A Kingdom on the move

With an International Islamic financial market and a regional bond market in the horizon, Bahrain is enhancing the opportunities for institutions to access capital—will others follow?

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By  Massoud Derhally Published  October 6, 2002

|~||~||~|The Kingdom of Bahrain, identified by many, as the financial hub of the Arabian Gulf, is expanding its financial infrastructure to accommodate the growing Islamic finance industry. Bahrain is relying on a new Islamic financial market to increase liquidity, attract an inflow of capital and guarantee the Kingdom’s position as the Gulf’s principal banking centre.

On August 11, Bahrain’s King Sheikh Hamad bin Issa al-Khalifa issued a decree setting up an International Islamic Financial Market (IIFM) to help meet the needs of international Islamic banks and financial institutions and essentially be a market for global Islamic capital that operates under Islamic financial principles.

Such a market will not only cater to the 18 Islamic banks operating in Bahrain, but will also complement and enhance the operations of the 20 commercial banks and 48 offshore banking units, with combined assets of more than $100 billion, that already operate in the Kingdom.

The unique feature of Islamic banking is that no interest is paid; instead the bank charges fees and shares its profits or losses. These requirements have in the past made it difficult for Islamic banks to access conventional international financial markets.

As such, the IIFM is being considered an important milestone that will make it feasible for Islamic banks to manage their overnight short-term liquidity and provide a channel to match surpluses and deficits in the management of Islamic funds.

Some bankers also point out that there are very few Shariah-compliant short-term instruments around. The lack of Shariah-compliant short-term instruments is compounded by the absence of a secondary market, which can provide easy liquidity, because there are not enough buyers and sellers.
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“The purpose of the IIFM is to basically endorse Islamic papers and issues. With that endorsement Islamic banks get the comfort that this is a product that has met all Shariah requirements of the IIFM Shariah board,” says Mohamed BuQais, general manager of the Bahrain based ABC Islamic Bank. BuQais believes that any institution participating in a product that has been endorsed by the IIFM will have the comfort in buying that paper.

Those who think the little Kingdom has neared saturation should think again. Last month Union Bank of Switzerland (UBS) set up Noriba, its first Islamic bank in the region [see box].

The recent royal decree will allow Bahrain’s IIFM to start operations that will cater to the needs of some 200 Islamic banks and financial institutions around the world. Many Islamic bankers welcome the recent move by the Kingdom, indicating that the IIFM will help them manage their liquidity needs on a day-to-day basis.

“The IIFM is set to open new horizons for investments and Islamic institutions, which are relatively limited because their banking system is based on Islamic Sharia law,” says Khalid Al Bassam, deputy governor of the Bahrain Monetary Agency. “If Islamic banks can offer the same services as conventional institutions, they will be able to capture a good part of the banking sector.”

Chances are an international Islamic market will succeed, given the collective input of industry movers and shakers. The setting up of the IIFM followed an agreement signed in 2001 between Bahrain, Indonesia, Malaysia, Sudan and the Saudi-based Islamic Development Bank. The Islamic banking industry has emerged as one of the fastest growing banking segments with 15-25% annual growth, according to Al Bassam.

“It’s the next step in building the foundation in terms of going to a place for Islamic capital markets,” says Rushdi Siddiqui, director of the Dow Jones’ Islamic Market Index. “Bahrain has a lead over other centres and this will increase the distance between it and others. The implications are that competition is good; innovation and choices are becoming more prevalent.”

The new IIFM does not represent Bahrain’s only ambition. On the agenda is a regional Islamic bond market with the issuance of about $700 million worth of bonds planned by the end of 2003, according to an announcement made by the Finance and National Economy Minister made on Sept. 7, 2002. These new Sharia (Islamic Law) - compliant securities overcome Islamic restrictions concerning trading in debt and interest-based instruments by providing a return that is directly related to the actual benefit that the government derives from the proceeds.
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The launch of this initiative, says Siddiqui is “a possible reaction to the successful oversubscribing (40% in the GCC) of the US $500 million global Ijara from Malaysia’s Bank Negara.” According to Siddiqui, a regional bond market can be considered as a source and place to for ‘super-national offerings’ and eventual corporate offerings.

The bonds, which will be a mix of government development bonds, Islamic leasing securities known as Al Salam Sukuk securities and treasury bills will be listed on the Bahrain Stock Exchange to facilitate trading and liquidity and to leverage the existing clearing and settlement infrastructure.

Bahrain started to trade short and medium term Islamic financing instruments, with its landmark issue of three-month government bills known as Sukuk al-Salaam in the middle of 2001. This was followed by five-year Islamic leasing bonds, known as Ijara worth $100 million, the first offered by any central bank in the area.

Both issues were oversubscribed, paving the way for a succession of future offerings. Through these securities, the government has tapped into local public funds for financing. Mainly designed to address the needs of Islamic banks and financial institutions, the securities’ tradability over-the-counter also enhances the asset liquidity of the financial institutions that hold and trade in them. “The creation of a regional bond market will greatly benefit new funding activity, private infrastructure projects, privatisation efforts of various governments, diversification of corporate funding and public funding of government expenditure.

The bond market will also create new investment opportunities for both large and small investors within and outside Bahrain,” said Abdullah Hassan Seif, Bahrain’s Minister for Finance and National Economy. Over the past three decades, the government in Bahrain has encouraged economic diversification and laboured to create a respected regulatory framework for its significant financial sector. The latest developments on the Islamic banking front are simply additional value-added measures in an ever-expanding Islamic finance industry.

“Through the securitisation, the bonds and the IIFM, you will be able to securitise long term assets and bring them to the market to trade. It [IIFM and regional bond market] is a good move for the industry because it will help solve some of the liquidity issues that Islamic banks are faced with,” says BuQais. “As Islamic banks and project owners start to accept Islamic finance and securitisation of projects through Islamic finance we will see and more issues coming to the market.”
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