Sunday, June 01, 2008

Credit crunch make sukuk more expensive, new IMF working paper on the soundness of Islamic banks

The total assets under management screened using Shari'ah screens in the GCC and Asia is now $267 billion, according to a report from Ernst & Young. The report also highlights the growth of the Shari'ah-compliant asset management industry noting that almost one-third of the 500 funds were established in 2007. In addition, the growth in Shari'ah-compliant funds is different in Malaysia and the GCC. In the former, there is greater pressure placed by investors on ensuring that Shari'ah-compliant products are competitive in returns with conventional funds, while in the GCC, Shari'ah-compliant funds are preferred to conventional funds, even if there are lower returns. Although the funds have seen greater geographical diversity recently, they are still limited in the asset class diversification, particularly to fixed income and real estate through REITS, which are typically highly leveraged and therefore do not pass Shari'ah screens that exclude investments with debt of more than 1/3 of assets.

Although Islamic banking is allowed in Turkey where it is called 'participation banking', it makes up a 'negligible' share of total banking assets and laws allowing sukuk have not been passed. Ten banks in Indonesia recently announced they are converting to Islamic banks and growth in Islamic banks exceeds that in conventional banks. However, the Islamic banking industry makes up a tiny portion of total bank assets and it will be a "struggle" to reach 5 percent of total bank assets according to the Deputy Governor of Bank Indonesia Siti Ch Fadjrijah. Dr. Muhammad Syafi Antonia of the Central Bank of Indonesia adds that "We have to see the Islamic instrument not from narrow base religious approach, but from a wider approach how to accelerate the growth and development of Indonesia". Ireland may be the next European country to see growth in Islamic finance, although official counts only show the Muslim population at 32,500. Malaysia's Securities Commission announced changes to the list of Shari'ah-compliant equities, adding 23 and removing 12.

Recent sukuk issuance have been denominated more in UAE dirhams, Saudi riyals and Malaysian ringgit because the credit crisis has caused dollar denominated sukuk to be more costly.

The Dinar Standard presents a summary and analysis of some of the themes covered at the recent Harvard Forum on Islamic Finance and adds the statement that Islamic economics needs "individuals with deep and sympathetic understanding of both Shariah and the fields of economics and finance, and a sincere desire to marry these together so that the product is more than the sum of the parts". The field is lacking, according to the author Dr. Athar Osama, academics of the caliber of "Adam Smiths, Maynard Keynes, and Irving Fishers".

Despite many opinions to the contrary, the credit crisis is having an effect on the Islamic financial industry by making sukuk more expensive for issuers. Several sukuk have been delayed because the returns expected by the investors (often linked to LIBOR) exceeds the return that issuers are willing to pay to receive financing. However, despite the added costs, there are likely to be between $12 and $18 billion in sukuk issued in 2008.
"The GCC/DIFX index tracks returns from Gulf Arab dollar sukuk over Libor, and was at 225.85 basis points more than the benchmark on May 23, up from 175 at the start of the year and more than three times pricing in June last year before the subprime crisis."

The Financial Times has an interesting interactive feature on their website about Islamic finance including a short discussion on the sukuk controversy and the Shari'ah-compliant versus Shari'ah-based question from Neil Miller, a lawyer at Norton Rose.

The IMF released a working paper and short article summarizing the paper that show that small Islamic banks are more sound than their conventional counterpoint, but that larger Islamic banks are less sound than either conventional commercial banks and smaller Islamic banks, possibly due to their greater reliance on profit-and-loss sharing (rather than fee based business). The paper did not find that the presence of Islamic banks does not impact the soundness of other banks in the financial system.

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