Islamic agricultural finance can benefit many not served now by Islamic banks

Agricultural finance is a relatively small part of the Islamic finance industry, something that is not entirely surprising given the arid conditions and high and rising level of food imports of some countries where Islamic finance has the greatest level of assets (e.g. the GCC).  However, there are many areas where Islamic finance is growing—and where the Muslim population that could potentially be served by greater focus on agricultural financing is significant.  

In an earlier blog post, I cited statistics from a paper written by the CEO of Pakistan’s Small- & Medium-sized Enterprise Development Authority (SMEDA) showing that for Pakistan, 45% of the workforce was employed in agriculture generating 20.9% of the country’s GDP, yet Islamic financing provided to agricultural clients represent just 0.1% of total assets. Since I wrote that post, Pakistan’s Meezan Bank announced that it was launching several agricultural financing products.  

In two other countries, Shari’ah agricultural finance has been growing, and seems set to continue to grow.  In Egypt, the Principal Bank for Development and Agricultural Credit (PBDAC) is expanding the Islamic finance it can provide up to LE50 million ($7.5 million), potentially up to double that level in June, according to the head of Islamic transactions, Abdel Rahman Al Kafrawi, speaking to Reuters.  Al Kafrawi also said that, of the 5.8 million landowners, the availability of Islamic agriculture finance could increase the take up of financing from about 1 million now to 3 million, without specifying a time horizon.

Meanwhile in Afghanistan, a USAID-funded organization, the Agricultural Development Fund, says 70% of the $11 million in financing it provided through April 2012 was Shari’ah-compliant.  According to the Reuters article cited above, “the ADF [as of October 2012] had provided loans to more than 15,000 farm households in 30 of Afghanistan's 34 provinces; it says it expects to reach 60,000 farmers by the end of 2014.”

All three of these developments are positive, but developing Islamic finance for agriculture and making it available will not work in isolation in the absence of demand for Islamic agriculture financing.  Just providing financing will not make a sustainable contribution to growth, but it can help because the aversion to interest-based loans limits the demand for credit.        

    

“The Afghan government is using Islamic financial contracts to extend credit to farmers in areas where conventional banking has not fully satisfied demand for funds […]Demand for such [Islamic] financing has been particularly strong in rural communities because people there tend to be conservative”

“[PBDAC’s] chairman Muhsin Al Batran told reporters last September that the bank would expand its Islamic services since a considerable proportion of farmers declined to take conventional loans because of Islam's ban on interest.”

Any time there is a subset of people who refuse to use interest based loans, their demand for credit (unless there is Islamic financing available) will be almost perfectly inelastic—even when borrowing costs fall, demand for credit will not rise accordingly.  In the case of Afghanistan, it appears from the perspective of the ADF that the demand for Shari’ah-compliant financing compounds a general shortage of financing (whether conventional or Islamic).  

These factors—if the growth can continue and be done with proper risk management by the organizations to ensure that the non-performing loans stay at reasonable levels—should make Islamic agricultural financing more successful.  Besides developing new markets for Islamic banks (in particular), they will provide financing to areas of the economy in many countries employ a large proportion of the labor force relative to the share of its contribution to GDP.  However, if it is to be sustainable, there has to be proper regulation which is more likely to be present in Pakistan (where Islamic finance is relatively well developed) than in Egypt and Afghanistan (where Islamic banking is a relatively new development and the regulatory system may not be as well prepared to ensure the stability of banks offering Islamic finance products, particularly those products that do not mimic conventional loans in their risk profiles.  

 Sign up for the ThomsonReuters Islamic Finance Gateway (it's free) and come chat with me on this subject and others Tusdays and Thursdays at 9:30am Mecca Time (GMT+3)

World Council on Credit Unions may take lessons from Afghanistan to Libya

The World Council of Credit Unions has spent the past 8 years building 34 Islamic Investment and Finance Cooperatives across Afghanistan providing murabaha, ijara and a murabaha-ijara hybrid product to its 92,456 member-owned cooperatives (here's the WOCCU's page on the IIFCs).  Now it is shifting its attention to Libya where there CEO of San Francisco Federal Credit Union said "As the country reconstructs, it is an opportunity for credit unions to participate in rebuilding the economy."

It would be useful to see the development of more Islamic credit unions, particularly in countries where access to finance (of any kind, conventional or Islamic) is low because the credit union model has a seeming overlap with Islamic banking.  Depositors of the credit union are members (i.e. owners) of the credit union and the return they get on the use of their deposits are returned to them as profit.  While there are still aspects where the credit union will replicate how banks work (for example, losses are unlikely to be passed through to depositors unless the credit union fails), there are fewer areas where there are difficult contradictions inherent in the model.

For example, if an Islamic bank goes out and tries to attract deposits using the mudaraba structure, they would be theoretically at risk of loss if the investments made with the deposits lose money.  Yet, how is that different from the equity owners of the bank, who should in theory have the same risk-return profile.  One difference between the mudaraba depositors and the equity investors is that the investors would have the right to participate in some ways in the management of the bank where the depositors wouldn't. 

However, that would make the structure of an Islamic bank more beset with conflicts of interest than a credit union (where members provide deposits and also act as the owners of the bank, which is typically a non-profit).  The equity investors (musharaka partners, essentially, have a right to a portion of the bank's earnings, much of which is made using the funds provided by depositors (the mudarib fee in the mudaraba arrangement).  The depositors are liable for the loss of their deposits if the investments are poorly chosen, and are entitled to the share of the profits accruing to them as the rabb al-maal but have no rights to direct the management of the bank. 

In the actual operation of Islamic banks, depositors are treated as being senior to the equity holders (they will have their deposits paid first if the bank were wound up, with any residual accruing to the equity holders).  That introduces an additional potential conflict of interest where the bank's equity owners would benefit from gains but would not have as much at risk to loss if the bank failed (since they would be investing with their equity capital plus the deposits).  This conflict of interest, of course, is the reason why banks (including Islamic banks) are so highly regulated. 

However, from the perspective of choosing whether an Islamic banking entity would work better using musharaka equity investments alongside mudaraba deposits as a privately held bank or a member-owned credit union, I think there is a lot to be said that the credit union would be better because the potential conflict of interest between the depositors and the equity owners would be eliminated by making the depositors the owners of the credit union.  There remains still, of course, the governance challenge of aligning management and depositor/member interests in a credit union, but using a structure with fewer conflicts to manage seems like a better way to go. 

Should Afghanistan issue a sovereign sukuk?

An article in Bloomberg discussed the prospects for Afghanistan to issue a sukuk to fund its budget deficit when international troops in the country leave (along with a lot of aid that accompanies them) in 2014.  I have offered a skeptical comment to an earlier Bloomberg article that reported about a proposal to allow Islamic banking in Afghanistan.

A sukuk provides a different set of opportunities and challenges from Islamic banking.  It is easier in many ways to issue a sovereign sukuk than it would be to develop a prudently regulated Islamic banking system, because the investors would demand a higher return (whether sukuk or conventional bond) based on the ability to get recourse in case the government defaults in the future.  These types of challenges are going to be common to either type of financial instrument. There are also questions about whether the country will be able to repay its debt, which again, will be priced into the yield the government pays. 

Biggest challenge unique to issuing a sukuk rather than a conventional bond, is whether the additional costs will be more beneficial to the government in terms of making a statement (and perhaps attracting some buyers who would avoid a conventional bond).  To a large degree, the cost-benefit analysis will depend on whether the sukuk is sold mostly to domestic buyers (e.g. banks) or to international investors.  The benefits may be higher and the costs lower in the former situation, compared to the latter situation, which may push the balance over the hump in favor of sukuk. 

There could also be a benefit if subscribing to the the sukuk were viewed as a politically favorable for the government-owned and government-related Islamic banks in the region (e.g. across the Gulf in the GCC).  At the end of the day, if that makes the cost of a sukuk competitive or advantageous compared with a conventional bond, then by all means the Afghan government should do it.  However, the government has higher priorities than getting into the sukuk markets, so the trade-off should be weighed carefully, so that it is not paying a nice extra bonus to an Islamic financial institution with funds that could be better used elsewhere. 

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? 

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.

Tahawwut slow to catch on in the GCC, Nakheel/Dubai World face trade creditors' claims

Lack of familiarity with derivatives products in the GCC has hampered the adoption and use of the Tahawwut Master Agreement for Shari'ah-compliant derivatives. There is also some skepticism that the implementation of the product is Shari'ah-compliant because the Master Agreement is just a template and not a specific product.

Although Nakheel has offered to pay trade creditors 40 percent in cash with the remainder in a tradable sukuk yielding 10%, several of Dubai World's trade creditors have taken their claims to the Dubai World Tribunal set up at the DIFC. Nakheel needs 95% agreement in order to issue the sukuk to pay the deferred portion of the amounts owed to trade creditors. One of Nakheel's trade creditors, Construction Delivery Group filed suit with the tribunal claiming it is owed Dh 50 million (13.6 million) for a construction management contract.

Other News

• Mushtak Parker provides a good assessment of an IMF report that found that Islamic banks fared better during the financial crisis.
  
• A study from Deloitte found that 79% of executives believe Islamic finance is growing. 66% believe the industry is under-regulated.
  
• Indonesia may issue a global bond or sukuk for $650 million in the first quarter of 2011. Jordan formed a committee to study the changes needed to be able to issue sukuk and a statement from a government official stated that the government is "serious about using Islamic sukuk to provide funds for carrying out vital and top priority projects.
  
• Citigroup, which co-managed the Kuveyt Turk sukuk says it is in talks for more corporate sukuk issuance in Turkey. AmIslamic Bank in Malaysia issued RM550 million in 7-year sukuk.
  
• The governor of the Kuwaiti central bank says that with five Islamic banks, the market for Islamic banking is saturated.
  
• RAM Islamic projects that the sukuk market in Malaysia will continue to grow.
  
• Qatar First Investment Bank and Gulfmena Alternative Investments are launching an Islamic asset management firm. Allfunds Bank launched an Islamic Services Unit to provide a B2B fund platform of Shari'ah-compliant funds.
  
• Luxembourg will host the 8th Annual Summit of the Islamic Financial Services Board (IFSB), the first time it has taken place in the EU. Luxembourg is the only EU member country that is a member of the IFSB.
  
• Zawya and the Ethica Institute of Islamic Finance announced a partnership for Islamic Banking certification and training.
  
• Pakistan, Afghanistan and Senegal see Islamic banking as a way to bring underbanked people into the financial system. Bloomberg updated its list of planned and expected sukuk.
  
• The Central Bank of Bahrain's 6-month sukuk al-ijara was heavily oversubscribed with BD62 million (US$164 million) in subscriptions received for the regular BD10 million issue.
  

Thursday bullets

• The first Sukuk ALim was issued by Cagamas for RM1 billion ($317 million) with a yield of 3.48% and a three-year tenor. 43% of the issuance was subscribed by overseas investors including one-third from the Gulf. The structure was jointly created with the Malaysian unit of Al Rajhi Bank to conform to both Malaysian and GCC Shari'ah-compliance standards. It was 2.7 times oversubscribed.
  
• An article in Reuters discusses the push to close the gap between Malaysia and the GCC in Islamic finance.
  
• Sukuk yields have continued to fall in the face of uncertainty about the global economy, with yields falling to lower levels in Malaysia versus the GCC.
  
• Afghanistan is planning to issue Islamic banking licenses for three Islamic banks, the first in the country.
  
• Gulf Finance House said it had recorded a net loss in the first half of 2010 of $47.7 million compared to $92.1 million in the same period during 2009. Reuters calculated that the second quarter net loss was $39.9 million compared with a loss of $54.4 million in the second quarter of 2009. As part of its restructuring plan it reduced its assets from $2.7 billion at the end of 2009Q2 to $1.4 billion at the end of 2010Q2.
  
• Barclays Capital began offering Islamic repos during the past couple weeks. The structure was not discussed in the Bloomberg article.
  
• The Islamic Bank of Britain's shareholders approved the capital injection from Qatar International Islamic Bank of GBP20 million ($31 million).
  
• Kuveyt Turk issued a $100 million, 3-year sukuk, the first in the country. The government issued "revenue-indexed bonds" that are similar to sukuk in early 2009.
  
• A fund manager in Guernsey, Argyll Investment Services, launched its World Shariah Funds PCC Ltd.
  
• Indonesia delayed its sovereign sukuk for up to $650 million until 2011 because of lower budget deficits. The country's central bank is reviewing whether to approve changes to rules that would allow Islamic banks to restructure loans that are current. Current rules restrict restructuring to loans that are non-performing.
  
• The chairman of the World Islamic Economic Forum Foundation, Musa Hitam, was on a global version of CNBC (video) talking about where Islamic finance stands today.
  
• A conference on Islamic finance in Jeddah will suggest that there be a database of "permanent fatwas". Presumably, this would include fatawa on the most common Islamic finance structures.
  

Pakistan central bank explores interbank money markets, Indonesia to issue global sukuk in October

Pakistan's central bank is developing Shari'ah-compliant interbank money market products. This follows the announcement that the UAE central bank is also developing inter-bank liquidity management Islamic certificates of deposit. This is a welcome trend to allow Islamic banks to manage their surplus liquidity and will help to provide greater stability to Islamic banks.

Global sukuk issuance is expected to rebound in 2011 as infrastructure projects begin in Asia and the Middle East following a significant slump since the credit crisis affected Islamic finance in 2008 and 2009. Indonesia is planning a global sukuk in October that could be as large as $500 million to $600 million, less than its $650 million sukuk issued in 2009. The government may issue 5-year sukuk, but would prefer 7-10 year sukuk, which would be beneficial as a benchmark for domestic corporate sukuk. This would be complementary to the possible tax holiday for sukuk to boost the domestic Islamic finance industry.

Other News

• Islamic finance is gaining popularity among bankers looking to "change some terms here and there" according to Andrew White, the director of the International Islamic Law and Finance Center in Singapore.
  
• Lahem Al-Nasser of Asharq Al-Awsat believes that an Islamic central bank is needed and that Islamic banks should have their reserves linked to gold. I disagree: bringing the gold standard to Islamic finance would be no more successful than it was in conventional banking and would limit greatly the growth potential of the industry while offering limited benefits as the price of gold fluctuates significantly.
  
• Ithmaar Bank, which recently converted to be an Islamic bank says it is fully Shari'ah-compliant and denied reports about disagreements with its Shari'ah board over conventional assets being converted to be Shari'ah-compliant.
  
• The governor of the Central Bank of Afghanistan is working with Pakistani experts to implement regulations for Islamic banks within the next two months.
  
• Indonesian bank Bank Permata launched an Islamic mortgage product based on ijara mutahiyah bittamlik (lease ending in ownership).
  
• Malaysian Prime Minister wants Bank Islam to expand the Islamic pawnbroking system Ar-Rahnu from urban areas to rural areas.
  
• A Bahraini investment house, Tharawat, plans to launch a $50-$60 million private equity fund investing in Saudi Arabian real estate in the third quarter.
  
• After delaying a planned bond issue, SABIC received $1 billion in Shari'ah-compliant credit from Alinma Bank.
  
• CNBC Europe has an interview with a professor of Islamic finance in Spain, Celia De Anca of IE Business School in Spain.
  
• The Nigerian Deposit Insurance Corporation is introducing Islamic deposit insurance using Malaysia as an example.
  

Islamic finance was not unscathed by the global financial crisis

I am getting a bit irritated with some of the media coverage of the Islamic finance industry. It is not that the articles are repeating any of the easily disproved negative comments about Islamic finance; in contrast, I am disappointed by the reporting because it is too positive. An article by AFP provides a few of the specific claims that are either not true or exaggerations (although this article is not unique, there are many articles repeating the same claims). The subtitle of the article claims that "Islamic finance has emerged unscathed from the global crisis". This is not true. Profitability at Islamic banks are down because of the recession and there have been enough distressed Islamic financial institutions (The Investment Dar, International Investment Group, Gulf Finance House) to claim that the industry is 'unscathed'. The first sentence of the article qualifies 'unscathed' by adding the word 'relatively' to the statement in the subtitle and the remainder of the article is more nuanced (it focuses on the need for tighter regulations). The financial crisis disproved, hopefully for ever, the notion that Islamic finance can be 'immune' from crisis. The article notes that:

"However, the global economic turmoil, which felled some mainstream banking institutions, has highlighted the need for the industry to shore up areas where it may be on shaky ground.

These areas of shaky ground for the most part reflect areas where there is not sufficient products available to Islamic financial institutions to survive downturn in asset values and (for banks) liquidity crunches.

Remember, the final nail in the coffin for many of the conventional investment banks was not necessarily the asset price deterioration of the toxic mortgage-backed products they held. That contributed (just as any asset price deterioration would), but the institutions were felled by a shortfall of liquidity after their funding dried up. During September and October 2008, the investment banks fell one after another and the primary thing that allowed JP Morgan and Goldman Sachs to avoid similar fates was their conversion to commercial banks, which allowed them access to the Federal Reserve as the lender of last resort. Had the Fed not been willing to step in, those banks might well have met similar fates as Bear Stearns and Lehman Brothers. The situation for Islamic banks will be similarly precarious in any future financial crisis: there are not lender of last resort facilities available that are Shari'ah-compliant and without this, the maturity mismatch between demand deposits and short-term sukuk (liabilities) and longer-term assets could turn a liquidity crisis into a solvency crisis as the banks would be forced into a firesale of assets.

The continuous reporting that Islamic finance emerged unscathed by the recent crisis lends some authority to belief that it will be impervious to future crisis and breeds dangerous complacency within the industry. It also somewhat minimizes the significant challenges that Islamic finance faces in its maturation process. If it withstood the most severe financial crisis since the Great Depression, the thinking might go, it will not have much to worry about until the next big global crisis which could be decades in the future. It would be far easier to worry about potential problems now when financial stability is in the forefront of the news than to wait and try to either develop it when the Islamic financial markets are booming, much less when the crisis does in fact hit.

Other News

• The central bank in Malaysia is drafting regulations covering ibrar, the rebate used in some contracts. In general, ibrar is used where a customer defaults on a murabaha or BBA transaction because under the cost-plus sale, the full amount is due in a default including the profit for the entire amount. In contrast, in a conventional mortgage, the balance due is the unpaid principal plus interest. Ibrar is used to make the economic outcome in an Islamic finance transaction equivalent, but is discretionary for the Islamic bank, which has created uncertainty and legal disputes. The central bank is expected to put the policy in front of its Shair'ah board by the end of May.
  
• France is seen as moving 'too slow' on Islamic finance.
  
• An article by Morrison & Foerster LLP describes (with transaction diagrams) the structure of principal-protected structured products.
  
• The latest sukuk al-ijara from the Central Bank of Bahrain was oversubscribed by 310%.
  
• The government of Indonesia is planning another global sukuk for October 2010. The government is also considering Islamic T-bills and retail sukuk to diversify funding sources.
  
• The Jordanian government is interested in issuing sukuk.
  
• South Korea's legal changes for companies to issue sukuk have been held up in the National Assembly. The chart for sukuk issuance looks inaccurate. It projects $30 billion in issuance in 2010 exceeding the 2007 total. IFIS reported that total issuance in 2007 was $47 billion.
  
• Pakistani Islamic banks are considering into Afghanistan.
  

Islamic banks to adopt more equity-based financial products

Two articles describe that Islamic finance is working to incorporate more equity-based financing structures and move away from its use of tawarruq, although this change will be done very gradually. In general, this is a positive development for the Islamic finance industry because it provides a greater reliance on products which are more differentiated from conventional financial products.

However, this change, however gradual its implementation, will be disruptive to the industry even as it recovers from the impact of the credit crisis. Investors will shy away initially from products that alter the risk profile of what is offered and this will increase the cost to Islamic banks, at least until there is greater familiarity and certainty under different legal systems of the new products. It will also create some disruption for Islamic banks who will have to adjust their risk management and reset the way they determine the cost for borrowers to remain profitable.

One aspect of any shift away from debt-based products and towards equity-based products that will be especially difficult will be that it adds to the difficulty of Islamic banks' business in addition to their already challenging liquidity management challenges. In some cases, the different risk profile of the banks' assets will create some additional risk that the bank will run into difficulty and this will be a challenge for regulators.

This regulatory challenge could make it difficult for Islamic banks to be regulated under identical rules as conventional banks if the risks facing Islamic banks change. In most countries, there is only one regulator of banks and this covers both Islamic and conventional banks. A rapid change in the way Islamic banks operate, especially if the change is codified by standards setting bodies like AAOIFI, could have a perverse effect of slowing the growth of Islamic banking in many countries.

Despite these concerns, it is heartening to see the industry publicly signal that it recognizing the need to differentiate itself from conventional banking. It would be useful if research organizations and standard-setting bodies would provide a more thorough look at the impact of any change towards more equity-based products on the Islamic finance industry.

Other News

• Dubai World is still working on a restructuring plan and is expected to sell assets and no plan will be done until at least the end of February. The creditors committee is made up of seven banks and if one declares Dubai World in default, it would tip the company into bankruptcy and turn the process over to the tribunal established at the DIFC.
  
• An article describes the cooperative Islamic microfinance being offered in Kandahar by the Islamic Investment and Finance Cooperative.
  
• Dar Al-Arkan is expected to issue its sukuk for between $500 and $750 million at the end of the week and it is expected to be priced to yield 10.5%-11%. One anonymous banker commenting on the roadshow described that "they have been struggling. They still haven't closed anything and they have been on the road for a long time now".
  
• Southeast Asia will be the region that will lead the sukuk market in coming years according to the leading arranger CIMB Group.
  
• Indonesia issued a 3-year sukuk for $856.3 million yielding 8.7% with significant uptake from retail investors. The issue was significantly oversubscribed and was more than double the target amount of 3 trillion rupiah ($318 million). Indonesia is also planning on issuing yen-denominated samurai bonds early in the second half of 2010.
  
• Ireland's new law, which is described in greater detail here, comes alongside a growth in the number of Islamic finance funds registered there.
  
• Saudi bank NCB Capital is launching a new Shari'ah-compliant fund focusing on sukuk and murabaha.
  
• Islamic mortgage company Tamweel reported a profit in the fourth quarter of 2009 while reporting a loss for the full year. The company is expected to be merged with Amlak Finance in the first quarter.
  
• Leader Universal Holdings, a power transmission company in Malaysia, received a 13-year, $65 million in istisna'a financing for one of its projects.
  
• First Finance's board of directors approved its acquisition by Barwa Bank.
  

Should Islamic finance move towards asset-backed securitization?

Two lawyers with experience in Islamic finance, Debashis Dey and Stuart Ure, wrote an article in The National about the future of sukuk and in particular, they highlight one of the important features of sukuk which is often misunderstood:

"In the majority of unsecured sukuk transactions the investors ultimately have no direct recourse to the assets themselves. The repayment of their investment is dependent on the exercise of a purchase undertaking by the seller of the assets at maturity or upon default. Thus, as with a conventional bond, the investors take credit risk on the seller who has granted the purchase undertaking.

Although typically there is a physical asset in the structure, it is present primarily to generate periodic profit payments, not to enhance the credit quality of the deal or provide investors with recourse to the assets upon a default."

This is one of the aspects of sukuk which I have criticized because it isolates the actual asset from the transaction and thus creates an unsecured debt that appears to be based on an asset. While this is clear in the offering documents, the amount of different articles that talk about Islamic finance as being more stable because it is based on real assets suggest that they have not read offering circulars of sukuk.

The solution, if the industry wants to make the rhetoric match the reality, in the eyes of these two lawyers (which I agree with) is:

"While Sharia principles seem harmonious with the nature of asset-backed securitisation, for securitisation to become more mainstream in the GCC, three prerequisites will be required: firstly, investors will need to demonstrate a commercial desire to take the risk (and reward) associated with the true sale of assets in an asset-backed structure, including the management of those assets in a default scenario; secondly, those companies seeking finance will need to demonstrate a desire to sell their assets (which will have accounting and shareholder equity implications); and thirdly, a robust legal framework will need to evolve as bankruptcy and asset-selling laws in many jurisdictions in the GCC remain opaque and militate against securitisation structures."

These three points are important and have not been the focus of the future of sukuk as much as they should be.

The prime example for a sukuk which does use an asset-backed securitization structure that has run into trouble (and therefore is instructive when compared with recent defaults of unsecured asset-based sukuk) is the East Cameron sukuk. This sukuk was a musharaka between the issuer SPV and an oil-and-gas exploration & production company. The asset was an overriding royalty interest (ORRI) and the two parties split the production from the musharaka assets (natural gas), which was then sold to make periodic payments and redeem the sukuk.

The transfer of the ORRI to the musharaka SPV was a true sale and this has been upheld in the bankruptcy court overseeing the reorganization of East Cameron Partners. According to documents filed in the bankruptcy court, the sukuk investors have provided debtor-in-possession financing to the company and a reorganization plan is expected to be submitted sometime in January 2010. However, for the discussion of ABS structures for sukuk, the idea of using a true sale rather than a sale of beneficial interest that is common in unsecured sukuk has shown to protect sukuk investors by giving them rights to the underlying asset that is insulated from the claims of other creditors.

Of course, this case occurred in the U.S. where the legal system is more developed in terms of understanding and resolving claims regarding asset-backed securitizations than in other jurisdictions where sukuk are issued. The ability to take this example and generalize to sukuk issued elsewhere is, therefore, limited. However, lack of generality does not make it a useless exercise.

Other News

• The UK has proposed changes that would put corporate sukuk issuance on equal footing with conventional bond issuance by removing them from regulation as collective investment schemes. A Reuters blogger, Cecilia Valente, says that there continue to be discussions about a sovereign sukuk from the UK government, although she ascribes the renewed focus as a reaction to moves by the French to promote their own ambitions of being a Western hub for Islamic finance.
  
• The Accounting and Auditing Organization for Islamic Financial Institutions released updated standards for the Islamic financial institutions.
  
• Thomson Retuers launched a risk management system for Islamic banks.
  
• The Islamic Development Bank is increasing the size of its medium-term note program, which will allow it to issue more sukuk to fund its activities.
  
• Bahrain-based Al Baraka is considering acquiring a large minority stake in Bank Muamalat, an Islamic bank in Malaysia.
  
• A report on microfinance in Afghanistan includes a suggestion that microfinance institutions offer Islamic microfinance based on client demand, although they note that it will be unclear if it will be demanded if it is more expensive than conventional microfinancial products.
  
• The Secretary General of the Franco-Arab Chamber of Commerce believes France will become a large part of the Islamic finance industry.
  
• Reliance Capital is entering Islamic finance through a Malaysian subsidiary, Reliance Asset Management.
  
• Forbes magazine provides a profile of Nicholas Kaiser, the head of the Amana Funds' parent company Saturna Capital.
  
• Indonesia priced its retail sukuk offering at 8.7%.
  

Sukuk, UAE to head council on Islamic finance, Islamic finance in Canada & the U.K. and growing interest in Islamic microfinance

The Islamic Development Bank is planning a $150 million sukuk issue in Malaysia that it expects to use within two years to finance projects in Malaysia, mostly relating to education, healthcare and basic infrastructure. The IDB also plans on another sukuk to be issued elsewhere to fund the bank's operations. Moody's expects the global sukuk market will reach $200 billion by 2010 (Moody's also expects to see significant growth in the number of Shari'ah-compliant funds). The GCC sukuk market has focused on larger sukuk issuance (like the $3.5 billion sukuk from DP World used to fund the purchase of UK-based P&O Ports), while small and medium sized companies have more luck issuing in Malaysia.

2008 will see first sovereign sukuk issuance from the U.K., Indonesia and Hong Kong.

The UAE will head a council with representatives of the Islamic financial industry as well as finance ministers, central bankers, the IDB, accounting and audition agencies the Islamic Financial Services Council, the World Bank and the IMF.

Further response to the Archbishop of Canterbury's comments about allowing some Shari'ah courts in the U.K. uses the example of how Islamic finance has incorporated Shari'ah principles into modern finance.

Ethical investing guided by faith is growing rapidly in Canada, with mutual funds that select investment based on religious principles. The most common faith-based funds appeal to Christians or Muslims. A range of additional services are available to Muslims in the U.K. including banking and home finance that have only limited availability in Canada.

Islamic microfinance is succeeding in Afghanistan where non-profits like FINCA offer Shari'ah-compliant microfinance. The success of Islamic microfinance has led to people like Joyce Lehman, a microfinance program officer for the Gates Foundation, to say that there should be greater availability of Shari'ah-compliant products: "Out in the field, MFIs are losing clients to other organisations that provide Shariah loans and it’s that type of market competition that is making MFIs look into providing Shariah products," she says.

Recently, a microfinance institution in Nigeria converted to only offer Shari'ah-compliant microfinance products.

Ijara sukuk compliance, WOCCU paper

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

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

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

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

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