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29 March 2024

UAE Islamic banks on solid ground to forge ahead

(SUPPLIED)

Published
By Karen Remo-Listana

Unlike the high utilisation rates of conventional banks, UAE Islamic banks stand on solid ground in terms of their liquidity positions with lower loan/deposit ratios averaging at about 80 per cent.

But this safe position should not make Islamic banks complacent, according to a recent report. Although Islamic banks are expected to weather the current economic storm much better than conventional banks thanks to its more conservative policies, they will have to be more creative and are advised to further increase deposit rates to address increasing competition.

In the past, Islamic banks have managed to attain higher deposit rates of about 50-60 bps over prevailing interest rates provided by conventional lenders. Islamic banks have also been more flexible as they can re-price deposits on a quarterly basis, controlling spreads between the loans and deposits. Thus, attractive deposit rates allowed Islamic banks to be more aggressive than conventional lenders in accumulating funding. So far Islamic banks have been net lenders in the interbank market since they have better liquidity positions.

However, deposit growth in FY08 has been slow due to "cut-throat" competition between banks to attract deposits, especially among conventional lenders. Since Islamic banks offer flexible rates and are dependant on profit and loss schemes, customers abandoned them and rushed to banks offering more attractive deposits.

"We believe this should stimulate Islamic banks to offer new retail and corporate structured products and higher rates to regain clients," the report by HC Brokerage, obtained by Emirates Business said.

"Nevertheless, Islamic banks were able to lend at lower utilisation rates than their counterparts. In addition, their conservative approach towards avoiding investments in debt securities and toxic assets will allow Islamic banks to weather the current storm much better than other banks," it added.


EXPANDING AGGRESSIVELY

Compared to conventional banking, Islamic finance is still in its infancy – being a relatively new concept to the market. However, with a short history, the industry has been expanding aggressively in introducing new products: corporate banking, project finance, and investment banking.

According to the IMF, growth has been estimated at about 15 per cent on average over the last three years, with the presence of about 300 Islamic banks operating in 75 countries. Currently, there is around $800 billion (Dh2.9 trillion) lodged in Islamic banks, mutual funds, and takaful insurance schemes and this figure is expected to reach $1trn by 2010. And with few products offered to date, the industry has huge prospects for growth to provide Shariah-compliant instruments that match its conventional counterpart.

"We favour Islamic banks' funding structure, which is mainly dependent on deposits, as demand is higher on the Islamic saving products than on the lending ones. This has provided banks with lower utilisation rates giving them higher ability to withstand the current liquidity crunch," the report said.

The UAE was among the first regional countries to enter the Islamic finance industry by establishing Dubai Islamic Bank (DIB) in 1975. As of 2007, the bank booked a market share of four per cent in terms of loans among national banks, and stands as the largest Islamic lender in the UAE with about 40 to 45 per cent market share in the local Islamic banking market.

Five years later, Abu Dhabi Islamic Bank (Adib) was established. Today, the number of Shariah-compliant banks is seven including, DIB, Adib, Sharjah Islamic Bank, Al Hilal Bank, Ajman Bank, Noor Islamic Bank and Emirates Islamic Bank. They together account for around 13.5 per cent or Dh170 billion of total banking assets.

UAE Islamic banks are backed by the government aiming to position the country as the industry's regional leader. The UAE central bank has been lenient with Islamic banks regarding the 20 per cent loans/deposit cap of real estate loans, as investment opportunities are limited for the industry.

On the funding side, the UAE central bank gave Islamic banks the option to issue repo's against their holdings of sukuk. As for the Dh70bn pumped by the Ministry of Finance, they were given through wakala deposits.

Moreover, in terms of their interbank position, Islamic banks were not allowed in the past to engage in inter-bank activity. However, with Shariah-compliant structured products they can now borrow and lend in the interbank market, according to a special formula.

As for deposit accumulation, unlike pre determined interest rates offered by conventional banks, rates are determined through profit and loss basis of projects backing the deposits through a pro rata basis.

EXPANDING ABROAD

The UAE's Islamic banks are also spreading their wings in other countries. Dubai Group, a conglomerate of seven private financial institutions, is banking on Islamic finance for its expansion plans.

Dubai Banking Group (DBG) and Noor Investment Group (NIG) – both subsidiaries of Dubai Group are planning to increase their outlets outside the UAE. Dubai Bank, a wholly owned subsidiary of DBG, will be increasing its network of 20 branches by 25 and will also embark on organic expansion of existing assets as well as direct acquisitions in the GCC, Asia and Africa.

In the Mena region, the firm is looking at expanding its current Dubai Bank branch network as well as starting up new operations in other key markets such as Saudi.

NIG on the other hand has set its eyes on building an icon for international Islamic financial services. Noor Islamic Bank has entered into a joint venture with Government of the Maldives and Islamic Development Bank to establish the first Islamic Bank in the Maldives.

Dubai Islamic Bank – which has a 45 per cent market share among Islamic banks – has diversified its commercial and residential project portfolio in key areas in Dubai as well as its international presence in Lebanon, Kazakhstan and Turkey. The bank also has a wholly-owned subsidiary in Pakistan and 52.3 per cent unit in Sudan. DIB is ranked among the top five Islamic banks in the world. DIB's major subsidiary is its 43 per cent owned Deyaar Development with a market capitalisation of Dh2.6bn.

Adib, the second largest Islamic bank in the UAE having a 27 per cent market share in terms of assets among Islamic banks, has also established its presence in the international markets. Adib applied to obtain a banking license in Algeria in 2008 but is still awaiting approval. The bank has a fully-owned subsidiary, Burooj Properties, which manages local and international property portfolios, and provides property management, valuations and Islamic property financing. It also owns Kawader, a premier recruitment consultancy based in the UAE, in addition to Abu Dhabi Islamic Financial Services and a 23 per cent stake in Abu Dhabi National Takaful. The bank currently has 45 branches across the UAE, and is concentrating on strengthening its presence in the northern emirates.

Established in 1997, the bank is 44.2 per cent owned by Emirates International Investment Company (EIIC), a fully-owned subsidiary of National Holding, a privately held conglomerate. Abu Dhabi Investment Council holds a minority stake of 7.61 per cent and the majority of 48.51 per cent is held by the public.

AS A FINANCE OPTION

The massive acceptance of the Islamic finance model has thus convinced some experts that more governments and businesses need to accept the concept.

Dr Nasser Saidi, chief economist at the Dubai International Financial Centre recently said Gulf governments should begin using Islamic finance instruments such as sukuk bonds to finance public spending deficits.

Saidi said the Islamic banking sector had proved relatively resilient to the global economic downturn. He said it should be seen by regional governments as an opportunity for bringing in Shariah-compliant financial instruments to finance large scale infrastructure and public works projects.

"This is the perfect time and opportunity for governments, and particularly in the GCC, to start using sukuk and other Islamic financial instruments as an integral part of public finance, of deficit finance and public debt management," he said.

During the fifth World Islamic Economic Forum (WIEF), heads of states who converged called on the world to adopt Islamic financial practices to overcome the global crisis. "Islamic bankers should do some missionary work in the Western world to promote the concept of Shariah banking, for which many in the West are more than ready now," said Indonesian President Susilo Bambang Yudhoyono.

Islamic banking, however, has a list of things to iron out, one of which is the issue of standardiSation. Because there is no single interpretation of Islamic law, each financial institution has a board of religious scholars who determine which products are Islamic - and what one bank considers Shariah-compliant may be unacceptable for another.

There are also some vague aspects on the concept. Under Islamic finance, sectors such as alcohol and tourism are prohibited.

And with few sectors allowed for investments, real estate took a chunk of Islamic banks books making them more vulnerable to a wave of defaults affecting their asset quality. Various products have been structured to meet Islamic banking requirements including: murabaha, mudaraba, musharaka, ijara and istisna'a, which are widely used among UAE banks. All tools mentioned have been backed by an asset as a property or a joint venture entity.

However, with limited permissible sectors for investments, real estate took its toll on the balance sheets of banks with heavy investments in the sector either through direct lending or fully-owned subsidiaries.

For instance in the case of DIB, real estate loans comprised almost 37 per cent of total loans as of FY07. Completed property can be financed through murabaha and ijarah, whereas istisna is used for undeveloped properties.

The key concept is that payment is interest free – in ijarah (leasing), rental payments are done in the form of installments reflecting the price of the property in addition to a pre-agreed rate applied over the fixed amount.

In order to protect itself against default, the bank registers the property under its name and ownership is transferred to the client upon the completion of payment.

According to DIB, home owners are spared payments until the unit is completely delivered by the bank and they have the option to either pay a lump sum of the mark up plus monthly installments or pay the full amount on installments.