US Debt Crisis Signals End to Bond Age

US Treasury yields soared after Moody's (NYSE:MCO) switched to a negative outlook for the United States, hammering home the news that the BRICS alliance has officially surpassed the G7 economies.

Make way for a new model.

The BRICS countries generate 31.5% of the world GDP in terms of purchasing power parity (PPP), according to the UK's Acorn Macro Consulting. The G7 alliance lags behind, with the group of industrialized countries contributing only 30.7% to the global GDP. As of 2023, BRICS is officially 0.8% ahead of the G7 coalition economically.

US treasury yields reached 16-year highs on Wednesday, October 18, amidst one of the biggest bond market crashes in history. As a result of this massive US treasury bond sell-off, attention is has been drawn to alternative debt instruments concentrated in BRICS countries that are less susceptible to rising interest rates.

Because of today’s high-interest-rate atmosphere, some BRICS banks are doing incredibly well, notwithstanding recent US bank meltdowns, including Signature Bank (OTC:SBNY) and First Republic. The US banks’ balance sheets were beset by low-rate mortgages, and their portfolios lost value as central banks boosted interest rates, preventing the possibility of obtaining capital.

Islamic banks stand out for financing hybrid debt-equity deals without charging any interest. They don't have fixed-rate mortgages because they adhere to Islamic beliefs. The West, which depends on bond indexes that do not go beyond conventional, debt-only securities, has up till now ignored Shariah-compliant investment.

Which BRICS banks stand out?

Some Islamic banks have earned stellar profits in 2023. They adhere to the prohibition against funding specific industries, and prohibit investing in sectors that Sharia considers illegal such as gambling, guns, pork, and pornography. Instead of investing in the kind of things that could turn a nation into a tinderbox, sharia offers healthy substitutes, financing of ethical enterprises that responsible investors would like to concentrate on and grow.

If we look at the other extreme, for instance, arms investment per capita—a figure that is rarely tracked—we can see that the top investors over the previous ten years are now being dragged into actual warfare:

1. Per capita, Israel is $97.71
2. Russia, a per-capita of $56.72
3. Sweden ($53.05 a person)
4. Belarus ($35.71/person)


Islamic banks have been making enormous profits.

The superior performance of shariah-compliant investments over conventional bonds raises concerns about the necessity of becoming mired in gnarly investments, such as weapons. Crossover markets, such as environmental and ESG investors, or investors who are simply cautious about interest rate exposure, find appeal in the sustainable features of Halal assets. The assets even have some Western cultural roots. The Bible has something to say about loan interest rates as well. Leviticus 25:35 in the Old Testament, which forbids interest on loans to the impoverished, speaks against usury.

Shariah debt-equity agreements, from parks, schools, and hospitals to massive infrastructure projects, have become increasingly popular because they provide a sustainable vision for the future.

Consider Saudi Arabia, which is building numerous infrastructure projects to transform the present sustainable model into an even more advanced one. Its flagship project, a $500 billion smart metropolis, is expected to require significant funding. With the support of Mohammed bin Salman bin Abdulaziz Al Saud, the newly appointed Crown Prince of Saudi Arabia, the eco-city is transforming a 170-kilometers ‘line’ spanning from the Gulf of Aqaba into the Arabian Desert.

The designers of NEOM, who wanted to diversify the economy of the largest oil exporter, positioned the city between two mirrored structures that protect residents from the sun and wind while providing views of the desert outside and park-like cityscapes within― an excellent natural cooling method since shadows can drop the temperature by 19 degrees Fahrenheit, or 10.4 degrees Celsius. Additional air filtering equipment will make the outdoors comfortable.

An End to Bond-age?

The US's shrinking influence marks the end of an era. It’s important to realize the size of the BRICS market, especially considering how media has skewed even physically non-negotiable facts like geography.

One can see why a country like Saudi Arabia would be on so many dance cards these days—it is not only among the countries that will be welcomed into BRICS on January 1, 2024, but also one of the nations that JP Morgan is considering adding to its emerging market bond index but also. Despite the honor, the unique bond-equity structures used in Islamic banking may nevertheless elude Western banks' bond indices. Sharia-compliant sukuks used in Islamic financing lead to direct asset ownership, whereas bondholders acquire indirect interest-bearing debt obligations.

Dubai Islamic Bank aims to enable financing of social and environmental projects, and has just published the first Sustainable Finance Framework in the UAE. “We are excited about the potential that the framework offers in accelerating our efforts to become a more sustainable bank as well as access sustainable funding in the capital markets to support our sustainable lending portfolio,” says Dr. Adnan Chilwan, an Indian banking industry executive who serves as the Chief Executive Officer of Dubai Islamic Bank Group and a major international spokesperson for Islamic finance.

Inflation-resistant lending

The recent collapse of the US treasury bond market shows that investors are unwilling to take on the excess government debt brought on by large deficits. Even the US’s own Federal Reserve Bank is selling bonds and transitioning from ‘quantitative easing’ to quantitative tightening.

In the meantime, Dubai Islamic Bank's total income increased by 49% year over year to AED 9.3 billion (about €2.4 billion) in the second quarter of 2023, in the absence of interest rate exposure on its loan books.

In Riyadh, Saudi Arabia, the second quarter saw a 22% year-over-year increase in return on equity for Al Rajhi Bank, the largest Islamic bank in the world.

In a world fraught with corruption and strife, these BRICS banks offer a more peaceful and sustainable model for the future.

Bio:

JL Morin is the author of six award-winning books, including, Nature’s Confession, which delves into the use of AI to attain sustainability, and is on many school and university course syllabi internationally. A graduate of Harvard and NYU’s Stern School of Business, she holds an MBA in Finance and has worked for the Federal Reserve Bank of New York under Alan Greenspan.