Oman’s development of Islamic banking has been surprisingly smooth, so far but the first roadbump may lie just ahead once the country’s new Islamic banks start deciding where to invest the deposits they have been gathering since the beginning of 2013. Specifically, how are they going to manage to earn sufficient returns to satisfy both equity holders and depositors in order to remain competitive with conventional banks in attracting both.
Register for the Islamic Finance Gateway (free) to read the full post
Showing posts with label interbank money market. Show all posts
Showing posts with label interbank money market. Show all posts
Wednesday, February 27, 2013
Sunday, May 13, 2012
Shari'ah risks are not the only risks to Islamic repo
Repurchase agreements, also called repos, are a common way for conventional banks to manage liquidity needs or to lend out surplus liquidity. By doing so, the banking industry is able to manage its liquidity in a way that, at least in theory, does not create systemic risks. This is because a repo transaction is a form of secured lending so that even if the counterparty in the repo transaction goes out of business, the lender can recover the amount lent by liquidating the securities provided as collateral.
The International Islamic Financial Market released a paper exploring the different options for a Shari'ah-compliant version of the repo transaction used by conventional banks. The paper, which I discussed in a newsletter and in a blog post, had several possible methods for an Islamic repo, but the most likely to be used in practice is likely the collateralized murabaha structure. A few using the collateralized murabaha have been executed in the market, but there is still not nearly enough agreement on the structure for it to become as commonplace as repos are in the conventional banking industry.
The National Bank of Abu Dhabi seems to be leading the charge into using the collateralized murabaha structure, since it first executed a one-week $20 million Islamic repo with Abu Dhabi Islamic Bank. However, moving forward in $20 million or even $100 million increments will not put the Islamic repo into common usage anywhere close to the levels of conventional repos (even when viewed in terms of relative size compared with total assets in the Islamic banking system).
Part of that is that it is new, and any new product will start out being used by one institution and other banks will only adopt it gradually. However, based on the Reuters article describing the discussions at the AAOIFI conference, the entire structure is still facing an uphill climb to gain industry-wide approval from various Shari'ah boards regarding some of the issues associated with the transactions (for example, margin interest and netting exposures by setting off positions against other transactions in similar amounts in the opposite directions).
These are thorny issues, but as the idea of an Islamic repo gains market acceptance, there will be other weightier issues around the systemic risks from repos that will arise outside of the current discussion over Shari'ah issues with repos. Specifically, if you return to remembering why a collateralized murabaha repo would be an improvement for the industry, it is because the collateralization protects the lenders in the transactions from default by the counterparty since in the case of default they can always sell off the collateral to recover the amount lent.
The collateralized murabaha repo would presumably give the lender the same right, which would improve on the current commodity murabaha inter-bank lending (which is unsecured). In the current state, lenders are likely to be more attuned to the risks that their counterparties default since their loans are backed only by the full faith and credit of the counterparty to repay the principal plus profit. There is no asset they could take ownership of and liquidate so Islamic banks would or should be more hesitant to engage in inter-bank lending with institutions at risk of failing.
They will be much faster at denying interbank credit to the very banks that need the funding the most to stay solvent and avoid a liquidation of their assets in a fire sale, which could turn a liquidity crunch into insolvency for the bank (which is where the systemic issues begin if the panic spreads to the banks who had been lending to the troubled one). A secured inter-bank financing market based on collateralized murabaha repos will make Islamic banks more likely to continue to lending to one another even if one becomes troubled since the lender will have the collateral to protect its financing interest in the counterparty.
The point where a risk remains is "what is the collateral?". Most conventional repos are backed by government or quasi-government debt and so in most times banks can be assured that there will be a stable market with a ready bid if it ever needed to seize and liquidate the collateral. The same cannot be said for most sukuk. There is, in the best of times, a thin market for sukuk and any troubles for the issuers of sukuk lead to sharp sell-offs.
When sukuk are used as collateral, the lending bank will require a haircut based on the strength of the sukuk issuer and the liquidity of the market for that sukuk, which introduces an inefficiency that, by requiring a higher degree of overcollateralization, will limit the potential for Islamic repos to replace unsecured commodity murabaha inter-bank lending. Or else, participants in the Islamic repo market will ignore the risks that the collateral itself can play in the repo transaction as a whole, which is perhaps a worse outcome.
The Shari'ah issues probably will be resolved to provide an Islamic repo structure that is accepted widely, mostly out of the need for such a product. However, the systemic issues underlying the growth in Islamic repo that uses risky collateral will not be addressed as easily. However, it is incumbent on the industry to recognize these risks, and while the adoption of international financial and accounting standards like the Basel standards should force this issue to the forefront for each institution, it should be another reminder of the importance of ensuring a large supply of high-grade sukuk with a liquid secondary market behind it.
The International Islamic Financial Market released a paper exploring the different options for a Shari'ah-compliant version of the repo transaction used by conventional banks. The paper, which I discussed in a newsletter and in a blog post, had several possible methods for an Islamic repo, but the most likely to be used in practice is likely the collateralized murabaha structure. A few using the collateralized murabaha have been executed in the market, but there is still not nearly enough agreement on the structure for it to become as commonplace as repos are in the conventional banking industry.
The National Bank of Abu Dhabi seems to be leading the charge into using the collateralized murabaha structure, since it first executed a one-week $20 million Islamic repo with Abu Dhabi Islamic Bank. However, moving forward in $20 million or even $100 million increments will not put the Islamic repo into common usage anywhere close to the levels of conventional repos (even when viewed in terms of relative size compared with total assets in the Islamic banking system).
Part of that is that it is new, and any new product will start out being used by one institution and other banks will only adopt it gradually. However, based on the Reuters article describing the discussions at the AAOIFI conference, the entire structure is still facing an uphill climb to gain industry-wide approval from various Shari'ah boards regarding some of the issues associated with the transactions (for example, margin interest and netting exposures by setting off positions against other transactions in similar amounts in the opposite directions).
These are thorny issues, but as the idea of an Islamic repo gains market acceptance, there will be other weightier issues around the systemic risks from repos that will arise outside of the current discussion over Shari'ah issues with repos. Specifically, if you return to remembering why a collateralized murabaha repo would be an improvement for the industry, it is because the collateralization protects the lenders in the transactions from default by the counterparty since in the case of default they can always sell off the collateral to recover the amount lent.
The collateralized murabaha repo would presumably give the lender the same right, which would improve on the current commodity murabaha inter-bank lending (which is unsecured). In the current state, lenders are likely to be more attuned to the risks that their counterparties default since their loans are backed only by the full faith and credit of the counterparty to repay the principal plus profit. There is no asset they could take ownership of and liquidate so Islamic banks would or should be more hesitant to engage in inter-bank lending with institutions at risk of failing.
They will be much faster at denying interbank credit to the very banks that need the funding the most to stay solvent and avoid a liquidation of their assets in a fire sale, which could turn a liquidity crunch into insolvency for the bank (which is where the systemic issues begin if the panic spreads to the banks who had been lending to the troubled one). A secured inter-bank financing market based on collateralized murabaha repos will make Islamic banks more likely to continue to lending to one another even if one becomes troubled since the lender will have the collateral to protect its financing interest in the counterparty.
The point where a risk remains is "what is the collateral?". Most conventional repos are backed by government or quasi-government debt and so in most times banks can be assured that there will be a stable market with a ready bid if it ever needed to seize and liquidate the collateral. The same cannot be said for most sukuk. There is, in the best of times, a thin market for sukuk and any troubles for the issuers of sukuk lead to sharp sell-offs.
When sukuk are used as collateral, the lending bank will require a haircut based on the strength of the sukuk issuer and the liquidity of the market for that sukuk, which introduces an inefficiency that, by requiring a higher degree of overcollateralization, will limit the potential for Islamic repos to replace unsecured commodity murabaha inter-bank lending. Or else, participants in the Islamic repo market will ignore the risks that the collateral itself can play in the repo transaction as a whole, which is perhaps a worse outcome.
The Shari'ah issues probably will be resolved to provide an Islamic repo structure that is accepted widely, mostly out of the need for such a product. However, the systemic issues underlying the growth in Islamic repo that uses risky collateral will not be addressed as easily. However, it is incumbent on the industry to recognize these risks, and while the adoption of international financial and accounting standards like the Basel standards should force this issue to the forefront for each institution, it should be another reminder of the importance of ensuring a large supply of high-grade sukuk with a liquid secondary market behind it.
Wednesday, January 11, 2012
Indonesia inter-bank money markets
It is difficult to tell exactly how the inter-bank money market will work (described in an article from Bisnis Indonesia). The article describes:
The difference between most commodity murabaha inter-bank lending and the Indonesian plan, from my reading, is that the inter-bank commodity murabaha would be collateralized using government sukuk. Bank Indonesia announced in the first half of 2011 that it planned to issue 3-, 6- and 12-month Sharia T-bills and was scheduled to issue the first 6-month T-bills in early August.
Collateralizing inter-bank commodity murabaha transactions is a good move from a risk management perspective, where lack of confidence by counterparties can lead to withdrawal of inter-bank lending and turn a liquidity crisis at a bank to a solvency crisis. If the inter-bank lending is collateralized, the counterparties to a bank that runs into a perception that it is in trouble will be less hesitant to withdraw funding to that bank (although they will certainly not be patient for ever). This is the reason that repurchase (repo) transactions have become a large source of short-term funding for many banks (with the caveat that the security of repo transactions is only as good as the credit of the collateral; the European debt crisis shows that even seemingly solid sovereign credit can lose their value as collateral very quickly).
The difficulty with developing this type of collateralized inter-bank lending is from a Shari'ah-compliance perspective. The issue of collateralized commodity murabaha was one of the proposals considered by the International Islamic Financial Market (IIFM) (see my initial comments here). It is still not necessarily widespread, but it is a promising way to make inter-bank lending more secure (which prevents funding from drying up as quickly and gives time to deal with troubled banks). However, there are obstacles--about which I cannot speak with authority---that make it more difficult to ensure it is widely accepted as Shari'ah-complaint. But, it adds to the forthcoming International Islamic Liquidity Management Corporation (IILM) as a new source of inter-bank liquidity management tools that will strengthen the Islamic finance industry.
In the end, we will have to wait and see what the final regulations around collateralized inter-bank Islamic lending from Bank Indonesia. However, I think that the development is positive and could help Indonesia be an area of growth for Islamic finance and banking in 2012 (more in terms of being rapidly growing; not necessarily having a large quantitative impact on the size and growth of Islamic finance as a whole). One area where it does not have much impact is in moving Islamic finance away from murabaha. However, it is probably better for Islamic banks and financial institutions to move other parts of their balance sheets away from murabaha and towards profit-and-loss sharing instruments before the inter-bank money markets are shifted away from murabaha.
"According to him [an unnamed source at Bank Indonesia, the central bank], the underlying asset in the money market may be in the form of sharia commodity futures. Moreover, collateral may use government’s sukuk.Taking apart the parts of this sentence, I would imagine that the "sharia commodity futures" refer to using a commodity market (for cocoa, cashew or arabica coffee, as the article suggests later) to back commodity murabaha between Islamic banks in Indonesia. A commodity murabaha is a common inter-bank money market instrument in the GCC and Malaysia. The latter has set up an exchange, Bursa Suq al-Sila, to connect palm oil producers with financial institutions that want to use palm oil to back commodity murabaha transactions.
The difference between most commodity murabaha inter-bank lending and the Indonesian plan, from my reading, is that the inter-bank commodity murabaha would be collateralized using government sukuk. Bank Indonesia announced in the first half of 2011 that it planned to issue 3-, 6- and 12-month Sharia T-bills and was scheduled to issue the first 6-month T-bills in early August.
Collateralizing inter-bank commodity murabaha transactions is a good move from a risk management perspective, where lack of confidence by counterparties can lead to withdrawal of inter-bank lending and turn a liquidity crisis at a bank to a solvency crisis. If the inter-bank lending is collateralized, the counterparties to a bank that runs into a perception that it is in trouble will be less hesitant to withdraw funding to that bank (although they will certainly not be patient for ever). This is the reason that repurchase (repo) transactions have become a large source of short-term funding for many banks (with the caveat that the security of repo transactions is only as good as the credit of the collateral; the European debt crisis shows that even seemingly solid sovereign credit can lose their value as collateral very quickly).
The difficulty with developing this type of collateralized inter-bank lending is from a Shari'ah-compliance perspective. The issue of collateralized commodity murabaha was one of the proposals considered by the International Islamic Financial Market (IIFM) (see my initial comments here). It is still not necessarily widespread, but it is a promising way to make inter-bank lending more secure (which prevents funding from drying up as quickly and gives time to deal with troubled banks). However, there are obstacles--about which I cannot speak with authority---that make it more difficult to ensure it is widely accepted as Shari'ah-complaint. But, it adds to the forthcoming International Islamic Liquidity Management Corporation (IILM) as a new source of inter-bank liquidity management tools that will strengthen the Islamic finance industry.
In the end, we will have to wait and see what the final regulations around collateralized inter-bank Islamic lending from Bank Indonesia. However, I think that the development is positive and could help Indonesia be an area of growth for Islamic finance and banking in 2012 (more in terms of being rapidly growing; not necessarily having a large quantitative impact on the size and growth of Islamic finance as a whole). One area where it does not have much impact is in moving Islamic finance away from murabaha. However, it is probably better for Islamic banks and financial institutions to move other parts of their balance sheets away from murabaha and towards profit-and-loss sharing instruments before the inter-bank money markets are shifted away from murabaha.
Friday, November 25, 2011
Islamic finance complexity (Part IIe)
After thinking a lot about how products are structured, I am moving onto some real-world breakdown in the actual balance sheet balances of some Islamic banks to translate the ideas of how they design their products into how they are actually represented in terms of the bank's liquidity profile. To do so, I picked one country (the UAE) to limit the differences between banks caused by different countries, different regulatory environments, etc, and focused just on the "Liabilities" items in the balance sheet at one point in time (December 31, 2010 for all except for Ajman Bank, which only had annual financial statements through the end of 2009).
The liabilities section is, in rough form, broken into three categories of liabilities: deposits, inter-bank borrowings and other liabilities (e.g. longer term liabilities like sukuk). In general, deposits made up the vast majority of the Islamic banks' liabilities that I looked at, ranging from 76% to 85%. Within the deposits, there were a few main types (current accounts, savings accounts and investment accounts). Most of the banks had just one type of investment account, which I am guessing is almost universally mudaraba-based profit-sharing accounts. Two banks (Al Hilal Bank and Emirates Islamic Bank) which had another category of deposits, wakala. The banks in general used "investment accounts" as their primary funding source, representing around 60% of total liabilities (three-quarters of the deposits), although this wasn't universal.
The real difference between the banks (only two banks offered this detailed breakdown, unfortunately) came with the maturity of the deposits. Dubai Islamic Bank had more (about two-thirds) of deposits in short-maturity or demand deposits, while Al Hilal Bank had more mid-range (3-6 month) deposits (about one-half) compared with the remainder split between longer-term (>1 year) and short-term funding (<3 months). The split between short- and longer-term deposits is more of a business decision, than it is something that goes to the heart of how Islamic banking differentiates itself .
However, with the limitations on Islamic deposit insurance, the maturity of deposits can be a factor in how resilient an Islamic bank is to future banking system problems (longer maturity giving more protection against runs on the bank becoming destabilizing). The offsetting factor (for the bank) is that longer-term deposits are more expensive than short-term deposits, and that will be true whether the bank is Islamic or not because in practice, deposit accounts are not entirely pass-through, and also must offer rates of return that are competitive with conventional banks.
The other two areas of liabilities on Islamic banks' balance sheets varied bank to bank to fill the remaining 15-25% of the liabilities with some having more in inter-bank financing while others had longer-term liabilities like sukuk or the Central Bank wakala financing that was provided to banks during the Dubai debt crisis. However, in general, the larger the bank the less reliant on inter-bank financing, although the three largest banks (DIB, ADIB and Emirates Islamic Bank) all had wakala financing from the UAE Central Bank, which skews the relative shares.
Removing the wakala financing from the Central Bank (assuming it was replaced with inter-bank financing) removes the previous relationship between longer- and shorter-term other (non-deposit) liabilities between larger and smaller banks (the smaller banks being Sharjah Islamic Bank, Al Hilal Bank and Ajman Bank; Noor Islamic Bank does not put financial statements on its website). The ratio of short term to the sum of short- and long-term non-deposit liabilities is the metric I looked at (moving wakala financing from long- to short-term) ranged from a low of 29% to a high of 87%.
The sample I chose was purposefully non-representative to try and limit the fluctuations due to country-specific factors, but a few trends emerge. First, most banks have deposits as the largest source of their funding, which is probably good because it is lower cost than sukuk and less volatile than inter-bank financing. The one exception to the stability of bank deposits is in a banking crisis and the UAE Central Bank did what central banks are supposed to do in a crisis: they lent freely on more costly terms than they normally would (the wakala is convertible into equity).
In the non-deposit liabilities, the wide range of splits between inter-bank financing (short-term) and longer-term financing like sukuk was mostly explained by the difference between banks that had sukuk outstanding and those that didn't. The banks with sukuk outstanding had lower reliance on inter-bank financing than banks that did not issue sukuk. This suggests that one way to mitigate the reliance of banks on short-term inter-bank financing is to further develop the sukuk market, especially finding structures that don't require physical assets, but can fund longer-term assets on the balance sheet with longer-term funding.
See the index of other posts: http://investhalal.blogspot.com/2011/11/islamic-finance-complexity.html
The liabilities section is, in rough form, broken into three categories of liabilities: deposits, inter-bank borrowings and other liabilities (e.g. longer term liabilities like sukuk). In general, deposits made up the vast majority of the Islamic banks' liabilities that I looked at, ranging from 76% to 85%. Within the deposits, there were a few main types (current accounts, savings accounts and investment accounts). Most of the banks had just one type of investment account, which I am guessing is almost universally mudaraba-based profit-sharing accounts. Two banks (Al Hilal Bank and Emirates Islamic Bank) which had another category of deposits, wakala. The banks in general used "investment accounts" as their primary funding source, representing around 60% of total liabilities (three-quarters of the deposits), although this wasn't universal.
The real difference between the banks (only two banks offered this detailed breakdown, unfortunately) came with the maturity of the deposits. Dubai Islamic Bank had more (about two-thirds) of deposits in short-maturity or demand deposits, while Al Hilal Bank had more mid-range (3-6 month) deposits (about one-half) compared with the remainder split between longer-term (>1 year) and short-term funding (<3 months). The split between short- and longer-term deposits is more of a business decision, than it is something that goes to the heart of how Islamic banking differentiates itself .
However, with the limitations on Islamic deposit insurance, the maturity of deposits can be a factor in how resilient an Islamic bank is to future banking system problems (longer maturity giving more protection against runs on the bank becoming destabilizing). The offsetting factor (for the bank) is that longer-term deposits are more expensive than short-term deposits, and that will be true whether the bank is Islamic or not because in practice, deposit accounts are not entirely pass-through, and also must offer rates of return that are competitive with conventional banks.
The other two areas of liabilities on Islamic banks' balance sheets varied bank to bank to fill the remaining 15-25% of the liabilities with some having more in inter-bank financing while others had longer-term liabilities like sukuk or the Central Bank wakala financing that was provided to banks during the Dubai debt crisis. However, in general, the larger the bank the less reliant on inter-bank financing, although the three largest banks (DIB, ADIB and Emirates Islamic Bank) all had wakala financing from the UAE Central Bank, which skews the relative shares.
Removing the wakala financing from the Central Bank (assuming it was replaced with inter-bank financing) removes the previous relationship between longer- and shorter-term other (non-deposit) liabilities between larger and smaller banks (the smaller banks being Sharjah Islamic Bank, Al Hilal Bank and Ajman Bank; Noor Islamic Bank does not put financial statements on its website). The ratio of short term to the sum of short- and long-term non-deposit liabilities is the metric I looked at (moving wakala financing from long- to short-term) ranged from a low of 29% to a high of 87%.
The sample I chose was purposefully non-representative to try and limit the fluctuations due to country-specific factors, but a few trends emerge. First, most banks have deposits as the largest source of their funding, which is probably good because it is lower cost than sukuk and less volatile than inter-bank financing. The one exception to the stability of bank deposits is in a banking crisis and the UAE Central Bank did what central banks are supposed to do in a crisis: they lent freely on more costly terms than they normally would (the wakala is convertible into equity).
In the non-deposit liabilities, the wide range of splits between inter-bank financing (short-term) and longer-term financing like sukuk was mostly explained by the difference between banks that had sukuk outstanding and those that didn't. The banks with sukuk outstanding had lower reliance on inter-bank financing than banks that did not issue sukuk. This suggests that one way to mitigate the reliance of banks on short-term inter-bank financing is to further develop the sukuk market, especially finding structures that don't require physical assets, but can fund longer-term assets on the balance sheet with longer-term funding.
See the index of other posts: http://investhalal.blogspot.com/2011/11/islamic-finance-complexity.html
Tuesday, July 19, 2011
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.
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.
Wednesday, June 30, 2010
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
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.
Tuesday, June 01, 2010
Takaful shortfalls, Islamic money markets, Shari'ah scholars
Takaful
Reuters has a fascinating article about takaful and specifically what happens if the policy holders' pool is in deficit. The article highlights a discrepancy between the regulatory view and the Shari'ah view. The regulatory view says that the shareholders of the takaful provider should be responsible for shortfalls (through a letter of guarantee for any shortfall) and the policyholders should benefit from the gain on any investments financed by the shareholders' funds. However, the Shari'ah view, as articulated in the article, says that policy holders should contribute to finance any shortfall and if there is a letter of guarantee but no cash drawn, the shareholders should receive the benefit. This is an issue that I had not spent much time thinking about, although I have acknowledged that the lack of sukuk and other fixed income products have made a shortfall more likely because the funds contributed by policy holders are invested in riskier assets than the premiums paid into conventional insurers (which are typically invested in bonds). There are no specific examples mentioned, which increases the risk to takaful companies and policy holders without significant experience where shortfalls are actually experienced and managed. However, based on the general trend for Islamic financial products to mirror conventional products, I think it is extremely unlikely that policy holders would be forced to make additional contributions to cover a shortfall.
Islamic finance needs money market to grow
Bloomberg has an article with several interesting comments from Mohamad Nedal Alchaar, secretary-general of AAOIFI. In addition to his comments about the need for more Shari'ah-compliant money market products to facilitate better liquidity management, he warned about "overexposure" to a single industry by Islamic financial institutions. His call is welcome given the fallout from the global financial crisis and property boom and bust in parts of the GCC, and it adds to the recognition that Islamic finance was hurt by the global financial crisis but this damage was accentuated by a concentration of investments in a few industries. He also warned that if there is not more done to create a more transparent forum for Shari'ah scholars to reach consensus from an industry body on products where there are no existing fatawa, the industry would remain dependent on a "fatwa-by-fatwa basis". While it is not surprising to hear the head of a standard setting body call for Shari'ah standards to involve an industry body, his point could strike a healthy balance between individual institutions being able to develop new products if their Shari'ah boards approve and the need for greater consensus among scholars through a central forum without requiring what could become rigid standardized fatawa.
Shari'ah scholars
Another article on the development of a younger group of Shari'ah scholars includes a profile of Taha Abdul-Basser, a scholar and the Muslim chaplain at Harvard University. Congratulations to him for being recognized and profiled as one of the prominent younger Shari'ah scholars who will be responsible for continuing the growth in Islamic finance that the senior scholars helped create during the past 35 years.
Other News
Reuters has a fascinating article about takaful and specifically what happens if the policy holders' pool is in deficit. The article highlights a discrepancy between the regulatory view and the Shari'ah view. The regulatory view says that the shareholders of the takaful provider should be responsible for shortfalls (through a letter of guarantee for any shortfall) and the policyholders should benefit from the gain on any investments financed by the shareholders' funds. However, the Shari'ah view, as articulated in the article, says that policy holders should contribute to finance any shortfall and if there is a letter of guarantee but no cash drawn, the shareholders should receive the benefit. This is an issue that I had not spent much time thinking about, although I have acknowledged that the lack of sukuk and other fixed income products have made a shortfall more likely because the funds contributed by policy holders are invested in riskier assets than the premiums paid into conventional insurers (which are typically invested in bonds). There are no specific examples mentioned, which increases the risk to takaful companies and policy holders without significant experience where shortfalls are actually experienced and managed. However, based on the general trend for Islamic financial products to mirror conventional products, I think it is extremely unlikely that policy holders would be forced to make additional contributions to cover a shortfall.
Islamic finance needs money market to grow
Bloomberg has an article with several interesting comments from Mohamad Nedal Alchaar, secretary-general of AAOIFI. In addition to his comments about the need for more Shari'ah-compliant money market products to facilitate better liquidity management, he warned about "overexposure" to a single industry by Islamic financial institutions. His call is welcome given the fallout from the global financial crisis and property boom and bust in parts of the GCC, and it adds to the recognition that Islamic finance was hurt by the global financial crisis but this damage was accentuated by a concentration of investments in a few industries. He also warned that if there is not more done to create a more transparent forum for Shari'ah scholars to reach consensus from an industry body on products where there are no existing fatawa, the industry would remain dependent on a "fatwa-by-fatwa basis". While it is not surprising to hear the head of a standard setting body call for Shari'ah standards to involve an industry body, his point could strike a healthy balance between individual institutions being able to develop new products if their Shari'ah boards approve and the need for greater consensus among scholars through a central forum without requiring what could become rigid standardized fatawa.
Shari'ah scholars
Another article on the development of a younger group of Shari'ah scholars includes a profile of Taha Abdul-Basser, a scholar and the Muslim chaplain at Harvard University. Congratulations to him for being recognized and profiled as one of the prominent younger Shari'ah scholars who will be responsible for continuing the growth in Islamic finance that the senior scholars helped create during the past 35 years.
Other News
- Qatar issued its first local-currency bond of the year yielding 6.5% and sukuk of the year with a $2.75 billion issue split evenly between a conventional bond subscribed by five conventional banks and sukuk, which was purchased by four Islamic banks.
- A firm with links in the Middle East is planning to launch an Islamic REIT in Singapore. There is currently one Islamic REIT in Singapore and plans for another later this year.
- Four mostly state-owned companies in Abu Dhabi are cooperating to launch a takaful company in the Emirate.
- Tabreed, the National Cooling Company in Dubai which missed a payment on its sukuk, may sell conventional or Islamic debt as a part of its recapitalization program.
- A Malaysian firm is planning an Islamic gold ETF in the country. There is currently only one Islamic gold ETF, the Dubai Gold Securities. In addition, companies like Bullion Management Group in Canada offer a gold bullion fund that is Shari'ah-compliant.
- The CIS has potential for Islamic finance, but there is little legislation in place that enables Islamic finance, according to a summary of a conference in Moscow written by Mushtak Parker in Arab News.
- Indonesian sukuk issuance is expected to rise 10-20% compared to last year according to the CEO of HSBC Amanah, Mukhtar Hussain. He said that the Asian economies have had a limited impact from the European debt crisis. Sukuk issuance was $23.3 billion in 2009, which was lower than the peak of $34.3 billion issued in 2007 according to Standard & Poor's.
- The Central Bank of Bahrain short-term sukuk al-salam issue was oversubscribed by over 400 percent. The sukuk matures in 91 days and has an expected return of 0.85%.
- Khaleej Times has an article on Islamic finance business education.
Friday, May 08, 2009
IFSB summit, Moody's weighs in on sukuk form versus substance, Sheikh DeLorenzo on Islamic home finance in the US
Moody's released a report looking at the future of the sukuk market with a suggestion that investors look not just at the form of the structure, but the substance as well. Although many sukuk use standard forms (as approved by AAOIFI), they can vary significantly across different individual sukuk using the same form. This is particularly important, Moody's notes, because "The assets in the structure are commonly there for Shari'ah compliance purposes only, and ultimately have no bearing on the risk or performance of the sukuk investments, particularly in a distress situation." This is an important point because it raises questions about whether the sukuk market has focused too much on structuring transactions to receive Shari'ah-compliance and too little on creating a different asset class.
There is an interesting opinion article written by Shari'ah scholar Sheikh Yusuf DeLorenzo describing the benefits from the Islamic home finance product in the US for both Muslims and non-Muslims. These benefits are due to the participatory structure of many forms of Islamic home finance in the US and the non-recourse nature of the loans. The combination of these two factors, according to Sheikh DeLorenzo, leads to a lower rate of foreclosure following delinquency because the Islamic finance companies can only take the house in a foreclosure and if this value is below the outstanding amount owed (the mortgage is 'under water'), the bank faces a loss. Although this is the case in many states for all mortgages, it is not always the case in conventional mortgages.
The IFSB says that Islamic finance regulators need to focus on the entire system instead of having a narrow focus on individual institutions to prevent a repeat of the current crisis facing the conventional financial industry in the Islamic finance industry. I think this is very important because there are fewer safeguards on the industry to prevent contagion from spreading from one troubled institution to healthy institutions, like inter-bank money market and a 'lender of last resort'. The president of the Islamic Development Bank Dr. Ahmad Mohamed Ali said at the IFSB summit that the industry still has a significant amount of innovation needed to continue its rapid growth. The head of the IFSB was also quoted speaking to the Straits Times: "It all comes down to risk management. You've to have proper risk management and proper governance and practices so that an institution doesn't fall down".
Bank Negara deputy governor is quoted speaking about two critical issues that the Islamic finance industry needs to deal with to become more resilient in the future:
Other News
There is an interesting opinion article written by Shari'ah scholar Sheikh Yusuf DeLorenzo describing the benefits from the Islamic home finance product in the US for both Muslims and non-Muslims. These benefits are due to the participatory structure of many forms of Islamic home finance in the US and the non-recourse nature of the loans. The combination of these two factors, according to Sheikh DeLorenzo, leads to a lower rate of foreclosure following delinquency because the Islamic finance companies can only take the house in a foreclosure and if this value is below the outstanding amount owed (the mortgage is 'under water'), the bank faces a loss. Although this is the case in many states for all mortgages, it is not always the case in conventional mortgages.
The IFSB says that Islamic finance regulators need to focus on the entire system instead of having a narrow focus on individual institutions to prevent a repeat of the current crisis facing the conventional financial industry in the Islamic finance industry. I think this is very important because there are fewer safeguards on the industry to prevent contagion from spreading from one troubled institution to healthy institutions, like inter-bank money market and a 'lender of last resort'. The president of the Islamic Development Bank Dr. Ahmad Mohamed Ali said at the IFSB summit that the industry still has a significant amount of innovation needed to continue its rapid growth. The head of the IFSB was also quoted speaking to the Straits Times: "It all comes down to risk management. You've to have proper risk management and proper governance and practices so that an institution doesn't fall down".
Bank Negara deputy governor is quoted speaking about two critical issues that the Islamic finance industry needs to deal with to become more resilient in the future:
"There are a lot of issues that need to be addressed, for example the link to economic activity also has got its shortcomings because they are too focused on real estate for example. The absence of a money market that is also a source of risk."
Other News
- France's new laws that put Islamic finance on equal footing with conventional financial institutions for taxes has attracted the first institution, the Islamic Finance Advisory and Assurance Services, a UK-based consultancy.
- There is an article in Foreign Policy magazine that I may have already linked to about Shari'ah scholars and the Islamic finance industry.
- The Islamic Development Bank is planning a $500 million sukuk in the first half of 2009. The proceeds will fund the IsDB's activities in member countries this year. This is the bank's first issue in a five-year bond program that aims to raise $1 billion per year. The Monetary Authority of Singapore expects $1.3 billion in sovereign sukuk issues from Singapore, Malaysia and Indonesia in the first half of 2009. The Monetary Authority of Singapore also unveiled measures to attract Islamic finance to the city-state including legal and regulatory changes that allow Singaporean dollar sukuk to be treated identically with conventional government bonds.
- Dubai Islamic Bank is going to buy back $200 million of its $750 million outstanding sukuk in a tender offer at between 86% and 90% of par. The Shari'ah-compliance of debt buybacks was not raised in the article. The sukuk last traded March 13 on the London Stock Exchange at 82. The buy back is therefore being offered between a 5% to 10% premium.
- RHB Islamic, the Malaysian bank, is expanding its business to Singapore and has applied for a full banking license in the country.
- Gatehouse Bank in the UK is setting up a Shari'ah-compiant investment strategy focused on the water industry with Sustainable Asset Management (SAM).
- Islamic mortage companies Amlak and Tamweel will receive "major government support" due to their losses caused by the collapsing property markets, increased funding costs and halt in financing.
- Fattah Finance, a Shari'ah-compliant brokerage subsidiary of Almaty Financial Centre, is the first Islamic finance company to open in Kazakhstan following the changes in law to allow Islamic finance. Mauritius' first Islamic bank, HSBC Mauritius Amanah, opened today.
- A Shari'ah manager at BMB Islamic provides an overview of the basic principles of Isalmic finance.
Wednesday, April 01, 2009
FT article on the Islamic financial services industry
The Financial Times has a fantastic article about the Islamic financial services industry that includes some very interesting descriptions that, while not new, are described clearer than I have seen in other articles about the industry. A few quites:
I fully agree that the industry has to some degree avoided problems because of its relative youth. The liquidity management concerns have been a frequent area of concern for me because the global economic crisis is not over yet and the industry, partly because of lack of interbank money markets, has been more cash-rich than conventional banks. The institutions including a few Islamic investment banks and mortgage providers have had difficulties and many in the GCC region have relied upon government capital infusions to shore themselves up as they faced difficulty issuing sukuk.
"To be clear, many of the Gulf’s Islamic banks have not been immune to the financial crisis – the liquidity squeeze in the region has put pressure on these banks just as much as their conventional counterparts."
[...]
"As Emmanuel Volland, analyst with Standard & Poor’s, the rating agency, says: 'Islamic banks were not caught by toxic assets as sharia law prohibits interest. At the same time, you can create and invest in very risky assets and be sharia compliant.'"
[...]
"Now, as their profits decline, banks are dipping into “profit equalisation reserves” to keep depositors satisfied. But they will face a dilemma if the economic downturn continues. Devout Muslims have increasingly migrated to Islamic banks in recent years, but will the trend survive if some of them start losing their money?"
[...]
"Last year a leading sharia scholar questioned a popular type of sukuk that promised to pay back the face value of the bond at maturity or in case of default. The scholar argued – and others had to agree – that this guarantee ran counter to the spirit of Islamic finance, which stipulates that risk must be shared."
"For those who closely watch the industry, there are more pressing concerns. As a recent S&P report noted, because of a lack of liquid sharia-compliant asset classes, some Islamic banks invested in equities, exposing themselves to the correction of recent months. The leading risk today, however, comes from the exposure to the real estate market. The rating agency estimates that this amounts to 20 per cent of total loans."
[...]
"It may have been lucky so far, and perhaps it will learn lessons from the troubles of conventional banks. But Islamic bankers will also have to think harder about how the industry can develop, and how it can resolve the tensions within."
I fully agree that the industry has to some degree avoided problems because of its relative youth. The liquidity management concerns have been a frequent area of concern for me because the global economic crisis is not over yet and the industry, partly because of lack of interbank money markets, has been more cash-rich than conventional banks. The institutions including a few Islamic investment banks and mortgage providers have had difficulties and many in the GCC region have relied upon government capital infusions to shore themselves up as they faced difficulty issuing sukuk.
Tuesday, March 17, 2009
Interbank markets & rates; sukuk preference strongly towards ijara
During the economic crisis, sukuk issuers and investors have shown a preference for ijara sukuk over mudaraba and musharaka because it creates a more stable, asset-backed (secured) stream of cash flows. More than 45% of all sukuk issued in 2008 were ijara sukuk and mudaraba and musharaka sukuk issuance fell by 83% and 68% respectively.
The development of an Islamic alternative to LIBOR could be potentially destabilizing if participants exploit arbitrage opportunities between conventional and Islamic markets according to a Shari'ah scholar. There are two things that stand out to me immediately. First, any IsLIBOR (Islamic interbank offer rate) would function in a similar way to any other LIBOR alternative (KLIBOR, SIBOR, KIBOR) in that it is similar to LIBOR with additional country-specific risk of the market in which the banks operate. Second, unless the Islamic finance industry offers a majority of financing in a way substantively different from the conventional products in the same regions, the IsLIBOR should mirror the interest rate benchmark for an overlapping region.
The Malaysian palm oil Commodity Murabaha House could be a preface to a global Islamic interbank market that is being planned by the Islamic Development Bank. The planned initiative, the International Islamic Inter-Bank (IIIB) market is expected to have initial capital of $10 billion to facilitate inter-bank liquidity management and serve as a 'lender-of-last-resort'.
A Scottish banker says the country could benefit if an Islamic finance house were established by attracting money from the Middle East.
The Investment Dar continues to mull asset sales including stakes in Aston Martin and Boubyan bank
Indonesia's government has been warned that it is a bad time to issue its first global retail sukuk.
The development of an Islamic alternative to LIBOR could be potentially destabilizing if participants exploit arbitrage opportunities between conventional and Islamic markets according to a Shari'ah scholar. There are two things that stand out to me immediately. First, any IsLIBOR (Islamic interbank offer rate) would function in a similar way to any other LIBOR alternative (KLIBOR, SIBOR, KIBOR) in that it is similar to LIBOR with additional country-specific risk of the market in which the banks operate. Second, unless the Islamic finance industry offers a majority of financing in a way substantively different from the conventional products in the same regions, the IsLIBOR should mirror the interest rate benchmark for an overlapping region.
The Malaysian palm oil Commodity Murabaha House could be a preface to a global Islamic interbank market that is being planned by the Islamic Development Bank. The planned initiative, the International Islamic Inter-Bank (IIIB) market is expected to have initial capital of $10 billion to facilitate inter-bank liquidity management and serve as a 'lender-of-last-resort'.
A Scottish banker says the country could benefit if an Islamic finance house were established by attracting money from the Middle East.
The Investment Dar continues to mull asset sales including stakes in Aston Martin and Boubyan bank
Indonesia's government has been warned that it is a bad time to issue its first global retail sukuk.
Sunday, February 15, 2009
Truth and fiction in reporting the Islamic finance industry
As I began reading this article about the prospects for Islamic finance in the year to come, I almost cringed as it began with yet another denial of the reality that Islamic finance was significantly affected by the credit crisis that resulted from the subprime mortgage crisis in the United States. However, as I read further, there was a discussion of the impact from the credit crisis on Islamic finance and an acknowledgement of its severity:
Another article discusses the recovery in Islamic financial institutions and describes their advantages in both not being leveraged like conventional banks and also not having 'exposure' to the interbank lending market, which led to the illiquidity that doomed Lehman Brothers and Bear Stearns. On the first point, I agree (with a few exceptions) that Islamic financial institutions are more prudent about leverage than most conventional financial institutions. However, I find the liquidity risk of Islamic financial institutions to be more significant than for conventional financial institutions in most situations. The lack of access to interbank money markets (except in Malaysia) create a significant risk that illiquid Islamic financial institutions could be unnecessarily transformed into insolvent institutions. One area where illiquidity is particularly noticeable is in the secondary market for sukuk where government-backed companies like the Jebel Ali Free Zone (JAFZ) can see their sukuk trading at less than 60 cents on the dollar.
"But to suggest that Islamic banking is set to grow strongly despite the global financial crisis may be stretching things a little too far. Last year’s credit crunch hit Islamic bonds much harder than other forms of debt as sharply lower international oil prices deprived oil-rich Middle Eastern investors of cash.The article ends with a very reasonable conclusion that the way Islamic finance is conducted without many of the financial instruments that cause excess speculation can serve as an alternate model to conventional finance. This, I believe, is the contribution of Islamic finance. It can provide an alternative model of financial services based on finance's underlying objective which is to facilitate the real economy. In the wake of the credit crisis, there is finally some understanding that all financial innovation is not necessarily beneficial and that there is too much of a draw created by financial services' pay packages for people qualified and talented in other areas besides finance whose efforts may better benefit the economy in these other fields. One lesson, however, that should not be underestimated is that even conservative areas of finance like Islamic finance can still become involved in speculative bubbles. Witness Dubai. A recent video I have seen on several blogs puts the popping of Dubai's real estate bubble in clear, on-the-ground terms, by interviewing a real estate agent in the Emirate.
According to rating agency S&P, corporate and government sales of sukuk (syariah compliant bonds) reached US$30.8 billion in 2007, but plunged 56 per cent last year to just US$13.6 billion. By comparison, conventional international bonds and emerging-market debt dropped 5 per cent and 15 per cent, respectively"
Another article discusses the recovery in Islamic financial institutions and describes their advantages in both not being leveraged like conventional banks and also not having 'exposure' to the interbank lending market, which led to the illiquidity that doomed Lehman Brothers and Bear Stearns. On the first point, I agree (with a few exceptions) that Islamic financial institutions are more prudent about leverage than most conventional financial institutions. However, I find the liquidity risk of Islamic financial institutions to be more significant than for conventional financial institutions in most situations. The lack of access to interbank money markets (except in Malaysia) create a significant risk that illiquid Islamic financial institutions could be unnecessarily transformed into insolvent institutions. One area where illiquidity is particularly noticeable is in the secondary market for sukuk where government-backed companies like the Jebel Ali Free Zone (JAFZ) can see their sukuk trading at less than 60 cents on the dollar.
Wednesday, January 14, 2009
Renewable energy sukuk, expectations for 2009, new Zawya.com blog
Singaporean renewable energy company Agni Inc plans on issuing a ringgit-denominated ijara sukuk to test the sukuk market.
South Korea Financial Supervisory Service governor says the country should explore using Islamic finance to attract capital.
Although 2008 was an extremely rough year in the financial markets, including Islamic finance, 2009 should see some recovery although other reports, like the one from Standard & Poor's, predicts the sukuk market will only recover towards the end of 2009.
The Associated Press has an article about the University Islamic Financial Corp. in Ann Arbor, Michigan, which is one of a few Islamic financial institutions in the U.S., and the only one with a Shari'ah-compliant deposit product. An interesting part of the article is that two banks have communicated with the UIFC about helping expand its availability across the U.S. Only one bank, Comerica, is named.
Deutsche Bank launched a new platform they claim will enable Shari'ah-compliant money markets, as well as other securitized products. I have not done enough review of the product, but I would hope to be able to study it a little more and post on my new blog at Zawya.com. This will still be a more frequently updated blog, but topics I think deserve more substance will appear there.
South Korea Financial Supervisory Service governor says the country should explore using Islamic finance to attract capital.
Although 2008 was an extremely rough year in the financial markets, including Islamic finance, 2009 should see some recovery although other reports, like the one from Standard & Poor's, predicts the sukuk market will only recover towards the end of 2009.
The Associated Press has an article about the University Islamic Financial Corp. in Ann Arbor, Michigan, which is one of a few Islamic financial institutions in the U.S., and the only one with a Shari'ah-compliant deposit product. An interesting part of the article is that two banks have communicated with the UIFC about helping expand its availability across the U.S. Only one bank, Comerica, is named.
Deutsche Bank launched a new platform they claim will enable Shari'ah-compliant money markets, as well as other securitized products. I have not done enough review of the product, but I would hope to be able to study it a little more and post on my new blog at Zawya.com. This will still be a more frequently updated blog, but topics I think deserve more substance will appear there.
Tuesday, March 27, 2007
Shari'ah Capital, Islamic finance education and the development of the Islamic financial industry
Shair'ah Capital Inc. unveils hedge fund platform
There is an article (sub. rqd.) in the Wall Street Journal (an also a freely available press release from Shari'ah Capital) about the launch. The new products will be based on al-arboon, an advance payment similar to a down payment towards the purchase price that gives the buyer the right to purchase a good at a given price. GRT Capital Partners, an alternative investment manager in Boston, will use the platform. Al-arboon is an alternative to the more controversial salam (forward) method of replicating options and shorts.
Islamic finance lacks depth
While Islamic finance has grown rapidly and continues to grow, it has not developed the depth of conventional financial markets, Reuters reports. Much of the growth has been in sukuk and private equity, as well as other financial services for high net worth individuals yet the secondary market for sukuk is almost non-existent. One of the most interesting parts of the article is the comment from the head of Arcapita, the Bahraini Islamic private equity firm which owns Church's Chicken, Caribou Coffee and Yakima in the U.S., suggesting that Islamic finance has been successfully marketed in the U.S. based on its similarities with ethical investing.
Western educational institutions offer courses in Islamic finance
Educational institutions like Harvard University, Tufts University, the Cass Business School and Rice University offer courses or programs in Islamic finance. Programs mentioned include:
Cooperation is key to developing new Islamic finance products
The head of International Centre for Education in Islamic Finance (INCEIF), Professor Dr. Malik Muhammad Mahmud Al-Awan believes that countries should cooperate in research on new Islamic financial products. This approach should take a non-confrontational approach to conventional finance, as Malaysia has done, in order to spur the acceptance of Islamic finance. He stressed that "the 21st century is seeing so much political conflict between Islam and the West, yet in the field of Islamic finance, the West has embraced it with open arms".
Other News
The world's oldest Islamic bank, Dubai Islamic Bank issued its first sukuk on the Dubai International Financial Exchange (DIFX).
Minority shareholders of Rashid Hussain Bhd (RHB) want it to remain listed. Employees Provident Fund, the Malaysian state-run pension fund which will control RHB has said it will delist RHB but RHB Capital will remain listed.
ABN Amro Bank Bhd, the Malaysian branch of the Dutch banking group, plans to seek approval from Bank Negara Malaysia, the central bank, to open an Islamic subsidiary in the country.
AmIslamic Bank will offer takaful in Malaysia in partnership with Takaful IKHLAS Sdn Bhd and FWU AG. FWU designed the plan, Takaful IKHLAS will be the trustee and AmIslamic Bank will administer the takaful plan.
Hong Leong Bhd subsidiary Hong Leong Islamic Bank will team up with UBS to offer non-ringgit structured financial products which are Shari'ah compliant.
CIMB Group Bhd will open an Islamic private banking service in Malaysia.
Foreign banks will be able to buy Malaysian Islamic banks, but will not be allowed to operate transactions in ringgit.
Bank Negara Malaysia (BNM) signed a Memorandum of Understanding with Qatar Financial Center Regulatory Authority (QFCRA) and the Dubai Financial Services Authority (DFSA) to cooperate on capacity building and human capital development.
Malaysia will offer commodity-based murabaha as a way for banks to manage liquidity in the Islamic interbank money market (IIMM). The murabaha will be based on palm oil-based contracts.
Indonesia should follow Malaysia's example and reduce double taxation to spur the development of Islamic finance in the world's most populous Muslim country.
KPJ Healthcare Bhd plans to expand its healthcare REIT
Finance professionals applaud tax changes in the U.K. dealing with sukuk.
There is an article (sub. rqd.) in the Wall Street Journal (an also a freely available press release from Shari'ah Capital) about the launch. The new products will be based on al-arboon, an advance payment similar to a down payment towards the purchase price that gives the buyer the right to purchase a good at a given price. GRT Capital Partners, an alternative investment manager in Boston, will use the platform. Al-arboon is an alternative to the more controversial salam (forward) method of replicating options and shorts.
Islamic finance lacks depth
While Islamic finance has grown rapidly and continues to grow, it has not developed the depth of conventional financial markets, Reuters reports. Much of the growth has been in sukuk and private equity, as well as other financial services for high net worth individuals yet the secondary market for sukuk is almost non-existent. One of the most interesting parts of the article is the comment from the head of Arcapita, the Bahraini Islamic private equity firm which owns Church's Chicken, Caribou Coffee and Yakima in the U.S., suggesting that Islamic finance has been successfully marketed in the U.S. based on its similarities with ethical investing.
Western educational institutions offer courses in Islamic finance
Educational institutions like Harvard University, Tufts University, the Cass Business School and Rice University offer courses or programs in Islamic finance. Programs mentioned include:
• Harvard Law School's Islamic Finance Project
• Dr. Mahmoud El-Gamal (Rice University)
• Ibrahim Warde (Tufts University)
• Cass Business School Islamic Executive MBA
Cooperation is key to developing new Islamic finance products
The head of International Centre for Education in Islamic Finance (INCEIF), Professor Dr. Malik Muhammad Mahmud Al-Awan believes that countries should cooperate in research on new Islamic financial products. This approach should take a non-confrontational approach to conventional finance, as Malaysia has done, in order to spur the acceptance of Islamic finance. He stressed that "the 21st century is seeing so much political conflict between Islam and the West, yet in the field of Islamic finance, the West has embraced it with open arms".
Other News
The world's oldest Islamic bank, Dubai Islamic Bank issued its first sukuk on the Dubai International Financial Exchange (DIFX).
Minority shareholders of Rashid Hussain Bhd (RHB) want it to remain listed. Employees Provident Fund, the Malaysian state-run pension fund which will control RHB has said it will delist RHB but RHB Capital will remain listed.
ABN Amro Bank Bhd, the Malaysian branch of the Dutch banking group, plans to seek approval from Bank Negara Malaysia, the central bank, to open an Islamic subsidiary in the country.
AmIslamic Bank will offer takaful in Malaysia in partnership with Takaful IKHLAS Sdn Bhd and FWU AG. FWU designed the plan, Takaful IKHLAS will be the trustee and AmIslamic Bank will administer the takaful plan.
Hong Leong Bhd subsidiary Hong Leong Islamic Bank will team up with UBS to offer non-ringgit structured financial products which are Shari'ah compliant.
CIMB Group Bhd will open an Islamic private banking service in Malaysia.
Foreign banks will be able to buy Malaysian Islamic banks, but will not be allowed to operate transactions in ringgit.
Bank Negara Malaysia (BNM) signed a Memorandum of Understanding with Qatar Financial Center Regulatory Authority (QFCRA) and the Dubai Financial Services Authority (DFSA) to cooperate on capacity building and human capital development.
Malaysia will offer commodity-based murabaha as a way for banks to manage liquidity in the Islamic interbank money market (IIMM). The murabaha will be based on palm oil-based contracts.
Indonesia should follow Malaysia's example and reduce double taxation to spur the development of Islamic finance in the world's most populous Muslim country.
KPJ Healthcare Bhd plans to expand its healthcare REIT
Finance professionals applaud tax changes in the U.K. dealing with sukuk.
Wednesday, March 21, 2007
BNM issues Annual Report & Financial Stability Report
The Bank Negara Malaysia, the Malaysian central bank today issued the Annual Report and the Financial Stability and Payment Systems Report for 2006.
The Annual Report describes the significant development in the Islamic Interbank Money Market program:
The ijara sukuk is based on the transfer of Bank Negara Malaysia (BNM) assets (buildings and land) to a Special Purpose Vehicle (SPV) which purchases the assets with cash from sukuk issue and then leases the assets back to BNM and distributes the leasing income to the sukuk holders. At the maturity date of the sukuk, BNM repurchases the assets at a prespecified price. The sukuk will be used as part of the BNM liquidity management purposes in the Islamic Interbank Money Market.
The Financial Stability report describes the Islamic banking sector as well capitalized, in part because of higher pre-tax profits, and presents a pre-tax preliminary (unaudited) profit growth rate for the Islamic banking system of 9.6% over 2005. Takaful operaters also saw contributions and assets rise. Malaysia saw the growth of new Islamic banks, the conversion of some Islamic windows into Islamic banking subsidiaries and the licensing of two retakaful (Islamic reinsurance) firms. The Islamic financial industry saw increasing adoption of the Capital Adequacy Standards from the Islamic Financial Services Board (IFSB) and the launch of the Malaysian International Islamic Finance Center (MIFC).
The Annual Report describes the significant development in the Islamic Interbank Money Market program:
"A major development in Islamic money market operations during the year was the inaugural issuance of the Bank Negara Malaysia Sukuk Ijarah on 16 February 2006, with an issue size of RM400 million."
The ijara sukuk is based on the transfer of Bank Negara Malaysia (BNM) assets (buildings and land) to a Special Purpose Vehicle (SPV) which purchases the assets with cash from sukuk issue and then leases the assets back to BNM and distributes the leasing income to the sukuk holders. At the maturity date of the sukuk, BNM repurchases the assets at a prespecified price. The sukuk will be used as part of the BNM liquidity management purposes in the Islamic Interbank Money Market.
The Financial Stability report describes the Islamic banking sector as well capitalized, in part because of higher pre-tax profits, and presents a pre-tax preliminary (unaudited) profit growth rate for the Islamic banking system of 9.6% over 2005. Takaful operaters also saw contributions and assets rise. Malaysia saw the growth of new Islamic banks, the conversion of some Islamic windows into Islamic banking subsidiaries and the licensing of two retakaful (Islamic reinsurance) firms. The Islamic financial industry saw increasing adoption of the Capital Adequacy Standards from the Islamic Financial Services Board (IFSB) and the launch of the Malaysian International Islamic Finance Center (MIFC).
Subscribe to:
Posts (Atom)