AAOIFI head criticizes the chairman of AAOIFI Shari'ah board; Islamic Development Bank launches work team to monitor credit crisis

The Islamic Development Bank is establishing a work team of experts to monitor the effect of the current financial crisis on the Islamic financial crisis. I think it is a good move and recognizes that, although the ethical requirements on the Islamic finance industry can help mitigate the effects, the industry is not completely unscathed from spill-over effects of the financial crisis. The spill-over flows through the conventional credit markets (many if not most sukuk are priced in connection with the LIBOR) and the effects of the crisis on the underlying global economy. While there is little that the work group can do to reduce the effects of the crisis on the Islamic finance industry, monitoring it closely can allow early moves to head off serious repercussions.

The head of AAOIFI, the global standard-setting body, lashed out at the head of the Shari'ah board, Sheikh Taqi Usmani, at the International Islamic Finance Forum for comments about the Shari'ah-compliance of sukuk that were followed by a drop in issuance in sukuk. Mohamad Nedal Alchaar said "The statements that were made by our sharia chairman about the sharia compliance of sukuk wrecked the market". While the timing of the comments were inauspicious, there is little doubt that the financial crisis wracking credit markets worldwide had far more to do with the fall off in sukuk issuance. Sheikh Usmani's comments, to be fair, were not followed quickly by a statement from the full AAOIFI Shari'ah board (that followed several months later). However, the comments in and of themselves, will probably benefit the industry in the long run by pushing the sukuk market, and hopefully Islamic finance in general, towards more differentiation with the conventional financial markets. Until now, most Islamic financial products have emerged from a process of 'Islamicising' of conventional products and have largely the same structure. What Sheikh Usmani was advocating (which was confirmed in the follow-on statement from the AAOIFI Shari'ah board) was removing fixed redemption of sukuk at maturity. This was instituted initially so that it resembled conventional bonds. Forcing instead on repurchase at market prices creates more risk-sharing because sukuk holders share in the appreciation or depreciation of the underlying assets used to back sukuk.

The shortage of qualified professionals, trained in Islamic finance rather than structured finance, could reduce the future growth rate in the Islamic financial industry, according to INCIEF CEO Agil Natt. Ahlibank deputy CEO Yehia Elbatrawi believes that, although the Islamic finance industry has been relatively unscathed by the credit crisis, it is at risk from an overexposure to real estate and private equity: "some of these markets are overpriced, which increases the exposure of many Islamic banks". Shari'ah-compliant investments, although shielded from a lot of the damage have seen indexes screened for Shari'ah-compliance lose $5.6 trillion in value, according to Standard & Poors.

Islam (and other religions) bring ethics back to the financial industry...and to Bosnia. Other countries are also changing regulation to attract capital from the Middle East by encouraging Islamic finance. The U.S. is even getting involved at a governmental level. U.S. deputy secretary of the Treasury Robert M. Kimmitt is in the Middle East learning more about Islamic finance. He noted that Treasury Department officials are increasing their familiarity with the industry and although he was "not sure that Islamic banking will also be itemized in the agenda, but it is a subject that is often dwelt in the public and private sector".

Another sukuk, planned by Deyaar, has been delayed. It's CEO, Markus Giebel says, "There is very little liquidity in the market right now and to launch a sukuk would be foolish. We have to obey market conditions and so we have delayed it but not cancelled our plan for it,"

Can Islamic finance have a crisis?

Umer Chapra, an Islamic economist, recently discussed the reasons he saw for the credit crisis and the reasons that Islamic banks would not create a similar crisis. While I agree that the Shari'ah restrictions on Islamic banks would limit the scope for excessive bad lending, I don't think that on its own Shari'ah-compliant banks would be completely immune from a similar crises caused by the growth of a bubble in real estate (or any other Shari'ah-compliant asset). The additional scrutiny that Shari'ah-compliant financial products face in the Shari'ah review process can potentially reign in excessive speculation and prevent some of the worst excesses that characterized the recent crisis in conventional finance. A lecturer at Al Azhar University, Shiob-bin-Mukhtar, goes further saying that there would be no financial crises if Islamic finance was exclusively used. The head of Global Council of Islamic Banks, Saleh Kamel, announces the failure of capitalism and suggests an Islamic financial system as a replacement.

An article discusses the possible regulatory and market changes in the GCC which are likely following the credit crisis.

An investment company in the UK, cru Investment Management, is creating an asset-backed investment fund that will invest in commercial agriculture in Africa. The investment is seen as good from both an investment perspective (the fund management expect a return of between 15-20 percent) and an ethical perspective: one of the stated goals of the investment fund is to "help to create jobs and give rural Africans the chance to help themselves out of poverty".

Islamic finance in Europe is set to grow, according to speakers at a conference in Paris. It is also starting to emerge and grow in Australia.

Coud the credit crisis spillover into Islamic finance? Sukuk issuance expected to exceed 2007 total

Despite delays in many planned sukuk, Kuwait Finance House expects sukuk issuance in 2008 to top the total from 2007 even though issuance through the first three quarters fell below 2006 and 2007 totals for the same period. The rationale is that since the economy is still growing rapidly in the areas in which many sukuk are originated, the GCC and Malaysia, and non-Muslims continue to invest in sukuk. This has been the case for much of the year, but there are indications that the real estate market in the GCC region is slowing from its torrid pace in 2007 and early 2008. Also, many of the non-Muslims investing in sukuk were hedge funds looking to have exposure to another asset class and many Western funds have been faced with redemption requests from their investors, damping their future demand for sukuk. KFH expects a total issuance of sukuk to be between $40 and $45 billion in 2008 compared with $32.65 billion in 2007.

An article in a newspaper in Guernsey proposes Islamic finance as an alternative to the problems created in the recent past by (conventional) financial system excesses. Overexposure to real estate investments, though, may pose a threat to the Islamic finance industry. Some Islamic finance practitioners see the Shari'ah-compliant securitization that is the heart of the sukuk market as a guard against the excesses that led to the credit crisis. I think that, not only will it not necessarily protect the Islamic finance industry, the use of some securitization products, particularly the opaque, highly structured ones could create a crisis within the Islamic finance industry, and one with a similar economic trigger: the fall in real estate values.

Also, despite growing rapidly over the past 8 years, Islamic finance has yet to make a significant impression on the global banking industry.

Without specifying who should lead, second finance minister of Malaysia Nor Mohamed Yakop wants a standardized documentation and policies for the Islamic finance industry. Currently, there are two main standards-setting bodies, AAOIFI in the GCC and the IFSB in Malaysia.

Islamic finance and the credit crunch

Islamic financial institutions are realizing that they're exposed to the credit crisis through their investments in the GCC real estate market which has begun to slow. The primary effect now is reduced profitability, but the lack of depositor insurance could allow falling real estate prices to feed through to depositors. In a few countries like Malaysia, the government has guaranteed all deposits even those at Islamic banks for two years. Islamic banks in Europe are also expected to see growth slow due to the credit crisis, according to the CEO of the European Islamic Investment Bank.

The editorial manager of Oxford Business Group in Abu Dhabi discusses the fallout from the AAOIFI ruling on sukuk and highlights the new, innovative products that are being developed.

Depositors in the UK have several alternatives to conventional banks, one of which is Islamic banks. A BBC news article discusses some of the opportunities and risks of Islamic finance.

In the U.S., Habitat for Humanity, a Christian charity, has built and refurbished many homes for Muslims and Muslims are now becoming involved in the organization.

Indonesia may delay its dollar-denominated sukuk because of credit market conditions.

Boeing Capital Corp to encourage sukuk, sukuk issuance falls, Islamic financial institutions not immune from credit crisis

The managing director of a Shari'ah-compliant microfinance institution in Uttar Pradesh provides a short description of microfinance and the priorities for Islamic financial institutions adapting their products to incorporate microfinance.

Boeing Capital Corp, the financial services subsidiary of the airplane manufacturer, encourages the creation of more types of Islamic financial products that use airplanes as the underlying asset. The regional managing director, John Matthews, said that "aircraft are ideal for Islamic financing since a fundamental criterion is that such investments be asset based". The company wants to introduce sukuk that mimic an enhanced equipment trust certificate (EETC). The ETC is similar to an ijara sukuk where funds are raised for the purchase of an airplane from investors and the airplane is then leased-to-own to the airline. An enhanced ETC is like an ETC, but has multiple tranches of certificates.

Sukuk issuance continues to remain weak, falling below 2006 for the first three quarters this year. In the most recent quarter, there were $3.21 billion issued, compared with $11.34 billion in 2007. For the first three quarters of 2008, only $14.77 billion have been issued compared with $36 billion in 2007 and $18 billion in the same period in 2006.

Two people at Deutsche Bank, Mohamad Safri Shahul Hamid and Manar Mahmassani, say that Islamic finance is not necessarily safer, but is more ethical than conventional finance. The Islamic finance industry is not 'insulated' from conventional finance and responds to similar underlying economic realities as a conventional product. A senior economist at Bank Islam adds to this commentary that until Islamic finance has a benchmark that is distinct from an interest rate benchmark like LIBOR, "it’s a fallacy to think that movements in global interest rates will not have any implications for Islamic securities". Islamic finance institutions are not immune from the credit crisis, according to the CEO of CIMB Islamic, Badlisyah Abdul Ghani.

Islamic finance at risk from commodity price volatility

Although Islamic finance has grown rapidly over the past 8 years, it still is not widely accepted by high net worth individuals in Asia, some of whom are concerned that it does not have a long enough track record. One of the concerns is whether Islamic finance will be able to endure after oil prices fall back to lower prices. After reaching nearly $150 per barrel, they are now trading around $80 per barrel. A Forbes article describes in further detail the risks of falling real estate and commodity prices for Islamic finance. In addition to falling commodity prices, which lowers wealth growth in the GCC compounded by slowing real estate price growth, there is another hazard: commodity price volatility. The reason that commodity price volatility is harmful is that, whether you agree with it or not, there is widespread use of products like commodity murabaha. In transactions like commodity murabaha transactions to synthesize conventional loans are structured using trades in commodities (e.g. metals). Greater volatility in the prices of these metals introduces trading risk if the prices at which these metals can be bought and sold (often on the London Metal Exchange).

The second soverign sukuk planned by the Malaysian government will reset the risk-free pricing benchmark for ringgit denominated issues and facilitate price discovery of ringgit-denominated sukuk during the current market turmoil. The last Malaysian sovereign sukuk was issued over six years ago.

Japan Bank for International Cooperation (JBIC) may be forced to delay its sukuk issue because of the credit crisis.

I disagree with the comments from Sheikh Qaradawi about the 'collapse' of the western financial system and the presumption that Islamic finance provides a unique alternative that can stand on its own right out of the gate. Islamic finance provides a good model for how to expand ethical finance beyond just screening investments, but there are still several products that are warts on the Islamic finance industry like commodity murabaha and tawarruq. In these two cases, products are structured to mimic conventional interest-based loans to meet financial demands of Islamic banks and consumers where alternatives that are unique from conventional products have not yet been developed. Islamic finance should not be focused on standing alone apart from other ethically-based financial systems. Other ethical systems share similar concerns as Islamic finance about interest-based finance, funding weapons and other products which have a socially detrimental effect like alcohol and tobacco. The similarities should be praised and used as a way to promote a more just financial system not just one for Muslims.

IIFM standardized murabaha document finished; sukuk market an alternative to the conventional?

The International Islamic Financial Market (IIFM) announced that it had finished the creation of a standardized agreement, the Master Agreement for Treasury Placement (MATP). The standardized document is primarily used for Shari'ah-compliant deposit products using commodity murabaha. The commodity murabaha product is a somewhat controversial way to replicate a short term loan and is used to address Islamic banks' liquidity management challenge. The move towards standardized documents for common products like murabaha will provide a way to maximize the value of Shari'ah scholars' scarce time by allowing them more time to review innovative or controversial new products.

The secretary general of ASEAN says that companies finding difficulty tapping the conventional credit markets have been turning to sukuk, although issuance is down sharply this year. An article describing why Islamic finance does not allow short selling morphs into a reminder about performance of Islamic banks.

Malaysia's central bank governor says that the reliance on profit-and-loss sharing agreements has insulated Islamic finance from the credit crisis. Because most products are not profit-and-loss sharing in form, it seems to me that the insulation of Islamic finance is provided mostly by continuing strong economic growth in the areas with the most Islamic finance, the GCC and Malaysia.

Islamic funds continue to receive good publicity in the U.K. Islamic finance and banking continues to lag in Egypt while booming in Bangladesh and encouraged in Japan through changes in the regulatory environment. Indonesia continues ahead towards issuing a dollar-denominated sukuk.

Credit crisis delays some sukuk, not others; Tamweel-Amlak in merger talks

GCC-based companies are divided on whether the credit crisis will impact the financing of their planned projects. Tamweel reaffirmed plans to launch a sukuk in 2009 despite the credit crisis while Kuwaiti-based Abyaar Real Estate is delaying a planned $1 billion sukuk. An Abyaar Vice President gave the following explanation: "We have postponed the bonds until a better time. No way any company can issue sukuk now. There is no cash."

Tamweel and Amlak, two government controlled real estate companies in Dubai, are in merger talks. Research analysts are not convinced that the combination makes sense because it does nothing to alleviate their need for large amounts of funding and could provide a distraction to the management away from continuing growth. The companies' press release was a little more upbeat concerning the possibilities for growth created by a possible merger.

Sukuk and future growth in Islamic finance

In an interview, deputy minister of finance Nor Mohammad Yakcop, describes the efforts taken by Malaysia's government to expand its international presence. One comment, in particular, struck me as a valuable observation that is often lost in stories about the rush of different cities like Kuala Lumpur, Singapore, Dubai and London to become centers of Islamic finance.

"Malaysia welcomes the growing acceptance and popularity of Islamic finance, together with the emergence of other Islamic financial centres such as Dubai. We believe it is not a zero sum game. In fact, the increasing number of financial centres undertaking Islamic finance, is a necessary condition to provide critical mass and sustainability for the sector."

The Islamic Bank of Britain claims that it saw an uptick in the number of non-Muslims opening accounts in the wake of the credit crisis. It would be interesting if, in addition to vague suggestions about the popularity of Islamic finance by non-Muslims, there were numbers attached to track the growth or contraction in numbers of non-Muslim clients. I think that would provide a more useful measure of how much progress is made to attracting non-Muslim to Islamic finance, an important thing for the growth of the industry particularly in countries like the U.K. with relatively small Muslim populations.

The sukuk secondary markets have about $40 billion in sukuk that are 'actively traded', according to a GCC-based asset manager. The yield difference between conventional and Shari'ah-compliant debt have fallen. Relative to US Treasuries, conventional debt with issuers sharing similar characteristics with issuers of sukuk yield 314 basis points while the yield spread for sukuk is 320 basis points.

The minister of finance in Indonesia was recently asked about the plans to issue a sovereign, dollar-denominated sukuk in the wake of a fall off in sukuk issuance:

Gulf News: An HSBC report recently reported that sukuks have witnessed a $10-billion drop in sales since early 2008 and an average price fall of 1.51 per cent. Viewed against Indonesia's impending plans to sell dollar-denominated sukuk, how do you view the appetite for Islamic bonds in the Gulf markets next year?

Sri Mulyani Indrawati: We still believe that our plan to sell sukuk is relevant and will get positive responses from Gulf markets. Our skuk will attract the demands of Gulf's investors for several reasons:

The sukuk is fully guaranteed by the government; The government has a good track record in fulfilling bond obligations; many investors are waiting the issuance of sukuk; and Indonesia is the biggest Muslim country, and the Sukuk is a tool to enhance the brotherhood between investors in Gulf countries and Indonesia.

My optimism also relies on data released by Standard and Poor's on September 9 suggesting that the Sukuk market will rise again.

In this regard, I think the liquidity in the Gulf is still abundant and requires secured investment instruments such as our sukuk.