UK Islamic home finance, sukuk; DIFC CEO calls for standardization; Indonesia plans sukuk in August

The Guardian newspaper in the UK describes in detail the different types of Shari'ah-compliant home financing available in the country. There were a few very interesting facts presented. First, a small minority of customers using the Shari'ah-compliant home financing are non-Muslims; currently about 2 percent of the Islamic Bank of Britain's customers are non-Muslims who turn to Islamic home finance for ethical reasons. Second, and this may provide a way for Islamic banks to broaden their interest beyond the Muslim market, is that in some cases, Islamic home finance is cheaper than traditional mortgages.

"If you bought a property for £250,000 using a diminishing Musharaka plan from HSBC Amanah, you would pay around £1,553 a month (made up of £1,246 in rent and £307 in contribution payments to increase your share), based on the bank buying 90 per cent and you putting down a 10 per cent deposit. If you took out a conventional two-year fixed-rate loan with HSBC (at 6.29 per cent and with a £799 fee) on £250,000, you'd pay around £1,655 a month over 25 years."

. There are of course differences in availability and structure that could negate the difference, the development of cost competitive Islamic home financing is a good thing for the industry as it seeks to expand beyond its current niche role.

Nasser Al Shaali, the CEO of the Dubai International Financial Center (DIFC), commented on the difficulty of operating Islamic finance in regulatory environments premised on only conventional banks operating, but also that the lack of standardization (such as standard, widely accepted fatawa) is hampering the industry's growth. While many countries are anathema to developing parallel regulatory systems for Islamic and conventional banking (as Malaysia has already done), there is still a case for assessing whether regulatory requirements designed for conventional banks are adequate for supporting a sound financial system where conventional and Islamic banks operate side-by-side.

The Indonesian government plans to issue its first sukuk in August and will use an ijara structure based on assets from the finance ministry. A cynical observer might question whether the assets of the finance ministry are Shari'ah-compliant since many activities in the finance ministry surely involve interest such as the also announced ORI005, the fifth retail (conventional) bond.

Meanwhile, Islamic banking continues to develop in Bangladesh but faces challenges in Thailand.

The UK government is "dragging its feet" and is unlikely to issue its first sukuk this year according to Mohaimin Chowdhury, head of legal, Shari'ah and compliance at the European Islamic Investment Bank. Although the difficulties for a sovereign sukuk from a tax perspective are real and the uncertain market conditions create challenges, Mr. Chowdhury feels they could "deal with them quicker". Kitty Ussher, the Finance Ministry is quoted as saying "There's no doubt in my mind that if we can find a way that works for the taxpayers to do it, the benefit to the City of London in terms if prosperity, jobs and expertise will be enormous [however] we just felt that since this is the first time we are doing it, it would be simpler and less risky to sell Treasury bills". Dr. Mohammed Ramady speaks to the situation in the U.K. and U.A.E. regarding the Islamic finance market as a whole in an editorial.

DIFC studies standardization, Japanese Diet to allow Islamic finance

The Dubai International Financial Centre (DIFC) is launching a research effort to study the possibility for greater standardization of Islamic finance globally as well as within the UAE and GCC.

A new bill is being proposed in the Japanese Diet to allow banks to begin conducting Islamic finance. While there is very little domestic demand for Islamic finance, Japanese banks see Islamic finance as a way to attract investors from the oil-rich GCC, some of whom often will only participate in investments if they are Shari'ah-compliant.

Islamic banking should continually be aware of its position and competitiveness with conventional banks to ensure that it can continue growing rapidly says Nicholas Brewer. In Malaysia, for example, Islamic banks are used by many non-Muslims because they offer competitive pricing and some aspects of Islamic banking may be viewed as more favorable to the borrower.

An editorial in the Guardian questions whether the literal interpretation of the prohibition of riba as interest may cause some to overlook the greater social requirements of Islam. Overly focusing on 'avoiding interest' but not necessarily having a focus on the underlying reason for the prohibition (and other requirements beyond avoiding interest). It would be possible to create an exploitative payday loan with high cost to the borrower while adhering to a narrow interpretation of the prohibition of riba by using murabaha or ijara (although it would be unlikely to be approved once Shari'ah scholars looked into more than just its form).

Malta issues guidelines on Islamic finance; data collection shortfalls hamper industry; Indonesian parliament to pass laws on Islamic banking

The Malta Financial Services Authority (MFSA) is working on a regulatory framework for sukuk and takaful. Recently, the MFSA released a framework for how Islamic banks would be regulated. This document provides descriptions of the regulatory treatment of many common Shari'ah-compliant transactions.

Indonesia's parliament is expected to soon pass legislation that will make it easier for banks to begin offering Shari'ah-compliant products. Despite the large Muslim population, Indonesia has lagged behind many Southeast Asian countries in changing laws to make Islamic finance easier and, as a result, has one of the less developed Islamic finance markets in the region.

A writer at Asharq Alawsat complains about the lack of publicly-available and accurate information on the Islamic finance industry noting that many different and contradictory figures are cited about even the industry's size and growth rate. Although there is some information available from sources like the Islamic Finance Information Service (IFIS) and Zawya, these tend to be constrained to very narrow pieces of information. With an industry that is estimated to be between $250 and $800 billion and growing between 15% and 30% per year, there should be greater resources dedicated to cataloguing and collecting basic data on the industry's size, growth rate, distribution of funds in types of financial products.

As Islamic finance moves from a niche to a mainstream financial industry, it will need to develop new products to compete with conventional financial institutions and also develop regulation to prevent excessive risk-taking by Islamic financial institutions that could put depositors money at significant risk. The latter point was the subject of a recent IMF paper, "Islamic Banks and Financial Stability: An Empirical Analysis" (full paper in PDF). Other challenges include bringing in new Shari'ah scholars to keep up with the growth in the industry.

UK reports results of sukuk group

The consultative group studying a U.K. government sukuk released its recommendations today. They include:

* the balance of advantages and risks lies with 'bill-like' sukuk rather than 'bond-like' sukuk;
* a rolling programme of up to around £2 billion of bill-like sukuk issuance would be achievable over time;
* a 'bill-like' sukuk programme would be fully integrated with the conventional Treasury bill programme, which has rolling issuance at 1, 3 and 6 month maturities; and,
* the Government would use a 'plain vanilla' Ijara-based structure to facilitate sukuk issuance.

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.