Wednesday, November 18, 2009

Islamic banks v. conventional banks, Islamic finance & SRI, GE Capital sukuk

A study by two professors at Ajman University of Science and Technology found that Islamic banks outdid conventional banks. However, the study, as reported, only looked at four years of data for three Islamic and three conventional banks. Although it is useful to know that Islamic banks have outperformed conventional banks in the past four years (at least among a 6 bank sample), it is not really a useful finding for the industry as a whole.

The dangers of extrapolating using data on just a few institutions over a few years are well known, there is an additional hiccup that could reduce the value of the findings further. The sample period, 2006-2009, was one in which the conventional financial industry saw the most challenging events worldwide as global credit markets froze up and economic growth slowed. And this period was also accompanied by the impacts of these events on Islamic banks (I have long argued that they were susceptible to the financial crisis and economic downturn). However, the financial complexity of conventional banks versus Islamic banks is divergent and not just because of the requirements for Shari'ah-compliance.

Islamic banks are generally operating using primarily basic contracts like murabaha and ijara and have very little use of mudaraba and musharaka. They also have nearly no exposure to any derivatives products which have been particularly volatile. This volatility extends beyond the so-called toxic derivatives. For example, the volatility index, which is based on options on index components of the Standard & Poor's 500 Index, reached record highs in 2008 and have been elevated for much of 2008 and 2009.

Islamic banks, therefore, are involved in lower risk investments compared to their conventional competitors. They also do not have significant exposure to the products which are widely held up as the 'preferred' Islamic products with profit-and-loss sharing. I offer this criticism only to put what I am reading about the study in context of where there might be questions remaining that cannot be answered based on the current experience in Islamic banking. I also should note that I have not read the study. I would appreciate if it were emailed to me so that I could give a more complete analysis.

An article about sustainable finance which criticizes the 'value-neutral' approach to finance points to Islamic finance as potentially providing an example and starting point for a sustainable financial industry that incorporates social welfare in the financial industry. While it acknowledges the limitations of Islamic finance as it currently is practiced (particularly the focus on negative screens and an absence of positive screens), it does demonstrate the benefits of Islamic finance as one method of implementing social responsibility in finance. In a related development, Islamic investment bank First Energy Bank is investing $1 billion in a Saudi solar plant.

GE Capital is planning its first sukuk, which is expected to be a 5-year sukuk of more than $500 million.

The Atlanta-based unit of Arcapita, the Bahraini private equity group is profiled in an Atlanta business newspaper, including a description of the group's investment strategy which differs from the stereotypical idea of private equity, "Arcapita, unlike some private equity firms, doesn’t have an exit requirement for its investments. Still, 'we don’t hold anything forever'" according to Charles Ogburn, the executive director and head of corporate investment.

Other News

  • Saad Trading, Contracting & Financial Services announced that the Golden Belt 1 Sukuk Company, the issuer SPV for Saad's $650 million sukuk due in 2012, would be unable to make a periodic payment because the company's assets were frozen.
  • The Investment Dar is planning to present its $3.5 billion restructuring plan to creditors soon.
  • Gulf Finance House received a $100 million convertible murabaha facility from Deutsche Bank, which follows its $100 million convertible murabaha from Macquarie Bank. This is a part of the firm's efforts to "redesign" their business model.
  • Luxembourg would 'welcome' the establishment of an Islamic bank. The President of the Central Bank, Yves Mersch, says that "We had Islamic banking institutions in the seventies which discontinued its services and as for now there is no Islamic bank that operates in Luxembourg, but there is no prohibition to have a setup of such an institution".
  • Sarasin, the Swiss firm offering a Shari'ah-compliant wealth management offering will start with the Gulf but also include Southeast Asia next.
  • Malaysia continues to see growth in its domestic Islamic finance industry.
  • The Islamic Development Bank is going to offer financing of $1 billion to agricultural projects with the UN Food and Agriculture Organization (FAO).

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