Tuesday, April 14, 2009

Reuters Islamic finance conference raises a number of important issues

Real estate exposure at Islamic banks

The Islamic International Ratings Agency reports that Islamic banks are weathering the economic crisis better than conventional banks, but "there will be an adverse effect of real estate exposure on their balance sheets, but we don't expect it to be critical". This is a point I have been making for quite some time as some industry practitioners have claimed that the industry is 'immune' to the current economic crisis because they were prohibited from the subprime lending and derivatives trading that sparked it. The reason is not difficult to understand: Islamic banks are closer to what banks have been throughout history in that they act as intermediaries between savers and borrowers to finance business and consumption. This is their appeal outside of their Shari'ah-compliance. However, their exposure to the economic activities they finance mean that changes in the general economic environment have a significant impact on their balance sheets. In the absence of perfect diversification which even banks in huge, developed markets lack, they will be hit by changes in asset prices in the economic sectors in which they have the most exposure. In the GCC for Islamic banks, this is largely (although not exclusively) in energy and real estate because both sectors are 'tangible asset rich'. Islamic financial products as they are designed currently favor these sectors because they provide a tangible asset on which financers can seek recourse if their clients run into difficulty and are not as susceptible to adverse selection. Adverse selection, having clients more likely to default because of the structure of products, is more of a problem with profit-sharing arrangements like mudaraba and musharaka because they give away more of any upside gain (profits) but cushion against some losses. The adverse selection process arises because clients who are most likely to be successful will seek more debt-like products to keep all their gains while those that are less likely to be successful (either naturally more risky projects or less qualified businesspeople) are willing to trade some possible upside for the downside protection that a profit-and-loss sharing arrangement provides.

Another idea that I have been pressing for several months, greater transparency, is also coming onto the front burner as AAOIFI highlights the need for greater disclosures from Islamic financial firms.


The sukuk market was negatively affected by Shari'ah-compliance standard changes during the second half of 2008. Contrary what has been reported, including on this blog, the fall of sukuk issuance during 2008 was probably impacted by the new AAOIFI rules issued in February 2008. According to the CEO of Dubai Islamic Bank which owns Islamic structuring consultancy Dar al-Sharia, "we lost at least $10bn to $15bn since the onset of the crisis". Among the reasons given were that companies approached the sukuk market with a mindset that was identical to that which they approached a conventional bond issue. DIB CEO Sohail Zubairi explained that "sukuk collapsed because the starting point was conventional. If the starting point would have been correct, I'm sure we would still have been up and running". While pinning much of the blame on the issuers not understanding the difference, the freeze up in the global economy still does bear some responsibility for the fall in sukuk issuance in 2008. A Shari'ah adviser with another Shari'ah consultancy Minhaj, Amin Fateh Amer says that "about 85% of what people are dealing with in the sukuk market are not Shari'ah-compliant at all". This was the same figure mentioned by Sheikh Usmani in November 2007 that caused the controversy which led to the AAOIFI Shari'ah board which he chairs to issue further guidance in February 2008.

Other News
  • The takaful market in the GCC has a significant growth potential with estimates from Ernst & Young projecting it will rise to $7.7 billion by 2012. Other participants at the World Takaful Conference 2009 in Dubai provided estimates that it could reach $11 billion by 2015. The growth has slowed from previous estimates like one from HSBC which predicted that the global takaful market would reach $14.4 billion by 2010. European insurers are still weighing whether to enter the market to capture first mover advantage or wait for it to become better developed.
  • There are a number of quotes compiled together from the recent Islamic Business & Finance conference organized in four cities around the world simultaneously by ThomsonReuters. Reuters also has a timeline of the growth of the industry.
  • The Bahrain Financial Exchange plans on launching 10-15 contracts soon including metal-related contracts, up to one-third which will be Shari'ah-compliant.
  • The market for Islamic financial products in Nigeria could grow significantly following the passage of the "Law Governing the Operation of Islamic Banks" which was introduced in mid-March 2009.
  • The overall market decline has caused a proposed Islamic equity fund to be cancelled and put another one in doubt.
  • Islamic investment bank Unicorn is planning a $425 million sukuk by the third quarter of 2009 to fund its expansion, planned largely through expansion. The bank had planned a $1.5 billion sukuk last year that was delayed because of market conditions.
  • The head of the International Islamic Financial Market (IIFM) says that sovereign regulators need to establish more standards for Islamic banking and in particular he pointed out that "we don't have a lender of last resort". Reuters provides a factbox about the regulatory bodies currently operating to regulate the Islamic financial industry.
  • HSBC Amanah, the Islamic finance division of the banking group has scaled back its plans for its worldwide growth and will focus on its largest markets, Saudi Arabia, the United Arab Emirates and Malaysia with a secondary focus on Indonesia, Pakistan, Egypt, Turkey and the U.K.. The group has offered Islamic financial products since 1994.
  • Mashreq unit Badr al-Islami is planning an open-ended sukuk fund to capitalize on the high yields on outstanding sukuk include Aldar Properties, Dubai Electricity & Water Authority and Dar al-Arkan and perhaps also property developer Nakheel. As the sukuk market develops, foreign firms may tap the market starting in 2010.
  • National Bank of Kuwait is awaiting central bank approval to buy 40% of Boubyan Bank, an Islamic bank partly owned by The Investment Dar which has considered selling its stake in Boubyan.
  • Lloyd's plans to begin offering Islamic reinsurance (retakaful) globally beginning in 2010.

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