New sukuk are smaller than last year; profits hold up for Islamic banks although challenges remain

A blog post at PBS, the U.S. public broadcasting organization, provides a brief description of Islamic banking seen through the prohibition of usury in the three large monotheistic religions: Judaism, Christianity and Islam. The U.K. may be providing the greatest example of how to allow Islamic banking to operate on a level playing field with conventional financial products.

A panel at a conference in the Dubai International Financial Centre (DIFC) tackles difficult subjects like the effect of the credit crisis on Islamic finance and the potential for 'greater good' efforts to expand Islamic financial principles to financial products without the 'Islamic' label (e.g. 'ethical' and 'green').

In another report, data show that the sukuk market has fallen off in 2008 compared with 2007. Issuance in the GCC fell from $14.15 billion in the first nine months of 2007 to $8 billion in the same period in 2008. The number of sukuk issued in the GCC only from 36 to 34 which means that the average size of sukuk has fallen (from $393 million to $235 million). There were some sukuk significantly larger than average issued by real estate companies: eight accounting for $4.85 billion (compared with seven in the same period in 2007 valued at $3.42 billion). This means the remaining 26 sukuk issued this year only averaged $121 million compared with the non-real estate issues in 2007 which averaged $370 million.

Business Week had a story that I missed a few weeks ago about Islamic finance weathering the credit crisis, but which was mentioned in another article on Islamic finance, because of its additional screens which help Shari'ah-compliant investors avoid some of the pitfalls that have been hurt the most in the credit crisis. Some non-Muslim investors may even be attracted to the industry by its relatively simple screens used to exclude companies that, while conforming with the Shari'ah screens, may also perform better in bad markets for several reasons including a lower reliance on debt financing.

Although Islamic finance is less susceptible to the credit crisis, Moody's warns that it is not completely isolated from global economic trends and are overexposed to real estate markets, particularly in the GCC, which have only recently began slowing. Despite this, the profits of Islamic banks remained strong in the last year.

The Islamic Development is planning a sukuk to raise money to assist member countries suffering in the wake of the credit crisis.

Sukuk: past and present; UK cancels plans for sovereign sukuk

Andy Jobst, Heiko Hesse and Juan Sole wrote an article looking at both the startlingly high growth rate of sukuk through 2007 and the significant fall off so far this year which is expected to continue well into 2009.

Seera Investment Bank has a white paper (pdf) on Shari'ah-compliant private equity.

News continues to emerge that the Islamic finance industry may not fully escape the global recession caused by the credit crisis because of its dependence on real estate to back sukuk. This creates problems in diversifying against a fall in prices in that sector. There should be several mergers along the lines of Amlak and Tamweel.

Germany lags behind the U.K. in facilitating Islamic finance. The U.S. has flip-flopped in the Treasury Department's public engagement educating its staff about Islamic finance. Meanwhile, the Islamic finance industry has grown across the country. Although it has led the way in placing Islamic finance on a level playing field with conventional finance, it recently cancelled plans to issue a sovereign sukuk, although it still is working with its Islamic Finance Working Group. Hong Kong is still wants to encourage Islamic finance and Singapore continues to plan for a sukuk issuance.

Islamic finance and the credit crisis; sukuk issuance to rebound in 2009

The Academy for International Modern Studies (AIMS) released a press release describing the advantages of Islamic finance based on its reliance on real economic activity underlying the financial system. While there are a number of benefits of the Islamic financial system, there are also risks posed by the way it is currently practiced. Specifically, the focus of much of the financing in the GCC on real estate projects leaves many Islamic financial companies overexposed to the real estate market and thus a fall in the value of the real estate could lead to the same types of problems facing the conventional financial system albeit less amplified because the Islamic financial companies do not use huge amounts of leverage that spread and amplified the crisis in the conventional financial system. Islamic finance is not just for Muslims either; the underlying ethical screens are widely held by many non-Muslims as well
and can be expanded to include environmental screens as well. The head of the Islamic law program at the New York City Bar adds his thoughts on the potential for Islamic finance to avoid crises like the one currently experienced by the conventional financial system.

Sukuk issuance will be slow until the second half of 2009 according to Badlisyah Abdul Ghani, CEO of CIMB Islamic. The head of Middle East capital markets at BNP Paribas expects the sukuk market to be $50 billion in 2009. The Wall Street Journal's Deal Journal Blog interviews a lawyer at Clifford Chance about Islamic finance generally and sukuk specifically.

The U.K. government will offer a Shari'ah-compliant pension option for people who do not already have a pension. An article describes Shari'ah-compliant banking in Kenya.

Standardization may support innovation, says Sheikh Nizam Yaquby

Sheikh Nizam Yaquby, a prominent Shari'ah scholar, commented on the controversy about whether standardizing Shari'ah-compliance in some ways harms the future of the industry. In contrast to the Shari'ah board of AAOIFI which criticized calls for standardization as detrimental to ijtihad, Sheikh Yaquby said: "In Islamic law we encourage debate, research, scholarship and it is an ongoing process which cannot be stopped by anybody. However, for the purpose of standardisation, it is important to have certain prudential rules and basic contracts especially repetitive ones to be accepted among a group." I have had the pleasure of hearing Sheikh Yaquby speak a few times and he always provides an interesting counter-argument to the conventional wisdom. I have frequently said that using Shari'ah scholar's time for approving the same contract over and over is not a valuable use of their time and it reduces the amount of time they can spend working on innovative products. I hope that his comments on this subject will start a fresh discussion about the merits of standardization in some areas and Shari'ah board review of individual contracts in other areas.

The International Islamic Financial Market (IIFM) is working on its second standardized contracts following the Ta'Hawwut Master Agreement (for treasury placement): I'aadat Al Shiraa'a Master Agreement (repurchase). The IIFM has also now thrown its support behind the AAOIFI Shari'ah board's refusal this year to allow repurchase agreements as a positive development for the industry in the future.

Sukuk issuance continues to struggle in 2008 compared with previous years because of the credit crisis. The reduced level of issuance and reflection on the dominance of ijara sukuk has led to suggestions that the sukuk issuance process should be reexamined.

The Aston School of Business in Birmingham, UK is planning to have a program in Islamic finance if it can find the necessary financing. Brimingham, the second largest city in the UK has a significant Muslim population and is home to the Islamic Bank of Britain, the Islamic retail bank. The Islamic Bank of Britain recently announced low cost home finance that could help spur the use of Islamic home finance by non-Muslims. The UK government sees Islamic finance as a way to promote greater inclusion of Muslims in the U.K., although many Muslims remain wary about whether the Islamic banking industry in the country is 'Islamic'.

A new website provides information about Islamic finance in France (available only in French).

Islamic hedge funds, short selling, derivatives, standardization.

Amiri Capital, a Malaysian firm, plans on launching its Shari'ah-compliant hedge fund early in 2009. The delay was delayed from this year when the prime broker they had been working with, Lehman Brothers, went out of business in September. The hedge fund's structure of its mechanism for shorting stocks (which, as conventially practiced, is haram because it amounts to selling something that you do not own). Two contracts, arbun and salam, are mentioned as possibilities. Using arbun, the purchaser provides the seller with a deposit towards the purchase of a good at a future date. If the purchase is not made, the seller keeps the deposit. Salam contracts establish a sale at a given price with delivery on a future date.

The Securities Commission in Malaysia is also deciding whether to allow Islamic financial institutions to short a limited number of stocks in order to "boost market liquidity" and that this has been approved by the SC's Shari'ah board.

The Malaysian central bank, Bank Negara, plans to issue guidelines for Islamic financial institutions to create greater standardization and establish a international Shari'ah research academy, a helpful development at odds with sentiments of members of the AAOIFI Shari'ah board.

The International Swaps and Derivatives Association (ISDA) and the International Islamic Finance Market (IIFM) are working on a standardized master agreement for Shari'ah-compliant derivatives for hedging (Ta'Hawwut).

The governor of the Central Bank of Bahrain, Rasheed Al Maraj, says that the credit crisis has been little impact on the Islamic financial institutions so far but, "The effects of the global financial crisis on the real economy have the potential to transmit shocks to Sharia-compliant institutions as well. This means that there must be a very high priority placed on sound management and risk management practices at Islamic financial institutions".

Fox News, a conservative news organization jumps on the anti-Islamic finance bandwagon in a story full of hyperbole, misinformation and fear-mongering with Frank Gaffney even saying that Islamic finance is a "seditious system that supports jihad". I typically don't like to even give space on my blog to criticisms that have so little basis in fact, but when they emerge from the fringe network of think tanks that create their own little echo chamber into a news organization that has mass appeal (in the U.S. at least), it should be mentioned for what it is.

One positive point in the article was a few quotes from Islamic finance practitioners who were quoted refuting the specious allegations thrown around:

"Nicholas Kaiser, fund manager at Amana Mutual Funds Trust in Bellingham, Wash., said that his company's Shariah-compliant mutual fund products are no different from any other religious funds and that the company carefully screens its investors. 'Our shareholders are American. We don't take money from non-Americans because of money-laundering laws. We have to know our shareholders and be sure they aren't engaged in nefarious activities. We screen and check and verify every shareholder,' Kaiser said. 'We simply take people's money, invest it and give it back to them when they want it. We don't try and convert the country. We don't have any religious position. We aren't evangelical. We aren't zealots. We're money managers,' Kaiser said. 'I happen to be Episcopalian.'"

Ibrahim Warde, a professor at Tufts University, is quoted explaining the motivations of the extreme critics of Islamic finance: ""People who don't like Islam and who are afraid of Islam would obviously not like the notion of Islamic finance. I'm not sure that those who hold this view necessarily know much about it, but it's some kind of visceral view that some people hold"

Shari'ah scholars don't want standardization; U.K. still plans to issue sukuk

A meeting of Shari'ah scholars at an AAOIFI meeting argued against standardization saying it would make Islamic finance more vulnerable to risks and challenge the concept of ijtihad (judicial reasoning). Although there should remain considerable flexibility for scholars to interpret the Qur'an and Hadith in judging the Shari'ah-compliance of Islamic financial products, there are more compelling reasons to provide some standardization. The most pressing is that there is a shortage of Shari'ah scholars well enough recognized to be selected as members of the Shari'ah boards of the Islamic banks providing the most Islamic financial service. If scholars are in demand to aid a rapidly growing industry but spend a great deal of time reviewing relatively uncontroversial products, there is an inefficiency that could reduce the amount of innovation. Top scholars should spend most of their time working on new innovative products that differentiate Islamic finance from conventional finance, not reviewing 100 murabaha contracts.

Despite a shrinking financial market in the U.K., Islamic banks are still expanding according to the International Financial Services London (IFSL). One reason that the Islamic banks are growing is because they have little or no exposure to many of the most troubled assets because of both Shari'ah rules and their young age. Most were started within the last year or two and therefore were not accumulating their assets throughout the property boom that started in 2002.

The U.K. remains committed to issuing a sovereign sukuk despite the turmoil running through the bond and sukuk markets.

A conference in Germany discussed the potential for that country to eclipse the U.K. in the size of the market for Islamic finance if legislative and regulatory changes are made to put Islamic finance on a level playing field with conventional finance. India is still working on changing regulations and legislation to allow Islamic finance to operate in the country.

Islamic finance at risk from fall in prices in the real estate market; CGAP study on Islamic microfinance released

My fears that the credit crisis in conventional financial markets is spilling over to Islamic finance are becoming to be realized. The primary mechanism I identified in my blog (and in greater detail in a forthcoming opinion piece for Business Islamica magazine) for transmitting a crisis through the Islamic banks was falling property prices in the GCC countries that had mostly escaped the direct fallout from the subprime crisis that began in the United States. Although the prices have not fallen as dramatically as in Western countries, they are beginning to fall and this has an effect on Islamic banking because these assets are the underlying physical property used in many Islamic financing deals. From a Gulf Daily News article: "Falling prices in mainly Muslim countries in the Middle East and Southeast Asia are likely to affect the Islamic finance market due to heavy reliance on such assets to support deals." A senior analyst at Zawya, Alexandra Tohme, adds her opinion on the link between Islamic financial institutions and the global credit crisis.

The Dinar Standard has an interesting article about the potential for Islamic banking in Europe.

The Financial Times has a Q&A on the basics of Islamic finance, as do a number of newspapers in the U.S. and there is also an article on finance based in Christianity.

Islamic finance could still grow by 20-25% a year despite the financial crisis according to Rushdi Siddiqui, the Global Director of the Dow Jones Islamic Market Indexes, but "Islamic banks should diversify their investments to generate revenues from different areas."

Hedge fund managers are targeting Muslim investors in the Middle East by developing Shari'ah-compliant hedge funds, but is it too late for them to attract investors given their often poor returns during the past couple of years.

The DIFC has lent its support to the new Master Agreements for Treasury Placements (MATP), the standardized contract from the International Islamic Finance Market (IIFM) that was recently announced.

Zurich Financial Services Group has launched a joint venture takaful company with the Abu Dhabi National Takaful Company to expand their operations in the GCC region.

The Consultative Group to Assist the Poor (CGAP), a multi-lateral effort to promote microfinance and based at the World Bank, released a study of 125 Islamic microfinancial institutions.