UFANA, Rusdhi Siddiqui on UK Islamic banking, inter-bank money markets, Indonesia sukuk

The Usury Free Association of North America (UFANA) held an event concurrent with the G-20 meetings in Toronto which was well covered in the local media. Investment Executive has an article. In addition, several speakers were interviewed by BNN: Shahzad Siddiqui (UFANA Executive Director), Guy David (Partner, Gowling Lafleur Henderson) and Stephen Ranzini (President & CEO, University Bank)

Rushdi Siddiqui provides what I think is the best analysis of the article that called Islamic banking in the UK a flop (although an article by Mushtak Parker in Arab News does also make some good points). I provided my analysis of the article in earlier blog posts and offered my oown suggestions in my latest newsletter (subscribe on the blog or email me at blake@sharingrisk.org). Rushdi Siddiqui, with his long and prominent experience in the Islamic finance industry, provides his usual clarity to the issue.

The need for interbank money markets for Islamic banks is put into context with a news story that almost one-third of all the UAE's central bank certificates of deposits are held by Islamic banks which cannot accept any return on the CDs because they pay interest. The central bank has been developing an Islamic CD to offer to Islamic banks. Out of the central bank's total outstanding CDs, AED20 billion (of AED68.5 billion) are held by Islamic banks. With such a substantial holding of non-interest bearing CDs, Islamic banks are missing an opportunity to generate a return on its capital, which is in part so large because they are not able to avail themselves of the liquidity facilities of the central bank because those are interest-based. The planned Islamic CDs would be based on murabaha (likely commodity murabaha) and, although an imperfect solution, would at least make an impact towards helping Islamic banks compete with conventional banks on price. In contrast to Islamic banks, the conventional banks holding CDs with the central bank earn interest (however meagre currently) on their capital. A great article in Arabian Business describes the situation, although it lists the deposits of Islamic banks at the UAE central bank at 19% (in contrast to the one-third in the previous article). It also points out the alternative to the additional capital held by many Islamic banks: hoping for the best. Instead of holding excess cash on the balance sheet, many Islamic banks may be maximizing their profitability at the expense of their stability by relying on short-term deposits to fund themselves while investing in longer-dated sukuk and other assets. Those institutions risk either a conventional run by depositors or a Lehman-style run by short-term investors who lose confidence in an institution.

A similar issue to the inter-bank money market is whether LIBOR should be replaced by an 'Islamic' metric. An article by Joseph DiVanna provides a good overview of the problem and some interesting potential solutions. However, in my opinion it is a waste of time. The Malaysian experience, where there is an Islamic and conventional yield curve determined by market forces from secondary market trading in debt instruments is largely similar. The difference in yields can be ascribed to the tax incentives provided by the Malaysian government for Islamic instruments. Pricing using LIBOR may be one more similarity to conventional finance that needs to be explained when it arises, but the cost of capital has much more to do with a specific company or market than it does with an Islamic versus conventional structure. When there are sukuk or other Islamic finance debt products that do not behave identically to debt, then the issue may need to be revisted. However, until then, there are more pressing problems like Islamic inter-bank money markets to be dealt with.

Indonesia's problems attracting investors to its sovereign sukuk continue as it rejected all bids for its latest $111 million sukuk offering. The total bids were only 474 billion rupiah compared with the target for 1 trillion rupiah in sukuk. The Reuters article that describes the failed auction correctly points out that previous failed auctions have been the result of investors demanding higher yields than for comparable maturity conventional bonds due to the lack of liquidity in the secondary market for sukuk compared to conventional debt. There is now 24.5 trillion rupiah in sukuk outstanding compared to 590 trillion rupiah in conventional bonds. The most recent failed auction may be somewhat disturbing because it failed to attract the planned issuance (although only one data point). This may suggest that investors are concerned that a viable secondary market may not develop in the sukuk where in the past investors only wanted a higher yield to offset this possibility. However, in the case of Indonesia, which has had success issuing conventional bonds, this should just serve as added impetus to develop its domestic sukuk secondary markets further, which a stronger Islamic banking sector could provide.

Other news

• Nakheel began to pay the cash portion due to trade creditors with the sukuk for the remaining balance coming later.
  
• Political concerns in Egypt, along with many fradulent companies in the 1980s that operated under the 'Islamic' label has slowed the growth in the country. Despite the headwinds, many GCC Islamic banks are eyeing Egypt as a possible growth area.
  
• Malaysia's banking system is now 19.6% Islamic with MYR303 billion ($93.6 billion) in assets.
  
• Gulf Finance House continues to work to extend the maturities of its debts after it ran into trouble following the financial crisis. The latest is a $100 million murabaha due in August.
  
• Malaysia may see a number of its cooperative banks convert to be Shari'ah-compliant.
  
• There was an article about the Northern New Jersey credit union that became the first credit union that I know of to to offer Islamic finance products.
  
• Kuwait Finance House was removed from CreditWatch Negative by S&P but with a negative outlook that reflects its "weakening asset quality" but with greater likelyhood of "extraordinary support" from the Kuwait government. A greater likelihood of government support amid weakening asset quality is not great news following the dismissal of a ratings agency that considered downgrading KFH Malaysia.
  
• Dow Jones offers its latest monthly commentary on the Dow Jones Islamic Market Indexes.
  
• The latest updated list from Bloomberg of upcoming sukuk issues.
  
• Some estimates target growth in the Islamic finance industry to $2 trillion in the next 3-5 years. By the most optimistic estimates, Islamic finance is currently nearing the $1 trillion mark.
  
• CIMB Islamic head Badlisyah Abdul Ghani says that Malaysia has developed Islamic alternatives to more products because of its' "effective product-development approval process". There has also been more government support for Islamic finance, a greater take-up by the non-Muslim population and also the benefit of a centralized Shari'ah board, which also has its own costs. CIMB recently lost its top spot as top underwriter of sukuk to HSBC, which either reflects a growing share taken by the banking giants or further globalization of Islamic finance based on HSBC's greater geographical reach.
  
• Among other things, the Islamic Development Bank expanded its capital from ID16 billion to ID18 billion. 1ID (Islamic Dinar) is equal to one Special Drawing Right (SDR) of the IMF.
  
• Reliance Capital is launching two Islamic funds in Malaysia by July and unveil other products at a later date. It is a sign of the underdevelopment of the Islamic finance market in India that the company has avoided its home market for Malaysia.
  
• Kenyan firm ApexAfrica Capital is considering expansion into Islamic investments.
  
• OSK-UOB Islamic Fund Management Bhd plans to launch equity-based ASEAN-centril Islamic financial products.
  
• Sri Lankan firm LB Finance is launching an Islamic unit.
  

Dubai World; Islamic 'lender of last resort'

News about possible options for Dubai World continue to surface in media reports and the latest is that Dubai World may seek to simply rollover its debts and lower the interest payments and repay over an eight to ten year period. The outcome for sukuk holders was not discussed specifically in the reports and I am still not sure whether the Dubai World restructuring will include specific accommodations to account for Shari'ah-compliance concerns. In my opinion, and I am not a scholar so I can't speak definitively about this, that any extension of maturity with continued lease or profit payments could be difficult because it would effectively exchange a delay in repayment for a higher level or repayment, which would probably raise some issues. However, I recall that the Nakheel sukuk incorporated defaults by extending the lease term and continuing the lease payments until repayment (analogous to what is being proposed), while retaining the lease as the source of the payments. This would probably be viewed more favorably because it would not include a delay in repayment in exchange for increasing the principal (by making periodic payments for a longer period). However, not all of the Dubai World Islamic debt is structured as ijara. One source in the FT article said that creditors could receive a share of future profits, which could be a way to extend the maturity by turning a murabaha or other facility into a mudaraba or musharaka. However, the lack of clarity on this issue in the media report suggests that there is either a minority of debt that is Shari'ah-compliant or the issue of Shari'ah-compliance is not at the forefront and is being viewed as a later issue when the general terms are agreed for something to be engineered to work around any issues. The National newspaper also offers its slightly different analysis. The Nakheel sukuk are discussed in another article as JP Morgan indicated in a note that sukuk holders could receive repayment at par.

The Union of Arab Banks says it is finalizing a way to allow Islamic banks to approach the central banks of the region for support. This is an important issue because without 'lender-of-last-resort' protection, Islamic banks are more vulnerable to runs. The lack of this support potentially can turn a liquidity crisis at Islamic banks into a solvency crisis if they are forced to unload assets at fire sale prices to meet depositors' withdrawals. This vulnerability should overshadow the more conservative lending standards in the pronouncements of Islamic banks' supposed immunity to crisis. The interbank market is important for banks to be able to have lower reliance on high levels of liquid assets that can reduce their profitability and thus the competitiveness with conventional banks. Following the launch of larger banks like Istikhlaf, which appears only to be an investment bank at the time being, there will need to be more attention paid to the systemic risk posed by larger Islamic banks. Without liquidity facilities at the central banks, investment banks and retail banks in the Islamic financial industry are extremely vulnerably. Beyond the fleeing of depositors in a 'classic' bank run, the demise of Lehman Brothers and Bear Stearns show how a run can start even without depositors if the wholesale funding partners of a bank withhold credit all at once. Both 'classic' and 'Lehman' runs should be considered in judging the urgency of establishing a 'lender of last resort' facility. When there is a new bank with $3 billion in capital expected, this could translate into $60 billion in assets (assuming a leverage ratio of 20:1). That would be a huge institution that would pose systemic risk to the Islamic financial system. It is an issue that deserves a lot of attention.

Other News

• The Dubai Financial Services Authority issued five Islamic finance handbooks for firms operating in the DIFC.
  
• Having announced last year investments in Chicago and a joint-venture with a publicly traded REIT, Kuwait Finance House is planning further expansion in the US, China and Canada. Other Islamic banks have urged China to consider Islamic banking as a way to attract capital from the Middle East.
  
• Indonesia raised 999 billion rupiah ($108.9 million) in its latest sukuk auction with a maturity range of 5 to 15 years sukuk. It had no winning bids for an 11-year sukuk auction. There have been several recent failed auctions for sukuk with investors demanding too high a yield to be accepted by the Ministry of Finance.
  
• Forbes has an article (written by Oxford Analytica) on the moves towards standardization in Islamic finance.
  
• The Islamic Development Bank will soon launch a roadshow to raise money for Istikhlaf, the 'Islamic Goldman Sachs' expected to begin operations later this year.
  
• Dar Al-Arkan redeemed a $600 million sukuk.
  
• The Jordanian government borrowed $100 million from Jordan Islamic Bank to finance a stockpile of wheat and barley.
  
• Centennial College in Toronto will offer an Islamic finance course starting in May.
  
• Has Islamic finance helped cushion Bahrain from the blow of the global recession? The finance minister thinks so.
  
• The Investment Dar continues to struggle on its restructuring and may seek protection under the country's financial stability law.
  
• Amana Takaful, a Sri Lankan takaful provider received an insurance license in the Maldives. The takaful industry continues to struggle over the lack of sufficient supply of appropriate investments, like sukuk, and a shortage of talent.
  

Islamic Development Bank wants G-20 to look at Islamic finance and inclusion in the IMF's Financial Stability Forum

The Islamic Development Bank says that the G-20 meeting in London should include a discussion on the opportunities offered by the Islamic finance industry. Ahmed Mohamed Ali also said that Islamic financial institutions should have representation within the G-20 and the Financial Stability Forum of the IMF. The article describes his comments:

"The major selling proposition of Islamic finance is its strong ethical foundation. Financial stability also requires to go back to basics under a new leadership, a special moral fiber and a character-and-integrity-based governance," he said.

However, it also entails recourse to "people values" and to "principles-oriented governance" and a strong linkage between financial services and real economic activities and transactions. It also requires a sense of responsibility and accountability. Islamic finance of course has an extra tier of compliance in the form of Shariah governance.

One of the important things discussed in the article is that the President of the IsDB remains confident about the Islamic financial industrty's resiliency but remains concerned about the effect of a slowdown in economic growth on the industry.

Bahrain based Al-Salam Bank and Bahrain Saudi Bank are planning to merge. Mergers between Islamic banks should continue through the next few years to reduce the number of Islamic banks and increase their average size. Regulators should be concerned about allowing Islamic banks to become 'too big to fail' especially without interbank lending markets and no lender of last resort. However, the risk of too big to fail is offset by the need for Islamic banks to be better diversified on the asset side of their balance sheets.
Other News

• There is an article about the Shari'ah screening process that includes a description of one of the most important developments the industry will need to make: the inclusion of positive (not just negative) screens.
  
• The sukuk market is expected to recover in 2009, although local currency sukuk will be more prevalent according to Islamic bankers like Badlishah Abdul Ghani, CEO of CIMB Islamic bank and Salman Younis of KFH Malaysia. The Islamic Development Bank is planning to issue local currency sukuk in Singapore, Indonesia, Kazakhstan and possibly Hong Kong.
  
• Bahrain's central bank is planning a $500 million sukuk to rollover a maturing $250 million sukuk as well as $250 million for a new issue.
  
• The Islamic Bank of Thailand is planning to issue its first sukuk this year.
  
• Indonesia plans to sell up to Rp 7.5 trillion ($650 million) in sukuk before June. The treasury director said that depending on changing valuations of the underlying asset could cause the issuance to change.
  
• Amana Bank Ltd will become the first Islamic bank in Sri Lanka when it opens. It recently received provisional approval from the country's central bank.
  

Legal review of Islamic financial products, private banking, Sri Lanka may consider Islamic finance

Malaysia struggles with how to accommodate Islamic finance within a non-Islamic legal system where judges are not familiar with Shari'ah requirements. In other parts of the world, Islamic financial products are structured in ways that legal systems are able to adjudicate without considering the Shari'ah-compliance of the products. This leaves little recourse for users of Islamic financial products who want to challenge the Shari'ah-compliance of products but allows the contracts to be constructed in legal systems where the outcome of challenges can be reasonably predicted from past case law.

The GCC is expected to have Islamic private banks developing in the next few years. An executive at Dubai Islamic Bank says that the Islamic finance industry should provide more alternatives catered to high net worth individuals.

Sri Lanka's government is looking at alternative sources of foreign finance and may be considering exploring Islamic finance (including Islamic microfinance) which is available in parts of the country which has a relatively small Muslim minority.

Islamic finance globalizes, receives growing attention as a 'safer' alternative to conventional finance

The governor of the Central Bank of Bahrain met with his counterpart from the Monetary Authority of Singapore, the city-state's central bank, to discuss ways that Bahrain can help Singapore develop its Islamic finance industry. Singapore is planning to issue a sukuk soon. Meanwhile, Dubai will work with Hong Kong to develop Islamic finance in China. A Shari'ah-compliant ETF will be launched in the second half of 2008 on the Taiwan stock exchange. The Financial Times discusses new efforts from policymakers in Paris to rival London as the European center of Islamic finance.

The most recent article I wrote is in the current issue of Islamic Business & Finance. The article focused on Islamic microfinance.

Islamic finance is becoming viewed as a 'safer' alternative to conventional finance in the wake of the subprime crisis. The Islamic Bank of Asia is seeing similar growth in demand for Islamic finance from both Muslims and non-Muslims because of its perceived status as 'safer'. The same idea is one of a number discussed in a Washington Post article on the growth in Islamic home finance in the United States, even as the mortgage market shrinks.

The African Development Center in Minneapolis has been providing small business loans with the city's Community Planning and Economic Development agency. The loans provided through ADC are the first in the U.S. to be provided from a public agency and also be Shari'ah-compliant. The CPED description does not provide a description of the structure of the finance that makes it Shari'ah-compliant.

An interview with the head of Praesidium Consulting covers continuing fall out from the questions over Shari'ah-compliance of sukuk.

A paper in Sri Lanka discusses the differences in treatment of Islamic finance by the country's tax authorities.

An article from Reuters highlights the continued push for 'standardization' of Islamic finance.

Toyota plans to issue its first sukuk in Malaysia.

Ijara sukuk compliance, WOCCU paper

The Shari'ah board of AAOIFI will meet January 15th to review the Shari'ah-compliance of ijara sukuk following the announcement by Sheikh Taqi Usmani, the board's Chairman, that the repurchase agreements contained in up to 85 percent of all ijara sukuk issued in the GCC region. Some criticize the way in which the announcement was made first in the media before the Shari'ah board met to discuss the issue.

The World Council of Credit Unions (WOCCU) released a paper yesterday describing the use of Shari'ah-compliant products by 2 credit unions it has established in Afghanistan. The paper highlights the advantages presented by the credit union model. One advantage that is easily grasped is the role of depositors as owners. This allows the credit union to replace deposit account interest with profits determined by the profitability of the credit union. The full report in pdf form is available on the WOCCU website under Research Monographs.

Recently launched Dubai-based Noor Islamic Bank may have plans for expansion through acquisition into the U.K. market. Of Western countries, the U.K. has one of the better developed markets for Islamic finance, much of this due to an accommodating regulatory environment which takes a 'no obstacles, no special favors' approach to Islamic finance.

Despite having a Muslim population that is less than 1/12th of the total population, Sri Lanka has adopted significant regulatory flexibility to allow Islamic finance and a company which offers ijara products in addition to other leasing products, People's Leasing Company, will issue a sukuk to raise funds.

The UAE is seeing the growth of Johara, all women branches of Dubai Islamic Bank, headed by Rana Al Hindawi. Mrs. Al Hindawi describes how "for many years it was difficult getting people to accept that we needed a separate banking service. Women have different needs when it comes to money and finance and we want to reach out to all types of women, including professionals and housewives". The branches will focus on allowing "women to be able to handle their own finances and for them to learn how to get the most out of their earnings".

Islamic finance in Sri Lanka, sukuk and sukuk trading

Riyazi Farook, a Master’s student at Middlesex University London, writes in the Sri Lanka Sunday Times (based on an article originally published in Islamic Finance News about the Islamic banking industry in the country. Although only 7 percent of the population is Muslim, the country's banking laws specifically deal with Islamic banks and a number operate in the country.

Kuwait Finance House, an Islamic finance provider in Kuwait and Malaysia, announced that it will create a subsidiary to trade sukuk. The limited liquidity of sukuk may provide one of the greatest challenges to the growth of sukuk. Only some sukuk can be traded at values different from par.

Sukuk issuance in 2007 totaled $30.8 billion, according to Bloomberg.

Thailand and Islamic microfinance in Sri Lanka

Islamic finance receiving attention in Thailand and the Islamic Bank of Thailand wants to lead the way in financing the halal food industry.

Muslim Aid and Amana Investments launched their Islamic microfinance program today in Colombo financing 10 microbusinesses with between 10,000 and 60,000 Sri Lankan Rupees (between $88 and $531).

The Institute of Halal Investing is also working on a Shari'ah-based microfinance program, which we are preparing to launch in a pilot study later this year. The website for this project is http://www.halalmicrofinance.org/

Growth of Islamic finance in Scotland & Sri Lanka, Islamic finance education standards

One of the challenges in Islamic finance is education standards across the globe (Reuters), with different training programs in Malaysia, Bahrain and the U.K.

Islamic finance is growing in Scotland (The Scotsman, U.K.).

ABC Investments, a new Islamic investment group, will expand to other areas within Sri Lanka (Lanka Business Online, Sri Lanka) besides Colombo, the only area in which it currently operates. Mohammed Razeek, the firm's managing director, explaining a new plan for funding construction of middle-class housing describes "We will not go into providing luxury apartments as a lot of companies already have done that.”

Standard Chartered Bank Malaysia Bhd, the Malaysian subsidiary of the large U.K.-based bank, wants to expand its banking assets in Malaysia (Business Times, Malaysia)with a focus on Islamic banking.

"The Securities House [of Kuwait] announced that it has incorporated a wholly-owned public limited company in the UK, which is currently applying for a license from the Financial Services Authority (FSA) to act as a deposit taking banking entity within the UK regulatory environment. The new company intends to establish itself in London as a Shariah compliant wholesale investment bank, focusing on the Islamic capital markets, Islamic treasury business and asset management." Securities House Press Release, July 18, 2007

The Toronto Star (Canada) has an article about the growth of the halal industry in Canada over the past 30 years as the Muslim population has grown from 70,000 in the 1970s to 850,000 today. The potential for Canada to be a global hub in halal products will be difficult given the attention the halal industry receives from the Malaysian government.

Sri Lanka Islamic microfinance & Opposition to UK Islamic gilts

Sri Lankan Islamic microfinance

Islamic financier Amana Investments introduced an Islamic microfinance program on a limited scale (20 entrepreneurs will be selected out of 1,000 applicants). The initial capital for the program will be Rs. 1.5 million (US$13,639). The bank will work with Muslim Aid, an aid organization with significant capacity building in Islamic microfinance, and initially offer murabaha (cost-plus asset sale) but as the program develops they plan on offering mudabara (investment with a profit-sharing agreement with the entrepreneur). The program will not limit the program by religion or ethnicity and will begin in Slave Island, a suburb of Colombo, Sri Lanka.

Plans for U.K. Islamic gilts encounter first resistance

In an editorial in the Financial Times, Andrea Minichiello Williams of the Lawyers' Christian Fellowship, an evangelical Christian organization whose self-stated mission is to "is to influence lawyers and the law for Christ" complains about the proposed U.K. Islamic government bond. She argues that issuing sukuk would hamper the ability of the British government to use the funds received and, while it would, Ms. Williams goes to great length to make the requirements made by Shari'ah scholars seem unreasonable by adding to the commonly used ethical guidelines and suggesting that sukuk funds could not be used for "animal welfare (which promotes the welfare of non-halal animals)[, the] furtherance of many individual freedoms, or in the promotion of any idealistic or political worldview other than Islam (including secular democracy)." While the complaints are unlikely to influence the government's decision on their own, they demonstrate some of the potential hurdles Islamic finance needs to overcome in the West in spreading knowledge about how Islamic finance works, the role of Shari'ah scholars and the ethical screens used to decide Shari'ah-compliance.

Other News

Dubai Islamic Bank will offer a new product to high net worth individuals incorporating the principles of Socially Responsible Investing with the ethical screens of Islamic investing. The product, a Shari'ah-compliant four-year principal protected note with a 'minimum guaranteed annual return' of 2% and a 'maximum potential annual return' of 11%, would be based on a basket of 10 stocks involved in purification, desalinization and waste management.

Another discussion of the new S&P and MSCI Shari'ah indices.

Hong Kong-based Bank of East Asia will raise its stake in Malaysian bank, Affin Bank, in part to avail itself of the Bank's participation in the thriving Malaysian Islamic banking market.

Plans for Dubai Islamic Bank to issue sukuk to fund a Jakarta monorail project have been disrupted by the lack of a proper regulatory environment. Two bills on Islamic banking are under consideration by the Indonesian House of Representatives; one would set the regulatory environment for Islamic banking and one would do the same for sukuk.

The agreement between al Rajhi Bank and e-Kencana Sdn Bhd (a company involved in the MEPS Cash system in Malaysia) was signed which will create a Shari'ah-compliant fund transfer system between Saudi Arabia and Malaysia with future plans to expand to other countries.