Islamic banking goes global

Mushtak Parker reports on how the growth of Islamic banking has continued unabated in a post-9/11 international financial environment

The central German state of Saxony-Anhalt is set to launch the first Islamic Eurobond this autumn following its confirmation in mid-July that it has mandated Citigroup to arrange a five-year 100m euros benchmark issue which will primarily be marketed in the Gulf states, Malaysia, Turkey, US and UK; and which will be listed on the Luxembourg Stock Exchange.

The transaction is based on a Sukuk al-Ijara (a leasing certificate), which usually involves the sale and leaseback of an asset. The German state, formerly part of East Germany and one of the poorest in the federation, is keen to broaden its investor base, reduce its finance cost, and attract FDI into Germany.

In June, 'the world's local bank', HSBC, launched its new international brand of Islamic financial products, HSBC Amanah, in Dubai. The brand packs a full menu of Islamic financial services including consumer finance such as mortgages and current accounts, corporate finance, structured finance, and capital market products. HSBC Amanah is spearheading the Group's growing range of Islamic products in the UK, US, Saudi Arabia, Malaysia, Singapore, Indonesia, Bangladesh, and Brunei. HSBC Amanah, because of its global reach, could be the precursor to 'the world's local Islamic bank'.

In early August in London, Bristol & West, one of the leading mortgage providers in the UK and part of the Bank of Ireland Group, tied up with ABC International Bank to launch the Alburaq Islamic home finance facility. Bristol & West is providing the financing and back-office support, while ABC (Arab Banking Corporation), one of the leading banks in the Arab world, is marketing the product initially in the UK and later in Europe and the Arab world.

Insatiable appetite

The list is almost endless - a seemingly insatiable appetite for IPOs (initial public offerings) floated in recent months by existing, and a spate of new, Islamic banks in the Gulf and Malaysia; and record subscriptions to a rapidly growing programme of global sovereign and corporate Sukuk. These are but three latest developments which underline the phenomenal growth of global Islamic finance as an emerging alternative system of faith-based financial management, and which currently has estimated assets under management in excess of US$400bn, and growing annually between 10% to 15%.

The positive impact has been the enhancement of prudential and supervision standards, the introduction of compliance and anti-money laundering measures, improved corporate governance, and a more forthcoming disclosure and transparency culture.

So much so that the US Treasury and its UK counterpart, the IMF, and the Bank of International Settlements (BIS) in Basel are all playing a back-room role in helping to develop uniform prudential and regulatory standards for global Islamic banking and finance.

The march of globalisation is also witnessing the breaking down of old barriers to financial liberalisation. Malaysia, for instance, brought forward its financial liberalisation plan by three years when it approved in June a licence under the Islamic Banking Act 1983 to Kuwait Finance House, one of the largest Islamic banks in the world.

Under Malaysia's ambitious Financial Sector Master Plan, launched in 2001, banking licences to qualified foreign players were only supposed to have been given in 2007. But Bank Negara Malaysia (BNM) governor Dr Zeti Akhtar Aziz confirms that two more Islamic banking licence applications from foreign consortiums are being evaluated.

While Malaysia is sincere in trying to bridge the gap between the GCC and Asia, there is also an element of self-interest. Kuala Lumpur is keen on attracting inward Islamic investment and funds, while at the same time encouraging its own institutions in going cross-border and to seek opportunities emerging in Middle East markets.

Private liquidity in the MENA (Middle East & North Africa) countries, for instance, total in excess of US$2.3 trillion, of which some US$1.5 trillion alone are concentrated in Saudi Arabia and the other GCC states. This is the so-called new money, created by the oil price bonanza of the 1970s and 1980s, the real estate boom, and investment in equity markets. The Boston Consulting Group similarly estimates that private family wealth and high net worth individuals in the MENA and Asia Pacific regions are sitting on a combined asset pool of a staggering $10.2 trillion, most of which are invested in the US, Europe and East Asia.

There are signs that little new Middle East money is being placed in the US because investors are wary of their funds being frozen, unhappy at the stringent immigration regime there which is deemed discriminatory, and incensed at the overbearing post-9/11 compliance measures and excessive scrutiny of personal data. Some funds have been repatriated to the EU, especially in UK and continental real estate assets, and to the Middle East region. But more importantly from an Islamic banking perspective, an increasing percentage of this private liquidity is being channelled into the sector.

Over-subscription

Earlier this year, Emaar, the largest property developer in the Gulf, issued an IPO for its mortgage finance subsidiary Amlak Finance. The IPO was supposed to raise AED412.5m. Instead, it was oversubscribed 33 times and received orders for a staggering AED13.7bn. One of the reasons for this huge over-subscription was that Emaar announced that Amlak was converting into a dedicated Islamic mortgage financing company. 'Most of the investors who came to us to subscribe,' explains Nathif J Adam of the National Bank of Sharjah, one of the agents for the IPO, 'wanted to be assured that Amlak Finance was indeed converting into an Islamic financial entity.'

The demand trend for Islamic finance augurs well for the future. In a recent survey for the inaugural HSBC Middle East Business Confidence Index, almost half of the companies with sales of over US$100m that are from or operating in the region, stressed that they expect to use Shariah-compliant (Islamically-compliant) financial services more over the next three years.

David Hodgkinson, CEO and deputy chairman of HSBC Bank Middle East, sees strong potential growth for the Islamic sector, particularly due to growing demand for such financing from large corporations seeking to raise expansion financing and cheaper ways of refinancing more expensive conventional debt. According to Hodgkinson, in Saudi Arabia, for instance, 95% of all new borrowing (both business and consumer finance) in the first quarter of 2004 was reportedly done on an Islamic finance basis.

Malaysia is oft quoted as the most advanced Islamic banking model running side-by-side a conventional banking system, co-operating but not inter-acting, to be emulated by others. In 2003, according to BNM, total assets of the Islamic banking system increased year-on-year by 20.6% to RM82,196m. Customer deposits similarly increased by 13% to RM60,212m.

The market share of Islamic banking deposits in relation to the total deposits in the banking system has passed the 10% barrier to reach 10.4% at the end of 2003. Total Islamic financing market share similarly reached 10.3%. However, the underlying rate of growth of market shares is slowing down suggesting that 2003 was either a slight aberration or the market is overheating. It puts into sober perspective the daunting task with which the Malaysian Islamic banking system is faced if it is to achieve the target of 20% of market share of total banking deposits by 2010, as envisaged by the country's Financial Sector Master Plan.

During a visit to London in July, Malaysian premier Abdullah Badawi pledged continued support to develop further and enhance the country's Islamic banking system. Badawi, whose National Front coalition was returned in a landslide general election victory in March, is also developing non-banking Islamic financial institutions as part of his strategy to reduce absolute poverty, especially among the hardcore poor, through the provision of Islamic micro-finance, co-operative banking, and other financial inclusion services.

The BNM also sees the enhancing of the effectiveness and efficiency of the Islamic banking system 'as an enabler of economic growth and development'.

In this respect, the Islamic bond structure (Sukuk) is now becoming so popular because it involves the leveraging of real assets in the real economy, as opposed to paper speculation. The Saxony-Anhalt transaction, for instance, stresses Neal Downes, of Trowers & Hamlins, the City of London-based international law firm which has a thriving Islamic finance business, is essentially a sale (to a special purpose company) and leaseback (to Saxony-Anhalt) of certain previously state-owned real estate assets. The issuer will pay investors in the Sukuk a return derived from rents paid to it under the leases by the state. Interest payments are forbidden under the Shariah (Islamic law). As such, returns based upon and generated by the ownership of assets and income from genuine trading transactions are however permitted and, indeed, transactions of this nature are actively encouraged.

Popularity

Downes adds that Sukuk are becoming more popular with conventional investors as they seek to diversify their holdings away from G7 borrowers who are suffering from increased public deficits. The coupons, says Trowers & Hamlins, are also highly attractive although, as more issues occur and the Sukuk market matures, pricing will certainly become finer.

In fact, almost half of the US$700m Qatar Global Sukuk in 2003 was subscribed by conventional institutions in the US, UK, Europe, and South East Asia. The proceeds of the Sukuk are being used to finance the construction of the athletes' village for the 2006 Asian Games which will be held in the Qatari capital, Doha. These facilities will be refitted after the Games are finished as schools, hospitals and other facilities.

'There is a growing acceptance,' adds Downes, 'that Islamic financial instruments can compete with conventional financial tools.'

Islamic finance, of course unlike conventional banking, is a faith-based system of financial management, which derives its principles from the Shariah, the Islamic canon law being derived from three sources - the Quran (the revealed Muslim holy book), the Hadith (the sayings of the Prophet Mohamed), and the Sunnah (the practices and traditions of the Prophet Mohamed).

Riba (interest), Gharar (deception or uncertainty due to a non-disclosure or non-availability of full facts relevant to a transaction), and investment in a ranged of activities such as casinos, gambling, pornography, breweries, pork production and processing, and in interest-based financial institutions, are all proscribed in Islam. The Islamic system places equal emphasis on the ethical, moral, social, religious, economic and financial market dimensions.

It is essentially a contract-based system of financial management in which the financial institution has a fiduciary role - that of Mudarib or manager. The main contracts are equity-based such as Musharaka (equity participation) and Mudaraba (trust financing), or debt-based such as Murabaha (cost-plus financing), Ijara (leasing), Salam (forward sale), Istisna (construction financing), and Bai-Bitahman-Ajil (deferred payment).

Islamic finance expressly does not deny market forces and the market economy. The profit motive and private ownership are both acceptable within the limits of the Shariah injunctions. Islamic legal advisories often stress that, in Islamic finance, everything is allowed except that which has been specifically forbidden.

Not surprisingly, at the launch of the Amlak Finance IPO, Dr Mohammed Khalfan Bin Khirbash, the UAE Minister of State for Finance & Industry, who is also the chairman of Dubai Islamic Bank, the first commercial Islamic bank to be set up in 1976, reminded that 'Islamic finance has proven its competence, and can grow to be a powerful force for good in our societies and beyond'.

Indeed, Sir Eddie George, former governor of the Bank of England, who has played such an important role in getting Chancellor Gordon Brown to amend the double stamp duty requirement for Islamic mortgages based on the leasing contract, sees no reason why Islamic mortgages, once they become as competitive as conventional ones, could not be marketed to the general public irrespective of whether they are Muslim or not.

Mushtak Parker is editor of Islamic Banker.