Last post of 2008

The past year has been a difficult one for conventional financial markets and the problems that began in the subprime mortgage industry spilled over to the economy as a whole. The problems which began in California, Nevada, Arizona and Florida have, by year end, expanded far outside these U.S. sunbelt states to impact global economic growth across Europe, Asia and the Middle East. These developments affected the Islamic finance market directly: most sukuk lease and profit payments are based on LIBOR (or another interbank interest rate) and the profitability of Islamic banks is directly related to the return on its investments which are heavily dependent on the economy.

The challenge for the Islamic financial industry in the coming year is to recognize and accept the linkages that connect it (through LIBOR and the global economy) to the conventional financial industry. Although Islamic finance presents a different approach to banking that in many ways represents a return to an intermediation role connecting depositors and borrowers. The lack of diversification in asset sector allocation, which is currently tilted towards struggling energy and property markets, could lead to the collapse of some Islamic finance institutions with exposure to underperforming investments in these markets.

One of the clearest description of these risks is from Badlisyah Abdul Ghani, the CEO of CIMB Islamic, the Malaysian Islamic bank, in an article from Reuters. The primary distinctions he draws are between banks with the most exposure to property markets versus those (mostly outside the GCC) with less exposure and (more importantly) the banks with sovereign backing versus private backing. The Islamic banks with the backing of a sovereign government are unlikely to fail no matter how impaired their assets become because they are, but private Islamic banks are going to be allowed to fail. The importance of sovereign backing was highlighted by the Tamweel and Amlak merger in progress with government assistance.

ING also highlights the reaction in the bond (conventional and Islamic) markets that are pricing in a depression, particularly those companies with exposure to the property market. One indicative sukuk they mention is the Nakheel Properties sukuk which was yielding 32 percent, although the secondary market is not very active.

There are bright spots to the industry in the coming year as economic growth should return eventually. There will be a few new sovereign sukuk issues from Indonesia and perhaps one or more non-Muslim majority country. The outlook long-term for Islamic finance is strong. A resumption in sukuk issuance would create more discussion among Islamic finance practitioners and Shari'ah scholars about creating products with greater differentiation from conventional products. Whatever challenges arise in the coming year, they will provoke a response that should make the industry more resilient in the long term and hopefully help nudge the industry towards more standardization.

Turkish sukuk

An article describes the changes likely to be announced by the Turkish government to enable the issue of sukuk. The changes have been in the works since 2003.

Mutual fund screening and the path to Islamic finance by a Japanese bank

Mutual funds designed to meet the criteria of a faith are not limited just to Muslim investors and some funds are moving beyond the Islamic funds in incorporating more proactive actions that do more than just using exclusionary screening. These including becoming activist shareholders and including 'positive' screens that support companies with the highest ethical conduct. I think it is the next step for Islamic mutual funds to become focused on more than just prohibition-based screens.

The path of Tokyo-Mitsubishi UFJ Bank from initially considering becoming active in Islamic finance becoming active in Malaysia with expansion plans elsewhere are described in a short article.

As usual, the sukuk al-salam issued by the Central Bank of Bahrain was oversubscribed, highlighting a continued need for short term investments for investors including Islamic banks.

A Shari'ah-compliant health insurance plan was introduced in Dubai.

Islamic finance in France, Dow Jones Islamic Market Indexes, QIB

An article today expands on the news yesterday about France's efforts to attract Islamic finance. The new facets of the article deal with the size of France's Muslim population in a country without anything comparable to the Islamic Bank of Britain in the UK as well as the potential roadblock for Islamic finance within France's staunch official secularism.

Dow Jones reports the preliminary results in December for the several Islamic market indexes and their conventional benchmarks. Qatar Islamic Bank, quoting Standard & Poor's, says that Islamic finance could become a $4 trillion industry in the next five years. The bank also plans to expand into Europe and Asia, already being licensed to open the European Finance House in the UK. Expansion is planned into France, Germany, Singapore, Indonesia and Brunei. Both were announced in their new in-house magazine Al Masraf.

Faith and finance

While reading a few articles at the Financial Times, I came across an article titled "Faith and Finance: What is it all for?". The article describes the frequent move between asceticism and profligacy in the financial system in London and speaks about the condemnation frequently issued by religious leaders for excessive focus on wealth, particularly in the financial markets. I was disappointed that its only reference to Islam and finance was "Islam has a more complex attitude to capitalism still", but it provides a chance for me to ask the question: "What do you believe the relationship between faith and finance should be."

Although the blog focuses on Islamic finance, comments need not focus on Islam only. I have focused on the "what" of Islamic finance, not the "why" primarily because I consider myself more qualified to discuss the former than the latter.

Islamic finance running into problems in the GCC, expanding elsewhere

France is considering regulatory and tax changes to allow Islamic banks to compete and enter the market which could be one of the largest in Europe based on the relative share of the population that is Muslim. At least three banks have requested permission to operate in France, the Qatar Islamic Bank, Kuwait Finance House and Al Baraka Islamic Bank of Bahrain. The Islamic banks operating in the UK would also likely be interested in France and would probably face an easier time expanding because of the financial sector harmonization promoted by the European Union.

The Commercial Bank of Kuwait cancelled plans to buy a 19 percent stake in Boubyan Bank from The Investment Dar, something that was part of reported plans by the Investment Dar to raise money.

As a result of the credit crisis, the Turkish government is considering issuing sukuk, although like the Islamic banking sector, it will not be explicitly labeled as Islamic (Islamic banks are called 'special finance houses' in the country).

A Shari'ah-compliant green fund trading carbon credits is being launched, although it is not immediately clear to me how they will engage in 'active trading' in the carbon markets in a Shari'ah-compliant way.

The market for sukuk and IPOs in Saudi Arabia has taken a tumble since the credit crisis spread across the world and out of the financial system into the real economy. The Central Bank of Bahrain's regular ijara sukuk issue was oversubscribed as normal however. The State Bank of Pakistan, the country's central bank, successfully issued Rs. 6 billion ($76 million) in sukuk, providing Islamic banks an investment for their surplus liquidity.

The property market in Dubai is experiencing a squeeze and, although it is not clear which companies bear the greatest brunt of it, there are probably some Islamic finance companies that will be hurt. Dar Al Shari'ah, a consulting subsidiary of Dubai Islamic Bank, believes that publicly traded Shari'ah-compliant securitizations could provide funding for home finance that would allow smaller investors to become involved.

An article compares the zero interest rate policies of the Bank of Japan and the US Federal Reserve to Islamic banking. I think the analogy is entirely incorrect because Islamic finance doesn't actually use a 'zero interest rate', it structures financing differently. Although some of the products may resemble interest-bearing instruments, they are not offered at zero cost. Borrowers are making financing available based on an expected (non-zero) return. I think that many articles miss the real compelling facets of Islamic finance when it is boiled down to 'they don't use interest'.

Legal review of Islamic financial products, private banking, Sri Lanka may consider Islamic finance

Malaysia struggles with how to accommodate Islamic finance within a non-Islamic legal system where judges are not familiar with Shari'ah requirements. In other parts of the world, Islamic financial products are structured in ways that legal systems are able to adjudicate without considering the Shari'ah-compliance of the products. This leaves little recourse for users of Islamic financial products who want to challenge the Shari'ah-compliance of products but allows the contracts to be constructed in legal systems where the outcome of challenges can be reasonably predicted from past case law.

The GCC is expected to have Islamic private banks developing in the next few years. An executive at Dubai Islamic Bank says that the Islamic finance industry should provide more alternatives catered to high net worth individuals.

Sri Lanka's government is looking at alternative sources of foreign finance and may be considering exploring Islamic finance (including Islamic microfinance) which is available in parts of the country which has a relatively small Muslim minority.

Islamic finance may face challenges from economic slowdown; another call for focus on the ethical basis of Islamic finance

Although there has been a lot of suggestion that Islamic finance is immune to the credit crisis (although it may be hurt by the follow on economic slowdown), the Islamic financial industry has not yet gone through a period where the legal structure has been tested if the issuers of sukuk, for example, default. For example, there has not been a challenge of whether sukuk holders have a claim on the asset used to back sukuk. According to an article in Asian Banker, the IFSB says that they should, but the fallout from the economic slowdown may result in an actual test of whether or not sukuk holders get ownership of the underlying asset in the case of default.

A EFG-Hermes report on the UAE says that the merger of Islamic finance companies Amlak and Tamweel will be a balancing act and that "one thing we can be reasonably confident is that while Amlak and Tamweel may make it to the beginning of the year, they are unlikely to make it to the end".

Farmida Bi argues that focusing too narrowly on specific rules as opposed to the intent of Shari'ah guidelines hampers growth and that "If Islamic finance is seen in its true guise as a form of ethical financing, of interest to all rather than only as a faith-based activity of interest to the Muslim population, it is likely to find favour with a different type of conventional investor who would be potentially willing to consider different types of risk-reward stuctures." I wholeheartedly agree that Islamic finance should focus on the objectives (maqasid) of the Shari'ah and should work to attract non-Muslims. This will ensure that the industry does not just become an exercise in structured finance, but promotes a greater ethical cause that is shared among peoples of all faiths.

Japan's largest bank, the Bank of Tokyo-Mitsubishi UFJ is planning to offer Islamic financial services in the Middle East and Asia. Japanese companies have been exploring growth into Islamic finance and some have started to become involved in the industry.

Islamic finance in India is finally beginning to develop some momentum.

UK sukuk document; Islamic finance in Japan

The UK's consultation document provides four options for regulating sukuk (full pdf)range from doing nothing to creating an exemption from certain regulatory requirement for sukuk to put them in a similar regulatory environment as corporate bonds. The transparent discussion of how sukuk are viewed from a regulatory perspective put the UK far ahead of other Western financial centers in promoting Islamic finance. The co-head of the London finance and capital markets team at Clifford Chance, Tim Plews says, "There’s confusion in Dubai as to requirements in other jurisdictions like Hong Kong, so with the U.K. setting the standard, it is providing real leadership".

Japan continues to slowly see an Islamic finance industry develop. Its growth is hampered by tax and regulatory hurdles yet to be overcome as well as a nearly nonexistent domestic demand for Islamic financial products.

UK moves forward on sukuk consultation

Moody's predicts that Islamic banks' assets will grow at a slower rate of 10-15% because of the global economic slowdown but will remain resiliant because depositors look at Islamic banks as focusing more on their role as an intermediary between savers and borrowers. Another article describes the UK Islamic finance market and the resiliency of the industry in the face of a severe economic crisis.

The Islamic finance media industry has seen good times recently.

Despite the announcement in the pre-budget report that the UK was not going to announce the imminent issue of its first sukuk, hopes for a sukuk are still alive. The UK Islamic Finance Experts Group (IFEG) met yesterday and HM Treasury is expected to release a consultation report on Islamic finance in January 2009.

The Islamic finance industry in Brunei is pushing the government to begin issuing longer maturity sukuk. While the country does not need to issue debt because of its large oil reserves, it began issuing sukuk in April 2006 with the aim of promoting the Islamic finance industry. New regulations of Islamic finance and takaful are coming into effect in the country.

Islamic finance expanding globally, including Brazil.

Are we all Islamic bankers now? Does the writer understand the difference between Islamic finance and zero interest loans?

New website on Islamic finance from Al Arabiya; More doubts about the ability of Islamic finance to insulate itself from the credit crisis

The Middle East TV news channel is launching a website devoted to Islamic finance and economics, which will add another source for news on the Islamic finance industry in addition to the few leaders in the GCC region, Zawya and Sukuk.net. The Times (U.K.) describes Islamic finance and the recent developments, particularly the growing opportunities for people to study Islamic finance at some universities in the U.K.

The Islamic Bank of Britain is looking to the Middle East for additional capital to fund its growth.

A number of practitioners in the Islamic finance industry discuss the industry's development moderated by Dr. Mohamad Nedal Alchaar, the Secretary General of AAOIFI.

In an article that should surprise no one familiar with the Islamic finance industry, future growth depends on increasing the number of Shari'ah scholars according to many including Sheikh Nizam Yaquby.

SEI, a large asset management firm, says that the Islamic finance industry has performed well compared with markets as a whole despite sharp falls in commodities and energy and a rise in the price of financial stocks. By virtue of the Shari'ah screens, Islamic investment funds tend to have very little exposure to financial stocks and more in energy and commodities than most of the indices. Despite doing better than the markets in general, Islamic finance does see repercussions from the credit crisis and global economic slowdown. An article in the Guardian casts doubt on the ability of the Islamic financial industry in the GCC to avoid a crisis similar to the one in conventional markets due to banks' asset-liability maturity mismatches and a falling real estate market accentuated by the illiquidity of credit markets worldwide. The regional head of Citi's Islamic finance in Malaysia discusses the effects of the economic slowdown on Islamic finance.

A Malaysian Shari'ah scholar says that the use of derivatives and options, which are allowed in Malaysia, could create a crisis similar to the one moving through the credit markets in the West.

Singaporean bank OCBC says that non-Muslims are becoming more interested in Islamic banking because it is more conservative than conventional banks which have been struggling because of over-aggressive investment in the real estate market and derivatives relating to mortgage-backed securities.

Malaysia's central bank is going to issue a 37-day sukuk for Ringgit 200 million ($55 million).