The article is not yet up on its own, so no link yet, but in the most recent issue of The Islamic Globe has a good article on the new Nakheel sukuk, which was issued last Thursday to trade creditors of the troubled real estate developer. The sukuk was part of a deal which included 40% of trade creditor claims paid in cash and the remaining 60% in a tradeable sukuk with a 10% coupon.
As The Islamic Globe's Paul McNamara writes, "Almost as soon as the Sukuk were issued, they were being sold by trade creditors hungry for cash and happy to get 84 cents on the dollar in spite of the hefty 10% profit rate the Sukuk paid to holders". The article points out that using a sukuk--rather than a conventional bond--added costs, but shows "that Islamic finance is moving out of the realm of specialist niche and into the mainstream of finance". I am not entirely convinced that this is the case, although the Nakheel sukuk does add another high-yielding sukuk and is reported to be trading like one, with a yield north of 15%.
Issuing a sukuk to pay claims to trade creditors--by a company with a limited ability to pay out cash--is probably a smart move. They get the publicity from issuing a sukuk, they give trade creditors a way to get some recovery (even if it is nearly 2 years after the problems started) and provides distressed debt investors with an opportunity to bid for around $1 billion in high-yielding sukuk.
Whether the sukuk works out for investors is a different story and we have 5 years to speculate about the possible outcomes, but in the meanwhile, we can watch at least a partial success for Nakheel's trade creditors as they recover some of what they are owed by the company.
Wednesday, August 31, 2011
Monday, August 22, 2011
Central Bank of Qatar directive coming into effect as IBQ sells Islamic banking unit to Barwa Bank
The International Bank of Qatar is the first bank to sell its Islamic banking portfolio to a fully Shari'ah-compliant institution (Barwa Bank) to fulfill the requirements of the Central Bank of Qatar (CBQ). The sale of its Al Yusr retail banking portfolio and branches (along with the employees at the branches)--although not the private or corporate banking portfolios--provides hints that the CBQ will not ease up on its requirements for conventional banks to dispose of their Islamic portfolios.
However, still uncertain is whether IBQ believes that the it will ultimately be allowed to keep its Islamic private and corporate banking units, or whether Barwa Bank was only interested in the retail portion of the Islamic window. It is doubtful that the CBQ directive was only focused on retail banking because at issue was the potential for commingling of funds between Islamic and conventional banking segments. If that is the primary issue, then allowing private and corporate banking, but not retail banking would seem illogical.
The only reason that I can see for why the directive might (and there are no definitive signs yet that this is the case) only include retail banking is if the CBQ wanted to strengthen domestic Islamic retail bank. However, this is probably unlikely because it would allow conventional (including foreign) banks to retain the areas of banking that are probably more profitable, which does little to help the domestic Islamic banks that are expected to benefit from the directive.
As the end-of-year deadline for compliance with the CBQ directive approaches, there should be more clarity about the full scope of the directive, as well as if there is any exclusions from the requirement for conventional banks to divest their Islamic banking portfolios. At this point (as opposed to my initial assumptions), I think it is more likely that full divestment will be required, although the deadline may be extended (given the lack of announced developments so far). If there is any major change by the CBQ, it will probably be limited to allowing banks to hold onto their existing Islamic banking portfolios until they naturally decay, while prohibiting them from taking any new business.
However, still uncertain is whether IBQ believes that the it will ultimately be allowed to keep its Islamic private and corporate banking units, or whether Barwa Bank was only interested in the retail portion of the Islamic window. It is doubtful that the CBQ directive was only focused on retail banking because at issue was the potential for commingling of funds between Islamic and conventional banking segments. If that is the primary issue, then allowing private and corporate banking, but not retail banking would seem illogical.
The only reason that I can see for why the directive might (and there are no definitive signs yet that this is the case) only include retail banking is if the CBQ wanted to strengthen domestic Islamic retail bank. However, this is probably unlikely because it would allow conventional (including foreign) banks to retain the areas of banking that are probably more profitable, which does little to help the domestic Islamic banks that are expected to benefit from the directive.
As the end-of-year deadline for compliance with the CBQ directive approaches, there should be more clarity about the full scope of the directive, as well as if there is any exclusions from the requirement for conventional banks to divest their Islamic banking portfolios. At this point (as opposed to my initial assumptions), I think it is more likely that full divestment will be required, although the deadline may be extended (given the lack of announced developments so far). If there is any major change by the CBQ, it will probably be limited to allowing banks to hold onto their existing Islamic banking portfolios until they naturally decay, while prohibiting them from taking any new business.
Sunday, August 21, 2011
S&P raises some interesting questions about takaful
While Standard & Poor's has taken some heat recently with the downgrade of the US credit rating, it still does provide some interesting insights in other research, specifically in an article on takaful. S&P writes:
The importance for a ratings agency of this structural contradiction is that technically it is rating the ability of the takaful fund to cover anticipated losses or the takaful company's ability to continue operating based on its management fees for managing the takaful fund. It complicates the rating process if the two separate accounts have loans between them because it creates a hidden liability for the takaful company, should the takaful fund go into deficit.
This problem goes side by side with the characterization of the takaful fund as being owned by its members, who should have a right to the surpluses in the takaful fund. S&P writes:
In this case, even though members legally own the surplus, it would not be prudential for the surplus to be paid out each year because there is a chance of a large claim in any given year (from the marine insurance) that would leave the fund in substantial deficit, which would eventually be made up by future surpluses being used to cover the deficit and leaving nothing for several years to pay out to the members at the time. This would amount to a transfer of surpluses to current members from future members (who might not be the same). In my mind, the easiest solution would be to have different funds for different types of insurance so that one set of members could receive surplus payouts each year (if there is a surplus) and other funds could withhold surpluses to cover potential future deficits, although I suspect there are some Shari'ah issues with the takaful fund withholding surpluses from members.
S&P concludes with a sentiment that is often talked about in Islamic finance, but is often lacking in practice: defining the value proposition for Islamic finance compared to its conventional alternative.
We note that the IFSB Standard 11 requires the separate solvency monitoring of takaful funds from shareholder (operator) funds. As takaful funds are the sole responsibility of the members (contributors), we see some regulatory logic in this, although in our view this seems to ignore the role of the shareholder in its active support and management of the takaful fund, as demonstrated through the provision of qard hassan (interest free loans), solvency margin and capital employed.
In its interactive ratings of takaful companies, Standard & Poor's is of the opinion that there is real fungibility from shareholder funds (and the attaching assets) to the takaful fund if the latter is in deficit (unless demonstrated otherwise). At the early stages of a company's development, when takaful fund deficits could be likely, this standard could create an onerous set of operational constraints.The key issue that S&P is highlighting is that legally the shareholder's funds (the takaful provider's equity capital) is separate from the takaful fund, which is owned by the members and invested on their behalf to pay for claims by members. However, if the premiums paid plus gains on the investments minus claims is negative (the fund is in deficit), the shareholder's fund will extend an interest-free loan to cover claims; members will not be called upon to cover the deficit when it occurs.
The importance for a ratings agency of this structural contradiction is that technically it is rating the ability of the takaful fund to cover anticipated losses or the takaful company's ability to continue operating based on its management fees for managing the takaful fund. It complicates the rating process if the two separate accounts have loans between them because it creates a hidden liability for the takaful company, should the takaful fund go into deficit.
This problem goes side by side with the characterization of the takaful fund as being owned by its members, who should have a right to the surpluses in the takaful fund. S&P writes:
Where the risk profile of the takaful fund is homogenous, then we believe the establishment of and distribution of surpluses to members should be uncontroversial. However, as the takaful sector grows in scale, it will increasingly seek to underwrite larger risk values in more commercial sectors, for example, marine and aviation. Although use of retakaful capacity can control loss exposures from high-value covers, we question the feasibility of a single takaful fund comprising such a heterogeneous mix of risks.In a homogenous takaful pool with insured risks that occur more regularly, but have low dollar figure claims when they occur. In this case, there is less likely for the fund's gains over several years to be wiped out by one outsized event. In this case, the takaful fund can pay out surpluses annually to its members (often by reducing the premiums for the next year). However, if this small claim amount with frequent occurrence is combined with larger takaful products like marine insurance, where the insurance is less likely to be claimed each year, but the amount if it were to be claimed is substantial (likely multiple times of a regular year's surplus).
In this case, even though members legally own the surplus, it would not be prudential for the surplus to be paid out each year because there is a chance of a large claim in any given year (from the marine insurance) that would leave the fund in substantial deficit, which would eventually be made up by future surpluses being used to cover the deficit and leaving nothing for several years to pay out to the members at the time. This would amount to a transfer of surpluses to current members from future members (who might not be the same). In my mind, the easiest solution would be to have different funds for different types of insurance so that one set of members could receive surplus payouts each year (if there is a surplus) and other funds could withhold surpluses to cover potential future deficits, although I suspect there are some Shari'ah issues with the takaful fund withholding surpluses from members.
S&P concludes with a sentiment that is often talked about in Islamic finance, but is often lacking in practice: defining the value proposition for Islamic finance compared to its conventional alternative.
In our view, the successful development of the takaful sector depends on the identification and promotion of a real value proposition that is distinctive from that being offered in the conventional insurance sector.This is a challenge for the industry as a whole, but with a shorter track record for takaful, there could be fewer entrenched ideas making it easier to change the way things are done than in the banking or finance industry.
Kazakhstan Islamic finance hits speed bump
Kazakhstan's Islamic finance ambitions appear to hit a speedbump according to an article by Alastair Marsh in FT Tilt. The article reports that Al Hilal Bank, the country's only Islamic bank (owned by the government of Abu Dhabi) had its license suspended for having too little equity capital, which the Abu Dhabi government says has been fixed and was due to large losses in its first year. In addition, progress on a sovereign sukuk is slow, partly because of concerns that a sukuk would be significantly more expensive than a conventional bond.
Friday, August 05, 2011
Indonesia developing an Islamic T-bills market
Indonesia is following the lead of Malaysia and developing an Islamic government Treasury bill market, according to an article in The Business Times (Singapore). The T-bills are denominated in Rupiah and are focused on the domestic market; Reuters reports that only 5% of the outstanding Rp 62.89 trillion ($7.4 billion) are held by foreigners.
As the liquidity management issue becomes more talked about globally with initiatives like the International Islamic Liquidity Management Corporation, there should not be a shift of focus away from individual countries addressing the liquidity management needs of their country's banks. In contrast, they should continue full speed ahead for two reasons.
First, the domestic banks need to balance their need for local currency-denominated short-term T-bills or similar instruments. The IILM will eventually offer local currency issues as they are demanded (read: in countries where Islamic finance has a significant foothold). However, the IILM will focus on global currency issues in USD, EUR, JPY and perhaps GBP.
However, the more important reason is that creating reliance on one product for funding needs puts the Islamic financial system at significant risk if there are political differences that freeze up the operations of the IILM. There is also the potential for Shari'ah differences to arise, although this is less likely given the similarities in interpretation between most Shari'ah scholars on the major issues. Another potential benefit from individual countries' efforts to develop their own short-term issues is that it provides many more testing grounds for different structures that could be more efficient or viewed as "more authentic" than what is likely to be a commodity murabaha-based product.
Indonesia is continuing to support the growth of Islamic banking, largely based on the model of its neighbor Malaysia, several of whose banks have invested in Indonesia. With its large Muslim population, if Indonesia becomes a growth area for Islamic finance, it could further shift the geographical center of Islamic finance eastward.
As the liquidity management issue becomes more talked about globally with initiatives like the International Islamic Liquidity Management Corporation, there should not be a shift of focus away from individual countries addressing the liquidity management needs of their country's banks. In contrast, they should continue full speed ahead for two reasons.
First, the domestic banks need to balance their need for local currency-denominated short-term T-bills or similar instruments. The IILM will eventually offer local currency issues as they are demanded (read: in countries where Islamic finance has a significant foothold). However, the IILM will focus on global currency issues in USD, EUR, JPY and perhaps GBP.
However, the more important reason is that creating reliance on one product for funding needs puts the Islamic financial system at significant risk if there are political differences that freeze up the operations of the IILM. There is also the potential for Shari'ah differences to arise, although this is less likely given the similarities in interpretation between most Shari'ah scholars on the major issues. Another potential benefit from individual countries' efforts to develop their own short-term issues is that it provides many more testing grounds for different structures that could be more efficient or viewed as "more authentic" than what is likely to be a commodity murabaha-based product.
Indonesia is continuing to support the growth of Islamic banking, largely based on the model of its neighbor Malaysia, several of whose banks have invested in Indonesia. With its large Muslim population, if Indonesia becomes a growth area for Islamic finance, it could further shift the geographical center of Islamic finance eastward.
Thursday, August 04, 2011
Islamic mega-bank HQ still not decided
The proposed Islamic mega-bank headed by Albaraka CEO Adnan Yousef is likely to be based in Bahrain, according to reports from Reuters. The bank would have paid-in capital of $3 billion, making it far larger than any other Islamic bank, with the possible exception of a planned cross-border mega-bank that is being set up in Malaysia.
It is understandable that it takes time to organize a bank with expected capital of $3 billion, especially with the financial crisis getting in the way. However, the progress is not even noticeable if the bank has not even decided where to locate the headquarters of the bank. If it takes this long to decide that (and even that decision has not yet been made), then it may be several decades before the bank is launched. By that time, existing Islamic banks will be able to grow to mega-bank size through organic grouth and acquisitions.
With little progress in launching the bank (searching back, it has been talked about for at least as long as I have been blogging--almost 5 years!), it feels less worthwhile to write another post about the positives and negatives of Islamic mega banks. Instead, I will hold my thoughts and wait until more measurable progress is made.
It is understandable that it takes time to organize a bank with expected capital of $3 billion, especially with the financial crisis getting in the way. However, the progress is not even noticeable if the bank has not even decided where to locate the headquarters of the bank. If it takes this long to decide that (and even that decision has not yet been made), then it may be several decades before the bank is launched. By that time, existing Islamic banks will be able to grow to mega-bank size through organic grouth and acquisitions.
With little progress in launching the bank (searching back, it has been talked about for at least as long as I have been blogging--almost 5 years!), it feels less worthwhile to write another post about the positives and negatives of Islamic mega banks. Instead, I will hold my thoughts and wait until more measurable progress is made.
Monday, August 01, 2011
Commodity murabaha spreads to deposits
The Indonesian subsidiary of CIMB, CIMB Niaga, is planning on launching a commodity murabaha deposit account, according to Bernama. A commodity murabaha is a product mostly used between banks to manage liquidity where one bank buys a commodity (like palm oil) in the spot market, sells it to the counterparty with deferred repayment, and the counterparty then sells the commodity in the spot market. It is as close as you can get to a conventional interest-based loan in Islamic finance. Its use has been controversial (commodity murabaha is the same thing as tawarruq) but deemed necessary to keep the Islamic finance industry running (and I accept its use where there are no or very few suitable alternatives, like in inter-bank money markets).
However, when it is introduced as a deposit account product, it is an unequivocal statement that 1) Islamic banking is not any different from conventional banking; and, 2) Islamic banking cannot offer anything new to consumers that will fulfill the role of deposits (liquid, safe places to store money and earn a return).
On the first point, the ideal structure (at least from early theoretical models) is that Islamic banks operate as financial intermediaries between depositors and borrowers (as in conventional banks), but introduce a profit-sharing mechanism that somewhat insulates the bank from the maturity mismatch in conventional banking because depositors are theoretically required to bear loss from their deposits. They provide the bank with capital under mudaraba and the bank provides financing under mudaraba.
The mudaraba model of banking on the asset side is not common. The asset side of banks balance sheets has always been more debt-based using ijara or murabaha (including tawarruq) to create a predictable stream of income and a financial statement that bank analysts can easily identify with (and which fits into regulations designed for conventional banks). On the liability side of the balance sheet, Islamic banks have mostly left the mudaraba model intact. Depositors are typically required to accept the possibility of loss, although in practice, they are protected from losses by surplus profit or profit-equalization reserve accounts, which shift the first loss position to equity holders and also hold the profits that would accrue to depositors in excess of conventional banks' interest payments on deposits.
In addition to the reserve accounts that protect depositors, there are other forms of deposit accounts like amanah, where the bank guarantees the principal of the account but does not pay a return. There are other deposit structures like wadiah and wakala that are also used that also require the depositors to (mostly theoretically accept losses). In the UK, the Islamic Bank of Britain was allowed to give customers the option to refuse deposit insurance if a loss in their deposits would occur due to bank insolvency (as far as I know this is not allowed in the US, although consumers could theoretically refuse to withdraw any deposits held in bank accounts of failed institutions which offer Islamic banking, if the FDIC got involved).
The striking thing about the use of commodity murabaha is that it acknowledges that any model where there is a possibility of loss (mudaraba, etc.) or where there is guaranteed principal but no return (amanah) is not enough to attract depositors. Instead, the conventional deposit account with principal protection and a return on deposits has to be (re-)created.
There is one other alternative that I can think of and that this product is being used to create Islamic certificates of deposit for retail consumers where funds are locked up for a certain period of time with principal guarantee and a fixed profit. If this were the case with this product, it would make some sense, but it still amounts to the bank managing its balance sheet into a form that is familiar to conventional bankers (and consumers!).
I would imagine that this type of deposit account is used by other Islamic banks, so I don't want to single out CIMB Niaga, but the implications of bringing commodity murabaha into the equation with depositors when so many near-equivalents are possible and already in use are not positive. It adds one area of the balance sheet to the list of "things the industry does to make it as close as possible to conventional finance". As much as I support using replicated products to offer new services to consumers in Islamic banking, I try to limit my support to areas where Islamic finance has not yet found a different way to do these things. Besides equity, deposits stand alone as the area of an Islamic bank's balance sheet where other, less cynical products are available and already in use.
However, when it is introduced as a deposit account product, it is an unequivocal statement that 1) Islamic banking is not any different from conventional banking; and, 2) Islamic banking cannot offer anything new to consumers that will fulfill the role of deposits (liquid, safe places to store money and earn a return).
On the first point, the ideal structure (at least from early theoretical models) is that Islamic banks operate as financial intermediaries between depositors and borrowers (as in conventional banks), but introduce a profit-sharing mechanism that somewhat insulates the bank from the maturity mismatch in conventional banking because depositors are theoretically required to bear loss from their deposits. They provide the bank with capital under mudaraba and the bank provides financing under mudaraba.
The mudaraba model of banking on the asset side is not common. The asset side of banks balance sheets has always been more debt-based using ijara or murabaha (including tawarruq) to create a predictable stream of income and a financial statement that bank analysts can easily identify with (and which fits into regulations designed for conventional banks). On the liability side of the balance sheet, Islamic banks have mostly left the mudaraba model intact. Depositors are typically required to accept the possibility of loss, although in practice, they are protected from losses by surplus profit or profit-equalization reserve accounts, which shift the first loss position to equity holders and also hold the profits that would accrue to depositors in excess of conventional banks' interest payments on deposits.
In addition to the reserve accounts that protect depositors, there are other forms of deposit accounts like amanah, where the bank guarantees the principal of the account but does not pay a return. There are other deposit structures like wadiah and wakala that are also used that also require the depositors to (mostly theoretically accept losses). In the UK, the Islamic Bank of Britain was allowed to give customers the option to refuse deposit insurance if a loss in their deposits would occur due to bank insolvency (as far as I know this is not allowed in the US, although consumers could theoretically refuse to withdraw any deposits held in bank accounts of failed institutions which offer Islamic banking, if the FDIC got involved).
The striking thing about the use of commodity murabaha is that it acknowledges that any model where there is a possibility of loss (mudaraba, etc.) or where there is guaranteed principal but no return (amanah) is not enough to attract depositors. Instead, the conventional deposit account with principal protection and a return on deposits has to be (re-)created.
There is one other alternative that I can think of and that this product is being used to create Islamic certificates of deposit for retail consumers where funds are locked up for a certain period of time with principal guarantee and a fixed profit. If this were the case with this product, it would make some sense, but it still amounts to the bank managing its balance sheet into a form that is familiar to conventional bankers (and consumers!).
I would imagine that this type of deposit account is used by other Islamic banks, so I don't want to single out CIMB Niaga, but the implications of bringing commodity murabaha into the equation with depositors when so many near-equivalents are possible and already in use are not positive. It adds one area of the balance sheet to the list of "things the industry does to make it as close as possible to conventional finance". As much as I support using replicated products to offer new services to consumers in Islamic banking, I try to limit my support to areas where Islamic finance has not yet found a different way to do these things. Besides equity, deposits stand alone as the area of an Islamic bank's balance sheet where other, less cynical products are available and already in use.
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