The Yasaar Media report, Islamic Investment Banking 2009 (available free from Yasaar Media as a PDF), provides a thorough review of the history and current state of Islamic investment banking. Below, I provide a basic summary of a few areas that I found the most interesting. It is not a comprehensive summary of the report and the areas that I highlight are very limited by what I took from them. I would strongly suggest a read through this interesting, detailed and timely report.
The premise from which the report begins is that although Islamic finance has experienced a rapid burst of growth during the past decade, not all areas of Islamic finance are experiencing the same pace of growth, particularly following the credit crisis which caused a global economic crisis. In the specific area covered by the Yasaar Media report—Islamic investment banking—there has been a significant reduction in the growth rate in 2008 and thus far into 2009. The areas in which this has been most pronounced is in private equity and sukuk issuance. One reason for this shrinkage is that on the whole, Islamic financial institutions, particularly investment banks, were too concentrated, both by industry (primarily real estate) and geographically (significant focus on the GCC region). The real estate sector in the GCC provided Islamic investment banks with a high rate of return relative to other areas and also provided an asset on which the financing could be based. This gravy train of high and stable returns ended when the global economic downturn led to the bursting of what had become a large bubble in parts of the GCC.
One of the first areas tackled by the report is the significant overlap between private equity and the Islamic concept of mudaraba. While this is familiar to one who thinks on the subject, the Yasaar Media report takes the comparison one step further in light of the financial situation of the day. In conventional private equity, there is significant reliance on high levels of debt that would not be possible in an Islamic private equity transaction. In the wake of the financial crisis, ‘deleveraging’ is the word of the day and therefore the more equity-based Islamic private equity transaction could be viewed by investors as well as the recipients of the investment as a preferable means of raising private capital.
The next area where the report focuses is probably one of the smallest parts of the Islamic financial industry—venture capital. Because the Islamic venture capital industry is not developed in any size, the report provides a broad focus on what it will take for an Islamic venture capital industry to emerge and highlights the role the Malaysian government is playing to develop the industry. In the course of describing the similarities between venture capital and Islamic principles that support profit-and-loss sharing, the Yasaar Media report raises the interesting dimension of how the profit-and-loss sharing ratio should be determined to remain Shari’ah-compliant. For a sector that has been largely overlooked, this leads one to recognize how even areas that seem quite natural for Islamic finance have more complex issues of Shari’ah-compliance that have yet to be resolved.
Mergers and acquisitions, another area covered, is on with particular relevance in the current financial environment where smaller institutions may be squeezed in ways that larger rivals are not. It has been the conventional wisdom that the UAE and other parts of the GCC are ‘over-banked’ for years. However, there are difficulties caused by several factors that may limit the actual merger and acquisition activity within the Islamic financial industry. As the report states, many of the M&A activity that is possible because of depressed valuations would be desirable from an industry-wide perspective may run into regulatory hurdles or simply the problem that the banks are not ‘for sale’.
Unlike many of the areas of Islamic investment banking that have been severely hit by the financial and economic crisis of the last year, Islamic syndicated lending has been one of the first to recover and although it is on pace to fall year-on-year, its supply has recovered quite a bit more substantially than, say, the sukuk market. As mentioned above, the counterpoint to the relatively quick recovery is the rethinking that has to occur about the desirability of using real estate as a large part of an investment bank’s investment portfolio.
The section on capital markets was one that provided thorough cover of the issues facing, in particular, sukuk following questions from Sheikh Taqi Usmani about the Shari’ah-compliance of the mudaraba and musharaka sukuk which was followed by a steep drop in issuance due to the credit crisis. These problems were complicated by the default or bankruptcies of several issuers which leaves the market for new sukuk somewhat in limbo. Although a reduction of the stress facing capital markets has led Indonesia and several GCC countries to resume sovereign issues, the supply of new corporate sukuk issues remains constricted by pricing and uncertainty about default resolution.
Following on a discussion of capital markets is a detailed overview of the situation Islamic banks face in terms of liquidity management as well as the avenues that are currently being used. More than most areas of Islamic finance, the types of liquidity management tools are incredibly varied. This reflects the rather underdeveloped state of this area of Islamic finance despite its premier importance to Islamic financial institutions. This will be a continued area of stress for Islamic bankers until there is something more uniform that is able to meet the demand in a way that is both comparable in ease to conventional inter-bank lending as well as broadly accepted as Shari’ah-compliant.
The report finishes with a summary of Islamic trade finance, a quietly important area of Islamic finance that, despite the lack of attention it receives compared to sukuk and liquidity management, provides significant value to the non-financial businesses that use it. It seems a relatively good area to conclude the report since it is the area that is most important for non-financial businesses and, unlike many areas of conventional finance, this is the ultimate raison d’etre of Islamic finance.
I have written a forthcoming report for Yasaar Media on Islamic finance in North America, which will also be available on the Yasaar Media website. To receive reports as they are released, you can email firstname.lastname@example.org with the subject line ‘Please send me your research reports immediately on publication’.