Absence of Saudi Arabia, Bahrain deprives IILM of key markets but peripheral Islamic markets should benefit

The absence of Bahrain and Saudi Arabia from the IILM deprive the institution of entry to key markets for Islamic finance, and may have cost the institution its top rating. While the reason for Saudi Arabia’s withdrawal, it could be due to concern over the possible use of IILM sukuk in Islamic repo transactions, or fears that the IILM sukuk program might curtail commodity murabaha participants profits. Even Qatar, which is more involved in the IILM as a result is showing signs it may not be confident in the IILM’s ability to succeed where others have failed by announcing its own plans for regular sovereign sukuk issuance.

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UK government faces uphill struggle to be Islamic finance hub

The UK government established an Islamic Finance Task Force to try again to find its place as an “Islamic finance hub” which it never fully attained before the financial crisis.  The government’s decision not to pursue a sovereign sukuk as recently as 2011 set London back in its ambition to challenge financial centers in the Middle East and Southeast Asia for preeminence.  The stated reason for not issuing the sovereign sukuk was that it did not ‘provide value for money’, which if true strictly on the basis of cost  could turn out to be a shortsighted mistake.  

The London Stock Exchange remains a formidable challenger for any exchange seeking sukuk listings, but the rest of the UK Islamic finance industry is underwhelming at best.  The opportunity cost from not issuing a sovereign sukuk after so many years of market expectation could be a significant headwind that an Islamic Finance Task Force will struggle to overcome.  If the UK hopes to attract capital through sukuk as a result of the task force—something it has struggled with to date—it will need to build credibility that the UK government is not just opportunistically looking to Islamic finance and that may be the hardest thing to do with the shelving of the sovereign sukuk.

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Is Islamic bank consolidation picking up the pace?

Gulf Finance House, the troubled private equity company, is considering merging Khaleeji Commercial Bank (of which it owns 47%) with another bank to create a larger banking entity.  The development follows the three-way merger between Capivest, Elaf Bank and Capital Management House, where the combined entity has total assets of around $400 million.  Those banks were Islamic wholesale banks, while Khaleeji Commercial Bank (KHCB) is an Islamic retail bank

There has been a lot of chatter over the years on the need for consolidation in some of the GCC markets (particularly Bahrain and the UAE), but very little has been done in terms of actual M&A (something which expected to be spurred on by a merger between Al Salam Bank and Bahrain Islamic Bank, which ended up falling apart due to disagreements on the relative valuations of the two banks in the combined entity). Reuters' article on the possible KHCB merger cited a reluctance by "main shareholders, often powerful local familes [being] reluctant to cede control [and demanding] exaggerated valuations".

It is worth noting that there is some empirical research on the optimum bank size and one article by Abdullah Al-Obaidan (pdf) concluded that "small banks [under $1 billion in total assets] are 35% as technically efficient as large bank [,] 50% as scale efficient as large banks [and] 18% as economically efficient as large banks".  The empirical results "indicate that an efficient optimal bank size in the Gulf region has total assets, on average greater than US$5 billion". 

The study was focused on conventional banks within the GCC but the conclusion are likely to be applicable to Islamic banks as well since, for the most part, Islamic banks operate with changes to the product structures, but few differences in the overall operational structure as conventional banks.  There are few Islamic banks that reach $5 billion in total assets, but a bank does not need to reach $5 billion in assets to become more efficient.  The economies of scale for banks underneath this level means that a bank with BD 459 million ($1.2 billion), which is the total for KHCB (pdf) as of September 30 will, ceteris paribus, be less efficient than a bank with BD 918 million ($2.4 billion) in assets.

Consolidation may be difficult, as the scant history of completed Islamic finance M&A indicates, but with Islamic banks already trying to grow in markets where they face competition from larger domestic conventional banks and the Islamic banking windows of global banks, every bit can help the industry grow and become more competitive. 

Bahrain should focus on developing its financial sector with a focus on quality, not quantity

The Central Bank of Bahrain is working on a new directive to try to attract more debt and equity market activity to the country, including Islamic finance.  However, it is hard to tell whether the directive will provide both a reason for issuers to return, and whether it is in the economy's best interest to see the financial sector continue to expand, or if the efforts should (and will) be focused on quality rather than quantity.

Bahrain is not ideally suited to grow its financial sector just in its size, and not just because of the political unrest in the country, because it already has a financial sector much larger than the entire economy.  As of the end of September, the banking assets in the country were $201 billion (down from $222 billion in 2010), compared to total GDP of $23 billion.

That's nearly 1000% of GDP (compared with an analogous small country with a large financial sector, Ireland before the crisis, whose debt spiraled to crisis proportions as a result of the government's bailout of the financial sector, was 872%.  Even the much larger UK economy, where the financial sector's total assets reached 500% of GDP before the financial crisis, the government struggled when government support was required for the Royal Bank of Scotland.  . 

This is not to say that a central bank directive could not make the existing financial sector better run, and that may be some of the reason (it is said to include licensing procedures, and will come on the heels of a directive to strengthen risk management standards and recently issued rules on Islamic banks' disclosures about fees and profit rates).  But, for Bahrain, there shouldn't be a focus on quantity since the financial sector is already large compared to the size of GDP (though still lower than the 2460% of Luxembourg).

Perhaps that will lead to more focus on Islamic finance since the government already has regular issues of short-term sukuk for banks' liquidity management, and can perhaps benefit from growth across the causeway in Saudi Arabia.  However, one area that is significantly lacking is in attracting sukuk issuers to Bahrain Bourse, where only 1 corporate sukuk is listed (the defaulted Investment Dar sukuk) along with the IFC sukuk and a few government and central bank sukuk.  We'll see how things develop, but hopefully it will be an emphasis on developing particular areas (like Islamic finance) and not just trying to increase quantity over quality. 

Bahrain changing its deposit insurance fund

The Central Bank of Bahrain held its first meeting to revise its deposit insurance for both conventional and Shari'ah-compliant financial institutions.  Bahrain has had a deposit insurance program in place since 1994, but it was a post-paid system (if a bank failed, the funds needed to repay depositors for their insured deposits would be collected ex post).  In a speech at the BIS in November 2008, Central Bank of Bahrain governor Rasheed Al Maraj acknowledged that "one of the lessons of the recent financial crisis is that it is important that depositors should be compensated promptly after their bank fails".  As a result, the CBB planned a new deposit insurance program:

Reflecting the lessons of the financial crisis, and also the recent development of international best practice standards on deposit insurance, the Central Bank is in the process of finalizing a new regulation on reform of the existing deposit protection arrangements. The purpose of this reform will be to establish a pre-funded scheme. This will be a scheme in which a fund of money is accumulated in advance of the scheme needing to make any payouts to depositors. The fund will be accumulated by regular contributions from the banks that are members of the scheme.

While it has taken a while from when Al Maraj acknowledged the need for a new deposit insurance fund (including coverage for Islamic bank deposits), it is good to see the wheels beginning to turn.  I wrote about Islamic deposit insurance--including the post-funded version used in Bahrain several months ago.

One additional point that is not directly connected to deposit insurance, but is also important to recognize from Al Maraj's speech at the BIS.  He was not naive about the spillover of the financial and subprime crisis to the GCC:

Even in the GCC the crisis has begun to have an impact. Although the GCC countries enjoy strong fundamentals, this has not shielded them from the crisis. Several have experienced significant stock market corrections. Some GCC members have needed to provide support to their banking sectors, either in the form of recapitalization funds, or by providing blanket guarantees of deposits, or by a combination of both. There is plenty of anecdotal evidence that investment projects are being delayed or scaled back.

There was some acknowledgement at the time that Islamic finance and the economies where it is most prevalent (the GCC and Malaysia) were not going to escape the credit crisis, there remained an ostrich-like obstinacy among many commentators who believed that Islamic finance could emerge from the financial crisis unscathed (it was able to weather the crisis fairly well, but was still significantly impacted).  And Governor Maraj acknowledged that likelihood, without distinguishing between conventional and Islamic banks.  So, kudos to him. 

Arcapita's district cooling investment in jeopardy

Arcapita, the Bahrain-based Islamic investment bank currently in Chapter 11 bankrupcty, filed a motion (pdf) that would allow a $1.9 million murabaha financing, with a profit rate of 15%, into District Cooling.  District Cooling is a joint venture with Dalkia Utilities Company that provides district cooling and other services to three developments in Bahrain and Abu Dhabi. 

The financing would be bridge financing while Arcapita and District Cooling renegotiate a concession agreement with Abu Dhabi’s Tourism Development & Investment Company (TDIC) to reduce capital needs by lowering the number of cooling plants at Saadiyat Island from three to two, as well as to pay for diesel fuel and rent for the temporary plants currently in operation on Saadiyat Island, as well as to continue construction required under the concession agreement. 

Arcapita stated in a filing with the Bankruptcy Court that it believes it is in the “ordinary course of business” to fund District Cooling and that it can do so without Court approval, but in response to objections from creditors it is asking for court approval to “support candor” in its disclosure of the transfer of capital to entities not included in the bankruptcy process.

Without the additional bridge financing, Arcapita believes it could lose its entire investment in District Cooling, a minority interest they estimate is valued at $20 million, which includes a guarantee made by Arcapita of a $10 million performance bond from Standard Chartered Bank, Arcapita’s secured creditor. 

Arcapita foresees a “public relations nightmare” that could inhibit its ability to conclude a reorganization plan if it is not allowed to support District Cooling.  It estimates that absent additional funding, Paragon ABD Cooling, the entity providing cooling and other services to Saadiyat Island, will run out of money in late September. 

District Cooling is currently negotiating with Dalkia and TDIC to modify the concession agreement, as well as negotiating with third-party and present investors and Dalkia to provide an exit for ABD that would preserve the value other two subsidiaries of District Cooling, one of which is currently operating at the Bahrain Bay development and another at Al Areen, both in Bahrain.  Arcapita has requested a court hearing on the motion to allow for the murabaha, but the date has not yet been scheduled.

Islamic mega-bank redux

I am a bit tired of writing blog posts about an Islamic mega-bank because it has been so many years of talk with very little to show for it (I called it an 'elusive dream' in my annual predictions at the beginning of 2011).  Back in 2007, I presented a quote from an article where Sheikh Nizam Yaquby said that an Islamic mega-bank was needed because there was "no collective efforts are seen at the institutional or regulatory levels to formulate a strategy on developing liquidity management tools.  Well, we are still waiting for the IILM to issue the first global liquidity management sukuk it has planned later this year, and there are others out there, including Islamic repo in the UAE, which are attracting limited interest so far.  However, this collective effort seems to be the most likely to succeed so far and I have questions about whether another effort would do as well as one backed by a number of central banks. 

Even as late as last summer, there were questions about where an Islamic mega-bank would be headquartered.  The most likely location is Bahrain because that is where the headquarters of the Albaraka Banking Group reside.  Albaraka is headed by Adnan Yousif, who has been the most public face behind the Islamic mega-bank.  However, the civil unrest in that country continues and it is unclear whether it is the suitable location for what is supposed to be a global bank that would represent in some ways the Islamic finance industry.  There has also been a notable decline in talk of the mega-bank becoming an Islamic Goldman Sachs after that august investment bank ran into a PR buzzsaw, and its sukuk attracted significant controversy.  There was even a name for the Islamic Goldman Sachs, Istikhlaf which the Economist noted was "Arabic for “doing God’s work”.

The size of the Islamic mega-bank has also been adjusted over time as expectations for its founding have moderated.   As late as last summer, the bank was expected to start with $10 billion in capital, with plans to raise this to $100 billion in the first 10 years.  Recently, this has been paired back to $1 billion, with $600 million coming from Arab Islamic banks and the remaining $400 million being publicly raised. 

If the bank were successfully incorporated and raised a large amount of capital, how would it fare?  Would it be able to contribute to the Islamic finance industry in a way that other large banks like Al Rajhi Bank cannot?  Would it be able to compete effectively with global financial institutions that have Islamic windows or engage in Islamic investment banking?  Most importantly, if you have a $100 billion or larger Islamic bank with the Islamic finance industry where it is today (with at most $1.1 trillion in assets), does that institution not represent a systemic risk to the industry (something I pondered last August when the idea generated some media buzz? 

I hope to avoid the idea of an Islamic mega-bank until one is actually launched (and to be a mega-bank worthy of my attention, it would have to have a serious likelihood of substantially exceeding the roughly $50 billion in assets of Al Rajhi Bank).

Islamic finance complexity (Part IIc)

Wakala and murabaha deposits

Reading through the previous posts, I realized that I focused on only two of the four types of Islamic deposit products (qard and mudarba).  The other two--wakala and murabaha--should also receive a quick discussion. The wakala deposit product is very similar to the mudaraba, except that the profit accruing to the bank is determined differently.  In mudaraba, the bank receives a share of profit as mudarib, while in a wakala, the bank charges a fee for serving as the wakil (agent).  In both cases, the losses are supposed to be borne exclusively by the provider of funds (rabb ul-maal under mudaraba and muwakkil under wakala) but in most Islamic banks, there are reserve funds to preserve depositors principal to remain competitive with conventional banks and also to limit the likelihood of a run on the bank.

The other product, murabaha, is a more recent development and is often a commodity murabaha.  On the one hand, a murabaha is a useful product because it is not ambiguous like a mudaraba or wakala, in that the deposit is directly exposed only to the credit risk of being a creditor of the bank, rather than existing in a middle ground of being exposed to the risk of the investments made by the bank, but in practice, relying on the bank prudently creating a reserve fund to protect depositors funds.  On the other hand, the use of murabaha in deposit accounts further entrenches the product which is seen by many as less than desirable because it further enforces the idea that Islamic banks develop products that replicate conventional bank products.

Islamic Deposit Insurance

However, the main issue I have not yet addressed is Islamic deposit insurance.  The idea of deposit insurance is at first glance anathema to an Islamic banking system that is based (at least in rhetoric) on profit-and-loss sharing.  There are benefits to making rewards related to the risks, but in a bank, putting risks on depositors shoulders when those banks are competing with conventional banks is likely to hurt their competitiveness when there are no protections to depositors like deposit insurance (or to a lesser degree reserve accounts).

Depositors are generally focused on safety of their deposits and immediate access to their funds on demand, with returns (to keep pace with inflation) being secondary for most depositors with current (demand) deposit accounts.  Time depositors sacrifice immediate access to their deposits for some return to offset inflation, but  generally are not focused on high returns, especially if those returns put their principal at risk.  For both demand and time depositors, the safety of their principal is important and without some form of Islamic deposit insurance, a proportion of these depositors would move to conventional banks that can offer deposit insurance.

Without deposit insurance, the security of depositors' money is reliant on their faith in the solvency of the bank and its ability to properly accumulate enough reserves to offset the losses of funds that are invested on behalf of the depositors.  However, the confidence in the bank and its reserve accounts are likely to be highly correlated with depositors' faith in the solvency of the bank and if one is put at risk, there is a possibility for a bank run to start, which will turn doubts of confidence into a self-fulfilling prophecy (in some, but not all, cases).  Thus the need for deposit insurance.

There is limited experience with Islamic deposit insurance.  Most of the Islamic deposit insurance programs (detailed in a survey by the International Association of Deposit Insurer's (IADI) Islamic Deposit Insurance Group (IDIG) conducted in 2009) are either part of a conventional deposit insurance program entirely or are done with small changes to be Shari'ah-compliant.  The only fully Islamic deposit insurance program is Sudan because the banking system is (or was at the time) fully Islamic.

Two deposit insurance programs which I looked at were Bahrain's (run by the Central Bank of Bahrain) and Malaysia's (run by the country's deposit insurance agency PIDM).  The deposit insurance systems are different.  Bahrain's covers deposits, not including mudaraba deposits or other deposits not involving safekeeping or custodianship where the depositor would be entitled to share in profits and losses.  It is post-funded (i.e. deposit insurance assessments are only collected from banks when there is a failure) so there are no issues with how the deposit insurance premiums are invested (although the CBB website does indicate that a new deposit insurance program is under construction that would shift it to being pre-funded raising the issue of investing the premiums collected by the Central Bank).

PIDM, in contrast, does both collect premiums (it is pre-funded) and does cover mudaraba depositors in addition to deposit contracts based on custodianship or safekeeping (e.g. wadiah).  The deposit assessments are calculated in a similar way to conventional banks, but the premiums are held in a separate fund from those collected from conventional banks and are invested only in Shari'ah-compliant government investments (e.g. bonds, notes, bills issued by the Government or Bank Negara Malaysia, the central bank).

Since PIDM's deposit insurance program does cover mudaraba, it would be natural to assume that it limits the profit-and-loss nature of mudaraba deposits, but the deposit insurance program does not cover regular losses that would accrue to mudaraba depositors.  It only comes into play when a bank that is a member of the deposit insurance fund fails.  In order to not place return-generating accounts above those that do not generate a return for depositors, the wadiah and qard depositors are placed ahead of mudaraba depositors in the seniority of creditors of a failed bank.

The deposit insurance issue should be more aggressively developed now that the Islamic finance industry has the experience of surviving a global financial crisis.  It is probably luck more than just about anything that there were no bank runs on Islamic banks during the crisis, and in part also due to the ad hoc interventions by governments.  A deposit insurance program (operating under kafala bil ujr, a guarantee provided for a fee, like Malaysia's) is essential if Islamic banks want to compete with conventional banks while also avoiding being covered by conventional deposit insurance programs (which may lessen perception of their Shari'ah-compliance).

As the Malaysian program shows, deposit insurance programs do not offset any profit-and-loss sharing of mudaraba deposit accounts, except if the bank fails.  This is probably prudent because while depositors are likely willing to risk small fluctuations of their deposits in rare occasions (where the reserve accounts are not large enough), they are unlikely to accept the total loss of their deposits, and will move to conventional banks if that possibility is shown to be real by the failure of an Islamic bank somewhere in the world.

The existence of Shari'ah-compliant deposit insurance (deposit takaful?) will, I think, increase, rather than decrease, the profit-sharing nature of Islamic banks by taking the 'tail risk' away from mudaraba depositors. They will still have to have faith in the bank adequately maintaining a reserve account (something that the bank regulators should focus on), but it will make the returns generated from a mudaraba account seem worthwhile, even if small, because the unlikely event that they suffer a large loss has been removed.  For proponents of a profit-and-loss sharing bank system, this should be a priority, especially before murabaha deposits become the norm rather than qard, wakala or mudaraba that prevail today.

See the index of other posts: http://investhalal.blogspot.com/2011/11/islamic-finance-complexity.html

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. 

Int'l Islamic Liquidity Management Corp to issue $200 to $300 million product this year

Bernama released an article based on an interview with CEO Mahmoud AbuShamma of the International Islamic Liquidity Management Corporation (IILM), which was established in October 2010 (and launched at the beginning of 2011). The IILM was established to provide short-term sukuk to global Islamic financial institutions for use in their liquidity management. Currently most Islamic financial institutions hold excesses of cash and use inter-bank murabaha (mostly) to manage their liquidity needs. Some countries (e.g. Malaysia, Bahrain and the UAE) have set up their own local currency denominated short-term instruments and all have seen strong uptake. However, there has not been any short-term sukuk issued by any institutions that are denominated in the global reserve currencies like the US dollar and are backed by supranational institutions.

The IILM has been quite mum about its own product and it remains largely unspoken now, but there were a few new pieces included in the article. The IILM now is hoping ("if all the systems have been put in place and the infrastructure is ready and the market conditions are suitable for the issuance"--a lot of 'ifs') to issue the first short-term sukuk denominated in US dollars for $200-$300 million by year end 2011. After the inaugural issuance, further sukuk will be issued "when needed by the market" and the IILM will consider issuance in other (local) currencies "depending on the requirements of the market" according to Bernama. The local currencies would presumably be those currencies that are used in the countries whose central banks are members of the IILM: Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey and the UAE.

While I describe the issuance as a "sukuk", the term is not used once in the entire article, instead describing it as "short-term liquidity products", which could mean the instruments will not be a tradable sukuk, but will instead be structured along the lines of other short-term products; Bahrain issues sukuk al-salam and sukuk al-ijara while the UAE Central Bank uses a commodity murabaha (as well as offering Islamic repo transactions using a commodity murabaha collateralized by the Islamic CDs that are themselves based on commodity murabaha).

There is still much work to be done and no certainty of issuance in 2011 given the careful hedging of the launch date by the IILM CEO (see the list of 'ifs' above). However, it is a step forward for the industry that this institution has come to form so quickly from its establishment (how long has an Islamic 'mega bank' been just over the horizon?) and the fact that the original idea for an institution similar to the IILM was "mooted by the Islamic Financial Services Board High Level Task Force" in the fall of 2008.

Differences in sukuk markets within the GCC

As I mentioned in an earlier post, the sukuk market is not a unified market. It is made up of many different markets, each with their own characteristics. In that earlier post, I broke down the sukuk market into 4 separate regional markets for sukuk: GCC, South Asia, Malaysia and primarily non-Muslim countries. However, even within these regions there are stark differences in the factors which impact the sukuk market health and today I saw four different article that demonstrate the differences within half of the GCC countries: Qatar, Bahrain and the UAE.

In the UAE, the sukuk markets could be on the verge of coming back strongly with what is reported to be a heavily oversubscribed $400 million sukuk issued by Sharjah Islamic Bank. The sukuk, which is in the mid-range in terms of size from the expectation is rated BBB+ by S&P and Fitch, at the bottom end of the investment grade rating category. The order book is reported to have attracted $5 for every $1 in sukuk being issued ($2 billion reported order book). Given the overwhelming dominance of sovereign sukuk issuance in the years since the markets froze up, it is a positive development to see corporate issuers, particularly one with a low-investment-grade rating to see strong reception for its sukuk. In part, this could be due to the UAE being viewed as a safe haven having not seen the protests that spread across much of the region, including the financial hub of Bahrain.

In Bahrain, the government's harsh crackdown on protests and assistance from Saudi troops stationed in the country has restored some level of calm in the markets with the yield on the sovereign sukuk from the Central Bank of Bahrain at its lowest yields since the protests began in mid-February. However, there remains a lot of uncertainty about whether the grievances which led to the protests will be dealt with or whether the calm is just a lull created by the government crackdown on protesters. For example, the US government lifted its 'voluntary departure' status for US embassy staff also noted that "potential for spontaneous civil and political unrest continues" and "Clearly, fears have subsided to an extent but given current spreads and CDS levels the market is telling you things are not back to normal" according to a director, Akber Khan, of Al Rayan Investments as quoted by Bloomberg from Qatar. Bahrain, which had become a large hub for finance--including Islamic finance--in the region has lost its status as a stable country, at least for the time being. Still, it will remain at the center of a good deal of Islamic finance in the region due to its accommodative central bank and the presence of international organizations like the International Islamic Financial Market (IIFM) and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). However, the reputation for stability has not (and probably cannot entirely) return to the pre-protest levels, which will impact future sukuk issuance coming out of Bahrain.

Qatar is much closer to the UAE in terms of having seen continued stability but having some 'baggage' like the UAE does with Dubai World (although not nearly to the same impact). Its central bank surprised bankers in the country by requiring conventional banks to shut their Islamic 'windows' by the end of 2011 and thus handing that market over to banks that are fully Shari'ah-compliant. The conventional banks being forced to abandon their Islamic windows have asked the central bank to allow them to hold their Islamic assets through to maturity instead of being forced to divest them entirely by the end of 2011. Qatar Islamic Bank, one of the country's Islamic banks, is reported by Gulf Times to be planning a five-year sukuk in the third quarter. This is not surprising given the boost that Qatari Islamic banks are expected to receive by having the competition in the country dramatically reduced by the central bank's order, although there could end up being a way for the conventional banks to continue to compete in the Islamic banking by launching separately licensed Islamic subsidiaries that are regulated alongside the wholly Islamic banks and separately from the conventional parent banks. However, there remains a lot of uncertainty about what the central bank will (and will not) allow.

Just as there is significant differences between the markets for sukuk--and other areas of Islamic finance--between the regions in which it is growing, there is significant heterogeneity within the regions based on the different political, regulatory and financial climates for Islamic banks and for issuers of sukuk. The protests which spread across the region and the Qatari Central Bank order relating to Islamic windows both demonstrated the uncertainty of anticipating future developments, there is likely to be continued activity in the primary market for sukuk in the UAE as well as among Islamic banks in Qatar (and Islamic subsidiaries of conventional banks if the central bank allows that possibility). There will also likely to be stiff competition between Qatar, the UAE and Saudi Arabia for the financial firms that decide to relocate from Bahrain.

A microcosm of the sukuk market

The sukuk market is often characterized as one marketplace with a number of companies tapping it for funding. However, in reality, the sukuk markets around the world are incredibly diverse and there are many local factors which affect issuance and many reasons for companies to decide to issue sukuk. Today, when reviewing the various news around the Islamic finance industry, several companies and government announced plans for sukuk (conditional on favorable market conditions). However, the diversity of the geographical spread and issuer type provide a microcosm of the "sukuk market".

The announcement that received the most attention was not a sukuk announcement at all, but the announcement at the IFSB summit in Luxembourg that the government there had put on hold their plans for a sukuk. In part, the reason why Luxembourg would be interested in a sukuk (although this was not ever announced formally) was to establish the Duchy as a gateway into Europe, primarily for funds, many of which are domiciled in Luxembourg as a way to enter the EU market. Luxembourg has also become more involved in the Islamic finance industry globally, being the only European country that is a member of the IFSB and the central bank governor Yves Mersch was appointed as the Deputy Chairman of the International Islamic Liquidity Management Corporation, which is working on liquidity management products for Islamic financial institutions. The official reason given for the delay was that with tax receipts improving, the government did not need the funds, but this announcement follows the indefinite postponement of a UK sovereign sukuk, which suggests that European governments may be cooling on the idea of being directly involved in the sukuk markets (as issuers).

In contrast, Qatar Islamic Bank and Sharjah Islamic Bank announced plans for sukuk in the remainder of the year. QIB said it planned on the sukuk issuance to reduce debt payments, while Sharjah Islamic Bank said the sukuk was <a href="planned to continue its growth. These two issues represent a different theme than the (perhaps temporarily) waning desire to enter the sukuk market on the part of European sovereigns. In contrast, they are more opportunistic, reflecting renewed confidence in the sukuk market in the stable countries in the GCC. Qatar has remained stable and is taking a lead in aiding the rebels in Libya in their continuing fight against Ghaddafi and has thus far avoided facing widespread protests in other Middle Eastern countries. Sharjah, one of the emirates in the UAE, has also seen stability so far and is likely benefiting from a reduction of the stigma on the UAE in the wake of the Dubai debt crisis in 2009 (which can indirectly be gauged by the fall in the yield on Dubai government sukuk and the upgrade on DP World's sukuk).

There is a new dichotomy in the GCC (in particular the smaller countries on the Persian Gulf) between those like the UAE and Qatar, which have remained stable and largely isolated from the Arab Spring, and those like Bahrain (where Saudi Arabia has sent troops) that are still facing protests. Kuwait, where sukuk issuance has picked up some is still dealing with several investment bank defaults on sukuk and so represents a third group. Despite the protest and violence in Bahrain, that country has not entirely withdrawn from the sukuk market, having recently issued a 5-year ijara sukuk in addition to the short-term ijara and salam sukuk. In addition, within the GCC region, the Islamic Development Bank remains a fairly regular issuer and is reported to be planning US Dollar sukuk (supported by its AAA credit rating).

Elsewhere, the sukuk market continues to move along its previous trajectory. Pakistan's government issued another sukuk to cover a portion of its large budget deficit and to provide an investment for the growing Islamic banking market in the country. This sukuk had the added twist of coming at a time when the government fears losing its military aid from the United States following the killing of Osama bin Laden in Abbottabad. Pakistan's government has issued sukuk fairly regularly, but has remained largely focused on its domestic market.

Malaysia, which along with Indonesia, have become countries of interest for global investors, have both been active or plan to be active in sukuk issuance. The latest sukuk from Malaysia is a corporate issuer, Ranhill, raising MYR 710 million ($236 million). The Malaysian sukuk market, in contrast to the GCC and most of the rest of the world has an active market with a much more regular issuance by corporates and government-related companies like Petronas (the government issued its last large sukuk form $1.25 billion in 2010 after close to a decade without a global sukuk). Malaysia has attracted investors because of its growing economy and strengthening Ringgit, which are somewhat exogenous to the sukuk market (Indonesia has seen inflows for similar reasons).

As this brief tour of recent sukuk announcements demonstrates, the sukuk market is largely determined by factors outside of the Islamic finance industry and is also influenced by regional factors that create divergence in terms of issuance. Just like the conventional financial markets (e.g. bond markets), the reasons why sukuk are issued has much more to do with the issuer, the country where the issuer and investors are located and historical factors around the stage of development of the country's Islamic finance industry than it does to with the growth in the global sukuk market as a whole.