The rise of Islamic finance

With billions of dollars pouring into over 300 financial institutions in 75 countries, Islamic banking is one of the fastest growing sectors in not only the region, but also the planet with a raft of western banks releasing an increasing number of compliant products. And this is just the beginning

  • E-Mail
By  Sam Lafferty Published  April 13, 2006

|~||~||~|When Dubai Ports World (DPW), the Dubai-based ports operator, raised US $3.5 billion in the biggest Islamic bond on record, the company could not have foreseen the impact it would have on the Islamic finance market. US congressmen, who were hostile to having six US ports in the hands of a Middle Eastern company, fought hard to scupper DPW’s attempt to buy British port operator P&O. This may have seemed damning at the time, however, the controversy surrounding the proposed acquisition catapulted not only Dubai, but also Islamic finance into the headlines, and proved it could be used to finance big-ticket transactions. Islamic finance is one of the world’s fastest growing niche markets and caters to Muslims who want socially responsible investments that avoid usury (charging a fee for the use of money), pork, alcohol and gambling. Under Sharia Islamic law, making money from money, such as charging interest, is usury and therefore not permitted. Wealth should be generated through genuine economic activity and trade. Worldwide assets total between US $500 billion and US $1.5 trillion and are growing at over 15%, according to various industry estimates. “Islamic finance is growing in importance and size worldwide,” said Afaq Khan, head of Islamic Banking at Standard Chartered Bank (SCB). Islamic banking traces its modern roots back just three decades. Since the dedicated Islamic financial institutions in the mid-1970s, there are now more than 300 operating in 75 countries, the International Monetary Fund said in December last year. The premise for Islamic banking came from Middle Eastern countries that wanted to abandon western economic and political systems in the hope that it would spur economic development. For a time, Islamic finance was the preserve of specialist banks that exclusively handled Sharia-compliant products, such as Malaysia’s Bank Islam and Saudi Arabia’s Al Rajhi, the Arab world’s largest listed bank in terms of turnover. Since 9/11, two factors have accelerated the flow of money into Islamic banking in the region. The main driver has been the hike in oil prices that has engaged countries to compete for petrodollars. The other is that many Arabs are now more comfortable using services at home rather than travelling abroad for the same end product. Ironically, it is Western banks that dominate the market for commercial banking and are stepping up their game plans to attract retail customers. And it is no wonder. Assets held by Muslims in all banks – led by Gulf Arabs – are estimated to be worth $1.5 trillion and are by growing 15% a year, largely because of high oil prices. Another impressive stat is that Islamic banking will account for 50 to 60% of the savings of the world’s 1.2 billion Muslims in the next decade, industry projections suggest. Robust competition among Western banks, as well as big brand names and economies of scale, is squeezing out indigenous banks, says Mahmoud Amin El-Gamal, a professor at Rice University in Houston, where he holds the chairmanship of Islamic economics, finance and management. “The market is very crowded now,” he says. “It is dominated by Western banks because they are skilled arbitragers. There is no way local banks can compete.” HSBC operates Islamic banking services all over the Arab world. Citigroup was the first international institution to set up a separately capitalised Islamic Bank called Citi Islamic Investment Bank. On the retail side, Citigroup sells Islamic mortgages in Malaysia and in Middle Eastern countries such as the United Arab Emirates. SCB plans to expand its investment business in the Middle East and South Asia and boost Islamic banking operations from a base in Dubai’s financial centre, the DIFC. The bank will add 300 new staff in the UAE this year. “We are looking at our entire footprint,” adds SCB’s Khan. UBS, the world’s top player in wealth management, will integrate its Bahrain-based Islamic bank Noriba into its main business by the end of this year realising the huge growth opportunities that lay ahead. “UBS has demand for Sharia-compliant products and will definitely look to expand these,” says a UBS spokesman. Islamic finance, however, has progressed from offering alternatives to savings accounts and home loans. The gambit now includes real estate and equity funds, credit cards, insurance and even hedge funds. The fastest growing segment of the market is the Islamic debt market. The international Islamic bond market, or sukuk, was started in 2002, when Malaysia issued the first global sukuk, a government-backed US $600 million five-year deal. Since then, sukuk issuers have included real estate, aviation, construction and petrochemical companies in countries including Malaysia, Pakistan, the UK, Singapore, Bahrain and the UAE. Citigroup is one of the leaders in the Islamic bond and loan market. It has raised US $400 million in an Islamic bond offering for the Islamic Development Bank and a US $250 million international Islamic bond offering for the Bahrain Monetary Agency. The bank also worked on the first Islamic bond issued by a European government authority in 2004 (German state Saxony-Anhalt’s US $121 million five-year floating-rate note).||**|||~||~||~|Demand for sukuks is outstripping supply, is pushing down borrowing costs and has prompted Citigroup and Dow Jones to jointly launch the first Islamic bond index to create a benchmark for the fast-growing market. Bankers expect the index to improve secondary trading by providing benchmark pricing for Islamic bonds. In 2004, HSBC Amanah Finance arranged a US $100 million financing based on Murabaha, for Turkcell, the leading provider of mobile communications services in Turkey. In Murabaha, goods are sold at a stated cost plus a profit, with the crucial element the presence of an underlying Halal asset. SBC later raised a US $96 million Islamic financing facility for Baitak Asian Real Estate Fund I, an Asian real estate fund started by the Kuwait Finance House Group and Singapore’s Pacific Star Group. In August 2005, Etisalat International, the foreign investment arm of the UAE’s state-owned telecoms corporation, said it would use a US $2.1 billion Islamic bridging facility to fund its 26% acquisition of Pakistan Telecommunications – a deal that was recently completed. A group of banks that included HSBC Amanah, Barclays Capital, Citigroup, Deutsche Bank and National Bank of Dubai jointly arranged the financing. The problem for many Islamic banks in the Gulf, however, is that they lack balance sheets large enough to compete with international conventional underwriters. Consequently, international banks are shutting them out. The lure of foreign investment has opened up countries to Western banks and non-GCC nations. Malaysia is the most developed market for Islamic finance having taken the lead in 1994 to create the world’s first Islamic inter-bank monetary market. Malaysia also has the advantage of being home to the Islamic Financial Services Board, a global organisation of Muslim bankers in charge of banking regulation and supervision that also works closely with the Bank for International Settlements. Islamic investments accounted for 11% of total banking assets in Malaysia in 2005. This is forecast to grow to more than 15% of assets by 2007 and to 20% by 2010, according to the Malaysian government. The opening of the Dubai International Financial Centre (DIFC) Authority, the financial freezone set up to attract foreign investment, will catapult the emirate into top slot overtaking Bahrain and Malaysia, El-Gamal says. “Dubai is becoming the Islamic banking centre of the world,” he adds. “Silicon Valley became so big because a couple of major players set up and everyone else moved in. That is why Dubai is making such strides.” A host of international banks and financial institutions have set up offices in the Dubai International Financial Exchange (DIFX) including Deutsche Bank, Morgan Stanley, Credit Suisse and UBS. HSBC’s Amanah Private Banking unit is already based in Dubai and the bank plans to move 250 investment, private and Islamic bankers into the DIFC. Qatar has also launched its own financial free zone. The Qatar Financial Centre (QFC) is expected to appeal to project financiers, principally because Qatar was the second-largest source of project finance deals last year, second only to China. One of the key challenges for Islamic finance is how to develop a regulatory framework. Different countries have their own approaches. Some, such as Malaysia, believe Islamic banks should have a separate regulatory regime to conventional banks, while other countries opt to put them under the same jurisdiction as non-Sharia banks. Another problem is attaining global standards for these products. Banks rely on advice from Sharia scholars, with many differing opinions on aspects of Sharia law. But as Islamic finance flourishes, critics are also descending on the industry. Some scholars disapprove of conventional banks using Islam to enter the Middle East. They argue that while Western banks have set up so-called ‘windows’ for Islamic finance, their primary businesses still operate on an interest-bearing basis. The doubters, however, are a minority and the industry continues to grow year after year.||**||

Add a Comment

Your display name This field is mandatory

Your e-mail address This field is mandatory (Your e-mail address won't be published)

Security code