Amidst economic challenges in Pakistan, Meezan Bank eyes overseas expansion

Meezan Bank, based in Pakistan, is eyeing overseas expansion starting with a potential entrance into Indonesia to capitalize on the growing Islamic banking market in that country while limiting the growth domestically due to economic difficulties arising from dwindling foreign exchange reserves, high inflation and currency devaluation.  Pakistan’s Islamic finance industry also faces a potential reputational risk should a significant number of the growing ranks of unregistered investment schemes offering high rates of return swells turn out to be fraudulent.  In spite of a difficult economic backdrop, Meezan continues to expand its Islamic financing at a healthy rate as deposits flow in and overseas expansion could be a foresighted plan to diversify the sources of the bank’s future income. 

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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.  

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State Bank of Pakistan adds transparency for mudaraba deposits

The State Bank of Pakistan released its new regulations (pdf) recently for how Islamic banks treat mudaraba deposits, and it is a welcome dose of transparency that should provide protection to depositors by providing greater transparency about the source of profits paid on the mudaraba depositor accounts.  The new regulations require Islamic banks to allocate deposits to separate 'pools' of assets and also require them to "specify the objectives, investment strategy, and risk characteristics of each pool".  

There appears to be little in the new rules that limit depositors to being invested in one pool, and the banks can likely use a 'fund-of-funds' approach to meet the liquidity and risk needs of the depositors.  For example, a longer-tenor deposit product (analogous to a fixed term certificate of deposit) couuld be more heavily allocated to longer-tenor deposit pools to generate extra yield, while shorter-tenor deposits will be more heavily allocated to shorter-term pools, with more assets like short-term murabaha and wakala and fewer long-term assets to maintain liquidity for depositors.  Islamic banks can invest their own equity as well as current accounts (qard), so long as they maintain the principal value and bear the investment risk themselves.

In addition to regulating how deposits are invested, there are requirements for each pool to maintain a liquidity buffer by holding 20% of assets in tradable contracts like ijara financing, ijara sukuk and diminishing musharaka (which can be reduced to 10% with Shari'ah-board approval).  This is likely a prudent move since each pool functions like a 'bank-within-a-bank', with its own assets, liabilities, funding sources and expenses.  If the assets were not liquid, then the bank would have trouble redeeming depositor's money (non-tradable assets like murabaha are typically only traded at par).

The liquid assets in each pool serve as a source of liquidity if depositors withdraw funds.  With an executive committee's approval, the bank can move assets between pools.  The only way this can be done equitably is with tradable assets; otherwise it is just moving assets (like murabaha receivables) between pools and shifting losses from one pool to another.  This is the one point where there is weakness in the regulations: there does not seem to be specific rules for banks that have pools which have run out of liquid assets before they meet withdrawal requests.

It is generally frowned upon for sukuk issuers to advance liquidity to mudaraba sukuk to meet periodic distributions, but would it be equally problematic for Islamic banks to advance liquidity to depositor pools by buying out the share held by depositors as rabb ul-maal if it is done at market value, with any loss first absorbed by the Investment Risk Reserve (IRR)?  Could the Profit Equalization Reserve (PER) be used to make up any of the shortfall in principal?

These are not clear from my brief read of the new regulations (readers who can help me understand anything I might have missed, should email me).  However, in general, I am supportive of efforts to introduce greater transparency into the Islamic finance industry, particularly transparency that delineates equity investors more formally from investment account holders.  The level of disclosure around the new rules, as well as the central bank's ability (as a regulator) to determine whether the actual pool investments meet the stated objectives of each pool will be the biggest factor in determining how beneficial these new rules can be. 

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. 

Why does Islamic finance ignore agriculture and SMEs?

An article about the new, as of yet undefined, strategic plan for Islamic banking in Pakistan interested me with a few statistics about Islamic banking in the country: "Islamic banks held 644 billion rupees ($6.8 billion) or 7.7 per cent of total banking assets in March this year, central bank data shows. [...] Financing by Islamic banks is currently dominated by the mainstream corporate sector at 73.9 per cent of total financing, with agricultural financing representing just 0.1 per cent and SMEs 5.1 per cent, central bank data shows." 

The article then went on to describe: "A campaign will also be launched to increase awareness of Islamic banking and boost growth momentum in Pakistan."  This is an important thing for Islamic finance to do; it must appeal to not only the segment of the Muslim population that will not interact with any interest-based financial institution. 

I am not intending to suggest that the plan in Pakistan is to 'increase awareness' among only those Muslims who avoid interest (they are going to search out alternatives on their own), but often efforts to increase awareness of Islamic finance focus on the religious aspects of riba and gharar, which are undoubtedly important, but the pitch seems to be one of 'Islam prohibits interest and Islamic financial institutions offer a way to be in compliance with this prohibition' rather than a positive message that Islamic finance can offer benefits on its own, that it can compete head-to-head with conventional finance. 

As I am sure the readers of this blog understand, there is a specific reason why Islamic finance has trouble making the positive argument.  The trajectory of Islamic finance has been one focused on recreating interest-based products that can be certified as being Shari'ah-compliant, by changing from a loan to a lease or a sale with a markup.  I read back to a blog post I wrote on the struggle between pragmatism and idealism in how Islamic finance operates (which comes down on the side of pragmatism) and I agree with the arguments I made in the post. 

However, it is not a satisfying answer for me to see Islamic finance replace interest-based financing with murabaha or tawarruq and say it can save the world.  There are difficult issues to be sure in adapting Islamic financial products to the regulatory environments that were built around interest-based financing, and this provides a real reason for why Islamic finance operates the way it does.  But from my own non-Muslim perspective, it is unsatisfying that Islamic finance must be constrained to trying to reach out across the diverse population of Muslims in the world with such an undifferentiated product.  Not to mention trying to reach non-Muslims who in many cases would be open to an alternative to the conventional mega-banks that have a large share of the financial services industry. 

The push for Islamic finance on its current path will proceed regardless of whether it is intellectually and personally satisfying for me in its current form, but it will always be relegated to 'niche market' status unless it can find a more compelling story to tell than just an appeal to consumers' piety, which is where most Islamic finance resides.  There are, of course, very pragmatic reasons for it to be sold as such, but this makes it much harder to get excited about than if the practice of Islamic finance were more unique and could elicit the same emotional enthusiasm as I have seen talking to people over the years (6 years at this point) about idea of an 'Islamic' financial system detached from the actual way it works in practice. 

For the most part, these discussions (mostly but not exclusively) with Muslims have relied much less on appeals to piety (although many of the people I have spoken with are motivated themselves by their faith) than conventional Islamic finance.  They are more often start with an appeal to a problem that the current financial system has created (for example, excessive indebtedness leading to debtors losing power over their own future because of an unexpected event). The discussions search for a way to change the power dynamic between debtors and creditors by relaxing the assumption that the creditor should be the last to take losses due to the unexpected event. 

These types of discussions don't have the simple conclusions of Islamic banking as it operates now. Where Islamic banks have reached a consensus that instead of interest-based financing, let's have the bank buy an asset and resell it to the customer with deferred repayment, the discussions I described above want a more sweeping change from Islamic finance than just replacing a loan with a murabaha.  However, more sweeping change is difficult and will be more slow to grow than the way Islamic finance works today, which is why the latter became the way Islamic finance operates. 

As I mentioned in the post linked earlier about the pragmatism versus idealism debate, I often tend to side on the pragmatic solution because if the industry is to grow in the near-term, it will have to develop in a way that is uncomfortable for the idealists about how Islamic finance should work.  At this point, you are probably wondering what this has to do with the statistics about Islamic banking in Pakistan that I began the post with. 

If Islamic finance is likely to continue its current trajectory of product development that it has in the last 35 years, it needs to have a source of differentiation to create excitement and to serve an underserved area of the economy.  A paper (pdf) by the CEO of the Small and Medium-sized Enterprise Development Authority (SMEDA) in Pakistan described: "The Economic Census of Pakistan-2005 lists 3.2 million business enterprises nation-wide and SMEs constitute over 99 percent of all.  Their share in industrial employment according to an estimate is 78 percent and in value addition approximately 35 percent."  Additionally 45% of Pakistani workers are employed in agriculture generating 20.9% of GDP.

These are clearly areas where Islamic finance should focus just because of the size of the population involved in agriculture or SMEs and their contribution to the economy.  Yet, Pakistan's Islamic banks focus on the corporate sector with "agricultural financing representing just 0.1 per cent and SMEs 5.1 per cent".  That is not an indictment of Islamic banking in Pakistan.  I would not be surprised to see the same disparity between contribution to GDP from agriculture and SME and the amount of financing from Islamic banks in many other majority Muslim countries.  

However, it is a place that Islamic banks can focus their efforts to provide financing in proportion to the share of the labor force and the GDP that is generated in agriculture and SMEs.  If the products that are used are not quite as easy to generate excitement about Islamic finance, then at least its impact on the real economy should be.  Doing that will require far fewer 'awareness' campaigns than the current course.

Open the takaful markets in Pakistan

The move by Pakistan's 5 takaful operators to try and block conventional insurers from offering takaful through separate windows (the same way conventional banks offer Islamic banking) seems to be myopic, although I don't profess to know the details of their objection.  If it is unsuccessful, it would represent a move in the opposite direction from the Qatar Central Bank directive that prohibited conventional banks from having Islamic windows. 

The reason I view it as a myopic move is because it would place shorter-term profits over the longer-term growth in takaful.  This is not necessarily without evidence from the Qatar Central Bank directive, which was intended to encourage Islamic banking by local, wholly-Shari'ah-compliant banks.  Instead the move led to consumers staying with their conventional banks and allowing their accounts to be shifted from an Islamic window to the conventional side rather than move their accounts, which is a time-consuming process.

Islamic finance has a natural market among Muslims who will either use Islamic financial institutions  or none at all, but relying exclusively on this market risks limiting potential areas of growth in Islamic finance.  Allowing conventional insurance companies, for example, to offer takaful alongside takaful companies may threaten the near-term profits of these takaful companies, but the market competition will benefit the customers of takaful companies. 

With competition from conventional insurers, takaful firms will be forced to compete on quality and price with institutions that have deeper resources than they do.  This will be difficult for smaller takaful companies, especially on the first day they have to compete, but it will prepare them better to draw consumers away from conventional insurers which is where the largest part of the market for their products lies. 

Without conventional insurers as direct competitors in the takaful market, the small takaful operators will manage over time to attract consumers from conventional insurance, but the process will be much slower than if they face competition in their main market to force better pricing and service.  And they will still be able to compete with conventional insurers with takaful windows because many people still question whether conventional insurers with takaful windows are fully able to segregate the takaful funds from their conventional business. 

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

A microcosm of the sukuk market

The sukuk market is often characterized as one marketplace with a number of companies tapping it for funding. However, in reality, the sukuk markets around the world are incredibly diverse and there are many local factors which affect issuance and many reasons for companies to decide to issue sukuk. Today, when reviewing the various news around the Islamic finance industry, several companies and government announced plans for sukuk (conditional on favorable market conditions). However, the diversity of the geographical spread and issuer type provide a microcosm of the "sukuk market".

The announcement that received the most attention was not a sukuk announcement at all, but the announcement at the IFSB summit in Luxembourg that the government there had put on hold their plans for a sukuk. In part, the reason why Luxembourg would be interested in a sukuk (although this was not ever announced formally) was to establish the Duchy as a gateway into Europe, primarily for funds, many of which are domiciled in Luxembourg as a way to enter the EU market. Luxembourg has also become more involved in the Islamic finance industry globally, being the only European country that is a member of the IFSB and the central bank governor Yves Mersch was appointed as the Deputy Chairman of the International Islamic Liquidity Management Corporation, which is working on liquidity management products for Islamic financial institutions. The official reason given for the delay was that with tax receipts improving, the government did not need the funds, but this announcement follows the indefinite postponement of a UK sovereign sukuk, which suggests that European governments may be cooling on the idea of being directly involved in the sukuk markets (as issuers).

In contrast, Qatar Islamic Bank and Sharjah Islamic Bank announced plans for sukuk in the remainder of the year. QIB said it planned on the sukuk issuance to reduce debt payments, while Sharjah Islamic Bank said the sukuk was <a href="planned to continue its growth. These two issues represent a different theme than the (perhaps temporarily) waning desire to enter the sukuk market on the part of European sovereigns. In contrast, they are more opportunistic, reflecting renewed confidence in the sukuk market in the stable countries in the GCC. Qatar has remained stable and is taking a lead in aiding the rebels in Libya in their continuing fight against Ghaddafi and has thus far avoided facing widespread protests in other Middle Eastern countries. Sharjah, one of the emirates in the UAE, has also seen stability so far and is likely benefiting from a reduction of the stigma on the UAE in the wake of the Dubai debt crisis in 2009 (which can indirectly be gauged by the fall in the yield on Dubai government sukuk and the upgrade on DP World's sukuk).

There is a new dichotomy in the GCC (in particular the smaller countries on the Persian Gulf) between those like the UAE and Qatar, which have remained stable and largely isolated from the Arab Spring, and those like Bahrain (where Saudi Arabia has sent troops) that are still facing protests. Kuwait, where sukuk issuance has picked up some is still dealing with several investment bank defaults on sukuk and so represents a third group. Despite the protest and violence in Bahrain, that country has not entirely withdrawn from the sukuk market, having recently issued a 5-year ijara sukuk in addition to the short-term ijara and salam sukuk. In addition, within the GCC region, the Islamic Development Bank remains a fairly regular issuer and is reported to be planning US Dollar sukuk (supported by its AAA credit rating).

Elsewhere, the sukuk market continues to move along its previous trajectory. Pakistan's government issued another sukuk to cover a portion of its large budget deficit and to provide an investment for the growing Islamic banking market in the country. This sukuk had the added twist of coming at a time when the government fears losing its military aid from the United States following the killing of Osama bin Laden in Abbottabad. Pakistan's government has issued sukuk fairly regularly, but has remained largely focused on its domestic market.

Malaysia, which along with Indonesia, have become countries of interest for global investors, have both been active or plan to be active in sukuk issuance. The latest sukuk from Malaysia is a corporate issuer, Ranhill, raising MYR 710 million ($236 million). The Malaysian sukuk market, in contrast to the GCC and most of the rest of the world has an active market with a much more regular issuance by corporates and government-related companies like Petronas (the government issued its last large sukuk form $1.25 billion in 2010 after close to a decade without a global sukuk). Malaysia has attracted investors because of its growing economy and strengthening Ringgit, which are somewhat exogenous to the sukuk market (Indonesia has seen inflows for similar reasons).

As this brief tour of recent sukuk announcements demonstrates, the sukuk market is largely determined by factors outside of the Islamic finance industry and is also influenced by regional factors that create divergence in terms of issuance. Just like the conventional financial markets (e.g. bond markets), the reasons why sukuk are issued has much more to do with the issuer, the country where the issuer and investors are located and historical factors around the stage of development of the country's Islamic finance industry than it does to with the growth in the global sukuk market as a whole.

Friday Bullets

• The future of Islamic finance--outside of retail banking--is moving more towards asset management with institutions realizing that the recurring revenue from this business is important to offset the highly cyclical nature of investment banking. No institution perhaps stands as a better example of overreliance on private equity/investment banking in Islamic finance than Gulf Finance House, which is planning to build its recurring revenue business now that it has extended the maturity of several loans.
  
• Pakistan's central bank is urging Gulf-based Islamic banks to open branches in the rural areas of Pakistan as a way to increase the country's share of Islamic banking assets, which the bank wants to double in the next 3 years.
  
• A few more articles came out on the Deloitte report on Islamic finance. One article from Gulf News includes two charts from the report that point to the need for regulation, particularly in accounting standards, risk management, corporate governance and Shari'ah standards & compliance.
  
• Adnan Ahmad Yousef, CEO of Al Baraka Banking Group, says that sufficient financing is available for Islamic financial institutions and the banking group is planning a $200 million sukuk to finance the bank's expansion into France next year. Qatar Islamic Bank is also planning a sukuk issue of up to $750 million when market conditions are right, according to a statement from the bank.
  
• An article describes the enforcement of an ijara-based financing in Dubai that went through the UAE court system.
  
• The Islamic Bank of Britain released results for the first half of 2010.
  
• The Nakheel 5-year sukuk to pay trade creditors may be issued by year-end and is estimated to be up to $3.2 billion. It will pay a 10% coupon semi-annually, will be tradable and will be listed on NASDAQ Dubai.
  
• An article in Arabian Business highlights the degree to which credit conditions in sukuk markets have recovered this quarter (and also the amount they still have to go before conditions normalize): "The spread between the average yield for Islamic bonds in the UAE and the London interbank offered rate shrank 104 basis points to 507 basis points so far this quarter, according to the HSBC/NASDAQ Dubai UAE US Dollar Sukuk Index." Issuance is expected to be as much as $5 billion in the fourth quarter, the highest since Q3 ofo 2007, before the AAOIFI ruling and the impact of the financial crisis caused a sharp decline in the volume of sukuk issued.
  

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.
  

Malaysia as a primary legal jurisdiction for Islamic finance, Islamic finance news

Malaysia wants to become a hub as the country where Islamic financial contracts are governed. Currently, most Islamic finance contracts are governed by English laws, because of its predictability. While Malaysia has a unique position having a Shari'ah advisory council at its central bank and could therefore provide governmental legitimacy to the process of litigating whether certain contracts were or were not Shari'ah-compliant, it would likely run into difficulty because the country's Shafi'i interpretation of Shari'ah is viewed as more liberal than the Hanafi and Hambali interpretations used in the GCC. Therefore, it may be unlikely that an Islamic finance institution would submit to the jurisdiction where a different interpretation of Shari'ah is prevalent.

The Shari'ah Advisory Council of Bank Negara Malaysia gave the go-ahead for wa'd (unilateral promise) to be used to hedge against currency fluctuations as long as there is no compensation paid for the wa'd, which would make it a bilateral wa'd. The promise is binding on the promisor.

Rusdhi Siddiqui's latest article tackles the area of Islamic finance news, which I agree does have too little depth behind it. Bloomberg articles (not to pick on them alone) give the bullet points and then re-spout market statistics with too little context. Other news outlets just string together a few quotes with generalities about "Islamic finance is designed to avoid interest, etc". If this blog does anything, I hope it provides a current and critical look at the Islamic finance industry. It certainly has an inherent bias towards the Islamic finance industry, but I have also been critical of the "party line" talking point (for a while at least) that Islamic finance was not harmed by the credit crisis. And thankfully, there are other reporters out there who take stands against things that are either ridiculous Panglossian ideas or products that too cynically avoid the restrictions that are the heart of the Islamic finance industry. However, it is always a good time to remind oneself to think critically.

Other News

• Kiplinger has an interview with Monem Salam and Nicholas Kaiser of the Amana Funds.
  
• Details about the Dubai World restructuring are coming and I expect more to come out as the process of implementing the restructuring proceeds.
  
• Mushtak Parker wrote an article about the growth of Islamic ETFs.
  
• Pakistan's government plans to sell sukuk by the end of the month. The sukuk are expected to carry a maturity of less than on year.
  
• Despite many suggestions that Islamic finance could become viable in Russia, there are few Islamic financial institutions in the country.
  

IIFM releases report on Shari'ah-compliant repurchase agreements (repos)

Conventional borrowers in the GCC are moving away from sukuk following the Dubai debt crisis. It is not said whether they are moving away from sukuk, which often have higher structuring costs, because of the structures or because the additional costs of structuring sukuk for issuers and a higher illiquidity premium makes it not cost competitive. Despite this there were 98 sukuk issued globally for $13.7 billion in the first half of 2010, up from $7.1 billion in the same period of 2009. S&P provided comments with their data release.

The IIFM released a paper on the possibilities for Islamic Repo transactions (I'aadat Al-Shira'a). You can download the paper from IIFM's website after going through the registration process. I hope to put up a post once I have a chance to read the document.

Other News

• Rushdi Siddiqui takes on the misguided "anti-Sharia" groups in the US who view Islamic finance as a threat.
  
• There is a video of my presentation at the UFANA conference in March in Toronto. It begins at about the 3:50 mark of this video and concludes at the beginning of this video.
  
• In a blog post on Monday I suggested that an article from Bloomberg describing falling yields on sukuk in the GCC was somewhat misleading and now Bloomberg's article that is similar to their earlier article is titled: "Persian Gulf Sukuk Yield Premium Widens on Fourth Default".
  
• Kazakhstan will issue a sukuk after cancelling a conventional bond sale.
  
• The American Prospect interviews Frank Vogel, who co-authored the book Islamic Law and Finance: Religion, Risk and Return with Samuel Hayes, both professors at Harvard University.
  
• A short video of a speech by the governor of Malaysia's central bank, Bank Negara, Zeti Akhtar Aziz.
  
• Khazanah Nasional is raising funds through 5- and 10-year sukuk to finance its bid for hospital operator Parkway Holdings Ltd.
  
• Indonesia's planned global sukuk will be smaller than the $650 million initially expected because the budget deficit is smaller than expected. An unnamed foreign bank is planning an Islamic banking service in Indonesia in the second half of 2010 according to the Head of Research, Development, and Sharia Banking Management of the central bank.
  
• Two Islamic banks in Pakistan became the first merger of two Islamic banks in the country. Emirates Global Islamic Bank and Al Baraka Islamic Bank will merge. The new bank will be called Al Baraka Bank (Pakistan) and will have combined assets of $582 million.
  

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).