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Thursday, 19 July 2012

A Trillion Dollars And Counting: How Egypt's New President Will Boost Islamic Banking

Islamic finance may not be familiar yet to many Westerners, but it's a trillion-dollar business that is set to get even bigger now that the most populous country in the Arab world has elected a president from the Muslim Brotherhood. Egypt's new president, Mohamed Morsi, is likely to give a new impulse to the growth of the Islamic banking sector in his country, the birthplace of sharia-law compliant finance.

For months since Egypt's parliamentary elections last year, the Brotherhood's Freedom and Justice Party has been drafting a series of laws that would revamp the role of the Central Bank, make the registration of new Islamic banks easier, and regulate the offering of Islamic financial products by existing banks. 
While the proposed changes aren't in effect yet, pending reinstatement of the Parliament, which was dissolved by the dominant military junta, the new government remains committed to boosting Islamic finance. That would fill a void largely not addressed by commercial banking, such as microlending. In addition to a growing global demand by Muslim investors for options in line with their religious tenets, there are also non-religious investors who recognize a growing global demand for Islamic financial products, fromGoldman Sachs to South Africa's government.
banking, Islamic transactions are not based on the paying of interest, which is considered usury and forbidden by sharia law. Institutions such as musharaka and mudaraba typically involve agreements based on profit-sharing, without the party financing a business getting any interest. Murabaha is the most common Islamic finance tool, in which a bank acquires an asset first and then resells it to a client at a profit.
Egypt's legislative measures would mean a dramatic departure for an industry that operated under the radar for decades during the Hosni Mubarak regime. Currently there are only three fully Islamic banks and 11 other institutions offering Islamic banking services in Egypt. At this time, there are no special laws governing Islamic banking; all the banks in the country are subject to commercial banking laws.
Mohammed Gouda, a member of the FJP's committee on the economy, anticipated the sector would grow from around 7.5 percent to 35 percent of the total banking industry in Egypt over the next five years. "This is our target, and whether or not we will achieve it depends on market conditions and whether or not people will accept it," Gouda said. He noted that short-term growth will come from banks that already have licenses and will now be able to apply them, as opposed to new Islamic banking entering the market. "In two fiscal years it might reach 10 percent, but faster growth will happen in the third year."
The legislative proposals would create boards to monitor compliance with sharia, strengthen Islamic sukuk law that governs the issuing of bonds, and add a chapter on Islamic banking to the Central Bank law, as well as create an Islamic banking department at the Central Bank that would regulate the sector.
The global Islamic banking industry has been growing steadily over the past five years and is expected to reach $1.1 trillion this year, according to Ernst & Young's world Islamic banking competitiveness report 2011-2012, compared with $826 billion in 2010. In the Middle East and North Africa region, the report estimates the Islamic banking industry will more than double to $990 billion by 2015, spurred by the changes unleashed by the Arab Spring and the euro zone crisis.  
In Egypt, with its predominantly conservative Muslim population of around 82 million, latent demand is particularly strong. "Apart from local demand there is also international demand, especially from the Gulf states," Gouda said. "They would like to invest here, but prefer to do it through Islamic or sharia-compliant banks."
Despite political will and solid institutional and retail demand, the development of Islamic banking on a wider scale is difficult amid political uncertainty. On July 8, Morsi reinstated Parliament, which had been dissolved after the Supreme Constitutional Court had ruled it unconstitutional. The Supreme Council of the Armed Forces assumed legislative powers for itself. On July 10, the court overturned Morsi's decision, exacerbating the ongoing standoff between the Islamists and the military.
While the sharia-based guidelines governing financial affairs known as Fiqh al-Muamalat are the same throughout the Muslim world, their application varies from country to country and even within the same jurisdiction. A lot of leverage is entrusted to the sharia boards that are responsible for interpreting the law, solving disputes and ruling whether a given financial product is sharia-compliant.
"In Islamic banking or sharia-compliant investment in general, we have different schools of thought," said Magdy Eissa, a business development director at IdealRatings, an Islamic finance data provider that specializes in the screening of stocks for sharia compliance. "We still don't have one entity [in the Egyptian market] telling us how we should invest according to sharia guidelines." IdealRatings, based in San Francisco, has a regional research center in Cairo. 
For example, there is no global consensus on whether financial instruments like derivatives are sharia-compliant. "Some Islamic product structurings are sharia-compliant according to few scholars in the West, which most scholars in Arab countries would not consider permissible," Eissa said.
The legislation proposed by the FJP does not delve into derivatives, and it would be up to the sharia boards to issue a ruling on these.
The Islamic banking proponents are unfazed by the legislative setbacks, arguing that a growing Islamic banking sphere will make commercial banking more competitive. "At the end of the day, whoever is offering better quality [of services] is the one who would grow the market share," Gouda says.
The FJP is also taking time to devise a distinct Egyptian model for Islamic finance, based on Malaysian and other practices. "We don't want to copy and paste any model, we want a separate Egyptian model especially because Al Azhar is here, the biggest Islamic institution," Gouda explained, referring to the Cairo university renowned in the entire Islamic world, whose clergy are accorded great authority in Sunni Muslim jurisprudence. 
It may take a while, but nobody knows more about patience than the Muslim Brotherhood, which had been banned in Egypt from 1954 until the fall of the Mubarak regime in 2011. "The change cannot happen suddenly," acknowledged Mohamed Al Beltagy, a co-founder of Egypt's Islamic Finance Association, who has advised the FJP on the draft legislature on Islamic banking. "Islam teaches us that you have to take it step by step."
(International Business Times / 18 July 2012)---Alfalah Consulting - Kuala Lumpur:
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Pakistan: The rationale behind growth of Islamic Banking: banks must extend focus beyond profits

State Bank of Pakistan and the ministry of finance have done a lot to promote Islamic Banking in the country but must make more efforts to promote this prudent financial industry in the country, insists the chief executive officer of Burj Bank, Pervez Said. He contends that "holding the relatively mature industry of conventional banking to the same rules as those applied on the Islamic banks, does not constitute a level playing field". 

Referring to the industry-wide, adjusted minimum capital requirement of Rs6 billion; Said argues that the efficacy of Islamic banks should not be measured by the same yardstick as conventional banks because by virtue of their asset holdings, "Islamic banks have much better liquidity and so they do not need this minimum capital requirement". Said addsthat "they should judge us based on the capital adequacy ratio instead". 


He believes that setting the same standard for MCR by SBP for Islamic Banks as those for conventional banks has created "a mismatch between the pace of the business growth and the growth of capital" for the Islamic Banks. Said contends that Islamic banks should be required to maintain a capital adequacy ratio of at least 8 percent as he believes that such a benchmark would ensure the financial viability of these institutions without stifling their growth prospects. 

While speaking exclusively to BR Research, Pervez Said contests the assertion that Islamic banks offer lower returns to depositors compared to conventional banks. He contends that this disparity exists between the big banks and smaller players and it is caused by the latter's limited ability to generate returns. 

He also points out that at present, only longer term Sukuks are available for investment. "Give us Sukuks for durations of 3 months and 6 months so that we are on a comparable footing to the conventional banks that have treasury bills of shorter maturities and we will bridge the gap on returns" says Said. 

He contends that due to their limited market share, Islamic banks have to offer returns similar to conventional banks for now. However he believes that once the Islamic banks have a market share of 20 percent or more, they would be able to break away from following trends set by conventional banks. 

The chief executive points out that this industry's market share has grown at a relatively rapid pace of close to 7 percent in seven years, when compared to other countries such as Bahrain where the market share stands at around 8 percent in 30 years and Malaysia where the market share is around 12 percent after 25 years of existence of Islamic banks there. Said insists that the government must give this industry market-based incentives, lowering the rate of tax on transactions with Islamic financial institutions, in order to encourage it. 


While Pervez Said is confident that the Islamic banking industry will continue to post impressive growth, he is cognisant of possible mergers and acquisitions among existing players, on the back of the central bank's gradual tightening of capital requirements. 

He opines that all Islamic Banks including Dubai Islamic Bank and Bank Islami may consider mergers, unless their existing shareholders are willing to inject additional capital to meet the MCR. 

Referring to his own bank's expansion plans, Said highlights that over the past two years; Burj Bank established 50 new branches and revamped its core banking system. The bank had planned to list at local bourses in 2008, however these plans were derailed by dull performance of local equities. 

Existing stakeholders have pumped in about Rs2 billion into the entity to help it meet its MCR. Now Said explains the bank plans to use profits to further augment its staff and infrastructure before the Board decides on avenues for generating further investments. 

While capital constraints are a hurdle for the Islamic banking industry, demand is not; asserts the CEO. Said highlights the basic tenets of Islamic banking: 

-- All contracts must be completely transparent 

-- Do not book fictitious assets 

-- Do not take undue risk 

-- Do not finance any activity that may be harmful to society 

He contends that recent economic crises have increased the general public's trust in Islamic banks as robust institutions and believes that the future is bright for this industry. Said also asserts that the edge enjoyed by bigger banks due to their numerous branches will soon blunt as internet banking is "a great equaliser". 


Pervez Said concedes that a significant proportion of the general public are either unaware or unconvinced about the differences between conventional and Islamic banks. He opines that "there will be five percent who say that there is no concept of banking in Islam while an equal proportion will insist that there is no difference between conventional and Islamic banks". 

But he insists that the overwhelming majority of the public are inclined towards the industry and that the industry itself is in a constant state of progression and improvement. 

"When I joined Islamic banking a decade back, 95 percent of the transactions were Murabaha transactions, which are the weakest (from a religious perspective)" says Said. He explains that with the introduction of more Islamic offerings, the proportion of Murabaha transactions has thinned to around 60 percent. 

He adds that religious experts such as Mufti Muneeb-ur-Rehman have also started disallowing some of the transactions that were previously allowed as now, better alternatives are available. 

The Islamic Financial Services Board which constitutes fourteen central banks has made significant headway in forming the regulatory infrastructure for the industry. The Institute of Chartered Accountants of Pakistan is also working to strengthen accounting standards for the industry. 

"Our own prophet took twenty three years to fully establish Islam" cites Pervez Said arguing that the Islamic banking industry may not be perfect but it is on the right path. 

He sums up by saying that conventional banks are primarily focused on money lending and that the real risk of their transactions becomes evident at "times of crises". While Said is not so keen on labelling banking as Islamic, he insists that the spirit of this industry must be providing fair and beneficial services to clientele which; he highlights is the core of every religion including Islam. 

Burj Bank which was formerly known as Dawood Islamic Bank, was established in 2007. After SBP raised its minimum capital requirement for banks, some of the bank's international stakeholders invested further and the bank assumed its new identity. The new name was chosen to depict the bank's aspirations for future growth into a regional player while also highlighting its link with the Middle East. 

(Businees Recorder / 19 July 2012)

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Cash-rich Islamic funds fuel wild Dubai sukuk rally

* Dubai 2014 sukuk yield plunges 235 bps since February
* Fundamental factors support a rally
* But some think euphoria has gone too far
* Liquidity temporarily boosted by maturities
* Approach of Ramadan may be spurring purchases
By Rachna Uppal and Mala Pancholia
DUBAI, July 18 (Reuters) - A spectacular rally in Dubai-linked Islamic bonds is pushing yields to record lows and influencing prices in the entire Gulf debt market. Some investors think the rally has reached excessive proportions, potentially setting bonds up for a partial pull-back when the euphoria starts to fade.
Dubai's $1.25 billion sovereign sukuk, issued at a profit rate of 6.396 percent in November 2009 and maturing in 2014, was yielding just 3.2 percent on Wednesday, for example.
That is a yield plunge of about 2.35 percentage points since early February -- an impressive gain for any credit and especially for Dubai, which until recently was seen as the ugly duckling of the Gulf because of its 2009 corporate debt crisis.
"Dubai Inc bonds have rallied significantly in the past few weeks and compressed spreads to ridiculously low levels," a regional trader said, requesting anonymity because he was not authorised to speak publicly.
"The market has been overbought for a while and now it's just trading on sentiment."
Dubai-related sukuk have been surging across the board. Emaar's $500 million, seven-year sukuk, issued at 6.4 percent last week, was bid at 5.78 percent on Wednesday.
There are some well-known and plausible reasons for the rally. Dubai's property market, the source of its debt problems, has been stabilising and even picking up in some areas, while its state-linked firms have been moving aggressively to resolve their debt restructurings.
Dubai's five-year credit default swaps, which represent the cost to insure against default, tightened to around 323 basis points this week, a nearly one-year low.
"Barring broader risk-off sentiments in global markets, the key to watch is whether Dubai CDS can break through the 300-320 bracket...that could well be possible if risk stays bid," said Raza Agha, senior economist for the Middle East and North Africa at RBS in London.
In Emaar's case, the company's business appears to be recovering significantly; analysts polled by Reuters on average expect the big property developer to post in coming weeks a second-quarter profit of 516.3 million dirhams ($141 million), which would be a 106 percent increase on a year earlier.
Special, temporary factors also appear to be behind the Dubai sukuk rally, however, and the market could lose steam when these eventually fade.
One factor is an excess of idle funds, especially Gulf Islamic funds, searching for investment targets. This has been expanded by the maturing of several big regional bonds in the past few weeks.
"Several sukuk have matured recently, and the holders of that paper are now looking to redeploy that cash into new sukuk. This has helped to increase liquidity in the market even more," said Nick Stadtmiller, head of fixed income research at Emirates NBD.
Earlier this week, Saudi Arabia's Dar al-Arkan Real Estate repaid a $1 billion sukuk from cash and proceeds from land sales. Prior to that, two Dubai state-linked firms, DIFC Investments and Jebel Ali Free Zone (JAFZA), repaid their sukuk, freeing up $3.25 billion. Emirates airline also repaid a $550 million sukuk.
A second factor is the approach of the Ramadan holy month, which is expected to begin around July 20. Trading turnover tends to fall during that month, so investors are scrambling to get hold of bonds before that happens; the dramatic rally of the secondary market has made some of them desperate.
Although there has been heavy supply of new sukuk in the last couple of months - the government of Qatar issued a $4 billion sukuk earlier this month, the largest dollar-denominated Islamic bond ever seen - there is no sign that it has satisfied investor demand. Oversubscriptions have prompted diappointed investors to buy the new sukuk in the secondary market, bidding prices up further.
And the global financial crisis continues to encourage interest in the Gulf, which to many looks like a safe haven compared to Europe and the United States.
This factor is unpredictable, however. If the global crisis continues to worsen and oil prices resume falling, the Gulf could quickly lose its safe-haven image. And if the global outlook somehow improves in coming months, investors will no longer need safe havens as much.
Some analysts also note that Dubai's economic, fiscal and corporate debt outlook, while improving, still carries risks. Sources told Reuters this month that Royal Bank of Scotland and two other banks had abandoned talks on restructuring Dubai Group's $10 billion debt and threatened to bring unprecedented legal action against the investment vehicle of Dubai's ruler.
"Debt refinancing will remain an issue for the next several years, but the progress to date bodes well for the process," Emirates NBD's Stadtmiller said.
"I would expect regional credit markets to be relatively stable if global risk aversion were to spike, but it would be a mistake to assume the local market would be immune to global problems." 
(Reuters / 18 July 2012)

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