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GCC financial system safe from AIG fallout

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Points of Essence:

  • The impending fall out of AIG was due to its over exposure to financial instruments like capital default swaps and derivatives which were had been largely despised by the Gulf Market due to their non-Shariah compliance. As such, the GCC financial system remains unaffected by this debacle.


MANAMA: If American International Group (AIG) had been allowed to go bust, the scale and complexity of its operations are such that it would have had such a devastating effect on the global economy that even the Gulf would have felt the effects.

But with the GCC financial system having largely avoided investments in subprime financial instruments the fallout would be more to do with what happened to the world economy than particular links to AIG.

“It’s difficult to think of any corner of the world not affected to some extent if the Federal Reserve had not stepped in with a rescue packet,” Gulf Finance House chief economist Dr Ala’a Al Yousuf told the GDN.

“Large international institutions in this part of the world are likely to have direct or indirect links with AIG through insurance, reinsurance, money management and credit derivatives but overall the main effect that would have been felt here would be the effect on the region from what happened in the rest of the world,” he said.

“AIG is pivotal in the global financial system not just the US,” he added.

“With assets in excess of $1 trillion, it has a complex web of operations covering insurance and re-insurance products, credit default swaps and mortgage derivatives.

“The bankrupting of AIG would have meant default on hundreds of billions dollars worth of contracts affecting many many institutions and businesses.

There would have been repercussions for the entire financial sector including insurance companies and asset managers. A lot of the current hurricane damage in the US is probably insured or re-insured through AIG.”

He said the big hit for AIG was its exposure to financial instruments like capital default swaps and derivatives.

“The actual default rate of homeowners defaulting on loans in the US is not actually that great,” he said.

“But a new climate of risk aversion means that these financial instruments are now almost toxic waste.

“Financial dealings in the Gulf banking system have largely not been involved in these derivatives. They do not exist in the Gulf market,” Dr Al Yousuf said.

“Some banks have invested in these instruments and suffered losses but so far there have been no signs of distress in any regional institution,” he added.

“Islamic financial institutions would not invest in these instruments because they are not Sharia-compliant.”

A lot of western institutions invested in these instruments when interest rates were low and they were looking for a higher yield by taking higher risks,” he said.

“Here, in the Gulf there were plenty of investment opportunities so the temptation to invest in risky assets like these was low.”

Essentially what triggered the subprime crisis was has been unbridled financial engineering purportedly to spread risk and generate high risk adjusted returns, he said.

“Risk management practices got undermined and did not keep up with the financial wizardry and a lot of institutions did not understand what their traders were doing and risk management was out of the loop,” he added.

There will be more distressed institutions in the US. Around 200 small to medium sized institutions have already gone to the wall and there may well be others, according to Dr Al Yousuf.



Written by Suapi Shaffaii

September 18, 2008 at 11:34 am

Posted in General Issue

Tagged with , ,

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