He is a well-known and highly respected banker in Saudi Arabia. When he speaks, his words get total attention from the who's who in the industry to the men in government and bureaucracy. Abdulrazzak M. Elkhraijy is an expert on the burgeoning concept of Islamic banking. He has more than 30 years of experience in the field having joined the National Commercial Bank, which is the Kingdom's oldest and largest bank by market capitalization, in 1980 as a management trainee. He holds a bachelor's degree in economics and business from Macalester College, St. Paul, Minnesota, and is currently the executive vice president and head of Islamic Banking Development Group at the NCB. In an exclusive interview with Khalil Hanware of Arab News, Elkhraijy talks about the contribution of and the role that Islamic financial services can and is playing in stabilizing the creaking and faltering global financial system.
Abdulrazzak M. Elkhraijy's extensive career took him to various positions and areas of responsibility within the NCB Group; working as deputy and branch manager in various locations in Jeddah from 1982 until 1985, and in 1985 he was promoted to the position of branch manager at Jeddah's main branch, one of the most important positions in the bank. Between 1987 and 1994, Elkhraijy was elevated to the position of acting and regional manager for the Western and Eastern Regions, and in 1994 he was made deputy head of the Islamic Banking Division (IBD). As deputy head of IBD, Elkhraijy was responsible for setting up its business strategy, new product and service development in addition to determining the suitability of investment opportunities for the assets that were under management and being the head of Islamic Credit Committee.
In 1998 he was made the head of IBD, a post he held until 2004. During his tenure, he managed and boosted IBD by converting individual and regional branches to Islamic banking, introducing first capital preserved funds, guidelines for Islamic equity investment and the launch of the first Islamic credit card. Moreover, he introduced a range of new innovative Islamic funds that helped propel NCB to become the leader in diversity and size of its portfolio of Islamic funds.
As a result of the merger of the retail division and the Islamic banking division, the Islamic Retail Banking Division was born and Elkhraijy was its head from 2004 until 2006. In December of 2006, he was made head of the Islamic Banking Development Group which was charged with overseeing all aspects related to Islamic banking at NCB divisions and some of its subsidiaries.
Following are excerpts from the wide-ranging interview with him:
There is this view that the Islamic financial services industry is helping to enhance the resilience and stability of the global financial system. Are you in agreement with this view?
Yes, I do. The Islamic financial industry is certainly contributing to strengthen the global financial system. The industry has provided a viable alternative financial system with new rules and standards to ensure its sound governance. However, what is more important to understand is the very basics of Islamic banking which have the potential to contribute toward financial and economic stability of any economy. With close linkages between financial transactions and the real economic activities, Islamic finance is helping to bring back the much-needed resilience and stability of the global financial system. The value of Shariah-compliant assets globally has grown by more than 20 percent to reach an approximately $1.2 trillion industry. The sukuk market has surpassed $100 billion and is doing well in 2012 up till now, thus providing the much-needed succor to the global financial system. In general, Islamic banks have grown faster than their conventional counterparts. This has been possible due to the strong ethical foundations of the Islamic banking industry. As you are aware, Islamic banking follows certain strict ethical principles such as (i) avoidance of riba and prohibition of making money from money; (ii) avoidance of speculative and gambling based transactions (mayseer); (iii) avoidance of significant contractual uncertainty (gharar) in dealings; and lastly (iv) avoidance of Shariah-prohibited activities such as dealing in alcohol, drugs, armaments, etc. and "not to sell what you do not own." These noble ideals of Islamic banking have served to protect the customer, the bank, the economy and the society at large.
They say that the Islamic financial industry lacks regulations. What is your take? Is there a need for a strong regulatory oversight for Islamic financial services industry and related capacity building?It is unfair to say that the industry lacks regulations. My view is that the industry does have rules and regulations, but these may not be as matured as their conventional counterparts have. Various central banks and standard setting bodies like the Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI), Islamic Financial Services Board (IFSB) and the International Financial Market (IIFM) have developed quite a few standards and are working hard to put in place the remaining standards and regulations to regulate the industry. There are also country-specific laws and regulations governing Islamic banking. Some countries, such as Malaysia, have a highly developed regulatory framework for Islamic banks. It is to be noted that various countries have taken different approaches, with some establishing regulations at the onset of introducing Islamic banking, such as Oman, and others taking a more hands-off approach and extending or enhancing the existing conventional regulatory system to apply to Islamic banks as well. In addition, each and every bank like the NCB have their own rules and regulations concerning management of Islamic banking portfolio in their respective banks. This includes conformity to the rules of Shariah which ensures that all the Islamic products and services launched in the market should strictly conform to the tenets of Shariah as derived from Qur'an and Hadith. Regarding the need for a strong regulatory oversight for the industry, my view is that it is necessary now more than ever before since the industry has grown big and transcended several jurisdictions. The industry is faced with problems of standardization and lack of single body to pronounce and enforce Shariah guidelines. There is no compulsion in adopting and applying the Shariah standards. Different interpretations of Shariah law are posing difficulties when structuring deals, particularly across jurisdictions. Also, there is a need to bring in harmonization between the Shariah law and Common law in various jurisdictions that the industry is operating in. Hence, there is a need to clearly define the rules and regulations governing this industry both in Shariah and matters of general rule to protect the interests of financial institutions as well as the investors and other participating entities. In order to do that, needless to say, collaboration among industry players, capacity building, skills and knowledge acquisition are of paramount importance or else how will the industry develop further?
So there is a need for structural reforms that can assist reducing pro-cyclicality in the financial system and make it more resilient to the external shocks?
This is what many leading economists have been saying. I agree that there is a need for structural reforms that can assist in reducing pro-cyclicality in the financial system and make it more resilient to the external shocks. Recent turmoil in global financial markets and the subsequent collapse of many banks and financial institutions in the West have highlighted the importance of systemic events that illustrate the disruptive effects of pro-cyclicality. What does it mean? In simple terms, pro-cyclicality refers to the mutually reinforcing relationship between the real economy and the financial system. It is only natural that in times of economic expansion and prosperity those banks tend to expand lending, while in times of economic contraction banks tend to similarly contract (reduce) lending. Bank policies including that of loss provisioning need to protect against excessive risk taking in times of prosperity and excessive contraction in times of economic difficulty. Hence, I agree that structural reforms and policy adjustments need to be done to reduce the pro-cyclical behavior of financial intermediaries and risk-taking abilities.
You think new standards and guiding principles in Islamic finance will endeavor to strengthen the basis for market development and to spur the development of new Shariah-compliant instruments?
Yes, to a large extent. It is not only important to develop new standards and guiding principles but also to adapt and implement it truly in letter and spirit. The combined effect of this will result in growing the industry further. In this context, I am looking forward to more research in Shariah and its application in modern banking so that the combined effect of this will see introduction of efficient products with greater conformity to Shariah in its essence and implementation.The World Bank has taken initiatives to support and enhance the capacity-building and research in the Islamic finance. What, according to you, can these initiatives be?
It is indeed heartening to see greater interest and involvement of world bodies such as the World Bank and the International Monetary Fund (IMF) in collaborating with Islamic finance industry bodies and banks in general to establish various prudential standards and institutional framework to govern the industry. As you know, the World Bank has declared Islamic finance as a priority area since there is a need to strengthen the foundations of Islamic financial system both in terms of implementing Shariah standards as well as in terms of establishing prudential standards so as to prevent the occurrence of another financial crisis. I would like to mention the views of the World Bank as articulated in a recently-held conference at Harvard, the following essential foundational issues and challenges need to be addressed to facilitate the growth of Islamic banking. These challenges are: (i) improving the regulatory framework; (ii) the need to rebalance tax treatment for Islamic bank transactions; (iii) the need to improve exit rules in the event of insolvency and default; (iv) the need to ensure adequate liquidity; and (v) the need to establish sound risk management standards specific to the practice of Islamic banking.
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Is it possible to promote global financial and economic linkages through Islamic finance?
Yes, it is. Today, we are living in a globalized world and there is a greater cross-border flow of money and financial transactions across the economies. Take the example of sukuk which is issued in one jurisdiction, distributed in another jurisdiction bringing economic benefits to multiple jurisdictions and different parties involved in the sukuk issuance process. Similar instances are now being seen more and more in cross-border mega deals and financing of projects. This is expected to grow in future. Hence, there is a need to move toward global connectivity and increased economic cooperation between the key centers of Islamic finance to help stabilize the global economy. However, the cross-border activities, in turn would require innovative product development that is Shariah-compliant and accepted across the jurisdictions, and robust and standardized regulatory frameworks with strong legal backing for its continued sustainability.
What role Shariah board plays in bank’s lending policies?
Shariah supervisory boards are an integral part of Islamic banking industry and it plays a very important role therein. It provides the assurance to customers and stakeholders that the Islamic products and services offered by the bank meets Shariah requirements strictly and have been duly approved. It is typically appointed by and reports to the apex-level body such as the bank’s board of directors or the general assembly of the bank or financial institution. The reputation of Shariah board members adds credibility to the bank’s Islamic offerings in satisfying the emotional and religious needs of the customers looking to buy Islamic products. Shariah board’s advice and guidance is required to formulate the bank’s policy and procedures to reflect the financing activity allowed under Shariah and their meticulous observance during post-financing period.
There is a call for stress testing for institutions offering Islamic financial services ...
Stress testing is a part of confidence-building exercise and one of the tools for the banks to understand the risk aspects of their financing portfolio better and to manage the bank’s risk appetite. Stress tests help in understanding the plausible impact of a “what-if” scenario. However, this requires an in-depth understanding of institutions and the market in which they operate including proper identification of the risks. One of the problems facing Islamic banks is that the risks associated with Islamic financing are, incorrectly, equated with the risks associated with conventional financing. For example, in a residential financing transaction, the conventional bank is an obligor in a secured lending transaction, while in case of Islamic banking, the bank may be an owner. Both have different risk profiles that must be taken into account when performing any type of risk assessment and management.
The sukuk market continues to grow globally due to an increasing interest in Islamic modes of financing. What prospects are there for sukuk in Saudi Arabia?
With more and more issuances in the pipeline, I see the prospects of sukuk market to be very bright globally. If the trend continues, we will see the global sukuk market reach a record of approximately $125 billion by the end of 2012. As companies and corporations are looking to diversify their sources of funds, sukuk markets are providing a lucrative alternative to get long-term funding. We have seen many large sukuk issued in Saudi Arabia since 2011, such as the Saudi Aramco Total Refining and Petrochemical Co. (SATORP) sukuk, General Authority of Civil Aviation (GACA) sukuk to fund respective infrastructural projects. However, I must add a word of caution concerning Shariah risks associated with the issuance of sukuk. Shariah requires that sukuk need to be asset backed and must represent ownership of a single or pool of underlying assets, and sukuk holders should be entitled to the cash flows and proceeds generated from those assets and not simply be from cash flow based on interest on a debt. This puts an onus on the banks to structure the sukuk in such a way that it conforms to the requirements of Shariah strictly and truly.
What role does Islamic finance play in the modern global economy?
As the global economy creates new financial architecture, incorporating lessons from the global financial crisis, Islamic banking is slowly emerging as a role model because of its focus on ethical investments. The developmental contributions of the Islamic banking industry are not limited to the direct economic development, but transcends to embody the social and moral aspects of development as well; elements that are not currently included in the “Human Development Index” of the UN. Lastly, any discussions on the role of Islamic economy and Islamic finance would be incomplete without mentioning about the tools of zakat, waqf and takaful which are an integral part of Islamic economy. These are very important tools for ensuring social and distributive justice. Together, with an array of Islamic banking products and services, they offer a composite solution to the moral and economic woes of the global economy. I would like to mention that the Islamic banking model is for everyone regardless of their religious denominations since it is based on solid foundations of ethics and real economy which has proved its strength during the global financial crisis.
As in every system, Islamic banking has its own challenges to overcome. These challenges cover various issues such as (i) multiplicity of Shariah board and Shariah opinions which has resulted in lack of homogeneity in some of the Islamic products; (ii) document standardization; (iii) lack of harmonization between Shariah and Common law and effective dispute resolution mechanism; (iv) lack of human capital expertise in the combined domain of Shariah and banking; (v) risk management; (vi) harmonization between AAOIFI and IFRS accounting standards; (vii) adequate liquidity management instruments and lender of the last resort issue; and (viii) IT systems, etc.
What is your advice to investors for 2012?
My advice to the investors? Be careful and cautious while investing. They need to build their strategy based on their in-depth understanding of the market with proper assessment of all the associated risks and their own risk appetite levels. Of course, it is recommended that they follow the age-old principle of “don’t put all your eggs in one basket” principle.
What impact, if any, the so-called Arab Spring has had on Islamic banking’s investment strategies?
The impact is still not fully known. However, as it happens with every change, this is an opportunity for Islamic banking to explore more and expand its reach. However, it needs to be done only after making prudent analysis of every opportunity and then moving forward crafting suitable investment strategies.
The world feels the heat of euro zone debt crisis. What resultant impact do you see on the Saudi economy?
Euro zone debt crisis is a matter of serious concern for everyone, both within the euro zone as well as outside, across the world. It would be naive to say that Saudi Arabia would be completely immune from the fallout of this crisis since we are living in a globalized world. However, even if there is an impact, I hope that the prudent policies adopted by the Saudi authorities and Saudi Arabian Monetary Agency (SAMA), will restrict the impact to the minimum. The Saudi economy is quite strong to withstand any untoward impact that may come as a result of further deterioration of euro zone crisis.
Are Saudi banks strong enough to withstand the impact of global financial crisis?
Yes, I do. Saudi banks are strong enough to face the impact of global financial crisis. My reasoning’s are: First, Saudi banks are fairly well capitalized and have a steady flow of customer deposits. As such, their liquidity problems so far have been minimal and well managed. Second, the government policies have played a catalytic role in propping up the domestic economy. This includes the launch of large infrastructural projects such as the railways, construction of economic cities, major expansion of airports, investment in health and education, etc, some of which on public-private partnership (PPP) mode resulting in increased levels of project financing by the Kingdom’s banks. Needless to say, this will boost the respective bank’s revenue base. Third, prudent policies of SAMA have helped in enforcing controlled exposures to certain sectors such as the real estate which was the cause of volatility during global financial crisis. The banks have also been advised to adopt prudent policies for provisioning against bad and doubtful financing. Last, the Saudi government and the banking sector have started focusing on the SME sector and affordable housing segment which will definitely contribute to the growth of domestic economy as well as contribute to job creation.
Total reserve assets of SAMA continue to grow and exceeded the SR2 trillion mark recently. Do you believe part of these assets can be used for the Kingdom’s economic diversification?
I believe that this is already being used for funding various infrastructure projects such as the investments in setting-up economic cities, educational institutions, hospitals, railway and airport project, religious tourism, etc. which will contribute to diversifying the sources of revenue in addition to generating much-needed employment for the Saudi youth.
What impact the approval of mortgage law will have on financing mode in the Kingdom?
The long-awaited mortgage law would act as a catalyst for the domestic real estate sector, expanding the housing finance market if it addresses all the related issues and helps in protecting the interests of all parties. It would widen funding options for all sections of society especially in the middle and lower-middle income groups. Currently, there are problems for these groups to buy a home of their own as well as for the banks to provide financing. I strongly believe that the mortgage law, if approved, will provide a huge impetus to the housing finance market with more players, more choices and competitive pricing for the homebuyers.
Your bank participates in various global Islamic finance forums. The NCB has been a major contributor to the industry’s advancement in the past, bringing forward best practices in Islamic banking and sharing hands-on experience in international conventions in order to support the growth of Islamic banking services worldwide. What role does the NCB play in such forums?
The NCB is a global leader in Islamic banking and was the “first bank” to launch several landmark Islamic products which have subsequently been adopted by the global Islamic banking industry. The NCB has been a pioneer in promoting and advocating the importance of Islamic banking in the domestic and global context as a viable and effective alternative to conventional banking model. Taking nascent footsteps in the early 1990s, the bank has come a long way. Having converted its entire branch network to Islamic in 2005, the bank has incessantly pursued the development of new Islamic products and services in all other areas such in corporate, treasury and capital market and be a role model and leader for the Islamic banking industry. Hence, it is only natural that the NCB sponsors and actively participates in the debates in Islamic finance forums to share its experiences among the industry leaders, scholars, researchers and regulators and provide its own point of view and also listen to what others have to say about various aspects of Islamic banking. Together it enriches the industry and enhances our bank’s Islamic image globally.
(Arab News / 19 June 2012)
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