Is Islamic bank consolidation picking up the pace?

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

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

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

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

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

Sukuk issuer quality, M&A, JAFZ downgraded

One of the areas of the Islamic finance industry that has been noticeable recently is the dearth of sukuk from non-high-quality issuers. This is particularly noteworthy in the GCC where a large supply of sovereign issues has not been followed by a comparable level of corporate issues. This trend was noted at a conference in Malaysia. The reasons commonly cited focus mostly on the pricing of sukuk and many even from sovereign issuers have priced considerably higher than they did prior to the financial crisis. With a pipeline of sukuk estimated to be $45 billion, a real recovery in the sukuk market should not be measured by the aggregate value of all sukuk, but by the ratio of sovereign versus corporate issuers.

Another area where the Islamic finance industry has yet to see much activity is in merger and acquisition activity between Islamic financial institutions. This is due to several factors, described well in the Yasaar Media Islamic Investment Banking 2009 report I summarized recently, but according to most industry participants there are simply too many Islamic banks and a majority of them are small. M&A activity could expand Islamic banks' balance sheets which would enable them to provide financing to more big projects as well as achieve greater diversification. in this light, it is noteworthy that Malaysian-based Bank Islam is reported to be 'actively seeking' a merger partner.

Jebel Ali Free Zone was downgraded by Moody's over concern about what support the Dubai government will provide to government-related entities. Jebel Ali Free Zone is a part of Dubai World. The downgrade puts a new light on the issue of valuation or illiquidity for the JAFZ Sukuk when looking at secondary market prices. Back in early February, I wrote a blog post on my blog at Zawya when the secondary market price was 66 . While the price has rebounded some to 77, that is still well below par and suggests that some price discovery may have been in fact occuring in sukuk secondary markets.

Other News

• Dow Jones Islamic Market Indexes named Tariq Al-Rifai, the founder of Failaka Advisors, to head its Islamic Index family following the departure of Rushdi Siddiqui last year to head Reuters' Islamic finance division.
  
• Gatehouse Bank combined two business units--its asset management and capital markets divisions--in the UK under new management to 'create an even stronger business' according to a company press release.
  
• Mayfair Wealth Management launched a Shari'ah-compliant UAE-focused distressed property fund and hope to raise $50 million.
  
• A UAE-based law firm Agha & Shamshi became likely the first Shari'ah-compliant law firm.
  
• South African fund manager has run into problems launching its planned Islamic equity funds, following the departure of its sole Islamic fund manager who remains as an external manager of their sole Islamic equity fund.
  

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.