Monday, February 08, 2010

Islamic banks to adopt more equity-based financial products

Two articles describe that Islamic finance is working to incorporate more equity-based financing structures and move away from its use of tawarruq, although this change will be done very gradually. In general, this is a positive development for the Islamic finance industry because it provides a greater reliance on products which are more differentiated from conventional financial products.

However, this change, however gradual its implementation, will be disruptive to the industry even as it recovers from the impact of the credit crisis. Investors will shy away initially from products that alter the risk profile of what is offered and this will increase the cost to Islamic banks, at least until there is greater familiarity and certainty under different legal systems of the new products. It will also create some disruption for Islamic banks who will have to adjust their risk management and reset the way they determine the cost for borrowers to remain profitable.

One aspect of any shift away from debt-based products and towards equity-based products that will be especially difficult will be that it adds to the difficulty of Islamic banks' business in addition to their already challenging liquidity management challenges. In some cases, the different risk profile of the banks' assets will create some additional risk that the bank will run into difficulty and this will be a challenge for regulators.

This regulatory challenge could make it difficult for Islamic banks to be regulated under identical rules as conventional banks if the risks facing Islamic banks change. In most countries, there is only one regulator of banks and this covers both Islamic and conventional banks. A rapid change in the way Islamic banks operate, especially if the change is codified by standards setting bodies like AAOIFI, could have a perverse effect of slowing the growth of Islamic banking in many countries.

Despite these concerns, it is heartening to see the industry publicly signal that it recognizing the need to differentiate itself from conventional banking. It would be useful if research organizations and standard-setting bodies would provide a more thorough look at the impact of any change towards more equity-based products on the Islamic finance industry.

Other News

  • Dubai World is still working on a restructuring plan and is expected to sell assets and no plan will be done until at least the end of February. The creditors committee is made up of seven banks and if one declares Dubai World in default, it would tip the company into bankruptcy and turn the process over to the tribunal established at the DIFC.
  • An article describes the cooperative Islamic microfinance being offered in Kandahar by the Islamic Investment and Finance Cooperative.
  • Dar Al-Arkan is expected to issue its sukuk for between $500 and $750 million at the end of the week and it is expected to be priced to yield 10.5%-11%. One anonymous banker commenting on the roadshow described that "they have been struggling. They still haven't closed anything and they have been on the road for a long time now".
  • Southeast Asia will be the region that will lead the sukuk market in coming years according to the leading arranger CIMB Group.
  • Indonesia issued a 3-year sukuk for $856.3 million yielding 8.7% with significant uptake from retail investors. The issue was significantly oversubscribed and was more than double the target amount of 3 trillion rupiah ($318 million). Indonesia is also planning on issuing yen-denominated samurai bonds early in the second half of 2010.
  • Ireland's new law, which is described in greater detail here, comes alongside a growth in the number of Islamic finance funds registered there.
  • Saudi bank NCB Capital is launching a new Shari'ah-compliant fund focusing on sukuk and murabaha.
  • Islamic mortgage company Tamweel reported a profit in the fourth quarter of 2009 while reporting a loss for the full year. The company is expected to be merged with Amlak Finance in the first quarter.
  • Leader Universal Holdings, a power transmission company in Malaysia, received a 13-year, $65 million in istisna'a financing for one of its projects.
  • First Finance's board of directors approved its acquisition by Barwa Bank.

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