When Dr. Zeti speaks, you should be listening

A few quotes and thoughts on Dr. Zeti Akhtar Aziz's speech at ISRA. 

Increased liberalisation and greater foreign participation in the Islamic financial markets are reinforcing this trend and resulting in increased cross border financial flows. This is contributing to increased international financial and economic linkages between nations, particularly among emerging economies.

The development of more cross-border financial flows by Islamic financial institutions is a big positive, and makes sense since Islamic finance is supposed to be focused on facilitating economic activity.  The European debt crisis, which has led to significant fall-off in import demand (not to mention the continuing slow growth elsewhere in the developed countries, means that developing countries are going to have to both focus on their domestic markets and other trading partners as sources of demand for their products.  If Islamic finance can provide financing for the trade flows--which should be a good fit with the products used in the Islamic finance industry, it will be beneficial.  The one area where it may be difficult for Islamic finance is where floating currencies are involved, since it is more difficult to hedge against fluctuations of currencies. 

These developments [the establishment of AAOIFI and the IFSB] have been particularly important to the recent intensification of the internationalisation of Islamic finance which in turn contributes towards building bridges and forging greater linkages among a wider range of economies.

 In this respect there is still more progress to make, since there remain concerns about the regulation of Shari'ah scholars, and no similar body to AAOIFI and IFSB to provide international Shari'ah scholar oversight, although it is being discussed. In one respect IFSB is much further along than AAOIFI in providing transparency in the regulatory standards under which Islamic financial institutions must abide, because it publishes its standards online, whereas AAOIFI does not.  Dr. Zeti does not mention this explicitly, but does highlight the need for: "greater leverage on technology for the active dissemination of information at real time further facilitates the harmonisation process."

She then moves on to globalization in Islamic finance:

In the recent years, the intermediaries have also gained scale and the financial markets have gained depth and maturity.

I would take issue to some degree with Dr. Zeti regarding the depth and maturity of Islamic finance markets, although from her perspective as the central bank governor in Malaysia, she does deserve a pass on this issue.  The Islamic finance market in Malaysia has developed considerable depth and maturity, enough so that it is attracting attention from companies in the GCC (mostly banks), who have looked east to tap more liquid markets, even though it exposes them to currency fluctuations (some of the banks are using the Ringgit markets to avoid currency risk where they have subsidiaries operating in the local Malaysian market). 

However, even some GCC markets have showed they are maturing as the prospect of default by Dana Gas on their $1 billion sukuk attracted some media coverage, but not the same level of concern as when Nakheel was seen at risk of defaulting on its sukuk (a key difference of course is that Dana Gas is a private company while Nakheel's first sukuk was backed by Dubai World, a quasi-sovereign entity). 

The speech shifts into high gear from here, when Dr. Zeti warns that " Its resilience during the global financial crisis should not result in complacency."  This is an important point and mirrors what the IFSB said in response to claims that Islamic finance was immune from financial crisis.  There is a consensus now which disputes the optimistic claims that Islamic finance was not touched by the financial crisis because its structure is fundamentally different than the conventional financial industry. 

It was not necessarily the complex products (CDO, CDS, etc) that ultimately led to the major bank failures, but was instead a failure in the markets of their assets, and doubts about their value, combined with the inherent leverage of the products themselves which dried the market up and took away the ability to use their assets as collateral in repo markets to meet liabilities as they came due.  A dramatic fall in the value of a firm's assets, whether those are complex derivatives or equity-based products, will lead counterparties to question the solvency of any financial institution, Islamic or conventional.

This lack of confidence will spread at a speed in direct proportion to the levels of leverage employed in the balance sheet, and the degree to which the bank is subject to possible liquidity crunches either from depositors with current accounts or other counterparties providing short-term debt.  The inability to access liquidity and the inability to roll over maturing short-term debt (a drying up of interbank liquidity) led to the conventional banks' failures during the financial crisis and could lead to a similar failure in the Islamic finance market as well since it was the liquidity, not the toxic assets, that were the ultimate reason for the failure.

Islamic finance remains vulnerable to a liquidity crisis because 1) there is limited inter-bank lending, 2) nearly no interbank repo, and 3) few options for the central bank to act as lender of last resort (except ad hoc means like the wakala deposits the UAE Central Bank placed with Islamic banks during the crisis).  The lesson from the financial crisis is that when an asset price falls that triggers a fall in the value of your assets and questions about your solvency, the line between survival and failure is the degree to which the financial institution is leveraged (where the debt acts to magnify losses, just as it does profits) and the degree to which you rely on short-term financing (either deposits or inter-bank financing).  Higher leverage and greater liquidity needs lead to a greater likelihood of failure.

Dr. Zeti then goes to highlight the linkage between Islamic finance and socially responsible investing (which I have highlighted before on this blog):

First is the need to highlight with greater clarity the value proposition of Islamic finance so as to ensure that it remains a form of financial intermediation that serves the real economy and that it will continue to be a benefit to society. This requires the development of financial products and services that manifests the value propositions of Islamic finance, and that such products are marketed with simplicity so as to facilitate a greater understanding of the main benefits of the products. In relation to this, Islamic finance presents significant appeal to the growing Socially Responsible Investment (SRI), sustainable investments and ethical finance. This is particularly relevant in the context of the recent global financial crisis. It [the financial crisis] has brought to the forefront the need for the financial system to be linked to the economy and for the need for greater and improved levels of transparency, fairness, ethics and social responsibility in modern finance.

Beyond financial returns, SRI also accords primary consideration to the impact on economic activity and on the broader society, thereby incorporating the important dimensions of environmental sustainability, social responsibility and governance. This is in close parallel with the inherent principles of Islamic finance, in which financial transactions must be underpinned by real economic activities, and its operations are guided by the principle that money should also be used to create social good.

Then she moves on to another favorite topic of mine, Islamic microfinance and a focus on making Islamic finance inclusive:

The second imperative is for the outreach of Islamic finance to be inclusive and to be accessible to all, particularly the lower income groups and small businesses. An important agenda in the global economy is to achieve a more balanced growth with reduced income disparities. Financial services has a tremendous role in contributing towards a more equitable economic growth and a more sustainable development. In relation to this, Islamic financial institutions need to strive to enhance the access of their financial services to all segments of society. This imperative translates into the need and demand for more Islamic microfinancial products. In emerging as a new market niche, Islamic microfinance would meet the differentiated demands of low income communities and provide support to entrepreneurial activities. Its strong value proposition reinforced by financial inclusion would result in significant potential to uplift the economic performance and development. Furthermore, Islamic microfinance, if supported by microtakaful, has the potential to provide a more comprehensive, sustainable and accessible financing and protection solution for the lower income groups and small businesses.

I have said it before and I will say it again, Dr. Zeti's speeches are almost always required reading and she has a knack for making important points rather than repeating the same platitudes that are too frequently repeated.  This should be commended, and also serve as a reminder that when Dr. Zeti speaks, you should be listening.

Priorities in Islamic finance

Rushdi Siddiqui asks a question he has asked before (and which I have written about before) about whether Islamic finance is missing a focus on microfinance and making institutions whose focuses include social responsibility (a focus on environmental, social and governance, or ESG, metrics, in addition to profits).  When I talk to people about Islamic finance, one of the areas that sparks the most enthusiasm is Islamic microfinance, and using Islamic finance as a way to broaden financial inclusion.

Yet, there is too little attention paid to these issues by Islamic financial institutions, where the focus is more on creating new alternatives to conventional products like allowing brokerages to offer 'Islamic margin accounts'. There is a demand for these products, I'm sure, and they help Islamic financial institutions compete with conventional brokerages for business, but is that the best use of resources for broadening Islamic finance?

Why not help new initiatives to reach the broad majority of Muslims who are not thinking "well, can an Islamic brokerage allow me to make leveraged bets on stocks?" but are instead thinking "I want to use microfinance to start a business, but I don't want to be involved with an interest-based microfinance institution".

There are new Islamic microfinance institutions starting up, including one, the Zayd Chit Fund in Bangalore, India (a form of rotating savings and credit association, or ROSCA), which launched last weekend, in a market that has huge potential for Islamic finance, but where political constraints have limited the ability of large Islamic financial institutions to enter.  What better way to enter the market than to go support (financially and with technical knowledge) the development of Islamic microfinance institutions, including Shari'ah-compliant chit funds.  It provides a way to enter a large, untapped market, and a way to show that the Islamic bank is focused on more than just the next quarterly earnings report. 

The Islamic finance industry is vast and rich with resources and talent (although, as many have noted, not as successful in finding jobs for the recent graduates).  It is also by its nature supposed to be concerned with providing ethically-based financial services that do not just preserve wealth for those who have it, but also in providing opportunities for people who, with an oppportunity, can create wealth, and jobs. In addition to providing banking products for higher-income people and those with significant wealth, it should also support financial institutions that provide for people with lower incomes or with no access to Islamic finance.  Not just because it makes nice PR material, but because it will help attract and retain talented employees, and will create a market of people familiar with Islamic finance who will then look to Islamic banks for services into the future.

Cooperation between the Asian Development Bank and IFSB may help the growth of Islamic microfinance

I was interested by the Asian Development Bank's decision to work with the Islamic Financial Standards Board over a five-year period to "support member countries in legal and regulatory aspects of meeting the IFSB's standards".  The reason cited by the ADB is that the majority of the IFSB's membership is located outside of the three countries with the largest Muslim populations (Indonesia, Pakistan and Bangladesh, which are home to only 7 members).

The development of Islamic finance has naturally occurred in countries that have either decided to extensively promote Islamic finance (like Malaysia) or countries where there is a large number of ultra-high net worth Muslims because that is where the profits are likely to be easier to come by.  With more resources to be potentially tapped by Islamic financial institutions, it will attract larger institutions that can provide the scale needed for Islamic finance to become large enough to reach the scale where it becomes profitable.  

As I wrote in my newsletter (which you can subscribe to on the right side of the blog), the recent decision by HSBC Amanah to leave many of the markets where it operates is a recognition that the bank is so large that many of the markets where Islamic finance exists are not large enough to support a bank of its size (and also move the needle in terms of its profitability).  

HSBC noted that although it is leaving 6 of the 9 markets where it offered Islamic banking services (with most post-restructuring business based in either Saudi Arabia and Malaysia), it expects to retain 83% of the pre-restructuring revenues. Included in the markets it is exiting are Bangladesh (it will remain in Indonesia, although with a limited presence), two of the three largest Muslim-majority countries in the world. 

Islamic finance exists already in Pakistan, Indonesia and Bangladesh, although these countries represent a small portion of total Islamic finance assets, with no countries appearing in the 9 largest countries (according to data as of the end of 2010 from The Banker, included in the UK Islamic Finance Secretariat's 2012 report).  The assets outside of those 9 countries accounts for just $83 billion, 8% of the total Islamic finance industry, even though 570 million people, most of them Muslim, live in these three countries. 

It boils down to a simple point.  Islamic finance, like conventional finance, is by and large not focused across the wealth distribution, it is targeted at people of moderate or high net worth.  And where microfinance has developed to provide financial services to those without significant wealth, there has been limited development of Islamic finance and it has not received much support from the Islamic finance industry.  The ADB helping countries adopt IFSB standards will not change this, but by supporting Islamic finance in countries where it is not well developed, and where there is likely to be demand for it, it may provide the governments with greater familiarity with Islamic finance that is a precondition for adopting regulations that could allow Islamic microfinance to develop. 

Goals for Islamic microfinance institutions

The Farz Foundation is working on Islamic microfinance in Pakistan, although I do not know much of how it works.  However, a paper they released in July led me to a few points that are applicable more broadly in Islamic microfinance.

A few quotes from the report with comments

"The foundation operates in Pakistan, currently has approximately 100 active clients, and is seeking to expand microfinance operations using the Farz methodology into other Muslim countries. "

 I think it is great to develop Islamic microfinance to provide alternative financial service models for people dealing with poverty, but with such a small group so far, I think it might be more advantageous for Farz to focus its efforts domestically where there is still significant demand, which also can avoid the problems of becoming unfocused, which is likely to act to the detriment to expanding Islamic finance.  That should not mean not sharing things that worked and things that didn't with other emergent Islamic microfinance institutions elsewhere in the world, particularly in other majority Muslim countries. 

"The basic premise of this is that interest is one of the major reasons for keeping the world’s poor trapped in a vicious cycle of debt and poverty. "

 I think this is a distraction from the point of Islamic microfinance.  Islamic finance is based on the idea that interest-based finance is damaging to economies, but it is not the cause of most poverty.  Most people struggling with poverty are completely excluded from the finance sector.  There are likely informal financial services available with high interest, where the debt is doubled and re-doubled, and this probably does do harm, even as it is in demand because there are no alternatives.  However, in Islamic microfinance, it is less important whether interest is a cause of poverty than if Islamic microfinance can help.  Re-engaging in this debate will create more questions about how Islamic microfinance is different (particularly when murabaha or muajjal are the financing methodologies) rather than letting it stand on its own. 

"A key component of the microfinance products provided by Farz Foundation is the Islamic concept of Bai muajjal-murabaha [...] Farz Foundation has applied Mudarba (a partnership based product in which Farz provides livestock and the poor farmer provides her or his services to nourish the livestock ) to cattle and livestock rearing with significant success in both Pakistan and south Cameroon. "

 I think this balance between murabaha and mudaraba is healthy for the Islamic MFI sector since murabaha is likely to be a common structure used, whatever the controversy may arise around the preference towards it versus mudaraba.  It can also provide a financial service that may be useful for some clients, and they should get access to Shari'ah-compliant products even if mudaraba may be preferred.  Murabaha can be an easy way to get people involved with Islamic microfinance by showing the similarities with conventional microfinance, while still offering an alterantive if mudaraba is available.

"In all potential countries where Farz seeks to operate, it must develop profit-generating self-sustaining business models. The ultimate aim of Farz over a 10 year period should be to eliminate or drastically reduce dependency on external funding sources."

 This is a key goal for Islamic microfinance (not to mention conventional microfinance) and should be a focus at all stages of development.  Islamic MFIs may not be profitable right away, and there are good reasons to operate in a not profitable state for a while, but the long-term (not immediate) goal should be self-sustainability so that Islamic MFIs will be around in perpetuity, focused on their clients, not finding external funding just to keep operating. 

The conclusions I reach from the report are:
1) Stay focused on the core market to expand access, but work with Islamic MFIs around the world to spread good ideas and failures.
2) Avoid litigating the causes of poverty; focus on solutions
3) Be open to replicating conventional microfinance using murabaha, muajjal and salam while developing additional products like mudaraba.  The former are needed to be able to provide service while the latter will be what differentiates Islamic microfinance
4) Don't try to make a profit the first year, but stay focused on making the Islamic MFI financially self-sustaining

Islamic cooperatives in Indonesia look for apex organization

Several Baitul Maal wa Tamwils (BMTs), small, lightly regulated Islamic microfinance cooperatives in Indonesia, asked the government to set up an apex institution for BMTs in the country.  In a paper from 2007, Hans Deiter Seibel described (in a paper presented at a microfinance seminar organized by the Harvard Islamic Finance Project) the BMT in existence as:

Islamic financial cooperatives suffer from the same regulatory and supervisory neglect as the rest of the sector. There is not much difference between Islamic and conventional cooperatives. At most one-fifth of Islamic cooperatives are in reasonably good health. The majority are dormant or non-performing; most of the remaining ones exist for the purpose of receiving funds from the government. The Ministry of Cooperatives does not register cooperatives as Islamic or conventional and provides no information on, or special assistance to, Islamic cooperatives.

The BMTs petitioning the government for an apex organization seem to be focusing on the important issues described above.  According to a rough translation: "With the apex, more scalable performance and BMT may be more developed. Absence of functioning as an apex institution to make our activities, such as financing and distribution of the velocity of money that we manage, unrecorded and unsupervised". 

Very small microfinance institutions--both conventional and Islamic--that operate outside of a suitable regulatory structure, as well as not having an apex organization, are likely to be less beneficial to their cooperative members because there is a greater potential for the organizations to fail, as well as for money to be stolen by unsavory people being allowed to work within them.  As Seibel concluded after on-the-ground research: "Unsupervised Islamic, like conventional, cooperatives are an outright menace to their member-shareholders and depositors, who risk loosing [sic] their money".

There are also several advantages for the cooperatives and their members from having an apex organization: mostly dealing with lowering costs.  If MFIs (conventional or Islamic) are responsible for collecting, managing and safeguarding deposits, as well as providing financing, and administering the collection of the repayments from clients, they will have difficulty without a system for tracking information internally, which will be costly.  This cost will eventually be borne by the cooperative members of the BMT. 

A lot of these functions can be more cheaply provided through an apex institution that will spread many of the costs across a larger number of institutions, as well as making it easier for effective regulation of the BMTs, something which was--at least at the time when Dr. Seibel was doing research on the BMTs--much needed. 

Takaful provider looks to microtakaful for growth

"Ghassan Marrouche, chief executive of Takaful Emarat in the United Arab Emirates, said his company was expecting double-digit growth rates in coming years, supported by the launch of several new products including a capital-protected instrument and a “microtakaful” product focused on low-income earners." 

The quote above is one of the most encouraging I have seen for the development of Islamic finance, if it is sincere.  It represents a relatively unique statement by an Islamic finance company that they can profitably move down the economic ladder as a way to expand their business.  It makes sense that this would occur with a takaful provider because there are fewer opportunities to grow their business quite as far as with Islamic banks or wealth management companies (you only need so much insurance, but you can be sold a much wider number of other financial products).  

In order to continue their rapid growth takaful providers should realize (and may be realizing) that they need to develop products to offer to lower-income people.  However, when these products are developed, they should be done in a way that offers a useful product, not just another high fee product to pad the income statement of the takaful provider.  

But the important point in the discussion is that Islamic financial institutions need to assist microfinance institutions (including those providing micro-takaful).  It will provide a much larger market to support decades of growth into the future. 

A few items that slipped through the cracks

There have been a lot of articles sitting in my feed reader and I won't have time to write more in depth on the topics, but here are the links with quick summaries.  

Size of Islamic finance industry
The City UK released its latest annual report on the Islamic finance industry showing the industry has $1.3 trillion in assets.  I hope to have more detail on this in another post when I have time to read it.

The Malaysian Islamic finance banking industry reached 22.4% of the country's total at the end of 2011.  Despite only having 15% of the outstanding USD-denominated sukuk issuance, it has one of the best developed (i.e. liquid) sukuk market, based on a lot of domestic MYR-denominated sukuk, but still showing that size isn't everything. 


Shari'ah standards
A conference participant suggests that investors and advisors should do their own Shari'ah research instead of waiting on a Shari'ah board to provide a fatwa.  Not much chance of happening, but interesting to see new perspectives. 

Goldman Sachs
Reuters gives the latest update on the Goldman Sachs murabaha sukuk which has attracted a lot of criticism, saying that the Shari'ah advisors have signed off and the ball is in Goldman's court.   I offered my perspective on the trading issue with a murabaha sukuk in an earlier post. 

IIFM-ISDA
The ISDA press release is available here for the new Mubadalatul Arbaah master agreement.

Australia
The National Bank of Australia is considering a $500 million sukuk issuance, the first from the land down under, as Islamic finance begins to develop in the country.

Hong Kong
HK returns to its work on attracting Islamic finance.  Despite expressing a desire to become an Islamic finance and sukuk hub, Hong Kong has not progressed far with the only issue coming from RMB500 million ($79 million) sukuk from Khazanah. 

Indonesia
The Indonesian government issued its first 4 series of project-based sukuk, although only the 30 year sukuk received bids accepted by the government.   Out of a 2.18 trillion rupiah ($237 million) in total bids, only 355 billion rupiah ($38 million) was accepted, all for the PBS0004 issue due 2037.

Microfinance
A microfinance product that offers a deposit product and interest-free loan program rolled into one.  When will Islamic finance get behind Islamic microfinance in a big way?

Do Islamic financial institutions care about Islamic microfinance?

The CGAP microfinance blog highlights the lack of progress in developing laws to facilitate microfinance since the Arab Spring. One point the post makes is that "The irony in all this is that only in Syria and Yemen, two countries still heavily affected by the uprisings, did the governments sanction savings mobilization by MFIs meeting minimum standards." 

It is interesting to me that in both these countries where microfinance was sanctioned by the governments there have been Islamic microfinance institutions, in Jabal al-Hoss in Syria and Hodeidah in Yemen.  There is still much to do in both countries, and in both countries there are more pressing needs with the departure of Ali Abdallah Saleh from Yemen and the continued fighting in Syria against Bashar al-Assad. 

However, despite the continued unrest in both countries, there have been examples of demand for Islamic microfinance which suggests that there is probably demand in other countries where the Arab Spring has run its course.  These countries should move forward on both conventional and Islamic microfinance development as a top priority.  Some may point out that there are more weighty concerns in the forefront today, but I would argue that the development of programs to provide economic opportunities should be at the forefront because the Arab Spring largely arose out of one man, Mohammed Bouazizi, very publicly died after setting himself on fire due to having his livelihood snuffed out by the police when they confiscated his fruit crates and electronic scale. 

It is fair to question whether Islamic microfinance is well developed enough to be moved to the top of the agenda alongside conventional microfinance.  However, with so many resources being devoted to developing the (macro) Islamic finance industry, there should be an equivalent commitment to developing Islamic microfinance.  Today, two of the biggest Islamic microfinance programs are being facilitated with funding for technical support from the US international aid agency USAID in Afghanistan and Iraq.  Where are the Islamic finance institutions who claim to embrace corporate social responsibility, ethical finance and a concern for the poor in laying the groundwork for Islamic microfinance to develop across the MENA region after the Arab Spring? 

Experimental evidence on Islamic microfinance in Egypt

From this week's newsletter (sign up on the left side of the page):

Continuing on the microfinance theme from last week, I came across a paper by Mahmoud El-Gamal, Mohamed El-Komi, Dean Karlan and Adam Osman which developed and tested a Grameen model and a "bank-insured RoSCA" in Egypt to see whether one was superior to the other in attracting clients and ensuring repayment.  The bank-insured RoSCA (rotating savings and credit association) is a slightly modified form of the traditional RoSCA where each participation contributes regularly and each period, one member receives the contribution.  In the modified form, the bank will collect a premium from the participants and if one of them does not pay the contribution, the bank will step in and make the payment and that participant will owe the bank.  It is viewed by the authors as a simplified credit union.  

Their test was focused on determining whether the RoSCA would lead to better, worse or the same take-up by participants, as well as whether it would lead to more frequent repayment.  To do so, they used real money in an experimental setting with participants who shared the same demographics as a typical microfinance client (in a country with a large enough Muslim population that a portion would be expected to turn down the Grameen loan because it required interest payments).  However, they did not include any factors that would affect the return on the investment that participants theoretically made (the investment was predetermined to have a certain return).

The reason for the higher frequency of repayment in the RoSCA model is that the loans between participants is interest-free. It will not benefit the participant to renege when the social cost of default is more than the amount of the loan (in the Grameen model, that tipping point is higher, at the amount of the loan plus interest).  In addition, when the social cost of default (which applies to the single defaulter alone) is lower than the loan amount, the bank (which guarantees the RoSCA, and to whom the defaulter becomes a debtor) can raise the cost of the penalty (which applies to both participants) to a level where default by a participant no longer becomes attractive.  

In practice, this was borne out in their field experiments.  The RoSCA attracted greater levels of participation and also had lower probability of default, which is what the game theoretic model predicted.  It creates one data point, albeit under simplified assumptions, for how a RoSCA could be used as an alternative to the Grameen model of microfinance, and perhaps even expanded in the future into larger, more formal financial institutions similar to credit unions.  It will be interesting to see what research develops out of this paper--either from the co-authors or from other researchers.  

Link: http://www.uh.edu/%7Eachin/workshop/EMF-04-11.pdf

Product mix in Islamic banks in Indonesia

The Islamic finance market in Indonesia has been growing rapidly, albeit from a small base, and remains far behind Malaysia in significance in the financial system overall. Malaysia has over 20% of the financial system in Islamic financial institutions, while Indonesia has just under 3.5% market share. A recent report by Rifki Ismal (from the Directorate of Islamic Banking at Bank Indonesia), "Islamic Banking in Indonesia: Lessons Learned," which was presented at the UNCTAD Multi-Year Expert Meeting on Services, Development and Trade: The Regulatory and Institutional Dimension held April 6-8, 2011 provides an interesting overview of the banking market in Indonesia, and specifically on the differences between the product mix between equity- and debt-based products.

The Islamic banking market is different in Indonesia than in many markets because there are far fewer products used compared to the GCC and Malaysia. According to Mr. Ismal, this limited product development is due to restricting contracts to those that are "all confirmed with Sharia". He notes that "Indonesia does not implement debatable contracts such as bay al dayn, bay al innah, tawarruq, bay al arbun and bay al wafa". Of these contracts deemed debatable, bay al dayn and bay al innah are nearly exclusively used in Malaysia. The product that has attracted the most attention is tawarruq, which was deemed non-Shari'ah-compliant by the OIC Fiqh Academy in the way it is currently practiced.

According to the report, the contracts used in Indonesia are mudaraba and musharaka (equity-based products) and murabaha, salam and istisna'a (debt-based products). These products are useful in many aspects of Islamic finance, but limit the variety of products that can be offered by banks. This is not necessarily always detrimental because it can check the growth of controversial products (e.g. Shari'ah-compliant credit cards). However, there are limitations by imposing limitations on the products because they will have a more difficult time competing with conventional financial institutions. The conventional banks--with a wider variety of products--can address customers needs in more different economic situations than Islamic banks.

The one bit of data in the product mix in Indonesia compared to other countries is the relative shares in equity-based and debt-based products. According to the report, roughly 1/3rd of the financing is equity-based means (mudaraba and musharaka). I don't know how to explain this difference. One thing that really is striking is the lack of Islamic investment banks:

"However, almost all of Islamic banks in Indonesia are retail banks which extend financing directly to real sector. The Islamic banking industry from other countries contains some investment banks which seek profit from trading Islamic securities in Islamic money market, Islamic capital market and Islamic stock market. The ideal practices of Islamic banks should directly extend funds to the real sector and seek profit directly from the robust performance of the real sector."

On the one hand, shifting the focus away from investment banks should lower the share of debt-based products because most Islamic investment banking (e.g. sukuk) creates Shari'ah-compliant alternatives to debt. However, the focus on retail banking seems out of line with a high rate of equity-based financing because it would appear to be even more costly to monitor these products (to limit losses from the well documented problems aligning incentives between the customer and the bank).

Just as the product breakdown differs between Indonesia and the rest of the world, so does the institutional setting. Most Islamic financial institutions around the world are (relatively) large institutions. Even the numerous smaller players are small mostly in comparison to other commercial banks. Indonesia, however, has commercial banks (11 full Islamic banks and 23 Islamic banking windows, according to the report) in addition to many more (151) Islamic rural banks, which are much smaller institutions than the commercial banks and, in addition to providing localized banking services in rural areas also provide Islamic microfinance. They are much different than the typical Islamic financial institution worldwide, which may provide some explanation for the differences in product types used in Indonesia.

There were many other interesting ideas presented in the paper presented at the UNCTAD conference, but the difference in breadown of product mix was the most stark to me. There are no firm estimates for product mix in other countries, but the general rule of thumb is that between 90 and 95% of the products used elsewhere are debt-based, with the remainder being equity-based (and possibly a few non-financial products like qard).

Incorporating Islamic finance into a sovereign wealth fund

FT Tilt, an emerging markets blog (one I recommend), has a article about the Qatar sovereign wealth fund and the more aggressive posture it has taken compared with the Abu Dhabi Investment Authority. The article compares the track of the Qatar Investment Authority with that of the Dubai World private equity subsidiary Istithmar and quotes another blog:

"They did not want to own 20 million shares of Costco, they wanted to own Barneys. They didn't want to own six dozen holiday inns in the Midwest [US], they wanted to own the W Union Square in New York. They didn't want to own 3% of Federated Investors they wanted to own Perella Weinberg and GLG. For the powers that be in Dubai making levered investments into high profile companies was part of building 'Brand Dubai.'"

As they note, the Qatar Investment Authority has not taken nearly as aggressive an approach as the brand-driven Dubai fund, but if the global economy continues to recover, it may be tempted to take a similar approach (although probably with less leverage than Istithmar given the "New Normal").

An alternative "brand-driven" approach for the sovereign wealth fund would be one based (at least in part) on Islamic finance. While it is relatively small ($60 to $80 billion) compared to Abu Dhabi's sovereign wealth fund, it is still large enough to be selective in its investment decisions to avoid the types of investments that brought Dubai World to the brink of default. In the process, it could use its clout to force the investment banks bringing deals to strip out extra costs normally associated with Islamic financial products.

This would add value not only to the Qatar Investment Authority but also to the industry as a whole. While doing so, it should avoid the pitfalls of capturing "landmarks" but instead creating opportunities for others. For example, instead of subscribing to sukuk on its own, it could focus on taking a 'lead investor' position in sukuk from GCC companies as well as global companies interested in 'jumping the gap' into Islamic finance. More helpful (both to QIA in the long run and other investors), it could adopt the approach of creating liquidity in secondary markets by selling a portion of its allocation in secondary markets in sukuk with significant investor demand.

This would have the advantage of capturing some gains in sukuk that see high investor demand but would also spur secondary market development in sukuk generally (and free up capital to buy in other secondary market issues). More liquid secondary markets benefits sovereign wealth funds not only in assessing market values for sukuk they already hold, but also by providing opportunities to diversify their holdings and move between different sukuk. Most bond fund investors already do this with conventional bonds, but it is currently much more difficult to do with sukuk, particularly where investors are looking for larger volume trading opportunities.

In addition to sukuk, a move into Islamic finance could create an opportunity for the QIA to contribute to broader social goals within and outside of Qatar through Islamic microfinance. Many Istithmar investments (like the W Hotel) were "status" purchases. They may have been viewed as solid investments pre-crisis, but the acquisitions were done with secondary motives in mind (building Brand Dubai). If secondary motives are included in the investment decision, shouldn't they do more to contribute than just through the acquisition of landmarks? Qatar have been working in other areas to increase its global profile in arts, culture, media and diplomacy. Blending a poverty reduction strategy into a sovereign wealth fund that incorporates Islamic finance seems like a good way to build credibility for both Qatar and Islamic finance.

What microtakaful needs to grow

Reuters reports that Tokio Marine Middle East is considering offering microtakaful in Egypt where it already owns 2 of the 8 takaful companies. The article specifically suggests that microtakaful could be offered for life, disability and accident insurance as well as livestock and crop insurance. Takaful is a Shari'ah-compliant form of insurance similar to mutual insurance where the takaful policy holders' premiums are invested separately than the firm's capital to cover the expected claims.

There is definitely a role for microtakaful to play alongside of Islamic microfinance because it will limit the chances that death, injury or a natural disaster (unpredictable events) could cause the MFI client to be unable to continue either their microbusiness or the payments on items or services financed by an Islamic microfinance instutiton. Even on the conventional microfinance side, there are many fewer institutions that offer microinsurance compared to the number offering microfinance (or more specifically microloans).

The CEO of takaful for Tokio Marine Middle East offered his case for microtakaful in an article from July 2010 in the Middle East Insurance Review (page 60-61, available as a pdf).

One issue that could become problematic for microtakaful firms is that in the absence of retakaful, the institutions could find it difficult to manage the claims when they are most likely to be made (and most likely to be needed by takaful members). Some of the risks that are insured against by microtakaful companies, specifically death, natural disaster and agriculture losses (including livestock) are likely to occur for many takaful members at the same time if the microtakaful firm is small and geographically undiversified.

For example, assume that 1,000 people in one region of a country form a takaful company that pays out $2,000 if a member dies, $500 in case of crop loss and $100 for each animal that dies. In exchange, each member pays $2 per month (these numbers are not based on any specific case). The takaful company estimates that it will have claims of 5 individuals who die, 10 cases of crop failure and 50 animal deaths. This would lead to the company collecting $24,000 per year in premiums and paying out $20,000. The surplus gets carried over to future years. In normal years, this works fine and the fund builds up assets.

However, imagine that a drought hits the region and causes widespread crop failures and animal deaths with also more people dying than in a normal year. Assume, for example, that there are 100 crop failures, 25 deaths and 250 animal deaths. This would cause the claims to be $125,000, compared with only $24,000 in premiums. Based on the normal years before (with $4,000 in surplus every year), it would take over 25 years of "normal" years to cover the extra loses from the one bad year. If that bad year happened in year 4, the takaful company would be unable to fully pay claims and without the benefit of retakaful (or a larger parent company with operations across many regions and countries), it could fail to support its members when they need it the most. A few failures of microtakaful (or conventional microinsurance) companies could hurt the aacceptance of microinsurance because of their vulnerability to catastrophic events.

Unlike Islamic microfinance, which will be affected by catastrophic events because of widespread business failures, the failure of a microtakaful company because of a widespread event which causes the failure is directly connected to what the company is offering protection against (rather than being a casualty of an unrelated external event.

The point of this long tangent from the initial story about the prospects for microtakaful in Egypt is that there is much more infrastructure needed to set up microtakaful in one country or region within a country than just opening the microtakaful company. If the macrotakaful industry wanted to assist microtakaful institutions, perhaps the best way would be to provide retakaful to microtakaful providers. Even if they cannot fully diversify the retakaful coverage they offer, it could be a diversification tool for their overall risk profile because the likelihood of a catastrophic event happening in one part of the world is unlikely to affect claims by their customers in another part of the world.

Thoughts on Islamic microfinance

PBS, the American public broadcasting network, had a segment on Islamic microfiance in Pakistan and there were a couple points that I thought were worthy of a further understanding.

"There’s a lot of compatibility between the notion of Islamic finance and microfinance. That’s how I see it, very simply. The first is you only do productive lending. In Islamic finance you cannot do consumer lending, for example. Similarly, in microfinance we are not really in the business of consumer lending. The second thing is you support the business itself, so you have to do a very detailed analysis of returns from the business."

This is not necessarily true. Islamic finance is easily adaptable to consumer finance, whether through tawarruq or through murabaha for consumer purchases. In microfinance, that is not necessarily a problem; there is no reason why low-income borrowers should not have access to consumer finance. Indeed, excluding consumer finance from Islamic microfinance won't reduce the debt burden on the clients. They will just find it elsewhere, often at higher cost.

However, the story does make a good point that the ability of borrowers to access finance from multiple microfinance institutions (MFIs) can lead to crisis for borrowers (and lenders) like it did in India recently. Without any way to gauge the client's other indebtedness other than just asking the client, there is a possibility that over-agressive lenders can give clients the opportunity to overextend themselves. Initially, this is to the benefit of the MFI, but when the debt load becomes unsustainable, the MFI will lose as well.

This is a problem that Islamic finance cannot solve on its own and I think the solution to the problem can be used by both Islamic and conventional MFIs, to the benefit of the institutions and the clients. There should be an organization that collects information on all the microfinance loans extended by all MFIs, organized by client. There will need to be significant effort and expense incurred to create and maintain this database, and make sure it maintains the client's privacy (just as consumers trust that the information reported to credit agencies in the West expect that their information will be protected).

However, unless each MFI is able to accurately assess the amount of debt each client has and is required to consider this in the lending decision, there will be problems in the future of MFIs unwittingly contributing to overindebtedness of clients, with predictable results. The problem is significant; avoiding measures that allow and require MFIs to consider the ability of clients to repay the financing they are provided will lead to more crises in MFI that will harm the reputation of microfinance.

The other issue is more relevant to Islamic microfinance. The reporter notes that:

[Clients] must share the high administrative costs. Borrowers pay an effective interest rate of about 35 percent. Zafar says it’s the only way to sustain the model, because Kashf has to pay between 14 and 16 percent on the money it borrows to make loans.

On this issue, there are ways that Islamic microfinance can create a unique model to reduce the cost of microfinance to clients and, in doing so, can increase the involvement of Islamic banks and financial institutions in microfinance (enhancing their corporate social responsibility in the process).

Islamic banks that receive impermissible (haram) income, either from aspect of their financing activities that their Shari'ah boards determine are non-compliant or from charging late fees to clients to encourage on-time repayment. On the latter issue, they are permitted to charge late fees, but generally are not allowed to recognize them as income and are required to donate this income to charity.

One possibility is that Islamic financial institutions could donate this non-permissible income to a cash waqf. To avoid conflicts of interest, the waqf would be independent of the institution and to increase efficiency in its charitable use, the waqf would pool donations from many Islamic financial institutions. These funds could then be used to provide qard hasan financing to Islamic MFIs, which would lower their cost of funds from 14-16% as the article describes to 0%.

Another alternative would be for the waqf to invest directly in Islamic MFIs to provide capital on a mudaraba basis (an equity investment), which would provide funds to expand the very limited Islamic microfinance industry. Most likely, both alternatives would be used. The continuing cash flow from Islamic finance institutions' non-permissible would serve to increase the size of the waqf, as well as to replace any funds lost from qard investments.

This source of funds from Islamic finance institutions, on which no return is expected or likely even permitted, would provide a source of finance for Islamic microfinance institutions that could lower the costs to the end-client, expand them as well as make them more competitive with conventional MFIs. It would also serve as a way to distinguish Islamic (macro-)financial institutions from conventional financial institutions which must bolt-on the corporate social responsibility and for whom CSR is competing for funds internally; this model funds the CSR with income that the bank is not permitted to recognize and must donate to charity.

The Islamic microfinance industry is underdeveloped and under-recognized in the broader Islamic finance industry. Yet, it plays an important role in poverty reduction and social justice that are important parts of the underlying reasons for the rules governing Islamic finance derived from the Shari'ah. Finding a way that Islamic banks and other financial institutions can help this segment of the industry without sacrificing their own competitiveness with conventional banks should be an important focus as the global economy returns to growth.

Islamic finance in Afghanistan

Bloomberg has an interesting article on the proposal to allow Islamic banks in Afghanistan. It would certainly have a market with the large Muslim population in Afghanistan. However, I foresee problems that could impact both Afghanis and the Islamic finance industry for a growing (albeit small) Islamic banking market in Afghanistan.

The first problem is whether creating commercial Islamic banks as a concept in a country that is still largely at war and where regulation is likely to be difficult (at best) will pose problems. It is not that Islamic banks require more supervision than conventional banks, but even in relatively stable societies, early experiments with Islamic banks have seen unscrupulous people come in promising to provide Shari'ah-compliant banking only to create "affinity fraud" (e.g. the various Ponzi schemes in the 1980s in Egypt that were promoted as Islamic banks). This is always a problem (for example, the alleged Sunrise Equities fraud in Chicago, Illinois), but in a country where the central government (let alone banking regulators) have limited control over some areas, it could become a serious problem. If this type of fraud became commonplace, it could create a general suspicion of "Islamic" banking generally and could hinder the growth of the industry if the country stabilizes.

The second is whether Islamic banking, by virtue of light regulation from a distant central bank and national center of regulation, could become captured by people who use it as a way to launder money or otherwise fund terrorism, either by the Taliban or other groups. This would create "evidence" (note the quotes around the word) that Islamic finance is nothing but a form of covert jihad that the anti-Islamic finance groups could use to try and discredit Islamic finance globally and use to limit the growth of Islamic finance particularly in the US and Europe (and also East Asia).

I would hope that my concerns would prove baseless, but being in the United States, I am well attuned to the "anti-Islamic finance" tactics (absent facts, they have gotten a lot of traction using just baseless insuinuations about connections between Islamic finance and terrorism, at least politically). If it is possible (and desired), I would wish for a thriving Islamic finance industry in Afghanistan, integrating both commercial and investment banks as well as microfinance institutions. This could be a fantastic way for the world to channel finance towards the rebuilding of the country and poverty reduction efforts in a country that has seen too much destruction and poverty since the Soviets invaded in the 1980s. However, it has to be done in a way that will benefit Afghanistan and not create "bad apple" examples of either lax regulation or fraud that could limit Afghani's or other countries' regulators enthusiasm for Islamic finance.

The tragedy of microfinance

An article in the New York Times describes the crisis facing microfinance institutions in the state of Andhra Pradesh, India where up to 80% of microfinance clients have stopped repaying their loans. The story compares the situation to the subprime crisis in the US: "Initially the work of nonprofit groups, the tiny loans to the poor known as microcredit once seemed a promising path out of poverty for millions [but now] some Indian officials fear that microfinance could become India’s version of the United States’ subprime mortgage debacle, in which the seemingly noble idea of extending home ownership to low-income households threatened to collapse the global banking system because of a reckless, grow-at-any-cost strategy."

Similarities with subprime

I think there are definite similarities between the subprime crisis and the microfinance crisis as it is described in the Times article. However, I think the article glosses over the underlying cause of both crises. With the exception of some banking laws in the US which prevented banks from 'red-lining' certain (poor) areas where they would not make loans, a lot of non-profit efforts to increase homeownership among low income Americans were community-based efforts that focused on providing education and other non-financial assistance to borrowers to help them qualify for mortgages. In a similar way, most of the early non-profit microfinance institutions were lending, but their lending was accompanied by a lot of other assistance to help the borrowers understand how to run a business and provide other non-financial assistance.

The subprime crisis was fueled both by aggressive sales efforts, which concealed more about the loans they were offering than provided education that is so vital to incorporating previously under-served portions of the population into the mainstream financial services industry. When the volume of loans (and the profits of the originators) became more important than the outcome (increased low-income home ownership) and the regulation of the activities of originators was lacking, it was a set-up for failure. In the subprime area, however, there was another factor: it was "conventional wisdom" that home prices did not fall either at all or to a degree that would be significant enough to put borrowers underwater on their homes.

The microfinance industry shared some characteristic and the role of education was even more important to finance a microbusiness in order to achieve the repayment rates that are now expected in microfinance. However, what appears to have happened in many cases was that the costs of providing that education became an impediment to increasing loan volumes. The NY Times article mostly describes situations of borrowers who were provided with financing for improving their homes or buying consumption items.

Consumer spending

There is certainly a role for microfinance institutions to finance consumer spending (some of the problems of a micro-debt spiral were due to microfinance institutions financing repayment of other debts, whether they were aware of it or now). However, the primary focus of microfinance should be to create a sustainable income for the borrowers. If that limits the industry's size to a level smaller than what has been achieved in areas of high penetration like Andhra Pradesh, that should be accepted as a reality of the market, not an opportunity to become more reckless with the lending process.

Islamic finance and the Indian microfinance crisis

Now, what does this all have to do with Islamic finance? The point of the twin stories of the subprime crisis and the current microfinance crisis in India demonstrate areas where conventional finance has failed, and has failed in a headline grabbing and significant way. In the case of the subprime crisis, the Islamic finance industry did not take the opportunity to highlight the ethical foundations of Islamic finance that should limit the type of abuses that contributed to the subprime crisis. Instead, a lot of the analysis and commentary (embodied in quotes in widely distributed articles) was that Islamic finance was 'immune' to the subprime crisis, despite the nearly universal absence of facts or theories to support that proposition. In fact, the industry had developed its own risks that would become apparent as the subprime crisis led to a deep global recession (for example, the problems of Gulf Finance House, as described by Mohammed Khnifer, Aatef Baig and Frank Winkler [PDF].

If the industry had been more up front about the vulnerabilities of Islamic finance to crisis (i.e. that it is not 'immune'), it could have spent more time discussing some of the features of Islamic finance that differentiate it from conventional finance, particularly in the sense of risk. There were many bad investments made by Islamic financial institutions in the run-up to the crisis, particularly in areas where the real estate boom rose the highest. However, the differentiating factor in most cases was that if one held an investment in a piece of property, it was unlikely to lose its entire value (although it is possible). In a collateralized debt obligation made up of lower tranches of subprime securitizations, it was easily possible that enough damage was done to the underlying securitizations in a recession that the entire value would be wiped out (for example, staff from the NPR show Marketplace bought a piece of a 'toxic asset' and reported extensively on in while they watched it die). However, at that time, the Islamic finance industry didn't take the opportunity to use the crisis to explain itself. Opportunity missed.

It may already be too late for Islamic finance to seize the opportunity to explain itself and explain how Islamic microfinance would be less likely to lead to the situation of microfinance in Andhra Pradesh. That the opportunity may be lost is due more than anything to the lack of attention that Islamic banks have paid to Islamic microfinance. However, should Islamic finance want to use this crisis as a way to demonstrate its differences from conventional finance (and in particular, microfinance), I think there are a few things that it should emphasize. First, it is useful to catalogue the problems in Indian microfinance are driven by several factors: i) large use of consumption loans; ii) rapid growth focused on boosting loan volumes; iii) lack of verification of customer financial situation and means for repayment; iv) lack of education of clients; and, v) focus on reducing interest rates by boosting loan volumes.

What should Islamic finance learn and how can it use this crisis?

The Islamic microfinance industry is still nascent and has not yet gotten to a point where it is common, let alone to the point of rapid growth, so there are a lot of things that can be used as cautionary tales for Islamic microfinance, as well as to highlight as differences between conventional microfinance and Islamic microfinance.

The over-riding lesson that the Islamic microfinance industry should take is that it needs to focus primarily on the development of business financing. That is where microfinance began and that is where it had the greatest impact and the fewest problems. The initial impetus for microfinance was to develop a way to help the poor create sustainable income sources in lieu of (or in addition to) charitable assistance. This should be the focus of Islamic microfinance as well and any move away from that purpose need to be considered very carefully to ensure that it cannot lead to the incentives for microfinance institutions (MFIs) to focus on their growth and profitability over the benefit of their customers.

Along this line of thought, there are plenty of products used in Islamic microfinance that can shift the incentives towards a more sustainable growth path. For example, while murabaha makes up the bulk of financing in Islamic finance (and may also become the case in Islamic microfinance), the use of mudaraba and musharaka rather than murabaha (or ijara/salam or other financing products) may make better systemic sense for the Islamic microfinance industry as a whole. The systemic benefit comes not from the greater stability of relying on these contracts (it will likely be more unstable than if murabaha is used), but it will focus Islamic microfinance on business financing and will also place the burden of failure more onto the microfinance institution, which should limit the incentives towards "growth at all costs". It will also to some degree limit the negative potential impact of reckless financing on the clients (which of course has important implications for the incentives of the client to act in both parties' mutual interest). However, for the Islamic microfinance industry, using mudaraba/musharaka should ensure that Islamic microfinance institutions continue to recognize the value (to them as well as customers) of providing education and technical assistance, along with financing.

There are still ways that non-business (e.g. for the purchase of an asset) microfinance can be effective in an Islamic context and there are even aspects to many of the contracts used that would prevent some of the abuses in Indian microfinance where loans were extended to repay other microfinance loans that led to customers becoming over-leveraged. Unless the Islamic microfinance industry develops and begins offering tawarruq/commodity murabaha-based financing (which it may still do), there will have to be some asset underpinning the financing. This can limit the excessive growth of debt without a corresponding growth in ability to pay.

There remain significant challenges for Islamic microfinance to develop when there are questions raised about the value of microfinance for customers, but also for the institutions funding the MFIs. However, there are specific areas where Islamic microfinance can focus that build in some safeguards (or incentivize Islamic MFIs to develop their own safeguards) to avoid the pitfalls being realized in Andhra Pradesh. It all adds to the issues that Islamic microfinance industry must grapple with as it develops strategies to attain the growth that the rest of the Islamic finance industry has seen in the past decade (even with the effects of the financial crisis).

An Islamic microfinance waqf

It has been a while since I wrote about Islamic microfinance, but the latest Opalesque Islamic Finance Intelligence included links to several resources on Islamic microfinance (in addition to other excellent articles). One article was released in August 2008 by the Asia-Pacific Economic Cooperation's Advisory Group on APEC Financial System Capacity-Building (pdf).

One of the ideas that I found interesting was that "Islamic banks can also use income derived from late-payment penalties as well other proceeds, which cannot be included in its income, such as earnings from treasury operations. These proceeds can be categorized as waqf and used for microfinance operations" (p.5). For an example of the types of fees that are not permissible, Bank Negara Malaysia's Shari'ah advisory board released a resolution in June that Islamic banks in Malaysia follow, and are likely to be similar to other Islamic banks internationally.

The key point is that Islamic banks are supposed to be concerned with upholding Shari'ah-compliance in their activities and there is a portion of their income that cannot be recognized as income because it is derived from fees to incentive repayment. Often this income is donated to charitable organizations. However, Islamic banks should also recognize that they are not excluded from conventional ideas of corporate social responsibility (CSR). In my opinion, the ethical basis of Islamic banking should encourage CSR at least as much as in conventional banks (although they are still, and should remain, for-profit companies). Currently, few Islamic finance institutions have embraced CSR in a meaningful way beyond charitable giving. By doing so, they are losing the opportunity to use their expertise in banking (as well as the expertise of their employees), as well as their resources which cannot be recognized as income.

The idea that they could use this money, and also volunteered time from their employees, to create a financing mechanism for Islamic microfinance appears to be a good fit. Their employees have more experience and training in banking than they do in charitable activities (and this should not stop them from charitable activities, which are valuable as well). This does not necessarily have to be a 'one bank, one waqf' activity. It would be much more beneficial and likely to be viewed with less suspicion (that it is promoting the interests of the bank above the microfinance clients) if it were a collaborative effort between several banks in a given country or region of a country. The banks would provide the capital and some volunteered experience of their employees to the waqf, which should be professionally managed by people with either direct Islamic microfinance or related experience in microfinance. It seems to me that this would be a way that Islamic banks could become more involved in developing Islamic microfinance locally, while also expanding their incorporation of CSR into their businesses in a way that does not hurt their profitability or compete for resources within the bank.

Thursday bullets

• The head of Shari'ah and CEO of IIMF believe that greater transaction document standardization, like the Master Agreement on Treasury Placement released by IIFM, will benefit the industry.
  
• There are a number of articles on Khazanah's S$1.5 billion ($1.1 billion) sukuk, including from Bloomberg, AsiaOne News and and Reuters.
  
• The Deputy Governor of the Central Bank of Malaysia gave a speech at the 21st Conference of Presidents of Law Associations of Asia on Islamic finance. The full text is available as a pdf.
  
• Al Rajhi Investment and Banking Corporation Malaysia Bhd, a subsidiary of the Saudi Islamic bank Al Rajhi Bank joined the Bursa Suq Al-Sila', the commodity murabaha/tawarruq platform in Malaysia.
  
• An article offers a few details about the Family Bank Bahrain, an Islamic microfinance institution that is working with the Grameen Trust.
  
• An article published by Zawya, written by three lawyers at King & Spalding, covers the different trends in how Islamic financial products are taxed.
  
• BMB Islamic released its Global Islamic Finance Report 2010, which in addition to describing the industry's growth also acknowledges that there is a shortage of authentic data on the size, growth and performance of the institutions making up the industry.
  
• The Maldive's Monetary Authority issued the first Islamic banking license to Maldives Islamic Bank Pvt. Ltd.
  
• Bloomberg has another article about the potential for growth in sukuk issuance from Asia while the GCC primary markets are at their slowest pace since 2005.
  
• A commenter for the Guardian Michael Tomasky takes a look at Islamic finance and realizes that the hyperbolic charges leveled against it are ridiculous on further examination.
  
• An Islamic brokerage, Makaseb Islamic Financial Services, in Abu Dhabi is closing.
  
• Malaysian companies Axiata Group Bhd and Malaysia Airports Holding Bhd are planning RM4.2 billion ($1.3 billion) in 7-10 year sukuk and RM3.1 billion ($981 million) in sukuk of unspecified tenor, respectively. The bulk of the Axiata sukuk will be sold to the Employees Provident Fund.
  

How tough is the market for new issues in the GCC?

An article in Bloomberg describes the falling yields on GCC sukuk, Dubai World and the sovereign Dubai bonds and sukuk with some optimism. However, it notes that the spread on Dubai World's debt (it doesn't say what the spread is based on, but one would assume comparable maturity US Treasuries) from 647 basis points after the standstill to 545 basis points (it incorrectly says the spread is 545 percentage points). The yields on sukuk from GCC-based issuers was 7.17 percent on July 23 (compared to 8.76 after the Dubai debt crisis), the Dubai 6.396% soverign sukuk is yielding 7.38% (435 basis points higher than the recently issued Malaysian sovereign sukuk), the Dubai World yield is sitting at 8.4% (for the 6.25% sukuk).

These figures reflect only limited thawing of GCC credit markets in the aftermath of the financial crisis and, in particular, the Dubai debt crisis. It is hardly surprising that other articles written recently describe a move in momentum in sukuk issuance from the GCC to Malaysia. That is in many respects not entirely fair. The Dubai debt crisis was triggered by specific factors--primarily an overvalued real estate market in Dubai that saw significant declients. However, it does suggest a general attitude that sukuk from the GCC are more risky than other emerging market debt (including sukuk) offerings. This will reduce the level of issuance of sukuk in the near term from the GCC, which would hurt the emergence of sukuk secondary markets. If anything, investors need more sukuk issuance to fill the portfolios of long-term, hold-to-maturity investors (like takaful funds) and therefore a reduction in issuance from one of the largest markets (and the regional market for many of the funds investing in sukuk) could reinforce the hold-to-maturity mentality among many investors. Some of those investors are probably sitting on large losses from Dubai-related sukuk that they are unwilling to realize.

Meanwhile, Nakheel is working through its own debt restructuring. Reports suggest that full payment will be made over 5 years for its syndicated banks loans (including Shari'ah-compliant financing) and 7 years for its sukuk. According to Reuters, "Bankers have until the end of August to respond to undisclosed terms of Nakheel's multi-billion dollar restructuring plan, including the rates of interest and repayment schedules for syndicated and bilateral loans. " Reuters is usually pretty good at describing the presence of Shari'ah-compliance in financing facilities, so the description they give (while it may be limited by sources speaking on background) does reflect the lack of a structure for restructuring in Shari'ah-compliant transactions. The restructuring of the loans (many of which are based on ijara) is probably being done in a rather ad hoc manner. The interest rate and payment terms are dealt with first and the Shari'ah-compliant structure are dealt with later. If this is the case, there remain significant gaps in the Islamic finance industry in dealing with distressed situations that should be at the forefront of the agenda before the next crisis comes.

Other News

• Kuwait-based International Investment Group defaulted for a second timek on a sukuk this year, missing a $152.5 million payment.
  
• Mushtak Parker offers his thoughts on the Sukuk ALIM being issued by Cagamas working with Al Rajhi Bank to be viewed as Shari'ah-compliant in both the GCC and Malaysia. He also offers his thoughts on the recent entry into the Islamic finance markets by Japanese firms, several years after the country said it wanted to encourage Islamic finance in the country to attract capital.
  
• A former Supreme Court justice in India, Krishna Iyer, believes that Islamic finance can help in efforts to alleviate poverty.
  
• Arab News has an interview with the CEO of the Islamic Corporation for Development of the Private Sector, part of the Islamic Development Bank group.
  
• The state-owned Islamic bank in the Philippines is planning the country's first sukuk to "fund growth in Muslim Minanao".
  
• A Malaysian firm is providing the first financial guarantee for a sukuk.
  
• A writer in the Business Recorder in Pakistan, Saqib Masood Chisti, suggests that Islamic microfinance could be expanded in the country while criticizing a program that provides cash payments to poor families as causing inflation and creating dependency (I am not knowledgable enough about the program to comment, but the description given resembles the successful Bolsa Familia program in Brazil).
  

Thursday bullets

• Dubai World formally presented its restructuring plan to creditors for $23.5 billion in debts. A Reuters article presents an analysis of what could come following a successful restructuring.
  
• A Bloomberg article describes the rally in Petronas sukuk, which are held by many conventional funds around the world. Petronas' sukuk is now yielding 3.13%, well below its 4.25% coupon.
  
• Bloomberg has an article on the Cagamas sukuk, which is structured to be acceptable in both Malaysia and the GCC.
  
• Citigroup is considering opening Shari'ah-compliant microfinance banks in Pakistan.
  
• The fund manager of the BLME Shari'ah USD Income Fund believes that there will be a revival in sukuk issuance starting this fall.
  
• There is another article on the struggles of the domestic Islamic finance industry in the UK which ends with a grim assessment: "Either way, it doesn’t seem like Shariah-compliant offerings in Europe will be the big boon many had expected a few years ago." I wrote a post on the issue comparing it with the US on Tuesday.
  
• Lahem al-Nasser writes that Islamic windows of conventional banks are viewed with suspicion by Islamic banking clients and it would benefit the industry for CIBAFI to commission a poll of Islamic bank's clients about attitudes towards Islamic windows.
  
• Chase Bank in Kenya is launching Islamic banking products.
  
• A spokesman for the government of Kazakhstan said the government is still "studying the possibility of selling Islamic bonds" despite a Finance Ministry statement that Kazakhstan's banks will not sell bonds overseas this year, removing the need for the government to issue a benchmark bond.
  
• A unit of Qatar-based property developer Barwa Real Estate received $3.5 billion in two murabaha facilities from Qatari Diar Finance. $1 billion will mature in 2015 and the remaining $2.5 billion will mature in 2020.
  
• Kuwait Finance House reported profits for the second quarter was up 22%. The profit was lower than what was reported by a newspaper citing an unidentified source last week.