s countries such as Bahrain and Malaysia began to promote Islamic banking in conjunction with the conventional system.[49] Products such as Islamic insurance and equity funds were developed, and both the Dow Jones and FTSE created indices that specifically listed Shariah compliant securities.[50] A regulatory body, the Islamic Financial Services Board, is established.[51] Culminating at the turn of the 21st Century, the Islamic financial system encompassed products such as: banking, mortgages, equity funds, fixed income, insurance, project finance, private equity, and even derivatives.[52] The ratings agency Standard & Poor's recently valued these interests at around $400 billion.[53] At growth rates of 15% over the past three years, Islamic finance as an emerging sector is expected to expand further especially with the rapidly increasing demand for petroleum exports, which brings fresh infusions of "petro-dollars."[54]      The Islamic Finance sector includes exclusively Islamic banks such as Saudi Arabia's Al-Rajhi Bank, which claims to be the world's largest Islamic financial institution.[55] More significantly however, a large number of conventional banking institutions such as Citibank, HSBC, and UBS all provide Shariah compliant financial products throughout both Islamic and non-Islamic regions. One example is HSBC, which on its website advertises a wide array of both personal and business financial products.[56] Customers are also able to search the biographies of the three sheikhs that compose HSBC's "Central Shariah Committee."[57]      A recent article described the widening advertising campaigned for Islamic financial products that various financial institutions are promoting in Malaysia.[58] Marketing for these products is becoming savvier as institutions emphasize the competitiveness of their products while remaining consistent with Shariah principles.[59] Markedly, some of the financial institutions are attempting to broaden their market to customers less concerned with compliance with Shariah than earning a competitive return.[60] In fact, some of the advertising is being aimed squarely at non-Muslims or others less concerned with the foundational mission of the products.[61] Perhaps these institutions through savvy marketing techniques are attempting to create a popular trend in an alternative financial market that is appealing to nominally religious customers more concerned with personal wealth and image. Other banks are responding with promises of steadfast devotion to Shariah: "One Bank Muamalat ad shows goldfish jumping from an overcrowded, dirty brown bowl in to a clean one. 'Free the national from the murkiness of interest payments,' sys the slogan with the ad."[62]      What are the prospects for this emerging financial sector called Islamic Finance? Will it meet the same dismal fate ushered in by political pressure as that of DP World in its ports deal? Or will Islamic Finance continue to expand and perhaps significantly compete with the conventional western financial system? No doubt the differences in approach and the underlying philosophical and religious underpinnings of Shariah-compliant products will raise questions about the legitimacy of certain features currently present in the western system such as the fractional-reserve banking system, the credit markets, and the problems associated with an excessive debt burden. Perhaps critics could point to the current financial crisis in the United Kingdom where the governmental had to bailout the British bank Northern Rock, after thousands of its customers removed their deposits in fear of the looming worldwide mortgage meltdown. Several legal and sociological factors may either prevent or contribute to the expansion of Islamic Finance in the U.S. and throughout the world.      As far as the world is concerned, one beacon of hope and perhaps an ideal model of an Islamic financial center is Dubai. Some of the world's largest financial institutions, investors, and even western business schools are all flocking to this region to get a piece of the growing pie.[63] Although not having the largest economy in the Gulf region, Dubai is marketing itself as the "one-stop shop" offering financial products ranging from insurance and stocks to sulak bonds.[64] Such a system openly flourishes in the predominately Islamic Middle East; what about in the United States?      There are several factors that may lead to the success or failure of such a system in the U.S. First, it should be noted that the conventional financial system currently allows for some Islamic financial products as long s the sponsoring institutions remain compliant with various regulatory agencies as well as state and federal laws. However, since the declaration of the "War on Terror", certain elements of Islamic Finance have come under increased scrutiny. One example of this arises from suspicions that Islamic financial institutions are used to launder and funnel money to international terrorist organizations. As of 2005, a total of 140 individuals have been arrested an over $25 million seized by the Department of Homeland Security on alleged violations of the Patriot Act for using hawala, or more specifically for participating in "unlicensed informal money transfer systems."[65 Could the same governmental crackdown come against other Islamic financial products upon the allegation of "terror financing?"      As far as private American citizens are concerned, Islamic Finance may be in more welcoming waters than those flowing from the public authorities. As noted above, Islamic financial institution as well as conventional banks offering like products are attempting to expand to the greater non-Muslim market base. In Malaysia for instance, the bank Al Rajhi partnered for the ad campaign that appeals to broad religious values with the slogan, "Truth. Honor. Respect. Just Values."[66] There are least two reasons why such an approach may be successful in the United States.      First, Islamic Finance and its underlying religious worldview can bring a sense of confidence to an investor that his assets are being responsibly cared for: "some people in the  West have begun to find the idea attractive. It gives the provider of money a strong incentive to be sure he is doing something sensible with it."[67] Thus instead of the oftentimes flimsy security that one has of investing in a system that is almost exclusive governed by sheer positive laws or utilitarian force, with Islamic Finance one is investing in a  system that naturally governs through conscience and obedience to a Higher calling.      Second, while Muslims are a minority group in the U.S., there is potential growth for Islamic Finance in America's large non-Muslim religious population. There are many large traditional religious groups in America, such as Christians and Jews, whose members are seeking to live out their lives with a worldview consistent with their religion. However, this has often proved to be difficult when it comes to investing or conducting oneself in the marketplace because so many business entities operate or invest in ways contrary to these traditional religious worldviews. There could be growth in Islamic Finance with non-Muslim customers who not only seek a modest return on investment but more importantly, desire a higher satisfaction that their funds are being used in a morally responsible way. For instance, many Catholics and Evangelical Christians would welcome the opportunity to invest in a financial enterprise such as Islamic Finance that is not involved with operations that violate their religious worldview by sponsoring pornography, providing non-spousal partner employee benefits, or promoting abortion rights.      Lastly, there are two reasons why Islamic Finance may steadily grow and expand across the world in the years to come. First, both domestic and immigrant Islamic populations are widely exceeding their replacement rates while much of the secular West, with the notable exception of the United States, is barely able to keep itself within replacement levels.[68 Second, as the demand for oil grows and the supply likewise declines, this will create increased influence and "petro-dollar" revenues for Islamic nations that insist on investing exclusively through the Islamic financial system. Conclusion      Islamic Finance is a subset of a larger concept called Islamic Economics that seeks to conform all of one's life to the tenets of Islamic ideology. This system has developed from under colonial rule and expanded to compete with some of the largest western financial institutions. The prospects for success of this emerging sector in the U.S. will depend on public enforcement of its laws as well as its reception by the American public. However, the prospects for Islamic Finance worldwide with diversified holdings are positive both because of growing Muslim populations as well as increased demand for petroleum exports from Middle Eastern countries. [1] Calling the Faithful, THE ECONOMIST, Dec. 9, 2006, at 86, available at [2] Id. [3] Id. [4] Zamir Iqbal & Abbas Mirakhor, AN INTRODUCTION TO ISLAMIC FINANCE: THEORY AND PRACTICE 1-2, (John Wile & Sons 2007). [5] Id. at 2. [6] Muhammad Taqi Usmani, AN INTRODUCTION TO ISLAMIC FINANCE xiv, (Kluwer Law International 2002). [7] Iqbal & Mirakhor, supra note 4, at 2. [8] Id. at 4-5. [9] Id. at 12-13. [10] Id. at 15. [11] Id. at 12. [12] 17. [13] Id. at 54 [14] Id. at 55. [15] Id. [16] Id. at 17. [17] Id. at 18. [18] Id. at 20. [19] Id. at 53. [20] Id. at 115; See also Wikipedia, Islamic Banking, (last visited Sept. 18, 2007). [21] Id. [22] Usmani, supra note 6, at 1. [23] Id. [24] Id. [25] Id. [26] J. Michael Taylor, Islamic Banking: The Feasibility of Establishing an Islamic Bank in the United States, 40 AM. BUS. L.J. 385, 395 (2003). [27] Id. [28] Id. [29] Id. [30] Id. [31] Usmani, supra note 6, at 83-89. [32] Iqbal & Mirakhor, supra note 4, at 84. [33] Taylor, supra note 26, at 396. [34] Iqbal & Mirakhor, supra note 4, at 103. [35] Id. [36] Id. at 108. [37] Id. [38] Iqbal & Mirakhor, supra note 4 at 23. [39] Id. [40] Id. [41] Id. [42] Id. [43] Id. [44] Id. at 24. [45] Id. [46] Id. at 25. [47] Id. [48] Id. [49] Id. [50] Id. at 26. [51] Id. [52] Calling, supra note 1 at 86. [53] Id. [54] Id. [55] Tom Wright & Yayu Yuniar, Islamic Finance Widens Pitch, WALL ST. J., Sept. 5, 2007, at B3, available at [56] HSBC Bank, (last visited Sept. 16, 2007). [57] Id. [58] Wright & Yuniar, supra note 55, at B3. [59] Id. [60] Id. [61] Id. [62] Id. [63] A Bouquet of Desert Flowers, THE ECONOMIST, Sept. 15, 2007, at 14, available at [64] Id. [65] Walid Al-Saqaf, Bush Team Launches New 'Hawala' Crackdown, WALL ST. J., May 24, 2005, available at [66] Wright & Yuniar, supra note 55, at B3.

Cuomo's Code of Conduct: Troubled Times for the Student Loan Industry

by Tola Adewola April 24 2007, 12:43
In November of 2006, the office of the New York State Attorney General initiated an investigation into the financial agreements between New York universities and student loan providers as part of an effort to eliminate practices that created conflicts of interests in the lucrative $85 billion student loan industry. [1] However, this investigation did not receive a high degree of publicity or momentum until February of 2007 when the newly appointed New York Attorney General Andrew M. Cuomo expanded the investigation to include more than 60 universities nationwide and major student loan providers and banks. [2] Attorney General Cuomo's investigation revealed questionable practices within the student loan industry whereby universities were receiving illegal kickbacks for including certain lenders in their "preferred lender" list. [3] This discovery has led to a nationwide reaction and the student loan industry has been under significant probing from several lawmakers as well as the U.S. Education Department. [4] [More]

Problems With Interest Only Mortgages

by Tara Cunningham April 6 2007, 17:11
I. Introduction:

In the microwave generation, everybody wants things right away. Things that our elders used to dream of having and save up for are now available instantly using credit. Credit cards give buyers the option of purchasing more than they can presently afford and paying back only interest. But while it may sound like a good idea to have everything now, for most living at the edge of their means, credit gets out of control and they get stuck in bankruptcy. A buyer overextending himself using a credit card is chaos on a small scale compared to the abuses of credit going on now. [More]

Subprime Slump: Will the Economy Follow?

by Alicia Filter April 5 2007, 01:33
On February 7, 2007, the Senate Banking Committee heard testimony which indicated that nearly 20 percent of subprime mortgage loans obtained in the period from 2005-2006 will result in foreclosure, affecting over 2.2 million families in the United States over the next few years. [1] On Monday, April 2, 2007, the second largest provider of high-risk, subprime mortgages, New Century Capital Corporation of Irvine, California, filed for Chapter 11 Bankruptcy protection and fired 3200 employees in the wake of its own "financial missteps" and trouble with the SEC and U.S. Department of Justice over financial statements which failed to accurately account for financial losses the corporation was suffering, as well as mismanagement of the corporation. [2] With more than 25 subprime lending companies shutting down over the past few months [3], many are wondering about the implications for the future of both the subprime market and the economy.

Subprime mortgages are those given to consumers with credit scores below 620, indicating that these consumers are generally late in paying their bills and often have significant delinquencies in their credit reports indicating frequent late payments on obligations of 30 to 90 days. [4] Alternatively, subprime mortgages are issued to consumers with high debt-to-income ratios or with limited credit histories. [5] As compared to prime borrowers, "subprime borrowers are disproportionately minority and lower income, older, less well educated, less financially sophisticated, and less likely to search for the best interest rate." [6] This indicates that subprime mortgagees may not fully understand exactly what they are getting themselves into contractually and financially at the time they sign their mortgage documents. [More]

Loophole in the U.S.A. Patriot Act enables Financial Institutions to provide services to undocumented immigrants

by Tola Adewola February 21 2007, 12:47
Bank of America recently announced its plan to nationalize its pilot program which provides credit cards to individuals who do not have credit histories and social security numbers. These individuals only need to have maintained overdraft-free checking accounts with Bank of America for at least three months and have a taxpayer identification number.[1] This program, which has been the target of criticism, is the latest of a series of programs commenced by various financial institutions that allows undocumented immigrants and other non-U.S. resident aliens to obtain certain financial services that would not have otherwise been available to them. Although Bank of America has asserted that its program complies with U.S. banking and anti-money laundering laws, many critics argue that this program opens business to illegal immigrants and undermines the anti-money laundering efforts of the U.S.A Patriot Act of 2001. [2] [More]

Virtual Bank, Real Scam?

by Mark Cassidy February 12 2007, 23:51
    Second Life is a popular “virtual world” in which people across the real world interact with each other using “avatars.” [1]  Avatars are three-dimensional alter-egos that can be completely customized; users can change their avatar’s clothing, height, weight, and even add features like wings. [2]  Unlike other virtual worlds, which are basically interactive computerized versions of fantasy role-playing games, Second Life is not a game in the traditional sense. [3]  It does not have goal or end; there are no monsters to fight, mysteries to solve, or princesses to rescue. [4]  Rather, Second Life provides its users with a toolkit with which they can create items within the virtual world. [5]  Users can create pretty much anything they want: buildings, vehicles, clothing, even games. [6]     Much of the activity in Second Life centers on commerce with users “buying” and “selling” “land” and each other’s creations. [7]  When a user signs up he or she receives an initial allotment of “Linden Dollars,” Second Life’s currency, and may purchase more, using real dollars, from Linden Lab, the creators of Second Life. [8]  Users are encouraged to “buy” land from Linden Lab, build a home for their avatar, and develop businesses. [9]  Given Second Life’s commercial orientation it is no surprise that in-game banks developed.     The best known bank in Second Life is Ginko Financial. [10]  As of this writing, Ginko claims to hold 114,398,068 Linden Dollars, the equivalent of $420,581. [11]  Ginko promises 0.10 percent daily accrued interest, approximately a 44 percent annual return. [12]  No real banks pay anything close to 44 percent annual interest and even top investment mangers do not promise such a high return. [13]       The Chief Executive of Ginko Financial, who goes by the name Nicholas Portocarrero in Second Life, will not reveal his (if “he” is in fact a man) real name or where he is located. [14]  Nor will he reveal anything about how he is generating such amazing returns for his depositors. [15]  In an interview with Reuters, Portocarrero was evasive at best.  When asked if Ginko was generating its returns through lending, Portocarrero responded “No, the bank is essentially loaning the money to itself right now.” [16]  An assertion that direct contradicts Ginko’s website which states “Ginko Financial takes part of the total cash deposited and gives loans to various trustworthy entities and persons, to make the money necessary to pay the daily interest rate.” [17]       The combination of outsized returns and zero transparency has led some to conclude that Ginko is a Ponzi scheme. [18]  In a Ponzi scheme, the promoter promises huge returns to investors on short term investments. [19]  The scheme works by paying older investors with funds from newer ones. [20]  The first few people who invest in a Ponzi scheme usually receive the interest promised them, but Ponzi schemes eventually collapse as they do not actually generate money and require an ever increasing number of new investors to keep up the interest payments owed. [21]  When asked by Reuters whether he was running a scam and if he had a good way to rebut such an accusation, given that Ginko operates without any oversight or regulation, Portocarreo was once again evasive. [22]  He first tried avoiding the question, but when pressed, he finally stated that he did not know of a way to rebut the accusation and denied that Ginko was a Ponzi Scheme. [23]  According to Portocarreo, Ginko’s lack of disclosure is the risk investors take on in exchange for their large returns and that people are just going to have to trust him. [24]       When asked if Ginko was profitable, Portocarreo once again avoided the question, stating “I could say yes, but it wouldn’t be entirely accurate.  It depends on how things are calculated and (what) you count and don’t count.” [25]  This is a remarkable response for someone who is paying 44 percent interest to his investors.       Ginko’s promised returns, lack of transparency, and evasive answers should make investors suspicious or at least cautious.  Nevertheless, as the numbers show, people have deposited a great deal of money with Ginko.  More curious than people’s willingness to give their money to Ginko, is that Linden Lab does not seem to find anything worrisome about the venture. [26]  Linden Lab’s CEO and founder, Philip Rosedale, believes that banks can exist within the virtual world of Second Life without regulation. [27]  Rosedale likens banks like Ginko to Grameen Bank of Bangladesh which makes small unsecured loans to the very poor to help them start businesses and work their way out of poverty. [28]  Grameen works closely with its borrowers to help them become successful. [29]  By lending to groups, and requiring that the first few people in the group begin to pay back their loan before Grameen lends to the others in the group, Grameen creates social pressure on people to pay back their debts. [30]  Ultimately, Grameen’s loan policy comes down to trusting the people they lend to, and so far Grameen’s trust has been warranted as they have a very low rate of default and numerous success stories. [31]       Rosedale believes that Grameen’s trust based model of lending can be applied in Second Life and that fear of being ostracized by the Second Life Community will ensure that banks like Ginko behave ethically. [32]  However, Rosedale has things backwards.  Grameen makes no secret of who they are, what they are, or how the bank works.  Grameen is the one who trusts that borrowers will repay their loans.  The risk is borne entirely by Grameen and the relationship between Grameen and its borrowers is a close and active one. [33]  Ginko is the exact opposite.  Rather than Ginko trusting borrowers, depositors trust Ginko.  They are the ones bearing all of the risk as their deposits are not insured, Ginko is completely unregulated, and none of the depositors know who is behind Ginko or how the bank makes money. [34]  Unlike the people who Grameen lends to who cannot simply leave with Grameen’s money, there is nothing stopping someone like Portocarreo from simply taking people’s money and shutting off his Second Life account.  In his Reuters interview, Portocarreo stated “ [w]e keep a [Linden Dollar] reserve of about 5%, sometimes less . . .” [35]  This means that at least 95 percent of the Linden Dollar deposits Portocarreo has received have been converted to real currency.  As depositors have no idea what Ginko does with their money, it is possible that Portocarrero has spent the money or transferred it to a location unreachable by U.S. creditors.       Given Ginko’s complete lack of transparency, if it turned out to be a swindle, it would be very hard for depositors to track down the person or persons behind it.  Even if they were found, there is no guarantee that depositors would be able to obtain redress.  If this were to occur, it is likely that the depositors would sue Linden Lab for not protecting them from fraud.  By not taking efforts to ensure that commercial activity in Second Life is conducted in a transparent manner, Linden Lab is in essence putting their stamp of approval on ventures like Ginko.  Linden Lab of course absolves itself of any liability for the actions of Second Life users in its Terms of Service Agreement, but there is no guarantee that the Terms of Service Agreement will hold up in court. [36]  If a court determines that Linden Lab is liable for fraudulent activities that take place within Second Life, they may be overwhelmed with suits.  To avoid liability, and governmental regulation of the commercial activities within Second Life, Linden Lab should develop rules and policies that ensure commercial transactions between users are transparent and legitimate. [1] Second Life, What is Second Life?, (last visited Feb. 12, 2007); Second Life, Create an Avatar, (last visited Feb. 12, 2007). [2] Second Life, Create an Avatar, (last visited Feb. 12, 2007). [3] Second Life, What is Second Life?, (last visited Feb. 12, 2007). [4] See Id. [5] Second Life, Create Anything, (last visited Feb. 12, 2007). [6] See Second Life, The Creations, (last visited Feb. 12, 2007). [7] See Second Life, Economy, (last visited Feb. 12, 2007). [8] Second Life, Membership Plans, (last visited Feb. 12, 2007). [9] Second Life, Own Virtual Land, (last visited Feb. 12, 2007). [10] Adam Reuters, Ginko Financial – Pioneer or Pyramid?, Reuters Second Life News Center, Oct. 15, 2006, [11] Ginko Financial, (last visited Feb. 12, 2007); Second Life, LindeX Market Data, (last visited Feb. 11, 2007). [12] Reuters, supra note 10; (Ginko recently lowered its daily interest rate from 0.10 to 0.09). [13] Id. [14] Id. [15] Adam Reuters, INTERVIEW: Ginko CEO Nicholas Portocarrero, Reuters Second Life News Center, Oct. 12, 2006, [16] Id. [17] Ginko Financial, About Us, (last visited Feb. 12, 2007). [18] Reuters, supra note 10. [19] Id. [20] Id. [21] Id. [22] Reuters, supra note 15. [23] Id. [24] Id. [25] Id. [26] See Reuters, supra note 10. [27] Reuters, supra note 10. [28] Reuters, supra note 10; Grameen Bank, Breaking the Vicious Cycle of Poverty Through Microcredit, (last visited Feb. 12, 2007). [29] Grameen Bank, Breaking the Vicious Cycle of Poverty Through Microcredit, (last visited Feb. 12, 2007). [30] Id. [31] Id. [32] Reuters, supra note 10. [33] Grameen, supra note 29. [34] Reuters, supra note 10. [35] Reuters, supra note 15. [36] Second Life, Terms of Service, (last visited Feb. 12, 2007).

China Makes Plans to Diversify its Currency Reserves

by Mark Cassidy November 6 2006, 23:50
People’s Bank of China Governor Zhou Xiaochuan announced at a meeting of central bankers in Frankfurt this past Friday that his nation plans to diversify its $1 trillion currency reserves. [1] Zhou stated that China has a clear diversification plan that includes “currencies, investment instruments, [and] emerging markets,” but does not include the sale of any of its dollar denominated assets, which make up approximately 70% of China’s total reserves. [2] Despite Zhou’s assurances that China would not be selling off its dollar denominated assets, the dollar fell to a two and a half month low against the Euro and gold prices rose to a two month high. [3] Many analysts believe that China is unlikely to sell off a large amount of its dollar denominated assets; as to do so would be against China’s interests. [4] If China were to make such a sale, the sudden influx of U.S. debt on the world market would cause the dollar to plummet, devaluing the rest of China’s dollar denominated reserves. [5] Because it is unrealistic for China to sell off a large amount of its dollar denominated assets, many in the banking industry believe that the dollar will not continue to fall. [6] In fact, rather than dumping their dollar denominated reserves, most central banks are switching from traditional treasury bills to higher yield agency-debt, and securities issued by Freddie Mac and Fannie Mae, the sale of which recently hit an all time high. [7] The Bank for International Settlements reports that dollars accounted for 66% of world-wide central bank reserves at the end of March, a small change from 2001 when dollars accounted for 70% of reserves. [8] The Chinese want to diversify their reserves in order to have greater flexibility in their monetary policy. [9] Many analysts believe that given China’s trade surplus the Yuan is undervalued. [10] The Chinese want to adjust the Yuan’s exchange rate gradually because they fear a rapid re-evaluation of the Yuan could lead to a serious disruption of China’s internal economy that would result in bankruptcies and unemployment. [11] China’s concern about destabilizing its internal economy is good news for the U.S. as it means that China is unlikely to make any dramatic changes in its reserve policy. While a change in policy is bound to happen at some point, it will most likely happen gradually over a long period ensuring that both the U.S. and Chinese economies are not seriously disrupted. [1], Dollar Falls on China Diversification Talk, Nov. 10, 2006, [hereinafter Dollar Falls]. [2] Simon Rabinovitch, Reserve Shift Taps Forex, emerging Markets: China,, Nov. 10, 2006, [3] Id. [4] Matthew Benjamin & Christopher Anstey, Zhou Says China Will Diversify Reserves Without Dumping Dollars,, Nov. 10, 2006, [5] Rabinovitch, supra note 2; Id. [6] Dollar Falls, supra note 1. [7] Benjamin & Anstey, supra note 4. [8] Id. [9] Rabinovitch, supra note 2. [10] Id. [11] Id.

Banks Cheating Workers Out of Overtime Pay Are In Trouble

by Tara Cunningham October 26 2006, 15:08

There is a common practice among banks to classify their brokers in such a way that makes them ineligible to receive overtime pay, and now their brokers are fighting back to receive the pay that they feel is rightfully theirs. Morgan Stanley, Citibank, Wachovia, and Bear Steams have all been sued for failing to pay overtime to eligible employees. The U.S. Department of Labor is now chiming in to say which employees must be paid overtime, and it is not looking good for the banks. [More]

Bank of America Settles Money Laundering Suit for $7.5 Million

by Mark Cassidy October 16 2006, 23:49
The Bank of America recently settled a money laundering suit brought by Manhattan District Attorney, Robert M. Morgenthau for $7.5 million, $6 million in penalties and $1.5 million in costs, ending an almost three year investigation conducted in coordination with foreign authorities. [1] District Attorney Morgenthau said that a series of transfers, totaling more than $3 billion, prompted the investigation because they possessed some of the ear-marks of terrorist financing, much of which comes from South America. [2] The transfers originated in offshore shell companies owned by illegal Brazilian money services and were routed through the Bank of America account of a Uruguayan money remitter. [3] Although officials do not know the identity of many of the recipients, District Attorney Morgenthau believes that some of the transferred funds went to Mideast terrorist organizations. [4] Under the terms of the settlement, Bank of America admitted that it failed to adequately asses the risk of some of its customers, agreed to cooperate with ongoing investigations, and to improve its anti-money laundering program. [5] Even so, Bank of America admitted no wrong, stating that it takes money-laundering seriously and that it never has knowingly done business with parties engaged in illegal activities. [6] The Bank of America investigation was part of an on-going anti-money laundering program that has traced almost $19 billion in illegally transferred funds, and recovered $19.5 million for the city and state. [7] District Attorney Morgenthau also announced that thirty four individuals and sixteen British Virgin Island companies, all of whom were involved with illegal transmissions of money from Brazil, had been indicted for violation of New York’s banking laws. [8] As Brazilian authorities are criminally prosecuting the defendants, in it is unlikely that District Attorney Morgenthau will prosecute them in the United States. [9] However, the indictments were necessary to freeze their illegally transmitted assets, which total $17.4 million. [10] [1] David Enrich & Chad Bray, Bank of America Settles NYC Probe, Business Week online, Sept. 27, 2006, [2], Bank of America Will Pay Millions To Settle Money Laundering Probe, Sept. 28, 2006, [3] Enrich & Bray, supra note 1. [4], supra note 2. [5] Id. [6] Enrich & Bray, supra note 1. [7], supra note 2. [8] Enrich & Bray, supra note 1. [9] Enrich & Bray, supra note 1. [10] Enrich & Bray, supra note 1.

China Approves Citibank-led Consortium’s buy-into Guangdong Development Bank

by Mark Cassidy September 18 2006, 23:48
China’s approval of the Citibank consortium’s buy-into Guangdong Development Bank ends a year-and-a-half battle for control of the bank. [1] The Citigroup consortium, which includes China’s largest insurance company and one of China’s largest electricity distributors, offered approximately three billion dollars for an eighty five percent stake in Guangdong Bank. [2] The Citibank consortium beat out its closest rival a consortium led by France’s Societe Generale. [3] U.S. based, private investment firm, The Carlyle Group, pulled out of the bidding. [4] Despite a last minute attempt to get back into the race, Ping An Insurance's bid was hobbled when they tried to make large donations to the Guangdong provincial government a portion of their bid. [5] Despite their leadership position in the consortium, Citibank will only take a 19.9 percent stake in Guangdong Development Bank, as Chinese law currently forbid a single foreign bank from owning more than 20 percent of a Chinese bank. [6] Both Citibank and Societe Generale lobbied the Chinese government to make an exception to the limitations on foreign ownership of Chinese bank to no avail. [7] China’s entry into the World Trade Organization was conditioned in part on it opening its banking sector to foreign competition. [8] Nevertheless, China has been putting up obstacles to foreign banks that want to set up shop in China. [9] By allowing the Citibank led buy-in to go forward, China seems to be taking a somewhat less protectionist approach.  While Chinese companies will still be for the most part own Guangdong Development Bank, Citibank’s 19.9 percent share allows the bank to receive the benefits of being part of a large, well-financed, and experienced banking organization. [1] Citibank beats out Scoiete Genrale for China's Guangdong Development Bank,, Sept. 13, 2006, [2] Id. [3] Id. [4] China cabinet backs Citibank-led plan to take over Guangdong Devt Bank – UPDATE,, Sept. 12, 2006, [5] China’s Ping re-enters bidding for Guangdong Development Bank- source,, Sept. 5, 2006, [6] Citibank beats out Societe Generale for China’s Guangdong Development Bank, supra, note 1. [7] Id. [8] David Lague, China tries to limit access for foreign banks,, Sept. 5, 2006, [9] Id.

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