IMF report, UAE Islamic banks, tawarruq attracts criticism, effects of the Dubai World debt agreement

The IMF released a study in August 2010 that provided an interesting analysis of what drove growth in Islamic banking from 1992 to 2006. The main finding of the study was that oil prices (which created a significant inflow of liquidity into the GCC, which is a major region for Islamic banking) had the largest effect. One interesting specification they used included both the price of oil and a dummy variable to measure the effect of 9/11 (to see whether growth was higher after 9/11, all other things being equal) and found that it did on its own, but when the effects of the oil price were included, the impact of 9/11 became insignificant. This suggests that the rise in oil prices in the 2000s was much more impactful on the growth of Islamic banking than 9/11. The argument for the impact of 9/11 was that following the attacks, many funds that were invested in the West were repatriated to (mostly) the GCC.

The head of Shari'ah at the Islamic Development Bank, Sheikh Mohammed Mukhtar Al Salami, says that tawarruq is 'usury' and therefore is 'haram'. His argument is that the transaction is "being carried out by Islamic banks as mere concealed usury operations as they are done not only at one place but at two place", reiterating an argument made by the Fiqh Council of the OIC. The OIC Fiqh Council's argument differentiated between classical tawarruq and organized tawarruq. In a tawarruq transaction a bank sells a metal of a client with deferred repayment (cost-plus-profit) and then the client sells the metal to get cash. In an organized tawarruq (also called reverse murabaha), the bank facilitates the sale of the the metal in the spot market (although the metal brokers used on each side of the transaction are different). Tawarruq is a commonly used product by Islamic financial institutions and greater Shari'ah risk around the product highlights the need for short-term liquidity management tools for institutions and new products for consumers, as tawarruq attracts more criticism.

Several articles describe the effect of the Dubai World debt agreement on other sukuk. Bloomberg reports that it is unlikely to lead to a 'massive' rally according to the CEO of Mashreq Capital in Dubai. Another Bloomberg article notes that the Dubai World agreement has failed to benefit Tamweel sukuk. Tamweel is a troubled Islamic mortgage company in Dubai that may be merged with Amlak Finance, another Islamic mortgage company, with assistance from the Dubai government. The Dubai World agreement could move the spotlight onto Nakheel, which has paid its trade creditors in cash and sukuk and has also repaid 2 of its 3 sukuk with assistance from the Dubai Financial Stability Fund. The Dubai World deal does raise an issue with Nakheel: the first two sukuk were repaid at par whereas Dubai World creditors accepted a writedown of principal and an extended maturity. The next key date for Nakheel is January 16, 2011 when the Nakheel Development 2 sukuk (the final one) is scheduled to mature. Will investors be forced to take a haircut or will the DFSF step in again to ensure repayment at par? It is too early to tell.

Profits in UAE-based Islamic banks fell 17% in the first half of 2010 compared with the same period in 2009. This is somewhat expected as the impacts of the financial crisis hit this region slightly later than in other parts of the world. However, despite the fall in profits, analysts believe the banks have not provisioned enough for non-performing loans, particularly in real estate in construction, the two sectors hit hardest.

Takaful continues to grow, but it is several years behind the growth in Islamic finance. Prudential BSN Takaful, a joint venture between Prudential PLC and Bank Simpanan Nasional Bhd in Malaysia, is launching three new takaful plans. An African Reinsurance company African Re, is launching a retakaful subsidiary with a wide focus on Africa, the Middle East and Asia. The Bahraini takaful compay t'azur recently announced a retakaful agreement with Hannover Re, a large conventional reinsurance company. Retakfaul is the Shari'ah-compliant version of reinsurance and has been very limited in availability. The Sri Lankan takaful firm Amana Takaful says that its operations are hampered by a lack of enough Shari'ah-compliant investments. If the takaful plan were managed like a conventional insurance pool, it would invest most of its assets into sukuk. However, the sukuk market has not been large enough to support the needs of takaful companies as well as other Islamic investors and unless there is significant growth in sukuk, takaful companies will have difficulties. They could invest in other assets: real estate, equities, commodities. However, all of these are more volatile than fixed income and it will probably not end well if a significant proportion of takaful fund assets were invested in these asset classes if there were a repeat of the financial crisis or even a less severe recession. It also makes it more difficult for the managers of the takaful funds to project its long term assets and ensure they match with expectations about its long term liabilities.

Other News

• The Javelin JETS Dow Jones Islamic International Index Fund, the first US-based Islamic ETF, will close. The company cites limited investor interest "through the marketing channels typically used by ETFs" according to Javelin's president Brint Firth.
  
• Mapletree Industrial Trust, a Shari'ah-compliant REIT, is raising $800 million in an IPO in Singapore.
  
• Indonesia plans to issue sukuk and global bonds in the first half of 2011. The government reduced its sukuk issuance in 2010 when deficits came in lower than expected. Several of the sukuk auctions failed during 2010 because investors demanded a higher yield than conventional bonds to account for the lower liquidity of sukuk compared to bonds.
  
• The development of Islamic banking in India is still not possible and the Indian Centre for Islamic Finance has approached the Reseve Bank of India, the central bank, and asked it to allow a few banks in Mumbai to open Islamic windows on a pilot basis before it considers any regulatory changes.