Liquidity and lack of regulation top agenda

Islamic banks in the Gulf and Asia are at a crossroads, with sukuk issuances down by more than 60 per cent this year as scarce liquidity and question marks over regulation of the industry hang over new opportunities for growth such as Iraq.

New Islamic bond issuance fell by two-thirds to a three-year low in 2008, with sales in the key Malaysian market dropping 78 per cent, according to the Islamic Finance Information Service, which tracks industry data.

Islamic institutions are starting to position themselves in Iraq to enable them to penetrate the relatively untouched market once the security situation improves, a leading consultant said yesterday.

"In the past 12 to 15 months, there have been decisions made about opening representative offices in Iraq. The strategy is to be able to have established a presence in the country, so the moment the country starts to grow again you are on the ground," Boston Consulting Partner and Managing Director Knut Storholm told the Reuters Islamic Banking and Finance Summit in Dubai, citing a spike in interest among banks in the Gulf and Asia.

A number of banks are building up their Islamic finance units in the wake of the global credit crisis, tapping into a nascent industry estimated at $700 billion (Dh2.57 trillion) to $1trn in asset size and a 15-20 per cent annual growth rate.

Royal Bank of Scotland, Rothschild and Bank of New York Mellon all are expanding in the field.

Earlier this week, UBS, the troubled Swiss-based bank that is slashing staff to offset losses, said it sees growth opportunities in Islamic finance and plans to expand in this market.

Armen Papazian, its new head of Islamic finance said: "My appointment comes as a new commitment to take that business forward in line with the strategic targets of UBS and re-emphasise that this is a strategic target of the bank."

Switzerland's largest bank needs new revenue. On Wednesday, it announced first-quarter loss of $1.7bn and said it is laying off 11 per cent of its workforce.

However, growth in the sector has been hampered by uncertainty over scholarly views on whether Islamic finance products truly comply with Shariah law and a lack of standardisation. This has made each product expensive and more time-consuming to construct.

The global economic downturn and the financial turmoil – caused by credit excesses – can act as a catalyst for new approaches to finance based on Shariah principles, he said.

"The crisis opens up doors, unleashes a process of rethinking on many levels. There is an opportunity for Islamic finance to contribute," Papazian added.

Faisal Private Bank's Chief Executive, Marco Rochat, called for a recognised body to oversee the Islamic finance industry.

"We need a body to oversee the market and ensure trading compliance, like you have in traditional banking, or in accountancy. A regulated environment would help a lot of investors," Rochat said."

"We need to see this period as the beginning of an evolution in this area," Rochat said. Without a broader and more coherent oversight, different markets will continue to treat products in an ambivalent manner, he said.

Rochat – whose bank advises on almost $500 million, which is invested entirely in Shariah-compliant products – said the lack of harmonised rules meant a lot of inappropriate products were sold to Shariah investors.

The main problem, he said, was that there are only a handful of scholars with the experience and reputation to judge the suitability of such a wide range of products.

Yet broad and consensual oversight is a necessary step if Islamic finance is to fulfil its potential to cater for up to a billion Islamic customers, and perhaps gain ground among a non-Islamic base as well, Rochat added.

Some bankers have attributed last year's downturn in issuance of sukuk, the Islamic alternative to bonds, to comments by Sheikh Muhammad Taqi Usmani that musharaka and mudaraba sukuk should not promise guaranteed returns.

Most Islamic bonds should be treated as equity instruments, said Usmani, Chairman of the board of scholars at the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI).

His February 2008 comments marked a shift for Muslims seeking fixed-income returns and, in the following months, coincided with a slowdown in the sukuk market as the global financial crisis deepened.

But bankers at the Reuters Islamic Finance Summit this week downplayed that link, saying the general slump in the global debt market was behind the drying up of sukuk, not a fear the structures failed to comply with the spirit of Islam.

"The sukuk market has shrunk as a direct result of the market conditions rather than an issue with the structures themselves," said Raphael de Ricaud, head of Islamic finance at Rothschild, an investment bank providing advisory services.

"I think it has been overblown," the Chief Executive of Standard Chartered Saadiq, Afaq Khan told the summit.

He added that he believed the market for Islamic sukuk is set to revive in six months with sovereign and corporate issuers raising at least $10bn in 2009.

Issuances of sukuk, the Islamic alternative to conventional bonds, would fall from about $15bn last year but still demonstrate strong growth potential, Khan added.

"I think it will come back in the next six months or so," Khan said.

However, Sohail Zubairi, Chief Executive of Dar Al Shariah consultancy – an off shoot of Dubai Islamic Bank – predicted that Islamic banks will face a crisis scenario by the end of September that could include forced consolidation if liquidity does not return to the financial sector.

He said retail lending will be hit first if bank funding remains sparse through the third quarter but that worse could be in store, including a possible bank collapse.

"Anything is possible in this scenario," he told the summit. "There is a real threat to the business of Islamic banking," Zubairi said.

"If the liquidity does not return, we will not be able to continue doing our business." Layoffs await the sector as well, he said.

Islamic banks are unlikely to lead the consolidation process themselves and political leaders will probably show the way, as has already happened with the proposed merger of mortgage lenders Amlak and Tamweel, Zubairi said.

"Islamic banks will not take any voluntary measures at all," he said.

"Islamic banks need to get bigger and one way could be a merger."

Several leading western banks have been forced to merge, such as Merrill Lynch, or close, like Lehman Bros, as a result of the global financial crisis.

But to date, Islamic bank executives have denied any intent to merge, Zubairi said.


Key dates in Shariah-Compliant Banking

- 1950s-1960s: First experimental Islamic banks develop interest-free savings and loans societies in Pakistan and the Indian subcontinent. Egypt and Malaysia see pioneering ventures in 1960s. New banks develop during the 1970s as oil money pours into Gulf states.

- 1975: First commercial Islamic bank opens, Dubai Islamic Bank. Close to 30 such banks set up over the next decade.

In October 1975, the umbrella Islamic financing institution, the Islamic Development Bank opens in Jeddah, Saudi Arabia.

- 1979: Pakistan becomes first nation to "Islamise" banking practices at state level. Process continues until 1985.

- 1983: Malaysia opens its first official Shariah-compliant bank – Bank Islam Malaysia.

- 1984: Iran switches to interest-free banking at national level after passing a 1983 Islamic Banking Law that was promised in the 1979 Islamic revolution.

- 1990: International Islamic accounting standards organisation, the Accounting and Auditing Organisation for Islamic Financial Institutions, established in Bahrain by the IDB.

- 1991: Indonesia's first officially sponsored Islamic bank – Bank Muamalat – established.

- By 2000: About 200 Islamic financial institutions have over $8 billion in capital, over $100bn in deposits, and manage assets worth more than $160bn, according to economist Mohammad Nejatullah Siddiqi.

- 2001: Malaysia's Financial Sector Masterplan sets target for Islamic finance to make up 20 percent of finance sector by 2010. By 2009, its share of financial assets is about 17 per cent. 

- 2002: International standard setting organisation the Islamic Financial Services Board established in Kuala Lumpur.

- Sept 2004: Islamic Bank of Britain – the country's first Shariah-compliant high street bank – opens in London.

- Nov 2006: Dubai's main stock exchange, Dubai Financial Market, announces it is restructuring itself into world's first Islamic bourse.

- 2008: Global credit crisis and economic slowdown send conventional financial markets into steep tailpsin and have chilling effect on Islamic finance as investors avoid risk and asset prices tumble. New Islamic bond issuance falls two-thirds to a three-year low of $15.77bn, Islamic Finance Information Service says.

- Jan 2009: Singapore launches first Islamic bond programme as it vies with Malaysia for market share.

- Feb 2009: Indonesia, the world's most-populous Muslim country, sells its first retail Shariah-compliant bonds, or sukuk.

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